With the Internet Economy in Southeast Asia rocketing to over $100bn in 2019, there’s a huge influx of small website, app and online business owners entering the ecosystem.
The daily growth of these new-generation small business owners is also driving a new breed of alternative asset investors as savvy buyers look to snap up this new generation and well-performing digital assets. From as low as $5000 to as a high as $5 million, these investors acquire to grow, to amass a portfolio and to build long term value in the digital economy.
Surprisingly, this is a fast-growth asset class but why buy rather than build a company from scratch?
Firstly, it’s a common strategy at the big end of town. Take Android, YouTube, Google Analytics and Google Documents as examples. They were all built by founders as separate companies, before being acquired by Google and going on to 100x+ their original size.
You should then consider the failure rate. It’s far smarter to buy something with established traction when you look at the failure rate of new business. More than 50% of businesses fail within 5 years.
So, do what Google did. Buy an existing business, and take it to the next level.
Venture Capital funded companies aside, it’s much cheaper and much easier to do than you might imagine. There are thousands of interesting companies for sale in any given month, across a wide variety of interesting niches and business models. Many businesses end up selling for between 1x and 3x annual profit, and occasionally for less.
There are two kinds of barriers to buying an existing business with the potential for radical development. One is psychological, the other is financial.
Starting off with a base (a product, a brand, a customer list) and then scaling it (marketing, retention, product extensions, additional staff) is often easier, and a much less risk than starting from scratch.
A successful business creator, in a moment of insight and inspiration, recognizes an unmet market need and comes up with an innovative solution of glittering genius, launches a successful start-up business from scratch and is henceforth hailed an entrepreneurial visionary. The reality is generally far less glamorous and usually, rather than starting a business on bare ground, success involves the acquisition and amplification of an existing business that already has relevant runs on the board and at least the beginnings of demonstrable market potential.
There are two kinds of barriers to buying an existing business with the potential for radical development. One is psychological. In the popular psyche, it is perceived as less heroically inspired to expand on the potential of an existing business than to create one where nothing existed before.
The second barrier is financial: a business buy-in or takeover requires access to substantial capital or an expensive loan facility, generally assumed to be at a higher level than the financial investment required to start from scratch. However, acting on this assumption without really thinking it through is very unwise.
The strategy of buying a compatible and highly pivotal existing business can lead to spectacular results. For example, HubSpot has worked to transition from essentially an App provider to a continually expanding platform suite through the purchase of nine separate businesses which were viewed as having the potential to expand HubSpot’s offerings, market penetration and customer base. The acquisition in 2017 of Kemvi enabled HubSpot to integrate artificial intelligence and machine learning to augment its sales force platform.
At this time HubSpot’s revenue was already in the region of 500 million USD, but its strategic decision entailed buying into an existing business with all of its established skills base, infrastructure and supplier agreements rather than attempting to build a compatible offering from the ground up.
If the primary reason for building from scratch is that you simply cannot afford a purchase, then it’s important to ask whether you can afford the long hours, the delayed cash flow at the same time as the necessary establishment costs are invested
Very clearly Airbnb, now valued northwards of 30 billion, isn’t short of innovative flair or the investment funds to drive its own creation of new offerings. However, when Airbnb decided to diversify and expand its revenue streams by moving into event space and meeting space online booking, with meeting spaces being available for booking for time periods as short as one hour, it settled on a business acquisition rather than a build-from-scratch approach. The result was Airbnb’s purchase in 2018 of the Danish-based business space booking platform Gaest.
According to Deloitte’s M&A Trends 2019 the predominant driver for buying existing businesses is now less to do with the acquisition of technological infrastructure and related logistical assets than with the diversification of services and the acquisition of new customer bases with recognized potential for expansion.
This development can be seen on a global scale. Australian based unicorn and graphic-design tool website and publishing platform Canva has acquired two photo-sharing sites Pexels.com and Pixabay.com to extend and complement the existing product offering and to increase market penetration of their core product. The acquisition strategy was preferred to adding new and complementary products by building them from the ground up.
We don’t need to be investing at the multi-million-dollar level for the buying-in rather than starting from scratch option to make compelling sense. The successful online jewelry store BlushandBar.com was first on Flippa.com for under $10,000 in 2017 by New York-based entrepreneur John Chen, who figured that his plans for developing the online business would be much more achievable if scaling up from an existing product and customer base. The head start enabled the business to grow revenue quite literally a hundred-fold in two years. John went on to sell the business for 50x his initial investment just over 2-years later.
The cost of purchasing an existing online business can appear daunting. Price calculations can be made in several different ways, but if based on net profit rather than revenue stream, as a general guide for smaller businesses the purchase price is usually around a 2x Annual Net Profit multiple. In other words, an established online business generating a dependable net profit of $50,000 will typically sell for around $100,000. That assumes that it’s older than 2 years old and is flat or growing (vs. declining).
An existing business bought as a foundation on which to build, or to round out the buyer’s existing offerings, comes with proof of concept, complete transfer of all agreements with product and service suppliers, including content producers, technology infrastructure and expertise, a verified customer and subscriber base, and a strongly or at least partially established brand presence.
The strategy is clearly an appealing one to large established operators who would have the assets and capacity to build from scratch if they chose to. Their preference for buying an already existing business should serve as a guide to smaller and newer investors and entrepreneurs. The time and care required for due diligence and the exploration of financing options is miniscule compared to the investment of time and angst in creating a startup from nothing but an innovative idea. And remember it’s almost always easier to access finance for a business purchase rather than a starting from scratch business creation.
The only real exception to this solid online business principle is where the creative idea is genuinely unique and not an emulation or elaboration of an existing concept. Additionally the entrepreneur must be convinced on a realistic rather than romantic basis that there actually is the capacity to build from scratch. The true cost of the protracted build period needs to be realistically valued.
If the primary reason for building from scratch is that you simply cannot afford a purchase, then it’s important to ask whether you can afford the long hours, the delayed cash flow at the same time as the necessary establishment costs are invested, and the daunting processes of establishing a website and systems, sourcing product and service inventory, developing a customer or subscriber base, creating business relationships, developing fulfilment systems and building a brand and its social media presence. Certainly, it’s initially a lower financial outlay but a massively greater time and effort investment, with little or no cash flow for a prolonged period and no guarantee of success.
Otherwise, it makes greater sense to follow the example of the companies and investors, whether large or small, who strategically use the buy-in strategy. It makes sound sense to head straight to the online business marketplace, to see what’s available for acquisition to provide the foundation for your next entrepreneurial vision.
Happy buying (or maybe you should sell).
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