BUSINESS FORUM: How do I build a better business by buying?

What are your thoughts on buying a business instead of starting one?

Sep 1st, 2010
29576

MILTON CHANG

Q: What are your thoughts on buying a business instead of starting one? I am 55, was a manager at a major corporation, a management consultant for a big firm, and a CEO for several VC-funded optical telecom startups (none made it).

A: I believe many of our readers would be interested in this topic so allow me to provide a long response. I feel positively about buying and can only come up with a few cautionary notes. In fact, I thought a lot about doing the same when I was leaving Newport and New Focus, and I still think about it from time to time. For sure the timing is right; at the 50th anniversary of the invention of the laser, many of the founders of laser/photonics companies started in the early days are ready to retire.

I will cover buying vs. starting up; key factors for success; what kind of opportunities to look for and what to avoid; strategy to lower risk; and how to manage after the purchase. I am assuming you are talking about buying a medium to small private company, not the kind of financial maneuvers big leverage-buyout private equity folks make. With that assumption and given today's IPO environment, your financial gains are likely to come from making money the old-fashioned way: by growing the business to get to a higher exit valuation.

One advantage of building on an existing business is development can be faster than starting one. You can capitalize on the infrastructure of the existing business, its organization and operational capability, and an existing customer base instead of having to start from scratch. That also makes efficient use of capital because you only need to make incremental investments to pursue any new business.

An important principle is to buy a business only when you have full confidence that you have the resources and ability to use it as a platform to build on, and avoid overpaying so you don't start with a deep financial hole. Personally, I would like to avoid inheriting a mess either in customer reputation or management turmoil. These situations are often difficult to overcome and may require substantial time to address. Some managers view these gaps as an advantage, believing that they are reflected in the valuation. But there must be a more productive way to spend time!

Before taking the plunge, make sure all the bases are covered and perform significant due diligence to understand the market risks and operational risks, and to find hidden risks. For that, nothing is better than writing a thorough business plan to lay issues right in front of you in black and white. When in doubt, move on to find another company until it all works. To be practical, start with one paragraph about why you think you can succeed, then a one-pager and two-, to keep from getting bogged down in details. Start over if at any time along the line your intuition raises a red flag.

For market risk, talk to key customers and engage industry insiders to uncover what you might miss. For operational and hidden issues within the company, try to include managers on the firing line to be co-owners. Convince them to co-invest to share the upside. Start over to play defensively if you have any concerns because you can lose all your money and several years of your life!

Finally, convince the current owner to retain some ownership and/or find ways such as earn-out to include that individual to share the upside. The benefits of the previous owner's involvement far outweigh the drawbacks. Corporate memory and good will could be taken for granted, but it is nice to have when you needed it.


MILTON CHANG is founder and managing director of Incubic Management LLC. He is also director of Precision Photonics and mBio. Chang is a Fellow of IEEE, OSA, and LIA. He has received Distinguished Alumni awards from the University of Illinois and Caltech, is a trustee of Caltech, and is member of the Committee of 100. Contact Chang at miltonchang@incubic.com with questions, and visit www.incubic.com for other articles he has written regarding entrepreneurship.

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