Should I buy or launch a business?

It’s that eureka moment. The instant when a germ of an idea resolves itself into something more solid – a business plan that can be nurtured, developed and ultimately brought to the market as the fully formed brainchild of its creator.

And for many of you, the thrill of taking a concept from scratch and transmuting it into a profit-generating business will be the reason you set up a company in the first place.

But taking a new venture from ‘0-to-60’ can be a long and uncertain process, and there are plenty of companies with proven track records that can be bought off the shelf. A business that has been profitable for the past three years is considerably less risky in investment terms than a great concept that has yet to be tested, so why launch when you can buy?

It’s not just a question for the start-up phase. As a business develops and expansion rather than survival becomes the priority there will be similar dilemmas. Does a retailer expand into new territories by scouting out premises city-by-city and opening one store after another or is it more effective to buy out an existing chain and rebrand? Do you launch a new product line – with all the R&D and market research that is involved – or buy up something already in existence? Do you become the number one player in a market by organic expansion or do you scale up virtually overnight by buying your biggest rivals? There’s no simple answer to these questions as your strategy will depend on circumstance and your own inclinations, but it is worth considering the pros and cons of launch and acquisition strategies.

THE ACQUISITION TRAIL

If you have the cash – or if you can raise it – one or more acquisitions can provide a means to enter a market at a speed and on a scale that would prove difficult if you launched from a standing start.

That was certainly the view of Paul Campbell and David Page, respectively CEO and chairman of Clapham House, a company floated on AIM as a shell on the basis that the money raised would be used to buy existing restaurant chains with growth potential. “We floated with little more than an acquisition strategy,” recalls Campbell.

With a solid track record of success at Pizza Express (Campbell was FD and Page CEO) they were able to raise £14m through the AIM flotation, and subsequently bought the Real Greek Food Company restaurant chain, the Bombay Bicycle Club group and Gourmet Burger Kitchen. These were established businesses with a four to five-year track record, and as Campbell is quick to stress, they were making money. “Starting from scratch would have been a lot more risky,” he says.

Jim Rogers, head of Growth Strategy Services at Grant Thornton, agrees that strategic acquisition can provide a means to launch into a market at a high level with a tried and tested formula. Indeed, he says that in certain markets acquisition is the only way in. “There are certain businesses you can’t launch from scratch simply because it would take too long to establish yourself,” he says. “If your ambition was to become one of UK’s top 10 accountancy firms, you simply couldn’t do it through organic growth.”

But there’s a caveat here. In order to make an acquisition strategy work; you have to buy the right business. Jeremy Furniss, a partner at M&A boutique Livingstone Guarantee warns that it is all too easy to get “caught up in the frenzy of buying a company” while ignoring the fact that the business in question might not be 100% right for your purposes. The moral – do your homework. Clapham House looked at around 30 restaurant chains before making its acquisitions, a process that allowed its founders to take a considered view on which businesses had the greatest growth potential.

According to Rogers, the key to a successful acquisition, whether diversifying into new areas or building on your existing venture is to know exactly what you require. Is it scale in the market? Do you need the people and skills the target company can offer, or its consumer base and by extension the power of its brand?

If it’s scale in the market you’re after, then acquiring a similar company provides a means to increase revenues while keeping admin costs stable. Sounds great in theory, but integrating systems and procedures can become a managerial nightmare. “You have to ask yourself if you have the right skills to run a bigger business,” asserts Rogers.

CULTURE CLASH

If buying in expertise is your goal, remember that the uncertainty of an acquisition often provides the catalyst for key staff – the ones you really need to keep the whole caboodle running – to up sticks and leave. This won’t be too much of a problem if your intention is to buy a brand rather than the people behind it. For instance, in this era of internet trading, you might buy the URL of a wellused e-commerce site in order to exploit its loyal customer base while using your existing order processing and fulfilment operation to deliver the goods. But if the acquisition is a people business, you really have to keep the key players on board.

One way to do this is through autonomy. Paul Campbell says that in the case of the Clapham House group, the individual restaurant chains that make up the group retain their autonomy. “As owners we see our role as being supportive but aren’t there to run each of the businesses,” he says, comparing the role of Clapham House parent to a VC investor, albeit one that is funded by an AIM flotation.

But if there are going to be changes, you need to make it clear right from the start what those are going to entail, whether that means the replacement of managers, staff redundancies or new ways of working. As Furniss points out, the first 100 days are crucial. “But you have to remember that you need to plan for those first 100 days ahead of making the acquisition,” he adds.

Customers can be an equally tricky proposition. While an acquisition should deliver more of them, they certainly can’t be taken for granted. Furniss cites the example of the 1980s trend for financial services companies to buy estate agencies as a means to sell mortgage products direct. “The problem was, consumers didn’t really want to buy mortgages through estate agents,” he recalls. A huge amount of money was spent for only limited results.

CAN YOU AFFORD IT?

An established maxim is that it might generate revenue for you from day one, but the more successful it is, the more you will have to pay. If, for example, you want to buy the number one player in a particular marketplace, then expect to pay top dollar. On the other hand, if you look for businesses with a potential for growth that has yet to be fully achieved – or indeed suitable candidates for turnaround – there are undoubtedly bargains to be had.

Furniss advises that you have to be clear about what you are prepared to pay. “If the cost of buying a business goes above a ceiling price take a step back and reconsider,” he says.

Ironically, provided you can demonstrate that you have the right team in place, raising finance can be easier in the case of larger deals. “There is a very sophisticated market for finance above £2m,” says Rogers. It’s not so easy to raise money in the half to two-million bracket.

But while VCs are more than willing to provide cash for expansion via acquisition, they will insist that at the very least you’ve done your homework. “We expect people to have done the pre-due diligence,” says Tim Levett, investment manager at Northern Venture Managers, a fund operating five venture capital trusts (VCTs). “They need to know if the business is available, if price is negotiated and we expect them to have some idea of corporate structures.”

And what if you can’t afford to buy outright? Furniss suggests a number of alternatives. If it is the people skills you’re after rather than the brand, you could always poach a rival’s team (a favoured strategy in law and media) or you could take a part stake in a company to ensure favourable treatment. “We always advise on alternatives to mergers,” says Furniss.

THE LAUNCH PAD

For some of you, of course, nothing will compare to the satisfaction that can be gleaned from a launch, whether it is a standalone enterprise or as part of an expansion plan. It’s an inclination typified by Al Gosling, CEO of Extreme Group, and a multi-faceted collection of businesses held together by the overarching theme of extreme sports. “I love start-ups. I love everything about them,” says Gosling. “I like the challenge.”

But you do have to accept that it will be a challenge. Spend £500,000 on an existing business and you know – more or less – what you’re buying and where it stands in the market. And it will be generating revenue. Start from first principles and you’ll have to put up development money that will sustain the project through until the time when the cash registers start to ring. You will need to devote time to thoroughly researching the product and the market. And that’s not just a question of time and money. According to Rogers, you also need to ensure that you have the right management talent in place. “You need project management skills – so ask yourself if you have the right people,” says Rogers. You also need to consider what kind of infrastructure you need to address the new market. And if you’re looking at overseas growth, you will have to get on top of new regulations and reporting requirements.

INVESTMENT

According to Aidan Carroll, a partner in the tax practice of Ernst & Young, one thing you should certainly do when deciding whether or not to buy or launch a business, is look at the tax implications of your course of action.

In the case of start-ups, Carroll points out that tax-free grants are available in some circumstances and there are also ways and means to relieve early losses depending on how you finance the working capital and the assets. However, without proper planning, you can find yourself paying too much tax based on paper profits while the company is in fact in deficit.

When acquiring a business, you can find yourself paying for the tax planning mistakes made by the previous owner – so make sure you carry out due diligence on that issue. Carroll adds that you should consider the implications of buying a business by purchasing shares rather than assets or vice versa. Failure to address the tax issue can be costly. “We have had far too many clients coming to us saying there were big costly tax issues they hadn’t foreseen.”

And that brings us back to a recurring theme. When you buy a business you really need to ensure that there are no shocks awaiting you when the deal is signed, whether these take the form of unforeseen financial issues, recalcitrant staff or a looming confrontation with the taxman. Launch and you’re in control – but the waters are uncharted.