Students and aspiring entrepreneurs often ask me whether it’s better to start a business from scratch or to buy an existing one. My answer is always “Both!”
As a business owner, I’ve launched companies both ways — and many other ways in between — over the years. Let’s examine how to initiate business ownership so that you can learn from my experience and make better decisions when breaking out as an entrepreneur.
The essential difference is really the amount of cash and capital you have available (or can raise) to purchase an existing operating company. It’s much easier to take over an existing company with operations, cash flow, employees, and customers than to start from scratch, however it’s usually more expensive than a low-cost skunk works garage start up. But a start up is always more exciting, and you can develop your own products or services, build a customer base, and attract partners and investors that can add strategic value to your business.
My partner and I founded Pavestone, a landscaping materials manufacturing company, from the ground up. Our first manufacturing plant cost $200,000 to get up and running. As we grew we built and staffed manufacturing plants across the country. Gradually our plants became larger and modernized with better automation and capacity, and the price to add a new plant rose to between $7 million and $17 million. Each entailed financing and a tremendous amount of work. At times the long hours and stress took a toll on me and my family.
We sold Pavestone after operating and growing it for 32 years, and the profits from the sale allowed me to quasi-retire and invest in other businesses.
Another major undertaking was building a nursing retirement center business. I purchased existing retirement centers and enhanced them significantly. Every center we purchased involved a month or two of investigating everything before buying it. Problems still surfaced after we made the deal and settled into daily operations. For example, one Dallas center had a particularly unique issue. Illegal tenants had taken over the closed wing after our initial inspection. They were running a prostitution ring in what had become the X-rated wing.
The sex workers on our property provided us a key lesson — and one that aspiring entrepreneurs will want to note: Make sure to inspect properties thoroughly before investing! You should never find yourself asking, “What have I gotten into here?” However, we put in many hours of sweat and tears to turn these into excellent properties with long waiting lists of people interested in moving in.
When beginning your entrepreneurial adventure, you will encounter many different issues that you’ll need to consider. Among those you will face include the following.
Carry out Due Diligence
Whether you start your own business or buy an existing one, you should always carry out due diligence. The due diligence process is time-consuming and extensive. Many entrepreneurs hire due diligence companies that employ accountants and lawyers to do it for them.
Work out the Funding
Are you considering starting a business from scratch? If so, do you have access to the funds you’ll need to create a business and grow it through the start-up phase? Start-up costs are usually lower than buying an existing business, which is why many new companies originate that way.
Understand What It Takes to Build a Business from Scratch
When you build your own business from the ground up, you can make it the way you want it. Business names and locations are up to you. You’re free to forge new relationships with financial institutions, suppliers, and customers. Starting from scratch also means that you will have to go through the laborious and costly process of setting up your business infrastructure, hiring and training your entire team, creating essential procedures for conducting transactions, maintaining inventory, finding suppliers, and developing your market.
Weigh the Pros and Cons of Buying a Business
Generally, buying an existing company that’s already profitable will get you rolling much faster and involve less overall risk than building your own business. Because an existing business already has positive cash flow and a product or service, it’s often easier to secure financing. Buildings, equipment, furniture, inventory, working capital, and customers are among the most common quantifiable assets. There are also established systems for operating the business, experienced employees to keep it running, and an established market or customer base.
However, there’s always a reason why the current owner is selling the business. Retirement or more significant opportunities can trigger a sale, but so can negative factors such as a declining market, new competition, lawsuits, tax problems, or complaints about the quality of the product. Therefore, it’s essential to perform a thorough due diligence investigation before buying an existing business so that you know exactly what you’re walking into. Even then, you can’t always detect problems with a company until you’re there every day.
Consider the Value from a Spin-Off
It’s possible to spin off a business from an existing one. Spin-offs can be a very attractive way to buy or sell a good operating division that you’re familiar with. This might be a division within a company where you work or a concept for a company that serves as a supplier or customer of your employer. Start-ups of this type come in many forms. Many entrepreneurs can’t resist starting a new business while they run their primary business or several businesses simultaneously. But in order to be successful, entrepreneurs still must take the time to evaluate the risks involved by examining the competition, researching market trends, and assessing the economic environment. If their investigation proves promising, they will go on to draw up a business plan that outlines the required costs, as well as staffing and equipment requirements, technologies, equipment, and office and manufacturing space. A spin-off typically has existing products and infrastructure, a proven market with an existing customer base, and assets that make finding investors or getting bank loans easier.
Always ask yourself if a spin-off is strategic for your overall business interests. Cutting off a highly profitable division or essential operation could cripple your existing business. Ensure that the derivative has enough resources to grow without draining the more valuable enterprise of its cash. Don’t spin off a company you’ll get bored with after a year or two; make sure it’s something you’ll enjoy for years to come.
Look Ahead to Attract a Buyer
Another aspect to consider may involve preparing your business to attract a buyer. In our experience, with the sale of the nursing centers and Pavestone, we learned that building our business to a “platform” level can be very lucrative. However, it requires significant time, effort, and resources. You will want your business to become so well-established that large companies will consider acquiring it because they can create a new revenue stream without having to start another one themselves. This saves them both time and money. Leverage buyout companies are willing to pay top multiples for a well-constructed platform business that someone else has built.
This strategy is, of course, not without risk. What happens if the market changes or supply issues make it harder to deliver on the promise of your business? Do you have a backup plan?
These are just a few aspects to consider when starting as an entrepreneur. Making the right choice for you, and one that is well-researched, will ensure that your business is both fulfilling and profitable.