Did you know that Facebook acquired Internet messaging service WhatsApp for $19 billion? It represents the largest-ever acquisition of an Internet company in history.

WhatsApp is a pearl for sure. The messaging service allows users to avoid text-messaging charges by moving texts across the Internet instead of the mobile phone carrier networks. This can save people who travel, or who live in emerging markets, hundreds of dollars a year, which is why WhatsApp is adding one million new users per day.

At the time of the acquisition in February 2014, WhatsApp had acquired some 450 million users. Their business model is to charge a subscription of $1 per year after their first full year of service. Even if all 450 million WhatsApp users were already paying, that is still less than half a billion in revenue. Why would Facebook acquire WhatsApp for a number that is somewhere north of 40 times revenue?

Nobody know for sure what is in Mark Zuckerberg’s head, but we can only assume that at least part of the opportunity Facebook sees is the opportunity to sell more Facebook ads because of the information they glean from WhatsApp users. Global advertising giant Publicis estimates 2013 online advertising spending in the US alone to be around $500 billion. Presumably Facebook believes they can get a larger chunk of the global online ad buy because they know more about its users by owning WhatsApp.

And therein lies the definition of a strategic acquisition. Most acquisitions run a predictable pattern of industry norms, but a strategic can pay a significant premium for your business because they are looking at your business for what it is worth in their hands. Rather than forecasting out your future profits and estimating what that cash is worth in today’s dollars, a strategic is calculating the economic benefit of grafting your business onto theirs.

There can be many strategic reasons why a big company might want to buy yours. Here are a few to consider:

1. To control their supply chain

In 2011, Starbucks announced it had acquired Evolution Fresh, one of their providers of juice drinks, for $30 million. Now Starbucks is no longer beholden to one of its suppliers.

2. To give their sales people something else in their briefcase

Also in 2011, AOL announced the acquisition of The Huffington Post for $315 million, even though HuffPo had just turned its first modest profit on paper. AOL wanted to give its advertising sales people more inventory to sell and HuffPo had 26 million unique visitors a month.

3. To make their cash cow product look sexier

Microsoft bought Skype for $8.5 billion dollars even though Skype was losing money. The good folks in Redmond must have assumed they could sell more Windows, Office and Xbox by integrating Skype into everything they already sell.

4. To enter a new geographic market

Herman Miller paid $50 million to acquire China’s POSH Office Systems in order to get a beachhead into the world’s fastest growing market for office furniture.

5. To get a hold of your employees

Facebook reportedly acquired Internet start-up Hot Potato for $10 million, largely to get hold of the talented developers working at the company.

Most acquisitions are done for rational reasons where an acquirer agrees to pay today for the rights to your future stream of cash. You may, however, be able to get a significant premium for your company if you can figure out how much it is worth in someone else’s hands.Curious to see what your business is worth and how you might improve its value to both strategic and financial acquirers?  Complete the Value Builder Score questionnaire today and we’ll send you a 27-page custom report complete with your score on the eight key drivers of company value. Take the test now:

Most company founders are good at the first stages of entrepreneurship. But in the phases that follow, they may only be average. Just because you have a knack for starting companies, doesn’t necessarily mean that those skills translate well into growing one.

There are celebrated cases of founders who have successfully started and grown a business – Elon Musk and Bill Gates come to mind. There are, however, many more examples of entrepreneurs who perform well initially and then hold back their company as it ages. But, as a business owner, you can avoid this.

How One Founder Unlocked the True Value of His Company

Damian James grew up in Melbourne and learned a lot about the aging population in Australia. Realizing that healthcare could be a lucrative field, he discovered a sector ripe for disruption, podiatry. This is a branch of medicine devoted to the diagnosis, medical and surgical treatment of foot and ankle disorders.

At the time, most podiatrists in Melbourne worked from a retail location where the doctor owned and operated a private practice. The podiatrist would rent space, hire some staff, and charge patients per visit. At night, some enterprising doctors would also visit old age homes to offer care. Reasoning that many old people nodded off shortly after dinner, James saw an opportunity for a podiatrist to visit old age homes during the day when it was more convenient for patients.

The Million Dollar Idea

James, who had earned a bachelor’s degree in Podiatry in 1996, started Aged Foot Care. He approached old age homes with a compelling offer of removing the traditional overhead of an office.

Aged Foot Care went through a variety of growing pains over the years, including an expensive rebranding to the name Dimple. By 2015, Dimple was generating roughly $200,000 of profit on $2.5M in revenue.

Time to Grow

Despite his success, James was frustrated. The company’s growth had stalled. His management team seemed perpetually incapable of hitting its targets.

Quarter after quarter, he would set goals with his team, but they would fall short. James decided it was time to bring in outside help, so he hired a Chief Operating Officer.

To recruit the new COO, James knew he would need to give up some equity, so he commissioned a valuation for Dimple which came in at $2.5 million. He offered a salary, plus 5% of the company. James also offered another 3% of the business (up to a maximum of 20%) for every $1 million the COO would grow Dimple’s revenue past $5 million.

The new role was a success. James quickly promoted him to Chief Executive Officer and stepped back from the day-to-day operations. He decided to let the company thrive under the new CEO’s leadership.

Down to just one day a week, James limited his involvement to providing a vision and protecting the company’s core values. The CEO, on the other hand, ran the day-to-day business – pursuing James’ core strategy of contracting with aged care facilities.

The company hit $11 million in revenue by 2017.

The Big Bonus

Zenitas had a similar strategy of bringing healthcare to patients in homes or care centers rather than having them languish in hospital beds. The company was keen to add podiatry to its stable of services. The decision makers realized that acquiring Dimple would allow it to become an overnight market leader.

In July 2017, Zenitas announced they had acquired Dimple for $13.4 million. Under different leadership, the company had grown in value over 500% in less than three years.

Starting and growing a company require different skills which are rarely found in the same individual. This begs the question, ‘is it time to find someone else to run your business?’

If you decide to sell your business to an outside acquirer, you’re going to have to decide between a financial and a strategic buyer—understanding the different motivations of these two buyers can be the key to getting a good price for your business.

A financial buyer is acquiring your future profit stream, so they will evaluate your business based on how much profit it is likely to make and how reliable that profit stream is likely to be. The more profit you can convince them your company will produce, the more they will pay for your business. 

But there is a limit to how much they will pay, because financial buyers are playing the buy-low, sell-high game. They do not have a strategic rationale for buying your business. They don’t have an army of sales reps to sell your product or a network of retailers where your product could be merchandised. They are simply trying to get a return on their investors’ money, so they tend to buy small and mid-sized businesses using a combination of this investment layered on top of a pile of debt, and they want to buy your business as cheaply as possible with the hope of flipping it five or ten years down the road.

Because financial buyers are usually investors and not operators, they want you and your team to stick around, so they rarely buy all of a business. Instead, they buy a chunk and ask you to hold on to a tranche of equity to keep you committed.

A strategic buyer is a different cat—usually a larger company in your industry, they are evaluating your business based on what it is worth in their hands. They will try and estimate how much of their product or service they can sell if they added you into the mix. Because of their size, this can often lead to buyers who are willing and able to pay much more for your business.

Tom Franceski and his two partners had built DocStar up to 45 employees when they decided to shop the business to some Private Equity (PE) investors. The PE guys offered four to six times Earnings Before Interest Taxes Depreciation and Amortization (EBITDA), which Franceski deemed low for a fast-growing software company.

Franceski was then approached by a strategic acquirer called Epicor, which is a global software business with a lot of customers who could use what DocStar had built. Epicor offered DocStar around two times revenue—a much fatter multiple than the PE firms were offering.

If you’re wondering what your business might be worth to an acquirer, there is a simple calculation you can use.

Let’s call it “The Build vs. Buy Equation”.

At some point, every acquirer does the math and calculates how much it would cost to re-create what you’ve built. If an acquirer figures they could buy your business for less than they would spend on both the hard and soft costs of re-deploying their employees to build a competitive product, then they will be inclined to acquire yours. If they think it would be less costly to create it themselves, they are likely to choose to compete instead.

The key to ensuring that what you have is difficult to replicate is focusing on a single product or service and building on your competitive point of differentiation. When you create a product that is unique and pour all of your resources into continuing to differentiate it from the pack, you can dictate terms, because re-creating your business becomes harder the more you focus on one thing.

The worst strategy is to offer a wide range of services and products only loosely differentiated from others on the market. Any acquirer will rightly assume they can set up shop to compete with you by simply undercutting your prices for a period of time and driving you out of business.

C-Labs Focuses On Building An Irresistible Product

Chris Muench started C-Labs in 2008 to go after the burgeoning opportunities presented by the Internet-of-Things (IOT). He began by writing custom software applications that allowed one machine to talk to another. In 2014, he got the industrial giant TRUMPF International to acquire 30% of C-Labs, which gave him the cash to transform his service offering into a single product.

By the end of 2016, Muench’s product was showing early signs of gaining traction but C-Labs was running out of money.

In the end, TRUMPF acquired C-Labs in a seven-figure deal that could stretch to eight figures if Muench is successful in hitting his future targets. Why would a large, sophisticated company like TRUMPF acquire an early-stage business like C-Labs? Because they knew that re-creating Muench’s technology would cost much more than simply writing a seven-figure check to buy it outright.

In other words, TRUMPF used The Build vs. Buy Equation and realized that buying C-Labs was cheaper than trying to reproduce it.

Selling too many undifferentiated products or services is a recipe for building a business that—if it is sellable at all—will trade at a discount to its industry peers. By contrast, the trick to getting a premium for your business is having a product or service that is irresistible to an acquirer, yet difficult for them to replicate.

John McCann sold The Bolt Supply House to Lawson Products (NASDAQ: LAWS) at the end of 2017.

McCann’s strategy involved learning from the acquirers who knocked on his door. He invited would-be buyers into The Bolt Supply House and listened to what they had to say. He was not committed to selling, but instead wanted to know what they liked and what concerned them about his company.

One giant European conglomerate, for example, approached McCann about selling, but after a thorough evaluation, they backed out of a deal, worried about McCann’s central distribution system. 

McCann thanked them for their time and set to work turning his distribution system into a masterpiece. Eventually, Lawson cited this as one of the many things that attracted them to The Bolt Supply House.  

When it finally came time to sell, McCann commanded a premium, arguing that he had built a world-class company he knew would be a strategic gem for a lot of businesses. He ended up getting five competing offers for The Bolt Supply House and eventually sold to Lawson.

When a big sophisticated acquirer approaches you about selling, the temptation is to decline a meeting if you’re not ready to sell, but hearing what they have to say can be a great way to get some superb consulting, for free. The investment bankers and corporate development executives who lead acquisitions for big acquirers are often some of the smartest, most strategic executives in your industry and—provided you don’t get sucked into a prop deal—hearing how they view your business can be an inexpensive way to improve the value of your company.

A great business is bought, not sold, so, if you look too eager to sell your business, you’ll be negotiating on the back foot and look desperate—a recipe for a bad exit.

But, what if you really want to sell? Maybe you’ve got a new idea for a business you want to start or your health is suffering. Then what?

As with many things in life, the secret may be a simple tweak in your vocabulary. Instead of approaching an acquirer to see if they would be interested in buying your business, approach the same company with an offer to partner with them.

Entering into a partnership discussion with a would-be acquirer is a great way for them to discover your strategic assets, because most partnership discussions start with a summary of each company’s strengths and future objectives. As you reveal your aspirations to one another, a savvy buyer will often realize there is more to be gained from simply buying your business than partnering with it.

Facebook Buys Ozlo

For example, look at how Charles Jolley played the sale of Ozlo, the company he created to make a better digital assistant. The market for digital assistants is booming. Apple has Siri, Amazon has Alexa and the Google Home device now has Google Assistant built right in.

Jolley started Ozlo with the vision of building a better digital assistant. By 2016, he believed Ozlo had technology superior to that of Apple, Amazon or Google. Realizing his technology needed a big company to distribute it, he started to think about potential acquirers. He developed a long list, but instead of approaching them to buy Ozlo, he suggested they consider partnering with him to distribute Ozlo.

He met with many of the brand-name technology companies in Silicon Valley, including Facebook, which wanted a better digital assistant embedded within its messaging platform. They took a meeting with Jolley under the guise of a potential partnership, but the conversation quickly moved from “partnering with” to “acquiring” Ozlo.

Jolley then approached his other potential partners indicating his conversations with Facebook had moved in a different direction and that he would be entering acquisition talks with Facebook. Hearing Facebook wanted the technology for themselves, some of Jolley’s other potential “partners” also joined the bidding war to acquire Ozlo.

After a competitive process, Facebook offered Jolley a deal he couldn’t refuse, and they closed on a deal in July 2017. Jolley got the deal he wanted in part because he was negotiating from the position of a strong potential partner, rather than a desperate owner just looking to sell.

Have you ever wondered why startup companies stop growing? Sometimes they run out of potential customers to sell to or their product starts losing market share to a competitor, but there is often a more fundamental reason: the founder(s) lose the stomach for it.

When you start a business, the assets you have outside of your business likely exceed those you have in it, because in the early days, your business is worthless. As your company grows, it starts to have value and becomes a more significant part of your wealth—especially if you’re pouring your profits back into funding your growth.

For most business owners, their company is their largest asset.

Eventually, your business may become such a large proportion of your wealth that you realize you are taking a giant risk every day that you decide to hold on to it just a little bit longer.

95% Of His Wealth In One Business

In 2000, Etienne Borgeat and Olivier Letard co-founded PCO innovation, an IT consulting firm. The company took off and, by 2016, PCO had 600 full-time employees and offices around the world.

As the business grew, Borgeat and Letard started to become uneasy about how much of their wealth was tied up in their business. By 2015, the shares Borgeat held in PCO represented 95% of his wealth.

That’s about the point that aerospace giant Boeing came calling. Boeing wanted PCO to take on a very large project and Borgeat and Letard turned down the opportunity reasoning that the project was so large it could risk their entire company if it went wrong. In the early days, the partners would never have turned down a chance to work with Boeing, but the partners had changed.

That’s when Borgeat and Letard realized the time had come to sell. They agreed to an acquisition offer from Accenture of over one times revenue.

The success of your startup is probably driven by your willingness to put all your eggs in one basket. You’re all in. However, at some point, you may find yourself starting to play it safe, which is about the time your business may be better off in someone else’s hands.

Jay Steinfeld built Blinds.com into a $100 million e-tailer before selling out to Home Depot. Here are five things that made it a spectacular exit.

Win The Make vs. Buy Battle

Companies like Home Depot have a “make or buy” decision when they see a competitor winning market share. They can opt to buy the competitor or choose to simply re-create what they have built.

An acquirer will likely opt to buy your company if you are so dominant in your niche that recreating what you have built would take too long and cost more than acquiring it from you.

Blinds.com got acquired, in part, because they were a big fish in a small pond. At more than $100 million in revenue, they were the largest online retailer of blinds in America by a long shot. Even though Home Depot has close to $90 billion in sales, Blinds.com were outperforming them in their tiny niche and that made Blinds.com irresistible to Home Depot.

Run It Like It’s Public

At the time of the Home Depot acquisition, Blinds.com had 175 employees, yet Steinfeld had been running the company as if it were public for years. He had put together a top-drawer management team and taken the unusual step of assembling an outside board of directors. He had quarterly board meetings with formal presentation decks, and Steinfeld hired a Big Four firm to complete a full audit of his financials each year.

Steinfeld credits this rigorous approach to running a relatively small company as a major reason Home Depot was interested in Blinds.com and able to close on the acquisition so quickly.

Keep Most Of The Equity

Steinfeld invested $3,000 of his own money into a basic online presence for his blinds store back in 1993 and grew Blinds.com to more than $100 million in sales without diluting himself by taking three or four rounds of institutional investment, as would be typical of an internet start-up. Steinfeld took a small investment from friends and family and used bank debt to help him buy distressed companies for pennies on the dollar. It wasn’t until 2012—almost 20 years after starting the business—that he accepted his first round of “professional” money from a private equity firm who wanted to invest more, but Steinfeld refused, only taking enough to buy out a few of his original investors and pay off some debt.

Keep Investors Aligned

One of the reasons Steinfeld accepted an investment from a private equity group was that he had become misaligned with two of his original investors. The investors saw the success of Blinds.com and wanted Steinfeld to start declaring regular dividends. Steinfeld, by contrast, was focused on building a growth company and needed the cash to fuel his 25% per year growth. After a while, his investor’s expectations got so far out of whack that Steinfeld opted to buy them out.

Share The Love

One of Steinfeld’s best memories is the day he told his employees Home Depot had acquired Blinds.com. Steinfeld had made sure every one of his 175 people had Blinds.com stock options and so stood to gain financially from the sale. Steinfeld went further and gave each employee $2,000 of his own money to start an investment account as a personal thank you for all they had done.

Microsoft’s recent $26.2 billion acquisition of LinkedIn provides an illustrative example of a strategic acquisition – the type of sale that usually garners the most gain for the acquired company’s shareholders.

You may be wondering what a billion-dollar acquisition has to do with your business, but the very same reasons a strategic acquirer buys a $26 billion business holds true for the acquisition of a $2 million company.

The financial vs. strategic buyer

A financial buyer is buying the future stream of profits coming from your business, whereas the strategic buyer is buying your business for what it is worth in their hands. To simplify, a financial acquirer buys your business because they think they can sell more of your stuff, whereas a strategic buyer acquires your business because they think it will help them sell more of their stuff.

One might argue that Microsoft overpaid for LinkedIn given that LinkedIn only generated a few hundred million dollars in EBITDA last year, meaning the good folks in Redmond paid an astronomical multiple of LinkedIn’s earnings.

But earnings are not the only thing strategic acquirers care about when they go to make an acquisition.

Microsoft‘s acquisition of LinkedIn is a classic example of a strategic acquisition. The Redmond-based technology giant has been undergoing a major transformation from being a software company focused on operating systems to a business concentrating on cloud-based software applications. Microsoft enjoys a dominant market share in the basic tools white-collar business people use to get their job done, but other software packages have begun to nip at the heels of their dominance in many product lines.

Take Microsoft Office for example. Many businesses have started to use competitive offerings from Google and Apple. Even more companies cling to older versions of Microsoft Office software, even though Microsoft is keen to move everyone over to the cloud-based Office 365.

In purchasing LinkedIn, Microsoft saw an opportunity to suck data from LinkedIn into Microsoft’s cloud-based software applications, making them irresistible. Imagine you’re a sales person and you just landed a big meeting with a new prospect. You enter the appointment as a Microsoft Outlook event and suddenly the details of the event feature everything LinkedIn knows about your prospect.

Now you can make small talk about where they went to school, the previous jobs they have held and know the scope of their current role – all without ever leaving Outlook.

Microsoft is betting this kind of integration across its platforms will compel more people to upgrade to the latest software applications. While your company is likely smaller than LinkedIn, the same thing that makes a giant buy another giant holds true for smaller businesses. To get the highest possible price for your business, remember that companies make strategic acquisitions because they want to sell more of their stuff.

Big public companies trade at a significant premium over small businesses in the same industry because investors perceive big, sophisticated companies as a safer bet than small, owner-dependent companies.

Let’s take a look at the professional services industry.  Although most consultancies are a small collection of experts, there are also a handful of big publicly traded professional services firms. Omnicom (NYSE:OMC) is a massive marketing services company with a market capitalization of around $18 billion. For all of 2013, Omnicom reported pre-tax income of $1.66 billion, meaning they are trading at around 11 times pre-tax income.

Smaller service businesses trade at much lower multiples. We know this because at our firm we offer The Value Builder Score questionnaire which asks smaller business owners (our typical user has between $1 million and $20 million in sales) if they have received an offer to buy their business, and if so, the multiple of their pre-tax profit the offer represents. When we look at the professional services segment, we find the average multiple over the last two years was 3.81—almost three times lower than Omnicom.

When we isolate professional services companies with at least $3 million in revenue, the multiple being offered goes up to 4.97 times pre-tax profit, but it is still less than half of Omnicom’s 11 times.

And in case you thought this phenomenon was unique to the marketing services vertical, take a look at the IT services giant Accenture (NYSE:ACN).  Accenture reported pre-tax income of $4.3 billion in 2013 and currently has a market capitalization of more than $52 billion, meaning they are trading around 12 times pre-tax profit, which is more than double the price we see being offered to smaller professional services firms.

How To Get a Big Company Multiple For Your Business

So how do you get a public company-like multiple for your business? One approach is to look for a strategic buyer. Unlike a financial buyer that is looking for a relatively safe return on their capital invested (which is the reason investors place a premium on big, stable companies trading on the stock market), a strategic buyer will value your company on how buying you will impact them.

Let’s imagine you have a grommet business predictably churning out $500,000 in pre-tax profit. These days, a financial buyer may pay you around 4 or 5 times earnings – in this case, roughly $2.5 million – if you can make the case your profits are likely to continue well into the future.

Now let’s imagine that a company that sells a billion dollars worth of widgets starts sniffing around your grommet business. They think that if they integrate your grommets into their widgets, they can sell 10 percent more widgets next year.

Therefore, your little grommet business could add 100 million dollars of revenue for the widget maker next year – and that’s just year one after the acquisition. Imagine what your business could be worth in their hands if they continued to sell more widgets each year because of the addition of your company.

The widget maker is not going to pay you $100 million for your business, but there is somewhere between the $2.5 million a financial buyer will pay and the $100 million in sales that the widget maker stands to gain next year that is both a good deal for you and for the widget maker. Premium multiples get paid to big companies, and also to the little ones that can figure out how to make a big company even bigger. If you’d like to know how your company performs on The Value Builder Score, simply complete the 13-minute questionnaire here:

https://score.valuebuildersystem.com/provengain/paul-wildrick