Build to Sell vs. Build to Own
Many entrepreneurs assume that to be successful they need to be acquired or go public in an IPO. Netscape, Google, and more recently LinkedIn teach us this, it seems. High-tech companies, then, are often built to sell. That tends to mean a focus on revenues over profits. It drives fundraising activity, as acquirers and public markets like to see rapid growth that seems more feasible with fat bank accounts filled by venture capitalists. Hiring centers on finding talented people excited about the prospect of stock options.
And that’s a perfectly legitimate business model.
The “build to sell” approach represents an all or nothing proposition. Go big or go home. Boom or bust. Once infused with venture capital, the focus must be on a liquidity event. The pressure mounts to demonstrate double or triple digit growth. Sometimes this growth comes at the expense of smart long-term decision-making because the five year time horizon isn’t as important as the 6 or 12 month one. For the build to sell company that goes the IPO route, this pressure becomes even more intense as quarterly numbers suddenly get made public and everyone will be focused on whether those numbers are hits or misses.
Personally, I prefer the “build to own” business model. That doesn’t mean I’m opposed to venture capital and would never start a company that raises funds. I might. The future is hard to predict. But I prefer to build businesses that I expect to own 5, 10, 15 years down the road. Think about it: if you make decisions based on the idea that you have to live with them, you’re likely to make smarter calls. In too many venture-backed businesses, the entrepreneur may — without malice or even intent — tend to make decisions for the near-term without care for the long-term because the likelihood of still being around a decade later is pretty remote. One way or the other, the fate of the build to sell company is likely to be decided in 8-10 years at most
Investors and others often derisively refer to “build to own” businesses as “lifestyle companies.” Corbett Barr offers up a good defense of the lifestyle company in a recent blog post. The points he makes about designing a business to meet today’s needs of the entrepreneur rather than future wishes are all excellent.
Not all “build to own” businesses need to be “lifestyle companies,” however. There are plenty of really big privately held companies that certainly don’t fit with the image that most have when they think of a lifestyle business. Forbes magazine regularly publishes lists of the largest privately held companies in America as well as the richest 400 people. Turns out there’s some overlap between the two because it’s quite possible to build — and continue to own — phenomenally successful business. Ever hear of Mike Bloomberg, for example? How about Jim Goodnight of SAS? You get the picture.
Yes the business that is build to own for the long term faces significant challenges. Without large amounts of venture cash, early growth can be more difficult. There are also tough decisions that need to be made along the way. For example, when should you start taking profits and how much should be reinvested in the business? How do you properly motivate employees if stock options aren’t the driving focus? How do you make up for the lack of connections and advice that VC’s might provide if you were a portfolio company? Do you push for a more comfortable existence as the owner or do you still take big risks and push hard for larger growth?
There are, of course, many rewards to building a business to own for the long-term. As Barr points out in his blog post, you have the opportunity to improve your quality of life now, rather than hoping for it in the future. A friend of mine once described it as “pre-selling” the company by taking out profits over time — and that’s an interesting perspective. For those who own businesses and have taken out profits, it is worth the exercise to total up the amount of profits taken out of the business over time. Then consider whether you would have been happy with that as a sale price of the company years ago.
It is also important to understand that just because you build a company to own doesn’t mean you can’t sell it. It just means it is not the focus. It will be harder to sell the company because the stream of profits (dividends, if you prefer) that the company pays make the cash from acquisition seem less interesting to some degree. It takes more of a premium to give up an existing income stream than it does to sell a company that generates no current-day cash for the owners.
The same can’t be said for “build to sell” companies. If 5 or 6 years into the exercise you decide you’d rather own the business than seek a liquidity event, you’re likely out of luck if you took outside financing. While there are certainly scenarios where one can buy out the investors — and it does happen — it is not all that common.
The point of this piece is not to advocate build to own over build to sell. It is just to make you think about the options. My personal bias is towards ownership, but there are lots of smart successful people who have taken both routes.