In their recent HBR book, Build, Borrow, or Buy: Solving the Growth Dilemma, authors Laurence Capron and Will Mitchell focus on those three growth strategies for companies to expand. Companies that “build” are those that scale up by doing more of what they’re doing now through internal innovation. Companies that “borrow” enter into joint contracts and alliances; and companies that “buy,” grow through mergers and acquisitions.
Whether a deep pocketed business or an entrepreneurial venture, leaders face a rapid market-driven pace, technological advances, regulators, and competitive upheaval. That turmoil requires companies to continuously analyze and address the gaps in their existing knowledge & skills and to make important choices.
The authors contend, “The firms that learn to select the right path to new resources gain the competitive advantage.” But what is that path and what are those resources?
Business leaders who have grown their companies using all three strategies headlined an Enlightened Speakers’ Series event in Dallas. They were: Curtis Eggemeyer, the CEO of Envirocon Technologies, the makers of LemiShine, a phosphate-free dishwashing additive; David Omholt, the founder of The Entrepreneur Authority (TEA), an expert on franchising; Michael Gorton, the chairman and CEO of Principal Solar, a solar power utility; and Tom Montgomery, co-managing partner of Montgomery, Coscia and Greilich, a Dallas-based accounting firm.
Eggemeyer said he has used each of the build, borrow or buy strategies at one time or another to grow Envirocon from a niche manufacturer of an environmentally friendly detergent additive to one of Inc. Magazine’s fastest growing private companies three years running. He wants Envirocon to be seen as a major competitor to the big names in the sector, such as Proctor & Gamble.
“We don’t want to be placed in the green aisle, rather we want to complete against the large conglomerates,” Eggemeyer said.
Eggemeyer’s family first invested in Envirocon, but when the company’s founder wanted out in 2007, they bought it outright. Now, they are in what he described as a “massive build mode.”
The company has been developing a line of products based on LemiShine, which began as a dishwasher detergent booster to remove hard water spots. Sales exploded in 2010 when phosphates were outlawed from detergents. First came LemiShine Rinse – an all-in-one rinse agent and booster made from fruit acids and citrus oil. In 2010, another product was added, LemiShine Machine Cleaner. In 2011, the company added larger sizes to their packaging to meet increased demand. This year, they’re in a test launch phase and LemiShine will roll out nationwide this year.
“We have distribution in HEB, Walmart, Target, Kroger, and Safeway and you’ll begin to see us in a much larger presence this coming year,” he said.
But as the company was building its product line, it wasn’t able to keep pace with a sales force. Authors Capron and Mitchell suggest that borrowing is a valuable path for companies to take. Borrowing does not have to mean getting a loan from a bank, but acquiring new resources through contracts or alliances with partner organizations. Envirocon did that with a national sales and marketing firm, Acosta, “which will give us complete penetration and distribution throughout the U.S.,” Eggemeyer said.
Now, the company is in a position to strategically partner with other firms, and Eggemeyer sees 2014 as a year to look for key opportunities to make some acquisitions. “We are still following the bootstrap model,” he said. “If we see it’s not effective enough, we’re prepared to go to our lenders.”
“Have awareness of all options, at all times,” he said. “As we’ve gone through build, borrow and buying, all three have to be working.”
Franchising expert David Omholt represents the “borrow” strategy for growth. His TEA organization has consulted and/or brokered for major franchise brands such as AAMCO, Denny’s, Great Clips, Potbelly’s, and ServPro. Omholt also leads the Franchise Center of Excellence, a training program that educates franchise consultants on the finer points of franchising.
“It’s the least risky of all the options and because of all the disclosure laws, it has the lowest incidence of failures,” Omholt said. “That doesn’t make it risk free, but it’s less risky.”
Companies are jumping on board. Over the last decade, 2,400 businesses began to franchise. “You can franchise just about anything,” said Omholt.
Four factors determine whether a concept is franchiseable, said Omholt: Is it a saleable concept? Can it be cloned? What is the ROI – is there a good economic story behind your concept? And finally, is there a success story waiting to happen?
“Look at these four concepts to determine if your business is franchiseable,” Omholt said.
Now is as good a time as ever to get into the franchise business, he added. Money is cheap. Lenders are willing to lend. “The failure rate in 2012 was the all time low of failure rates in the franchising world,” Omholt said.
In addition, market share is up for grabs. Omholt contends that legacy businesses have let relationships with customers atrophy, and companies that play to win will go after them.
The commercial real estate market is favorable, too, he said. “I’ve never seen a better situation for tenants than there is today.”
So, what’s hot in franchising right now? “The senior category,” said Omholt. “Someone turns 65 every eight seconds and they have dollars.” He picked eco-friendly, solar, and franchising itself as categories with potential. “Food is always an interesting category and a hot category,” he said. “There are a thousand ways to make money in food and one thousand and one ways to lose it in food.”
A company doesn’t even have to pick an either-or strategy to franchise, Omholt said. It can choose to grow organically with company stores and it can have franchise locations. “You don’t want to be stuck at being mediocre at both, and there are trade-offs for both scenarios,” Omholt concluded.
The “buy” strategy was represented by Michael Gorton, the CEO of solar energy company Principal Solar. “Solar is for tree huggers and Democrats and there may be a few of each in this room, but I am neither,” he said. Instead, he described himself as a capitalist who looks for ways to make change, and opportunities where change is about to happen.
Right now, he said, Principal Solar in engaged in a national rollup strategy. That’s the acquisition of multiple companies, which reduces costs and increases valuation. “If you can do those things in a fragmented market, you’re going to achieve hyper-growth and you’re going to make a great expansion of your business model.” Gorton said. He pointed to Waste Management, Kraft, and Auto Nation as example of companies that have grown by using that strategy.
“The reality is,” he said, “in the solar business, there are a lot of guys that are not great businessmen and they have built businesses that are cash flow positive around the country and that’s an opportunity we see to roll it up into one big company.”
Principal Solar is putting together the financing for $104 million in acquisitions under letters of intent. “That’s just scratching the surface,” Gorton said. “There’s probably $3 billion worth of assets nationwide that we’d like to acquire.”
Acquisitions in the solar industry are typically done with 40 percent debt and 60 percent equity, said Gorton. The government also makes benefits available to alternative energy concerns.
“What we call project equity is actually a way to deliver ten percent IRR’s to our equity investors in a five year flip model,” he said. “They get their money back in five years and we also give them a little bit of the revenue after that – it’s a model that works really well for us.”
Gorton said that when he acquires another solar company, he isn’t really buying a field of solar panels. Instead, he’s acquiring cash flow. Capital is a necessity for that, and Gorton says his company is increasingly turning to the oil and gas industry to help finance the transition to solar power. “We believe that Texas is and should always be the leading energy state in the country,” he said. Gorton said his board is made up of “luminaries of traditional energy in Texas.”
One of the biggest issues with the rollup strategy is bringing on employee teams from the company that’s been purchased. Gorton is up front about not keeping those teams on. “We’re very clear that all we want are the assets,” he said. “We buy the power purchase agreement, not the employees, so we don’t have the number one issue with most acquisitions – merging in the new employees.”
In the next couple of years, Gorton said solar energy will take the world by storm, and do it with “real capitalism.”
Whether a company grows by building, borrowing, or buying, the transaction must be funded. CPA Tom Montgomery consults companies on M & A financing and strategic and operation planning. He said funding an acquisition is one of the most critical decisions faced, and companies should look at three major variables.
First, the dynamics of the business. What stage is it in in its life cycle? How scalable is it? Second, people. Montgomery said people are the most difficult piece of the business to manage and execute. Finally, capital. “I look at the U.S. economy and world economy today and see huge headwinds,” Montgomery said. He cited high tax burdens, a difficult regulatory environment, and confusing administrative and legal rules.
“On the other side, the ability to start a business has gotten so much easier with technology, transparency, and the sophistication of capital sources,” he said. “The build decision is a great way if go if your business concept is a solid one.”
But concepts often take time to gel, and it might be necessary to borrow, he said. And then there’s debt. Depending on how capital intensive the business is, debt could range from 60 to 80 percent.
So, an entrepreneur might decide to buy. “Buying a business is a very effective way to grow your business,” Montgomery said. “However, it’s also very risky.” Potential owners rationalize away the risk, he added. But consider the seller, who knows the most about the risk and rewards. Why is he selling?
Borrowing could work for some, Montgomery said. “People leveraging” is an effective way to borrow, whether joint ventures to distribution networks or franchising. “Usually you franchise to tap into higher quality people who are entrepreneurial who have a proprietary interest,” he said. “That is why those work well and are effective because you can get high quality people to join you.”
Eggemeyer, said Montgomery, “hit it dead on when he said, ‘You need to evaluate all your options.’” But then the decision must be continuously reevaluated. “It may build one time, it may be buy another time and it may be borrowing another time – successful companies deploy all three methods of building their companies,” Montgomery concluded.