When To Buy And When To Build: A Guide To Business Acquisitions

I think of every acquisition as a “buy or build” decision.

Back when I was building Wilmar Industries in the mid 90s, whenever we wanted to expand into a new market, we would start sending direct mailers to that area. Thousands upon thousands of them. We had a list of prospective and current customers, and every month a mailer would go out. We’d start getting call-in orders, and they’d say, “Do you have a salesman in the area?”

When we had enough business demand, we’d put a salesman in the area.

Once we had a few salesmen, that’s when we would open a distribution center.

We mitigated our risk by ensuring there were customers already waiting. Then, we would expand to that area, and repeat the process somewhere new. The whole approach was extremely disciplined.

However, if we wanted to expand somewhere and we knew there was already a competitor dominating the market in that area, then we would consider what would be cheaper: trying to beat them on their territory, or make a deal and buy them.

Every market, every region, was a buy-or-build decision.

There are countless examples of this happening in every industry. Why did Facebook buy Instagram? Well, because they were asking themselves whether it would be cheaper to build a competing platform with similar functions, or to just make a deal. At the time, Facebook’s $1 billion purchase of Instagram was considered ludicrous. Five years later, the public can unanimously agree that $1 billion was cheap.

That was a great deal.

When you’re thinking about expanding your own company, you need to question which is going to be harder, and also more expensive. Technically, anyone can expand by building it themselves, but that doesn’t necessarily mean it’s going to be successful. There is an art to business acquisitions. It can’t just sound great in theory — it has to make financial sense too.

Whenever you’re faced with a buy-or-build dilemma, here’s what you need to consider:

1. What are you really buying?

If I can measure it, and I have the cash to spend, I love doing deals.

In some cases, you can look at acquisitions as a way of just buying your ideal customer. Yes, you’re buying a company, but once you acquire it, what you’re really buying is their book of business. You might not need their CFO, because you already have one. Or, you might not need their offices because you already have offices in those areas. So it’s not so much that you’re buying the infrastructure, as much as you are buying their customers — which you can then roll into your already working machine.

Another example would be if you’re competing for market share in a certain area, and you view the acquisition as a way to “own” that area. If there is already a competitor in the area, you could spend millions on marketing and still not dent their business. In that case, it may be better to just strike a deal and acquire your competitor. This is one of the reasons I advise so many young entrepreneurs to reinvest into their business and not take out unreasonably high salaries.

You’re going to want cash on hand to strike deals like this, and expand your business.

2. How are you going to measure success?

Here’s an example of an acquisition that didn’t go as planned.

In my first acquisition deal, I paid $4 million for my first acquisition. They were doing about $10 million in sales, profiting $1 million a year, so I paid them $4 million.

Well, the integration didn’t quite go as planned, and the first year of owning that company we went backwards. That portion of the business did $8 million.

Whenever you strike a deal, there have to be synergies.

Now, in the above example, we did end up turning the business around and bringing it up to $20M in sales.

But any time you do an acquisition, 1+1 has to equal 3, not 2.

What I mean is that you have to be buying more than just something that works in isolation. You don’t grow a business by having separate arms all doing things individually. They have to be able to leverage each other.

That way, you get a much nicer return on your investment.

3. Don’t get into bidding wars.

The last piece of advice I give people looking to make big deals is to avoid bidding wars at all costs.

What they turn into is an ego show, instead of a composed business decision. Bidding wars end up inflating the price beyond what it’s worth, and you lose sight of what it was you were actually buying in the first place.

Instead, walk into the room knowing what it’s worth to you, and what your threshold for pain is. That way, if the other party starts driving the price up, you know this isn’t the right deal for you.

At the end of the day, an acquisition isn’t about having more just for the sake of having more. It’s about looking at the financials of your business and deciding that if you take one step back, spend the cash and buy an asset instead of building it yourself, then you will be able to make it back faster and more effectively down the road.

As soon as the deal becomes about something other than that, you’ve made a mistake.

The math has to add up.

That said, acquisitions can be a powerful growth strategy, and one I have and will continue to opportunistically deploy with all of my businesses.

This article originally appeared on Inc Magazine.