- What an investment thesis is and how to define it.
- What should be included in your investment thesis.
- How to find your unfair advantage.
- How an investment thesis will help you find better deals and quickly disqualify bad ones.
- The difference between must-haves and nice-to-haves.
Your investment thesis is your guiding light on your acquisition journey.
An investment thesis is a set of rules that defines what you will and won’t invest in. In terms of acquisition entrepreneurship, a properly defined investment thesis will ensure you know what type of business to look for and where to look for it.
A properly defined thesis can help investors evaluate potential investments and quickly disqualify bad deals.
Acquira’s Ty Trumbull sat down with Acquira CEO Hayden Miyamoto to discuss how to create an investment thesis and when, why, and how to iterate it. You can see that conversation in the video below.
What Is Included In An Investment Thesis?
An investment thesis helps investors evaluate investment ideas, ideally guiding them in selecting the best ideas in order to meet their investment objectives. It is a systematic mandate that helps to remove subjective opinions and emotions from the analysis of a deal, as well as quickly screen opportunities and separate the signal from the noise.
Despite the fact that it is so important, many Acquisition Entrepreneurs will skip this step due to their eagerness to get started.
“Most people skip it, and then when they make it, they deviate from it. It's very common,” explains Acquira CEO Hayden Miyamoto. “You want to get a deal done, so you typically will say ‘Hey, according to my thesis, this is a deal-breaker. But I'll make an exception because, hey, this other deal has an amazing growth opportunity.’ That's very common. I think it's a mistake.”
While investment theses will be specific to the individual Acquisition Entrepreneur, there are certain factors that should always be considered, according to Hayden:
- Where is the business located?
- How large is the business?
- Is it management run or ownership run?
- Are there any risks to the business like customer concentration or keyman risk?
- How big is the business?
- What are your own unfair advantages?
- How high is your own risk tolerance?
Find Your Unfair Advantage
Your unfair advantages are the things that set you apart from the competition. Maybe you have experience working at a plumbing company. Or perhaps you’ve handled the Human Resources for a company in the past and know what it takes to find and retain top talent.
In Acquira’s case, one of our unfair advantages has always been digital marketing. We know digital marketing well because our early portfolio of businesses consisted of online companies, where we were able to carve out a market share. That led us to look for businesses that could be expanded geographically, both quickly and predictably, spurred on by effective digital marketing campaigns – all of which led us to home services companies.
If you’re not sure what your unfair advantage is, there are a few questions you can ask yourself:
- Where do you have domain expertise?
- Who is in your personal network?
- Where do the people you know live?
- Do you or anyone you know have an existing business in the space?
- Does your family or friends have any businesses that you could take advantage of?
By locking into your unfair advantage, you’ll be able to better define what type of business you should look for. After all, if you know you can bring something to the table that will help improve the business, then it will help you stand out from your competition and help you stand out to potential sellers who want to see their business taken care of.
Change vs Iterate vs Pivot vs Ignore
While an investment thesis should be solid enough to guide your decisions, you should revisit it regularly to make sure it still holds up. Ideally, your thesis will evolve with your level of education.
That education comes from practical experience. Namely, by analyzing actual deals. “I always recommend you start looking at the businesses,” says Hayden. “You said plumbing, HVAC, and roofing? Then you need to really look at three plumbing, HVAC, and roofing businesses each.”
After you start digging into those deals, you may learn that certain sectors don’t fit your investment thesis. For example, you may start out with the idea that an HVAC company would be a good fit but after looking at a few HVAC businesses, you may realize that you don’t like how dependent the business is on certain seasons. That might lead you to decide that any HVAC business you DO consider should have a second product line that can keep your staff busy during the shoulder season.
As you make your way through more deals, you’ll start to refine your thesis more and more. You may find after looking at a few different industries that you only really like two types of businesses. That realization may lead you to realize you need to expand your geographic scope.
The point of this exercise is to avoid “shiny object syndrome.” You should avoid constantly chasing different deals and switching your thesis just because you like a deal. Rather, if you are going to evolve your thesis the decision should be based on an objective analysis of the data.
Once you feel that you’ve looked at enough deals and solidified your thesis, you should revisit that thesis once every three months.
Nice-to-Haves Vs Must-Haves
When crafting your thesis you should start thinking about certain aspects of a deal in terms of “must-haves” and “nice-to-haves.”
Must-haves are non-negotiable qualities that, if they’re absent, will cause you to disqualify a deal immediately. If you’re somewhat risk-averse and believe the economy is headed for a downturn, you likely want to avoid businesses that do badly during a recession.
For example, plumbing and HVAC companies tend to do well regardless of how the economy is doing. If someone’s house is flooded because a pipe burst, they’re going to call the plumber regardless of the economy. If they want to paint their house during a recession, they’ll likely just do it themselves and skip paying someone to do the work.
The Necessary Must-Haves
There are a few categories that we consider essential to any business deal. They include:
- The company is big enough to support becoming management-run.
- The company is big enough to support any hiccups within the first year of acquiring the business.
- The seller is willing to stick around for a period of time, ensuring a positive transition.
- The business falls within your own risk tolerance.
- The gross margins are above a certain amount that you’ve decided based on your research.
- The business has an existing and positive company culture.
- The seller is willing to share all of the company’s records.
Of course, not all of the above points are things that will jump out on a balance sheet or financial report. Determining whether a business has an existing and positive company culture can be difficult, so you often need to think outside of the box. With that specific example, we recommend looking at employee retention. If people stick around, it likely means they enjoy the company culture. If the seller isn’t willing to share those numbers, that should be another warning sign.
“The seller is your most important relationship for the first year of the business,” explains Hayden. “It needs to be a collaborative efforts to relieve the seller of their current roles 90 percent of the time, because 90 percent of the time these businesses have owner operators that are very involved in the business.”
You also want to ensure that the business is making enough money to support the implementation of systems and any other changes you make to the business. It’s not uncommon to see a dip in profits in the first year as you improve things so it’s important to have a buffer.
“I've always said that the sweet spot is between $700K and about $1.2 million,” says Hayden. “And obviously, you need to make sure you enough cash to to buy that type of business.”
Some nice-to-haves might include:
- The company is more than 10 years old
- There are a specific number of employees
- The company has a specific EBITDA margin
- The company has some marketing sophistication
- The seasonality of the business
- The SDE is growing or declining
Each of the above points will be tied to specific numbers that you will define while crafting your investment thesis. If you want a company that has a specific EBITDA margin, you need to define that margin.
When it comes to SDE, you should be able to look at that number and determine if the business will require work to turn it around or if it’s already growing. If you’re buying the business based on growth, you’re likely going to pay more. Each of these factors will be based on your own investment thesis.
How Long Should It Take?
How long it actually takes to define an investment thesis is entirely dependent on the Acquisition Entrepreneur. Hayden recommends giving yourself certain success criteria and then refine that thesis.
As you look at those deals, put them through the right calculators, and refine your search, you’ll start to see certain patterns. These patterns will allow you to zero in on certain types of businesses in certain geographic regions that match your criteria, ensuring that you find the perfect deal for you.
Acquira provides a number of training options for Acquisition Entrepreneurs, and the first step in each of them is to help you define your investment thesis.
Our programs have you fill out specific information and answer certain questions. You will assign a weight to various factors defined by your individual thesis. Then you will input all of that information into a calculator that will automatically disqualify deals that don’t match your thesis.
We recommend that people start with our Accelerator Program. The Accelerator is designed to help you close a business in half the time at half the cost it would take you to find a business on your own.
If you have any questions, schedule a call with us through the form below and someone will be in touch shortly.
- Defining your investment thesis takes time and hard work.
- You should analyze multiple deals as you iterate and refine your thesis.
- Everyone has an unfair advantage.
- Choose your must-haves and nice-to-haves and don’t deviate from them.
- Revisit your investment thesis at regular intervals, at least every quarter.
Acquira is a business acquisition in a box service. We help entrepreneurs buy businesses and we invest in them and their chosen businesses. We are here to help ensure that each business we work with is posed to make the biggest positive impact possible for its owners, employees, and community.