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Where Does Most Business Growth Really Come From (Clue: It’s Not Startups)?

by Walker Deibel, Managing Director of  Centra and author of “Buy Then Build: How Acquisition Entrepreneurs Outsmart the Startup Game

If I asked you to name a business success story, what would you think of? You’d probably go for one of the titans of technology who dominate the business media: Bill Gates, Steve Jobs, Jeff Bezos, Mark Zuckerberg, and Elon Musk, to name a few. These entrepreneurs, and others like them, have enjoyed such remarkable success that they have obtained celebrity, even legendary status.

Lately, we’ve seen startups able to reach a billion-dollar valuation, so-called “unicorn” companies, in the limelight. These companies are changing how we live and work, and they are not only creating tremendous value but are introducing new business models. Indeed, all startups today aim to be the “Uber of [enter your industry here],” right?

All these companies sourced venture capital (VC) to launch their companies. If we have engineered a better way to start from scratch, it probably looks a lot like this. The average successful VC-backed startup raises $41 million. That’s a lot of money and must solve a lot of problems.

According to Harvard Business School lecturer, Shikhar Ghosh, even VC-funded startups — the ones that every MBA startup strives to attain — have a 75 percent failure rate. So, extremely well-financed startups with the support of the best investment teams in the world are successful in doubling the already minuscule success rate of non-VC-backed startups. But the large majority of these companies still never make it to sustainability.

The VC game is one of portfolio management. Meaning there needs to be a sizeable enough portfolio for VC backing to make sense. This is why, as of 2008, the average VC fund is $350 million. This provides capital for eight to fourteen companies per fund. Three winners pay for the fund and its return, while nine entrepreneurs get a shot “at bat” in a game that only accepts home runs. As an investor, you might like this game. Lots lose, but the few that win provide exceptional returns for you.

As an entrepreneur, you need to understand that you are not invested in the portfolio. You are invested in a specific company, so the economic advantages gained by the VC are not extended to you, and there is a very quantifiable 75 percent chance that your specific company will be a loser. It turns out, for the entrepreneur, VC isn’t all it’s cracked up to be.

Even with Venture Capital, Most Startups Fail.

In summary then, VC is no guarantee of success. For an investor with a solid portfolio, it usually works out okay in the end. For an entrepreneur aiming to build a profitable company, there’s a high chance of failure, even with the advantages provided by VC.

I share this not to crush the dreams of entrepreneurs everywhere but to share insight into what engineering success might actually look like. Understanding that unicorn companies are more anecdotal than typical is simply a prerequisite. Starting a VC-backed company believing that you will be the next magazine cover success story is highly ambitious. It could happen, but the statistics suggest otherwise.

Despite these hard numbers, many people believe that the few high profile, fast growing companies that gobble up column inches are the ones driving the economy and new jobs. They do drive trends by encouraging investors to place significant bets on adolescent markets, but this is not actually where growth comes from.

Where Does Growth Really Come from?

We’ve known the answer to this question for decades. In 1979, in his statistical report, The Job Generation Process, economist David Birch revealed that small businesses are responsible for creating the large majority of new jobs. After release of the report, Birch continued to refine his findings, eventually settling on the term “gazelles” to define the 2–3 percent of companies that create 70 percent of new jobs every year.

What is a gazelle? The term is defined not by size but by rapid growth. To be classified as a gazelle, a company must have a starting revenue of at least $1 million, then grow at a rate of 20 percent every year for four years, resulting in the company doubling in size during that time.

As job creation vehicles, gazelles easily beat out the elephants (Fortune 500, think Wal-Mart or ExxonMobil) and mice (Main Street). Admittedly, elephants and mice are defined by size instead of growth rate, so technically either could exist as a gazelle. That said, most gazelles are found neither on Wall Street nor Main Street, but in the middle market.

When forced to think of a gazelle, you might be tempted to think of technology companies. After all, isn’t tech synonymous with high growth? Well, in the 1990s, yes. Zoltan Acs, director of the Center for Entrepreneurship and Public Policy at George Mason University, released his findings in 2008 that supported the notion that there were more gazelles in the tech industry in the 1990s than any other industry. However, in the 2000s, the leading industry was housing-related services. I can speak to this myself, since our aluminum railing company grew at over 38 percent in 2017. Hardly high tech.

Acs observed that gazelles are found in all industries. Birch supports these observations highlighting that about a third of gazelles are found in wholesale and retail, and a third in the services industry. More likely, technology plays an important role in a company’s productivity, but delivering high-tech products and services doesn’t make it any more likely that a company will continue to be healthy in and of itself. After all, Acs’ findings report that a mere 2–3 percent of all companies ever reach gazelle status, and none of them stay there forever.

One of Acs’ findings could be surprising to fans of the “fast growth is only found in startups” myth. During a 2009 interview with Forbes, Acs revealed that gazelles tend to be twenty-five years old. These are the economy’s most productive enterprises—and they’re clearly not new companies coming out of accelerator programs. Instead, these are established, long-time companies. Which raises the question: how can you find, and purchase, your very own gazelle?

As Baby Boomers Retire, There Are Many Gazelles for Sale.

As luck would have it, there is a ready source of gazelles on the market.

The baby boomer generation owns more businesses than any other generation ever in history. In 2013, they owned 12 million small businesses, which is 43 percent of all small businesses in the country. That same year, they also started to retire at a rate of 9,000 per day.

The rate at which boomers are retiring is going to increase significantly over the next eighteen years. By 2021, baby boomers will be retiring at a rate of 11,000 per day. Almost 77 million people, about 20 percent of the US population, will retire between 2013 and 2029, and it is estimated that $10 trillion in existing business value will need to change hands.

The boomers are already selling off their established, successful small businesses at record rates. These businesses provide an unprecedented opportunity for acquisition entrepreneurs to focus on running, growing, and innovating a business immediately, all while enjoying a stability not found in startups.

This substantial increase in supply of available businesses for sale is expected to result in a buyer’s market like we’ve never seen. This means the infrastructure built by generations before will be available for purchase at the most affordable levels ever experienced.

Put it all together and this is what we have. Startup “unicorns” are incredibly successful and drive industry trends, but they’re also incredibly hard to emulate, even with millions of dollars in VC funding. Most business growth comes not from glamorous, high-profile entrepreneurship, but from successful medium-sized businesses, known as gazelles.

The even better news is that a lot of gazelles are owned by baby boomers, who may well be looking to retire and sell on their businesses. In summary, if you’re looking to flex your entrepreneurial muscles without taking on the huge risks of the startup scene, you may wish to investigate acquisition entrepreneurship.

Find a solid business, buy it, and make it better. It’s where the growth is.

 

*adapted from “Buy Then Build: How Acquisition Entrepreneurs Outsmart the Startup Game

 

Walker Deibel is an entrepreneur and investor who has co-founded three startups and acquired seven companies. The Managing Director of  Centra – which currently owns and manages three companies – and author of “Buy Then Build: How Acquisition Entrepreneurs Outsmart the Startup Game” is also a certified advisor and former SEC-licensed stock broker.

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