A few years ago, I was involved with just this type of start-up. It was located in the US. A small, very competent group of four software specialists started their own niche product development after being made redundant by a major global business. We started the business with ,000 – no salaries were paid at the start. The team took a 10 x 10 sq ft room with no windows on the 65th floor of the World Trade Center, and also worked from home. (The World Trade Center office was exited about nine months before 9/11.) We raised million from family and friends gradually as the business needed it over the next two years, but always kept the headcount to seven or less.

They took on some software development and consulting business to pay the wages, but battered away at the key concept we had identified in the healthcare area. Eventually we managed to attract a breakthrough client that gave “theoretical” scaleability to the idea, and within a few months we’d sold the business to a UK public company for million cash.

The sale was made post tech/dotcom crash. The price represented both real value for the buyer and a good deal for the team, for a relatively short blitz of work. The investors were very happy as well.

An accident rather than a plan
The early sale of the business in this case was an accident rather than a plan, but we liked the model. The team in question is now well into its second effort, and the original founder is on the way to his third. The concept is to opt for less than the maximum possible return in exchange for not having to build a traditional operation.

This model of making a small sale to a major trade buyer at a very early stage in the development of the business is now a more widespread phenomenon in the US and other entrepreneurs are starting out with this as their strategy.

Small acquisitions are on the up

The numbers are interesting. A typical niche in-filling business would not get beyond ten or so people, would have gained a major client for the product, and would be sold within 15 to 36 months from foundation for proceeds in the region of £5 – £15 million. To give you an idea of the number of small acquisitions, research shows that there have been over 5,000 tech acquisitions so far in the US in 2004 with an average price of million. This represents the large hoovering up the small at an enormous rate.

These deals work well for both sides. The big tech companies have global distribution, but also possess a desperate need to rapidly add features and products to push down that channel, both to maintain competitive advantage and achieve year-on-year revenue increases. Plus, few of these mega-businesses are great innovators any more. The small nimble company is miles faster and cheaper. So for product add-ons and gap-fillers, it’s a great strategy to use financial muscle to just buy these up.

Make a pipeline of fillers
For the small company the barriers to entry, risks and costs of following through to create a medium or large business are greater than ever. So why not take the cash and possibly a steady job for a while, then maybe do another niche filler to generate another wodge of cash? Ironically, in this area the value of what you create probably starts going down after a certain point, so you really don’t want to develop the business too far.

The acquirer is buying some intellectual property, proven to work with a client, plus maybe some people and niche knowledge. The price is simply a good number for you to give it up to them a few years earlier than they would develop it for themselves, and allows them to benefit from getting it into the global market. If you hang on to your business too long you will have people, operations and clients that the mega-companies don’t really want.

Spotting a filler
Sometimes you may find you have an asset in your existing core business that can be turned into a niche filler – a pure bonus. I was talking the other day to the UK owner of a print and fulfilment business. Very traditional, but he knew his sector well. He mentioned that one of his USPs was the software he’d developed. He knew this to be “world class” compared with what else was available on the market to support and optimise list management and fulfilment.

His clients were getting a serious value-add from him in terms of straight return on investment in the projects he managed for them. ‘That’s interesting,’ I said. ‘If what you say is true, why don’t we put that product into a separate vehicle, get another major client, and pass it on for a decent price to a software major? You can still keep an eternal licence in the core business, the advantage that you have today will arbitrage out in the market anyway, but you can remain on the front curve of new development by becoming the early user (or beta tester) of the new versions.’ ‘Hmmm,’ he said. ‘Fancy lunch next week?’

Peter Williams is a serial entrepreneur who is also a Founder of Myles & Co, an advisory firm focussed on family and business strategies for family business owners – contact pw@mccl.co.uk