More Investors Will Be Buying Small E-Commerce Companies
Yesterday I predicted that we’ll see a record number of e-commerce businesses sold this year. I shared why I think the timing is opportune for many founders to sell. A friend pointed out that it takes two sides to complete a transaction and my post didn’t address the buy side. He’s right.
I believe significantly more buyers will be looking to acquire e-commerce businesses doing less than $10 million in annual revenue. Here are my reasons:
- The pandemic accelerated the shift to e-ecommerce, and this trend will continue. Buyers who want to participate in this trend but don’t want to spend time catching up and building something from scratch will be interested in buying a business.
- We’re in a low-interest-rate environment. Cash is earning nearly nothing, as are savings accounts and other risk-free investments, so people are looking for other investments to earn returns on their money.
- Many other asset classes have appreciated significantly in the last year and a half. We’re at peak prices historically for many asset classes, and some investors aren’t sure how much upside appreciation is left. Multiples on businesses have increased as well, but a small business in a large market that’s growing quickly has the potential to appreciate significantly.
- Finally, sophisticated investors are raising large sums of money to buy these businesses.
E-commerce businesses have historically been viewed as less sexy than other types of businesses and have received low multiples. I think that will change this year!
What’s Next for Some Small E-commerce Founders
Over the last year, I’ve chatted with friends who are seasoned e-commerce entrepreneurs. They saw their businesses explode. People were at home more than usual and ordered online instead of going to physical stores, so that makes sense. I’ve heard stories and read articles about e-commerce businesses having their best year ever.
I predict that this year we’ll see a record number of e-commerce businesses sold—specifically, those doing less than $10 million in annual revenue. I believe this for a lot of reasons, a big one being timing. Founders who’ve spent years building these businesses and recently have thought about exiting have a great opportunity. Businesses of this size are usually valued based on trailing-twelve-months financials. This means the valuation is largely based on how the business performed during the last twelve months—which have been record setting for a lot of these businesses. Many sellers may see this as the perfect time to cash in on their hard work.
I look forward to paying closer attention to the private market for these businesses and hope the founders who were tenacious and built great businesses are rewarded handsomely this year.
Stay Motivated by Celebrating along the Way
Before the pandemic, I regularly did a variety of physical fitness activities. During the past year and a half, I wasn’t comfortable doing them, so I stopped. A few months ago, I decided I wanted to work toward a new health and fitness routine that focused on outside activities. I set some goals for myself and committed to them. I started tracking my progress, and I shared my goals with others who could hold me accountable.
Today I reviewed some of the data, looking back at the progress I’ve made to date instead of ahead to the day my goals have been achieved. I celebrated some of the little wins I’ve had, which reenergized me.
Setting goals is key to a company being successful. It helps with alignment, focus, and a variety of other things. Working to achieve them is a journey that has its ups and downs. Along the way, it’s important for teams to take time to celebrate the progress they’ve made, even if they haven’t achieved their goals yet. Celebrating those mini wins along the way can help teams stay motivated and give them confidence that they can make it to the finish line.
The Rise of the Lifestyle Business
The last year and a half thrust the world into experimenting. It limited interactions and separated people from family and friends. For many, the separation crystalized the importance of relationships and in-person interactions. Companies were forced to embrace remote work to safely continue operations, and many workers opted to work remotely near the family and friends they missed—some for weeks or months at a time. The flexibility to do so added immense value to their personal lives. This kind of flexibility isn’t something that many workers have experienced before, and I don’t think they’ll want to give it up.
I anticipate that many people will leave full-time work as employees to become entrepreneurs and solopreneurs over the next eighteen months. The desire for flexibility and a better quality of life will drive many of these transitions. This group will create the next wave of lifestyle businesses.
Entrepreneurs will have lots of opportunities to help these lifestyle businesses succeed. Their founders will make time a top priority and will pay for products and services that save them time. Many of their businesses will be dispersed, so they’ll pay to be part of communities (physically or digitally) of like-minded people.
I’m excited and looking forward to watching this explosion in lifestyle businesses. The ripple effects from it could be big and reshape things in ways we never would’ve imagined.
Large Landlords Acquiring Tenants on Airbnb
A friend shared an article with me today. It’s about an institutional investor, ReAlpha, planning to spend $1.5 billion to buy 5,000 homes to rent out. I’ve followed institutional buyers of single-family homes for the last decade. Atlanta is one of the biggest markets for companies like Invitation Homes and American Homes 4 rent, both of which are publicly traded and own tens of thousands of single-family homes across the country that they rent out on a long-term basis. The strategy has worked well as home prices and rental rates have steadily increased since the financial crisis.
The article discussed a slightly different strategy: purchasing thousands of homes to rent out short-term on Airbnb. The idea isn’t new, but it hasn’t been pursued at scale by institutional investors. The customer acquisition strategy is intriguing. Instead of acquiring customers (i.e., renters) through traditional sales and marketing efforts, they plan to acquire them on Airbnb, which is a marketplace.
Marketplaces are places where buyers and sellers connect. Using a marketplace to acquire customers is an attractive and capital-efficient strategy for sellers. The fee (or take rate) is usually a fixed percentage of the revenue a buyer pays. That leads to a highly predictable customer acquisition cost. Sellers pay X cents for every dollar in revenue from buyers. Sellers don’t have to worry about paying to attract potential buyers who never pan out; they pay only to acquire revenue-producing customers. Sellers don’t even need to take on sales or marketing—they need only have the ability to service customers.
This approach has downsides, and the customer relationship is a big one. The marketplace owns the customer relationship. Buyers aren’t loyal to the seller they transact with; they’re loyal to the marketplace. Concentration is also a big risk. If you get all your customers from a single source that you don’t control, changes can significantly affect your revenue. Lots of stories circulate about businesses being crushed when a marketplace they rely on changes how listings are displayed or suspends their account.
If ReAlpha moves forward with these plans, it will be a huge growth opportunity for Airbnb. I’d imagine ReAlpha will seek discounts on Airbnb’s fees, but even so this could unlock a new product offering with the potential for massive scale in Airbnb’s platform.
I’ll be watching to see how this evolves.
Weekly Reflection: Week Sixty-Five
Today marks the end of my sixty-fifth week of working from home (mostly). Here are my takeaways from week sixty-five:
- Travel – It’s summer and lots of people are traveling. They’re making up for lost time and looking for a change of scenery. I’m curious to see how productive this summer is compared to last summer.
- NBA playoffs – The Atlanta Hawks made the NBA Eastern Conference finals and won their first game. It’s amazing how much a sports team can unite a city (when they’re winning). If the Hawks make it to the finals and win, that could fuel more momentum for Atlanta.
- Nonobvious big markets – I’ve been thinking a lot about markets that are both large (or growing quickly) and not obvious to people outside the space.
Week sixty-five was a steady and productive week. Looking forward to closing out June next week.
Incubating a New Company within the One You’ve Got
Companies aim to create value by solving a problem. Founders, to increase their chances of creating a solution that has value—i.e., that customers will pay for—should have a deep understanding of the problem. An interesting approach to this goal is incubating a company inside another company: A company has a problem. It builds something to solve it. Management realizes others have the same problem. The company begins selling its solution. The solution grows so quickly that it’s separated from the parent company to become a stand-alone entity. I know a few founders who’ve successfully incubated companies this way—and the new companies became massive over time.
I’ve noticed a few things about this approach. If the parent organization has ample resources (usually money and people), this can be a great way to get something off the ground without raising capital. If not, it can drain and burden the parent company. The legacy company’s leaders often are attracted to the new growth company because it has great potential. But managing both companies can become challenging. I’ve seen leaders put someone in place to run the legacy company while they focus on the growth company. This works well—if the right person can be found, which isn’t easy.
I like this approach. It isn’t realistic in most companies, but when it is, it can lead to something big.
Think about Using Other People’s Assets
At CCAW, to expand our distribution, we partnered with companies that had underutilized warehouse infrastructure and wanted to optimize it to get a better return on their investment. Using other companies’ warehouses, we could add a new distribution point in a matter of days, so we scaled our distribution network rapidly and could reach any consumer’s home in one or two days. With technology, we overcame lots of logistical challenges, which I I won’t get into. I still love this concept. I think it’s applicable in many other areas.
I learned about a company planning to build a national restaurant brand using this approach. No more building out locations or franchising. This brand hopes to leverage, through technology, existing restaurant infrastructure that’s not fully utilized. I’m not sure if it will work, but I like the thought process.
Some companies have become big winners by solving problems for customers using others’ underutilized assets. For example, Uber and Lyft got their start when their founders noticed how many cars on the highway had only one occupant (i.e., lots of empty seats). I think that technology will accelerate this trend. We will see more companies leveraging existing assets and building large businesses in the process.
If you’re a founder looking to solve a problem but don’t have the assets, consider using some else’s.
What Kind of Idea List Do You Have?
A close friend and entrepreneur keeps an idea list. It’s a running lists of things he’s interested in building that could become his next company. Whenever he has a new idea, he adds it to the list. We went over a few of his ideas recently. As he explained what he wanted to build, I found myself repeatedly asking what problem he was trying to solve. Then we’d talk about whether what he envisioned building would solve the problem.
I kept an idea list for many years, as do many other founders. I thought it would lead to the new business that I wanted to create at some point. It never did, and I discontinued the list. After the exchange with my friend, I realized I’d approached things all wrong. My ideas were essentially solutions. If I thought the world needed an XYZ and people would pay for it, I added it to my list. But I had no idea what the world needed and what people were willing to pay for.
In hindsight, I realize that I should have been capturing problems that I thought people would pay to have solved (and that I was qualified to solve). Doesn’t sound like a big difference, but it is. By capturing solutions, I was trying to convince others to see the world my way. I should have been capturing problems—trying to understand people’s problems so I could build a solution that created value others were willing to pay for.
Many people take a solution approach to entrepreneurship, and it can be a mental trap. You can be in the vicinity of a huge entrepreneurial opportunity (i.e., problem) but give up because the solution you envision doesn’t resonate with people. Focusing on the problem is better—it’s more likely to lead you to a solution people are willing to pay for (i.e., a big business). Neither approach is easy and neither guarantees success, but looking for problems to solve increases your chances.
Current Labor Market = Entrepreneurial Opportunity
An interesting dynamic is playing out in the labor market right now. For many reasons (which I won’t get into), some businesses, such as restaurants, are having trouble hiring enough staff to meet customer demand. Some of them aren’t succeeding. Some are even having to reduce operating hours (or close entirely some days) so they don’t overwork and burn out the staff they do have.
These business owners are looking for ways to meet customer demand. Their traditional method of throwing manpower at the problem isn’t viable, so they’re open to new solutions. I think this staffing challenge will lead to accelerated adoption of technology in these industries. Technology can’t do everything a person can, so it won’t make the problem disappear. But it can make processes more efficient and allow businesses to do more with less. Their increased bandwidth can help them meet customer demand.
The current labor market has created a great opportunity for founders to build big businesses. Big markets are experiencing extremely painful problems, and decision-makers are in search of solutions to them. This is a dream scenario for an entrepreneur with the right background to solve these problems!