When Should Your Company Build Instead of Buy?

Is acquisition always the best path for companies looking to grow and accelerate investor value?

Not necessarily.

That answer might sound like heresy coming from an M&A advisor. But though acquisition is often the best answer, it’s not right for every company at every point in time.

“De novo” is a Latin term that is usually translated as “starting anew.” It is used in a wide range of contexts, from our legal system (a new trial with no assumptions based on earlier proceedings) to biology (a mutation that no parent possessed or transmitted). In the world of M+A, it refers to launching and building a new operation based on what you’ve learned in the past.

So when would an ambitious company that is trying to accelerate investor value favor de novo over acquisition?

Here are six circumstances where it makes abundant sense:

1. Strategic Sense: Sometimes investment platforms are built with a plan to grow by replicating their operating model, whether for products, services, or both. They may offer a very unique approach and de novo systems are built to support it.

2. Economics:Investors determine that de novo is more cost effective than acquisition. Considerable financial analysis, where the same time and dollars are applied, may be needed to support this decision.

3. Fragmentation: The market may be very fragmented with largely Mom and Pop companies, so there is often considerable room for best practice innovation by a larger, more established firm with more access to resources and technology. Within healthcare, this is particularly evident in the substance abuse treatment field, where there is a proliferation of small programs that are predominately 12-step-focused.

4. Quality: When a company has a high quality service model with demonstrated results, its leaders may believe that that the only way they can guarantee good outcomes is through de novo. For example, if a company has a dynamic, well-established company culture, it may be easier to replicate this in a new venture rather than try to insert in an existing agency.

5. Too Few Opportunities: Some markets are so new that they lack sufficient acquisition opportunities. In these cases, there is greater upside in de novo than hunting for hidden gems.

6. ROI Challenges: Although good acquisition targets exist, the investment frenzy may have pushed EBITDA multiples beyond a reasonable rate of return. This pushes many investors to the sidelines while others pursue replication through de novo as a more valuable course of action.As advisors, it’s crucial to recognize when and why potential clients may explore alternate options — so we can advise clients on the path that will create the most value for their company and have the greatest impact on their market. Most growing companies embrace, or at least strongly consider, both strategies at different points in their growth trajectory.