Finding the RIGHT business for YOU
The 3 criteria to buying a profitable business that fits your dream lifestyle
Article Summary:
3 criteria to choosing the correct business to buy
Management
Profitability
Competition
Finding out the answers to the 3 criteria is a mixture of good rapport with the seller, some private investigation, and an awesome due diligence partner.
The situation
Businesses are unique. Every one is different.
Some are cool and trendy, some are lame and boring (just like us).
Even businesses that are in the same franchise or under the same owner have major differences.
Some of those differences are minor, but some can be game-changers.
When you are looking to buy a business it is important to find one that meets a certain criteria that will set you up for success and become a solid foundation for your future acquisitions.
But how do you know for sure? You don’t.
Due diligence is extremely important, but will not be able to tell you EVERYTHING about a business. Some things are learned by doing.
When I talk with my clients about choosing the “right business” for them, I focus on three areas.
Management
Determine what your goal is.
You want a 9-5 job? Or a couple hours a week?
If you want to purchase a business and never think about it again, your in the wrong place.
Buying small businesses is not completely passive.
If you are looking to leave your current W2 job and work full-time in a industry that you love. That’s great! You can still create life-changing wealth.
My preferred path (and most of my clients) is to have a general manager run the business while they focus on increasing cashflow and buying other businesses.
In order to have a general manager run the business it needs to meet certain thresholds of profitability and complexity.
The business needs to be large enough to sustain the salary of a general manager (still leaving profit for you) and not too complex to find someone with the skills to run it.
To sustain a general manager, the business needs to be able to pay around $50k-60k a year plus profit sharing (to align incentives) and have enough left over to comfortably grow the business and leave you a tidy profit.
Profitability
In order to accomplish this, you are looking for a business doing consistently over $250k in SDE (for first acquisition).
What does that mean?
It means after all expenses AND the loan costs that you incurred buying the business, the business will be making $250k+ in profit.
This roughly translates to a purchase price between $600k-$1M.
The price will vary depending on the amount of assets and the industry the business is in.
There are multiple ways to buy a business making less than $250k profit and have a general manager run it BUT it is much riskier and the probability of a cash-flow crunch is much higher.
For the majority of you reading this, the $250k minimum is a good benchmark to have for your first acquisition. Add-on acquisitions are a different story and can be much lower in SDE, even burning cash (more in future article).
Competition
The competitive landscape is a huge factor when looking at buying your first business.
Every industry has competition. That is healthy.
You are looking for two things: Moats & Fragmentation
Moats are barriers to entry for your business. Moats exists in every industry but some are much larger than others. The bigger the better.
An example would be the difference between a landscaping company and an HVAC company.
In most states, anyone can start a landscaping company if they go to Home Depot and buy a push mower. In 1 day they can be up and running and mowing lawns.
HVAC is a different story. In every state, HVAC companies need a license to operate and that license is hard to get. It incurs significant cost and years of training to get.
To prove it, google “landscapers near me” and “HVAC near me” and let me know which one has more options. It probably isn’t close.
You want the largest moat you can get.
The second aspect is fragmentation.
Fragmentation is the sophistication of a particular industry. You want to buy a business in an industry where BIG players do not like to play. Some of those big players include private equity shops and massive companies like Amazon and Walmart.
You want industries that are filled with mom & pop competition and not an industry that is being consolidated by institutional money.
Example would be pet grooming vs. self-storage.
Over the last 15 years self-storage has become super competitive as more and more institutional investors have gotten into the space and have driven prices high and cap rates low.
Conversely, pet grooming is a growing industry that is dominated by mom & pop owners and has little incentive for institutional investors to get involved (scaling issues).
How?
Now that you know the criteria that you are looking for in your first acquisition, there are a few ways to find out this information.
Good rapport with the seller
It is extremely important to work on building a good relationship with the seller from the start. If they like you, they are much more willing to let you visit their business and talk with their employees (gold mine of info)
It will also give you relationship equity as you go through the due diligence process when the surprises pop up. The seller will be willing to negotiate more since they want you to buy the business.
Private investigation
Sellers have a vested interest in only showing you the “good” stuff regarding their business. So you need to use ethical ways in order to get the “real” story.
Some of these strategies include calling the business as a customer and seeing what the customer experience is like (tells you A LOT)
Checking out the social media of the business and their product/service reviews (very important)
Due Diligence (DD)
Having a quality DD partner is worth it’s weight in gold. DO NOT skimp on your DD provider. I have done that in the past and it ended up costing me more money that I would have spent on a top tier DD provider.
Keep a neutral mind throughout the process. Whatever is turned up in DD, investigate it and if true and a deal-breaker, be prepared to drop the deal. Never get emotionally attached to a deal.
Make sure to get a QoE (quality of earnings) report so that your idea of the businesses profitability is accurate and your offer price is correct.
Connect
Buying businesses can be hard, but it is also life-changing if you buy right and repeat the process.
If you have questions or comments, please post them below and I will respond to each of them.
If you are interested in 1-1 coaching on how to buy businesses for generational wealth, comment “more” below and I’ll reach out with next steps.
Ben
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