HBR Guide to Buying a Small Business

Think Big, Buy Small, Own Your Own Company

Richard S. Ruback, Royce Yudkoff

• Publisher: Harvard Business Review Press
• Year: 2017
• Print ISBN: 9781633692503
• eBook ISBN: 9781633692510
• Topic: Business
• Subtopic: Entrepreneurship
• Index: Business

Are you looking for an alternative to a career path at a big firm? Does founding your own start-up seem too risky? There is a radical third path open to you: You can buy a small business and run it as CEO. Purchasing a small company offers significant financial rewards—as well as personal and professional fulfillment. Leading a firm means you can be your own boss, put your executive skills to work, fashion a company environment that meets your own needs, and profit directly from your success.

But finding the right business to buy and closing the deal isn't always easy. In the HBR Guide to Buying a Small Business, Harvard Business School professors Richard Ruback and Royce Yudkoff help you:

• Determine if this path is right for you
• Raise capital for your acquisition
• Find and evaluate the right prospects
• Avoid the pitfalls that could derail your search
• Understand why a "dull" business might be the best investment
• Negotiate a potential deal with the seller
• Avoid deals that fall through at the last minute

PART ONE

Think Big, Buy Small

This part of the book introduces you to the opportunity to become an owner and a CEO of a successful existing business. In chapter 1, “The Opportunity: Entrepreneurship Through Acquisition,” we describe the opportunity involved in acquiring a small business, the magnitude of such an opportunity, and the practicality of achieving it. You’ll also meet people who have traveled this path, and you can begin to think about whether you want to do what they did. Chapter 2, “Is Entrepreneurship Through Acquisition for You?,” then focuses on the skills and traits we’ve repeatedly seen in successful, satisfied entrepreneurs through acquisition. Whether this path is right for you depends on what you value, what you don’t, and what skills you can draw on. Finally, in chapter 3, “The Acquisition Process,” we give you an overview of what to expect when you are searching for and purchasing a smaller business—steps that we will revisit in more detail in the remaining parts of this book.

CHAPTER 1

The Opportunity: Entrepreneurship Through Acquisition

If you are a manager thinking about making a change in your career or a newly minted MBA looking to begin a management career, this is an opportunity you should consider: You can buy an existing business, right now, and run it as CEO. We call this entrepreneurship through acquisition, and through our work teaching and researching the subject at Harvard Business School, we have seen many professionals find it an intriguing and rewarding alternative to a more traditional job.

Running your own company offers a radically different career path and career lifestyle than does working at a traditional large corporation. It allows you to lead an organization, make decisions that matter, and have the flexibility to work in a way that suits you best. If you have struggled to find professional independence and fulfillment in bigger companies, entrepreneurship through acquisition could be a path for you.

The financial prospects of buying and running a small business are also appealing. Entrepreneurs through acquisition usually purchase their company using a combination of debt from banks and equity from investors and structure the purchase so that they retain a meaningful economic stake in the business. Such a stake means that you have the opportunity for significant financial reward. You can buy high-quality small businesses for a price that allows you and your investors to earn an excellent return on your investment. Some of this return will be cash flows that you’ll distribute each year to your investors. Eventually, you and your investors might sell the business, and if you’ve been able to grow it, you should be able to sell it for far more than the purchase price, resulting in a meaningful financial gain. So, entrepreneurship through acquisition offers both an exciting career and a significant investment opportunity.

Part of what ignites our passion for small businesses is also the variety and uniqueness of the businesses themselves. Entrepreneurs whom we’ve studied have gone into home health care, exotic travel, musical instrument rental, specialized software, and manufacturing. Some of these businesses provide services you might have known about, like commercial window washing for skyscrapers; others you may never have thought of, like testing fire hoses. These are smaller firms with steady annual revenues of $5.0 million to $15.0 million and annual cash flows of $750,000 to $3.0 million. They aren’t rapidly evolving tech companies or glamorous businesses, and journalists don’t write as much about entrepreneurs through acquisition as they do about founders of big start-ups. But we estimate that there are about 200,000 of these businesses in the United States—with many more around the world—and that every year thousands of them are bought and sold.¹

You may be more qualified to run a small business than you think. Experiences such as managing others and taking on responsibility for financial performance give you much of the background you need. We’ll introduce you to a number of entrepreneurs through acquisition—people we’ve known and worked with (and in some cases even invested in) so you can learn from their experiences. You may see that these people are not so different from you. (See, for example, the sidebar “Tony Bautista: Entrepreneur Through Acquisition.”) Almost none of them were CEOs before; rather, they typically have 5 to 15 years of professional experience, mostly at the junior level, and some have middle-management experience. None had bought a business before or had significant personal wealth when they started, and all of them raised money from investors to complete their acquisition. Some of the entrepreneurs pursued opportunities in the United States; others found that this path was the perfect way to put their management skills to work in their home countries around the world. And contrary to popular myths about entrepreneurs, all of them are generally careful people rather than reckless risk takers. Instead, what sets them apart is that they are energetic, tenacious, and smart individuals open to pursuing opportunities in smaller businesses and niche industries rather than focusing only on opportunities with the biggest brands or in the most popular sectors.

Tenacity is important because there can be some significant challenges along the way. As we studied the market for these businesses, we were surprised to find that the earliest stumbling block for purchasers—and one of the biggest—comes in the search for and acquisition of the business. We’ve seen potential buyers quit because their search has dragged on unproductively too long; we’ve seen deals fall through after months of work because the buyer didn’t ask the right questions of the seller at the beginning of the process; and we’ve seen starry-eyed searchers buy businesses that didn’t live up to expectations. We’ve also seen many people who didn’t even start the process, because they didn’t feel qualified or didn’t know how to begin their search or raise the capital to pay for their search or their acquisition.

TONY BAUTISTA: ENTREPRENEUR THROUGH ACQUISITION

Tony Bautista, CEO of Fail Safe LLC, a leading fire-hose testing service for local fire departments, acquired the company after a 10-month search. “Looking back,” Tony observed, “the biggest barrier wasn’t capital, wasn’t experience, wasn’t contacts. More than anything, the barrier is internal: It’s making the decision to do it.”

Boston-born Bautista grew up with his younger sister in a household headed by a single mother, herself a first-generation immigrant to the United States. “We were certainly never hungry,” he reflected, “but mom usually worked two jobs, and we also relied on food stamps. More than anything, my mother impressed on my sister and me the value of an education.” Tony was enrolled in a weekend and after-school acceleration program at his local public school, and the program eventually led to a full scholarship to college. While there, he earned money managing a tutoring service for high school students.

After college, Tony worked for a large investment-management company for over three years. “I learned a lot about financial analysis and accounting,” he said, “but I felt I was just shuffling numbers around. When I ran the tutoring service, I could see the impact of my work. This disconnect bothered me, and when my mom passed away prematurely in 2010, I was galvanized to do something about it.” Tony enrolled in business school and worked in venture capital in the summer between his first and second years. “That didn’t do it for me either,” Bautista reflected. “Venture capital still seemed removed from what had satisfied me so much in the tutoring firm—satisfying clients, giving a paycheck to employees, and directly building a business. On top of that, backing start-ups seemed so risky to me.”

During his second year at business school, Tony decided to search for an existing smaller business to buy, although he was only 28 years old. “Besides being a hard worker,” he said, “I think my greatest strength is being able to relate to a wide range of people. Not coming from a wealthy background but going to college and business school taught me this. I could talk to business brokers about numbers and financing a purchase; I could talk to rough-edged owners who ran firms with lots of blue-collar employees; I could talk to investors who might back me in my purchase.”

In 2014, Tony acquired Fail Safe from its retiring CEO/owner. Fail Safe sends crews to local firehouses to perform annual safety testing of fire hoses; Tony is immersed in the tasks of talking to customers, scheduling, managing his crew chiefs, and the other myriad tasks of running a mission-critical service business with workers spread across many states. “Looking back,” he said, “my biggest gap was a lack of experience in the details of operating a business: How exactly do you run a monthly payroll? for example. I learned as I went; it was sometimes painful, but not fatal.”

Bautista added: “For me, the most satisfying experience is having employees do work for which I send them a paycheck: I am supporting someone who is like me, and, of course, when I’m doing this, it also means my company is making money.”

The search process is critical. If it works, you’ll be managing the business for a significant number of years—perhaps much of your remaining working life. The financial success of the business will determine your lifestyle, your location, and even the schools you can send your kids to during that time and after. There is also no easy out if you make a mistake and buy the wrong company. If your company fails, you’ll likely lose it and all of your savings, as well as any investments you’ve accepted from friends and family. Choosing well is very important.

In this book, we give you the advice and tools you need to successfully find and purchase the right small business for you to run. We’ll show you how to take several important steps:

• Determine if this path is right for you.
• Use your time and resources during the search efficiently.
• Pick the right business for you.
• Ensure that the owner is serious about selling at a reasonable market price.
• Raise the capital you need for your search and for buying the business you have selected.
• Focus on the right priorities as you close the deal—and beyond.

Managing the Risks of Ownership

Does running a small business seem risky? Perhaps you’re imagining the things that could go wrong once you acquire a company: What if it stops generating as much revenue when you are at its helm? What if your most valued customers switch to a competitor? What if the market for the hot new technology you’ve invested in crashes? What if you can’t pay the employees who depend on you? What if, what if, what if? You can probably assemble a nearly endless list of challenges. It’s true; a lot of bad things could happen. Be mindful that they could happen to a big firm too but, as a small firm, your enterprise is certainly less sturdy than a large corporation.

But during your purchase process, there are ways to mitigate these risks. In this book, we show you how to find a business that is enduringly profitable, one that is more likely to continue to have a stable income over time. It’s not always easy to know what makes a small business enduringly profitable, but we have identified a few indicators to use as you evaluate potential businesses: for example, the business should be an established one that is growing slowly and has recurring customers. We recommend against buying a tech company or any business in a volatile industry, and we urge you to stay away from companies that “just” need a turnaround. We think “dull” businesses are terrific business opportunities—and a great way to mitigate the risk of small-business ownership.

Also, recognize that the alternatives to entrepreneurship through acquisition may actually be more risky than you think. If you’re considering entrepreneurship by start-up, for example, you must build a company from scratch, without knowing whether the product or service can support a profitable business. When you start a company—before you make any money—you face a long list of required tasks. You must develop a product or service, identify your potential customers, and figure out how to deliver the offering to the customers. You must also hire all your workers, market to customers, build a management system, and then hope your offering is something customers want to buy at a price high enough for you to make a profit. Buying an existing, enduringly profitable business is less risky—not 100% safe, but much safer because the fundamental questions about the viability of the basic business model have already been answered. When you buy a business, the product or service is already established, and if you buy the kind of company we recommend, it is likely to produce steady cash flows while you focus on improvements and growth.

And what about working at a large firm? All of the entrepreneurs we studied turned down or quit a good job at a large organization to pursue this opportunity. When we asked them about the risks involved, they reminded us that working in a large company is also risky. Coca-Cola, Intel, or Tata are not going to vanish the way that a small enterprise might, but in a large company, your division might shut down, your job might be eliminated as part of a reduction in force, or your career could be held back because of the politicking common to large organization...

Table of contents

• Cover
• Series Page
• Title Page
• HBR Press Quantity Sales Discounts
• Copyright
• Contents
• Preface
• Part One. Think Big, Buy Small
• Part Two. Preparing for Your Search
• Part Three. Finding the Right Small Business to Buy
• Part Four. Making an Offer
• Part Five. Completing the Acquisition
• Conclusion: Parting Thoughts
• Appendix A: Indication of Intent (IOI) for Zeswitz Music
• Appendix B: Letter of Intent (LOI) for Zeswitz Music
• Index
• About the Authors