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Absentee-run businesses


JBird

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I've seen a lot of small businesses ($500k- 2 million price tag) selling for 3-4x owner earnings. At those prices it seems like if the business and industry is sound and the manager is able and honest you're bound to make above-average returns. But I'm suspecting there are as many horror stories from these situations as there are happy outcomes. If that's actually true, what separates the two?

 

I've never wholly-owned a business myself, absentee or otherwise, so I'm just trying to figure out how much I don't know.

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I have no experience in this area either, but as is usual, my view is that my cocksure ignorance is ample qualification to offer a couple of observations.  ::)

 

If you can find a $1m business selling at 3X, that means that owner earnings are $333k.  But, as an absentee owner, you'd need to pay somebody to manage your business for you.  If that costs $100k/year, your net would be $233k on your $1m investment.  So, assuming that there's no CAPEX requirement, that would be 23.3% return annually. 

 

I would suggest that the simple purchase of BAC shares today would probably net you a double-digit return over the next 2 or 3 years.  With a bit of leverage you could push that up near the 23.3 percent that you might get from your small business.  The key difference is that if you ever tire of BAC for any reason, you can exit very easily....but if you ever tire of your small business, you could have one hell of a tough time to exit.

 

 

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I've seen a lot of small businesses ($500k- 2 million price tag) selling for 3-4x owner earnings. At those prices it seems like if the business and industry is sound and the manager is able and honest you're bound to make above-average returns. But I'm suspecting there are as many horror stories from these situations as there are happy outcomes. If that's actually true, what separates the two?

 

I've never wholly-owned a business myself, absentee or otherwise, so I'm just trying to figure out how much I don't know.

 

You're right - there are very attractive returns to be had acquiring solid businesses at those prices. As Stubble mentions, however, if you're going to be absentee you need to make sure you're still generating an attractive return after paying the folks to mind the till. Businesses of this size frequently sell for such low multiples because they (a) are "flying low to the ground," meaning any hiccup in revenue could have disastrous cash flow implications, (b) often have substantial customer concentration, and © often thrived by sheer force of personality of the existing owner. All that being said, the ROICs on some of these businesses, because they fly below the radar of larger competitors, can be phenomenal.

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We see these issues of this in the private businesses we value.  One thing you may want to see if the business has recurring revenue not tied to the owner/employees.  In some of these small businesses it hard to separate the owner from the business and you need to understand customer purchase decision rationale (the less tied to the owner/principals the better).  However, it is hard to find these types of businesses in the price range you are considering.

 

Another aspect is the lack of marketability and the potential of having to add funds or personally get involved if the business goes south for whatever reason.  This is like having a rental with little or no real estate collateral so it can be a full time job.  In my mind marketable securities are much easier to deal with on an absentee basis but that is why there are so many of these at low cash flow multiples.  I found that many times the best buyer of these firms are operators who have the expertise and skill to maximize the cash flows from these businesses.

 

Packer   

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I've seen a lot of small businesses ($500k- 2 million price tag) selling for 3-4x owner earnings. At those prices it seems like if the business and industry is sound and the manager is able and honest you're bound to make above-average returns. But I'm suspecting there are as many horror stories from these situations as there are happy outcomes. If that's actually true, what separates the two?

 

I've never wholly-owned a business myself, absentee or otherwise, so I'm just trying to figure out how much I don't know.

 

I have a question. If someone is selling a business for 3-4x owner earnings. Why are they doing it? Wouldn't it be better for them to just hold it?

 

This reminded me of a guy I know. He starts restaurants, gets them running till they are doing awesome business and then sells them around 3 years later. Then he starts another restaurant. He is the reason his restaurant does so well. People buy his restaurants but I don't think the restaurants do as well as they did when he was running them.

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I have a question. If someone is selling a business for 3-4x owner earnings. Why are they doing it? Wouldn't it be better for them to just hold it?

 

This reminded me of a guy I know. He starts restaurants, gets them running till they are doing awesome business and then sells them around 3 years later. Then he starts another restaurant. He is the reason his restaurant does so well. People buy his restaurants but I don't think the restaurants do as well as they did when he was running them.

 

Often the owners are older and looking to monetize what in many cases is nearly their entire net worth.

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\You're right - there are very attractive returns to be had acquiring solid businesses at those prices. As Stubble mentions, however, if you're going to be absentee you need to make sure you're still generating an attractive return after paying the folks to mind the till. Businesses of this size frequently sell for such low multiples because they (a) are "flying low to the ground," meaning any hiccup in revenue could have disastrous cash flow implications, (b) often have substantial customer concentration, and © often thrived by sheer force of personality of the existing owner. All that being said, the ROICs on some of these businesses, because they fly below the radar of larger competitors, can be phenomenal.

The above is right on target.

 

I've never bought a business, but have thought about it quite a bit lately. There is a local upscale restaurant where I live that is for sale for $200,000. The owner says he makes $120,000/yr, but he is the chef and manager. So if I were to buy it, I'd need to hire a chef (37k/yr according to him) and a manager (30k/yr if I'm lucky) plus financing to buy it (about 18k/yr). So it goes from buying it at ~1.6x earnings to about ~5.7x earnings. That still isn't too bad, but can I invest my money elsewhere and make a higher return with less risk? Adding another 200k of real estate is much less risky in my eyes and I know how to run it well. The main reason to buy the restaurant would be to expand the number of locations dramitically.

 

One upside of owning the restaurant would be good food all the time. That may be my downfall though  ;)

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I've never bought a business, but have thought about it quite a bit lately. There is a local upscale restaurant where I live that is for sale for $200,000. The owner says he makes $120,000/yr, but he is the chef and manager. So if I were to buy it, I'd need to hire a chef (37k/yr according to him) and a manager (30k/yr if I'm lucky) plus financing to buy it (about 18k/yr). So it goes from buying it at ~1.6x earnings to about ~5.7x earnings. That still isn't too bad, but can I invest my money elsewhere and make a higher return with less risk? Adding another 200k of real estate is much less risky in my eyes and I know how to run it well. The main reason to buy the restaurant would be to expand the number of locations dramitically.

That smells fishy to me.

 

Haven't you watched Kitchen Nightmares?  The restaurant business is not easy.

 

Also, his numbers don't make sure.  He should go out and hire a 37k/yr chef and a 30k/yr manager if it was so easy to make 53k/yr.  I have a feeling that his restaurant is extremely marginal and he wants to get out of it because it's a bad business for him.

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That smells fishy to me.

 

Haven't you watched Kitchen Nightmares?  The restaurant business is not easy.

 

Also, his numbers don't make sure.  He should go out and hire a 37k/yr chef and a 30k/yr manager if it was so easy to make 53k/yr.  I have a feeling that his restaurant is extremely marginal and he wants to get out of it because it's a bad business for him.

 

I have never seen kitchen Nightmares, but I am well aware of the difficulties of the restaurant business. No one ever says it is easy.

 

The numbers he gives have not been verified. I haven't seen his books or accounting practices. He has been in business for nine years and said he is tired of it dealing with the small day to day issues. He has hired a chef. That's where the 37k number is from. The idea that he is selling came out from a random chat with friends.

 

I do appreciate your input though. I'm still considering it, but obviously much more due dilligence is needed.

 

By the way, are you in the restaurant business? Any tips?  :)

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No, I'm not in the restaurant business.

 

It just struck me that a lot of people in the business say that it's not so great.  Anthony Bourdain says not to do it.  David Chang had a rough time with the business side (this is from reading his cookbook).

 

It always struck me as a very, very difficult business.  But people rationalize it away, plunge in with their life savings, and some of them end up crying on camera on Kitchen Nightmares.  (I would too if I lost most of my life savings.  There's the dignity aspect too because your friends will envy you for being your own boss, and you lose that when you lose your restaurant.)

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The owner says he makes $120,000/yr, but he is the chef and manager. So if I were to buy it, I'd need to hire a chef (37k/yr according to him) and a manager (30k/yr if I'm lucky) plus financing to buy it (about 18k/yr).

 

At those rates, I wouldn't have a problem if the employees robbed me blind. Those are super below market rates in either case, especially if benefits are included in that wage, and they'll want to make up for the differential some way.

 

Why work their duffs off to make you money when they could just go find a do-nothing govt job and have less stress and generate a higher hourly rate?

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The owner says he makes $120,000/yr, but he is the chef and manager. So if I were to buy it, I'd need to hire a chef (37k/yr according to him) and a manager (30k/yr if I'm lucky) plus financing to buy it (about 18k/yr).

 

At those rates, I wouldn't have a problem if the employees robbed me blind. Those are super below market rates in either case, especially if benefits are included in that wage, and they'll want to make up for the differential some way.

 

Why work their duffs off to make you money when they could just go find a do-nothing govt job and have less stress and generate a higher hourly rate?

 

This is a small town in West Virginia. Living expenses are low. 37k/year isn't a terrible salary to earn here. You can live decently on that.

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This is a small town in West Virginia. Living expenses are low. 37k/year isn't a terrible salary to earn here. You can live decently on that.

 

And you can live decently as the absentee operator pulling in $53k (or $35k inclusive of financing costs). The manager's knowledge of this (since they will have a good idea of the flow of money) may create friction.

 

It's not terrible, but if that is inclusive of benefits, and they're the ones going through the day-to-day operational struggles, expect for them to get extra somewhere. Here are 99 ways they can: http://skurlas.files.wordpress.com/2012/03/99-ways-to-steal-sps.pdf.

 

I am reminded of a court case where a fast food cashier was able to steal $20k over 2-3 years. Rather than being miffed at the ordeal, the absentee owner should have been satisfied that they were still able to generate semi-passive income even in light of at least one leak that took a few thousand orders a year to recover from.

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I've spent (and continue to spend) a significant amount of my time looking for these types of businesses, mostly in Chicago and the Midwest. The problem you run into more than anything else, is that the "businesses" are mostly just a job that you are buying. After adjusting the earnings for the cost of hiring full time managers (of the caliber that you want so that business can actually be close to 'absentee-run'), the earnings multiple of the purchase prices often goes up too much that its not a reasonable return given the illiquidity, transaction costs, and time involvement.

 

After that, another big issue you will often find is that the revenues for these small businesses are strongly tied to just a handful of customer relationships. During due diligence, you will need to get comfortable that the large customers are not sustained entirely on a personal relationship with the former owner.

 

The business brokerage's lower market space is shockingly low quality. The brokers at the Sunbelts of the world, and on BizBuySell.com, mostly convince a business owner that they can take their business to market at a unrealistically high valuation. After that, the bids come in at much lower prices, and the business owner has simply already mentally retired, so they go with the lower bids even though they wouldn't have begun the process if they knew the final selling price was going to be so low. Ultimately, the SBA loans enable most of these transactions because their debt is available for a reasonably low yield and with a reasonably low downpayment.

 

Bottom line - like everything else, if you find the right opportunity, it can be lucrative, but for every worthwhile opportunity, you have to sift through 1000 bad ones first...

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I think gg is right on point here.

 

As an example, after oddball posted a link to a video game store for sale on the "What to do with $100k cash" thread that was nearby, I actually went through the store's UPC list and valued them according to Amazon resale value on the inventory. Even being a little generous, of the $30k they listed at, the inventory was maybe worth $3k-$4k or so, and that was assuming 100% sale of all products, which wasn't likely given the low sales rank (or popularity) of a lot of the products.

 

In addition to this store, I've valued about 2 other stores the same way with similar conclusions. I can't imagine trying to get into a business where you just have to "take the owner's word" as to the value of the inventory/operations.

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Hey Morgan, I was thinking about the restaurant business you were looking at. I was thinking you could partner up with a chef so both of you have ownership interest in the business and since the chef owns part of the business, it incentives the chef to make sure the restaurant does well. Yes the cash flows will be split among you two but I think its better than being totally absentee. Also you do need to find a partner you can trust. Thoughts on this?

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Hey Morgan, I was thinking about the restaurant business you were looking at. I was thinking you could partner up with a chef so both of you have ownership interest in the business and since the chef owns part of the business, it incentives the chef to make sure the restaurant does well. Yes the cash flows will be split among you two but I think its better than being totally absentee. Also you do need to find a partner you can trust. Thoughts on this?

 

If I went down this route, I would make sure the Chef has some kind of financial investment in the business too, gotta have skin in the game if he/she is going to be a 50% partner.

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I would never invest in a restaurant unless it is a fast food joint and just requires unskilled labor.  Restaurants do not translate into absentee-run business at all.  It is very time consuming, lots of headaches, and managing the inventory and staff is never an easy task.  Someone pointed out that with most small businesses "you are essentially buying a job." The guys who are able to offer the highest prices are the ones who plan on working there 7 days a week and not having to pay a manager.

 

If you want something absentee, buy a fast food joint. Buy a rental property. Buy a anything else but a restaurant. What will you do if your chef walks out the door one day?

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And you can live decently as the absentee operator pulling in $53k (or $35k inclusive of financing costs). The manager's knowledge of this (since they will have a good idea of the flow of money) may create friction.

 

This is something I have wondered about. Pay differences must cause friction at a certain point for some people. There is another local business where my friend works and I learned revenues, COGS and markup and from there can estimate the other expenses. The owner probably makes 60-70k/yr and pays, in total, his three part-time employees about 29k/yr ($10/hr * 55 hours/wk * 52 weeks/yr). Only one employee is needed at a time. My friend never complains about the pay and has a few other part time jobs to make ends meet. Not that I don't agree with you, pay differences can cause friction, but I think a good portion of the population doesn't really think about it too much. Board members probably care more than average because we're investors and naturally just run the numbers in our head. Either way, it's interesting to think about and be aware of.

 

As per the chef partnership comments, that is something I have thought about. It makes more sense, especially in a rapid expansion scenario. Thank you everyone for the comments.

 

 

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