Local businesses

[LC]

Has anyone looked into buying local businesses? I periodically browse biz upswell.com and there are businesses, albeit not great ones, selling for 2-4x cash flow. The seasoned appraisers here will argue there is a reason for this (commodity businesses, geographic concentration, etc.) but for something like a convenience store or coffee shop, I would imagine it's not hard to manage. Does anyone on the boards have experience with this, or know of obvious pitfalls to look out for? Just curious, TIA.

[TwoCitiesCapital]

Would be curious as well. Have been doing the same thing as OP.

[rayfinkle]

I've done this from a few different angles:

-Professionally: bought out small $5-50M revenue businesses without audits

-Personally: Spent several months shopping for smaller ($100-500k owners fcf) businesses

 

My learnings are:

1) You can buy businesses cheap: 2-5x owners cash

2) You can get unreal leverage (6-12 month payback on owners cash), with personal guarantees (be careful, this steals sleep)

3) Determining owners' FCF is hairy. I've literally spent a month of 7 day weeks, 10 hour days digging through bank statements and credit card statements, talking to finance partners & equipment appraisers to nail down my 90% confidence FCF figure. It's possible, but doing the work is IMPERATIVE. Even so, cut 30% from your best work and exercise some good professional skepticism with respect to seller representations

4) There is real opportunity to buy stable businesses cheap, but you'll need to put 6-12 months into learning every little detail. It's not easy and on day zero everyone knows more than you.

5) Although many small businesses are under-managed, don't underestimate the power of momentum (in other words, sellers have done things for a reason. It could be laziness, but often it's a real hairball problem

6) Don't fire people day 0. I've seen this go sideways. Aim first then shoot.

7) Access to capital / banking relationships is a competitive advantage. Knowing how to manage a capital structure is not a common skill.

[yadayada]

Ray where do you shop around for these private businesses? Is there like a register? Or do you just make phone calls to random businesses.

[Philip Morris IV]

There was a thread on this topic earlier this year -- I remembered because I was also interested in this.

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/absentee-run-businesses/

 

As much as I like the idea, Packer and gg made very effective cautionary points.  The marketability of your stake and key-people risk is substantial in this space.  A majority are owner-managed and therefore not passive investments.  There's also conflicts of interest with the business broker websites.

 

I wonder if one would have better luck just approaching business owners.  If you have reliable intelligence, life events like divorce, death, and retirement can perhaps trigger quiet business sales that wouldn't appear online.

[rayfinkle]

all of the above. brokers are tough but have deal flow. door knocking is tedious but can pay off.

[LC]

Thanks for posting your experience, ray.

 

What are the red flags that immediately tell you to pass? Part of what I'm trying to figure out is how to best filter through these. With public companies it is a bit easier because financials are usually spelled out cleanly and there is a lot of information as to industry dynamics.

[LC]

There was a thread on this topic earlier this year -- I remembered because I was also interested in this.

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/absentee-run-businesses/

 

As much as I like the idea, Packer and gg made very effective cautionary points.  The marketability of your stake and key-people risk is substantial in this space.  A majority are owner-managed and therefore not passive investments.  There's also conflicts of interest with the business broker websites.

 

I wonder if one would have better luck just approaching business owners.  If you have reliable intelligence, life events like divorce, death, and retirement can perhaps trigger quiet business sales that wouldn't appear online.

Thanks for that link.

 

Marketability isn't a huge concern to me, but key man risk is.

 

I'm also very curious about the brokers who are selling these deals. I assume the diligence they do is minimal at best. Therefore the buyer needs to work with the seller to obtain accurate financials information, client/vendor lists, etc. I want to be prepared before I engage a seller in a round of due diligence, and also know what to look out for.

[oddballstocks]

There are some insane deals out there.  Someone passed along a deal they participated in maybe two years ago now.  It was a chocolate shop in Long Island that was doing $250k in FCF a year, they were selling it for...$250k.  The owner divorced and needed to cash out ASAP, they also liked the company and wanted to continue to work there running it.  The friend ended up investing.

 

I know someone else who found a similar business in Florida and invested.  He outlined his goals and the owners who were looking to cash out were so excited they stayed to run it with him.  They got a payday plus the potential for the future.

 

Here's the thing with these deals, they are often low in terms of valuations but there is a lot of upfront legwork required.  You might need to pay $5-10k in lawyer and accountant fees for due diligence alone.  So be prepared to pay maybe $5k and then have to walk away, that's expensive. 

 

Key man risk is big, but I think you can minimize that by working out some transition period.  Don't buy into something where the key man can't walk away though because they're married to their baby.

 

There's a book I'd recommend, The Origin and Evolution of New Business.  Pabrai mentioned it in one of his talks, for 99% of this board it isn't applicable.  But if you own your own business, or are starting one the book is invaluable.  It talks about how most bootstrapped businesses start, factors for success.  Then how there's an entirely different set of skills and factors between what's needed to start something from scratch and grow it beyond a certain point.  This gap is the reason most small businesses never grow into large companies.  Recognizing this, and seeing the skills required will be good.  You'll also appreciate the key man risk more as well.  In the beginning EVERYTHING is done by the founder.  They create a business by sheer force of will.  That means some relationships and clients are there because of the founder, the Christmas gift they send, the kids on the soccer team together etc.  You need to appreciate these things, they are important.

 

You will probably end up owning something smaller that isn't scalable but throws off a lot of cash flow.  The leg-work up front is why most don't get involved in these things.

 

One other thing, those two deals mentioned above were found on brokerage sites.  Just like stocks those investors continually turned over rocks for months before finding a deal that looked decent.  A brokerage site is just like real estate.  Put yourself in the shoes of a local ice cream shop owner who wants to sell.  How do you find a buyer?  You probably list and wait.  The broker gets a cut, but that's fine.

[bookie71]

A good source could be your CPA (Chartered Accountant) and attorney.  They could have a client wanting out for a variety of reasons.

[LC]

Nate, thanks. Very informative as always. Also thank you PM and bookie for potential outlets to find other deals.

[JBird]

Thanks Nate. Great post as always-- bought the book on your recommendation.

[oddballstocks]

Thanks Nate. Great post as always-- bought the book on your recommendation.

 

Thanks, you'll enjoy it.  As I read it I could a lot of it applied to different companies I've worked at both large and small.  My wife thought I was crazy as I read it.  I just kept nodding my head, the book explained so many real-world things that I'd seen, but couldn't put my finger on.

 

I'm sure someone smarter than myself will be able to take the themes from that book and then apply it to investing as well.  You could probably use it as a blueprint for finding growth companies that will explode from being small to large.  If someone could identify true growth valuation doesn't matter as much anymore, just buy and hold on.

[peter1234]

Fascinating discussion.

 

Any insights on how a good buy-out structure increases success rate?

 

Like mile-stone based earn-outs on sales, profits, customer retention?

 

Go work in the business for 1 week, 1 month, etc?

 

 

[siddharth18]

Great info in this thread! Is there a particular time of the year that better deals are likely to be found? (for example stocks get beaten down during the month of December).

 

 

Also like stocks, there are lot more deals to be found during a recession/slowdown?

 

 

Cheers!

[Uccmal]

Awesome thread. 

 

I had a long talk with a fellow, who was slowly selling a coin laundry in a small town in central ontario.  I was doing the laundry.  He was quite interesting.  The coin laundry business is one of the few businesses where you get cash up front and pay your bills out over time.  He had it doubly good in the small town he operated in.  He left the doors open twenty four hours with no one around.  You couldn't do that in the city.  The only drawback with this business was that you or me have to collect the actual cash, or you have to have someone you totally trust do it.  I almost bought the business but he wanted far too much for the adjoining land. 

 

Other businesses of this type that come to mind are car washes, and self storage units.  None of them suffers from key man syndrome. 

 

Businesses at the opposite end of the spectrum require one to put cash up front before sales and rely too much on working extremely long hours.  Convenience stores come to mind, as do most retail where some employees dip into the cash, products sit on the shelves if you goof up etc. 

 

Small manufacturing and distribution companies rely on the key man.  If its not you, then who is it. 

 

After giving this alot of thought, I realized it wasn't for me.  I am too good at value investing to justify the effort spent on running a business.  If I had a good idea for some product it would be fun to produce it, but I dont.  I am a lousy sales person, which is vital when running many businesses.  I would be at the mercy of key man in the sales department. 

[rayfinkle]

Thanks for posting your experience, ray.

 

What are the red flags that immediately tell you to pass? Part of what I'm trying to figure out is how to best filter through these. With public companies it is a bit easier because financials are usually spelled out cleanly and there is a lot of information as to industry dynamics.

 

It's tough. Here's a few:

-Is the owner selling for the right reasons, or is the roof on fire?

-Can you back into the "capacity earnings" of the business, and do they foot with your assessment (and the sellers representation) of actual cash production? If not, why?

-Does the business have a local moat?

*can amazon kill it

*coin laundries are great bc convenience matters a lot

*service companies often have serious key man risk

 

Just riffing, will think of more

[giofranchi]

I have never bought a whole business. Until my two businesses keep giving me free cash that is a meaningful percentage of the capital I manage, I don’t feel the need to add a third business.

The capital I manage though is growing faster than how my two businesses are growing their free cash. And if I want to keep new cash coming in as a meaningful percentage of the capital I manage, sooner or later I will have to look around for a third business.

 

My experience with the first two leads me to the following conclusion. I want the third business to be:

 

1) Very low in capital requirements. It doesn’t necessarily need to possess high margins, but I should be able to take out of the business practically all its earnings. The freedom to reinvest them in the same business, or somewhere else is invaluable. Furthermore, a business that doesn’t require much capital is easier to grow or shrink as necessities require. You never know what might happen, so flexibility is a huge advantage.

 

2) On “autopilot”, or almost… It is not realistic a business won’t require your continuous attention, but you should be able to confine your duties basically to: a) strategic decisions (which goals to pursue, and how to evolve), b) watchful control. Your second duty should help mitigate what has been called the “key man” risk… But whever you hire someone, that risk cannot be eliminated! Therefore, first of all you must choose who will be in charge of operations, and you must choose wisely! ;)

 

Gio

 

[dolce far niente]

I'm a young business owner myself.

 

Les Schab was an interesting & insightful book. Writer details how profit sharing is done among branch manager, service centre and himself. Hat tip to Munger for this book.

 

In my area, the smaller accounting firms may also throw up some good deals from time to time.

[giofranchi]

Les Schaw was an interesting & insightful book.

 

+1! Very interestig! :)

 

Gio

[yadayada]

what about websites in niche areas? A friend of mine had a tracking website for some video game. Produced nice and steady cash flow from advertising and required very little maintenance work. They can be the perfect business.

 

Read an AMA about some guy a while ago who would buy websites that were badly run or designed but got decent traffic. He would then change design, change the way they monetized it and often make quite nice profit.

 

Ofcourse that all requires the ability to code and know about this stuff.

[txfan2424]

bumping this

[mjohn707]

bumping this

 

I'm from this world and it seems like this would be pretty tough to do as an outsider in a industry you didn't know well.  There are usually a lot of not so visible inputs that mom and pop are putting in that would be hard to replicate as a passive investor, and you could be in for some thorny regulatory and personnel issues, key man risk too.

 

It just seems very tough when you don't have enough scale to pay a very large salary for a CEO type of position

 

[DooDiligence]

what about websites in niche areas? A friend of mine had a tracking website for some video game. Produced nice and steady cash flow from advertising and required very little maintenance work. They can be the perfect business.

 

Read an AMA about some guy a while ago who would buy websites that were badly run or designed but got decent traffic. He would then change design, change the way they monetized it and often make quite nice profit.

 

Ofcourse that all requires the ability to code and know about this stuff.

 

+ bump, bump

[StockDuck13]

This is one of the more fascinating threads I've read in a while.. Sort of a "how to" discussion on building your own little Berkshire.

 

There is a Dairy Queen franchise in a small town near where I live that is not known for speedy or efficient service. But they are the only real ice cream shop in town and so they get an undeserved amount of business (they're essentially a monopoly).

 

I believe that with some retraining, a few staff changes, and some remodeling, it could be a very profitable business. Does anyone have any experience in this area that can contribute? I don't have a lot of money and would likely need an outside investor or substantial seller financing, not to mention actually buying the place from the owner. Any thoughts?

 

Have a good day if you want to,

 

Alex