Misconceptions about the buying process stop and/or slow many otherwise good business owners from changing their lives in a meaningful way. With a little knowledge (and confidence), small business buyers can turn a W2 (working for someone else) into a W2+equity, and parlay their life experiences and passions into something that will bring their family into the world of business ownership, serving community, and building something of value.
The first and most common misconception has to do with financing.
"I can't afford to buy a $3MM business or a $10MM property."
To this misconception, we say "you're probably right." You can't afford to buy either if you think you're going to open your wallet or stroke a check from your bank account. Those who can buy a business or a property from their wallet or bank account know better and generally wouldn't do that. The math is not favorable. Those who think they have to buy a business or a property using their own wallet or bank account are often left out of the game all together.
A little deeper into the discussion, some smile and say:
"Of course I'm not going to use my wallet or bank account. I'll put some money in, but that's what the bank is for. I'll get a loan."
This is also true. There are many fine bank financing programs and finance guarantee programs (think insurance for the banks) like the SBA 7(a) or 504 programs that work for a lot of buyers. I don't have the actual statistics for this post, but a large percentage - perhaps the majority - of main street businesses are financed with an SBA 7(a) program. 504 is popular when real estate is involved. Money lent through one of these programs is lower risk because it's covered by the Small Business Administration (SBA) as a way to encourage more lending to entrepreneurs and to stimulate our economy. This is not the full story or where sophisticated investors and business buyers stop.
A little deeper, we find unsecured, cross-colateralized, and other lending programs. There are situations where SBA (7a) is not the best solution. Often, but not always, other lending programs are a little riskier for banks and can cost a little more in terms of interest rates (a refection of the increase in risk). These can be used in place of or in conjunction with other forms of lending. In a distressed asset situation, for example, that has poor cash flows, other financing might become the only alternative.
An example of a capital stack with mixed forms of financing might be a piece of real property funded by a first trust deed (collateralized by the land or asset on the real property), a mezzanine loan with a slightly higher interest rate, and owner's equity on top of that in what we call "first loss position" (the financing that is the least secured in the deal). The three types of financing in this example, all have different cap rates or risk/reward profiles for the courses of the capital - a suject for another post.
It is not common or even preferred for all of the money in a deal to come from a single wallet, a bank account, or a lending institution. The sum total of the various forms of financing in a deal is referred to as "the capital stack." There are many ways to build your capital stack. Of a nearly infinite number of ways to do this, here are just a few examples to illustrate the point.
Other places to get capital for your capital stack might include:
- Court appointed debtor in possession (DIP) financing
- Property Assessed Clean Energy (PACE) financing
- Discretionary funds financing (from funds looking to invest in whatever you're buying)
- Insurance companies (bigger deals w low interest rates and high security for the lender)
- Friends and family money
- Syndicated capital (IRS Regulation D sections 504, 505 or 506)
- Private equity
- Seller financing
More sophisticated buyers / investors will consider buying on terms. Let's say, for example, that we'll buy your property or business today for $1 and pay you 1.5x what your asking price is in three years or when we hit X revenue hurdle. Terms may allow the buyer to get into a deal with little upfront capital to the seller, then stabilize or turn a bad deal around. Term may simultaneously allow the seller to get a purchase price (or more) that they want - as long as they can wait a little while.
Finally, don't ignore competition! Expect that multiple buyers will be attempting to buy the business or property that you want. Your offer might not be as good as you'd like it. Maybe another buyer is in a similar situation, but you each bring different and complementary strengths. It might be useful to combine offers - make your competitor into your partner and bring a much stronger offer to the table! A percentage of something is generally better than nothing.
The second misconception has to do with operating experience. It's rarely true that just because you ran a lemonade stand as a kid that you are qualified to safely run a more complex business model. So what do you do if you want to buy a business that you don't have operating experience with?
The simple answer is: you find it.
We don't mean that you spend the next 10-15 years trying to learn the ins and outs of the business you're most interested in. By then, the deal you wanted is gone and you may be too old to enjoy it anymore. We mean, you find the experience you need and add it to your team!
Adding experience to your team may come in the form of what is commonly called a "keyman." This is in no way a reference to gender, but a more generalized term meaning someone of vital importance. Usually, but not always, this refers to the primary operator or manager of an aspect of the business. In practical terms, this may mean you need to interview and potentially hire someone - contingent on your offer being accepted and closing.
Bringing in an experienced operator is so common that there is an entire insurance product dedicated to it called "Keyman insurance." Many lender require keyman insurance whether you hire someone to do this job or you do it yourself. The fact that keyman insurance exists is a recognition of how important people with the right experience are to successfully running your business venture (and to getting creditors and investors paid).
If you find yourself competing for a business or a piece of property and your offer is going to come up a little short on the experience side of things, then consider finding that capability in someone else and adding it to your team. Teams are more fun anyway!
The third and final misconception for this post is related to confidence. Out of the gate, it may seem like everyone else is more confident than you are. This may be true initially, but after reading what we wrote above, we're hoping that you can shed this idea and be more confident in your buying ability.
You don't need all the money and you don't need all the experience to be successful buying and/or running a business. You need enough humility to understand that you will need a team if you want to do bigger things. As you assemble your team, you'll pick people smarter than you (if you're smart). As you surround yourself with smart people, your confidence will go up!
You just need enough confidence to know the steps you need to take to get the ball rolling and coordinate financing, operations, and other aspect of your business as needed. A good business broker will likely have a list of industry experts in the fields you need expertise from. They will also know the nature of the various competitive bids being made on businesses in a given niche. We have a list of more than 365,000 active buyers on our list. Some need A, some need B, some are good to go as-is, but it makes sense that if you add your name to the list, your business advisor is going to be looking at not only you, but how you might compliment someone else in the buyer pool who's interested in the same things that you are. They may be able to help!