When the question of investment arises, it can be tempting to think that instead of investing in walls, whether private or commercial, it might be a good idea to invest in a business. Except it’s not that simple.
This column by Sylvain Perret is part of ours 2023 Guide to investment and real estate
First, let’s compare what is comparable: a real estate investment is a passive investment where the owner has little to do in the end, especially if he leaves the management to a specialized agency. An investment in a business, except in specific cases that will be discussed below, is an active investment, that is, the owner must invest time in the business for the results to be positive.
Are there any cases that “run themselves alone?” “. Yes, but they are rare and expensive. We often see businesses for sale called “absentee owner”, but in my experience this argument is wrong in most cases, and relying on it risks leading you to complicated situations. They real “absentee owner” companies are often national franchises, Mc Donalds, Dunkin… where there is an established staff with the complete chain of command from the general manager to the new team member. In this case the new owner acts mainly as a shareholder who oversees his investment and the franchise also exists to oversee good results. This type of business is almost comparable to a real estate investment, and certain highly recognized brands guarantee resale without delay. These cases generally sell for over $1 million. To think that you can buy a $200,000 business that brings in $100,000 a year without having to work there full time is an illusion.
In the vast majority of cases, investing in a company is therefore an active investment, where the buyer will invest money but also time, often full-time. This does not necessarily mean playing a 100% operational role, but a permanent presence to ensure that the business functions is necessary. The saying “when the cat is not there, the mice dance” is very true, and during the recovery it is also not uncommon to have to get rid of a part of the team that does not correspond to the new type of management. , which therefore implies being even more present.
As for a real estate investment, the criterion of the purchase price will be important, and in the same way that we compare the prices of two identical houses, we can compare the prices of companies according to a certain number of criteria, mainly accounting. The price/EBITDA ratio (mid-sized companies) or price/seller-discretionary earnings (small companies) are the most commonly used to value companies. Schematically, the price of a company is estimated at X times what it generates in cash. The average price/seller’s estimated earnings is generally between 2.5 and 3. Many other criteria will affect, up or down, the final price at which the transaction will take place. Supply and demand are important elements: in some areas business is sought, and there may even be one-upmanship.
Buying a business requires you to surround yourself with professionals: CPAs, lawyers, business brokers, because the acquisition of a business, if it can bring in more than real estate, is also much more risky.
When you buy a property, except in special cases, its value cannot be zero the next day. Even if the market fell sharply, you would get some of your capital back. With a business, the added value can be very significant, but the loss can also be total. As such, the first question to ask when meeting someone who is selling their business is “Why is he selling?”. On the honest answer to this question may depend the success of the recovery.
Another element to take into account in a business takeover is that your risk is not limited to the purchase price. A long time ago, in Orlando, a cozy cafe for sale in a shopping center, for $89,000. At that price, it’s a bargain!!! Not really, because during the acquisition it was necessary to take over the remainder of a commercial lease with another 6 years of validity at $14,000 per month… The real price of the deal was more like $89,000 + $14,000X72… I’ll let you do the calculation. This example illustrates that with business often come obligations that must be assumed on behalf of the seller. In the case mentioned, the seller would have dropped the price to almost nothing on the condition that we get rid of this disastrous lease.
Investing in a business does not necessarily mean taking over an existing one, it can also mean creating one. For the person who has a job in his hands, experience, this is an excellent solution. The most beautiful creations that we have seen in Florida in recent years are made by people who know their business, communicate well (marketing), know how to adapt, have impeccable customer service and once again know how to ‘surround’ . It should be noted that the major difficulty that we have noticed in recent years in the creations lies in the deadlines and the costs of the development work. In some sectors, a year’s work before opening is not uncommon: You need a strong back.
We mentioned franchises above, and investing in a franchise, whether through the acquisition of an existing unit or the creation of a new one, can bring opportunities: established brand, proven processes, marketing managed by the franchise… A franchise business is also often better resold than an independent business. But beware, there are franchises and franchises, and we encourage you to take several opinions, to be interested in franchises that have proven their worth, to be assisted by a lawyer specializing in franchises to proofread the franchise information document.. .
Investing in a business generally cannot be compared to investing in real estate, except in the rare cases mentioned above. Your investment will often generate your main income, enroll you full-time, and sometimes justify your status in the United States via a visa. This is often, in a way, to buy his job. This is why you must be extremely strict, leave no question unanswered, get to the bottom of things, almost do the work of an investigator to ensure that this business will allow you to live, flourish, create a legacy . But entrepreneurship is exciting and the success of your business creation or acquisition project is a happiness that we wish you!