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No Michael Scotts in a Small Business

Matt (not his real name) wants to buy a business. He is 45 years old and has spent the past twelve years in an executive position with a locally prominent company. Matt has the kind of job and title most people would love to have by the time they reach their mid-40s.

But Matt told me he’s ready to chuck corporate life and “become my own boss.” Perhaps you’ve read prior stories I’ve written that sound like Matt’s. Suffice it to say, I get a lot of calls like this, they usually go nowhere.

Please understand, I am not disparaging Matt’s sincerity or his ability to eventually be a successful business owner. But what confounds me is how someone can come into such a life-altering process on a flawed premise. Here’s what I mean. I asked Matt what kind of business he was looking to acquire. Instead of describing the kind of business, he described a seller’s mindset. Matt said, “I’m looking for a business where the owner doesn’t have a son or daughter to take over the business, so they need to find someone they can train to take it over.” He went on, “The owner needs to be willing to carry some or all of the purchase price to fund his retirement.” I then asked Matt how much money he was willing to invest. He hemmed and hawed, the question obviously made him uncomfortable, before he finally said, “I could go as high as $500,000 maybe more for the right opportunity.”

Ok, let’s assume for the moment that we can find this kind of owner. To see how far Matt can get with a $500,000 equity investment, let’s reverse engineer a typical capital structure.

Assume a bank would loan 35-45% of a deal’s total value and assume a seller would carry 20-25% of a deal’s total value.  That leaves 35%+/- of a deal value to be supported by Matt’s $500,000 cash. This implies a total deal value of about $1,500,000. If a business is valued at $1,500,000, we can assume its free cash flow (i.e., EBITDA) is around $500,000). In other words, Matt wants to buy a business generating $500,000 of cash flow with 60-70% debt. On a seven-year, level-term amortization schedule, that means the first $180,000 of that cash flow goes to pay the bank and seller debt, which leaves $320,000 for Matt to pay himself and grow or improve the business.

OK, so far, so good, but here’s the fly in the ointment. While there are exceptions to every rule, it’s likely fair to say that Matt will have to “do the work” that generates that $500,000 cash flow. That means managing the factory floor, running the machines, meeting the customers, whatever.  Yet I have learned a hard truth counseling scores of people through this process: a man or woman used to a white-collar office job looking to buy a small business will usually be shocked to learn they have to get their hands dirty (literally or metaphorically). While no one will come right out and admit this, most people making the leap from corporate life to buy a small business envision themselves like The Office’s Michael Scott, just roaming around checking on the staff, holding meetings, developing culture, and the like.

No matter how successful you have been in corporate life, it translates very little to the emotional ethos necessary to run a business valued under $5 million or so. Businesses this size aren’t loaded with teams of people to crank out the work. So unless you have $2 million or more to invest that can be leveraged into an acquisition value of $5 or $6 million dollars, you are going to be doing the work necessary to pay yourself and the bank. That’s a hard leap to make for most.

Final (bonus) thought. What I have learned over the years is that almost all those folks who say they “want to be their own boss” aren’t really expressing a desire to be an entrepreneur. They are really just saying they don’t like their current boss. Finding a new role with their current employer, or finding a new job, is usually their best career move.

 

JIM CUMBEE is President of Tennessee Valley Group, Inc. a retainer-based business brokerage and transition mediation firm in Franklin, TN. Cumbee is an attorney and has an MBA from Harvard Business School. Jim is the author of Home Run, A Pro’s Guide to Selling a Business. https://www.amazon.com/Home-Pros-Guide-Selling-Business/dp/1599329239 .  He has a wide range of corporate and entrepreneurial experiences that make him one of the most sought-after business transition advisors in the state of Tennessee. The principles above are true, but the story, names and fact patterns are changed to preserve the parties’ identities.

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Tennessee Valley Group

Jim Cumbee established Tennessee Valley Group to help business owners fulfill their dreams for life after business ownership. It’s a mission that his 30+ year career history had prepared him well for—in addition to being an attorney, transition mediator and business broker, Jim has been a buyer, seller, and entrepreneur. His broad range of experience gives him unique insight into how business buyers and sellers can achieve their goals.

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