- Why buying a company for passive income may be the wrong motivation.
- Why properly implemented systems are integral to growing a business.
- Why a business needs to be able to support the cost of implementing those systems.
- The “sweet spot” valuation that makes a company the most attractive for acquisition.
No two industries are the same. Different types of companies have different needs, the number of employees they require will differ, and the money they bring in will vary.
However, there are some general guidelines you can follow as you embark on your acquisition journey. In this three-part series, we will cover a range of topics to help you determine what size company you should buy and how to grow it so you can make the best exit possible.
Namely, we’ll discuss how to find companies that aren’t too small or too big, how to understand the different types of buyers you might be competing with and how to avoid them, and how to use roll-up acquisitions as a means of growing your company to the point where it either runs on its own or you can sell it for a much greater multiple than you paid.
Don’t Look To Buy Passive Income
When you buy a business, you're buying an established brand, book of customers, and skilled labor pool. It's usually held together by the blood, sweat, and tears of an owner-operator. That owner is likely doing multiple jobs and wearing multiple hats within the organization. They are also likely looking to gracefully retire within a year of selling their business. It's your job to help create systems to replace everything the owner was doing and make the business run smoothly, without your day-to-day involvement.
That is one of the big reasons those companies sell for multiples of 3x.
Companies like this are usually valued at 3x because they require a lot of expertise to run – expertise that big buyers like private equity firms and other institutional investors don’t have and don’t want to spend time (and money) developing.
Generally speaking, if you don’t know how to run a company then you’re not really buying a business – you’re buying a job. This means that you should at least be familiar with the fundamentals of a company before you buy it.
If you want to grow a company and sell it for a higher multiple, say 7 or 8x, the business needs to be highly systematized to the point where the owner doesn’t have to do much. Stated simply, a systematized company has a way to create priorities and can define its mission, vision, and values. A company like this has a number of systems and processes to help it succeed, including:
- It runs from a budget and forecasting model
- It makes targets and hits them
- It has a leadership team
- It encourages the development of leaders from within the company
- It has an organizational chart with depth
- Everyone has clear job descriptions, that link to clear operating procedures, that link to clear KPIs
- More than one person can do any job, so there is no single point of failure
- It has structured communication
- It has regular performance reviews
- It has one-on-one meetings between management and employees
- Ideas are brought from the frontline to management in a quick and efficient manner
- Good ideas are acted upon and recognized
- Management spends time talking to the customer
When these systems are properly implemented the company should be able to create a Board of Directors, where the owner serves as the head of the Board, allowing them to step away from daily operations and have more personal freedom. They can monitor reports, P&L (profit and loss) statements, and do little more than correct problems when they arise.
In our experience, a company with those systems in place will sell for 7x to 8x of its EBITDA. Depending on the industry, it could sell for more. In industries like HVAC, for instance, a company with proper systems and processes can sell for as much as 12x.
Finding The Sweet Spot
When considering what to look for when buying a business, the valuation of the company can actually be a great indicator of how much potential exists for growth.
The goal of many Acquisition Entrepreneurs is to find a company that is attractively priced, grow that business by implementing systems and growing its culture, and then sell it at a much higher multiple. But finding an attractive price often means avoiding your biggest acquisition competitors. Importantly, if you’re looking for growth, rather than buying a small business you should consider buying something a little bigger.
Generally speaking, there are two types of buyers: individual buyers and financial institutions. The best way to buy a business like that is to target acquisitions that are too big for individual buyers and too small for financial buyers.
We’ll discuss these different buying universes more in depth in next week’s article, but at its most basic we’ve found that targeting companies that are earning between $600,000 and $1.2 million is the “sweet spot.” Companies of that size are generally too big of a risk for individual buyers, and anything below $1.2 million isn’t worth the time of institutional buyers. And because institutional buyers aren't interested, they still sell for 3x EBITDA multiples.
It’s also generally true that companies of that size have a lot of room to grow. They have succeeded due to the skills of their staff and the talent of their leaders, but they usually don’t have the systems in place to take it to the next level.
They have succeeded due to the skills of their staff and the talent of their leaders, but they usually don’t have the systems in place to take it to the next level.
There are additional benefits to businesses of that size that we’ll discuss in a forthcoming article, but suffice to say that businesses in this range are a great opportunity to buy a company and grow it to the point where you can create passive income for yourself.
What To Know When Buying A Business: Implementing Systems Costs Money
The point of finding a company that is earning at least $600,000 is that it’s big enough to implement many of the systems we discussed earlier. That’s because, simply put, implementing systems costs money.
Our rule of thumb is that most businesses require some form of software/technology, and at least two additional hires to replace what the owner was doing. The combination of those things typically adds about $100k-$150k per year in recurring expense to the business.
Costs that can often pop up during this process might include, but aren’t limited to:
- General manager
- Recruiting and onboarding
- Technology upgrades
- Enterprise Resource Planning (ERP)
These are incremental costs that will adjust your EBITDA going forward, but over time they will help the company grow exponentially. This is the reason why it’s so important to find a company large enough to support the costs of implementing these systems. These added costs are often the same regardless whether the business is earning $300,000 per year or $1 million.
Next week, we’ll discuss the different types of buying universes and how different buyers’ approaches can impact the overall market – and your acquisition search. Check out Part Two here.
Have you thought about what size of business you’d like to buy? What considerations went into your decision? These are important questions to ask when buying a business. We’d love to hear your thoughts in the comments.
If you know of anyone who’s considering buying their own company, we’d love it if you could share this article with them. If you’re embarking on your own acquisition journey, the best place to start is with our Acceleration Gauntlet. It's a primer on business acquisitions and helps you decide if you want to work with us.
If you'd like to learn more about what we offer, schedule a call with us so we can discuss how to help you along the way.
- Rather than looking for a business to acquire that can provide passive income, instead, look for a business that you can grow to create passive income.
- A company needs to be systematized to sell for a higher multiple.
- The best size acquisition to target is a company earning between $700K and $1MM.
- Systems cost money to implement, and a business needs to be able to support that cost.
Acquira is a business acquisition in a box service. We help entrepreneurs buy businesses and we invest in them and their chosen businesses. We are here to help ensure that each business we work with is posed to make the biggest positive impact possible for its owners, employees, and community.