The Third Path: Acquisition Entrepreneurship Versus Traditional Career Paths

What You’ll Learn
  • Why you need to understand your personal risk tolerance.
  • What “the Third Path” looks like.
  • How the Third Path compares to the traditional career path and the path of a startup founder.
  • Why the Third Path offers more upside than the other options.

Creating wealth is a difficult endeavor no matter what path you take. The traditionally accepted wisdom is that we keep our heads down, rise through the ranks as we progress in our careers, and quietly put away a certain percentage of our paychecks each month until we retire to enjoy our golden years.

In the last few decades, a second path emerged: the tech startup. Startup founders like Facebook’s Mark Zuckerberg and Twitter’s Jack Dorsey became household names. These people became billionaires seemingly overnight and defined a new career trajectory for a generation.

Both of these paths aren’t without a certain amount of romanticism. It’s hard to fault the hardworking person who advances through their career until they find themselves in a comfortable and high-paying leadership position like the Vice President at an IT company. It’s also exciting to imagine inventing an idea in your garage or college dorm room and growing it until it becomes ubiquitous the world over. 

But there is now a third path: Business acquisition allows entrepreneurs to increase their wealth and maintain a high quality of life while experiencing new challenges and constant personal growth. 

In this article, we will break down certain milestones for each career path, how they can impact your net worth, and how much risk is involved in each step. We will look at a typical career employee, an average startup founder, and an Acquisition Entrepreneur. You can see the full infographic here.

Just to keep things fair, we will begin with the assumption that each person has $200,000 in savings when they start out on their path. Let’s also assume that their living costs are about $100k per year, and they live in a zero income tax state. We have not included the value of assets like homes or equity in the business, given that those can vary so much from region to region and business to business.

A Note On Risk

It’s important to understand your own risk tolerance and how it will be impacted by the path you choose. Essentially, what does failure look like for each of the paths?

When it comes to the traditional career path, failure is less likely to have a long-term effect. If you lose your job it doesn’t impact your credit score and you’re probably not going to lose your home. The worst thing that can happen is the economy takes a downturn and you may lose some money that you’ve invested.

Startups are much more likely to fail, but the actual risk to the founder personally usually isn’t extreme. You may build a business and then lose it but that’s often the extent of the troubles. However, if you go into personal debt through the course of growing the company, you could end up hurting your credit score. Depending on how extreme your debt is, you may have your assets seized to pay it back.

When it comes to acquiring a business, the risk of failure of the business is relatively low but the personal effect of that failure can be quite high. A failure in this instance can impact your ability to get future loans. If the business fails and you’re unable to repay the loan, the bank could seize your house.

As Investor.gov points out, “The reward for taking on risk is the potential for a greater investment return.” You should be aware of your own personal risk tolerance before you embark on any major life decision.

Year One

The Career Employee:

Let’s imagine you’ve worked your way up the ladder, and are now VP level, earning $200k per year ($157k after taxes). At the end of the first year, you’ve managed to save $57k from your paycheck and added it to the $200,000 you started with. That leaves you with $257,000 in your savings account. 

However, for a position that pays that well, you’re likely working long hours, which keeps you away from your family. This leaves you with a middling quality of life.

End of Year 1 Snapshot:

  • Salary: $157,000 after-tax
  • Net Worth:  $257,000 in cash / liquid investments
  • QoL: Medium
  • Risk: Low

The Founder:

In this example, let’s assume you quit your job, living off of your $200k savings, in order to bootstrap a startup. You manage to get a business loan, meaning you don’t have to put any of your savings into the startup. So your salary is $0, and you start out as a one-man company. You manage to earn $100k in the first year and use $50k to pay yourself. You invest the other $50k into building your company.  Meanwhile, you’ve used $100k of your savings to get through that first year.  (And since you’re only paying yourself $50k, as shown above, in salary to last through your second year in business, you’re going to need to take out an additional $50k from savings to live on throughout that second year.) 

As far as lifestyle is concerned, you’ll be working long hours at an incredibly demanding job.  The initial newness of the experience however will likely make this fun for the first 6 months.

Just look at Entrepreneur Coach Matt Munson, who is the CEO of SanityLabs which helps coach entrepreneurs and high-ranking executives. In his blog, he discusses founder burnout at length.

“Burnout is rampant in the startup community, and nobody is talking about it. How can you?” he writes. “You’ve convinced professional investors to entrust you with millions of dollars. Tens or hundreds of employees have changed their lives to follow you on this journey. Exits are few and far between, and nearly impossible to engineer when founder-burnout is the primary driver.”

With fatigue and stress essentially woven into the fabric of what it is to be a startup founder, it’s clear that the quality of life is relatively low. Especially in the early stages of the business.

End of Year 1 Snapshot:

  • Salary: $50,000 (43k after tax)
  • Net Worth: $143,000 in cash/liquid investments
  • QoL: Low
  • Risk: Medium

The AE:

By the end of year one, you’ve found a home services business and invested in it. Here are the details of the investment:

  • The company was making $500,000 in EBITDA. A company of that size is typically valued at 3x, or $1.5 million.
  • Fees of $150,000 were added to that $1.5 million, for a total purchase price of $1.65 million. That extra $150,000 was made up of some combination of three items:  first, costs associated with the purchase, such as legal fees, M&A fees (where applicable), and quality of earnings fees; second, provision for working capital; and third, provision for growth.
  • Fees of about $40,000 related to the SBA loan (again, where applicable).

Often, you can receive an SBA loan that allows you to put down 10 percent of your own money. In this example, you seek an SBA loan of $1.65 million (the $1.5 million purchase price plus the $150,000 in fees), less your 10% downpayment of $165,000. The remainder is paid off at an interest rate of between three and six percent over 10 years. (SBA loans are generally at variable rates, so the interest rate is likely to fluctuate.  For this example and for the sake of simplicity, we’re treating it as fixed at three percent.)  Your total loan is therefore $1,485,000, and $1,525,000 when you include the $40,000 in SBA fees.  

At the end of year one, your net worth and earnings have not changed greatly,  and your quality of life is lower in the first year as you work to improve and systematize the company you just purchased. You will have financed your own cost of living during that year through a salary that you’ve awarded yourself. To be in line with the paths of the career employee and the founder, that salary is $100,000.

With the SBA debt terms outlined above, you’re looking at a monthly loan payment of $16,116.16 ($193,393/year). After growth expenses related to making the company management-run, the business is taking in approximately $176,000 per year:

  $500,000
- $193,393
- $100,000
-   $30,000
—-----------
=  $176,607

The costs noted above include (an optional) $100,000 for hiring a General Manager and $30,000 for software expenses. The debt payments will cost $193,393. That leaves $176,607 in distributed cash flow that goes to you, the owner.

End of Year 1 Snapshot:

  • Salary:  $176,607(140K post-tax) in the form of distributions
  • Liquid Assets: $211,607 ($176,607 + $35,000 (which is left over after you invested $165,000 of your initial $200,000)
  • Illiquid Assets:  $317,500 ($165,000 down payment in the business, plus $152,500 in equity repayment over the first 12 months)
  • QoL: Medium
  • Risk: Medium (Your debt-to-service is still high)

Year Two

The Career Employee:

After two years your life will be basically the same. It’s too soon to ask for a raise and you haven’t been able to change where you live, though you have been able to put away 36 percent of your salary again.

End of Year 2 Snapshot:

  • Salary: $157,000 post-tax
  • Savings: $314,000
  • QoL: Medium
  • Risk: Low

The Founder:

As a founder in your second year, you’ve managed to double your business and take in $200,000 in revenue. You put half into the business, and pay yourself $100,000, meaning you’re no longer eating into your savings. The failure rate for startups in their second year is 30 percent, and that very knowledge causes many founders to feel anxious and stressed.

End of Year 2 Snapshot:

  • Salary: $100,000/year ($82,000 post-tax)
  • Savings: $125,000
  • Net Worth: Just your savings at the moment, the business does not yet have inherent value so the $100,000 you invested into it is not shown
  • QoL: Low
  • Risk: High

The AE:

By this point, your income has probably doubled thanks to the free cash flow from the business. As the investments into systems that you began implementing in Year One start to show results, the company should become more efficient, causing revenue to rise. This, combined with executing on the low-hanging fruit opportunities available in any acquisition, mean that it’s not uncommon to see 40 percent growth in the second year. This leads to EBITDA of $700,000 ($500,000 + $200,000).

Moreover, the company is now valued at $2.1 million. (That’s the EBITDA of $700,000 x 3.) You’ve made two years’ worth of principal repayments to the loan ($152,500 x 2 = $305,000). So your remaining debt is $1,222,000.  

That leaves your overall net worth at a little over $1.3 million. 

Though it’s important to note, for this to be any more than numbers on a page (also known as “notional value”) you'd need to refinance to access the cash or sell some of your business.

Meanwhile, your quality of life is improving as you begin stepping away from everyday operations and the leadership team you put in place is handling most of the daily responsibilities. Ensuring the proper systems are implemented still takes oversight and hard work, but the team you’ve assembled should be doing a good enough job that you can see a light at the end of the tunnel.

End of Year 2 Snapshot:

  • Salary: $700,000 – $193,393 = $506,607 ($354,200 post-tax) 
  • Liquid Assets: $565,807 ($211,607 from year 1 + $354,200 net salary)
  • Illiquid Assets:  $878,000: ($2,100,000 in business value minus $1,222,000 in remaining debt)
  • QoL: Medium
  • Risk: Medium/Low (due to debt service ratio)

Year Three

The Career Employee:

Your life remains more or less unchanged. You continue to live frugally and set aside savings. Perhaps you receive a small raise to compensate for cost of living increases.

End of Year 3 Snapshot:

  • Salary: $157,000 post-tax
  • Net Worth: $371,000 in liquid savings
  • QoL: Medium
  • Risk: Low

The Founder:

If your company has survived this long, the business will likely have actual equity value.  Let’s assume you were able to double revenue again, and the business is earning $400,000 in revenue.  You’ve got a couple of employees and the business is netting $200,000 in EBITDA which you pay to yourself as salary. For the sake of a standardized comparison with the career employee and the AE, we count this as $100,000.   

End of Year 3 Snapshot:

  • Salary: $200,000 ($157,000 post-tax, of which you save $57,000)
  • Liquid Assets: $182,000 in cash ($125,000 from year two plus $57,000)
  • Illiquid Assets: $400,000 in company value (about 2x the EBITDA as it’s a small operation)
  • QoL: Low
  • Risk: Medium

The AE:

This is where things really get interesting for the Acquisition Entrepreneur. You’ve optimized the business and you’ve grown the company another 10 percent resulting in an EBITDA of $770,000 per year before debt, and $576,607 after debt coverage. That means that each year, you’re making nearly three times what you started with in savings.

Meanwhile, your quality of life has never been higher. You’re visiting the business once a quarter, and working one day a week. You can travel, which means you don’t have to spend your winters in cold climates (unless you want to).

Furthermore, your net worth has continued to improve as the business’ value appreciates (due to EBITDA growth) and you continue to pay off the principal of the business loan. And as you’ve improved and systematized the business, you’ve ensured that it can be re-sold with little difficulty. Your overall risk has dropped as the business value is substantially higher than its debt

End of Year 3 Snapshot:

  • Salary: $576,607   ($399,000 post-tax)
  • Liquid Assets / Savings:  $964,807 ($565,807 from year 2 + $399,000 net salary)  
  • Illiquid Assets:  $1,240,500 ($2,310,000, which is the $770,000 in SDE x 3) in business value minus $1,069,500 in remaining debt)
  • QoL: High
  • Risk: Low

Year Five

The Career Employee:

By this point, you’ve probably received a raise and you’re making 20 percent more on your salary. You continue to live frugally and set aside savings for retirement. 

End of Year 5 Snapshot:

  • Salary: $183,000 (post-tax)
  • Liquid Assets: $537,000
  • Illiquid Assets: 0 
  • QoL: Medium
  • Risk: Low

The Founder:

By year five, half of all startups have failed. If you’re part of the cohort that has managed to stay in business, you’re likely making the same salary you were two years previous, just waiting for the company to go public so you can cash in your equity. By now though, your quality of life has likely improved somewhat as you hire more employees and delegate more of your workload. Your revenue is at $800,000, double what it was in Year 3, though EBITDA is at $250,000, just a little higher than it was a couple of years ago as the business is now becoming more management-run.  

Though, you’re still a few years away from an exit. As Crunchbase points out, most SaaS-related startups take nine years to exit, while B2C (business-to-customer) companies take around seven years.

End of Year 5 Snapshot:

  • Salary: $250,000/year (~$192,000 post-tax, of which you save $92,000)
  • Liquid Assets: $274,000 ($182,000 from year three plus the $92,000 you saved from your salary; note that we skipped over savings from year four here)
  • Illiquid Assets: $750,000 in company value (about 3x EBITDA)
  • QoL: Medium
  • Risk: Medium

The AE:

According to the Pikes Peak Small Business Development Center, “Entrepreneurs that buy an existing business have a 90% to 95% chance of still being in business after five years.” That means that by this point in your business buying journey your overall risk is very low. Assuming you’ve been able to continue growing your business by a modest 30 percent over the last two years, the business is now earning a shade over $1,000,000 in SDE.

By this point, if you chose to sell the company, it’s probably worth about 5x. So your $1.5 million company is worth approximately $5 million. You’ve made five years’ worth of payments towards your loan – a total of $762,500 – leaving a balance of $762,500 on your loan, which means your overall net worth is now a very healthy $5.75 million. Your quality of life has never been better and the company is now growing under its own momentum. 

This is often a “do or die” moment for many Acquisition Entrepreneurs as they debate whether they want to exit their business or pursue more rapid growth through roll-up acquisitions.

End of Year 5 Snapshot:

  • Salary:  $806,607 ($1,000,0000 – $193,393 SBA loan repayment) ~$550,000 post-tax, if earnings are entirely pass-through)
  • Liquid Assets:   $1,514,807 ($964,807 from year 3 + $550,000 net salary) – note that this amount would actually be higher because we’ve skipped savings from  year 4’s salary
  • Illiquid Assets: $4,237,500 ($5 million – $762,500 in remaining business debt)
  • QoL: High
  • Risk: Low

Conclusion

No matter which path you choose, there is always risk involved. The pay-offs from the traditional career path have shown diminishing returns over recent decades, causing many people to look elsewhere. 

It was this mindset that led many to seek riches in Silicon Valley with their own startup and it’s what is now leading many to look toward acquisition entrepreneurship.  

As shown above, business acquisition allows entrepreneurs to increase their wealth and maintain a high quality of life – all while experiencing new challenges and constant personal growth.  

If you’re interested in starting your own acquisition journey, it all begins with our Accelerator Program. If you’d like to learn more about the program, schedule a call today.

Key Takeaways

  • Make sure you understand your risk tolerance, no matter which path you choose.
  • Acquisition entrepreneurship often offers better returns on your investment.
  • By year three, the Acquisition Entrepreneur can step away from the day-to-day operations of the business.
  • By year five, it’s possible for the AE to make an exit from the business for much more than what they paid.
Accelerator

Leave a Reply

Your email address will not be published.