SO YOU WANT TO BE AN ENTREPRENEUR
One of the great myths of the American way of life and of the capitalistic system in general is the concept that secretly everyone wants to be in business for themselves. The truth is that most people don’t have the temperament to own a business and many just like the security of a “regular and dependable” paycheck and to go in at nine and leave at five.
Others are turned on by participating in the great game of corporate politics and revel in the contest. I’ve known people who can conduct great meetings, but never do anything of substance and others who can tell you everything about a highly technical product or service but couldn’t sell special favors on a troop train.
The irony of the whole thing is that people often don’t find out if they are able to function in an entrepreneurial situation until they have to go to the bank and put a second mortgage on their home in order to pay their employees, while not getting paid themselves. If you can do that without throwing up in your waste basket, then you may be able to handle the real tough stuff when it comes along. Just for grins, let’s say that you’ve got the grit. What’s the best way to get in your own business?
Clearly the best route to business ownership is to inherit it from Daddy. This is doubly desirable if you are an only child and Daddy has become senile. The old man is out of the picture, there are no siblings, and Mommy thinks you’re the reincarnation of Warren Buffet. If you have any talent for running a business, you may actually grow the enterprise over the years, and at worst, you don’t completely screw it up. However, it is very difficult to choose your parents and you have to depend on the “lucky DNA club”.
The second easy pathway to owning a business is to marry one. This method is fraught with pitfalls. If your bride is beautiful, intelligent and an only child, you will have clearly married above your station, at least so in the eyes of her father, who is probably an ex-marine drill sergeant who also played linebacker for the Chicago Bears. He looks at you like pond scum. However, he gives you a job at the office in Zaire and has you answer to the company’s version of Idi Amin. And oh, by the way, men on his side of the family live to be 113 and you will end up working for your wife’s second husband, the one with the MBA. Oops!
You can always choose a man with a very homely daughter, one who was turned down by the convent due to her looks, personality and personal hygiene. This lady will have no other suitors and is an easy target. Her father will be so grateful to get her married, he will make you a senior vice-president on your first day. You will advance rapidly and will be poised to take over the whole shebang when your wife shoots you for messing around with the entire accounting department. Maybe there is a better way to get your own business. Why not just start one from scratch?
When you decide to launch a new business, you encounter a hierarchy of risk, each of which comes with an unknown price tag. Just a sampling of those risks:
Capitalization Risk – Can you raise the needed capital, and can you go back to the well when you realize that you vastly under estimated the amount needed.
Business Formation Risk – There are certain costs that are common to every business. Things like licenses, intellectual property costs, office, computer and telecommunications costs, insurance, etc. Those things that make up the G&A costs on an operating statement. Many times these costs will overrun your estimates by a significant amount.
Personnel Risk – Can you find and hire the proper people to manage and run the business and can you properly estimate the total cost of the task, things like travel and entertainment, not to mention FICA, Medicare and a host of State and Local issues.
- Research & Development Risk – If your product or service requires additional R&D, even a minor tweak, you can run into a sinkhole of time and cost.
- Operational Risk – You will have to put all of the wheels and gears into motion to turn all of this into a functioning business. This may well take longer than you anticipated and the process might reveal problems that you did not know about until you encountered them.
- Marketing Risk – There is one thing you can count on: “If you build it, they will not necessarily come.” You will have to go out and drag them in kicking and screaming to sell your wares. This is the most expensive, most important and most underfunded thing in a new business.
Good Lord, you ask, how can I avoid any or at least some of these risks? The best way is to buy an up and running business that has already dealt with most of that stuff. If you can find an owner in transition, someone who is retiring or just tired of the rat race, and most importantly, whose business is cash flow positive, the chances are you can buy this ongoing enterprise for less than it would cost to start a competitive business.
If you can buy such a business for less than six times EBIDTA¹,you can use leverage to the extent of your credit worthiness and/or your ability to structure a debt like equity piece and finance at least as much as your free cash flow can service on a five year amortizing basis. You can use your equity to pay the rest of the buying price and provide operating and growth capital.
If you can simply operate the business as it is for five years, then sell the business for the same six times EBIDTA, you will have paid off the debt and will walk away with a bundle of profit. The results will be even better if you are able to grow the EBIDTA during the time you own and operate the business. Not a bad plan as you miss most of the startup risk and don’t have to reinvent the wheel.
¹If you have to ask, “What is EBIDTA?” do yourself a favor and don’t quit your day job.
I love it! Thanks Tom.