Many people are fleeing the stock market these days. They are turning to buying a business as a way to actually own an asset. The nice part of owning a business as opposed to a stock is the cash flow that is paid to you, the buyer, on a daily, weekly, or annual basis. This is not to say that running a business is not hard work. Some of the same people getting out of running a business tell me the same thing, “I can’t wait to go back to having a job that I can walk away from every weekend.” So, beware, there are many risks to owning a business, but the rewards can certainly be worth it if you want an asset as opposed to a dream.
Stock’s are valued on what earnings they may produce in the future. Small to mid-market businesses are priced mostly on past performance. While current earnings will factor in, the first thing a bank will ask for is last year’s tax return when a loan is involved. Besides, what’s easier to predict? Since none of us have a crystal ball, buying a business has the reality of the situation right before our eyes in the P&L’s and tax returns. While everyone has the story of a friend who made a fortune in some stock, those stories are becoming more and more infrequent these days. Save some money for that far-reaching stock and a couple of lottery tickets because they are just about the same thing. Another nice thing about a business purchase are the dividends. Public companies keep most of the profits to reinvest, while your business should normally pay you a “dividend” of 33% to 50% of your purchase price every year. While real estate may seem like a natural progression from stocks, we have all seen that real estate deals can lose value. Plus, typical returns or “cap rates” in real estate are in the 8% – 12% range, nowhere near what a business will pay for your risk.
The main recommendation for buyers is to find something you like or where you have some interest. Running a business is hard, so make sure it’s something you have some passion about, or when the inevitable pitfalls occur, you can really start despising what you bought, which is never good. The next question we get is should I buy an existing business or start a new one? Why take the risk? Any existing business you are contemplating should have a good track record. And, by the way small businesses are priced, the business should be affordable, usually anywhere from 1 to 4 years of the owner’s profits. Typically, this number is in the 2 – 3 range of profits. Unfortunately, when you consider the start-up costs and what may be on the line once you sign a personal guarantee on the lease, it makes no sense to start a business unless you have prior experience with that particular business. You do not receive any value on resale for leasehold improvements, which are a large part of a new business’s start-up costs.