Beyond stocks and real estate: why buying a business could make sense
While I am not sure about you, I know I have been beaten up in the stock market over the past couple of decades. For many investors, there are typically three types of investments that they consider:
- Shares in companies or indexes on the stock market
- Real Estate, including rental units and commercial property
- Interest bearing bonds
Often they look no further. However, there is a good option: buying a business.
Investors don’t often consider buying a business. Here are some reasons why buying a business could make sense.
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- Higher Returns on your money! Typically, businesses sell for three to four times Sellers Discretionary Income (profits) plus assets. If I told you that you could consistently get a 33 percent return on investment (ROI) on your money in the stock market or real estate properties, you would probably call me a liar and rightly so. Yet there are many profitable small businesses where these types of returns are possible.
- Growth Potential. A few years ago, I sold a business where the owner was making a couple of hundred thousand dollars but was tired. The new owner took over and grew the business based on some ideas of the previous owner and his own initiative. He told me a few years later that he was now making over $1 million a year in profit and considerably more in sales.
- Stability: The stock market is subject to significant volatility based on changes often out of the control of the private investor. The economy, politics, and global market conditions can drive shares up or down, often to the detriment of the small investor. Owning a business is subject to much less market volatility with much more ability to control one’s destiny.
- Leverage: It is true that it may take considerably more money to purchase a business than to invest in the stock market. However, with business banks or vendor financing, the return you get on your actual investment can be very significant.
So how do you make money by buying a business?
Typically there are three ways:
- Profits and sellers discretionary income. Playing to win should be the motto of every investor. This is no different when it comes to buying a business. Your intent should be to buy a business that can give you a return on your investment and make money for you. These can come in several different forms, including profits and benefits. Ideally, you want a business that gives you a profitable return year after year, but there can also be other benefits to business ownership, including business write-offs that benefit the buyer. These might include cell phones, entertainment, travel, asset purchases and amortization. They could also include jobs for family members and other social benefits that impact your world and the people in it.
- Passive income on property purchase. If your business doesn’t come with a property, you might wish to purchase some. Owning a business is a great way to pay off a mortgage on a property you own long after the business has been sold again. In fact, banks often favour financing a property where the business is located. This enables you to put your lease or rent money to work paying down a mortgage and subletting other parts of the property for passive income.
- Increased valuation. In the first part of the article, I told you about a business owner who grew a business he bought for several hundred thousand dollars, now worth millions. While not every business purchase appreciates as quickly, buying the right business enables you to sell the business later for much more money.
So what should you look for in a business?
- Profitability and profitability potential. Most investors want to buy a profitable business; you should too. However, I recently sold a marginally profitable business at a great price because the new owner saw the potential to turn a small profit into something much bigger.
- Consistency of revenue and multiple revenue streams. I have seen businesses with sales that fluctuate wildly from year to year. As an investor, this makes me nervous. Look for businesses that have consistent business revenue and a variety of revenue streams. This might include different types of product or service lines, geographic territories, and a variety of customers.
- Growth potential. Buying a profitable business that pays for itself over a period of a few years is essential. However, if you want to increase the value of your investment, you should be looking for a business with significant growth potential.
- Systems. A business operating without systems is hardly a business. You want a business that relies more on systems than on particular team members. People are hard to replace unless you have systems or processes that ensure the business continues to operate when some of the team moves on.
- A management team. Good businesses have a team that can run the business even when you are not around. Look for a business that has some key staff that you can rely on.
- Focused business. Sometimes, when business owners get ready to sell or retire, they lose focus, and as a result, sales and service dip. Be cautious when buying a business where the owner has let sales slide.
- Industry and passion. Your passion for a specific industry or business can significantly influence your success in a business purchase. Yet I often have buyers looking for profitable businesses regardless of the industry.
Buying a business may or may not suit your investment portfolio. But it is often sound to consider the alternatives and investigate opportunities that ensure you are on the right track for your retirement and meeting your future financial obligations.
Dave Fuller is a Commercial and Business Realtor, award-winning business coach, and business author.
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