The fundamental principle of investing is to buy low and sell high. Every investor seeks to achieve this principle, regardless of what they invest in. Whether you trade stocks, bonds, gold or real estate, everyone seeks to find the diamond in the ruff or “The Bargain”. If you’ve ever read my blogs, or spoken to me on the phone, you know that I look at business ownership as an investment, and just like all the other investments, there are “Bargains” here as well and you could make a fortune buying under performing businesses as long as you know what to look for.
My definition of a business that is under performing is a business that is not reaching its full potential. It has been a long practice of Asset Management companies to seek out businesses in a specific industry that are under performing, fix them, hold them for several years and then sell them for a profit. Now Asset Management companies typically have access to millions of dollars and seek large companies, however you don’t need to have millions, to duplicate the same process. You can seek smaller companies which are readily available and require a lot less money to buy, thus for $200K you could own 3-4 small businesses and keep growing from there. The key to finding an under performing business is to know what to look for, ask the right questions, do some investigative work and come up with a business plan and strategy on how to fix the problems that maybe facing that particular business. Here are some of the things to look for:
1. Owners Participation: As I have stated in the past, owner’s participation is key to any business success and most absentee owners leave too much responsibility to key employees who have nothing at stake to make a business more successful. These businesses typically have higher than usual costs, lack in customer service, and have ineffective or non existent marketing campaign. These are all easily fixed with an active owner and if you must have a manager running your business, give your manager an incentive to be more diligent. Profit sharing, bonus program or compensation based on performance are all excellent ways of motivating your staff. There are plenty of businesses where the owner is actively participating in the daily operations of the business, but lack the “business experience” of running the business. Most successful businesses have an owner who is the CEO and the CFO of their company and are actually working ON the business, not IN the business. Here are some examples of this: A plumber who does his own work, and thus does not have time to actively network the business, restaurant owner who works in the kitchen, instead of managing the restaurant. When the owner is too busy working IN the business, that business will typically have the same problems as if it was being run absentee.
2. Distressed Owner: A Distressed owner is someone who is selling because they are retiring, getting a divorce, relocating or illness. Most of the time their companies and businesses are doing very well, but they are selling below market value for a fast sale. Keep in mind that you still must do a thorough due diligence, to verify the reason for the sale.
As you do your due diligence, the important things to look for, besides all the things I have mentioned above, are sales trends over a period of 3 years if possible. If there is a trend down ward year after year, ask why, it a good sign of mismanagement, but could be a sign of something worse, like a product getting obsolete, contracts being lost, etc. Stay away from businesses that sell trendy products, since trends get hot and cold. Interview the owner and find out why sales have been going down. Talk to employees if possible, landlords, suppliers, etc. The important thing for you to identify is what can be done to improve the company and the business and then ask yourself if it is something you can accomplish. If the answer is yes, then you got yourself a “Bargain”, if the answer is no, move on. Here is one more thing to consider. Some of the best bargains are in Franchise Resale’s and they might be the easiest to do your due diligence. Once of the best tools available to anyone looking to buy a Franchise is the ability to speak to existing Franchisees, Area Developers, and Regional Managers. These people could be a great source of information for you and may give you an outline of what needs to be done in order to make a business work. This is only available in the Franchise Industry, so if you are a new business buyer, or even a seasoned one, look at Franchises first.