Thursday, February 16, 2017

You Should Consider Buying a Small Business. But When?

You Should Consider Buying a Small Business. But When?

FEBRUARY 15, 2017

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For the past five years, we have taught a course at Harvard Business School that prepares students to search for, purchase, and run a small business. The course is always taught in the spring term of the second year of the two-year program, and indeed, as graduation looms, our students have to decide whether they will look for a company to buy and, if so, when to do it. Each year roughly a third of the 80 or so students decide to begin their search right after graduation; a third decide that the career path doesn’t make sense for them, at least in the near term; and a third tell us they plan to work for a few years, learn a bit more about business, fulfill some obligations, pay off some debts, but that surely, in two years or less, they will be searching for a business to buy.
Here is the rub: Only one or two of those students have, to our knowledge, actually left their jobs after a few years to start searching. Whatever the intentions and logic of that third group, the fact is that they very rarely begin a search in the five years after business school.
As we’ve considered the question of whether there is a “right” time to begin a search, we’ve focused on what accounts for this discrepancy (other than inaccurate self-reporting), how it can be avoided, and what it can tell us about the ideal timing for embarking on this career path. Here’s what we’ve found.
First, you do learn a lot about business when you take a job after business school. But you learn about those businesses you actually work on. If your job is in a traditional post-MBA career, like consulting or private equity or investment banking, you’ll learn about big businesses, those worth hundreds of millions or billions of dollars. Small businesses, those with annual profits between $750,000 and $2,500,000, don’t hire large consulting firms or investment banks and are too small to attract the attention of private equity firms. If your job is in financial services, again, you won’t become very familiar with small firms because they are not an efficient vehicle for institutional investment. So, while those who postpone their search for a business to buy while pursuing these kinds of careers will learn a lot, they won’t learn about small business. Even after a few years of working, any holes in their skills or experience will still be there.
Second, some students tell us that they want to work in a traditional job to raise the capital for their search through savings. That is really hard. While the cost of a search can vary widely depending on its parameters, most try to have roughly $100,000 in hand as they begin. Can a searcher save about $100,000 while working in a traditional job? Assume that a traditional post-MBA job pays at most $150,000 (including a bonus but excluding noncash benefits like health insurance and the like). After federal and state taxes, say you’re left with about $90,000. From this after-tax amount, subtract the cost of housing (an average of about $3,000 per month for a one-bedroom apartment in New York City, where many of these jobs are located). You’re now down to about $54,000 before buying any necessities like food, utilities, or clothes or any niceties like entertainment or a vacation. Given that the cost of living in New York is double the national average, our estimate is that with discipline you could probably save $10,000–$20,000 per year toward your self-funded business search. Either way, it will take far longer than a year or two to accumulate the $100,000 to self-fund a search. It may be that eventually these capital accumulators will use their savings to launch self-funded searches and that we’ll learn that the “year or two” of a traditional job is actually closer to five or 10.
What about students who have educational loans or whose MBA was sponsored by their company? We’ve found that students who are really passionate about buying and running a small business often come up with creative ways to fulfill those obligations without going back to a traditional job in a large company. For example, we had some students who decided to search for a business to buy right after graduation even though their MBA was sponsored. They agreed with the sponsoring businesses that the value of their obligation was roughly $150,000 and that they would transform the obligation into a loan, payable once an acquisition was completed. The searchers rolled the cost of the loan into the acquisition cost, and that allowed them to begin right after graduation. $150,000 is a lot of money, but it is a fraction of the $6–$10 million cost of an acquisition, and it frees up the searcher to do what he or she really wanted to do — find a business to acquire and run. While the period of employment and regular paychecks is a fine time to repay some educational loans, similar arrangements are possible for those as well.

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All of this raises an important question: If you’re going to acquire a company to run later in your career, do you pay any penalty for doing so? We’ve observed that those of our students who held traditional jobs for a decade or more before beginning their search for a business to buy, like those who search right out of business school, use a variety of different funding approaches to the search and are willing to consider a range of industries. They do tend to have tighter geographical preferences than people who search earlier in their careers. But overall, we don’t see any big advantages or disadvantages for mid-career searchers. This ought to come as good news to them. And to us, it confirms our view that most people don’t learn much that is relevant to buying and running a small business in a traditional post-MBA job and that most people are unable to accumulate significant capital from a traditional job to self-fund their search.
This leads us back to the essential question of whether there is a right time to search. Because we see so little difference in the successful approaches to buying a small business for those early or later in their careers, we think entrepreneurship through acquisition can work at any point in your professional life. There is no “right” time to search. Working at a traditional post-MBA job for a few years does not make it easier to buy a small business — but neither does it make it harder. At the same time, we don’t see much merit in the common reasons for postponing a search and then taking a traditional post-MBA job. So, if you want to search right after business school, even if you have financial obligations from your MBA education, you should do that. If the time isn’t right then, for professional or family reasons, the time might be right later on. But don’t give up on your dream. Life is simply too precious.

Richard S. Ruback is a professor at Harvard Business School and a coauthor with Royce Yudkoff of the HBR Guide to Buying a Small Business (Harvard Business Review Press, 2017).

Royce Yudkoff is a professor at Harvard Business School and a coauthor with Richard S. Ruback of the HBR Guide to Buying a Small Business (Harvard Business Review Press, 2017).

This article is about ENTREPRENEURSHIP
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