How to buy a good business without using your own money - Part 1 - Why This Works:
We all know the principle of leverage.
In its primary application it is where you use tools and positioning to increase your power and ability to lift or work with heavy objects.
Archimedes stated "Give me a lever long enough and I can move the world".
Well, we don't need to move the world and we are not talking about moving heavy objects but in its truest application, leverage can be used in financial transactions just as in mechanical applications.
You can use the principles of financial leverage to buy a good, solid business without using your own money.
Financial leverage is a fancy way of saying "Other Peoples Money".
When you use other people's money to buy a business it's called a leveraged buyout or LBO.
Leveraged transactions (LBOs) work this way:
The buyer finances the transaction with funds borrowed against the assets and projected cash flows of the business being acquired. Through the use of proven deal structure the buyer accommodates the needs of the business owner yet creates a means to defer additional cash required to purchase the business from them.
Leveraged buyouts are financed chiefly with borrowed capital (from lenders and even from the business seller themselves), not only because such funds are readily available, but also because if you used cash to buy equity you actually lower the return on your investment than when transactions are financed predominately with debt and cash deferral deal structure.
Debt is less costly than equity financing for two reasons. First, equity is at greater risk. It is subordinated to debt, trade creditors, and others as to rights to the cash flow of the business.
If you funded the acquisition through bringing in equity investors, they expect substantially higher returns on their investment than do lenders.
Second, interest on debt is a deductible expense whereas dividends on equity are paid with after-tax dollars. So from a buyer's standpoint it is more costly for your business to provide a return on equity than it is to provide the same level of return on debt.
You structure the leveraged buyout of a business by using the assets and cash flow of the business to finance and pay for the entire purchase price; both the cash down payment and the monthly installments to pay for the business.
The business buys itself and you own it.
This way of buying business has been going on for decades; earliest actual reports of LBOs date back to World War II and no doubt occurred even farther back than that.
In fact leveraged transactions such as LBOs are so accepted by the financial communities that an entire financial services industry supports these types of transactions.
Even the Business Brokerage industry is trying to educate people to the benefit of using creative ways to structure deals; recently the International Business Brokers Association distributed an article entitled "Creative Financing for Buyers with Limited Capital".
Brokers understand that the more they can educate buyers to use the same tools as we discuss in this book, the more businesses they can sell.
We know that if you are reading this, that you might be interested in buying a business of your own. But you probably have two main questions:
Who would sell me a good business if I don't put my own money into it?
Can I really do it?
Those are good questions; we'll answer them directly.
Right now we're entering a period of tremendous availability of good solid businesses; baby boomers that own businesses get older every day and many of them need to find a way to exit their business as best they can. And remember just because you do not put cash of your own into the transaction; it does not mean that the seller does not get a cash down-payment and other acceptable terms to satisfy them in order for them to sell their business to you.
Yes. Leveraged buyouts and buying businesses without using your own money is done every day countless times in the United States and internationally.
Most people think that they have to have a lot of their own money to buy a business.
That is just not true.
It does take money to buy a business but again we're talking about learning how to use other people's money ... not your own!
Perhaps you have another question like "I've heard that it is very hard to find money to start a business ... why would someone provide money for me to buy a business?"
- It is cheaper smarter safer and much faster to buy a good business rather than to start one.
- Established businesses have proven revenues and cash flow.
- They have existing customers and supplier relationships.
- The financial communities know that it is much safer for them to put money into an established business as compared to a start-up business.
- The financial community that we mention above is familiar and comfortable in working with business people in leveraged transactions for solid established businesses.
They understand their business and what's more they are comfortable and understand the businesses of their clients.
They know that asset-based transactions are a good investment for them and that historically they have worked well for many buyers who use their services (and capital) to buy businesses.
Keep in mind, as an example, if you buy a successful business for $1 million using other people's money; you own a significant asset that produces a regular income.
It doesn't matter if you bought the business without using any of your own money.
When the financing is paid off you will own a $1 million business asset free and clear. Paid for by other people's money that is paid back from the cash flow of the business!
The business market favors the knowledgeable buyer!
Right now we're entering a period of tremendous availability of good solid businesses as baby boomer business owners look to exit their businesses.
Here's a couple of interesting statistics from the business brokerage industry:
Over 90 percent of the people who began the search to buy business fail to complete a purchase and they look at business for sale listings for eighteen months yet still never buy
Only 25 percent of business broker listings sell; 75 percent of the business listings do not sell
So we have a very significant and dynamic event shaping up. More business owners than ever in history reaching a point where they need to sell, faced with people who want to buy but 90% of the time, never do!
Why do "buyers" not buy and "sellers" not sell?
I have been involved in literally hundreds of types of transactions over the course of my business career and I can answer this question with absolute certainty.
Lack of knowledge.
Buyers that do not know how to find, evaluate, structure and negotiate transactions and business owners who do not understand how proper valuation and deal structure can help them sell their business for a fair (in some cases premium) value and with a structure that optimizes tax benefits for them.
For buyers that understand these things there will be hundreds of thousands if not millions of dollars made by them over the next few years as they are presented with opportunities from thousands of business owners motivated to sell their business.
Again you don't need your own capital, you just need to learn how manageable leveraged transactions are done and go out and do it.
You've probably seen the big business buyers always in the news. There are hundreds, if not thousands, of smaller business buyer success stories that happen every day that you never hear about ... setting their life up so that when they retire, it will be with a pile of money ... and all they are doing is buying businesses using other peoples money.
The huge number of available businesses out there and business owners interested to sell their business coupled with the fact that there are not enough knowledgeable, truly knowledgeable buyers out there is one of the main reasons why this works when you become one of those knowledgeable buyers.
The point that we make in this book is that the cash for the down-payment does not have to be yours.
- Asset based and collateralized lending has been around for hundreds and thousands of years.
- Using the assets and cash flow of a business to help you buy it is something that's commonly accepted in the financial community.
- There is a whole industry of lenders and investors who focus just on that very thing.
- There are literally hundreds and thousands of investors and lenders that put money into businesses based on the assets of the business and its cash flow and ability to pay the money back.
All of the above, are the reasons that leveraged transactions have worked in the past, they work today and will work in the future!
If you are interested in this thread let me know and I will post: Part 2 - "How It Works".