I read the HBR Guide to Buying A Small Business after listening to the authors, Richard Ruback and Royce Yudkoff, interviewed on the Invest Like The Best podcast. The firm I work for does some private equity investing in exactly the types of companies discussed in this book.
Ruback and Yudkoff teach a course at Harvard called “Entrepreneurship Through Acquisition.” This book draws on many of their students’ experiences. Rather than go out and start up a brand new company from scratch, one can go out and buy an existing business to become an owner/operator. This is less risky than launching a startup.
Many of the entrepreneurs who go this path are highly skilled and motivated, but for whatever reason do not want to work in a large corporate environment. Maybe it’s a desire for control and flexibility. Maybe it’s a dislike of institutional politics.
This book is a guide to the process, from deciding whether to become an entrepreneur through acquisition up through raising capital and closing a deal. In fact, it works pretty well as a private equity primer. Ruback and Yudkoff are basically walking you through a leveraged buyout, though I don’t think they ever explicitly call it that.
Worth mentioning are the key characteristics entrepreneurs should look for in a business:
- “Enduringly profitable” businesses with EBITDA margins of 15-20%
- “Boring” businesses with modest growth prospects
- Businesses with sustainable competitive advantages (a.k.a “moats”), such as high customer switching costs or market dominance in a local or regional niche
The idea is to buy the business for 3-5x EBITDA and structure the transaction so you are targeting an annual return of about 25% to the equity investors. Structurally, this is a very attractive area of the private markets for smaller institutions and high net worth individuals to invest. Big piles of money can’t flood into the space and drive up prices because the deals are too small, in the $2 million to $5 million range for the most part. Imagine SoftBank’s $100bn Vision fund trying to move the needle on performance investing in deals like these!
Who Should Read This Book
Anyone seriously interested in owning, running, or selling a small business would benefit from reading this book. Even if not going the acquisition route it is useful for understanding business models, competitive advantage and strategic financing decisions, as well as the basic principles of financial modeling and valuation. The book is written for a broad audience and is accessible to readers without a finance background.
This book would also be useful for fundamental investors interested in backing an entrepreneur operating a small business, or investing in small public market companies. It is especially helpful in exploring how a small firm can build and maintain competitive advantages over time (a common misconception is that only large cap companies can possess competitive advantages).