There Is No Free Lunch

Understanding Why You Can Actually Make Millions Buying A Small Business

Would you like a couple million dollars?

I think we’ve hit peak search. The Instagram Money Influencers talking about SBA loans has the same vibe as Strippers in Vegas buying their 5th house before the Housing Bust or the Japanese Waitress borrowing her way to a $4bn stock portfolio before the Nikkei collapse. The popular pitch goes something like this:

• Boomers are retiring and they own a ton of stable, profitable businesses

• You can buy them for attractive prices with little money down

• You can make a couple million dollars in a few years

Culturally, buying a small business is now squarely in the same category as flipping houses, multi-level marketing, and crypto. Categories where more money is made selling courses on how to do the thing than actually doing the thing. What they all have in common is a cheap ticket to day dream about a better life because you discovered a shortcut. That’s what people are buying. It’s buying the Gold’s Gym membership and never going, but feeling like you’re doing something.

That observation isn’t particularly interesting. The human brain is evolutionarily predisposed to get excited about these types of shortcuts. It was helpful for our species to get a dopamine hit every time we saw an opportunity to get to food (or other goals faster). Combine that with the overconfidence bias (everyone thinks they’re an above average driver) since a lot of actions that are good for the species are not good for the individual (crossing a river that only 50% survive to more fertile land) and you get a dangerous combination.

Instead of asking themselves where the catch is, people get excited about a potential short cut to their dream life and then their overconfidence tells them the reason they have this opportunity is because they are smart and found it. In reality, there is no shortcut. There is no free lunch, so let’s talk about why you can make good money buying a small business (if things work out).

Small business are not cheap and kind of like cargo sail ships

The first crucial misunderstanding as a searcher is that buying a small business for 3-5x EBITDA means you’re buying it cheap. The worst comparison is to look at where public companies are trading and then feel like you are getting a good deal. Small business aren’t an assets that will spit off cash and go up in value. The best way to think about buying a small business is like a 18th century cargo sail ship. If you sail in the right direction, with the right crew, weather the storms, and maintain the ship you can make a bunch of money. Buying the ship or owning the ship doesn’t make any money. And just because the last captain made a bunch of money with the ship doesn’t mean you will.

Why can I make a bunch of money doing this?

So if we know the wealth creation isn’t coming from buying an asset cheap and selling it at fair value, why would the market potentially give you millions of dollars in only a few years? The short answer is headaches and risks, but let me explain why.

A good exercise when evaluating a business is asking why customers are willing to pay more than what the product of service costs the business. It can be convenience - don’t want to mow my own lawn. It can be utility - can’t build my own iPhone. It can be risk reduction - Consulting with a lawyer with 20 years of experience significantly improves my odds of making the right call. There are a tons of them. When it comes to small businesses, it’s very unlikely you have a unique service or product, so the likely answer why your customers are paying more than your cost is convenience and reliability.

Consistently delivering high quality products and services to your customers is difficult and strenuous. Your employee didn’t show up - that’s your problem. Supplier delivered the wrong product - that’s your problem. Insurance doubled because drivers in your area had a bunch of accidents - your problem. The vast majority of the money you can make in buying a small business is compensation for dealing with headaches and problems.

The smaller reason you can make a bunch of money buying a small business is the risk. Your main customer leaves and you can’t pay for that machine you bought to service them - your problem. Best sales rep has to move for family - your problem. Your equipment breaks down - your problem. Running a small business is risky and so part of the money you can make is for taking the risk other people won’t.

You’re not getting paid for your advice or degree

Notice how neither of the two reasons you can make money in small business is strategic advice, technology, branding or anything else you can learn in an MBA class? There is not enough margin in these businesses for advisors. You need to earn your money by contributing to the operations. Doesn’t mean you are the one doing the work. It means at a minimum, you are the backup anytime something goes wrong and you better fix it fast or there goes a week of profits.

Conclusion

The reason you can make a bunch of money buying a small business is because it requires successfully executing day after day, dealing with all kinds of headaches while carrying all the risks. It’s a path most people don’t want to deal with and so similar to danger pay for military or underwater welders, the market pays you a premium for dealing with all the risks and headaches.

Obviously business acumen and smarts help in improving operations, getting more efficient, and growing the business. But you won’t get paid for that on a day to day basis. You need to steer the ship, manage the crew, and weather the storms. And if at the end of a 14 hour day you have the energy to improve the sails or find a better route, it will make your next day a little easier. Buying a small business just means you get to start with a bigger ship. You make money running the ship - not buying it.