Can't IPO the local furniture mart for an exit. I'm guessing the liquidity is almost non-existent.

Aren't you basically talking about financing the purchase of a small business? Pretty doable if you have the capital. Talk to some local business brokers or check out bizbuysell.com

Def doable. Really depends on initial capital and target asset class. Easily done with real estate for example. Not sure about the local gas station though.

Maybe I'm missing something here, but how are you going to discover a business with good fcf if the entity is private and the finances are impossible to get? For a small individual investor, convincing the owner to turn over his finances to you will be the hardest part.

This type of business is more personal and the owner/operator probably has not grown the business with the goal of taking it public or being bought out the way that start up owners/operators do. As others have pointed out it seems the financial engineering is quite doable. Convincing someone to walk away from a successful business is difficult, especially if building that business does not give them "exit ops" the way that a tech CEO or founder would have. So, you would have to pay enough to basically set up the owner for life financially, which would probably be a big premium. Also, timing an exit from the business would be almost impossible as (as other posters have alluded) a small business is not a liquid asset class. There is not a large group of people looking to take over a small business and there aren't larger financial buyers or strategics.

But, I think this is a pretty sweet idea. I am sure over the years small businesses have been bought out by larger chain competitors. Maybe you could build a small fund dedicated to sniffing out these opportunities, paying a decent premium to the older, paying down some debt and then getting a decent premium from a larger competitor. That could provide a cool niche industry. Might do some research myself, cool idea.

Def doable. I know a fund buying and consolidating small simple businesses. Insane IRR (like 60%+). Also know a bunch of guys (former McKinsey and Roland Berger partners) doing small LBOs on a deal-by-deal basis, works very well for them.

I think the beauty of small cap is that it's a diverse environment with a lot of interesting assets and you often need to source investments directly (versus being called by GS for a larger target and then bidding together with 26 other PE firms). Sourcing really is super hard as you'll need a strong very senior network to introduce you to opportunities or the stamina to do top-down sector searches and then spend time convincing management teams that you are the right partner. You're quite looking for the needle in the haystack because often current management don't really want to sell. Also brace yourself for a broad spectrum of management talent (although that means in many cases you can really create value by turning places around by implementing approaches that are general practice in larger companies).

I can tell you right now that you are not the only one who does this. What do you think PE firms do?

This definitely sounds like a pretty cool idea. Please keep us informed if you decide to move forward.

"lever up a local business, hold it for a 3-5 year time horizon, and get out for a modest but worthwhile IRR"

For the average investor, I wouldn't recommend it...

Liquidity, financing, operating risk, growth at the rate of inflation... you're talking about running a mom-and-pop

Do some research on the payback period on a gas station or fast food franchise.

I would be very careful about investing your time, capital, and personal balance sheet in a local business. Sure, it can be done, but there are few levers you can pull to generate value, short of becoming an owner-operator (good luck)... at which point you may be better off simply investing in residential real estate...

You're on the right track. Assume a 1% hit rate if you know what you're doing. LOTS of high-priced crappy businesses out there to sort through. Just like any investment, one is high risk, a diversified portfolio helps but that's even harder to develop.

Have you tried talking to some of the local brokers yet? This sort of business is certainly doable.

This is something that has definitely piqued my interest before. I think it very much depends on the financials of the business & if you start working there full time, etc-. If it's a business that can generally be self-run by staff or whatever it is that is being sold (group of laundromats, etc-), then there is less of a time commitment for you, and therefore you can choose to not draw a salary/money out of the company & find ways to improve efficiency of the business on the whole.
I think it would be key for you to have a ton of knowledge in the specific industry - it would be hard to get an owner to sell to someone who doesn't know what they're doing, as well as it being hard to earn a return and improve efficiency of a business that you know little about.
I had never seen bizbuysell.com - awesome link; really interesting stuff there.

An example of what you're talking about was detailed here about a kid who did one: http://nerdbusiness.com/blog/how-acquire-company-using-leverage-buyout http://www.reddit.com/r/Entrepreneur/comments/25e3y0/old_thread_where_a…

However, it turned out that it was full of BS, so it may not actually work, but it gives you an idea. Read through the Reddit comments as well to see what some people have talked about with it.

Another idea would be to try and see if you can pick up a distressed business that has filed for Ch.11 & see the financials and the assets that the company has and pick it up at a steal - this would probably be much harder to find and vet, and would require more work for you to do to turn everything around.

EDIT: For some reason, line breaks aren't working so everything above looks bad/hard to read; sorry OP!

1 Issue in my opinion is definitely the liquidity in actually being able to make the exit at all. Anecdotal: Father-in-law has been trying to sell his small civil engineering firm for the last 5+ years with no luck (company designs stuff like strip mall parking lots and large retaining walls as well as small bridges and street planning/drainage in new residential developments). I don't know his financials but he's been in business for a couple decades with >25 employees so I think it's reasonably healthy. Like many small business owners, he's not a businessman by trade (Stanford engineer) so I think that while it's provided a solid income for his family, there is certainly room for improvement on the business side of his operations. Nevertheless, selling has proven very difficult and I don't think this is an uncommon issue for businesses in this range.

actually thought about this as my family have bought several rental properties.. i want to move into small businesses (gas stations, restaurants, etc).

I recommend look at http://www.bizbuysell.com. Like actually… get to know the brokers. A lot of the people selling are retiring. Find a good operator/manager and tell him to contribute some capital too or give him an incentive management fee on top of his regular pay.

sound like pretty risky nano-LBO...

Nice basic article on full process of LBOing a small business

http://nerdbusiness.com/blog/how-acquire-company-using-leverage-buyout

I think it could be difficult to find good candidates. I believe your examples don't generate the kind of cash flow that you would need. Those examples can make the owner a solid income but that's with paying themselves to be the president of the company / lead manager. My family has owned a business for generations - whoever runs it usually makes ~$100k-$200k a year depending on the year. It would be very hard to find someone who would be willing to put up with all of the headaches for anything less than that type of salary. If you do find someone, then the business doesn't have enough cash flow to pay down any kind of debt.

I only skimmed the comments, but my biggest concern would be unloading the business(es) when the time came. I can't imagine the market for small businesses to be very liquid (just assuming, I could be totally wrong). The last thing you want is to be left holding the bag on a portfolio of pizzeria laundromats.

One major issue I can think of off the bat, besides continuing to run these businesses, financing, etc is liquidity. It will make or break this strategy. 1) How feasible is it to find a sound business to purchase with the owner actually willing to sell? Obviously for the right price, almost everything is for sale, but you don't want to overpay. 2) How feasible is it to find someone who will actually purchase this business from you later down the road? There just isn't enough liquidity for this strategy to provide you with worthwhile returns. Small businesses are peoples livelihoods, and the most successful ones are often their "babies". Obviously it all depends on the size of the businesses you're talking about, the sector, but I don't believe this strategy would work consistently for an individual investor.

It's not a bad or undoable business but you're not going to be in the LBO business, you're going to be a gas station/dry cleaner operator and need to devote full time to it. I don't know the gas station or dry cleaning business at all but you'd have to roll up a bunch of them to attract any attention on an exit, and I really don't know if there's an ultimate buyer in that type of business. You may want to concentrate on smaller manufacturers or things like that where there's a chance if you roll up a few there would be a trade buyer or a smaller PE firm who may be the ultimate acquirer. Small service businesses are more difficult to finance because they typically rely on key personnel (usually the seller) and they don't really have recurring revenue or long term contracts or MSA's in place that can at least give some assurance for future revenue. See the poster above who's in laws own an engineering company. Advice for his in laws: sell it to the employees, either a few key people or through an ESOP. The father in law would probably have to guarantee the loan for the employees/ESOP, but he may be able to get a lump sum up front (some of which would have to be reserved unless he has significant assets if the loan isn't repaid) and get off the guarantee either when the loan is repaid or when it meets certain eq/d or debt service ratios.

The issues you will face are that debt will almost certainly have recourse and you'll need some personal assets/balance sheet to qualify. The lender will also be wary if you personally don't have experience operating that type of business or partner with/bring in an operator (i.e. it would be easier if you worked at the company in a more senior role when the owner wanted to sell to retire and you went to the bank then, most likely with some seller financing involved as well). You'll also be walking into the front door of a small bank and asking for a loan so the lender involved will not be super sophisticated and you'll have to tick all of the boxes of traditional lending: basically you won't be doing any tricky or creative debt structures, you'll be doing plain abl and/or cash flow based lending with shorter amortizations and cash flow sweeps and it won't be 100% debt financing so you'll need either personal equity or to bring in a HNW investor with you. Like another poster said as well, you'll need to fund the due diligence and get through closing (accounting & legal fees for example) which will not be a couple thousand dollars, it will be more. Using the real estate is a good idea and is done in larger deals (I can think of a real estate fund in Philly that was buying larger retailers with long term leases with the idea that the retailers themselves were valued less than the value of the real estate that they were essentially buying with 25 year leases and extensions in place, but I have no idea how that worked out for them) but if you buy a gas station or even a small manufacturer with a 10-25k SF industrial building, the value of that real estate is really dependent on the operating company paying the lease and if the operator goes out, the value of the real estate is cents on the dollar. Think about how many empty gas stations you see if the operator goes out of business. Or the actual value of a 15k SF older industrial building on a back street compared to a new and modern 300k SF industrial building that can be re-leased to many other tenants.

You could always go the franchise route. A friend who's a consultant to a lot of larger LP's and I were talking about this. One of his LP's backed a guy who opened and rolled up a bunch of franchises but he had deep experience in that field, had some skin in the game himself and the LP had deep pockets to back him. We were talking about trying that but the big problem is choosing the franchise: you don't necessarily want to be the 40,000 +1 Subway store but if you could have been the 1000+1 Subway store a few decades ago and secured a geographic territory, you'd have made really good money but it would have taken a lot of operational work.

Other problems are understanding the financials of small privately owned businesses. There's a near certainty you're not going to get audited/review three financial statement financials with notes. There may be no deceit on the seller's part but due to unsophistication and the fact that most small business owners only have to make sure that they're kosher with the IRS and have a feel for how they're businesses are doing based on a few KPI's that they almost instinctively know and you won't have tons of good financial due diligence. And this isn't just for the gas station owner, we've done deals buying from an owner for companies worth 9 figures that have the crappiest accounting/finance systems in place and they don't care.

Exit would be the biggest problem in my mind. If you find something very stable, you can essentially re-lever the business every 3-5 years and recap it.

Also, who is going to run the store? Are you going to give current management upside? Seems less likely when they already own 100% of the business and could put on the debt themselves vs. a MM buyout where liquidity is a driver and serious upside potential remains.

If you're going to run it, look at is in flipping houses, but with small businesses. Again, less of an exit market than housing though.

Good thread OP.

As others have said, the two biggest hurdles to this strategy will be getting adequate leverage and exiting your investment. On the first point, you're likely going to be working with small community banks to get a loan, not GE, CIT, or a bulge. You'll probably be able to finance around 50% of the acquisition with leverage from these lenders, which is not that attractive if you're viewing it from an investment from an LBO lens. An SBA loan is another option but those take a long time to get approved and there are other issues involved.

The other issue is exiting the investment. There aren't that many buyers in the market for small businesses. PEGs look for assets with scale (even MM PEGs don't start to get excited until a business is hitting around $5MM EBITDA). I think looking at small business ownership is an excellent idea, but I wouldn't advise going into it if you think you are going to be able to flip it in 3-5 years like a PE deal unless you think it is a great consolidation play. There are a glut of small businesses that generate around $100K in EBITDA but less than $1MM in EBITDA.

LBOs, etc. of this kind are feasible, and banks may lend to a business with proven cash flows. But beware entering a business in perfect competition on a levered basis, particularly an independent one. Consider buying into a franchise whereby you may be able to take advantage of the name brand (for a reasonable fee). For this, considerable DD is required in various respects, and particularly in evaluating the franchisor. The illiquid nature of the purchase is a valid concern, though this fluctuates partly with the population size of the city/metropolitan area within which you are operating, and your willingness to facilitate a sale via seller financing etc. (which may ease the burden).

There are plenty of private equity search funds that target small businesses ranging from 5M-30M, hold it for 3-7 years, then exit to earn a very solid return.

Most of the time these small business owners are not as "high calibre" as people with experience of high finance and lack some business acumen. Lots of operations and efficiencies can be improved as a result of a change in ownership if you are a finance professional looking for some ventures.

So I understand that a lot of people are worried about liquidity but what if you just never exit? If you could buy in at a low enough multiple, say 3-4x cash flow, why not just leave it and hire a manager(assuming you have enough scale in the business) to run it assuming it has enough scale and let it throw off more cash flow for you to invest? Leverage up only 50% and you would be getting crazy IRRs. Also, I'm sure you could definitely find some inefficiencies and improve the operations if you have experience in the industry. This all depends on your ability to find these businesses of course. If you really wanted to exit, if you bought a lot of, say liquor stores, or a bunch of niche manufacturing companies, you could package them and sell them to a smaller PE firm who wants a larger meal.

Because you still need 50% equity, and assuming you aren't investing the cash yourself because you're young and don't have it, equity investors typically want their principal back and if it's a smaller deal it would most likely be an HNW that you know personally and they typically don't have the 10 year horizon (or patience really) that a pension fund may have.