Buying a Business is not Investment but a Job

As a business broker in Toronto I receive a lot of inquiries from investors looking to purchase a small business as an investment. These investors include Lawyers, Doctors, Real Estate owners, busy corporate executives earning high salaries and others. Returns on the purchase of small businesses look much more attractive than almost any other available investments including stocks, bonds and real estate, and risk seems much smaller.

The underlying assumption most these investors make is that you can easily hire a manager to replace the current owner and the remaining profits after paying the manager salary is pure profit to the investor. This assumption has however many flaws:

1. Small business owners have the entrepreneurial drive that most managers lack. Most businesses require constant innovation and change to remain successful. Entrepreneur are good at reading market trends and adapt to change. Manager on the other side are very good at executing processes and streamlining the business, but are rarely good at introducing new product lines, understanding and adapting to customer changing needs, taking risks and trying new ideas etc.
2. Business owners work more hours than normal managers, so the cost of truly replacing the owners is almost always understated.
3. Owners wear many more hats at the same time than managers. They possess a variety of skill sets that are very difficult to find in one manager.
4. Business owners are much more motivated than managers because they are taking more risks. The extra effort put and attention to detail that are common to owners are rarely found in managers.
5. Finally, a large portion of the value of a small business is tight to the previous owner and is transferred to the buyer in the form of training in the transitional period. If this training is provided to a manager instead of a new owner, then the investor becomes dependent on the manager. If the manage leaves, most of the value is lost.
   

These are some of the reasons why replacing the previous owner with a manager doesn't work as anticipated. The consequences can be devastating to the investor:

1. Some customers leave because the manager is not providing the same quality of service as the previous owner operator.
2. The business is hardly profitable now that the investor has hired a few more people to replace one previous owner operator.
3. If the manager leaves, the business is in serious trouble.

Some investors however became very experienced at buying small businesses, making them profitable and then restructuring them in a way that they remain profitable even after being managed by managers. This is however the exception rather than the norm. These investors are very skilled at hiring the right people and putting in pace the right control processes.