Many years ago, I worked with an incredible individual – Jerry Efros. He was a WWII veteran, a tail gunner, and post-war he was an extremely successful businessman. He evolved into business brokerage and did that well into his 80’s. He passed away a few years ago, and every Memorial Day I reflect on the presentation he made to a group of brokers every year on that weekend, which was so impactful.
Jerry had some incredibly wise guidance that he happily dispensed. One of his lines, which I have used countless times (and I always credit Jerry), is regarding the best business to buy. When buyers would ask him “what’s the best business,” or “what business is recession proof,” or “what business can I buy that’s risk free,” he always told them: “Buy a toll booth.”
There is more truth than fiction to Jerry’s answer. The reality is that few if any businesses are risk-free. Recession-proof businesses, while seemingly an attractive concept, are not necessarily available in abundance, and moreover, how does one quantify a “recession-proof” business? The flip side is that these types of businesses are generally those with limited upside in boom times.
If you want to be a true entrepreneur and are looking to buy a business as your vehicle, you must get comfortable with risk. That does not mean reckless; it simply suggests that there is going to be risk in every business purchase. The key of course is to either mitigate it with agreed upon deal terms, or to determine whether you can accept it.
There is a mechanism to deal with the risk in most small businesses. If it is a customer concentration issue, then a buyer can have an earnout component to the deal. Such provisions allow for an adjustment in the purchase price if certain clients do not continue to purchase from the company. If it is a key employee issue, a buyer can enter an employment agreement. When evaluating a potential risk, a buyer needs to determine:
- What impact will it have on the business if it materializes?
- Can I live with it?
- What can I negotiate in the deal to lessen the impact of the risk?
- If it looms too large and cannot be solved, am I prepared to walk from the deal?
Recession-Proof – What Does That Really Mean?
If a buyer wants a business that will not decline during a recession, how can that be determined? Is it one where the company’s goods and services will be required regardless of the macro economy? Determining how a business or sector will perform in down times should never be left to a guess. It cannot be a case where a buyer, with limited information, thinks that the business should do okay or not.
The only viable way to underwrite that is through a stress-test. Consider the sector and research how these types of businesses fared during previous recessions. Moreover, you want to know what happened afterwards, and how did they perform?
The ‘Perfect’ Business
As my late friend Jerry’s earlier quote points out, there is no such thing as a perfect business. Every business has warts. Finding a business that can withstand an economic downturn and exit completely unscathed may be possible, but it is not common.
When evaluating any business, address the concerns from a probability standpoint. Identify all the things that can go wrong and attach a percentage to each of the risk materializing to the best of your ability. This can be done by seeking out experts in the field, current owners of similar businesses and conducting deep research. Make sure the total of each scenario’s percentage added up equals 100. Then, determine if the largest one(s) is something you can live with or solve. If the answer is ‘no” to both potential outcomes, your decision not to buy it becomes easier. On the other hand, if it is livable, then adopt the mindset of a true entrepreneur and recognize there is always going to be risk; if you cannot handle it, then perhaps business ownership is not for you.