At the Lab, we get asked a lot about whether it’s possible to acquire a company but not operate it. Sometimes it’s because an acquisition entrepreneur isn’t the best fit to operate the company while other times, it’s because they’re interested in a multi-acquisition strategy.
This article will outline the drawbacks and benefits of hiring a general manager / president / COO to run your business as well as the two things you need to do in order to get it done successfully.
Without a doubt, one of the most common questions I get every single time we run a new cohort through the Acquisition Lab is,
“Walker, how do I hire somebody, you know, to, to go in and run the business for me?”
“How can I be an absentee owner?”
The important thing to highlight is that this is not a highly recommended approach for your initial acquisition. But if you’re going to do this, you probably want to adjust the type of business that you’re looking for.
There are inherent risks to absentee ownership.
The biggest risk is intangible: Leadership.
Leaders are the foundation for the implementation of strategy as well as culture. Plus, the business typically takes on the personality of the leader. If you are not the leader and it’s going to be someone you hire then finding the right person is absolutely vital.
The first time you do an acquisition, we recommend that you buy 100% of that business and run it as CEO for at least seven years. While, Walker did acquire seven companies over about 10 years, six of them were acquired in the final three years just to give a little perspective.
The first and primary drawback of hiring an operator is it requires that you be comfortable giving control to someone else on a business that likely has a personal guarantee with your name on it. Right?
Putting someone in that role who doesn’t share the personal guarantee is difficult because they lack the same level of conviction. As an employee, they have an easy path to exit in the face of challenges.
They may quit.
A company that Walker owned but was operated by a general manager. He started receiving job offers from other people. At first, it was easy for him to turn down offers but ultimately, he didn’t retain him.
A local company, owned by a father and son, targeted my general manager after the father had a heart attack. Eventually asking “what’s it going to take?”.
Despite providing some ridiculous number, it was granted. Many people would have done the same thing if they were in his shoes.
In these situations, you cannot blame them especially since this was a known risk you willingly took so you don’t have to spend time in the business. Yet, when it does happen then you have a massive special project on your hands requiring immediate attention.
Number three is the fact that hiring is challenging, especially when you’re hiring such a big role.
A mis-hire is so costly….
If you hire someone who doesn’t have the right skillset, who can’t execute, who isn’t good with the employees or the customers or whatever it is, not only can it cost you hundreds of thousands of dollars or more but it’s going to be a huge drain of cash and it can completely derail your business strategy.
Because of these risks, you have to be really careful with these strategies.
The benefits are number one, you get to leverage your time.
One of the things that Walker did when he bought all of these companies was start thinking that because he was acquiring these businesses with debt he wasn’t needing a whole lot of cash in order to build sort of the smallest private equity firm you’ve never heard of.
A series of different businesses. He had three companies sorry, six companies in three different verticals. Running at the same exact time.
He was able to do that because he was able to leverage general managers. The fact of the matter is he owns two companies right now, one of them he manages outright. This doesn’t include the Lab by the way. These are companies I have acquired.
One I manage completely. The other one is a manufacturing company. And let’s categorize them as blue-collar workers, we have residential customers, we’ve got B2B or other business customers who are repeat and bigger customers. The company is growing 10 to 25 plus percent year over year.
There’s no way that Walker would not be able create videos for the Lab, grow his hair out if he was managing that company. Instead, he gets to do things like write books, start another company on the side, run a different business.
All the while, achieving benefit number two, maximizing his return.
Returns in the private capital market are larger than any other asset class. It has been that way for decades.
Not only did he acquire one business that he operates, he’s also acquired another business that he doesn’t operate. It allows him to act as a chairman and the rhythm is more like a monthly visit and a quarterly strategy meeting.
He helps set the vision and helps hold the general manager accountable but is not required to spend his time in the day to day. All the while owning 81% of that firm.
So, while building up equity, he’s getting cash returns and they’re growing. It’s a wonderful way to sort of expand beyond you.
Number three is the ability to provide a great opportunity for others.
The general managers are people that are very effective at leading teams, at managing companies, building organizations. They don’t have the same risk profile that an acquisition entrepreneur has.
So instead, they get to come in as the manager and help execute by doing what they do best. They’re getting a great opportunity to lead and manage a small business in a way that they probably wouldn’t get anywhere else.
Now let’s talk about the three best practice you should consider.
Number one is, like you’ve likely read in Buy Then Build, it’s critical the business aligns to an entrepreneur’s three A’s: attitude, aptitude, action. When you make that hire, you’ve got to make sure that the target, the business that you’re acquiring actually aligns with the three A’s of the person that you’re putting in place. In other words, please do not acquire a company and then go out and put a listing for a job out on the internet and meet people for the first time.
Build a bench of managers ahead of time so that when the opportunities pop up, you know which person you need to recruit,
This is absolutely critical. It should be the number one best practice.
Number two is this, hire for these things: intelligence, drive and integrity.
I think it was Warren Buffet who said, “I hire for these three things: intelligence, drive and integrity.”
Integrity has to be one of them, pick two. It’s really, really rare to find all three of those things. But if you’ve got someone who has integrity, who has that loyalty, who has that honesty then they will be a good part of your team. And then they’ll either be driven or they’ll be intelligent and so they’ll be able to figure it out.
If you have someone who is driven and intelligent but doesn’t have a high level of integrity, they may end up taking advantage of you.
Number three is, do not give up equity.
The minute someone gives you money even if it’s an institution, you owe it back. That’s your responsibility you have to do it.
Now, if you give somebody equity, if I say, “Hey manager, come on in here’s 20% equity, I want you to manage my company for me, see you later.”
It kind of goes back to those three drawbacks that we talked about in the beginning. Number one, you’ve got to be comfortable giving control to someone who doesn’t have that personal guarantee on the liabilities. Number two, they’re not as committed as you and they might eventually quit and walk away with equity in your company. You don’t want someone to walk away with 20% equity in your company. And number three, hiring is hard and you might make a mis-hire.
In all three of those situations, they end up either wrecking the company or leaving and they walk out the door with 20% of your company, don’t ever do that.
Now, the solution in sort of the startup world is hey, let’s do a vesting schedule and we will get you equity, but we’re going to invest it over a period of time. Nope, still can’t do that. And the reason why is for the same exact reason. Even if I stretch it out over a decade, okay. Let’s just say I’m going to give them 20% we’re going to invest it over a decade. You’ve got to have milestones in there to make it real. So assuming we get to year five, they might own 10% of your company, which opens up the door to the same risks we’ve had before.
Here’s a potential solution to consider.
Consider phantom stock. When you own equity in a company there’s really only two ways that it benefits you. Number one might be if there’s a whole bunch of people involved and there’s politics and there’s a big board of directors and all the rest of it and you need to sort of jockey for power or whatever. That’s usually not happening in these smaller companies. And the bigger one is that the day the company sells is the day that all of the benefit of ownership comes to you. And in fact, it’s estimated to be 50% of all of the financial benefit of owning a business comes in the day that you sell.
Since you’re likely not going to die with your business, the day’s going to come eventually that you need to sell. I’m just talking about even if you run your whole career and you work for 25, 30 years at one company, eventually you’re going to sell that company. That’s the big payday, right?
So the point is that that’s the day that having the equity actually counts, actually matters.
And so phantom stock says listen, I’m not going to actually give you stock, but here’s an agreement that we have that basically signals that you have this 20%. Just a note that we’re using 20% in these examples because it’s the standard textbook private equity while in a search fund it’s based on milestones, earning up to a little above 20%. Twenty percent is a pretty good peg for someone who performs in running your company.
On the day the business is sold whether that be tomorrow or in 20 years, there will be proceeds of the sale.
Out of these proceeds you have to subtract related expenses such as the legal expenses, the M&A advisor fees, maybe the CPA which can be viewed as like the gross net proceeds. But still not the net benefit because you’ve got to subtract out any liabilities that you have which can include accounts receivable minus accounts payable plus inventory. But there will be other liabilities save for example an SBA loan that was used to acquire the business.
Let’s look at an example of what they may look like.
You run the business for seven years and reduced the debt to 25% of the original loan amount. Originally purchased for a million now the debt principal balance is sitting at $250,000. You were able to grow that business so now you’ve got 5 million in revenue say. And it’s being sold at 1X revenue or $5 million. If you’re going to spend half a million dollars on fees then we need to subtract that $250,000.
You as the owner then gets to take 20% of those proceeds, pay it to your manager and it becomes an additional expense that lowers your taxable gain when you take a 80% of the total net benefit of that transaction to you.
So, you see you’re able to promise all of the benefits of equity without necessarily taking all of the risk on.
Some alternative solutions for managers would be the minute that the debt is paid down the buyer will give them 20% of the company. And another one is once the buyer has worked with someone for a certain period (Ex. five years), offer that they sign on the personal guarantee as well and gain percentage ownership. This option reinforces that they’re as committed as the buyer. Which eliminates that first and number one risk,
If you are interested in buying a company in the next 12 to 18 months, this is why we started the Acquisition Lab. On the one hand you can read Buy Then Build, you can read the Harvard Business review guide to buying a small business and go out there and do it yourself. You can go hire a buy-side advisor and pay them $150,000 on a million-dollar transaction if you want or Acquisition Lab is a do it with you, buy-side advisory service. We’ve got world-class education, coaching, a suite of tools and a vetted community.
For more information, visit www.acquisitionlab.com.