Every once in a while I get a call from and old friend in the business.  Let’s imagine I recently got a call from someone (I’ll call him “Old Friend”) which was very inspiring. Old Friend was actually intrigued with this blog. Not that I didn’t think I had something to offer but as I pointed out to Old Friend, this blog was sort of an experiment and even an afterthought to my daily life.  I should share a few of the interesting points we discussed and maybe add some in subsequent posts.

First and foremost is a kind of  validation of the market we are in. The name of this blog, Small Business Buyer, is there for a reason. We believe that the LBO market is vast for buying small businesses. It can be done in any economic climate, and sized wallet and by anybody. But there is a right-sized business. We look for businesses of over $500,000 in cash flow and $5.0 Million revenues.

By contrast, Old Friend is a professional business buyer but targeting distressed companies. Larger companies than described above. Not really doing LBO’s, rather channeling the needed capital/investors to buy such companies with cash.  This once was a great market and may be once again but, as Old Friend points out, it has stalled as many owners have decided to hold onto their distressed properties.

Old Friend liked our strategy and the market – the small business, positive cash flow market. Now my position on this is that anyone who has bought distressed companies and lived to tell about it could do LBO’s on small market businesses with their eyes closed.

It is important to point out a key difference. Distressed companies usually do not make good LBO’s. That’s because they are leveraged up already. They don’t have equity built up, excess assets or any of the requirements needed for an LBO. Often times they are simply LBO’s of good companies that fell on hard times. Hence you usually need capital, and sometimes lots of it, to play that game. And once you buy your distressed company you may need more capital before your investment pays off.  Once you start down the path of more capital after closing you are in the Venture Capital game. For my money this is a game best left to deep pockets and specialized expertise not the average buyer.

Small Business LBO’s are bought once and that’s it. We take money out of them not throw more money in. If things go really really bad, we may have to close up shop but our intention is to make that initial investment pay off many times over with cash-on-cash and exit strategy returns. This is entirely possible with the right structure and positioning going into the deal.

Now let’s say you want to grow the business, which Old Friend wanted to do. After all what good is a distressed company if you don’t grow it? With a distressed company, this takes time, turnaround expertise, luck and, yes, often times new money. I say to that: you better be right. Or your investors get testy and you don’t make much money. With an LBO we have structured the cash return up front, so that we know how much we will be paid and what get”s paid to third parties. And say we can’t see pulling out $100,000 per year from the investment, well we might not want to do the deal. If we can see pulling that amount out then we don’t even care if we grow, we just need to hold our own. I will testify first hand that holding your own is easier than turning companies around or even growing them.

So my final point on this is you can spend your time and expertise on keeping a profitable company stable or you can spend your time, expertise and add money on turning your company around. While the latter probably offers more upside, the former presents less risk. This was an easy choice for me once I had my own taste of both.

Next: some other interesting points raised in my discussion with Old Friend.