- Cash flow and equity
- Purchase price tends to be relatively low compared to profits
- If you buy a business for $10.25m with $2.5m profits that gives you a 25% annual return
Let's say closing costs are $250k and you fund the purchase with a $7.5m loan at 6.5% and $3m equity from investors. The agreement is that you receive 20% of any profit from running (or selling) plus $150k salary to run the business
- Interest expense (6.5% on $7.5m) = $490k
- Net profit ($2.5 - $490k) = $2.01m
Increase in wealth in one year for entrepreneur is 20% of 2.01m plus $150k = $550k (before taxes). If you grow the business at 5% a year for 10 years your annual wealth increase would be $850k per year. If you sell the business on year 10 (assuming similar market conditions) then share of capital gain is $1.3m. Over 10 years the total wealth increase is $8m (before taxes).
These opportunities exist because owners of successful companies eventually need to sell to retire, health issues, divorce etc. They don't have the same options are a bigger business. The search can take significant time, effort, and funding and there's a steady supply of small businesses that are forced to sell which keeps the prices of small businesses lower.