Pros and cons of buying a business as an investment

Buying a business can be a highly lucrative way to invest your money. This type of investment doesn’t have some of the same limitations that investments like stocks do. But the unique advantages come with some disadvantages. When deciding what investment strategy is right for you, there are a few factors to consider:

1. Risk

2. Liquidity

3. Upside or potential return

4. Demands on your time

Below, the different common investments are compared: stocks, real estate, and owning a business. Low risk, low return investments like CD’s and bonds are not covered. Note that in this context, buying a business refers to buying business assets directly from the owner, which differs from buying stocks in a business.

Risk

All investments involve a degree of risk. Risk can be mitigated and managed by understanding your market and playing within your risk tolerance. The advantage that stocks offer is that you can invest small sums which isn’t an option with real estate or businesses. But small sums leads to small returns. And playing with stocks is a gamble based on factors largely out of your control.

When you make a large investment in real estate or a business, you have a lot of money on the line. But real estate is a fairly consistent investment. The market fluctuates, but people always need homes or space for their business. Property values and mortgages are determined by supply and demand; rent prices trend slightly higher, to cover mortgage + maintenance + property tax, and put a little in the landlord’s pocket. There’s always the risk that you’ll have long periods of vacancy or find yourself desperate to sell in an untimely buyer’s market, but if you do your due diligence, the risk in real estate is very manageable.

The same applies to buying businesses, but there is more risk. What’s different in buying businesses is that you have more control over the success of the investment, because its based on the performance of the business, which you have control over. Real estate values are largely driven by external factors, and improvements to a property have a direct cost-to-appreciation relationship. This is less true of businesses. The wild card is your ability to run a profitable business.

Through market analysis and due diligence, an investor can determine how much potential for profitability a business has. The rest is effort and resourcefulness. The great thing about investing in a business is that you can put your experience in business to work to control the appreciation of the business, rather than relying simply on external factors.

Liquidity

Its hard to argue with the liquidity that stocks offer; they can be converted to cold hard cash in as short a period as a few minutes. Even real estate offers more liquidity and flexibility than buying a business. A real estate sale might take a month. The process[Link to: previous post about the process of selling your business. See Todd or Jordan with questions] of selling a business can take as long as 6-12 months. And equity in real estate can even be mortgaged for cash in a pinch, though this is certainly a longer process than cashing your stocks in.

Where owning a business can beat out real estate or stocks is in cash flow. Stocks offer small cashflows unless the holdings are in a company that sees uncommon growth. Rental properties offer a predictable and modest monthly cash flow, while flipping properties results in a one time payout. A good business, meanwhile, puts cash in your pocket each month. How much cash depends on market potential and how well run the business is.

And lack of liquidity can have advantages, too. Real estate and business sales need to take so much time because there is so much money tied up in one deal. You might find yourself at a bargain because the seller is desperate to close, and needs to get the ball rolling. And the simple fact that selling a business requires so much work means there is less competition, which might give you as the buyer some leverage.

Potential ROI

When it comes to ROI, consider both potential ROI and probable ROI in each investment. Stocks have the allure of seeing astonishing growth in uncommon cases, but the responsible investor does not expect to see these kinds of returns. A more realistic approach is to sit on holdings for residual in come and long term appreciation. This form of growth is probable.

The potential growth with real estate is based on market fluctuation, but again, hoping on such external factors is not the most responsible way to invest. The probable ROI comes from residual monthly income (aka rent payments) and building equity that can be cashed in at a later date.

Businesses have the highest potential and probable ROI, because the cash flow month-to-month can be much greater. Additionally, a business can and should become more profitable over time due to factors within your control. This leads to increased cash flow and an increased sale price when you offload the investment.

Demands on your time

This is where the tremendous upside of buying a business over real estate or stocks is earned. Stocks are a relatively low maintenance investment. Real estate, meanwhile, requires more of your time, both to make deals and maintain your property. The sale of a business takes even more time than that. Additionally, a business is a high maintenance investment once acquired. Even if you have an excellent team in place, oversight is still going to be your responsibility. You’re only going to reap the full benefits of investing in a business if you’re willing to steer the ship yourself. And while a company can be developed into a more autonomous one, that’s going to take time upfront.

The main reason to invest in a business is that you can leverage your most valuable asset — your business sense. There is greater potential return in buying businesses. The ability to run an effective business is always worth a lot of money. If you have experience in business and you’re confident that it will help your investment appreciate, buying a business might be your best investment strategy.

For help buying or selling a business, contact Free Vector Advisors by filling out a contact form here.

 

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