Summary: Some business brokers and influencers promote the idea of buying businesses operated by absentee owners as an easy way to generate passive income. Buyers imagine they can just acquire the business and collect payments. Unfortunately, the reality is often different.

Buying an absentee-run business requires many things to line up correctly. The opportunity must be right. The business must have the right employees and systems. Furthermore, the buyers must have a specific set of management skills. Get one of those wrong, and the business will likely fail.

Getting acquisition financing for absentee-run businesses is difficult due to the high risk of these transactions. This article provides an overview of how to finance these transactions. It covers how absentee-owned businesses work and what red flags to look for if you plan to buy one. We also show you how lenders evaluate and finance transactions. You will learn the following:

1. What is an absentee owner?
2. Myths and reality
3. How do absentee-owned businesses work?
4. Absentee ownership challenges
5. Buyer risks and red flags
6. Can absentee-run businesses be financed?
7. Typical financing structure
8. Red flags for lenders

1. What is an absentee owner?

An absentee-owned business is a small company that can operate without the owner's daily involvement. The owner is effectively a non-operating investor in the business. Successful companies typically have seasoned management and business systems in place.

However, an absentee owner isn't always 100% hands-off. Owners can have several levels of involvement. Some owners may live locally and visit the company regularly. These owners work part-time and may be considered "semi-absentee."

In other cases, the owner lives in a different state. They may check on the company sporadically but have a "hands-off" approach.

2. Myths vs. reality

Some potential buyers are under the impression they can buy an absentee-run business, let it run, and simply collect the profits. After all, the business has a manager who can handle all the work.

This popular perception of absentee-run businesses is mostly wishful thinking. For all intents and purposes, it's a myth. Most small businesses require some level of owner involvement regardless of how they are organized. It's just how small businesses work.

We understand there may be a few businesses out there where the owner is truly absent and has minimal involvement. In our experience, we find these opportunities to be very rare.

3. How do absentee-run businesses work?

The typical absentee-run business owner has worked in their business for a long time. They know the business inside out, have the right people in place, have the right systems, and know which metrics to monitor.

This combination of features allows the owner to step back from day-to-day business operations. The owner still manages the business, albeit part-time. Basically, their efforts shift from managing all employees to overseeing the company's key managers.

The typical successful absentee owner can evaluate the company from afar to determine if it is running correctly. This knowledge allows them to step in and correct problems only when needed.

a) The right people

The business must have the right people in place. The team must have dedicated front-line employees and seasoned managers. The team enables the owner to be away from the business while they run the company.

b) The right systems

The business must have the right systems in place. These vary based on your industry. At a minimum, they include accounting, services, sales, customer support, and marketing. It must also have a clear and well-defined reporting structure. All of this must be well documented so new employees understand them.

c) The right skills

The absentee owner must have the right skills and knowledge to manage the business from afar. Without an owner who has these skills, the business will likely fail even if everything else is in place.

These skills are similar to those of a regional manager. Consider the typical regional manager of a retail chain or large business. They can work with the local managers, develop their teams, and step in when required.

d) Detailed knowledge of their business

Absentee business owners typically know every detail of the companies. Most worked in their business for a long time before moving into an absentee role. The owner also knows which operational and financial Key Performance Indicators (KPIs) are needed to determine if the business is being managed correctly. These metrics enable them to determine the right course of action and step in if needed.

4. Absentee ownership challenges

Becoming an absentee owner is not as easy as some people portray. Small businesses often have a hard time overcoming the challenges of operating without an active owner. This is because small businesses have fewer resources than their larger counterparts.

a) Finding managers is difficult

Some buyers are told, "All you need is to find a competent operator. They will run the business for you." This advice may give the impression that operating a business as an absentee owner is easy and simple. It's neither.

Finding competent and dedicated managers is very difficult, especially for small companies. Few individuals have the specific skills needed to manage a small business effectively.

Even if you find the right manager, hiring them may be challenging. Remember, you are competing against larger companies that can provide higher salaries and better benefits. Ask yourself, "Why is working for me better?" You need a good answer to this question if you want to attract quality employees.

b) Implementing systems is expensive

The business must have the right systems and processes so that all essential functions work smoothly. These systems must be well documented so existing and new employees can do their job effectively.

Deploying, maintaining, and documenting the systems can be expensive. You must also account for the expense of training employees to use these systems effectively.

c) Developing the right skills takes time

Your role as an absentee owner is to oversee the manager to ensure the business is being run as it should. You must understand which metrics are important and how to interpret them. You will need this knowledge. Otherwise, the business will likely fail.

One way to obtain these skills is to hire the seller as a consultant after the sale closes. This strategy can have varying degrees of success. We think a better approach is to work in the industry for some time before the acquisition. This work provides practical experience and allows you to be better prepared as you enter the acquisition.

d) Needing to step in at times

As an owner, you are ultimately responsible for the company's success. Ideally, the manager should be able to handle any major issues. These include employee absences, customer issues, etc.

However, no business is 100% perfect and works every time. You can never have a completely "hands-off" approach. Sometimes, you need to step in and fix the problem.

5. Buyer risks and red flags

Buying an absentee-run business requires a substantial amount of due diligence. Remember, there is a reason that lenders consider these opportunities to be riskier. This due diligence helps you identify potential red flags that could impact the business after closing the sale. More importantly, they can help prevent you from buying a "bad business."

a) Why are they selling?

Brokers and sellers typically promote these companies as generating substantial profits that require little effort. If this is the case, consider this question: "Why are they selling the business?" This is the type of opportunity an owner would want to keep for as long as possible, isn't it? After all, the business presumably generates free cash flow with little involvement.

Brokers – and even the seller – won't likely provide much helpful information. Typical answers to this question include "owner is retiring" or "owner is pursuing new opportunities." These answers may be accurate but provide no useful information. You need to do your own research and figure it out.

Remember that the last thing you want is to buy a business that is difficult to run. Or worse, a business that may not be profitable due to changing market conditions.

b) Can the business survive with new ownership?

Examine how much the business depends on the seller. Just because the seller can run the business as an absentee owner doesn't mean that anybody else can.

Consider this simple example. Assume a seller has a long-time manager in place. They have a good dynamic, excellent rapport, and work well together. The manager has a sense of loyalty to the owner. Will you be able to build a similar relationship with the manager? If not, the business could be in trouble.

c) Will key employees stay?

An absentee-run business relies on key employees, such as the general manager. The business could easily get into trouble if key employees leave after the sale.

d) Consider a Quality of Earnings report

Consider working with an expert to develop a Quality of Earnings (QOE) report for the company. The report provides a comprehensive evaluation of the target business. The report covers most aspects of the business and helps uncover issues that could impair the company's value. Ultimately, it helps you determine if the target company's revenues are sustainable.

6. Can absentee-run acquisitions be financed?

Lenders typically only finance transactions in which the buyer is actively and directly involved in the business. Direct buyer involvement in operating the business reduces the lender's risk. Consequently, financing a "true absentee owner" business is difficult.

While this requirement may rule out certain transactions, it does not rule out all of them. Many transactions have a solid chance of qualifying for financing if structured correctly. It depends on how "hands off" you plan to be.

There is nothing wrong with having a general manager who handles all front-line operations. Basically, you acquire the company and directly oversee the managers. This is not a hands-off approach but rather a "part-time" approach. It also frees time for you to develop a strategic plan for the company.

You may be able to finance a transaction in which you operate the target business as a part-time owner. Note that you will still need to have direct involvement. Each lender has different requirements and risk tolerance. We suggest you discuss your plans with the lender early on. This step helps ensure everyone's expectations are met.

7. Typical financing structure

Most small business acquisitions under five million dollars are financed using Small Business Administration (SBA)-backed financing. SBA-backed financing typically has the simplest qualification requirements and offers a great value.

Most transactions are financed with the following components:

• Equity injection
• Seller financing
• Lender financing

a) Equity injection

Every lender requires that the buyer contribute funds to the transaction. This down payment is called an equity injection. The equity injection must cover at least 10% of the transaction value. It can be reduced to 5% if the seller provides financing with a standstill clause.

b) Seller financing

Most transactions have a seller financing component that covers 5% to 15% of the transaction cost. Most sellers prefer an immediate payment and want to offer the lowest possible amount of financing. However, seller financing is important for buyers and lenders because it compels sellers to fulfill their post-sale commitments. Additionally, seller financing typically has competitive terms and is flexible.

c) Lender financing

The remaining portion of the transaction is financed with an acquisition loan, typically from an SBA-backed lender. Acquisition loans typically cover 70% to 90% of the transaction.

SBA-backed loans are designed for small business owners and work well for acquisitions under five million dollars. They offer competitive rates and have simpler qualification requirements than conventional bank financing. Read "How to Get a Small Business Acquisition Loan" to learn more.

8) Red flags for lenders

Two specific red flags tend to appear in the prospective "absentee owner" acquisitions we have reviewed. While they may appear individually, they typically appear together.

a) Buyer plans to be 100% hands off

We don't know any lenders that finance transactions where the buyer plans to have no operational role in the target business. Experience shows that most small businesses require a level of owner involvement. Lenders consider that small businesses with no owner involvement have a higher risk of failure. Consequently, they prefer to avoid them.

b) Buyers without meaningful experience

Lenders want to see buyers with meaningful experience in business operations. This experience shows lenders they have the needed management skills to run the business. Buyers without meaningful management or business experience may face difficulties finding financing for these opportunities.

Consider the lender's point of view. They see a potential client with no meaningful business experience who wants a loan to buy a business and let another person run it. How will they be able to manage the business and determine if things are going well? More importantly, how will they manage the company when things go inevitably wrong?

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The first step to work with us is to submit this form. Once we review it, one of our associates will contact you to discuss the specific details of your acquisition.

 

Editor's note:

This information should not be considered legal or financial advice. Given the complexity of business acquisitions, this document is not guaranteed to be 100% accurate or cover every potential option. However, we make every effort to provide you with the best information. If you have comments, suggestions, or improvements, contact us via LinkedIn.