I recently sent out a short reader survey.
Many of you completed it (thank you!).
A few things stood out:
- 60% of you are full-time employees
- 75% of you are interested in building passive income
- 90% of you earn more than $100,000 in household income
I love it.
Today, I’d like to explore a question that I suspect may resonate:
Can you realistically acquire a profitable small business to generate passive income while working a full-time job?
A lot of people would passionately argue that you cannot.
“It’s too time-consuming, too risky, and too difficult to find good operators.”
But I disagree.
In fact, I’ve done it (while also becoming a first-time dad in the middle of diligence!)
The goal is to make your involvement semi-passive.
Semi-passive means you spend no more than 2-3 hours per week on it.
Akin to the Chairman of the Board role for a public company.
You exist to provide strategic direction and help with capital allocation decisions.
In practical terms, you never (or very rarely):
- Visit the office in-person
- Directly respond to a customer email
- Manage virtual assistants or contractors
If this is your goal, here are 5 obstacles you’ll need to overcome (with examples of how I overcame them):
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Obstacle #1: Deal Flow
You need a pipeline of relevant businesses for sale.
3 steps to get this done:
- Define your investment criteria.
- Create filters on popular listing sites.
- Reach out to regional brokers in geographies you’re interested in.
Then diligently analyze 3 deals per week, spending no more than 20 minutes on each deal.
As I’ve said before, stick to brokered deals your first time around.
Off-market sourcing is very time-consuming.
There are only so many hours in the day.
Obstacle #2: Deal Structure
Here are my structuring rules for full-time workers looking to acquire an SMB:
- Do not pay more than 4x annual earnings
- Bring at least $50,000 of your own cash to the deal
- Every deal should have a seller note (20%+ of purchase price)
- Every deal should have an earn-out (10%+ of purchase price)
These rules ensure you retain significant equity (high upside) while also having ample cash flow available to service your debt obligation (low downside).
The seller note and earn-out incentivize the seller post-close (further de-risking the investment).
Obstacle #3: Due Diligence
Performing due diligence on a million-dollar asset can be intimidating.
That’s why you should never do it alone.
Commission a Quality of Earnings report and hire an attorney.
Do not be cheap.
You still have your day job.
Use it to fund due diligence.
You should be comfortable losing $15-20K in diligence fees if your team finds a red flag.
That does happen.
Obstacle #4: Delegation
From day one of your search, you want to be focused on delegation.
Look for businesses where you can confidently hire an operator to run it.
In practical terms:
- Avoid businesses with key man risk. Specifically, situations where the seller performs at least 30% of all essential day-to-day operational tasks.
- Avoid businesses with significant technical barriers, which makes identifying the right talent quite difficult. Key word being significant. A small barrier is a good thing (creates a moat).
- Avoid businesses without a strong team of virtual assistants / full-time employees already in place. A big piece of the value you are paying for is the operational team that gets things done day-to-day.
An alternative approach is to identify an operator before you commence your search.
Perhaps someone from your professional network.
You find the deal and structure/close it.
Your partner contributes equal equity and manages the business day-to-day (while drawing a reasonable salary).
This can be a huge win-win for both parties.
I’ll have more on this arrangement in future newsletters.
Obstacle #5: Mindset
Last but not least, setting the right expectations upfront is essential.
Know what you are getting into.
Finding and diligencing a business will absolutely require more than 2-3 hours per week in the beginning.
There is a lot you won’t fully understand (and will learn along the way).
It can be incredibly rewarding, but very challenging as well.
Surround yourself with the right team and find good mentors (my inbox is always open).
There you have it.
5 steps to build semi-passive income by acquiring a profitable small business:
- Build a curated pipeline of deal flow
- Utilize creative financing to reduce your risk and retain upside
- Outsource diligence to a team of experts
- Partner with a strong operator to run day-to-day activities
- Expect more time investment upfront
If you are serious about this and have questions, just hit reply.
Thanks for reading, my friends.
Until next week,