As M&A advisors to privately held businesses in the lower middle market, we see companies generally divided into two camps i.e. those being operated as “lifestyles” and those being operated as “investments”.
Wikipedia describes a lifestyle business as “[one] set up and run…..primarily with the aim of sustaining a particular level of income and no more; or to provide a foundation from which [the owner can] enjoy a particular lifestyle.” Key indicators of such a business are sequential P&L statements showing little or no growth in revenues over an extended period of time. Businesses operated as investments, on the other hand, tend to have P&Ls showing a consistent upward trajectory in revenues over time.
How owners choose to operate their businesses is entirely their choice and for which there is no right or wrong answer. However, that choice should be informed and made with a full understanding of its potential implications in light of the fact that all business owners will eventually exit their businesses…..it is only a question of how and when.
Given that an exit is inevitable, an important consideration in how one chooses to run a business is how much value one wants to extract from or build up in the business over the owner’s tenure in preparation for that exit. Lifestyle businesses often have value depressing characteristics e.g. little/no revenue growth as cited above; focus on organic growth only; owners operating in the business and not on the business; underinvestment to increase cash flow to the owner; reliance on a concentrated set of customers/clients; contentment with being a “me too” enterprise; etc.
Businesses operated as investments typically have value enhancing characteristics e.g. consistent growth over time as noted above; focus on growth via both organic and non-organic means; strong second tier management teams; debt and/or equity infusions as required to maintain growth; broad customer/client diversity; niche leadership; etc.
Just as these two types of businesses are differentiated by their operating characteristics, so are their outcomes at the time of exit. The lifestyle business may have been very lucrative for the seller; but its very nature represents a risk to the follow-on buyer who will have to scale from a sub-optimized platform to generate an acceptable ROI. All other things being equal, that risk will be reflected in a lower valuation than that for the business run like an investment where the latter’s attributes make it more readily scalable and more likely to generate an acceptable ROI for the buyer.
Again, there is no right or wrong answer to the question of how, between the lifestyle or investment paths, owners should run their businesses. However, they should fully understand the implications of their choice. An investment banker can provide an objective view of the business by examining it as through the eyes of a buyer to help in that choice and advise on mid-course corrections to meet the owner’s objectives for the inevitable exit.
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