In five years of running the Acquisition Lab, I’ve discovered the more ambitious a buyer is, the quicker they usually want to hire an operator to run the business. They’ll say to me, “Walker, I don’t want you to help me just find and buy a business – I want you to then help me hire an operator to run the business.”
I get it. We all want the turnkey passive income streams that allow us to kick back on a remote beach in Tahiti with a tropical drink in hand while our assets are hard at work. That said, replacing yourself with an operator isn’t a good idea to do from day one (in fact, it’s better to sit tight with the business for a bit before you make any drastic changes).
I’ve hired a number of operators myself – successfully and unsuccessfully – and I want to share with you the right way to do it and the wrong way to do it (not to mention the strain you’ll take on by hiring an operator too soon and in the wrong way). I’ll share the proper framework that will help you approach replacing yourself with an operator.
Some of you might be wondering, why would I want to hire an operator? There are a few reasons why. Hiring an operator:
- Frees you up to buy other companies
- Gives you a higher return on your time
- Allows you to work on the business instead of getting stuck in the weeds
- Introduces more stability and growth to your business
I’m all for you replacing yourself with an operator – just at the right time and in the right way.
Size of Owner-Operated Businesses
Now, one thing that’s important to note is that when we talk about hiring an operator for a business, there’s a specific size of business we’re looking at.
If you are buying a business for $50 – $200 million, you’re buying a company that already has a management team in place (or you’re the luckiest entrepreneur in the world).
Most people going out and acquiring their first business will be purchasing smaller businesses that are generally owner-operated. This is why I wrote Buy Then Build: How Acquisition Entrepreneurs Outsmart the Startup Game – there’s an abundance of small businesses that transact every year and all the boomers need to sell them before the end of the decade. On top of that, there’s all this financing available for these small businesses.
Source: WealthManagement.com
So you can generally get up to $5 million to acquire these businesses with as little as 5 or 10% down. Most of the buyers I’m interacting with are telling me they want to buy a business for anywhere from $1 – $5 million and they want me to help them hire an operator. Because this is the size of most of the target acquisitions, this is the size of business that I’m going to be discussing.
Mistakes to Avoid When Hiring an Operator
As I said, there’s a right way and a wrong way to hire an operator.
The wrong way is typically by hiring an operator too soon, and there are a few reasons for that. Ultimately it comes down to needing to increase the safety of your acquisition first, before you do anything else.
If you hire an operator before the right time, these are two mistakes you’ll likely run into:
1. You won’t be able to afford an operator (even if you think you can)
I’ll give you an example.
Let’s say we’re working with a business with a seller’s discretionary earnings (SDE) of $1 million. Assuming 15 to 20% SDE to revenue, I’m going to guess this business pulls in $5 million in revenue, and we’re going to buy it for four times earnings.
That would be $4 million, but not so fast. There’s going to be accounts receivable, working capital in terms of inventory, and extra cash that you want in the bank to make sure that you’re safe. So instead of buying it for $4 million all in, I’m just going to go ahead and say you’re buying this company for $5 million all in.
Using rough math, let’s say it costs about 50% of your SDE in principal and interest costs for the loan. We’re going to subtract about 50% and that leaves you with about $500,000 in post-acquisition SDE.
Now, how much are you going to pay this operator? If you’re looking for someone who has industry experience who you have confidence in, particularly since you just bought the business and can’t train them yourself, let’s say you’re looking at hiring them from $250,000 all in. This includes salary, taxes, healthcare, and a 401k match.
After you hire this person, you have about $250,000 in earnings in free cash flow, which you’re using to operate this business on. That sounds great, but due to cyclicality of cash flow and potential seasonality of the business, it’s not $250,000 averaged out monthly, or around $20,000 per month. Before hiring an operator, you have half a million dollars in working capital moving through accounts receivable minus accounts payable plus inventory. You can see how some of this cash might be tied up – money you owe, money that’s owed to you, and money outstanding for new inventory. Not to mention, you haven’t even paid yourself.
This can quickly turn into a very lean situation, where you’re managing a $5 million acquisition with $250,000 left, creating a financially tight position to be in.
Here’s the point: when I buy a business, I always start by operating it myself and focus on building up cash.
The minute you add this manager, you’re using all of your growth capital for the entire business simply in operations. You have to make that hire right, and there’s not much wiggle room if you don’t.
2. You won’t be in control of your business
Not only are you setting up your business to be a pretty lean operating machine, but if you don’t understand the business, then this operator is going to have all the control in the dynamic of your relationship. Control in itself isn’t bad – you don’t need a whole lot of control to effectively run a business. However, you do need to have awareness and context of what the operator is controlling.
Look, I’ve worn a lot of different hats in my life. I’ve done a lot of marketing, sales, inventory management, operations in a blue collar industry, and all the rest of it. You may have as well.
Source: REVA Global
However, even though I’ve had a lot of experience, there are still certain things I just don’t know about. If you don’t know the details of how things work and can’t or haven’t created SOPs around those processes, you can’t remove yourself and put someone else in.
For example, when I hire a software developer and ask them for a certain scope of a project, I never know if I’m asking them, “Hey, can you pass me the salt?” or, “Hey, can you build me this parking garage?” I don’t really understand what I’m asking, and likely, you won’t either for some time.
You need to learn the business first, so you can decide which hats to take off and in what order. If you need to fill in for the operator or replace the operator with someone else who can seamlessly fill the role, you need to understand what the operator is doing within and for the business.
How to Replace Yourself with an Operator
One of my good friends Dan Martell wrote a book called Buy Back Your Time: Get Unstuck, Reclaim Your Freedom, and Build Your Empire, and when I read it, I realized it perfectly answered the question I get about how to replace yourself with an operator. Dan laid out this concept really well in his “replacement ladder.”
The replacement ladder is the sequence in which you should hire people in order to slowly replace yourself but, more importantly, build an infrastructure within your business that allows for scaling.
This is the order in which you should hire employees:
- Admin: calendars, emails, scheduling
- Delivery: product or service fulfillment, delivery, and customer service
- Marketing: defined marketing strategy that generates and nurtures leads
- Sales: sales process with the software, scripts, and training for new salespeople
- Leadership: executive-level leaders who can take over higher responsibilities
This order of hiring is somewhat intuitive when you think about it. Typically for a business even with $1 million in SDE, the odds that the owner is doing sales or marketing are really high, even if they’ve offloaded the first two tiers of admin and delivery.
I want to point out the obvious here: before you outsource leadership, you should first outsource admin, delivery, marketing, and sales first.
When buyers tell me they want to buy companies they haven’t operated or worked in for a single day then replace themselves with operators from day one, they’re essentially telling me they want to jump to the top of the replacement ladder and replace the highest level.
If you want to do that, you need to consider how lean your business is going to be when you do that. Also, if you hire an operator off the bat, you’re not taking the time to build up cash, develop SOPs, and increase your knowledge of the business. You want to be in a position where you know your business to the extent where you can fall back on SOPs and effectively run your business if you need to hop back into the operations of it all.
Once you’ve done that, then you can replace the leader as the last step.
Ready to acquire a business in the next 12 months? The Acquisition Lab is your first stop. Reach out to us today and get on the fast track to becoming an acquisition entrepreneur.
