Imagine this: You’re getting ready to buy one of the largest companies in the U.S. using a highly leveraged bank loan that will cover up to 90% of the acquisition cost. 

“I must be insane,” you think. All the advice about how to keep your debt at a minimum starts to swarm in your head. 

“Debt is dumb,” you hear Dave Ramsey say. 

On the surface, buying a business with only 10% (or less) down sounds incredibly risky, doesn’t it? 

But is it as dangerous as it seems?

In today’s article, I want to answer that question. One of the main risk factors when it comes to debt is going bankrupt, but the possibility of bankruptcy happening is often misunderstood. Not only are the chances of this happening are incredibly low, but there’s another risk factor you’ll want to keep an eye out for instead, which I discuss in greater detail below. 

Ultimately, the question that lies at the heart of all buyers is, “How can I be sure I won’t fail when I buy a business?” 

Let’s dig into that. 

 

The Reality of Startup Failure

 

The first misconception people have is that failure is synonymous with bankruptcy or collapse. 

For decades, we’ve been told that about 90% of startups fail, but this statistic can be misleading. For one, we don’t know the exact percentage of startups that fail. Sure, you can find some data points, like businesses started by a single founder, but without large-scale, statistically significant data, the numbers don’t fully add up.

When I speak with entrepreneurs or venture capitalists, we often reference the general rule that only about 10% of startups succeed. But if you talk to those who’ve been through it, they’ll tell you the real number feels even lower – because they know what it really takes. The most reliable data we have comes from VC-backed startups, and about 75% of them go completely to zero.

However, acquisition entrepreneurship tells a different story. For example, SBA loans have historically had a default rate of just 1.7%. 

I was the keynote speaker at an entrepreneurship-through-acquisition talk at Duke University, and when I shared this fact, a representative from Live Oak Bank, the largest SBA lender in the country was there in the audience and validated that point right there and then.

 

 

1.7% is significantly different from the 75% failure rate we see in startups, which supports why buying a business is less risky than starting one from scratch.

 

Why Bankruptcy Isn’t the Failure to Worry About

 

Many people mistakenly think the biggest risk in buying a business is going bankrupt or seeing the business fail completely. But that’s not the real threat.

The actual risk is buying a company that doesn’t deliver the outcomes you hoped for. 

Maybe the cash flow isn’t what you expected when you did the back-of-a-napkin math. There could be a few reasons for this, but most commonly, your monthly debt payments might be taking up a good portion of your cash flow, preventing the business from growing as planned. 

And because you’re cash-strapped, you might find yourself investing more time and money than you anticipated, turning what was once your goldmine into a “zombie company” – a business that limps along and forces you to pour all your resources into it just to keep it afloat. 

Ultimately, after years of effort and paying off loans, you may be left with little more than a business to sell, without having gained much in return. This is the worst-case scenario.

In other words, success doesn’t mean just avoiding bankruptcy. It means achieving the financial and personal outcomes you desire – the ones that drove you to take the leap into acquisition entrepreneurship to begin with. 

If you’re stuck with a business that only treads water, that’s arguably a worse situation than dealing with an outright failure because you’re locked into a long, drawn-out process of just trying to survive.

 

Source: Anton Gudim

 

Here’s the point: regardless of how precise the numbers and data are, the risk in buying a business can’t be eliminated entirely – so stop trying to engineer it out. Risk will always be part of the process, but it’s about how you manage that risk in the long run. 

 

What the Data Shows: Financial Performance

 

One of the best sources of data on small business acquisitions comes from Stanford, which periodically releases studies tracking the performance of search funds, which are investment vehicles used to buy businesses. 

Stanford released a 2018 study that showed search funds had an internal rate of return (IRR) of 33.7%. When excluding the top three performing funds, the IRR was 29.4%, and excluding the top five, it stood at 28.3%. The multiple of invested capital came in around seven, showing strong returns for entrepreneurs who pursue acquisitions.

The study has been updated since then, and the latest data highlights even better results. 

Financial performance has increased by about 8% to 10% across the board. IRR increased to 35.3%, and the success rate of acquisitions also rose. Excluding the top three, the IRR is 33.4%, and excluding the top five, it’s 32.1%.

 

 

Additionally, if you look at the slide below, about 66% of all search funds successfully closed on a business, and of those, 73% generated a financial gain. 

This means that over two-thirds of acquisition entrepreneurs saw positive returns on their investments. 

This shows a significant improvement in financial returns overall.

 

 

Out of all officially formed search funds, 34% never actually complete a business acquisition. However, 66% do end up closing on a business. Of those that close, 27% experience either a partial or total loss, which is significant.

 

 

That means 73% of these acquisitions result in some financial gain. However, many of those partial losses are likely what we call “zombie companies,” which I referred to earlier – businesses that hobble along without major growth. 

However, if we focus on the gains, the data becomes more positive:

 

 

69% of acquisitions either doubled their investment or saw up to a 10x return. In the most recent update, this figure has risen to 73%. Additionally, the percentage of funds achieving a 10x return increased from 9% to 10%. This is a full percentage point increase, which is a solid improvement.

In 2019, there were 51 search funds, 25 acquisitions, and 12 exits.

 

 

By 2021, the number of funds grew by 29% (59 to 66 funds), with acquisitions up 76% (25 to 44 acquisitions), and exits increasing by 50% (12 to 18 exits).

 

 

TL;DR – financial returns in acquisitions are getting better, interest in search funds is growing, and failures are decreasing. 

 

The Silver Tsunami

 

The surge in interest in acquisition entrepreneurship is largely driven by an impending shift in the business landscape: the Great Wealth Transfer. 

By the end of the decade, an estimated $10 trillion in business value will change hands as baby boomers retire. This transition represents about 48% of the U.S. economy, creating a massive opportunity for the next generation of entrepreneurs.

Rather than starting from scratch, these entrepreneurs are buying established businesses – companies that already have customers, revenue, infrastructure, profits, and a proven track record. With historical valuations and bank financing readily available, acquiring these businesses is a more practical path than building a new one from the ground up.

This is why search funds are growing at an incredible rate – comparable, some might say, to the meteoric rise of Apple’s market value over the last 20 years. 

 

 

I kid (somewhat), but when you look at the growth rate, it’s not far from the truth. The growth in acquisitions is explosive, and for good reason.

 

Putting Acquisitions Risk Into Context

 

Buying a business is risky – there’s no way around that. However, the data shows that it’s not as risky as it seems at first glance. Acquisition entrepreneurship offers a path that allows you to mitigate a lot of the risks you’d normally face if you started a business from scratch. 

With a less than 2% default rate on SBA loans, the chances of going bankrupt are much lower than you think. Instead, the real challenge is ensuring the business you buy aligns with your financial and personal goals, so you achieve the returns you’re looking for and avoid running a zombie company that drains you of your time, energy, and money. 

With the right approach, buying an existing business can be highly rewarding, provide stability, and offer the potential for significant financial gain. Whether you’re a new entrepreneur or have been in the game for years, consider acquisition entrepreneurship as a way to build wealth and secure your financial future.

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.