Over the last few decades, many individuals have placed their hard-earned money in the stock market with the hope of being able to enjoy an enhanced standard of living in the future. Although some folks are able to protect and create wealth from stocks, there are a number of ways to accomplish this besides investing in public equities. One such way is to purchase existing businesses. This approach to investing may be extremely attractive to those investors who wish to have direct control over their investments.

Millennials who are interested in creating wealth but would like to escape the volatility of the stock market should consider acquiring small successful businesses. These firms include those that can be scaled as well as failing enterprises that can be bought at an undervalued price, turned around and then eventually resold for tremendous profit. While it is often thought that investing in private equity is usually reserved for the ultra-wealthy, Millennials can build a portfolio of privately-held businesses by using one or more of the following methods.

Owner Financing

Buying a private business is an expensive endeavor. For the most part, Millennials will not have sufficient funds to purchase an enterprise on their own as an acquisition price can start anywhere from a couple hundred thousand dollars to well over a million dollars. As a result, private equity transactions will typically require the use of external capital. In fact, wealthy people and large companies seldom use cash alone to finance the acquisition of another company. Millennials can take advantage of a financing method called owner financing in order to overcome this dilemma.

When a business is bought with owner financing, the seller plays the role of a bank and finances the acquisition. This method is often used when both the buyer and seller wish to expedite the transaction by avoiding the long process of applying for and receiving a loan. Owner financing is also an alternative option for buyers who have not been successful getting a loan from a traditional lender.

In an owner-financed deal, the buyer makes a down payment for the business to the seller instead of paying the entire price all at once. The original owner would then receive a monthly payment from the new business owner until the outstanding balance is cleared. Owner financing might be attractive to entrepreneurs who have owned their business for years and are looking to cash out slowly over a period of time.

Here is a simple example. The local food court has been listed for sale at a purchase price of $500,000. Joe analyzes the listing and decides that he would like to purchase the business; however, he only has $150,000 in cash. After speaking with the owner, Joe is able to use his $150,000 as a down payment and agrees to pay the seller the remaining $350,000 in monthly installments over a three-year period at an 11% per annum interest rate.

Leveraged Buyout

A leveraged buyout is similar to owner financing in that the buyer pays for the business in the form of monthly payments. However, unlike owner financing, leveraged buyouts are financed by a traditional lender, such as a bank, rather than the actual seller. As a result, the seller receives the entire acquisition price in a lump-sum, and the bank is repaid in installments, including interest, over a predetermined amount of time. In this arrangement, the assets of the company – for example, machinery and real estate – are used as collateral and will be seized by the lender in the event that the buyer defaults on the loan. (For more, see Understanding Leveraged Buyouts.)

Pooling Money With Family and Friends

Pooling money with family and family might be necessary if a person lacks the funds to even make the down payment. This can also be useful in increasing the size of a down payment and thus reducing the amount of debt. Additionally, this method can be used to purchase a business solely with cash and no debt.

With this financing arrangement, family and friends would contribute money into an entity that would become the holding company for the business to be purchased. In return, they will receive an equity stake in that entity based on how much they contribute. That entity would then purchase the business.

For example, four friends wish to pool their money together so that they can buy a small bookstore that is being sold for $200,000. The friends form a limited liability company and each put $50,000 into the newly formed entity. This will give each partner a 25% equity share of the LLC. Acting as a holding company for the friends, the LLC purchases the small bookstore with the pooled together $200,000.

Offering Equity in a Holding Company

Another option for financing with little to no debt is to offer the seller a portion of equity in a larger company. Actually, this is what publicly-traded companies do when they buy a smaller company. The shareholders are bought out with a combination of cash and equity. Pharmacyclics, for instance, was acquired for $21 billion by AbbVie Inc. (ABBV) in March 2015. Forty-two percent of the transaction was financed with shares in AbbVie.

If a buyer already has a holding company that owns a collection of other business, it can sometimes be wise to offer the seller equity in that holding company. This reduces the amount of cash that has to be paid out to the seller as a portion of the acquisition price will be covered by shares in another entity.

A simple example of a situation like this would be if a person who formed a holding company that owns four car rental agencies in one state and is interested in purchasing another that is selling for $750,000. Instead of acquiring this business through a leveraged buyout or by paying the seller all in cash, the buyer can offer the seller $400,000 in cash and $350,000 worth of ownership in the holding company.

Some sellers might find such an arrangement attractive because they are able cash out a portion of their equity in a business and convert the remaining equity into ownership in a much larger and more diverse company.

The Bottom Line

Investing in the stock market is certainly not the only way to create wealth. Buying private businesses is a good way to maintain greater control over your investments while increasing your income and avoiding the fluctuations of the stock market. The perceived high barriers to entry should not discourage millennials from investing in private equity. By using leverage as well as owner financing, pooling money together with friends and offering equity in a holding company, millennials can successfully build a portfolio of private businesses.

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