When considering a small business buying strategy, it is important to carefully consider the role you will take in the business. Two common options are becoming an owner-operator or an independent sponsor, and both require fundamentally different approaches and skill sets to be successful. In this article, we will outline the benefits and drawbacks of each approach, as well as provide advice for those considering their options.
Definitions: Owner-Operator | Independent Sponsor
An independent sponsor is an individual or small group that buys and grows companies by identifying acquisition targets, raising capital on a deal-by-deal basis, and working in a similar way to traditional private equity firms. They are informally known as “fundless sponsors” or “cashless funds” because they do not have a dedicated investment fund and may receive fees and equity in the acquired assets as part of their investment structure. They may seek equity investment from a single investor or a small group of investors. When they acquire a company, they usually hire an operator, or retain existing management to run the business day-to-day.
An owner-operator is someone who acquires, owns and runs their own business, managing all aspects of it including contracts, equipment, and employees. They are responsible for securing and maintaining contracts, purchasing equipment, and hiring and managing employees. They are also responsible for the search that precedes the acquisition, including fundraising, due diligence and post-acquisition transition from the previous owners.
Pros and cons of each acquisition style
Choosing the best small business buying strategy is a personal decision and buyers need to consider how different approaches align with their strengths and goals.
The advantages of becoming an owner operator include the potential for high income, independence, and the opportunity to “be your own boss”. Owner-operators have freedom to operate the business the way they want, which can be an attractive proposition. However, there are notable drawbacks to this lifestyle, including long working hours, significant financial and operational responsibilities, and the need to constantly secure and maintain contracts. Other potential downsides include the need to purchase and maintain equipment and the potential for liability if something goes wrong on the job.
It is no wonder that some entrepreneurs choose to become independent sponsors rather than operating their business acquisitions directly. The advantages of becoming a business owner without operating the business may include reduced stress and risk, as well as the ability to focus on strategic decision-making. However, the challenges may include the need to hire and manage employees, potentially increased costs, and reduced control and visibility into operations. Owners without operational experience may also face challenges in effectively leading and managing their team.
Another obstacle independent sponsors may face is that their track record is important for sellers who want to preserve their legacies and may be wary of bringing in new owners without knowing exactly how the operating team is going to look. This can make it harder for independent sponsors to buy their first business using this approach. Additionally, it can be challenging to find the right operator for a business, as the right fit depends on the specific needs and goals of the business.
There are cases when independent sponsors start off as operators but then step back to take a more hands-off role. Justin Vogt, a guest on one of our Private Market Insights episodes is an an example of someone pursuing this strategy. He is currently operating AVUITY, but plans to ultimately transition to a holding company strategy with a dedicated operator. In general, this approach can allow independent sponsors to focus on strategic decision-making and growth, while still retaining some level of involvement in the business.
Economics of being an operator vs independent sponsor
The economics for an operator and an independent sponsor can differ in several ways. For an operator, the primary source of compensation is typically a salary, which may be paid in cash or equity. Operators may also receive bonuses based on the performance of the business, as well as benefits such as health insurance and retirement contributions. The specifics of the owner compensation structure vary depending on the acquisition funding mix (own capital, outside investors, debt, seller notes), the health of the business, and the individual searcher’s negotiation skills. As an owner-operator, you may be able to negotiate a higher percentage of equity in the business if you are able to contribute a significant portion of the purchase price through your own funds or through a loan.
Independent sponsors, on the other hand, typically retain a smaller percentage of equity in a business because they are not the primary operators of the company.. Their compensation may include an upfront fee for sourcing and executing the acquisition, as well as an ongoing management fee for overseeing the business. In addition, independent sponsors may receive a share of the profits and/or equity in the business as part of their compensation. The specific terms of compensation for independent sponsors may vary depending on the specific deal; the negotiation between the independent sponsor and their investors; and the overall health of the business being acquired, including the new operator costs.
Owner-Operator vs Independent Sponsor – Which is better?
Unfortunately, there is no single verdict to this dilemma. The decision of whether to become an independent sponsor or an owner operator can depend on a variety of factors, including your personal situation, access to capital, background, and ability to dedicate full-time focus to the newly acquired business.
Ultimately, the decision of which role to take on will depend on your personal circumstances and goals. It may be helpful to seek the advice of a financial professional before making a decision.
The best starting point for your journey of buying a business
Regardless of your choice, when starting your entrepreneurial journey, it is vital to present your strategy effectively to brokers, sellers, and other capital providers. It is important to be transparent about your intentions, abilities, and financing/operational strategy. This will help to ensure alignment before a letter of intent (LOI) is signed. By clearly communicating your goals and plans for the acquisition, you can build trust and establish a foundation for a successful partnership. Being upfront and honest about your capabilities and financing strategy will also help to prevent misunderstandings or misalignment later on in the process.