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This is a counterintuitive point, and I think mostly gets glossed over in a lot of high level thinking. For example, if you're reading some generic advice about

by netcan 11y ago

This is a counterintuitive point, and I think mostly gets glossed over in a lot of high level thinking. For example, if you're reading some generic advice about valuing a small company, it will usually point out that "profit" needs to be expressed net of the owner/manager's salary, the salary a buyer would need to pay someone to be General manager of this business. Economics textbooks do something similar. This might give you the impression it's normal to hire general managers for businesses. In reality, it's rare that a "small company" (say a turnover of $1m-$10m, for a typical software or services company, or even 10X that) does this. A clean break between ownership and management is a difficult thing. Jacques does an admirable job of breaking it down in a way that gets the message across. To go further, I actually think it could be a great topic for an out-of-the-box young economist to take on. Like a modern Ronald Coase's "Theory of the Firm." It's got tentacles in a lot of interesting questions. The unpopularity (these days) of "adult supervision" investor supplied CEOs, for example. The relative obscureness of SMEs as an investment class outside of high risk VC for another. It would be very unusual for someone to put his/her net worth (say $2m) into a small business unless they can run it. Does an economist-ic explanation exist?

roymurdock 11y ago
Human capital - the original owner/manager knows infinitely more about the business than the new manager does. For example: I recently took a class in college where a team of engineers and business students would pick up and run with a venture from the previous semester. My team was producing mechanical agricultural products for rural women in Ghana. I was technically the "Project Manager" but in reality, I had no idea what was going on for the first two months: who were our contacts in Ghana, why should they trust me, how had the design of our products changed over time, who was supplying our raw materials, what was the state of our financials & grant proposals, how about marketing and sales channels, what even is a Cassava?! It was really disorienting and frustrating. Yes, there was documentation [1], but reading something vs. doing something are completely different. The most valuable members of these teams are always the ones who have stayed on the project for multiple semesters, with the overseeing professor (6 semesters of experience) being simply indispensable. If he had been replaced, the project would've fallen apart immediately. Of course, this becomes less and less essential as the company gets larger. Replacing the CEO at a Microsoft or an Apple may change high-level decision making, but most of the human capital is stored within the large, diversified, hierarchical employee base. As for putting your entire net worth into one investment, that's a simple risk/reward profile. If you're going to put all of your monetary assets into one investment vehicle, you're probably going to put all of your other assets (skills, contacts, time) into this investment as well. Capital attracts capital, be it fiscal capital or human capital. [1] The documentation was actually excellent as each exiting team had sworn to do a great job so that the next team wouldn't have to go through the same frustration that the exiting team had experienced. Wishful thinking.
- bmh100 11y ago
  This is part of the reason why working for a company as part of buying the company exists. In small businesses, it is possible for an interested purchaser to actually work under the existing owner for months or years to receive training and ensure the business will continue to survive. Even founders of lifestyle businesses take a lot of pride in what they've built, so there is a sentimental reason to sell this way too.
- netcan 11y ago
  This kind of reason seems to exclude selling a business too, though. But small businesses do get sold to people who don't know anything and often succeed.
RockyMcNuts 11y ago
The 'economist-ic' explanation is 1) diversification 2) agent-principal problem 3) asymmetric information (books are cooked, owner is selling because something is about to hit the fan). Investors and business brokers deal with them by 1) low prices / earnings multiples, not putting your entire net worth into a small business 2) as OP suggests, you either manage it yourself or somehow have loyal staff with skin in the game 3) earn-outs for original owner who gets paid out over time from earnings after successful transfer. Because of the risks, small businesses sell cheap relative to earnings, often fail not long after they are sold.

by netcan 11y ago

roymurdock 11y ago

Human capital - the original owner/manager knows infinitely more about the business than the new manager does. For example: I recently took a class in college where a team of engineers and business students would pick up and run with a venture from the previous semester. My team was producing mechanical agricultural products for rural women in Ghana. I was technically the "Project Manager" but in reality, I had no idea what was going on for the first two months: who were our contacts in Ghana, why should they trust me, how had the design of our products changed over time, who was supplying our raw materials, what was the state of our financials & grant proposals, how about marketing and sales channels, what even is a Cassava?! It was really disorienting and frustrating. Yes, there was documentation [1], but reading something vs. doing something are completely different. The most valuable members of these teams are always the ones who have stayed on the project for multiple semesters, with the overseeing professor (6 semesters of experience) being simply indispensable. If he had been replaced, the project would've fallen apart immediately. Of course, this becomes less and less essential as the company gets larger. Replacing the CEO at a Microsoft or an Apple may change high-level decision making, but most of the human capital is stored within the large, diversified, hierarchical employee base. As for putting your entire net worth into one investment, that's a simple risk/reward profile. If you're going to put all of your monetary assets into one investment vehicle, you're probably going to put all of your other assets (skills, contacts, time) into this investment as well. Capital attracts capital, be it fiscal capital or human capital. [1] The documentation was actually excellent as each exiting team had sworn to do a great job so that the next team wouldn't have to go through the same frustration that the exiting team had experienced. Wishful thinking.

bmh100 11y ago
This is part of the reason why working for a company as part of buying the company exists. In small businesses, it is possible for an interested purchaser to actually work under the existing owner for months or years to receive training and ensure the business will continue to survive. Even founders of lifestyle businesses take a lot of pride in what they've built, so there is a sentimental reason to sell this way too.
netcan 11y ago
This kind of reason seems to exclude selling a business too, though. But small businesses do get sold to people who don't know anything and often succeed.

RockyMcNuts 11y ago

The 'economist-ic' explanation is 1) diversification 2) agent-principal problem 3) asymmetric information (books are cooked, owner is selling because something is about to hit the fan). Investors and business brokers deal with them by 1) low prices / earnings multiples, not putting your entire net worth into a small business 2) as OP suggests, you either manage it yourself or somehow have loyal staff with skin in the game 3) earn-outs for original owner who gets paid out over time from earnings after successful transfer. Because of the risks, small businesses sell cheap relative to earnings, often fail not long after they are sold.