Is it always bad to purchase a business you don't understand?

Question

...YET. A business you don't understand yet.

Say you're a random fellow. You work in, I don't know, a retail store. In so doing, you somehow build up enough money to purchase a restaurant that somebody's put up for sale for whatever reason.

You're thinking, I want to go into business. The restaurant business isn't too technical, I could do that. Definitely.

You're planning on learning the ropes as you go.

Is this something that any learned investor would frown and shake his head at? Should you never do this? Even if the business already has a number of employees and management that know how things go, and can help the new owners get their bearings?

Answer 1

You should see "Restaurant Impossible" on TV, shows exactly how you'll end up if you take this direction. Bottom line - yes, it is usually bad. There's a race condition there in the hiding: you either learn the ropes as you go, or you run out of money and go bankrupt, whichever comes first.

My personal experience shows that things that seem simple from the outside may become very very complex once you're actually inside. As an engineer I know perfectly well that the devil is in the details. As an investor I know not to step into something I don't know how to step out of.

If someone sells something - you should give a thought as to why they're selling. Is the restaurant making money? What's the cashflow? Are there underlying issues? What are the development plans in the neighborhood for the foreseeable future? What's the clientele, and what are the trends? What's with the competition? Can you answer these questions? If not - you're not in a position to enter the business.

Answer 2

It isn't always bad. There are cases where it works. Unfortunately these are hard to predict.

There is no magic formula: if you have X years of experience in profession Y that makes it perfect to go into business Z. Even if Y and Z are the same, unless you have the correct type of experience in Z you can quickly get over your head. Ten years as a waiter doesn't help you to understand the entire restaurant business.

In some cases the key to running a successful business is having years of experience running a business. In other cases the knowledge has to be domain specific. The less complete your knowledge, the more landmines and blind spots that will exist in your operation. The weaknesses have to be filled by others in your team. But that exposes you to other problems, they can let you down without you knowing it.

The better approach is to say in a few years I want to own a business. What do I need to do to get to that point besides money to buy the business, money to run the business, and money to survive the early years. What knowledge do I need to gain, or team members do I need to recruit.

Answer 3

As the saying goes... "Failing to plan is planning to fail."

If you want to be successful you must have a plan on how you are going to succeed. Part of making that plan is understanding what the potential points of failure are and how you are going to handle them. It is impossible to do this if you do not understand the business. If you have to react to situations and make snap decisions your risks of making bad decisions increase. This increases your chances of your business failing.

You also need to be able to tell when there are problems with your business. If you do not understand the business, and have little experience with the business, then it will take you longer to recognize that there are problems. The earlier you spot or prevent problems the easier, and less costly, it is to deal with them.

When it can work is when you go in as the silent partner with someone who does know the business. If you watch the show "Shark Tank" you will notice the sharks invest in either business that they know and understand and can help guide the business through the pit falls, or in people they believe in because they just need the money not the partner. None of them say heck neither of us know what I we are doing but lets take a shot together. The reason is there are more fun ways to throw away money than investing your heart, soul, blood and sweat, into learning a business the hard way.

Most people who do learn and build a business with no prior experience actually start from nothing rather than buying a business that has already been built. Of those that succeed big, they teamed up with someone who understood the business side, but they were the power behind the innovation. And most of them got in when there was virtually no competition. Your question does not fit in here.

Answer 4

The restaurant business in particular is very difficult; a whole bunch of them fail in the first year. And it tends to be expensive to get into; I saw $250K as an average to get a space up and open.