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Why Buying Your Building May Be An Economic Mistake
Jim Parrish, MBA
Certified Business Analyst, USF/SBDC
The owner of a small business usually has limited capital resources. Matter of fact, lack of capital is the second most common reason businesses fail. Even though new businesses have a very high rate of failure, small business owners have decided to accept that degree of risk. They hope to "beat the odds." While the required rate of return on capital invested in small businesses varies greatly from individual to individual, most consultants suggest that it should fall within a range of 25%-40% per year.
Let's say you are a small business owner with $50,000 cash. You have various opportunities to invest that cash. You could put it in a savings account, buy a certificate of deposit, buy publicly traded stock, buy your building, or use it to expand your business. If you can obtain the suggested required rate of return for a small business (25% - 40%), why would you invest in any of the other options? It would be highly unusual for any of these to produce sustained earnings even close to 25% per year. If you want to own your building in order to control your future, there are ways to get control without investing any of your precious capital.
You may lease/purchase your facilities. Leasing with an option to purchase puts you in control and preserves capital. This allows you to save your capital for what should be your first priority - your business! You should consider purchasing the real estate when you have capital in excess of the amount needed by your business.
Should your landlord wish to sell, you should consider the equity/sharing concept. In this concept, investors put up part or all of the down payment needed to purchase the property. After a specific time, the investors are bought out or the property is sold and the profits are split. In a variation of this idea, the investors purchase the property in their name and lease it to the business with an option to purchase in the future. These concept has an additional benefit. There are dramatically more real estate investors in the world than there are small business investors. Therefore, it is usually easier to find equity investors than it is business investors.
Before you buy your building, ask yourself if this a good economic decision or a mistake?
» Jim Parrish is a Certified Business Analyst with the University of South Florida’s Small Business Development Center and a columnist for FloridaStartup.com.
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