In 2015 house flips accounted for 5.5 percent of all single-family home and condo sales, according to a RealtyTrac report. But the flipping concept isn't limited to homes. More and more entrepreneurs are realizing they can turn a profit by quickly acquiring, rehabbing and selling small businesses in 5 years or less.

The upside is that flipping a small business can be easier than flipping a home. However, flipping a small business also involves significant risks for entrepreneurs who lack the knowledge and skills to convert a lackluster company into a hot acquisition prospect.

Market Conditions Are Favorable for Flipping a Business

The right entrepreneurs shouldn't have any trouble identifying potential business flips in the current marketplace. According to Q1 data from BizBuySell.com (my employer), the number of businesses listed for sale is up 6.4 percent year-over-year and at the highest levels since 2009. The current market also holds good prospects for selling a small business too.  Reported closed transactions are pacing to a record year in 2016.

Although many of the businesses listed in today's market are financially healthy (median revenue is up 4 percent and median cash flow is up 2 percent year-over-year), more listed businesses means more businesses that are candidates for rehab - and more leverage for acquirers interested in picking up an underperforming operation. But here's the catch: Not everyone is cut out to flip small businesses.

Previous business ownership improves the odds for a successful business flip because it gives the entrepreneur experience both at running a business AND as a business seller. At the end of the day, business "flippers" live and die by their ability to understand the market and reshape their acquisitions into companies that are attractive to qualified buyers. These entrepreneurs are out there as a recent BizBuySell report on The Demographics of U.S. Small Business Buyers and Sellers found that more than half (58%) of all business sellers are serial entrepreneurs or individuals who have owned more than one small business over the course of their careers.

How to Evaluate Candidates for a Business Flip

Previous business ownership clearly contributes to the success or failure of a business flip, but it's not the only factor to consider. Not surprisingly, some businesses are more suitable for a flip than others. If flipping a business is something you are considering, there are several characteristics to look for when you begin to evaluate candidate companies.

  • Industry. Given the importance of selling the business quickly, it's critical to identify industries that are experiencing exit growth. In recent years, those industries have included health and wellness, data storage and security, customer relationship management, travel and others that have seen surges in successful exits.
  • Value. Buy low, sell high should be the mantra of every entrepreneur, but it's particularly relevant for individuals who flip small businesses. To create a healthy profit margin, you'll need to know the market and be prepared to jump on opportunities that are priced below market value.Look for opportunities where you can pick up a business at a valuation (cash flow multiple) that is lower than average for that business category in your location.
  • Cash Flow. Forget assets. The best business flips offer significant cash flow opportunities for acquirers and future buyers. Ideally, you're looking for a company that doesn't have fantastic cash flow now, but could generate it in a matter of months under your ownership.
  • Low Barriers. Time is money for entrepreneurs who flip small businesses. If a candidate company has requirements like specialized skills, long sales cycles or high-touch owner involvement, the barriers may be too high to successfully flip the company in a year or two. You must be able to identify the reasons the business is under-performing so you can size the barriers to improving it.
  • Growth Potential. Growth potential is one of the most important characteristics to look for in candidate companies. Ask yourself whether a few changes could realistically turn the business around in a short period of time. Try to scope out some bottom-line benchmark numbers that can give insights into growth opportunities. If you're not sure, move on to another opportunity rather than rolling the dice on an unknown.

Acquiring a business to flip is different than acquiring a business for a long-term ownership scenario. If you plan on owning and operating the business for many years, there has to be a certain amount of chemistry. You'll need to identify an opportunity that is personally rewarding because it aligns with your interests and skill set.

But if you're planning to unload the business in a relatively short timeframe, chemistry is less important. From the beginning of your ownership tenure, every decision you make will be determined by whether or not it increases your ability to sell the company quickly and profitably.

Published on: Jul 15, 2016
The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.