It all started when Amazon suggested I read a book called “Buy Then Build: How Acquisition Entrepreneurs Outsmart the Startup Game.” As a multiple-time startup founder and failure, I relished the idea of buying a business with existing momentum and the focus on using that momentum to grow. It seemed so simple and much less risky than starting a business! And while the latter part of that is true, the former certainly is not.
I bought the book and cruised through it in a matter of days. It was a revelation for me! Acquiring a business can be EXTREMELY complicated, but it is a process that can be learned. To further my education, I joined the Buy Then Build LinkedIn group and read two more books about acquisition entrepreneurship: The HBR Guide to Buying a Small Business and The BizBuySell Guide To Buying A Small Business. Both books added depth to my understanding and new perspectives.
The HBR guide introduced me to the concept of “enduringly profitable” businesses. These businesses exhibit high barriers to entry, recurring customers, and a singular focus on their niche. The BizBuySell guide helped outline a step by step process to finding and buying a business using online platforms.
By the end of reading all three books and listening to countless podcasts on the topic, I started my search. Here is what I’ve learned since then.
Treat your search like a business
If you’re serious about buying and subsequently running a business, you must treat your search like a business as well. The complexity of the transactions and quantity of work involved necessitate than you treat looking for a business as a job and not a hobby. You’ll be building financial models ad nauseum until you find the right one. You’ll be on the phone with brokers, sellers, lawyers, accountants, and many others in trying to search and vet potential acquisitions. With so many moving parts, the only way to succeed is to stay organized. That’s why 90% of people who set out to buy a business never actually do it.
The HBR Guide suggests that searchers focus on their search full time and not work their day jobs. This is the one part of the book I fundamentally disagree with. I plan to remain in my job even after I have purchased a business. If you choose to go the “side hustle” route, be prepared to work late into the night, early in the morning, and on weekends. You’ll have to engross yourself completely in the process to succeed. It will be hard, but I promise it’ll be worth it.
Organization is important
Set aside time to work on the search. Actually put it into your calendar. Use a productivity tool like Amazing Marvin (my personal favorite), WunderList, or Trello to keep track of your tasks as they pile up. Keep a running list of the opportunities you have looked at, their respective financial results, what stage of analysis you got to, and why you decided to pass or move forward. Build a robust financial model to project earnings and loan payments into the future. If you don’t know how to do this, there are many templates available online you can adapt to suit your needs.
Long story short, in order to succeed both at finding a business and running it, you should approach everything as a professional. You’ll save yourself a lot of stress if you do this from the start.
Look bigger than you are
The vast majority of aspiring acquisition entrepreneurs turn out to be “tire kickers.” Brokers know this. Their time is valuable and they are only paid if they close the deal. Their incentive is to work with people that they believe are likely to actually buy a business. That’s one reason why treating your search like a job is beneficial.
Part of being perceived as a professional is to make your effort seem larger than it is. Here are a few things you can (and probably should) do to legitimize your search.
- Incorporate as an LLC. This legal entity actually owns the company and protects you from lawsuits in the event your company is sued.
- Invest in a high quality logo for your brand. I recommend 99designs for this. I got my logo from there and it is (in my opinion) fantastic.
- Build a professional looking website or hire someone to do it. This will be the first thing brokers will likely find about you and your search. With so many intuitive site builders out there these days, it should be fairly straightforward to build a basic website even if you have no coding experience. You can then use the site as a platform for gathering leads and managing your message as you look for businesses.
- Get an email address ending with your website (i.e. email@example.com). I recommend Google’s GSuite for this. It’s cheap, reliable, and easy to set up.
- Set up a dedicated phone number for your business. This will likely be how business brokers contact you and you’ll probably want to keep it separate from your personal phone number. I recommend Google Voice for this. It’s free, reliable, and you can pick where you want the number to be from.
- Get some business cards with your logo, business email address, business phone number, and website on them. I used Vistaprint, but there many other options out there as well. No need to go crazy fancy with these. Just pick something clean and professional.
Valuing a small business
Public companies are often valued based on a multiple of their net income, also called a price to earnings (PE) multiple. Because of their size, predictability, stability, and liquidity, these multiples can go way above where smaller companies are valued. In fact, the average PE ratio of the S&P 500 for the last 130 years is 15.74x. To put that in context, most small businesses sell for 2-5 times SDE.
Intuitively this might seem like small companies are quite the bargain! But remember, you’re giving up a lot to get that lower multiple. You’ll have basically no liquidity after you buy a business. The business is small, potentially has customer concentration concerns, may not have a long history, or might succumb to competitors. And success or failure of the business will ultimately come down to you. If you’re not okay what that, then maybe acquisition entrepreneurship isn’t your best option.
Value the businesses you look at accordingly. Look at the risks of the business through a rational, realistic lens. While it is certainly true that you can’t predict everything that can or will go wrong in a business, taking a long hard look at your opportunities for what they are will go a long way toward avoiding making a VERY big, VERY long term mistake.
A good financial model is KEY
Small businesses are priced and sold based on their recent financial performance. As an aspiring acquisition entrepreneur, you will ultimately buy a company because of what the future will look like, because it’ll be your responsibility to create it.
To do this, you should find or create a spreadsheet that properly models out the projected financial performance of your acquisition. THis model will look something like a simplified leveraged buyout model. Your model should include the following:
- Revenue line items corresponding to the individual sales channels the company uses. These are projected using your growth rate assumptions.
- Cost of goods sold and operating expense categories. These are projected as a percentage of sales or a fixed amount (for things like rent).
- EBITDA add backs that you will use to arrive at SDE.
- Inputs including purchase multiple (of SDE), sale multiple (of SDE), percent of total purchase that is financed by a bank, percentage of the purchase that is financed by the seller, and their corresponding interest rates and terms.
- Loan interest and principal calculator to project out loan amortization.
- A set of assumptions governing future revenue and expense growth.
- Sources and uses table outlining where the capital will come from (you, a bank, the seller) and where it will go (purchasing the business, fixed assets, inventory, closing costs, and additional working capital).
For a lot of people, especially those without a strong financial background, this can seem overwhelming. I am building a simplified version of the financial model I use that you can adapt it to your own situation. I’ll post it in the Tools section of the website once it’s complete.
Margins can be pretty bad, especially if you finance the purchase
For most non-professional acquirers, paying cash to buy a business isn’t exactly an option. Most people (myself included) will have to rely on some form of financing to buy a business.
Most of the businesses I have looked at have net margins around 15 to 30 percent, with the exception of software-as-a-service business, which are known to have much higher margins. When you finance 60 to 90 percent of an acquisition, you have monthly interest and principal payments to make with the proceeds of the business. In many cases, these payments eat significantly into your margin.
Your model should account for the impact of financing, so you can accurately gauge whether the business will still make money after taking on debt. Modeling your expected loans will also allow you to calculate an extremely important metric: the debt service coverage ratio (DSCR). The DSCR is one of the main metrics a bank will look at in deciding whether to underwrite your acquisition. The DSCR is the annual EBITDA or SDE of the business divided by the annual debt and interest payments due on all debt.
You’ll want to see the DSCR as high as possible. Intuitively, a high DSCR means your sales or margins could drop substantially before you defaulted on the loan. I tend to look for a year one pro-forma DSCR of at least 1.5x.
Many businesses rely too much on one sales channel
Many of the businesses on the major exchanges are heavily dependent on one sales channel. Whether it’s a standalone website powered by Shopify or an Amazon FBA store, as a potential acquirer of this business, you must evaluate the platform risk of each of these heavily concentrated businesses.
Just as you’d never put your whole investment account in one stock, your business should never rely on one platform for all its business. I like to see businesses with less than 50% of their sales coming from their largest customer/platform.
I’d prefer to see several sales channels, including Amazon, a standalone website, Wal Mart, Ebay, and others contributing sales. That way, if Amazon changes it algorithms, or, worst case, your store gets suspended, you’ll still have other revenue streams contributing to the business.
You’ll likely have to put more than 10% down
The books above and many Internet resources may make you believe your business will be eligible for SBA financing with only 10% down. Sometimes, this is the case. But in the vast majority of the businesses I have looked at, the seller requires at least 20% down from the buyer.
When you’re crafting your target statement outlining the kind of company you’re looking for, keep this in mind, as it could mean looking for a much smaller business than you originally anticipated.
Some business brokers are much better than others
Some business brokers are rock stars but some refuse to return your calls and emails. A few have sophisticated processes that automatically send you an NDA and the prospectus upon execution of that NDA while others will have you print, fill out, and fax back a buyer profile form and NDA the old fashioned way.
As you start looking at companies, you’ll begin to see a lot of the same names pop up. The best brokers tend to represent the same kinds of businesses over and over. Focus on building a relationship with them. The broker can end up being your best friend in a transaction or worst enemy. Remember, they represent the seller and have the seller’s ear.
At the end of the day, they also want the deal to happen. Get a constructive dialog going with the broker as you perform your analysis. Ask thoughtful questions, but respect their time. Know that they are likely receiving a lot of inbound requests about the businesses they are selling. And as I’ve mentioned before, many potential “buyer” just end up being tire kickers. Show you are different by conducting yourself as a professional. In short, act like this ain’t your first rodeo.
Define your criteria as soon as you can
There are THOUSANDS of business listed for sale online right now. If you don’t narrow the field a lot, you’re likely to end up lost in a sea of bad options for you. Buy Then Build advises that you construct what’s called a “target statement” outlining the specific characteristics you are looking for in an acquisition. Your target statement will become your North Star in your search. It will inform and direct you in every decision you make.
Be thoughtful and intentional about what you put in it. Remember, if you don’t have significant value to add to a restaurant, you probably shouldn’t be targeting a restaurant. If you’ve never run an online ad campaign, you probably shouldn’t buy a marketing business. Focus on what you know, what you like to do, and what you’re good at.
Your target statement should include:
- Location – The city, state, or regions where you’d like to live and work
- Size – What SDE range are you looking to acquire? Remember, you may have to put down up to 30% of the full cost
- Industry – What specific industry, products, or services your target offers
- Financial characteristics – Profitability, margins, customer concentration, B2B vs B2C, seasonality, etc
- Timeline – When are you looking to make an acquisition?
Buying a business is hard, but so is toiling away at a job you hate when you know you’d be much happier working for yourself. The opportunity cost of not doing anything to change your situation is far greater than taking a chance and failing. As with anything else, action will always trump inaction and fortune favors the bold. And because there’s no way I could say it better than him, I’ll end with this wonderful quote from Theodore Roosevelt.
It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.Theodore Roosevelt