Understand yourself and set your criteria
Being a business owner is not for everyone. It takes hard work, dedication, appetite for risk and tolerance for stress. Buying a business requires a plan and an unwavering commitment to execute that plan. Soul search, and take the time to create a comprehensive list of what you are good at and what you enjoy doing. Set criteria for yourself and the business you plan to buy. List your skills and what you like to do. Define the skills you will need to operate the business of your dreams. With each and every business you look at you must systematically verify the business against your personal criteria. Otherwise you could end up wasting time and money only to find an incompatibility or even worse find out you cannot manage the business you bought. To give you an example of what I mean, I have a very particular set of criteria when shopping for a business. Firstly, I look for a business that is broken; that is barely profitable and needs restructuring. I look for a business where the product or service being produced by the business is somewhat unique. Something that not everyone can produce or possibly requires a trade secret to produce. I also like to find a business with a significant barrier to entry. An example would be a business which requires a particular license in order to operate and the license is very difficult to attain. Another feature I look for is intellectual property such as patents, trademarks or copyright material that could potentially generate passive revenue. That being said, everyone is different so take the time to establish your criteria and use it as your guide to matching you with the right business.
Get a commitment for financing the purchase
Although this seem like putting the cart before the horse, it is important to have some level of financing in place before you start the process of looking for a business. This means being able to make the finances available quickly in order to act on an opportunity. If a great business comes along and there are multiple offers, you must be ready or you could miss out. Remember that the seller typically has the leverage and will choose the buyer who he feels has the best chance to close the deal and also has the best capability to continue running the business successfully. Having financing in place shows you are serious and are ready to buy.
Find a Business Intermediary
Similar to buying a home, a buyer should have representation when buying a business. A business intermediary will know the purchase process, what information to request from the seller, how to value the business, know the best negotiation methods and how to avoid pitfalls. Seek out an experienced business intermediary who is familiar with the industry or opportunities you are interested in.
Search for a business
Be clear on the type of business you are looking for. Know your skills and what you enjoy doing. Match those skills with the published business ads and make a connection with the intermediary. Take a pointed approach in selecting one business at a time instead of a shotgun approach of contacting several businesses. Buying a business is not like shopping for a home where you can visit two or three in a day. Give each business the time required to ensure it is what you want. The most important thing to remember is that there is no perfect business. Every business I have dealt with carried some form of risk. Know what you are looking for and consider the amount of risk you are willing to take.
Meet the business intermediary and review the financials
This is your first opportunity to get unpublished information about the business. The goal at this point is to ensure that the business meets the criteria of the business you want to buy. You and your intermediary should ask as many questions as you can. Although you are qualifying the business, remember that you are also being qualified by the seller (through the business intermediary). You should be aware that you may not get all the answers you want at this stage due to limitations of confidentiality. Don’t be discouraged as this is normal; just keep the remaining questions ready for the next opportunity if you and the seller are still motivated.
Meet the owner and get to know the business
This is typically the opportunity to meet the owner and scrutinize the business. Be prepared with all the questions you need. Avoid immediately bombarding the seller with a flurry of questions. Take your time and build a relationship. Synergy between the seller and the buyer is critical. Even though most sellers are there to sell their business, it is my experience that they won’t just sell to anyone even if you have the money.
Make an unbinding commitment
Typically at this stage, you and your business intermediary know enough about the business for you to perform your due diligence and confirm that all the reported information is in fact correct and that there are no skeletons in the closet. I recommend that you negotiate price at this time and clearly spell out all the terms and expectations. Prepare a letter of intent to the seller outlining the price and the terms. This will allow you to commence the due diligence process and verify the details of the business. If you are unsure, seek the advice of a lawyer when drafting a letter of intent.
Commence due diligence
The due diligence process is arguably the most important phase of buying a business. It is your opportunity to examine and verify all the details of the business (financial and other) and expose any material defects that might prevent you from buying the business. It is the time to assess the risks in the business and ensure it matches all your criteria. The due diligence process is far too complex to discuss in this paragraph and as such I strongly advise that you seek advice when conducting a due diligence. Having an business intermediary to assist in the due diligence process can help identify potential risks and confirm the value of the business.
Final negotiations and binding commitment
Once the due diligence is completed you will be asked to make a binding commitment by presenting an offer via a purchase and sale agreement. If you found any conflicting information in the due diligence process this is the time to present it and complete final negotiations. If you are content in proceeding, the sellers’ business intermediary will typically draft a purchase and sale agreement at this point. Be sure to include any pertinent conditions at this stage such as approval for financing and lease renewal/transfer confirmation.
The closing transaction is typically coordinated by the seller’s business intermediary and the lawyers representing each party. Put your intermediary in charge of making sure the closing is not delayed and that all information is delivered and received promptly. Have your financing in hand before the signature meeting. Make sure there are no loose ends and that all negotiations are complete prior to the signing meeting. At this stage both parties have spent money and you don’t want anything to jeopardize the deal.
The transition phase is your opportunity for training and to extract any remaining knowledge from the exiting seller. The transition phase is important and needs to be carefully considered and negotiated prior to closing the deal. The transition phase may include the seller or other knowledgeable employees staying on for a period of time to assist in training as well as the creation of operation manuals. In most cases I represent the seller and therefore always create a comprehensive documentation package (with the approval of the seller) to aid the buyer in the transition. Be sure to check with the seller’s business intermediary if any documentation is to be provided to assist the transition. If no training manual is provided take the time to create one yourself and have the seller verify all the information. Remember that after the transition period the seller may not be available and you will have to rely on what you have collected. Be sure to use this transition time wisely and extract every piece of knowledge possible from the seller. This includes visiting customers, extracting trade secrets and market knowledge not typically shared by the seller during the due diligence process.
TOP 10 ITEMS TO CONSIDER WHEN BUYING A BUSINESS
1. DOES THE BUSINESS PRODUCE A PRODUCT OR SERVICE THAT MEETS YOUR CRITERIA?
Can you see yourself operating this business, do you have the skills? What advantage does buying this business bring you? What are the risks in this business? Do you have the finances to act on this opportunity? Compare the business in question with your criteria and don’t get emotionally attached. It’s ok to walk away and look for the next opportunity.
2. ASSET SALE OR SHARE SALE?
Determine if the business is being sold as an asset sale or a share sale. From a buyer’s perspective it is almost always more advantageous to buy the assets of a business rather than the shares. This is because when buying the shares of the business you are also buying all the history, liabilities and risks taken by the previous owner. Sellers typically prefer to sell the shares for peace of mind, taxation purposes and to take advantage of the lifetime capital gains exemption. Whatever your decision, make sure it fits your business plan and risk profile.
3. WHAT ARE THE EARNINGS OF THE BUSINESS?
Your earning expectations should consider any loan repayments, your standard of living and your cash flow comfort level. Finding a business that is highly profitable is obviously good but it may not be great value and could take a long time to realize the return of your investment. Finding a business that is barely earning a profit can be great value and a shorter return on investment if turned around quickly but there may be immediate cash flow issues. Regardless of the earnings preference, it is critical to have a clear understanding of what the earnings are and what you need to make the business succeed. Deriving the exact earnings of the business takes a bit of investigating so make sure to take your time. Just reviewing the past financial records can be deceptive as tax filings are typically formulated to avoid or defer corporate tax. It is important to look at the discretionary earnings of the business. These earnings relate to expenses incurred by the business which are not required to operate the business. A simple example is an owner of a business who drives to work in a Lamborghini and claims the lease payments as a business expense. Although it would be nice if driving a Lamborghini to work every day was a requirement of the business but in most cases it is not a true operating expense. As a result, this expense is business profits that could be used elsewhere or as compensation to the owner. Typically if the sale is being conducted by an experienced business intermediary they will have extracted the discretionary earnings from the income statement. Make sure to review all expenses and determine whether they are a true operating expense or not.
4. IS THE SELLER WILLING TO FINANCE A PORTION OF THE SALE PRICE?
A seller’s decision to finance part of the price of the business will depend on whether it is a buyer’s or seller’s market. Businesses that have a tougher time selling usually have seller financing to make the business more attractive while highly profitable and well run business often have fewer seller financing options. Even if the business is well run it is always better to negotiate some seller financing as part of the deal. Even if it is only 10% paid out at the end of the transition period, it shows that the seller is willing to put skin in the game to work with the buyer and ensure the success of the business.
5. WHAT IS THE MANAGEMENT STRUCTURE LIKE?
In many businesses the employees are the main asset. Businesses that can operate with little involvement from the owner are highly sought after. I favour companies that have long term employees with a good understanding of the business and its products. Assuming you treat them as good or better than the previous owner it is likely they will continue to be a long term asset. Having key employees also helps in training new recruits as the company grows and is a source for business history if the owner has transitioned out.
6. IS THE LEASE ASSUMABLE?
Although this is 6th on this list it can rank as high as #1 on location specific businesses such as a marina or farming business. The reason is simple, if the lease cannot be renewed; the success of the business is at risk. Get it documented that the lease is assumable to you in the purchase and sale agreement. Also be sure to have a clause in the assumable lease that allows the option to renew for an additional term after the current one.
7. WHAT ARE THE RISKS IN THE BUSINESS?
Are there any pending lawsuits? Are there any contractual agreements that are detrimental to the operation of the business? Are there any contractual agreements that impact the business’s earning potential such as commissions, severance or pensions? Identify and note every risk and weigh its value. Every business I have ever been involved with carries some risk. Take the time at every opportunity to assess the risks to avoid any surprises. It can make the difference of whether you get a good night’s sleep or not.
8. WHAT IS THE SELLING PRICE?
Although price is important, it is more important that the business be properly valued and that it fits your budget. Have the seller or their business intermediary explain and break down the valuation of the business. Make sure it makes sense based on the risk and return of investment you are looking for. When negotiating avoid “low-balling” without any justification as it only frustrates the parties involved and causes you to lose credibility. In my experience if a business is well priced it is almost always better to negotiate terms (like seller financing) instead of haggling the price.
9. HOW LONG IS THE OWNER WILLING TO TRANSITION?
In the ideal scenario the seller will be willing to stay on as long as the buyer deems necessary to successfully transition the business. Sometimes the seller may choose to stay on in some capacity either as an employee or contractor. Many times the seller is burned out and so sticking around for longer than needed is not an option. Determine early on how much of the seller’s time is needed to transition the business. If the seller has a VTB (vendor take back/seller financing) it is not uncommon to have the seller choose to stay on in some capacity until the debt obligations are met. Although it depends on the size and complexity of the business, generally I try to have the seller phase out over a period that works for everyone which is usually 6 months full-time plus 6 months part-time or an on call arrangement.
10. WHAT ARE THE GROWTH LIMITATIONS?
Almost all businesses run into growth limitations which are often not management or skill related. Limitations often exist due to the size of market, competition, market trends, lack of skilled labour or limitations on capital to grow. My last business entered a declining market and although we did well, constant costly changes had to be made to stay competitive. We also experienced problems finding skilled labour for our environment which became a costly challenge. Consider the limitations of any business carefully and look for any glass ceilings. Ask yourself, why is this business not doing better, what will this marketplace look like in 10 years, will there be resource limitations in the near future, will there be capital limitations for growth? Whatever the limitations, be sure to identify them and make plans for them.
FREQUENTLY ASKED QUESTIONS
WHAT TYPE OF BUYER ARE YOU?
- The individual buyer is looking to buy a business for the primary purposes of employment and income. This type of buyer is interested in earnings to support their standard of living. They are in essence, buying a job.
- The investment buyer is looking to invest in a business to generate growth and build equity in order to sell it at a later date. Typical investment buyers operate the business day-to-day but from a high level and almost always have an efficient management structure.
- The strategic buyer is looking for a business to increase market share, increase capacity, eliminate a competitor or build on his existing corporate empire. The typical strategic buyer is not involved in the business day-to-day but has a comprehensive management team that runs all aspects of the business.
HOW LONG WILL IT TAKE TO FIND THE RIGHT BUSINESS?
This really depends on how aggressive you are and your expectations. For many, finding the right business can take years. If you’re willing to invest in finding a business there are intermediaries who will search for a business (matching criteria you define) for a fee. The key to finding the right business is knowing what you want and being prepared when the right opportunity comes along. If you know the exact type of business you wish to buy, you may want to contact the owner directly. This is very much hit and miss however, as the likelihood of the timing being right for the owner is unlikely.
IS THERE FINANCIAL ASSISTANCE WHEN BUYING A BUSINESS?
There are a number of options for financing available to buyers. Major banks, private lenders, private equity, venture capital firms, government assistance, seller financing and even friends and family are typical sources. There are agents available who specialize in finding financing for buyers for a fee similar to a mortgage broker. When acquiring financing consideration must be given to risk. The amount lenders provide is related to risk and although borrowing to buy an existing business is typically easier than for a start-up it is always dependent on risk, collateral, deposit and the borrower’s credit history. That said, finding a suitable lender for your opportunity could take time, so start early and have it ready.
DO YOU NEED TO HAVE FINANCING READY IN ORDER TO BUY A BUSINESS?
When investigating a business for sale, be prepared to show evidence that you have or are able to acquire the funds to complete the transaction. The seller’s agent usually confirms this early in the process and it is important to have this taken care of in order to be taken seriously. Typically a bank statement showing cash in the bank, pre-approved loan statement, a private lender note or even proof of the ability to liquidate an investment will satisfy.
WHAT ARE THE FEES AND COSTS ASSOCIATED WITH BUYING A BUSINESS?
The amount of investment required to buy a business can be broken into 3 parts: pre-sale, sale and post-sale. ‘Pre-sale’ involves the cost to search for a business which may include the costs of a business intermediary, accountant or legal counsel. Costs involved in the ‘Sale’ include the purchase price of the business, accounting fees, legal fees, brokerage fees and any disbursements. ‘Post sale’ costs may involve transfer of licenses, leases, contract prepayments etc. There can also be professional fees for accountants to set up the books, legal fees to update the corporate minute books and perhaps business coaching fees should you seek advice in the first year.
HOW DO YOU KNOW IF THE BUSINESS HAS BEEN PROPERLY VALUED?
This usually comes down to the appraiser and the method of appraisal. There are essentially three levels of appraisal:
- The public, buyers and sellers.
- Trained professionals, salespeople, intermediaries.
- Professional accredited appraisers.
In most cases business valuations are performed by the seller’s business intermediary as they are trained in business valuation. Valuations performed by accredited professionals tend to be most commonly used in applications where proving the value of the business is critical such as in financial lending, litigation, partnership arrangements and insurance claims. There are many methods that business intermediaries use to appraise businesses but the most common are Market Approach, Income Approach and Asset Approach. Valuations are derived from many things but usually the balance sheet, income statement and goodwill are the key items. This topic is too big to break down into a single paragraph but the bottom line is that a valuation needs to be supported by facts, well documented and justifiable. If the value is not visible, don’t be afraid to ask the business intermediary to explain how he arrived at the valuation. It is always recommended to seek advice when reviewing valuations.
WHAT INFORMATION SHOULD YOU REQUEST FROM THE SELLER?
- Financial Statements for the past 3 years (minimum)
- Discretionary earnings, capital equipment and inventory schedules
- Review of corporate records and Articles of Incorporation
- Copies of all lease agreements and loans, including property
- Legal contracts, claims, judgments and agreements with government, customers, suppliers and employees
WHAT IS YOUR PLAN FOR GROWTH ONCE YOU ACQUIRE THE BUSINESS?
In my experience, buyers tend to jump into their newly purchased business and start operating it without much of a strategy. New owners often start making changes immediately rather than letting it run the way it has been and make careful observations and make change over time. Sudden change can unnerve employees and disrupt business. This assumes of course that there are no serious issues impacting current profitability. Take the time to see the business from a detached point of view and judge what the important features of the business are. Use this to make incremental changes from a functional need as opposed to a preferential want. By now you should have a solid understanding of how the business generates its revenue, how it handles its cost of goods and should have a firm grip of the businesses operating expenses. Take the time to understand what profits you would like to earn and from there build the 1, 3 and 5 year income and expense budgets. Working backwards from this data will give you a sense of what growth you will need in order to meet your profit goals. It should also identify what changes need to be made to the operations of the business in order to get there. Remember functional changes first and preferential changes last. I always recommend getting the ideas of an experienced business coach to get a short and long term third party view; especially if this is your first business. You will be surprised what an experienced outsider can see in your business. Check out my grow page for more info or better yet, contact me for a talk on how we can improve your business.
SHOULD YOU USE A BUSINESS INTERMEDIARY WHEN BUYING A BUSINESS?
Absolutely! Having someone in your corner looking out for your best interests is important considering the risks and challenges of buying a business. In my experience, sellers don’t always disclose all the risks in the business up front. An experienced business intermediary can identify areas of value, areas of concern and is able to validate the asking price of the business. A business intermediary facilitates negotiations as you are not negotiating directly with the seller which most often becomes stressful, emotional and confrontational. In the majority of business sale transactions the seller is represented by a business intermediary. If you are not sure what information to ask for or what to look for, you will be at a disadvantage. Having a business intermediary to oversee and guide you through the transaction will provide peace of mind and just makes sense. For a comprehensive list of reasons why you should use a business intermediary [click here].