A very small percentage of the individuals and institutions attempting to buy a business actually achieve success. Research indicates that less than three percent (3%) of qualified potential Buyers [those networking with Intermediaries, Accountants, Lawyers, Bankers, etc.] ever buy a business within any given year.
The majority of potential Buyers spend a tremendous amount of time personally and of others looking at potential acquisitions. Most simply fail to go through the acquisition process correctly and turn up empty. Failure is often the result of lack of proper preparation as discussed on our web page “Finding the Right Business” and application of the following eight basic steps:
Develop Disciplined Criteria
The first step is to decide on criteria for an acquisition and then sticking to it. For example, criteria may include:
- Geographical Restrictions if you have decided you do not wish to relocate,
- Type of Business based on qualifications and interests as a Business Owner,
- Sales Volume based on well-defined research that should result in pre-defined profitability,
- Profitability that likely determines the value of a Business Owner can afford based on multiples,
- Personnel based on the size and type of staff a one is interested or qualified to manage.
As a potential Buyer it is critical to pre-determine the available down payment and personal financial strength you have that results in how much you can pay for a business and provide in working capital. The most common mistake we see is that a potential Buyer treats being financially qualified as an afterthought to the process.
Business Candidate Search
Unlike Residential Real Property, there is no consolidated list of businesses for sale. There are many sites that can be considered as large aggregators of many of the business listings on the market but, there is no all-inclusive solution. The issue is further compounded with the confidentiality surrounding the sale of a business. Business Owners that wish to sell their business tell no one except their closest Advisors with good reason. For these reasons, working with experienced Advisors in addition to a great deal of personal research is required to leave little or no stones unturned during this phase of the process.
Candidate Screening and Pre-Diligence
The goal with effective screening and pre-diligence of candidate business opportunities is to identify any deal-breaking issues or criteria that would rule out a company before too much time or expense is committed. Look at your criteria and if the business doesn’t fit – STOP – too many times we see a Buyer attempt to make a business fit to circumvent further effort in conducting additional search time and effort. Once a business passes the criteria test, it’s time to look for deal breakers. Examples of deal breakers to look for have to do with financial misstatements, employee retention issues, stability with financial performance, shifts in the competitive landscape to name a few.
Determination of Business Value
Mentioned elsewhere on this website, there are a variety of approaches to valuing a business and no one approach will always be the right one. The most common ways to make a preliminary determination of business value is with a multiple against either Seller’s Discretionary Cash Flow (SDCF) or Adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). It is important to have a reasonable understanding of what the industry range of multiples should be for either of these measures adjusting for a variety of other factors associated the actual business itself. With either approach, if the financial performance of a business must support the new Business Owner’s minimum compensation and debt service.
Negotiation Business Terms of Sale
Major negotiations will occur twice during the acquisition process:
- Letter of Intent – This first negotiation happens at a high level, identifying the major terms and financial considerations through a non-binding Letter of Intent (LOI) or Term Sheet. This is the phase in the process where the Buyer and Seller attain a general meeting of the minds financially and with the terms of transfer with Business Ownership. Successful negotiations at this stage will motivate both parties to move forward in a positive and constructive manner during Due Diligence.
- Purchase Contract – The Buyer has made a lot of assumptions in preparing and negotiating the Letter of Intent. Many times, in discovery during Due Diligence and preparation with the Purchase Contract, details dictate modification with initial terms agreed upon between the parties. With proper preparation and disclosure up front, most negotiations relate more with the expansion and definition with terms and how they will be executed.
Due Diligence is the time in the process where detailed investigation needs to be made with financials, personnel, business and accounting systems, inventory, corporate documents, etc. – all designed with four overarching questions in mind:
- Does this acquisition closely fit with the Buyer’s criteria?
- Do the business financial details support the initial assumptions with business valuation?
- What is the best way in which to structure the acquisition?
- How should any post-acquisition operating, accounting and legal issues be dealt with?
Finalization with Financing
As mentioned earlier – a Buyer should not wait until this point in the process to think about financing. This is a step in the process where the Buyer is working with a Lender to validate financials and valuation against the final terms being negotiated with the Purchase Contract. Unless you are dealing with cash Buyer which is extremely rare – this is a phase in the process where many times, the Lender may be dictating terms to both the Buyer and Seller as a condition to obtain desired financing. Research tells us that Sellers are required to finance part of the final acquisition price in about 85% of all acquisitions.
Much earlier in the pre-qualification process, a Buyer should already have discussed their acquisition criteria with the Lender they wish to work with. This is an important thing to do early the process as each Lender has their own niche as to the type of financing, industry preference, collateral requirements, terms, and geographical preference. It is important to stay current with your Lender as their portfolio preference and restrictions may change. As an example, a lender known to lend actively in the restaurant industry may suddenly close their portfolio to additional lending to balance risk with lending in other industries such as medical or manufacturing.
Everything done properly in the previous seven steps and closing becomes a ceremonial celebration where everyone signs the closing papers. Mis-steps earlier in the process, closing can be one of the most frustrating steps in the process – up to, and including the deal falling apart at the closing table.
The most common mistake Buyers and Sellers make is attempting to short cut or eliminate the use of professional help in an acquisition. First time Buyers, in particular, should avoid using the Buying Process as on-the-job training. Proper preparation, diligence and commitment to the process will lead to a successful business acquisition. The process takes a lot of hard work but can be rewarding when done the right way.
Past frustrations and failures with attempted business acquisitions should not discourage you, the Buyer. What’s important is to learn from your mistakes, do your homework and be properly prepared the next time you attempt to achieve your dream of Business Ownership. Intemedior Business Advisor’s team of Trusted Advisors appreciate and respect the hard work Buyers put into acquiring a business and are committed to help them achieve their dreams.