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Buying a Business ¾ Three Key Steps to Success

A recent e-mail summed it all up. “I have been looking at the financial side of a potential CEO offer, and let's just say that the financial rewards are not that of an owner.” After talking to business owner friends, this prospective business buyer realized that being the CEO of a mid-sized company did not offer the financial rewards of business ownership.

Why do stockbrokers, estate planners and other purveyors of financial products and services target business owners? Because, as the book, “Marketing to the Affluent” (Thomas Stanley, Dow Jones-Irwin, 1988), points out, that’s where the money is.

My presentation at the TENS December meeting was no different than any similar presentation. I asked, “Why do you want to own a business?” The answers were control, financial well-being, independence, benefit myself (not someone else) and, of course, enjoy what I do (have fun). If you like controlling your own destiny, are willing to take calculated risks and enjoy making decisions, business ownership may be for you. And buying a business is faster, cheaper, safer and easier to finance than starting a company or franchise.

Locating is the number one

A franchisor emphasizes that you get a plan of proven success (somewhere else). With an independent business you get a proven plan plus a customer base, cash flow, reputation, profits, experienced employees, vendor relationships and more.

Finding a good company is not easy. There is a lot of junk out there. According to numerous studies, only 20% of businesses for sale ever sell. Most just liquidate or fade away.

BusinessWeek magazine coined the term “hidden market” for small businesses. This is because over 80% of sales are direct from seller to buyer. Only 15-20% are advertised or sold by a broker. You must get into the hidden market to be successful. Over the last year I’ve found that one of my best services for clients is “cross pollination.” That means, what one client doesn’t like may be perfect for another client. It’s speeded up and jump-started the process (and none of these companies have been advertised or listed).

A poor search plan is where most buyers fail. They don’t see enough good companies and settle for the best of the mediocre. While it’s okay to overpay a little, for a good business with wonderful potential, it’s suicide to overpay for (or even to buy) a bad company that will be nothing but a living nightmare. And don’t pay for potential you create.

Is it what they say it is?

A new client recently wrote, “If your objective was to show me how little I knew about this company you succeeded.” Before hiring me he had made a $1,000,000 offer (and had it accepted). Luckily for him, he was able to get out of the deal and he saved his bank account.

Most errors made are errors of omission. Not knowing what to do. Even experienced buyers make mistakes when they get “buyer fever.” Wanting a business, or at some point in time any business, so badly they suspend their common sense.

It doesn’t have to be overwhelming, for buyer or seller. Ask the right questions, go into more detail on subjects you feel need clarification and when you feel that your strengths match well with the risks of a business, go for it. Accept the fact that there are no perfect businesses, no perfect deals and there is more risk in business ownership than in a blue-chip stock.

What’s it worth?

This is always the tricky area. Books, some of them inches thick, have been written on business valuation. Realize that profits are the driving force behind value and price. There are no worthwhile rules of thumb, sweat equity means nothing and potential is blue sky (goodwill is profits the assets create).

Most buyers are looking for a return on investment of 20-35%. This means they will pay 3-5 times profits (after owner compensation). If there is a logical reason why the future of the business may be brighter than the past, consider an earn-out. This is where a percentage of profits or sales is given to the seller for having the platform that, due to circumstances, he or she is unable to capitalize on.

The bottom line, have a system that covers all areas of search, analysis and due diligence (without falling into the analysis-paralysis trap). Business ownership is a wonderful thing and it’s not that hard to do it right. Have an experienced guide and a proven plan. Follow the plan, paying attention to the details. Happy hunting.

© Copyright John Martinka 2003. All rights reserved.