The Roadmap to Entrepreneurship: An overview on how to find a business to buy and close the deal.
Acquisition entrepreneurship is a lesser-known way to jump into a higher income bracket fast. Private equity firms have been doing leveraged buyouts for decades and the amount of deals has accelerated in recent years. Our goal is to demystify the process and make it more mainstream to allow anyone to benefit from this wealth strategy.
Buying your way into entrepreneurship is attainable with a small amount of money upfront and knowledge of the process. Below I will outline an overview of the steps you can take to find a business and close the deal.
Step #1 - Find a Business
The process of finding the right business will most likely be the longest step in the road to becoming an acquisition entrepreneur. Take your time and be selective. An error in this stage can be the difference between taking a calculated risk and a gamble. While there is always a risk in entrepreneurship, the more time you take to research and evaluate the potential the less likely you are to buy a riskier business.
If you want to get an idea of all the opportunities available, check out bizbuysell.com. There are some other sites like bizben.com, but BizBuySell is the most comprehensive in my opinion. I recommend starting with your current location and seeing what is available.
You can narrow the search down in many ways. I tend to start with setting a price range and minimum cash flow. If you have a number in mind that is the lowest amount you would accept as annual earnings, start with entering that in the cash flow filter. In my experience, a business making less than $100,000 is not worth the risk.
For asking price, one way to determine the maximum amount you can spend is to think about the funds you have to invest. Assume you will need 10-15% down for an SBA loan and at least $3000 to pay your acquisition team, which will consist of a trustworthy CPA and an attorney. You will also need additional funds to cover working capital for the first month or two as the new business owner. That amount will be unique to each business based on its monthly expenses. Note: Your bank could offer working capital in the form of additional loan funds or a line of credit if they like the deal.
Keep in mind asking price is always negotiable. Sellers tend to set the listing price at the best possible value for their business. To understand the overall market, BizBuySell has a great resource to see what trends are nationwide. The Insight Report linked can show you price trends in active listings and businesses that sold in your region.
There are two items I see of note in these trends. First is the average sale price. You will notice the median asking price is always higher than the median sale price. Secondly, while there are quite a large number of businesses for sale during any given quarter, the amount sold is significantly lower. In my experience, the reason for that is many businesses are not in a good position to be sold. Financial numbers are often inflated. Clean books are somewhat hard to find. I've also encountered owners who are not willing to negotiate even when the valuation for the business is high.
In general, I tend to look for a business with solid sales numbers for a decent price. With my first business, I knew I could invest around $65,000. I actually sold my house and used the profit to buy my business. I looked at BizBuySell listings in the $300,000-$400,000 range and found the ones with the best gross sales numbers to contact and request more information. This was followed by a simple review of the balance sheets and P&Ls. At the time, I didn't have an in-depth knowledge of these statements, so do not let this step scare you off. That is why you are hiring an excellent CPA to do the real due diligence for the business.
The number of businesses you contact can start to get overwhelming. During my last search, I reviewed around 50 businesses. I tracked my inquiries in an excel spreadsheet to make sure I didn't contact anyone multiple times. That spreadsheet is in our free toolkit with several other resources to help you with your search.
After you have narrowed the search down to 2-3 businesses, the next step is to interview the owner and visit the facilities. During the business owners pitch (remember they are trying to sell you on all that is good about the business), carefully listen for hints about any potential headaches. There is always a reason someone is selling a business. Most likely, the reason listed in the ad is only part of the story. When we purchased our first business, the broker representing the seller told us every business has its warts and that is a fair statement. Each business has its own unique set of problems. Your job is to determine what those are and decide if you can either fix or deal with them when you take over operations.
Step #2 - Make an Offer
Once you have found the business you want to buy, the next step is to do a valuation on the business to determine what to offer. There are multiple ways to value a business depending on industry, sales, and profitability. Acceptable approaches include income, asset, and market-based valuations.
In general, I prefer to take the average SDE (Seller's Discretionary Earnings) or EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) from the last three years earnings and use the standard multiplier for that business type to determine what the business is worth. I will go into this in detail in a future post and provide worksheets to help you understand the math behind making a determination of value. It isn't difficult, but it does take practice and a good overview of financial statements.
I do think if you are serious about making a deal you should have a copy of the annual Business Reference Guide. This is my go-to when valuing a business, and it is used by most business brokers in the industry. It has rules of thumb for over 600 business types and pricing strategies from experts within each industry. I also appreciate the industry outlook provided for each type of business. It gives me an idea of how much growth is expected in the future. You can invest in older versions of the reference guide for less, but I highly recommend you have this book to find the multiple and industry standards for each type of business you consider.
Once you have come to a number you are willing to pay for the business, you will submit a letter of intent to purchase. It isn't legally binding. The intent is to show the owner you are serious about purchasing the business and get it off the market.
The owner may not accept your first offer. That is when the negotiations on price, training period, and other outlined terms begins. The owner will work with the business broker to come up with acceptable terms and send them for your review. You can accept at that point or continue negotiating until both parties can agree on the terms of the sale.
"The best deals are when both parties that come to an agreement feel just a little uncomfortable." – Marcus Lemonis
Step #3 - Due Diligence
Once you have agreed on a price and terms, your due diligence period will start. This is the time to engage your acquisition team. Your attorney will start helping you draft up a purchase agreement with terms that are favorable to you as the buyer. The attorney will also help you form your business entity and prepare any legal documents required.
Your CPA will look through the financial records and make sure everything adds up. They will present findings on the financial health and the challenges with the business. They will conduct an interview with the current owner. Any red flags discovered will be disclosed.
Recently, when we were preparing to sell our business, I found the original due diligence document our CPA provided during the acquisition. Reflecting on his advice, he was spot on in terms of what to expect with our business. The previous owner did the all the sales, and service jobs lasted on average 2 to 3 days. He told us to prepare to constantly be on the road trying to make sales. He was right. That was one of the main challenges we faced in the business.
If everything is acceptable in the due diligence period, your attorney will finalize the purchase agreement to sign. If the numbers or profile of the business differs from what was originally presented, you can either walk away from the deal or renegotiate based on your findings.
Tip: A knowledgeable acquisition team is crucial for making a good deal especially if this is the first business you are buying. This is not the time to look for a bargain. These professionals are there to protect you. My advice from experience is be specific in what you want your team to do. The hourly rate does start to add up over time. For example, my CPA and attorney had differing opinions on what should be in the purchase agreement. They went back and forth for weeks about small terms that ended up not being important in the transaction. This cost me about $10,000 upfront before even closing the deal. I should have stepped in early and given them more clear directions on what was a priority to save time and money.
Step #4 - Close the Deal
The purchase agreement is signed and due diligence is complete. It's time to close the deal. Financing the purchase is the top priority of this phase. As I have stated previously, I prefer buying a business that is SBA pre-qualified. It tells me a bank has reviewed the business finances and agrees the business can support the loan payment. If pre-approval was obtained prior to listing the business, the broker should have provided the proposed loan terms offered by their lender in the initial business information packet. You can pursue that option or find your own lender.
Start contacting lenders to see the terms available for their SBA 7(a) loan. In most cases, funding the loan will take at least 6 weeks. The biggest hurdle you will face is convincing the underwriter you can be successful. If you don't have prior experience in the industry, do some research on trends. Have a business plan outlined and ready to discuss. Convince them how you will maintain or grow the current business model.
Not having prior experience in the industry doesn't automatically disqualify you. Our first acquisition was a construction service business, my husband and I had no prior experience within the industry. We leveraged my prior management experience and his engineering and business background to convince the underwriter we could handle the operations of the business.
Another option is to find a short certification class within the industry that you can take to demonstrate knowledge of the field. Search online to see if any courses are offered that do not require a long time commitment. My husband was able to get certified in our niche field of construction by taking a weeklong course. This can go a long way in proving your readiness to lead the organization.
The bank will also require you to get a new lease to ensure the business will have no disruptions to operations. SBA 7(a) loans typically require a 10-year lease. This can be broken down into smaller lease terms with the option to renew for up to 10 years.
The business broker representing the seller will assign an escrow company to handle closing the deal. The escrow officer will work with the bank and you to prepare the final loan documents for signatures on the close date. On the day of close, you and the seller will meet to officially sign and change ownership. Congratulations! You are now a business owner and ready to start the transition of ownership.
Ready to Start your Search and Become an Acquisition Entrepreneur?
The roadmap presented above is only an overview of the steps to buying a business. Over the next few months, you'll gain a better understanding of each step in the process. Sign up for my newsletter to receive updates and get alerts when new articles are available.
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