4 Ultimate Guiding Principles for Buying a Business

Growing your small business through making an acquisition can be an excellent way to turbo-charge your plans.  Every business needs organic growth through the usual marketing.  Buying another business though can, almost overnight, take your business to the next level. In my career, I have been involved on both sides of many transactions.  Through this, I developed my 4 ultimate guiding principles for buying a business. 

These apply whether you are buying a new business or making an acquisition.

There are obviously pros and cons to this strategy.  As a business mentor, my role is to help my clients assess these. Assuming the decision is made to proceed, I then support and guide through the process.

Remember my 4 ultimate guiding principles for buying a business and you will greatly reduce your chances of taking a false step.

 

4 Ultimate Guiding Principles for Buying a Business

Julie was the CEO, founder and main shareholder in a professional services business.  She had been running this for around ten years, with no small degree of success.  She had built revenue to around $3m per annum and was making a reasonable profit margin.

Several years back, Julia had moved to new offices to accommodate organic growth.  She took on additional space and staffed up in anticipation of organic growth.  This came, but not at the rate she expected.  This means that she had under-utilised resources in the business, and she wanted to change that quicker than she could through normal sales and marketing.

She decided to start looking for a similar, but smaller business to acquire – something with around $1 to $1.5m of revenue and three to four staffers.

 

Principal 1: Kill the Deal Quickly

There are many ways to locate potential acquisitions.  In my experience, especially when it comes to services firms is to either

  • Network and then approach through industry associations or
  • Engage an agent to represent you.

There is a little bit of reverse psychology at play here.  You probably don’t want to buy a business that someone is trying hard to sell!  Rather, it’s ideal to locate a business that could benefit from a bigger partner and lacks the immediate resources to grow on their own.  

From this activity, we put together a shortlist of five prospects.  One in particular seemed very promising.  It had all the qualities we were looking for.  Good staff, great client list – but the business was in a poor location and the profit margin wasn’t all that great.  The owner was an excellent professional, but not a fantastic business person.

Negotiations went very well.  But then, suddenly, they didn’t.  Items that we thought had been agreed for our Terms Sheet were brought up for re-negotiation.  Issues like the outstanding lease on his premises were a bit different from how they had been represented.  He tried to change the timing of purchase-price instalments.

We tried to accommodate the new demands and adjust to the new information that our Due Diligence process uncovered.  But for every new demand that was met, another appeared.

Ultimately, we couldn’t reach an agreement.    But we spent a lot of time – time that ended up being wasted – trying.

Truthfully, Julie got sucked into this rabbit hole, because the deal had such great potential

We took too long to kill the deal.  We fell for the myth that there is a perfect deal or a scarcity of opportunities.  

My experience in business acquisitions tells me, if an agreement on the broad terms and purchase price can’t be reached within a couple of meetings, then it never will be.  When this happens, just walk away.

Reduce your opportunity cost.

Kill the deal quickly.

 

Principle 2: Succession not Acquisition

Why is a business worth anything anyway?  OK, you have the tangible assets that could fetch a few dollars in a fire sale.  Mostly though, the value of a business comes through its goodwill (especially in service firms).  This Goodwill is an intangible asset that reflects the customers of the business like these services enough to keep coming back for more.

For example, an accounting practice.  If they do a good job, customers will keep coming back year after year, with a high degree of regularity.  They have established a relationship with the people, and that is hard to replicate or to break.

And an important part of buying a business is to do it in a way that preserves the goodwill.

Think about it from the perspective of a loyal customer of the seller.  They hear that the business is being sold.  It’s moving to a new location.  The name is changing. 

Typically, the average customer is now thinking about maybe finding an alternative solution.

Then they read that, actually, the owner – and the other staff – are staying on.  There aren’t any redundancies.  The key people – the ones with customer relationships – are continuing.  This is good news for the customers, and you.  It means that most will keep bringing their business.

In designing a transaction, we kept in mind that we wanted most of not all staff to come across.  Remember, the profit lay in making better use of Julie’s existing resources, than for necessarily reducing the target’s costs.  That would happen anyway because we retained most of the revenue whilst losing the target’s rental costs.

The lesson is to stop thinking of an acquisition as a purchase and start understanding it as a succession plan for the existing owners.  Tie that in with a smart transaction design, namely, an upfront payment, followed by an earn-out, all linked to an employment contract.

Instead of buying someone’s business from the owner, you are assisting them to have a plan to gracefully exit over (say) several years.  Whilst this happens, they continue providing great service to their customers long after he or she has left the business.

But what about vendors that just want to get out?  Well, you won’t be buying businesses like that, because you always keep in mind Principle 3….

Stop thinking of an acquisition as a purchase and start understanding it as a succession plan for the existing owners.

Principle 3: Culture and Client Value Proposition

Wait.  Are you buying a business to add on to your existing operation, gaining synergies and increased profit margin through scale – or are you just buying a new silo in a conglomerate?

If it is the former, then you need to dig deep in the due diligence to make sure you have a culture and a Client Value Proposition that is a close match to yours.  Or be prepared to invest a lot of time and money to mould the business to fit your model.

My friends at Business Health used to say, are you buying a hamburger stand or a fine-dining experience?  Both of them cook you dinner, but they deal in very different markets with a very different culture. Try and combine the two as they are, and both will suffer.

Julie spent a lot of time getting to understand all about her target’s ideal client, their value proposition – even how they packaged and charged their fees.  This also fed into the culture of the organisation.  She realised that the new combined company would have to make its own new culture and it was critical to start with two great cultures.

This aspect is often overlooked, as much of the focus is on the financial models.  However, if you are going to be working together for several years, you want to enjoy it, right?  Equally, you want your new customers to feel at home, and your existing customers to not feel like you are ‘losing your way’.  

These intangible or market aspects are very important.  Combined with a killer financial model you can not only achieve fantastic growth, you can create an amazing business and have a lot of fun along the way.  

Culture and client value proposition always make a HUGE difference in ensuring the final principle:

 

Principle 4: For the Right Deal, Money will always be Available

The financial engineering of any acquisition is important.  For the purchaser, before you go shopping, you need to know what your limits are and how this can be financed.  Will it be through borrowing, or having your shareholders contribute, using the company’s funds or a combination of all three?

In Julie’s case, it was a combination.  She negotiated to pay 65% of the anticipated purchase price upfront, with the balance paid in two instalments, at the first and second anniversaries (the exact amount of these latter payments were based also on financial performance post-sale).

She had some retained earnings in her company, plus some additional borrowings, to cover the first instalment.  We projected that the increased cash flow of the combined business would allow the second and third instalments to be paid from the company.  In other words, it would become self-funding.

The lesson though was that this was such a compelling transaction, the bank would have happily funded it completely.  Alternatively, Julie and her other two partners had the resources to put their funds in if it was required.

It’s tempting to hold off making acquisitions especially if money is tight.  In my experience as a businessperson and as a business mentor, I can promise you that for the right deal, there is never any shortage of money.

 

The role of the Business Mentor

Through this whole process, the role of the business mentor is an important one.  In any deal, everyone has an angle.  The vendor wants more money.  The bank wants you to borrow it.  The lawyers want to make the negotiation complex and expensive.

Everyone is looking after themselves.

Except for your Business Mentor.  Your business mentor looks after YOUR interests.

Want to more or have questions about the detail of this case study?  Go here to see how a business mentor can help your cash flow.

You can contact me TODAY, right here.  I can’t wait to hear your story!

Business Mentor Case Study: Marketing Consultancy Start-Up

The Client

Carl* is the founder of a digital marketing consultancy that helps companies integrate client relationship and marketing systems into their business.  He was a superb designer but a novice businessperson.  Although Carl is very experienced, his business was quite new. He launched on a dream but his only financial capital was his savings.  These were fast disappearing as Covid caused his clients to shut their wallets. 

Carl couldn’t face going back to being an employee in someone else’s business.  He needed to make fast progress to stay in business.  I was referred to Carl by a business contact.  During an initial, obligation free Zoom call, he told me his story and challenges.

The Business Mentor Need

As the business founder, Carl faced a number of issues normally associated with small businesses, especially in a global pandemic:  

  • Where is my next client coming from?  
  • How do I manage cashflow and access capital?
  • Where do I find the right team members?
  • Will I be able to spend enough time with my family?   

He also had issues with some of the subcontractors he used – they were letting him down in terms of quality and turnaround times.  And there simply wasn’t enough time in the day –  between business development, covering for the mistakes his sub-contractors made, and doing his own work with clients, Carl was exhausted.  His relationships with his family, especially his three adolescent kids, were suffering. 

The Business Mentor Engagement

I believed I could help Carl, and I presented him with several options on how our business mentoring could work.  We agreed on a three month, high intensity mentoring engagement.  This included two scheduled meetings per week, with additional unlimited phone/email support.

At the start of each session (which lasted roughly about an hour) I would outline and get agreement on our agenda.  At the conclusion, we would agree on next steps and who had responsibility for what.  

In between, Carl would occasionally call me to ask for guidance on client and supplier matters.  Other times he sought simply a sanity-check or to review draft client presentations.  I also arranged some introductions ot my own contacts where I thought there would be mutual benefit.

Carl was exhausted. His relationships with his family, especially his three adolescent children, were suffering.

Issues faced

Let’s face it – Carl is a start-up dreamer who is super at his craft but naive and inexperienced in commercial matters.  Importantly though, he is smart, hard-working and persistent.  We faced some big challenges:

  • Business Plan: finalising a Value Proposition and Ideal Client definition as well as a cash flow budget.
  • Pricing:  Carl loved what he did, but he undervalued it, like many small business owners.  Too often, it seemed like he simply broke-even on a job.  
  • Marketing:  Design and establish a digital marketing strategy
  • Support team:  Existing subcontractors were unreliable – they had to go and new ones recruited
  • Business infrastructure: Poor contracts needed replacing
  • Balance Sheet: Sell rental property to free up personal capital

Actions we took Together

First, we finished his business and marketing plan and identified the number of new clients and revenue he needed to live the lifestyle he desired.  Ironically, as a digital marketing consultancy, Carl didn’t have a great digital marketing plan himself.  Working together we identified a good outsourced solution to produce and manage his digital marketing in a manner congruent with his own brand.

Next, we put together a pricing model to ensure that Carl got not only paid for his time, but also got a profit margin for the risks he was taking as a business owner.  Simply having a consistent methodology added efficiency.  Now, he had a process for pricing work – not just relying on gut feel!

As a new business, Carl uses sub-contractors as required for projects, rather than hire employees.  However, some of them were not performing to expectations.  We rationally reviewed their performance.  I referred Carl to a new lawyer that was better suited to his needs, who then drew up new supplier and client agreements – no more white-anting of clients!  We broke off engagement with unsatisfactory suppliers and established a process which allowed Carl to find three new and better subcontractors.

Growth through Mentoring

Carl had a specific business opportunity in the UK with an Australian client that had offices there.  We identified a partner director for him to collaborate with, incorporated  an office in the UK and won the UK business of the client.

We reviewed his personal balance sheet and compared it with his revenue needs and business capital requirements. In particular, we ran the numbers on a couple of investment properties he owned.  One wasn’t performing, so  Carl decided to sell one that was absorbing a lot of his time.  This freed up capital for business investment, but also took away a lot of stress and gave back valuable time that he could then devote to his family (he also got $60,000 more than he had valued it at).

Next Steps

In the three months I was Carl’s business mentor, we completed a lot of work and made many positive changes.  In addition to the above actions, I’d been able to refer him to some new clients which more than covered the fees he paid me.  It was time for Carl to now focus on cementing the gains he had made and build on the momentum.  The business mentor engagement was done for now – we now touch base quarterly and he engages me on an ad-hoc basis.

You can read more about Business Mentoring here, or better yet, drop me a line to start our discussion today!

 

*Names and some details have been changed to protect privacy.  Personal references always available on request.