The Fine Art of Buying

Buying a business is not for the faint of heart, but the best argument for entrepreneurs to acquire an established business, rather than start from scratch, is that buyers know so much more about what they are getting into. There's not automatically less pain and anguish, especially if the due diligence process turns out to be a headache, but Sverre Roang, an attorney-shareholder with Whyte Hirschboeck Dudek, thinks it's still better than starting from scratch. "Starting a business, you literally have to pick the stationery and think about where your first sale is going to come from, whereas if you're buying an existing enterprise, you know the animal you've got and can plan to take it forward to a different level," he explained. "You are starting from a little bit higher up the chain. You know a little bit more about the customers, the cash flow, about everything. With a true start up, it's much more of a gamble and much more risky."

Staying on your turf

Should you acquire a business in the industry you're familiar with? Not necessarily. "I think that's actually more important if you are starting from scratch, that you would have some knowledge about the industry," Roang said. "You need to find those first sales, and you need to know where they are going to come from."

If you are buying an existing business, and if you know how to work through normal business issues, industry expertise isn't critical. Getting up to speed on the industry is critical, but it's easier to buy the industry expertise than it is to buy business expertise. "The concepts of business are the same, but if you don't know the nuances of a particular industry, it can be dangerous buying a business in an industry you are not familiar with," said Nathan Brinkman, president of Triumph Wealth Management. "You have to get up to speed on those nuances."

The due diligence process is something buyers have to prepare for, and that's true even if business valuation is addressed beforehand. The valuation of a business is more art than science, and buyers must understand that the differences of opinion often are a rude awakening for sellers, especially with a third-party valuator.

"The valuator is seeing it in terms of actual value of the business, and sometimes, it's very surprising," Brinkman said. "An independent valuator goes in there and says 'this is what the real value of the company is,' when the people buying or selling may have never thought of it that way before."

"Valuation is probably the first thing that is difficult," Roang concurred, and sometimes that difficulty lies in who the buyer is. A strategic buyer, for example, is someone already in the industry who is buying a business for a strategic reason like market share. In terms of valuation, there is a very different analysis for a company making a strategic play than for a buyer who simply wants to make a living and therefore is more concerned with cash flow and profitability.

Roang stressed that valuation should be a pre-due diligence issue (as are letters of intent and confidentiality agreements), because if you don't get to a point where both parties generally agree on either the valuation methodology or the purchase price, they don't need to get into due diligence.

Usually, sellers have to provide some sort of indemnification to ensure they are not selling a company that has a lot of skeletons in its closet. Full disclosure in the context of a complete due diligence process can essentially eliminate any exposure. "Due diligence is good for the buy side because you are finding out what all those skeletons are and making an informed decision about the ultimate purchase," Roang said.

The normal things a buyer would ask about include the completeness of organizational documents, validity of intellectual property ownership (which is sometimes more assumed than actual), and any unresolved human resource issues. Any sloppiness related to intellectual property would be revealing. "If it's a product or service with intrinsic value, you must understand how much exclusivity the company has to that product or service," Brinkman stated.

The issue of financing has taken some interesting turns. More skin in the game is required from buyers, but quantifying that is hard to do with the increased reliance on seller financing. To help put together financing packages, sellers are now lending to their buyers with greater frequency. Roang provided a hypothetical example: "Say you want to buy a business for $10 million, and assets on the balance sheet are $5 million, so the bank will give me $3 million on that. So I have a bank loan for $3 million and a $7 million spread between what the bank will give me and the value of the company. I have to come up with that $7 million somehow.

"What a lot of buyers are doing is saying to sellers, 'If you want to sell your company at this price, what you need to do is give me a lot of that. You essentially need to lend it to me.' That sort of thing, and in those ranges, are happening a lot."

Another thing that is occurring, according to Brinkman, is recession fatigue, and that could provide an atmospheric advantage to buyers. This fatigue is experienced by seasoned business owners who are anxious to move on with their lives and have come to the conclusion that the economy will not get better in the short term, and therefore they are willing to sell their businesses – hopefully for the value they place on them. That might not be possible in a struggling economy, which would make selling psychologically difficult, but they might be willing to pull the trigger if they see no realistic opportunity to rebuild value in their company in the short term. "It creates opportunities for buyers if recession fatigue has set in," Brinkman noted.

Networking net worth

Other than saving money and possessing business acumen, the most important thing would-be entrepreneurs need, in order to position themselves to acquire a company, is networking skills. "You need to know a lot of people, and you need a lot of people to know you are looking for something to buy," Roang said. "There is an element of luck to bring a buyer and seller together, and you can reduce the luck you need by making sure a lot of people who deal with sellers – accountants, lawyers, brokers – know you are interested in looking."

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