Thinking of buying a business?
Stuff to think about . . .
The Short Version . . .
Buying a business often starts with seeing an offering that peaks your interest. As long as your interest continues the easiest path is . . .
- You and I discuss the business and the buyer qualifications set by the seller as to time, talent and treasure. You simply tell me if you qualify. There’s no checks. This is just to save time.
- I arrange for you and the seller speak about the operations over the phone to feel each other out and gain comfort you could step into the seller’s shoes.
- A tour of the premises after hours.
- Tons of questions through me to the seller until you either lose interest or think this might be a suitable match.
- If interest continues, you and I would draft up a letter of intent to show to the seller.
- He will come back with his changes.
- This will continue back and forth until one of you walks away or both of you shake hands.
- If it’s a handshake, you will take the letter of intent to your lawyer to be drafted into a purchase contract.
- Your lawyer will send the completed contract to the seller’s lawyer. If his lawyer thinks your lawyer’s contract fairly reflects the letter of intent, both of you would sign.
- This may be followed by due diligence by your accountant to confirm the books are in order.
- Finally, with your accountant’s approval, cheques and keys will change hands.
If this sounds good to you, give me some times that work best for you for the phone conversation. I will show them to the seller and let you know which works best for him.
The long version . . .
Let’s first agree on what a business is.
It’s only the comfort of continuing this cash flow that that defines the value of a business,
And it’s the buyer’s comfort that the cash flow will continue through a change of control that determines the multiple to cash flow to be paid over and above the current assets less any debt.
Think about his for a second. A collection of assets etc not producing a positive cash flow is not really a business. Any value would be determined by the auction value of its equipment etc.
But the big jump is realizing that value comes from the cash flow stemming from this collection of ‘stuff’ and the way it is put together. It is almost impossible to figure out what any particular component of the collection is worth.
How can we determine how much the left handed torque machine contributed to cash flow compared to the web site that brought in the customer, the bookkeeping system that correctly prepared the invoice or the truck that delivered it?
So the first thing is not to get hung up on the value of any particular facet of the business. You are buying a collection of ‘stuff ‘ that produces positive cash flow and only that continuing cash flow gives the business any measurable value.
Sometimes you may run into folks without much business experience trying sell a business by pricing assets separately from the cash flow.
Run. Value only comes from cash flow and your comfort that the cash flow will survive a change of control. All the operational assets that contributed to the cash flow should be included in the purchase.
The value of all the operational assets you can see and touch plus the intangibles such as customer loyalty, location, staff are all there represented in the cash flow number. Trying to figure out the contribution of any of them on their own is a mug’s game.
Do you know what type of business is right for you?
As Alberta’s most visited and best known business brokerages, we have had long discussions with many buyers to help them decide what kind of business would be right for them.
First, we have to sort out the ‘time, talent, and treasure’ you can devote to the new business.
Do you want to actively work the business or come in at the ‘director’ level of a firm that already has good management in place? How much ‘time’ do you want to spend in the business?
What are you best at? This is your ‘talent’. In really broad strokes, you can think of any business in terms of operations, marketing and administration.
Different prospective buyers bring different gifts to the table while sellers leave different holes that need to be filled.
Do you want to make the widgets while relying on others to find you customers and pay the company’s bills?
Are you the wonder-kid at bringing in new customers and can rely on others to provide the service and manage the books?
Or are you the administrator? More comfortable behind the computer ensuring all you bills are paid and more importantly, all your invoices are paid?
Once we know who you are, we can look for companies where your talents can fill the skill-set being vacated by the Seller.
Then there’s price. We have to know what you can afford. This doesn’t mean what are you worth, it simply means what part of your treasure you want to spend on a business.
A good rule of thumb is that the price of an owner operated business is two to three times the firm’s normalized cash flow. And yes, inventory is extra. Only firm’s not making much in cash flow ever say ‘inventory included’.
We can fine tune this selection process even more. Some businesses deal with ‘hard assets’ selling items made either by others or by their own operations. But more and more businesses these days are in a sector where they really get paid for what they know or do instead of something their customer can touch.
Where’s your comfort? More importantly, where’s your banker’s comfort? He can attach ‘hard assets’ but not ‘talent’ or ‘knowledge’.
Another real division in business is between the firms that continue to sell to the same customer or firms that only sell to new customers because of the length of the replacement cycle for their product or service.
Think ‘bakers’ v ‘roofers’.
The baker can re-sell to the same customers on an almost daily basis while the asphalt shingle installer can only sell to them once every generation or so. One business survives on creating customer loyalty while the other depends on pricing and marketing. What do you do best?
Finally, and broadly speaking, any business sells primarily to the public or it sells primarily to other businesses. Each type of business takes a different mindset. There are folks who thrive maintaining relationships with a few dozen commercial accounts who have to pay attention to price and specs. There are others who see the buying public as their oyster.
Both can be successful if they buy the business that matches their talents.
See also Businesses Wanted then call me to discuss how to post your particular search needs.
A Typical Purchase
Here’s a brief outline of what to expect of the process of purchasing a typical owner operated business.
The transaction was initiated by a Business Owner offering his business for sale.
The Potential Buyer will catch wind of this and search out more information. But there are two or three steps before the potential buyer will get more information than what’s available to the general public.
The Seller knows that to sell the business he will have to share information with the Prospective Buyer that he otherwise would prefer kept away from both the public and the other stakeholders such as employees, suppliers or customers.
Because of this, the Seller often insists that I qualify the Prospective Buyer to ensure that information is only shared with folks who have the ‘time, talent and treasure’ to buy the business.
This sounds more ominous than it really is. There’s a discussion to explain why the seller needs the buyer’s assurance that he’s qualified. We have no way of checking. The point is not waste each other’s time.
And it works. I’ve really never had an instance of folks claiming more time, talent or treasure than they really had.
The Seller will definitely insist that the Prospective Buyer sign a Non-disclosure Agreement. The Prospective Buyer will agree not to share anything he learns with anybody other than his lawyer, accountant or other professional advisers and who will also be bound by this agreement.
Here is a link to the dual agency and confidentiality agreement we will sign (CADA).
After these preliminary formalities are completed, the Seller will likely give further information in a staged process.
If the prospective buyer comes across a ‘deal breaker’ that is unacceptable to him, then to protect confidentiality, no more information will be provided.
It is often possible for me to arrange for a serious prospective buyer to gain an inside view of the seller’s operations. This can happen after normal business hours or, for some operations, during the day, by posing as customers. The above non-disclosure agreement precludes the prospective buyer from approaching staff or other stakeholders of the business.
But it always important to first bring the buyer and seller together for an information session where the business operations are more fully explained and the Prospective Buyer can ask specific questions about ‘the forest’. Often this is most conveniently done in a phone conversation.
This process continues until the buyer is ready to propose a transaction. This is done through a letter of intent.
This is not an offer like in real estate. It is simply an ‘agreement in principle’ that proposes the commercials terms, including amounts, dates, conditions etc.
I will show this to the seller who will, no doubt, make some changes. We’ll go back and forth until both parties are ready to sign.
The seller will have made financial representations and the buyer will ask an accountant for advice on how to verify them. Often this is simply making any deal conditional on the accountant’s approval.
The buyer will take the letter of intent and the verification terms suggested by his accountant to the buyer’s lawyer.
The lawyer will incorporate the letter of intent into a purchase agreement and send it to the seller’s lawyer for review.
If the seller’s lawyer believes the purchase agreement fairly reflects the letter of intent, we’ll enter a period of ‘due diligence’ giving the buyer open access to verify all the representations, conditions etc made by the seller.
As information is verified and other conditions are met, the conditions are removed. If they are all removed by their due dates, the deal is completed by the lawyers and keys, cheques etc change hands.
This isn’t rocket science. But it is important to be coached by somebody who’s experienced it before and has a sense of where the lions are.
Terms (sometimes called ‘Price and Terms’) state what you are buying and for how much. Examples of terms include the price you are paying, the balance sheet ratio on close, the training period to be provided by the seller all the way through to who owns the ATCO deposit. Sometimes this is where we stop, draw up a letter of intent and let the lawyers take it the rest of the way. Each deal will differ. I will give you guidance here.
Conditions run the range from ensuring that the Regulatory Permits are valid to stating the financials have to be approved by the Buyer’s accountant. Each condition has a date on which Buyer (or sometimes the Seller or sometimes both) has to waive it. If it’s not waived by that date, the deal dies. These differ from deal to deal. I will give you guidance on what should be conditional in your offer.
Your initial deposit cheque was placed into a trust account with your own lawyer as your act of good faith when your proposal was accepted. This is as far as you should have gone in incurring a cash expense and, if, in good faith, you don’t waive the conditions attached to your offer, those funds will be returned so all you are really out is your time.
Unfortunately some buyers have sometimes incurred other expenses that could easily have been avoided. The most common are paying lawyers or accountants to give you professional advice on the business when you don’t have enough information for them to consider.
A smart buyer will realize that all the information that will be given him by the seller prior to the accepted offer amounts to a view of the forest. This is what business men mean by ‘the bottom line’ or economists call the ‘aggregates’. You’ll get the big picture, but not the details. And the devil can be in the details which is actually when you should go to your professional advisors.
Your professional advisors are there to look for the swamp willows that may be infecting the forest and that sort of detailed information will not be forthcoming prior to the accepted letter of intent.
It is much more cost effective to include conditions in the offer to the effect of stating that your lawyer or accountant has to approve the transaction. This way their charge clocks don’t start running you until they can really see what’s going on. And should they find enough swamp willows that you chose not waive that condition, your deposit cheque is returned.
Take-overs and other business expansions
A decision by one firm to purchase another firm can develop for all sorts of reasons. Sometimes it is because the buyer’s current premises are too small to expand. Or it could be a firm from outside wants to expand into some other location in Alberta. Instead of starting from scratch, they want the security of cash flow from a ready made customer base.
I purchase and maintain a data base of company names and contact names for firms throughout Alberta. If you are thinking of expanding through a Calgary or Alberta business acquisition, I can undertake a canvas of the firms in your industry of interest and bring you together with vetted potential sellers. This is done discreetly so that your name remains private until you decide to meet with the potential seller.
I can also arrange for you to meet with experts in business expansion financing at both RoyNat and the BDC.
BDC also publishes some great booklets for entrepreneurs. There’s one about starting or buying a business that I highly recommend. You can find it on this page of their web site.
There’s no set structure for how to do any of this. Give me a call to discuss what might work best in your circumstances.
A Mile in his Moccasins
It would be a good idea to read the Seller’s Page to get an idea of what’s going on in the seller’s head. The more both sides of a transaction can understand each other’s needs, the greater the likelihood that a deal can get done. Also see the Tips Page for ideas to smooth the process.
Acting for Buyers instead of Sellers
See the in’s and out’s of Buyer Brokerage – Click here