How to choose a great business to buy

with Pete Seligman

 

Choosing a business to buy can be tricky but here is how you do it.

In this episode our special guest, Pete Seligman, explains how to choose a business to buy.

Photo of Pete Seligman Buying A Business specialist

Pete Seligman

This is an important episode to listen to if you are contemplating purchasing an existing independent business or a Franchise.

Pete Seligman – LinkedIn Profile

Pete Seligman – Alpin

Links and resources for buying a business.

Buying a business-where to begin?

How to find and choose the right business to buy

Buying a business-valuation and choosing the best deal structure

Is this a bad time to start a business?

Which is the best way for you to own a small business?

How to choose a business partner.

Where to begin buying a business?

In episode 16 we identified the importance of your personal mandate to start the buying process

Pete Seligman explains where to find a business and choose the right one to buy using a 555 funnel technique. 

A clearly defined personal mandate will help you choosing the right business. 

So, where would you look to choose a business to buy?

Brokers run many commercial business sale websites. Start surfing those sites and get a feel for what’s out there. You will get an idea of the types of businesses for sale and the values assigned to those businesses, along with the types of people putting them up for sale. So the easiest way to start is a relatively quick search of the business broking sites. These sites are well structured and allow you to apply all sorts of filters such as

  1. how much I want to pay
  2. the kind of industry I want to be in
  3. the geographical location that suits me 

Adjust filters and get a good feel for what’s available. You will quickly find is that there is a high volume of businesses for sale, many of which may not suit you.

So, for example, I’m particularly interested in buying industrial services, manufacturing or engineering type businesses that suit me the best. Access to those via brokers sites is relatively thin, not only because of the industry but usually their larger size. When we first started buying a business seven or eight years ago, we started on websites. But you have to sift through many franchises. 

Franchises and cafes dominate businesses for sale websites.

Frankly, if your aspiration is a coffee shop or to build a portfolio of franchises, you’ll find plenty of targets. So it depends on who you are and what you’re looking for, but at least it’ll give you an idea. Start to identify which brokers have most of the businesses in your area, industry, type or size. And then what you can do is quickly is request an information memorandum (IM) or effectively a flyer that describes a bit more detail behind each business. And that’s how you start a more detailed conversation with particular brokers that seem to be suited to what you’re looking for. 

How vital is the location when choosing the right business to buy?

It goes back to your personal mandate. When we first started, we aspired to sit in as the manager of the business once we’d acquired it. So geography was vital because I was going to be turning up to that location. Now the acquisitions I’m looking at, it’s more likely that I will put an operator in there. So it’s less necessary for me for the business to be right on my doorstep.

In your situation Pete, it’s the type of business, and the potential that you see in the business is more important than physically where it is. For other people, location is a very significant thing for them. 

When we started, there was no point in us looking for a business based in Brisbane, let alone Newcastle or Wollongong, because we’re in Sydney, and we needed to commute. So that very quickly limited our search, and you need to be pragmatic about that. Whereas now, I think, not only because of the experience we’ve had, the skills we’ve developed and the network we’ve got, we can look further afield because we can start to partner with other operators who can then sit in for us. And for example, right now, there are potentials that I’m looking at in various locations in New Zealand. The only reason I’m able to do that is that I’ve learned how to do it myself over the last few years. 

What is a business broker, and what are their pros and cons?

A broker is similar to a real estate agent. The broker has helped the business owner identify the need to sell their business. A business broker works with an owner to articulate the details relating to the business and how much it might be worth. They consider what benefits it might have for someone else and prepare the documents that present that business for sale. So the broker is accountable to the business owner to take that business to market and find a buyer. They are similar to a real estate agent that a property owner would use to help them take a property to the market. Some of the larger business brokers are often associated with or are subsidiaries of real estate agents. 

Business brokers are licensed here in New South Wales. 

A good business broker should broker the deal

It’s a fair and reasonable comment that the broker industry has its good and bad brokers. And I don’t think that’s an unreasonable comment because some don’t take enough time to properly understand the business so they can really “broker” a good deal. Some just produce a document that they can put on a website to try and find a buyer. 

 And then, as soon as buyer and seller are in conversation with each other, they fall into the background, whereas a good broker will actually “broker”. 

A good broker finds all the good points and the potential. 

The broker helps the buyer and seller to navigate the complicated process. So, there are good brokers and bad brokers.

If you’re only ever going to buy one business, you’ll only really have one or two experiences with a broker. But, if you’re going to do more buying businesses, you’ll start to know the business brokers that work well with you and those that don’t. Business brokers are valuable, particularly if you aren’t currently in an industry or role where you have the kind of network that would help you identify businesses. 

Can you use a buyer’s agent to act for you? 

Yeah, absolutely. I perform that role for some of our advisory clients. For example, when we’re working through our advisory business with business owners looking to grow, some of that growth will often come via acquisition. The client may already have a business, and they want to expand, so they need to find other businesses to buy. We help them go through that process. The purpose of a buyer’s agent is to help the buyer effectively articulate “Your mandate” so then they can identify businesses that fit. The right buyer’s agent will help you clarify what you want.

Then they’ll have various tools and techniques to map the market that you’re interested in and identify businesses to buy. Equally, what they will help you to do if you can’t do that yourself is to identify businesses that aren’t even on the market. They’ll say, based on what you’re looking for, business x, y, z could be great for you. Let’s approach their owner and see if they are interested in selling.

As we’ve discussed in prior episodes, you know there are lots of business owners out there that might not necessarily have overthought selling. Still, if asked, they might say “yes”, so that’s another area where a buyer’s agent can help. They can help you with “cold approaches”.   

What is the role of accountants when buying a business? 

As soon as they think about business and finance, many people would think of their accountant. 

So, are accountants involved in this?

They need to be involved. Now, the one caveat to that is to make sure that they only advise on what they are competent.

My assessment would be the best accountant would know the parts of this process that they can help and add value to and the parts of this process they should be advising their clients to find specialists. Often we’ve found when we’ve been on the buy side, and the seller relies completely on their accountant for the whole process. And the good accountants say, “Look, I’m a tax accountant, and I’m a personal accountant. I’m not an m&a (mergers and acquisitions) or company transactions accountant. We need to get someone else in on the sell-side to help us navigate this arrangement”.

The unfortunate situations are where the tax accountant for the vendor tries to be all things to all people. And I think that always ends up in a bad situation. 

Good advisors on the buy and sell side makes for a better deal.

If you’re a buyer, it’s like playing a game of tennis. Some people might think, and as an experienced buyer, “oh, wouldn’t it be great if they only had a tax accountant representing them”? Because then I could clean the court with them. We could get a really good deal because the people on the other side aren’t as capable in this particular thing as I might be, but that’s not correct. Yet, like playing tennis, if you’re an outstanding tennis player and you’re playing against someone that’s not that great at tennis, you don’t play your best game. Not only because the way they’re playing is so unpredictable, but also because you’re not forced to play your best game. So you don’t get the best outcome.

And I think it’s the same in this situation. As a buyer, you want an excellent representative on the sell-side because that’s when you can get reliability when you go through the deal. And you know that you’re going to get the best deal for you but also the best deal for the seller. We’ve been in situations where we’ve recommended to the seller that they appoint specialists to represent them to make sure that they’re well represented. I’d much prefer to go “head to head” with a good representative for the seller than someone inexperienced in that realm. 

Buying a small to medium business can become emotional.

These are very emotional transactions, much more so than deals that I used to do when I was working at the larger end of town. Those are much more scientific. Smaller business sales are very emotional deals. If there is a mismatch in the capability of the sales and buyer representatives, the seller can feel cornered. If the seller is not well represented, their response can be understandably emotional. This can kill the deal.

As a buyer, you need to back off and not play your best game, which isn’t good for anyone. Or you end up in a situation where you’re trying to play your best game. But as a result, you kill the deal because it goes from rational to emotional. If the seller is well represented, they know that it’s a fair negotiation, and everything can stay much more rational. 

That takes the heat out of the negotiation because two independent agents deal with the emotional triggers. And a good seller’s agent will reassure the seller that what the buyer is doing is not unreasonable. When we propose a transaction structure or present our valuation, the value that the seller’s agent can give to the seller is to say, “No, this is normal. This is okay and not unreasonable. Actually, this is very normal practice”. 

What is a non-disclosure agreement (NDA) or confidentiality agreement?

One thing that we probably should just touch on is that we’re sitting in New South Wales in Australia. So obviously, whatever jurisdiction you’re in, you’re going to have to check out your buyer’s agents and the legalities. So we’re talking in very general terms here. But one thing, no matter where you are, is to be asked to sign some kind of non-disclosure agreement or confidentiality agreement to get any information from the agent. 

Would you need to see a lawyer before you sign an NDA? 

They’re all relatively stock standard, again, jurisdiction dependent. And, you know, there are “one-way non-disclosure agreements” and “two-way non-disclosure agreements”. And I think that’s quite important, and I would always tend to try and get a two way NDA because you never know what you might need to share during the process that you don’t want them to use. 

Not just them sharing information with you, but you sharing information with them. 

I think you do need to take NDAs with a “grain of salt”. They’re a bit like a patent- only as strong as your willingness to enforce them. But I think even just a process of executing one gives both parties some comfort that people are willing to put pen to paper. I think it’s almost in some ways a helpful practice run for drafting agreements and executing them between the parties.

So, I think they’re an excellent first step. It’s an excellent way of acknowledging that we are moving to the next phase of this process. I do think that if you haven’t done it before, having someone with a legal background look at it for you is very useful. And that’s not just to check that it’s a reasonable NDA, particularly if it’s the first time you sign one. Just to walk you through and say this is what this cause means and the impact is this. It’s almost an educational process. In the future, you can get an idea of what you’re looking for. I don’t get a lawyer to review the NDAs we’re looking at unless I see something funny because I’ve seen so many. 

But the point is, you now know what something funny looks like, whereas initially, it all looks funny. 

The Should I Own A Business Podcast team always recommend seeking professional advice.

Exactly. 

When choosing the right business to buy, how do you shortlist possible choices?

I think in the previous episode, you introduced this concept of the buying funnel. But let’s say, to begin with, you see 100 potential businesses, and then you’ll want to get that down to, say, a shortlist of maybe 15. And then maybe a very short list of five to buy one. So you’ve got a funnel situation. How much information do you need, and how do you chop down to say 15? 

That’s a really good question, not only because you chose those numbers because they are a good representation of the ratios. But also you chose that many steps because I think it nicely fits the description I’m going to give. So what we use is a relatively simple formula that we refer to as 555. 

The 555 System for choosing the right business to buy

The 555 Buying A Business System is five minutes, five hours and five days. And obviously, those numbers are indicative, not real. But you can almost sometimes do it in exactly those numbers.  

To get from 100 to 15. It’s five minutes, and I don’t mean five minutes across all of them. I mean, you spend five minutes on each of the hundred to work out, which 15 you shortlist. 

How to select the right business to buy with a 5-minute test

And there are three main questions that we ask when we spend those five minutes answering. 

1 Industry choice

Is it in an industry that we believe has some potential or the attributes that we like? 

Is it geographically suitable?

2 Unique attribute

Does it have some kind of niche or some kind of unique attribute? 

If not, is there a very quick pathway to it becoming unique? 

3 What value can we add?

What value can we add? There’s no point in doing it unless there’s something we can contribute to help. 

You’re looking very much at the potential of a business, and what do you can do with it? 

Not profit or turnover or anything financial. 

I cut out the businesses that turn over less than 200,000 dollars, so maybe, that cuts from initially 500 potential businesses for sale to 100. You are right- at that point, we are not trying to hit a particular financial number. I’m looking for the potential rather than what I’m buying. It’s like when you buy a house. I’m looking for a location, not whether or not it’s got the right kitchen bench top because I can change that. 

So that’s five minutes each, and that’s cut 100 down to 15. 

Getting the information for “the 5-minute test” from the broker is straightforward. 

You don’t even need an NDA for that bit. So this will be almost just looking on the internet. 

You ask for a flyer, like a two-page version of the bigger document you need under NDA. And that should describe enough about the business to answer those questions. 

The summary flyer should be enough at this stage.

The Buying A Business 5-hour test

So the next step takes five hours, and this is all just about people. We would then get the detailed information memorandum (IM), which has a lot of financial information and other things. So we can learn a little bit about business, but ultimately, we want to meet the vendor and their leadership team and visit if we can. The main conclusion we want to reach at the end of these five hours is around the people. 

It’s like, “yes, this is a team that we think has the foundation or the existing capability to exploit the unique market proposition and the value we want to add”. 

So we are asking the question, “Is this business investable”? 

You might also be thinking about the financials or asking questions about the customer profile or that kind of thing. But ultimately, if you were to boil it down to just one thing, these five hours- the people.  

And so that’s why we spend these five hours. You would probably spend four to four and a half hours thinking about and speaking to and learning about the people and half an hour looking at a few more numbers just to make sure there isn’t anything jumping out early. But, ultimately, it’s people. 

You know this business is in a good sector. 

It’s got a unique proposition, or we think there’s an angle that we can bring to create value. 

This stage checks the team and if they’ve got a good foundation that we can add to. 

Making An Indicative offer.

At the end of this second phase, we’re probably starting to put in an indicative offer. 

We’re starting to say, “look, we’ve got enough of an understanding of what the numbers look like that if we assume what you’re telling us is true, we can start to work out how much we think this thing might be worth”. So subject to detailed due diligence will give you an offer to see if we’re on the same page around valuation. 

An indicative offer stops both parties from wasting too much time because the next stage we’re going to talk about is time-consuming and costs money

You’re saying: “We like what we’re seeing and we think we can do something with it. If we made you an offer in this range, are you interested? Are we close?”  

This means that both sides are agreeing when we start to invest real time and money; on the next stage, we’re on the same page. 

Buying A Business- 5-day due-diligence test

Now, this is when what most people would describe as “due diligence” kicks in. 

I appoint my lawyer to start drafting documents and reviewing the business documents. The documents might be reviewing leases or customer contracts, or it might be all sorts of things. I will probably appoint my accountant to start reviewing the books and records in more detail. I will appoint my tax advisers to start helping me understand the tax implications of the deal. 

Now I’m going to start incurring real third-party costs and, so will the seller as they ramp up their lawyer and their accountant and get into a lot more detail. This due diligence process to understand some of the nuances in the way the business and finances operate. 

Two outcomes will happen from this detailed due diligence; you should be pretty confident at this point that you’re going to get to a deal. There are two things that you’re looking for when you go through this detailed due diligence phase. 

Due diligence when choosing the right business

The first goal of due diligence

First is, “discover things that will change the nature of the sale and purchase agreement I need to draft to protect me?”

Say I find out there’s an old customer contract that might pose a liability to the business. You speak to the vendor about it, and you say I need a warranty in the agreement, so if this does come back to bite us in three years, you’ll make me good for it. This is like a risk management tool for the sale and purchase agreement. The purpose here is to identify the risks that you need to manage in the document. 

The second goal of the due diligence process

A second reason for doing this detailed due diligence is actually to find deal killers. You’re looking to make sure there’s nothing that means you should put your hands up and say, “You know what, I found something here- it’s a complete landmine- this deal, unfortunately, can’t happen”. 

You’re either trying to find the risks that you need to manage in the document or unmanageable risks, and the deal is off. 

What is due diligence when buying a business?

Okay, so maybe one thing we should just expand a bit there is this the concept of due diligence. So, in essence, everything that we’ve talked about so far is due diligence, correct? Because getting your personal mandate or headspace or, the right frame of mind for all this is due diligence. But what we’re talking about now becomes a physical process. There’s the financial aspect, and there’s also a physical aspect to it, especially if you’re buying, a manufacturing business, for example. I’ve been through this as we were acquired. You’ve got things like the assets, the buildings, the leases, and everything that is purported to have a value, has to be verified. 

What’s it like doing due diligence on small to medium businesses (SMBs)? 

I’m pausing because I’m trying to work out which element of ease to describe, though, so easy is relative to how you set your due diligence expectations. When I worked for Macquarie, we were doing very detiled due diligence on multi-billion dollar companies. A lot of work, frankly, because there are lots to look at. But it can be relatively daresay low risk because the seller is very well structured, very well advised and very well informed. So when you have a question or risks that you want for due diligence, you can find all the information you need to answer that question. In small to medium enterprises (SMEs), you often can’t fully answer the questions you want to ask due diligence. 

The secret to good due diligence when buying an SMB.

So the trick with the due diligence of an SME is to spend a fair bit of time asking yourself the questions. 

What are the really big things that will impact the value of this business after I buy it? 

Nail the top three to five questions you must get answered. 

Not the 500 questions that I like to ask. When you get good at asking those key questions, it’s also about understanding what a good enough answer is instead of a perfect answer. 

Because if you think you’re going to ask 500 questions, you never will. And if you think you’re going to get a perfect answer, you never will either. 

Get good at understanding “what good enough is” when it comes to an answer- that’s the trick. Many people and including me, struggled in the transition from buying big businesses to buying smaller ones. When you buy big businesses, you don’t realize the luxury you have with the information. 

Assuming the seller says “yes”, what’s the next due diligence step? 

When you get to the last five-day phase of detailed due diligence, it should be confirmatory. We’re looking to confirm our assumptions from prior stages. We’re not looking to try to change the deal by “chipping”, as buyers in the private equity space get accused. We’re trying to confirm the deal as we understand it. The outcome is an excellent sale-purchase agreement or share-sale agreement or whatever heading you want to use. A contract for sale is the product at the end of this process, and it needs to be an excellent product rather than just a template that people signed to hand over money. 

The 555 buying funnel process will keep you on track if things get messy

So that’s a very eloquent way of taking us through a funnel from what could be 500 businesses. But taking 100 down to 15 and then down to five and then down to one.

Like most things, its easily described, more challenging to execute, but if you keep coming back to those core fundamentals, that helps you make decisions along the way. 

It will get messy as things don’t happen nicely and sequentially in the real world, but you must have a structured process to keep you on track. 

That’s a perfect place to end this episode. What do you think we should be talking about next? 

The next episode could be about the transition in a little bit more detail from the due diligence into the document into the share sale agreement. 

After that, we can talk about elements of a share sale agreement, such as earn-outs and transition periods and all that kind of thing. So maybe what we can do is talk about what it looks like from that share sale agreement through the date of completion and into that initial transition of ownership.  

That sounds perfect, and Pete Seligman what another great episode? Thank you for your expertise and time. We look forward to the next episode. 

Disclaimer

The information contained in this podcast is general and does not take into account your situation. The content does not constitute legal or financial advice and should not be used as such. You should consider whether the information is appropriate to your needs, and where applicable, seek professional advice from a financial adviser or lawyer in your jurisdiction. To find out more, please go to www.ShouldIOwnABusiness.com.

 

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