Episode Summary – Buying a business-choosing the right business to buy
How do you find businesses for sale and go about choosing the right business to buy?
This is the 3rd in the series of our interviews with Pete Seligman about buying a business. In episode 16 we identified the importance of your personal mandate. Today Pete explains where to find a business and how to choose the right one to buy using a 555 technique.
Links and resources
Podcast Episode 16 – Buying a business-where to begin?
Podcast Episode 13 – Reasons to buy a business in 2020 not start one
Podcast Episode 2 – You-360 What do I really want?
Podcast Episode 3 – Understanding Your Motivation to own a business
Alpin – website
Pete Seligman- LinkedIn Profile
Episode 20: Buying a business-how to find and choose the right one
Choosing the the right business to buy and where to find businesses for sale can seem overwhelming. Today we explain a proven process to follow.
So back in Episode 16, that we called “buying your business where to begin” Pete, you introduced us to this subject of the Personal Mandate. So let’s assume then that we’ve listened to that and we’ve worked out what we want and have produced our “personal mandate”. The next question that would come to mind for me is, where would I find a business for sale that matches that mandate? So where would you look?
It’s an interesting question. And I think it depends on where you’ve come from and your background. If you’re coming from a corporate role or as an employee of a business and you’ve never set foot into the field of, business or business acquisition or business ownership, then the easiest place to start is similar to how you would start looking for a house.
How do you find Businesses For Sale?
There’s a lot of commercial business sale websites available that are run by a range of brokers large and small. 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. They show you some geography as well because you’ll also see from the sites the business location. These sites are well structured and allow you to apply all sorts of filters such as
- how much I want to pay
- the kind of industry I want to be in
- the geographical location that suits me
So you can 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 which suit me the best. Access to those via brokers sites is relatively thin, not only because the type of business 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.
But 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 are best suited to you, that 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 a 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.
Going back to geography because that’s an interesting angle on it there. If you’re looking at more physical businesses, the bricks and mortar, industrial, like you say, a fabrication, manufacturing, then there’s less of them. So I assume then like for your particular case, geography is less important because they’re not going to be on your doorstep probably?
How vital is location when choosing the right business to buy?
I think it goes back to the 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
So in your situation, it’s the type of business, and the potential that you see in the business is more important than physically where it is, whereas, for others For other people who might be in this stage, 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. And 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?
What’s the role of the broker and what are the good and bad points about using a broker?
A broker is similar to a real estate agent, who has helped the business owner identify the need to sell their business. A business broker works with an owner on how 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. So they are similar to a real estate agent, that a property owner would use, to help them take a property to the market. Quite often some of the larger business brokers are either associated with or are subsidiaries of real estate agents.
They’re licensed here, by the real estate agency?
It’s a fair and reasonable comment that like in any industry the broker industry has its good and bad brokers. And I don’t think that’s an unreasonable comment, because I think that some don’t take enough time to properly understand the business so they can really “broker” a good deal. Some just work out a way of producing 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”.
Yes. Find all the good points and the potential.
And help the buyer and seller to navigate the process, which is a 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 of buying businesses, you’ll start to know the business brokers that work well with you and the ones that don’t. But business brokers are very valuable, particularly if you aren’t either currently in an industry or role where you have the kind of network that would help you identify businesses.
Can you use buyer’s agent for choosing the right business to buy?
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 that are looking to grow, some of that growth will 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. Yes, there are buyer’s agents out there that have approached our advisory business directly because they know that we’re looking to buy and they have suggested they can help us. The purpose of a buyer’s agent is to help you as 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. Now, they’ll do that with a little bit with the help of brokers and sellers agents effectively. 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. You know, as we’ve discussed in prior episodes, 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”.
And they’ve got a hidden network of people that you as a punter have got no idea exist. And all those conversations: “If you find the right buyer, let me know”.
Absolutely. So the buyer’s agent is beneficial.
What is the role of accountants when buying a business?
I’m guessing many people would, as soon as they think about business and finance, they 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 situations are those in which the accountant says “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.
Yes, in the business advisory side that you and I are working, we see that same parallel situation where they want to be “all things to all men”.
Yes. And I think that that’s difficult. I mean, it frankly, it would be like me trying to give tax advice to someone! So I think, 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, you play your worst 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.
Well, I guess you have the knowledge that you’re getting the best possible information because the seller is on their game and you know that you’re not missing anything. You might not like what you get, or agree on the value of it, but at least you know, you’re getting the whole picture.
Buying a small to medium business can become emotional.
And also these are very emotional transactions much more so than deals that, frankly, 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. Because the seller is not represented well enough, their response to that will be understandably emotional. It can just kill the deal. As a buyer, you either 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?
So I guess one thing that we probably should just touch on is that when we’re talking about this, 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 that will I’m sure no matter where you are, you’re going 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?
Or are they pretty stock standard things?
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. They’re 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 kind of acknowledging that we are now 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 for what you’re looking for. I don’t get a lawyer to review the videos that 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.
Choosing the right business to buy – how to shortlist your possible choices.
I think in the previous episode, you introduced this concept of the funnel. And I can’t remember exactly what those numbers were. But let’s say, to begin with, you see 100, 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 with the intention of buying one. So you’ve got a funnel situation. If you’ve got 100, how much information do you need and how do you work out how to, chop down to say 15?
That’s 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’re going to be left with.
Choosing 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.
1 Industry choice
Our first question is it in an industry that we believe has some kind of tailwind or has kind of the attributes that we like? If you are interested in geography, you could ask the question too, because that can very quickly discount something.
2 Unique attribute
The second one question is, does it have some kind of niche or some kind of unique attribute? Or is there a very quick pathway to it becoming unique?
3 What value can we add?
The third question is, what value can we add? Because we’re not just about investing in businesses hopefully, see the management team do something good with it, like on the stock exchange. We’re interested in investing in businesses so we can actually get our hands dirty and make a change. So there’s no point in doing it unless there’s something we can contribute to help.
In five minutes, we ask three quick screening questions.
- Do we like the industry?
- Sub-question geography or location?
- Do we think this particular business has some kind of unique angle, or can we develop one?
- And what can we do that’s going to create value?
That’s really interesting. I think they’re brilliant questions. I love the second one in particular. But the interesting thing there is you haven’t mentioned any numbers. You haven’t gone looking at profit or turnover or anything? You’re looking very much at the potential of a business, and what do you can do with it?
Yep, and I think that’s right. I do implicitly, cut out the businesses that turn over less than 200,000 dollars, so maybe, that cuts from 500 potential businesses for sale to 100. You are right- at that point, we are not trying to hit a particular number when it comes to financials. Because what I’m looking at is, the potential I’m buying rather than what I’m buying. It’s like when you buy a house. What I’m looking for is location, location, location, not whether or not it’s got the right kitchen bench top because I can change that. Okay. So that’s five minutes, and that’s cut 100 down to 15.
What information do you need for this step?
Getting the information for “the 5 minute test” from the broker, I assume, is relatively straightforward?
You don’t even need an NDA for that bit. So this will be almost just looking on the internet. On these websites, you can almost you can filter a fair bit of it. You can then ask for a flyer, which is like a two-page version of the bigger document that you need under NDA. And that should describe enough about the business to answer those requests.
Okay, so you’ve nailed it. So really the summary flyer should be enough at this stage.
The Buying A Business 5-hour test
So the next step takes five hours. Ultimately, for us, this is all just people. We would then get the detailed information memorandum (IM), which does have a whole bunch of financial information and other things in it. So we can learn a little bit about business but ultimately what we want to meet the people. 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 this five hour period is around the people.
It’s like “yes, this is a team that we think either has the foundation or the existing capability to exploit the market the unique proposition and the value we want to add”.
So that we answer the question “Is this business actually investable”?
You might also be thinking about the financials or questions you could ask about the customer profile or that kind of thing. But ultimately, if you were to boil it down to just one thing, this five hour period or the second stage is around the people.
Brendan’s Business Philosophy
I suppose if you’re new to business or you’re new to this, this is a bit of a suppose philosophy, isn’t it? Is business all about money? Or is business all about people?
And in my experience, business is all about people and money is an outcome.
If you don’t get the people side right, you’ll never get the money side right.
And so that’s why we spend these five hours. If it was five hours, you would probably spend four to four and a half hours thinking about and speaking to and learning about the people, and then you might spend 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. Now 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. They’ve got either good people in there already, or they’ve got a good foundation that we can add to.
Buying A Business – The Indicative offer
I would say that 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.
And presumably, that stops both parties wasting too much time because the next thing we’re going to talk about is time-consuming. 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, 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’m going to appoint my lawyer to start drafting some documents and reviewing the documents of the business like it might be reviewing leases or it might be customer contracts, or it might be all sorts of things. I’m going to probably appoint my accountant to start reviewing the books and records in a bit more detail. I’m probably going to appoint my tax advisers to start helping me understand the implications of the tax on the deal. 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.
For two reasons mainly, and we touched on this earlier. 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.
The first goal of due diligence when choosing the right business.
First is, “what are the things that I might find that will change the nature of the sale and purchase agreement I need to draft to protect me from the details I find in this phase?”
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, then you’ll make me good for it. 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.
The 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 used to work for Macquarie, and we were doing due diligence on multi-billion dollar companies due diligence is very detailed. 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) often, you can’t fully answer the questions you want to ask in due diligence.
The secret to good due diligence when buying an SMB.
So the trick with due diligence of an SME is to spend a fair bit of time asking yourself the questions.
What are the really big things that are going to 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, as opposed to 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. A lot of 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. The 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.
So that’s a very eloquent way of taking us through a funnel from what could be 500. But 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 it’s crucial that you 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 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.
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