Advice on Buying a Business

[KTrain]

I'm in the process of doing my due diligence on the purchase of new business. They're an existing company who have been around for a decade. An online/software business with no real physical assets. A few employees who won't be sticking around after the purchase.

I obviously can't go into too many details at this point but I thought I would access the CP Braintrust for advice from anyone who has purchased a business before. Other than consulting lawyers and accountants, is there anything you wish you would have done, or did do, that most people don't think of? Any pitfalls I should avoid? Any details I should get from the current owners that might not be obvious at first?

[Sliver]

How did the company arrive at its valuation?

[Sliver]

FWIW, we use the Ibbotson Build-Up Method using five-year historicals to value our business, and I think it produces a fair result.

[Bleeding Red]

Wife & I though about buying a business a few years ago. Babes in the woods with no business experience or education, we got schooled - luckily before we spent too much money.

A few things we learned:
- Look into talking with (or hiring) a Certified Business Valuatior (CBV). He/she can give you a good idea of what the business is worth.
- Determine exactly what you are buying - the whole business (employees, debt, intellectual property, any outstanding contracts or leases, customer lists) OR just the name.

- Get everything in writing! Not just the transaction (I agree to buy the business for $X - If the seller says that the employees won't be sticking around have him detail - in writing - what is happening to them - John is retiring in 6 months (and you are on the hook for a pension or payout of $X), Jane will be let go (and you are on the hook for the severance). Who pays those employees to go away affects the purchase price.
- If nothing in in writing yet. watch out for surprises - seller changes the price or failed to mention an obligation earlier. (One odd thing I can think about is maybe they want the official office at the old address till the end of the fiscal year to reap the tax benefits.)

- Make sure the seller knows what they are selling.
- Try to talk to a few people in the industry/business (friends or relatives) to find out what they think about the business overall, how long they think it will last, what the wave (good times vs. bad times) is like, if it is crowded, how they envision the next 5-10 years.



In my case we got a valuation and the price was right, but at the last minute the seller wanted to keep a cash asset (government grant money) after the transaction (ummm, NO!), then assured us his employee was retiring, but wanted us to agree to a severence payment (ummm, NO!). At one point, in a meeting with the sellers accountant the seller proclaimed "but that's not good for me!" at which the account replied "please excuse us while I explain to the seller what it is he is selling."



Unfortunately, what we thought would be a good opportunity and something that could be fulfilling and life changing, fell completely through.


Hope all works out for you.

[you&me]

This might be obvious, but are you familiar with their product and the market in which it's applicable?

I would think a software business, in which some employees won't be sticking around could be a real hornets nest if you don't REALLY know what you're doing... And when you say "some" employees, how many is that? What about the others? Of the ones that are confirmed to be leaving, who are they and what do they do? What terms are they leaving on? Do they have a non-compete? It would suck to have a group of decade long employees leaving the company you've just bought to start a competitor...

[Locke]

Great advice above.

Value the business yourself and independently.

Do not take the seller's word for anything! Ever. EVER!

Be prepared for hardship.

If you're married it is ultimately important that you and your spouse are on the same page on everything because there are going to be periods of time that absolutely suck and the last thing you want or need is one person saying 'I told you so!'

[Scornfire]

Originally Posted by you&me

This might be obvious, but are you familiar with their product and the market in which it's applicable?

I would think a software business, in which some employees won't be sticking around could be a real hornets nest if you don't REALLY know what you're doing... And when you say "some" employees, how many is that? What about the others? Of the ones that are confirmed to be leaving, who are they and what do they do? What terms are they leaving on? Do they have a non-compete? It would suck to have a group of decade long employees leaving the company you've just bought to start a competitor...

This is vital, a faction of the employees breaking off to start a competitor can easily take a large portion of your customer base with them. IT/Software customers tend to be pretty loyal to their service reps when the Support is good (and will drop you on a dime if they're feeling neglected, which can happen pretty quickly if you're losing experienced staff and trying to train up new ones)

[KTrain]

Just to cover off everyone's responses: Thank you!

I'm going to treat all the questions as rhetorical for now, since I shouldn't really go into details of the business or sale here. However, there are some great questions to ask myself, partners and the current business owners.

Keep them coming. When/if the sale goes through, I'll come back and answer what I can.

[Calgary14]

A couple of extra points:

Find out what the seller's true motivations for selling are. Are they going to retire, or form a competitor business that could quickly become your biggest competition?

Also find out where the revenues are coming from. Are they from multiple sources or a couple large accounts that could drop you if you become the owner?

Is there any undisclosed debt? Make sure to get confirmation from CRA about any amounts owing and have an accountant review prior year returns.

This is more on the accounting side of things but what has the owner been taking out of the company (compensation) if anything at all? Salary? Dividends? How is it structured?

As mentioned above what portion of the price relates to goodwill (customer list)?

What have the revenues been annually, trending up/down and why? What are the annual expenses? Is there an opportunity to increase revenues or decrease costs in the future (ie. opportunity for improvement) that hasn't already been addressed?

Is the company local? What are their reviews like? Not google rating - any business can easily inflate that. Have you spoken with current customers to get their honest feedback?

[PostandIn]

Similar to some the above comments, if the business is dependent on a core group of clients for most of its revenue, you will want to know if there are contracts in place that give you some visibility of future earnings or otherwise understand the nature of the client relationships.

Further, you may want the current owner to introduce you to the key players with the most important clients so that you can establish relationships early and without undue pressures or odd-ball circumstances. Lots of small businesses are only as good as the relationships between the business owner and one or two client people. Likewise, you may want to jettison clients that are a net drag on operations at the time you take over. Lots of small businesses have clients that are not ideal and cause a disproportionate amount of care and feeding than they are worth. Smart companies unload clients (as tactfully as possible) that don't pay in the long run.

[Sliver]

Originally Posted by PostandIn

Similar to some the above comments, if the business is dependent on a core group of clients for most of its revenue, you will want to know if there are contracts in place that give you some visibility of future earnings or otherwise understand the nature of the client relationships.

Further, you may want the current owner to introduce you to the key players with the most important clients so that you can establish relationships early and without undue pressures or odd-ball circumstances. Lots of small businesses are only as good as the relationships between the business owner and one or two client people. Likewise, you may want to jettison clients that are a net drag on operations at the time you take over. Lots of small businesses have clients that are not ideal and cause a disproportionate amount of care and feeding than they are worth. Smart companies unload clients (as tactfully as possible) that don't pay in the long run.

Man, that's so true and something I wish I had known 15 years ago. I wasted so much time and energy on the worst customers for a while there.

[you&me]

Originally Posted by KTrain

Just to cover off everyone's responses: Thank you!

I'm going to treat all the questions as rhetorical for now, since I shouldn't really go into details of the business or sale here. However, there are some great questions to ask myself, partners and the current business owners.

Keep them coming. When/if the sale goes through, I'll come back and answer what I can.

I can appreciate the position you're with being unable to disclose much.

I, however, am not in such a position and can share a few more details about my situation which may have some relevance to the business you're looking at.

One of my business partners was a founder at a relatively successful software company. He parachuted out after about 5 years and that was about 3 years before the company was bought out by one of the industry majors (he still kicks himself over the missed payday!). But the fact is, he still knows the business and a lot of the players. Not only do you need to know about the current employees that are planning on leaving, but it would be immensely beneficial to know about any key players that have already left the company and even better if you can find out what they're up to now.

Similarly, do you know what else is happening in the industry? Who are the major players and what are they doing? Are the big guys gaining market share by buying out the smaller guys? Are they simply rolling over the smaller guys that end up closing up? Or, are they moving away from this space, which would tell you the opportunity for this market might not have as bright of a future as you'd like. Might you get "Amazon'd"?

And then there's the question of why you'd need to buy this company. As I said, my business partner already had relationships with many of the other players in the space. We became partners when another junior player in the same space approached him about buying them out. We both have a solid understanding of the market, the business and the growth opportunities and the company that was for sale was a decent opportunity, but when I asked the opinion of people I respect & trust, they all came back with the same question - "Do you really need to buy these guys, or can you just build it yourself?"

Is that an option for you? Is there anything incredibly unique about this company that you couldn't recreate yourself?

From my experience, those would be two major concerns... Who's out there that could potentially beat you / crush you / out-manoeuvre you & do you really need to buy this company to operate and be competitive in this business?

FWIW, we passed on the opportunity to buy the company that was for sale. It cost us an extra 8 months or so to get to market, but we did so without any baggage with a much better product and were able to self-fund, rather than having to find a way to finance the purchase... The lack of stress from that alone might be worth it.

[CaptainYooh]

We bought someone's business once. Everything they told us about the intangibles was a complete lie. All of their financial statements were cooked. Their client list included all clients they've lost over ten years. Their assets were valued at new replacement costs. I can go on...


The goodwill is always my favorite part of the valuation...

[Locke]

Originally Posted by CaptainYooh

We bought someone's business once. Everything they told us about the intangibles was a complete lie. All of their financial statements were cooked. Their client list included all clients they've lost over ten years. Their assets were valued at new replacement costs. I can go on...


The goodwill is always my favorite part of the valuation...

This is why you never, ever take the seller's word for anything.

[woob]

Originally Posted by CaptainYooh

We bought someone's business once. Everything they told us about the intangibles was a complete lie. All of their financial statements were cooked. Their client list included all clients they've lost over ten years. Their assets were valued at new replacement costs. I can go on...


The goodwill is always my favorite part of the valuation...

So what happened once you found this all out? If you're free to disclose.

[puckedoff]

Originally Posted by woob

So what happened once you found this all out? If you're free to disclose.

Have you ever seen John Wick?

[CaptainYooh]

Originally Posted by woob

So what happened once you found this all out? If you're free to disclose.

You can't really do much after. They had a client list, for example, but they didn't tell us that half of the clients were not happy with the service and looking elsewhere. They didn't tell us that two of the key staff members were about to open a competing business in the area and telling current clients about it. They didn't tell about the landlord having plans to renovate the building and raise rents/op-costs. These are not easy-to-check things. But these are very easy to present as "we didn't know" things.

We went through some really tough times, financially and emotionally. You put your name and your personal assets behind a small business. Lots of obligations. You can go broke.

[marsplasticeraser]

Lots of good advice here. A few other things:

1. Are the current clients going to stay if the current owners leave? A lot of small businesses are entirely relationship based. Founder leaves and many clients could decide to go out for bid with no loyalty to new owners.

2. Tie the price you pay to results of first few years with you operating, and structure payments over that time. If they flat out refuse to have some sort of earn out, then I’d be wary. You’ll pay more with an earn out, but I wouldn’t want to do anything but that unless I had worked with the company and knew their business really well.

3. As an outsider, if lots of staff and owners are leaving what kind of business do you actually have?

4. Valuations are imprecise. A good business valuator will show you valuations by 3-5 different methods, and the result is a range of valuations. I’d be wary of any advisor who says there is only one way to value a business.

Good luck.

[topfiverecords]

Not sure you’d be allowed to but I’d be bringing in the Bobs to interview each employee to get an inside sense of who the straight shooters with upper management potential are, who the Lumberghs are, and if there are any Miltons ready to burn the building down.

[Mickey76]

Not to be negative on your idea and I am sure you know what you are doing but I would say don’t do it. Buying a business is perilous, especially when buying businesses is not your business. People who do this for a living look at 100 to buy one. You found a business you like and are thinking we should buy this and could do well at it. The likelihood of this particular business being the one in 100 that makes sense is very low. I am off to yell at the clouds.