May 17, 2022
Millions of people in the world dream about starting their own business. The reality is that only a fraction of those people will actually do it. An even smaller fraction will survive and succeed beyond the first year. I don’t say this to intimidate you or dissuade you from starting a business, but rather to reinforce that even though every stage of owning a business brings challenges, getting started is the hardest part. The grind to vet an idea, find customers, build systems, establish logistics, find startup capital, and work far more than 40 hours a week are just a few of the reasons that starting a business from scratch is not for the faint of heart. The good news? It may not be in the cards for every entrepreneur to be a founder, but it is still very possible to own a business!
Reasons you may want to acquire a business instead of starting your own
Often times when people think about acquiring a business, they assume it will be way too expensive or way too complicated. While both of those things may be true, it completely depends on different factors like what type of business, the size of the business, how successful the business is, the seller's motivations, etc. So, as we work through the steps to acquire a business it will become more clear to you how attainable an acquisition may be based on your desired outcome. Now, I’ve already touched briefly upon reasons you may want to acquire a business rather than start from scratch, but a few others may include:
- Getting a head start or traction on something you are passionate about
- Efficiency - the beginning of a business is often times the most expensive and inefficient time as you are learning to scale and optimize your business for profitability
- Remove a competitor and grab more market share if you already own a business in the same market
- Capitalize on an economic downturn for a long term game - many businesses become affordable if owners/founders can’t weather economic storms
- Create passive income and stay out of the business day to day - perhaps you’ve already done your time as a founder and are looking to expand your portfolio with more control but can still stay out of the day-to-day grind
- Maybe you’d really like to get your hands on a specific piece of tech, idea, customer base, employee culture, supply chain, etc. to expand on what you’re already doing or build an industry vertical
Now that we’ve covered more of the WHY to acquire a business, let’s get into the HOW to acquire a business.
1) Choose what business or type of business you’d like to buy
I think we can lump prospective business purchasers into four buckets. One is those who already know what type of business or industry they’d like to get involved with but prefer not to start from scratch. The second is the individuals who are looking to expand their business through acquisition. The third is someone who really wants to own a business either to grow but they aren’t sure what type of business to buy. Lastly, the fourth are individuals looking to acquire a business simply for the passive return and don’t want to be significantly involved. Depending on what bucket you fall into, that changes this step and many of the subsequent steps pretty dramatically. For this step, we’re going to focus on bucket number three because the first two buckets likely already have an idea of what types of business they are going to be looking for, and bucket number four can start with step number two.
First, let’s assume you are really looking to cut your teeth and become a business owner, you know you want to acquire, but you aren’t sure what business or industry is the right fit for you.
There are two questions you should ask yourself.
A) What am I really good at or experienced at that makes me more of an expert than the average person? Although it’s not required, being an expert in your industry gives you a lot of momentum when owning a business including things like:
- You can problem-solve industry-specific issues
- Gain the trust of the existing employees
- Have existing connections in the industry
- Win over customers and suppliers
- Establish confidence in investors and lenders
B) What am I really passionate about or interested in? While this question may not make you as “qualified” a business owner in a specific industry, it is still very important as it speaks to a few things like:
- You will enjoy the work that you are doing
- You likely have done a lot of research and self-taught specific skills and relevant information
- You are interested in learning what you don’t know
- You will trust and lean on the existing knowledge of your team
- You may bring a fresh perspective to the business
So, when you are exploring what business or industry could be the right fit, ask yourself those two questions and then go down the follow through and get as specific as you can on what you actually might want to do. For example, let’s say you spent 7 years working at a tech company as an account manager, but you’d love to be your own boss and build something meaningful. You ask yourself “what am I passionate about?” and you say that you are really passionate about fixing and restoring cars. Then you think about what aspects of car repair and restoration you like the most. And rather than doing the repairs yourself or buying and flipping cars, the thing you enjoy the most is the treasure hunt of finding the parts needed for the repairs because they may not be manufactured anymore. Then you ask yourself “What am I good at or experienced at? And you say that you’ve repaired and restored 20 cars with your dad and had to track down all of the parts through car enthusiast online forums. But you also know from your day job experience that you know how to manage many different relationships with customer accounts and deliver a satisfactory experience.
At this point, we don’t have just a broad industry we know we like, but a specific business type such as an automotive parts reseller. And we know that you have some experience and skill set that would make you “qualified” to be successful. Now, you can definitely keep going through that exercise and get more specific which may lead you to ideas you can try in your new business or even a concept of a brand new business you may ultimately decide to launch, but the more specific you get the harder it may be to find a specific business willing to sell. You also may not have a specific outcome like this example and that is okay too. Ultimately, these are questions just to help you reach a few business ideas that you are comfortable with before we try to find them.
2) Find someone willing to sell their business
Now that you’ve figured out what type of business you’d like to purchase, it’s time to find out what businesses are actually for sale! All of these options are viable regardless of the buckets mentioned in point number one.
First up, you can use a business acquisition broker. Think of this process as using a realtor when buying a home. They are going to take what you are looking for and your ballpark price range and they are going to explore their current listings or go out and help you track down potential sellers. As you’d expect just like buying a home, they want to help you find the right deal but ultimately their goal is to get a deal closed so they can capture their commission. So, while the help may definitely be worth it, be aware of the additional costs which can include an upfront retainer but more commonly a 4-12% of the total sale price paid at closing based upon the size and complexity of the deal. If you are looking for a broker there are both local/regional brokers if you have an idea of the location you want to search near such as Indiana Business Advisors in Indiana or a national broker such as PBC. Either way doing some google searching will help you find a broker.
Next, an option that is growing in popularity, is to search on a marketplace of businesses for sale. On these websites, you can scroll through hundreds or thousands of businesses that are for sale and filter by different things such as industry, price, revenue, and profit to find the right fit. An example we like is Microacquire which specializes in startups that are listed for sale, most of which are tech or digital businesses. The cost to you will be free or much lower than if you use a broker, but you will be doing the vetting on your own as you navigate this process.
Lastly, good old-fashioned networking. I don’t necessarily mean go to your local chamber of commerce and start meeting strangers (who knows maybe that would work 🤷🏽♂️) but instead, connect with people you know who can put some feelers out there or may have connections in industries of interest. Professional connections, friends, family, local business owners, etc. by letting them know you are exploring buying a business and you’re interested in “fill in the blank” industry. This is clearly a less direct approach and I would say is a better route if you are open to whatever opportunity could pop up or you are really interested in a small local business that would be unlikely to make it onto a marketplace or business broker catalog.
3) Crunch basic numbers or complete full financial projections (you’ll need them eventually)
Now that we’ve narrowed in on an industry and even a specific business, it’s time to start doing some number crunching. Now, at this point, we’re likely not going to have access to financials, tax returns, or any sort of significant financial data that we can perform detailed due diligence or airtight financial projections on, but we can start playing around with numbers to get an idea. Depending on how you found the business opportunity, will likely dictate how much information you have. If you find them through a broker, the broker likely has a full stack of financial information and can give you specifics. If you find them on a marketplace, you likely have access to high-level information, but not the specifics. And if you heard Steve’s Fiddle Shop down on Main street is looking to sell, you likely have no information other than knowing about the seller’s intent.
The number-crunching step or “back of the napkin math” step could take as long as you’d like you’re just pondering the opportunity, or it could go really quickly if introductions are being made and you are motivated. It may just be one late night of googling and playing around with calculations of typical industry numbers, or it could look like plugging what you know into our acquisition financial projection template (which you’re going to have to do sooner or later). This step at least starts to give you some basis of cost and return as you explore this process. We’d recommend doing this before ever talking to a seller or taking a serious step towards acquisition.
4) Do some undercover investigation
Let’s say after a few nights of some late-night calculating using your nifty financial projection template you decide that the business is worthy of research. The previous steps are kind of like if you’re considering getting a dog but you’re just researching what breeds you’re interested in, how much they cost, how much do they typically cost to care for each year, etc. but you aren’t actually going down to the pet store to pet puppies. Everyone knows that as soon as you hold the puppy, there is a high likelihood that it will be going home with you. This is similar (and a whole lot more expensive!) that as soon as you see the business in person, learn about its people, dream about what it could be like to own the business, and what changes you could make - you begin to form an attachment. Your decision-making becomes more biased at this point.
At this step, things start to become a little more real. I’m not saying you need to make any commitments and you probably aren’t even talking to the seller yet, but you are letting yourself imagine what it would be like to own this business and you have established that the numbers are within the realm of possibility. Once you’ve accepted, start researching the non-financial details of the business that you can obtain (legally). This can look like some of the following things.
- Explore the company website if you haven’t yet
- Read the founding story if they have one
- Look up some of the team members on Linkedin if they are listed. Especially managers and leaders if it’s a larger company so you can get a first impression of the makeup and competency of the team
- Visit the business as a customer if that’s possible. Don’t express the fact that you are looking to buy the business, but you are contemplating a big investment so you are entitled to perform an undercover investigation. Call the business as a perspective business or submit an interest form if they aren’t nearby. Don’t waste the time of their team members by expressing too much intent if it’s a long sales cycle.
- Purchase a product if they have smaller dollar items so you can see what the purchase process and customer service are like
5) Create a rough plan for the business and what you hope to do with it
To be completely honest, this step may not be entirely necessary depending on your familiarity with the business or industry and your comfort level with buying a business. If this is a huge risk and step for you and is potentially outside the realm of something you have ever done before, it is likely worth the extra effort and will help you prepare to not only own the business but to convince funders if that will be necessary.
Again, remember at this point we may have not even spoken to the seller or taken any formal step towards acquisition beyond deciding we are willing and interested to move forward. At this point, you should create a written plan for what you hope to do with the business. A full-blown business plan is likely not necessarily seeing as this isn’t a startup, lenders and investors are going to want to know you actually have a plan at least. If it’s a successful business and this will mostly just be a transfer of ownership and the business will keep plugging along with no significant changes, a detailed plan is likely not necessarily outside of assuring funders things will maintain. If it’s a struggling business that you hope to turn around or a promising business you hope to scale or something along those lines, a written plan will be worth it. Not only for your potential funders, but for you. To have a basic roadmap to validate your decision and also refer back to if you follow through with the purchase. If the purchase of the business is competitive, it’s possible the seller may want to vet your plans for the business and you may have to make a pitch or if it’s a long-time owner who wants to make overly sure they are leaving the business in good hands.
6) Express Intent to the seller
Now things are starting to get serious! After all of those days and nights of running some numbers, daydreaming about the business, and investigating in the shadows it is time to emerge from the dark and express your intent to the seller. As you likely expected, this step looks different depending on each situation and what method you used to find the business you wish to buy. If you are working with a broker they will likely bring you and the seller together to begin discussions about a deal, back and forth verbal negotiations, and then ultimately a letter of intent (LOI( with agreed terms will be drafted for both parties to sign. It is also not uncommon for an LOI to be drafted and sent over to kick off negotiations and conversations. This could result in LOIs being set back and forth with revisions which could slow the process according to exitpromise.com. It is recommended that a legal professional is involved at some point during this phase to protect yourself if you aren’t using a service with a guided intent process. The process of expressing intent is not commitment to buy, but rather it moves things along to the due diligence portion where most deals are closed or lost.
If you are using a marketplace service like Microacquire, expressing interest can look different because expressing intent may come before any formal conversation with the seller. Most online marketplaces have the ability to request access to a full listing or additional information so you can learn enough to then send a LOI. Microacquire actually has a built-in LOI building process that can help you through this stage.
7) Perform Due Diligence
Due Diligence. I capitalized both words just to emphasize how important this step is in the business acquisition process! This is the phase where after the LOI has been signed, sellers start focusing on getting the deal done seeing as the agreed-upon terms were to their liking, and the buyer (you) gets access to behind the curtains of the business you are courting. This is essentially an audit to make sure that the business is performing as expected and there are no major unknown issues that would risk the success of your acquisition.
The length and intensity of this process will look differently depending on the size and complexity of the acquisition. If it’s a multi-million dollar purchase of a large established business then expect lots of lawyers, financial experts, advisors, and a good chunk of time to pour over documentation. If it’s the purchase of a small business the number of people involved will be limited to whatever makes you comfortable but you should consider hiring experts if you aren’t familiar with financial analysis or legal matters. Although the acquisition of a small business sounds easier (and often is) there is also a higher likelihood that the financial documentation is less reliable so you need to be observant to identify gaps of information that you can ask the seller about.
You can ask the seller to put all of the key requested documents in a data room which is typically used by investors to complete due diligence before investing in a startup, but could also be used in an acquisition scenario as well.
As due diligence nears completion, the goal is for the buyer to get comfortable enough to enter into a purchase agreement. Buyers still have the ability to back out of the transaction during and at the end of due diligence as well as to try and renegotiate based upon findings during due diligence.
8) Create financial projections (now you definitely need them)
Now that due diligence (lower case now that it’s done) is over and you and the seller have entered into a purchase agreement, it’s time to make sure you can actually secure the capital necessary to execute the purchase agreement. In order to land the capital necessary, we have to create financial projections which is clearly our favorite part here at ProjectionHub!
Even though when you are acquiring a business that has financial performance records like an income statement and balance sheet, lenders and investors are going to want to see financially how you expect to take the business from the point of acquisition to loan repayment or what type of return you will generate. Especially if the business up to this point is not delivering desirable results.
Using the financial information collected during due diligence, you will build financial projections where you can tweak and adjust assumptions based on how you plan to run the business after the acquisition. Lenders and investors typically want to see 5 years of projections in the forms of an income statement, cash flow statement, and projected balance sheet. These projections will be comprehensive but agile so that you can make adjustments on the fly and see things update in real-time as you work with lenders and investors. Two important things to keep in mind while making your projections are to 1) be realistic. Conservative and realistic are two different words. Don’t sell yourself short or the business short if it is already showing promise or unrealized potential that you can access. 2) Be purposeful. Making projections is an important validation step for yourself to make sure this acquisition is smart, but you should have done that earlier in the process. At this point, your projections are to demonstrate what you already know to the people who may give you money. Do not manipulate your projections just so they look like a good return or guaranteed repayment, but when creating your plan for the business after the acquisition you want to ensure that success means success for your potential funders as well.
Creating financial projections may seem like a daunting task and to those not using the proper tools, it can be. It’s also important not to oversimplify this step either. At ProjectionHub we have helped nearly 50,000 businesses create financial projections and many of which have been used during acquisitions! We offer custom financial consulting services for complicated acquisition projections, and reliable user-friendly financial projection templates for more than 50 unique industries.
9) Find the money - finance or investment
It always comes down to money, doesn’t it? As much as we’d like to say that financial projections are the most important part of an acquisition (okay maybe we are biased), none of this happens if you can’t show the green. There are many different ways money can be brought to the table if you are the buyer, especially if you want to get creative. So don’t get discouraged if the first bank you talk to says “no” because here’s a non-exhaustive list of a few different ways. Also, if you have the cash then you can just skip this part.
- Bank Loan - Probably the most obvious place someone thinks to get a loan when they need it. Going to your bank or any bank is definitely an option, but banks are known to be the most conservative options so unless you are cash-flush and the business you are acquiring has a lot of assets, be prepared to hear “no” more than one time as well as being required to have anywhere from 10-20% in cash to put down on the purchase price.
- SBA Loan - Many people get shivers down their back when they hear about getting a loan from the Small Business Administration due to the fact that they are guaranteed by the government. SBA loans are a great option for acquisitions that can have very favorable terms if you do your homework and talk to the right people. Yes, banks can offer SBA loan. But you have to remember that even though the fed is backing the loan, the bank is still the one lending the money. Getting an SBA loan at a bank is often as difficult as a traditional loan at a bank. Other options to look into are Community Development Financial Institutions (CDFIs), SBA microlenders, SBA Community Advantage Lenders, and SBA 504 lenders. These are all lender types that can help you get an SBA loan that operate independently of a bank which gives them greater flexibility, but come with a slightly higher rate and lower loan amounts.
- Seller Financing - Seller financing is a type of agreement where you may pay a certain percentage upfront to the seller and then a monthly payment over some amount of time directly to the seller until the sale price is paid off. It’s like a loan except nobody is actually giving you the money, you are just paying the sales price over a period of time. This is often done with some amount of interest as well but can typically be paid off early with no penalty. Seller financing can be an attractive option as well as it incentives the seller to help as much as possible to ensure the success of the transition.
- Earn-Out - Earn-out payments are similar to seller financing but rather than a “debt” payment made over X years until the sale price is completed, this is when the buyer pays a percentage upfront and then a percentage of some number over a period of time. For example, the buyer could agree to pay 20% of the purchase price upfront and then pay 3% of EBITDA each month for 5 years. This type of payment agreement is common when there is a gap between what the buyer wants to pay and the asking price. This structure also keeps the seller involved to ensure the success of the transition.
- Investment - There are many different types of equity or investment arrangements that could be used when landing funding for a business acquisition so we will keep it simple. One route a buyer could go is to raise investment funds from a firm, fund, or person in exchange for a permanent percentage of the ownership of the business. This can compensate them in recurring dividends or profit shares based upon the business's performance as well as an asset that they own. “Selling” equity is one of the most expensive ways to raise capital as you are giving away the future value of the business. Often times this route is discouraged unless you are gaining very strategic partners with resources that can help you grow the business beyond what you could do on your own.
10) Close the deal
You’ve done the dreaming, the planning, the scouting, the negotiating, the diligence, and you’ve secured the funding. All that’s left is to seal the deal! Along with your lawyer and the seller’s lawyer, you will go through to make sure that all agreements have been met up to this point, and then execute the final agreements and closing documents before you pop the bottles of champagne. Then it’s time to get to work!
11) Use the owner and cornerstone employees as much as possible during the transition
Depending on the agreements made with the seller and the structure of the transaction, hopefully, there is a reason for the previous owner to remain involved to some degree. Depending on how long they were the owner, they will likely be an invaluable resource when it comes to helping you understand the ins and outs of day-to-day operations, how to retain employees, introductions to key relationships, and more. If the previous owner is sticking around to help with the transition, be sure to have healthy boundaries in place. While it is important for them to help bridge gaps, make introductions, and train you - you also want to make sure that the employees get used to seeing a new person at the helm. Schedule chunks of time each day to meet with the previous owner. Meet at places outside of the office. Gain permission to call and message them as needed. Identify who on the team are the influencers that will impact the rest of the earn and drive the success of the acquisition.
There are a lot of details to make sure that buying a business ends up being a successful venture for you, but with the right planning and team around you, it could be very lucrative and fulfilling. Always consult an expert when taking a big step like this and if our team here at ProjectionHub can help take away the anxiety of creating financial projections, don’t hesitate to reach out at firstname.lastname@example.org.