Buying an existing business is a great way to fast track business ownership without doing all the hard work of a start-up. However, you must be prepared to pay a premium price to the owner for building a good business, and you must be capable of doing good due diligence. Otherwise, you may be buying someone else’s problems and be grossly disappointed.
This blog piece discusses some important issues related to buying a business with some “Insider Tips” at the end. I strongly encourage serious investors to watch a recorded presentation on this same topic by clicking the link below.
Buying an Existing Business Webinar Replay
Due Diligence
Due diligence is the process through which a potential buyer evaluates a target business for acquisition. In other words, due diligence is the investigation of a business prior to purchasing the business. The buyer must become satisfied with the seller’s historical financial statements, tax returns and related metrics, as well as any projections of future financial performance. After all, the value of a company for a buyer is directly related to the future financial performance of the business, not the past.
As you would expect, the larger the transaction the lengthier the due diligence process and more professionals involved (i.e., financial, legal, and industry professionals). For smaller transactions, buyers cannot afford to pay professionals to do many of the due diligence activities, so the buyer must perform these activities. Their ability to do so is key to their success. Furthermore, the waters of smaller transactions (under $1 million) get muddied by business brokers and sellers who manipulate the numbers and other important matters to close deals with incompetent buyers. Buyer beware.
Needle in a Haystack
People invest an enormous amount of time seeking the needle in the haystack of “publicly listed businesses for sale”. And, in most cases, the results are disappointing. Most businesses that are listed for sale in a public space are not the best opportunities. These businesses have typically been for sale for quite some time before being listed publicly. And, you can assume that other buyers have walked away from these transactions for reasons other than price and terms. Unless you are an industry expert, then I recommend you assume the worst—someone is unloading a bad egg.
Based on 20 years of anecdotal information gathered from professional business investors of all types with a financial appetite for businesses under $2 million, we come to the following conclusions:
- 90% of businesses for sale that are listed publicly are crap,
- Of the 10% remaining, the EBITDA or operating cash flow after due diligence adjustments tends to be 50% of what the seller/broker have disclosed. In other words, the financials provided by the owner and/or broker are overstated and need major adjustments.
- Why is the owner selling? There is always a challenge or reason for a sale that is not truly disclosed.
What is a Good Strategy
Find a way to look at quality companies earlier in the process, before a business is posted in the public market for sale. This requires, just like in real estate, that you have your funding ready and you have an insider track for deals.
- There are many businesses that will educate you on your funding options and cost of capital. I can refer you to 3-4 leading companies depending on your assets and goals.
- In terms of insider track, well that would be me for franchise business resales. If you are interested in non-franchise business resales, then you will want to connect with a well-established, local business broker.
Best Opportunities are Franchise Resales
Franchise resales are unique in that we can easily obtain more information on the business for sale, business metrics, industry, and much more. This reduces risk tremendously. Furthermore, the franchisor continues to provide important functions after the purchase (i.e., research & strategy, digital/web, training & support, national relationships). Finally, you can speak with other franchisees in the system. If you conduct your research discreetly, franchisees will provide you with insight about the specific business and the franchisor that you may never be able to determine on your own.
In my practice, I benefit from an “insider” position when it comes to franchise resales. I learn about franchise resales, in many cases, long before they become public. And, it doesn’t hurt that early in my career I was a financial analyst for an investment banking company performing due diligence on numerous companies. This enables me to efficiently pinpoint potential franchise resale opportunities for clients.
10 Insider Tips on Franchise Resales
- Do not be rushed by anyone. There is always someone else who is ready to buy the business if you do not move fast enough. If you can demonstrate that you are serious, financial qualified, and prepared to conduct due diligence, then the signing of Non-Disclosure and Memorandum of Intent Agreements can put you in the driver seat.
- Make sure you do your due diligence on the franchisor. You do not want to buy a good franchise unit of a bad franchisor. Is the franchisor established with many happy franchisees? You should be provided with the latest Franchise Disclosure Document (FDD) and be walked through the same information exchange process of a new potential franchisee. Find out if you will need to sign a new Franchise Agreement? If yes, what terms will change?
- Make sure you understand the role of owner and whether you can do this well. Consider working in the business for a few days.
- Evaluate labor issues. What makes a good employee? How do you hire, manage, and retain a good team? Will you be good at managing employees in this brand/industry? Get to know some key employees if possible.
- Talk to other franchisees in the system. Try to confirm their revenue, margins, EBITDA, likes and dislikes, etc. Will you be able to work with the neighboring franchisees? Existing franchisees are more likely than the franchisor to give you the real scoop of the situation, or at the very least will validate the stories you get from the franchisor and the seller.
- Does the franchise have an independent franchise association? This is where franchisees can discuss topics of importance without having to “walk the company line”. You may find a great deal of helpful information from the key members of this group.
- (If applicable) Go to the planning/zoning office for that city, county or other municipality and ask for any and all information about future planning for that area. You need to know if there will be any potential external business disruptions such as road work, transit maintenance, destruction of buildings, etc.
- (If applicable) Talk to the other tenants. Make sure you visit current tenants in your strip or community center to see if they are happy, how long they’ve been in business, etc. Review your lease terms and renewal issues.
- Check to make sure all assets are in good condition and are current. Will you need to invest in anything to become current with franchisor (i.e., new equipment)?
- Good franchise resales rarely hit the public market. Existing franchise owners and other “insider” people see resales long before they get listed “publicly”. If it is a good opportunity, then these insiders will typically gobble it up rather quickly. So, you should be very cautious about any business that has been listed in the public arena.
Again, I encourage serious investors to watch a recorded presentation on this same topic by clicking the link below.