Friday, September 30, 2016

Lesson #246: Buying a Business is Hard Work!!

Posted By: George Deeb - 9/30/2016

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As you may know, Red Rocket has been on the hunt for a business to buy.  We are specifically looking for digital technology companies with at least $500,000 of profit, where we can apply our sales and marketing expertise to help grow those businesses.  We have looked at over 50 businesses in the last few months, but have yet to get to the finish line.  I wanted to share some learnings with all of you, in case you are ever on the hunt to buy a company.  As you will read: buying a business is really hard!!

LOTS OF HUNTING REQUIRED

You need to explore multiple channels in terms of knowing where to look.  Leveraging your network, reaching out to investment bankers or business brokers in your space and even searching online, on sites like BizBuySell, BizQuest and BusinessesForSale.com, are all fair game.  And, it is a fluid market, so new stuff comes up all the time, so you need to constantly be working these channels in high frequency, to make sure you don't miss anything important and be able to move quickly.

CUTTING THROUGH THE CLUTTER

Firstly, there is the process of narrowing down the targets that are most interesting to you.  Even if you are narrowly focused, on something like e-commerce businesses, as an example.  There are so many different types of products being sold across a wide range of revenue size, and needing to narrow them down to the ones which are most interesting for your needs.  And, secondly, how a company markets itself for sale, does not always match up to the reality of the situations once you start due diligence.  For example, they said they have $1MM of profit with the way they had been running the business (on a shoestring budget), but fully loading expenses on a going forward basis, maybe it only has $500K of profit, which materially changes the story.

DUE DILIGENCE SHORTFALLINGS

In addition to the financial due diligence shortfalling described above, there is often times operating issues that get uncovered during due diligence, as well.  As an example, you think you may be buying a strong e-commerce business with a lot of direct traffic to their own website, but often times they are simply Amazon dependent sellers that look to Amazon for marketing to customers and fulfilling orders.  That creates problems like, Amazon owning the customer list, not the business, and risks Amazon disintermediating this product seller with similar product or squeezing them on margins long term, putting the future financial health of the business at risk, entirely dependent on Amazon.

LOTS OF COMPETITION

There is a lot of money on the "sidelines", looking to be invested into interesting businesses.  And, the more attractive the business, or more profitable the company, the exponentially more investors looking at the same business.  Which means you need to be prepared to move quickly (with capital lined up) and potentially pay premium prices to outshine the other offers, or risk losing the deal.

INSANE VALUATIONS

Many companies just don't have a reasonable expectation to what their business is really worth, with them proposing very high asking prices.  For example, if they are in the venture world, they drink the Kool Aid of "unicorn-level" valuations multiples (e.g., 10x revenues).  When the reality is, without them venture funded and growing a lot slower, they are typically valued at more reasonable 3-4x cash flow multiples.  So, finding a seller with reasonable valuation expectations is not always easy.

MULTIPLE PARTIES TO PLEASE

There are typically three parties involved in any transaction:  the seller, the buyer and the financing source.  If you can finance the transaction yourself with your own cash or equity, that is preferred, given one less party to make happy.  But, if outside private equity investors are required, it materially complicates things.  Because not only do you need to like the business, but the investors need to like the business too.  If any one of the "three legs to the stool" is wobbly, the whole deal can fall apart.

LOTS OF HOURS INVESTED GOING NOWHERE

Based on all the issues above, you often need to invest many hours of work into any single project before realizing it will never get to the finish line.  This is not a really efficient use of time, but the process is what it is, and you really don't have a choice, unless you outsource the deal searching, due diligence process and fund raising process to others.  So, be prepared to be frustrated and spin your wheels.

Hopefully, this gives you a good expectation of what to expect when starting to hunt for businesses to buy.  But, if you are persistent and patient, all it takes is one deal to get to the finish line!!

Be sure to read these companion articles on Things to Consider for M&ASetting M&A Goals and Potential Pitfalls with M&A.

For future posts, please follow me on Twitter at: @georgedeeb.


1 comments:

Greg Chapman said...

After having been involved in the world of business acquisitions for more than a decade, I couldn’t agree more. The section regarding due diligence was particularly helpful. I found myself failing to attend to this variable when I was a novice. This list is great because it summarises all the important purchasing points to take into account.

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