Dangerous M&A Mistakes You Should Avoid with Deven Soni

0:00Hey guys, Eric Su here. So the following is a clip from the Leveling Up Founders Mastermind that happened in Beverly Hills. and you're going to hear from some amazing founders, some amazing marketers and investors. And this was a private event that happened. So again, you'll get a preview of it. If you want to learn more, you can go to levelingup.com slash founders. Once again, levelingup.com slash founders. And without further ado, enjoy the clip. When people go into saying, hey, I want to buy something, there's often a whole host of reasons that pop up. I want to buy something in Maui because I like the beach or I like the reach of this company or there's a great team, one of the things I found is that the more you start trying to muddy your mind on why an acquisition or a deal or even doing an acquisition makes sense, the more you start really looking at and missing the picture on the most important thing.

0:45So the one thing I've really found, the most successful deals we've done is we've had one specific thesis. And these are some of the theses that make the most sense. We're a roll-up. We want to expand our multiple by growing revenue. We have a product or a service and we want to buy someone that has distribution. It can make a lot of sense for folks in the e-commerce space, for example. One of the deals I'd done a long time ago was we were converting affiliate content sites into Amazon sites. So we'd buy these best pillow websites and then just release a pillow and then make it the top reviewed one.

1:15That worked extremely well because that was the only goal we had with buying the business. Does this fill our pipeline? Similarly, it could be cash flow. It could be we're acquiring human talent. But I would just suggest buy it for one reason and one reason only. And similarly, when you're buying a business, especially when you're starting out, I think having these like metrics that you're using to buy a business written in blood and saying, here's what we're using to evaluate the company makes a lot of sense. The two that I love the most, especially when I was starting out, one is return on invested capital.

1:45Everyone in this room, no matter how much money you have, has a limit of their capital and you've got different choices of what to do with it. You can buy ads, you can launch a new product, or you could buy a business. And for me saying, hey what's the actual return i'm going to get year one year two year three in dollars in cash flow from buying this company and how does that compare to buying ads or launching a new product or adding a new channel so i think that's a really good one and the other one and i think a lot of people miss this one and it's weird because you're like okay this company has a million dollars of cash flow it has all these users and you say what would it cost me to actually replace all this stuff if i went to the store to tiktok to buy a giant list like what would it cost me if i was you saying i I want to go build all these relationships.

2:25What would it cost me? We've often found in really boring brick and mortar companies and even in smaller niches, the companies that are under monetized, so that are not making enough money relative to the value of their assets, often trade at really great discounts to replacement value. And I'll give you an example. We bought a company a few weeks ago. It was in the HVAC space in Phoenix. And it had a customer list of 25 ,000 or 30 ,000 people that acquired and serviced over the last 10 years. And they were not doing anything with it. They lost some tax. The owner got sick. So the company wasn't making a lot of money.

2:55So we were able to buy the company for$200 ,000, even though it was making half a million dollars a year or something. Paid them in cash, bought the trucks, took over some loans, whatever. But what we ended up getting is a customer database that was probably worth like$2 million to us. And just because we looked at the replacement value, the one thing we were looking at when deciding to buy the deal was how much would it cost us to get all these leads. So I think just picking that one thing makes a lot of sense. Another one I think that's really important is, and I also see those people that start a company.

3:23Don't start a company because you're not going to know how to finance it, how to raise capital, how to incentivize your team unless you know exactly where you want to go. I think buying a company is really similar. And I think there's also this kind of integrity and trust component to it. When private equity firms buy a business, which is often the most common buyer, they'll tell the owner, we're going to go flip this thing in two years to somebody else. You're going to make a bunch more money. That's the story, right? That's why they may take a lower valuation, rule over some equity. but if you don't know where you're going to go with that acquisition, it's really hard to have this integrity-driven conversation with owners, employees, about what's happening to my job, what's happening to the stake I have in the business, how are you financing the acquisition as well, what are you telling lenders?

4:02I think all these things come from this real understanding of what do I want to do with my company. And these are the ones that seem to make a lot of sense. You sell it, flip it, you sell it to a financial buyer, to a PE firm, take the company public, which I personally think is going to be a really big trend over the next four or five years, or you just say, I'm going to hold this forever and that's how I capitalize it. Another one is I think when you're trying to buy a company, especially in a niche you may not know really well, it's all, grass is always greener, right? You think everything is amazing.

4:28My business sucks. This business is great. But what you realize after you've done a couple of these deals is you don't know often what's going to smack you in the face, but something will always. One of your employees is going to run off with half his customer list. One of your suppliers is going to go away. Pricing is going to increase. You never know, but it's 100%. percent of the companies I've bought, there's been some just like nuclear punch in the face event that you wake up one morning, my revenue is 20 % less, right? At least. So I always say if you don't go into a company, unless you know how you're going to grow it, how you're going to double it, because that doubling isn't, hey, I'm going to double a business.

4:58That doubling is I'm going to be able to stand still because the other stuff's going to go wrong that I haven't thought about. Another mistake I made, especially early on, I didn't buy a lot of companies. I was like, let me just go buy this little thing. I'm going to experiment on it. I'll mix a thousand dollars a month I'm going to pay whatever$20 ,000 for it but again what happens is you get punched in the face and that$1 ,000 a month turns into$200 a month or whatever it is for people and it just becomes not worth it anymore you forget about it you don't want to spend the time like I've only started to buy companies now some of their add-ons and they're very strategic to us but if it's like a big new acquisition I only really will get into it if it's going to really hurt if it doesn't work out and I think that motivation is something that's really important at least for me because if I've got nine things going on and this thing's making$600 a month, I don't care.

5:42The next one is really just now you're getting to the diligence process, speaking to sellers, speaking to companies. I think one of the things I've found is you listen really carefully when people are having conversations with you about the opportunities, the growth opportunities, but also some of the downsides. And one of the things I've found just so true, and I have the sixth sense about it now, which I think has just come from looking at thousands of deals. But when you're talking to a seller and they sideways mention something that could be this employee is getting a little older, they may want to retire in a few years, or this customer has given us some indications.

6:12That's stuff people will tell you, but it's always way worse than the seller selling you. Oftentimes we've had this situation where someone will think, oh, the GM has some knee problems, he's going to retire, and then three months later we're talking to the seller again, he softly mentions it again, whatever. And then 100 % of the time, what happens, you buy the business, and two days later the guy leaves, right? Or two days later the customer that the person's indicated is a loose end will change their mind or something. So like always listen to people and really double down when people mention things that are anything less than like effusive.

6:41Right. And I often those are the biggest risks in the business and the ones you should really be documenting when you're looking at buying something. This one, I think, is really obvious, especially in markets like this. But a lot of people say, look, COVID hurt my business. I've got all these new deals in the pipeline. That's why my company is worth a billion dollars, even though I made nine bucks last year. And I think like usually or almost always you don't want to be paying for these things. You want to say, look, you can retain some equity and you can get some upside on this. Or, hey, we'll pay you for that growth if it happens.

7:10If you close this big deal, you'll get a big bonus. That kind of stuff is fine. But we never pay for stuff that hasn't happened yet. It's also going to be your responsibility to make it happen, so you should be getting the reward. This is one of the counterintuitive ones. It's way more true in markets like this. But it's a lot easier to buy a big business than a small business, especially if you're financing it. Banks do the exact same amount of work if you're buying a million-dollar company as a$100 million company. Their underlying process is identical. So they want to put more money to work, and for them, it's not worth it for small deals.

7:39So we've really found in markets like this, unless you really have... One thing is like government-backed loans like SBA, and you can buy small businesses. Those are great up to a certain limit. But once you get away from government-backed acquisitions, you're not going to borrow money or really raise money oftentimes unless you're making$5 million of profit in this market. It used to be one or two. It's really gone to five. Once you go to 10, you'll have people knocking on your door being like, can I please give you money, sir? which is amazing. And it's just something that really flipped in our head.

8:05So finding those large acquisitions that have a lot of opportunity to really change your business and financing in great terms can happen much more easy with bigger deals. Another lesson I think we've learned along the way is, and these are the next two are pretty similar, is I had this irrational fear that the company, that the person that was running this knew Wayne more than me, and the minute they joined, they were gonna be reinvigorated to grow the business. And same with key employees, that they were the core. And I think the thing I really learned from losing people time and time again was that the business tends to survive.

8:40So you never want to keep people that don't want to be there. You never want to put handcuffs on someone that doesn't want to be there. If they're a bad fit for the culture, if they're stifling growth, I think it's almost always okay to get rid of somebody and find someone better, find someone that wants to be there, find some fresh blood that's going to improve the culture of the business. And this is pretty much the same lesson. No employees are replaceable. We used to be terrified of losing the top tech, the top salesperson, and we said, look, this is the deal killer. We have to structure the whole business around not losing this person.

9:07So we would look at the forest for the trees and say, our only goal is keeping this person. But what we realized was that there's a lot of amazing talent out there. And if you're a good employer that's growth-minded, that pays well, that offers good benefits, you're going to attract good talent. And oftentimes in subscale businesses that are ready for selling, those owners have not actually done that. They haven't cultivated their employee base. You have people that are a little gun-shy, that haven't had the autonomy. So you can Oftentimes, reinvigorate the business by buying new, adding new people.

9:36And the last one is, I think just, anytime you're buying a company that has humans and people, you sometimes lose sight of the fact that the people around you are the most frightened. The more opportunity, the seller's happy because they just got a big check. You're happy because you just grew your revenue. But the people on the front lines, the employees of these companies are often just terrified, right? They hear, my company's got acquired. I'm going to lose my job. I'm going to lose my benefits. The sales packages are going to change. I'm going to have to move. Do I have to sell my house? That's like the fears going through their head.

10:03And you have these echo chambers where employees will talk to each other and be like, what do you think? Have you seen this guy? Someone will go look up your old YouTube video where you're talking about something silly. And look at this guy. This is the joker that's running our business. I think getting in front of that and spending every single minute as possible after that deal is announced, making people comfortable, showing that they're heard, saying like every single person from the sales rep to the tech to the general manager, you kind of wanted to say, hey, what are your goals here? I'm here to build this together.

10:27And the second thing with that is really just like making clear that your goal is not to change things It's the more we've changed things in the first 30 60 90 days the more mistakes we've made like sometimes you change something here and something brings over there The best thing you can do for the first six months is observe and learn from from the people that are there So that's the last kind of just lesson that i've learned from the last bunch of years