414 - The Process Protects You: 10 Lessons Every Business Buyer Needs!

0:00In yesterday's Empire Group meeting, we discussed financing, valuation, due diligence, leadership, and several other parts of business acquisition. They may seem like separate subjects, but they all reinforce one important lesson, and that lesson is successful business acquisition requires persistence, flexibility, and the discipline to follow the process. One of my mentees recently completed an acquisition, his first, after every bank he approached said no. All the lenders did not like the fact that his holding company lacked any operating history. Why? Because they had not done a deal before.

0:40Many buyers would have concluded the deal was dead, but he did not, thankfully. He raised debt from friends, family, and some other people who believed in him. The seller agreed to deferred payments. He found another way to assemble the financing without surrendering a large percentage of the company. All those investors got debt only. A bank rejection does not necessarily mean the deal's dead. It means the particular financing structure did not work. However, financing creativity must not become financial recklessness. If a business has a debt service coverage ratio of only one. Virtually every dollar available is required to make the debt payments.

1:28There's no meaningful margin for a lost customer, higher payroll, delayed collections, or an equipment failure, or all the other things that can possibly go wrong. A deal that only works when everything goes perfectly does not work. Stress test it. Reduce the revenue, increase the expenses, delay collections, add an unexpected repair, and you're in trouble. You should be looking for approximately 1.5 times debt service coverage. If you don't know what that means, that means, for instance, if you have$150 ,000 free cash flow at the end of a month, meaning you can spend that however you want to, and your debt is$100 ,000, you have$150 ,000 to cover $100 ,000 or 1.5 times debt service coverage ratio.

2:22The same discipline applies to valuation. Suppose a seller claims the business has$250 ,000 of EBITDA, and you agree with four times multiple. That suggests a$1 million purchase price. But the letter of intent should not lock you into that price. The price should be based on EBITDA as verified through due diligence. If the verified EBITDA is only$200 ,000 instead of the$250 ,000 that was claimed, the price becomes$800 ,000. Again, four times multiple times the EBITDA. Even a questionable$30 ,000 of add-back charges, the purchase price then can be reflected by four times that$30 ,000 or$120 ,000.

3:15So even a small change in the EBITDA can reflect a significant change in the purchase price. The seller's number begins the discussion, but due diligence determines what the business is actually worth. Be particularly cautious when the year immediately before the sale is dramatically better than every previous year. Expenses can be delayed. Bonuses can be eliminated. Necessary employees can be removed or not replaced. Revenue can be pulled forward. The financial statements may be accurate, but that does not mean that the performance is sustainable. In one recent acquisition, we used an average EBITDA over four years because the latest year was substantially better than the others.

4:05And we didn't have a lot of confidence that that wasn't a fluke. You are not buying last year's financial statement necessarily. You're buying the cash flow the company can realistically produce after you own it. Once you acquire the business, ask a simple question. When were the prices last increased? Some owners have not raised prices for five or even ten years,

4:35Bruce Whipple:even though labor, insurance, rent, and materials have continued to rise, particularly in today's environment. And do not recklessly increase every customer's price on your first day. Understand the contracts, the market, and the customer relationships. But examine pricing systematically. A reasonable price increase may fall almost directly to the bottom line and profitability. The acquisition process also requires you to become comfortable being uncomfortable. You will ask a successful executive to join your board. You will contact owners who have spent decades building their business. You will negotiate price.

5:17Bruce Whipple:You'll raise money and make decisions that will change your life. Of course, that feels uncomfortable. Confidence normally comes after you do the difficult thing, not before. And do not decide that someone will reject you before you ask. I once approached one of the cheapest people I knew because I needed to raise money. I was almost certain he would say no, but guess what? He said yes. Never ask, never get, right? You do not know who will say yes. Your responsibility is to make a reasonable request. Their responsibility is to answer it. Persistence, however, does not mean chasing someone forever.

6:02Bruce Whipple:For most board candidates, advisors, acquisition contacts, five thoughtful follow-ups should be enough. After that, send a final message asking whether you should assume they're not interested, and then move on. A lot of times that will pull somebody back. Maintain a full pipeline so that no one person or acquisition becomes more important than your process. The process also applies to your chairperson. A powerful chairperson can provide tremendous value, but your chairperson is an advisor. Your chairperson is not your boss. Do not let someone's experience or resume intimidate you into structuring an acquisition before your board and professional team are ready.

6:52Bruce Whipple:Follow the steps. Complete the board, retain the appropriate professionals, interview lenders, then evaluate acquisitions. Finally, stop solving problems that do not yet occur. Do not spend your time worrying about complicated shareholder agreements, voting rights, or legal structures for an acquisition you have not found. That is not preparation. It's distraction disguised as work. Ask yourself one question. What is the next action required by the process? Then do that action. Business acquisition does not require you to have every answer today. It requires you to ask the right people, verify the numbers, protect the downside, follow the process, and complete the next required step.

7:47Bruce Whipple:And remember, you put this board together to give you experience and guidance that probably you didn't have along with their wisdom. Use it. I'm amazed sometimes at how many times people fail to use the tools that are in front of them. And one of the best tools you'll have, if you built your board correctly, is your board. So I hope that helps. I hope you realize that as this person found in the acquisition after all the banks said no, as my grandfather said to me more than once, where there's a will, there's a way. And that is certainly true. If you don't know the process, go over to askbrucewhipple.com.

8:33Bruce Whipple:you'll see 12 quick questions take you less than 10 minutes and you'll get back a score which will show your readiness and also show you the areas that you need to work on to complete the shortcomings that you have in the process so i'd encourage you to do that again askbrucewhipple.com take the test get the results and you'll also have an opportunity to download free my online book 29 pages quick read a lot of good information and it'll help you