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Tips for buying or selling a business are good to know, regardless of which side of the desk you’re sitting on.
Because unless you’re a business broker, someone who does these types of deals every day, chances are that buying or selling a business is one of the biggest transactions of your life.
So can you really afford to make a mistake?
What You’ll Discover About Tips for Buying or Selling a Business:
* The top 3 mistakes people make when buying a business
* How to find advisors with the right expertise to assist you in buying or selling a business
* Key things to look for when buying a franchise
* Why 80% of businesses put up for sale don’t sell
* How sellers can address the biggest fear buyers have
* And MUCH MORE.
Guest: David Barnett
Barnett loves to say that it took him 10 years to un-learn what he was taught in business school. University had trained him to be a middle-manager in big enterprises, he was totally unprepared for the realities of small business.
After a career in advertising sales, Barnett started several businesses including a commercial debt brokerage house. Helping to finance small and medium sized businesses led to the field of business brokerage. Over several years, Barnett sold dozens of businesses for others while also managing his own portfolio of income properties and starting his career as a local private investor.
Barnett regularly consults with professionals and banks on business and asset values. Presently he also works with entrepreneurs and would-be entrepreneurs around the world who are buying, selling or trying to improve their businesses.
Related Resources:
If you liked this interview, you might also enjoy our other Sales episodes, including these related interviews:
- Leadership Quality: Mergers and Acquisitions Red Flags With Claire Chandler
- What Entrepreneurs Need to Know About the Exciting World of Mergers and Acquisitions
Contact David and connect with him on LinkedIn, Facebook, Twitter, Instagram, YouTube, and SoundCloud.
Books by David Barnett:
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Powerful Tips for Buying or Selling a Business with David Barnett
Tips for buying or selling a business are good to know, regardless of which side of the desk you’re sitting on. Because unless you’re a business broker, someone who does these types of deals every day, chances are that buying or selling a business is one of the biggest transactions of your life.
So, can you really afford to make a mistake? Stay tuned.
This is Business Confidential Now with Hanna Hasl-Kelchner. Helping you see business issues hiding in plain view that matter to your bottom line.
Welcome to Business Confidential Now. The weekly podcast for smart executives, managers and entrepreneurs looking to improve business performance and their bottom line. I’m your host, Hanna Hasl-Kelchner, and I’ve got a great guest for you today. He’s David Barnett.
David has been working with businesses for over 20 years, helping entrepreneurs buy and sell businesses as well as helping them finance and grow them. He’s the author of seven business books and the host of a YouTube channel with hundreds of videos about buying, selling, financing and managing small and midsize businesses.
It’s a tremendous pleasure to have him with us today. Welcome to Business Confidential Now, David.
Hanna, thanks for the invitation. It’s great to be here.
And it’s a tremendous pleasure to have you with us on the show today, David. When it comes to tips for buying or selling a business, two of the seven books you’ve written deal with that subject actually on either end of the spectrum.
You wrote 21 Stupid Things People Do When Trying To Buy a Business so that they can avoid the common novice mistakes. And you also wrote How to Sell My Own Business. Now I’m all for learning from other people’s mistakes.
Available at fine brick-and-mortar and online book sellers
It’s actually the mission of this podcast, helping people see things hiding in plain view that matter to their bottom line. So, I’m particularly intrigued about this title, 21 Stupid Things People Do To Try To Buy a Business.
I mean, you really put it out there, you get straight to the point, and I know we can’t cover all of them, but in your experience, what would be the top three mistakes people make when buying a business?
Well, the reason that book exists is because I kept seeing the same things over and over again, as you can well imagine. But I would say that the number one thing is that people don’t understand the value of their time.
When people enter this world of businesses being for sale, particularly if they’re new to the world, they sometimes will have all these things thrown at them that they don’t necessarily understand fully. One of them is the way that cash flow is presented. When a business is put up for sale, it’ll often be presented as a seller’s discretionary earnings or a term similar to that.
And people will sometimes believe that that number that they’re shown is the profit that ends up in their pocket. But it’s not. What it is, is a level of cash flow that a buyer then has to decide how that money will flow. And out of that discretionary cash flow, you have to take home enough money to feed your family so you could get a salary for a manager.
That’s going to be you as the new business owner. You also have to service debt. You have to do any kind of capital equipment acquisitions because this number is often created by adding back depreciation, which is how we recognize the value of equipment that wears out.
And you also have to pay your taxes of that money and get a rate of return on the cash you put into the deal. And so, one of the things that I’ll see people do is they’ll overcommit from that amount of SDE cash flow to what they feel they can pay for debt servicing the business and they’ll undervalue the fact that they have to work full time in the business to make the business operate.
And they’ll do a deal and realize later that they don’t quite have the level of cash flow they thought they were going to enjoy to be able to support their families. And it’s because they didn’t value their own time carefully enough when they’re making this forecast or this plan to buy a business. That’s the biggest one.
That’s the biggest one. And that keeps coming up time and again, you say.
Yeah, it does. It does. I call it the day two problem. People will say, okay, well, if I buy this business and this is the cash flow and this is the debt service, then I should be able to do it okay. But they don’t take into account all those other things. And so, when we look at small businesses, they often sell for relatively low multiples of this cash flow.
And this is the reason why. Even though someone might pay a 2.3 times seller’s discretionary earnings as a purchase price for a small business, they might pay that off over ten years. And it’s because of all those other considerations that I mentioned that have to come out of that cash flow like taxes, debt service, their own paycheck and any kind of capital improvements, capital equipment being bought by the business.
What other types of mistakes are most common in your experience?
Oh, getting advice from the wrong people. I see that a lot where people will turn to people that they trust that don’t necessarily have any kind of experience in the world of small business or small business acquisition.
And just like people will go to find, for example, a CPA or attorney, lots of different people or CPAs and attorneys, those professions cover a lot of different things. Within that profession, there are people that specialize in different types of things.
So I often point out to people, for example, that the vast majority of CPAs spend most of the time doing tax returns and preparing financial statements; it’s actually a very few number of people amongst that profession that work in the world of acquisitions or helping people to analyze and take a look at a business if they’re going to be buying.
And so, there’s a lot of mistakes and things that I find in small business’ financial statements that you need to have a keen eye for. I’ll give you a quick example. I actually got hired by a CPA in Hawaii who was looking at buying a retail business of his own. And one of the things he noticed on the balance sheet of the business was that they had almost four months’ worth of purchases in their payables.
And that would seem to mean that the suppliers of that business were giving this company 120 days to pay their bills. That doesn’t seem to make sense, does it? And so, because of my experience in working on these deals, I knew right away what that was. It was simply that the business owner uses a credit card to make all their purchases.
And that happened to be the balance on the credit card, about four months’ worth of purchases. And that’s the kind of stuff that I see all the time in the world of small businesses that doesn’t quite conform to the normal world of bookkeeping or how people expect to read financial statements.
And so, believe it or not, some of the people that fall victims to some of these problems of interpreting information are actually people from the world of big business. Because in the world of big business, everything is taken care of to sort of a higher standard, a higher degree of perfection.
And following all the rules that oftentimes you don’t see in the world of small business, where a lot of small business owners are making their own books.
Well, you make an interesting point about the world of big business. And it’s not uncommon that I’ve seen where somebody who has had enough of the corporate ladder wants to be their own boss, decides they want to go out and buy a smaller business so that they have more control and hopefully more freedom.
Understood that they may be spoiled by having all of these experts at their fingertips previously. But whether somebody is jumping off the corporate ladder or just somebody who’s not there but still wants to buy.
How do they find the people with the right expertise to advise them? Because you make a great point about not all accountants or not all attorneys are experienced in these types of transactions. So how do they find them?
The key is to build the team before you start your search so that you have enough time to go and network in with different people in the different professional fields that you’re going to need. And your team is going to include several people. You’re going to need an attorney at some point who hopefully has experience with small business acquisition.
You’re going to need that CPA. You may also need certain technical experts if you figure out what kind of industry you want to buy in. You may want to go looking for different consultants or business coaches that have a background in that particular industry.
What I do for people is I’m a former business broker and so today I work as a consultant, and I just advise people on deals. I go through the information that’s been provided and I look for the different problems that I see frequently. Help to give a ballpark valuation of what I think a business might be worth.
In the case of working with a buyer and point out the areas that they’re going to have to untangle. The particular things that different industries offer that might represent hazards for some of these prospective business owners. There can particularly be danger when somebody wants to make an industry change.
If you’ve never worked in the construction industry, for example, and you decide that you want to get into that business. There can be particular dangers about how that business functions, how that industry functions, that you’re not aware of, and failing to understand those things can lead you to making a bad deal.
I was talking with a gentleman just the other day in New Jersey who was looking at getting into a custom home builder. The biggest thing that I wanted to know was how many homes that this company built every year.
Because if it’s a relatively low number of homes, if it’s only building a dozen homes or so, then the question I want to ask first of all, is where does the goodwill reside? Does it actually reside in this business and the business’s name or do people happen to know the person that owns the business? Is that the person that encapsulates the goodwill that people want to deal with that individual?
So, if you bought that business, would people necessarily want to come into business with you? The second thing I asked him was, do you understand what the holdback or repayment rates are in New Jersey? Because in that industry, when you build a house, typically part of the final payment for the home is held back for 45 or 60 days.
It varies depending on the jurisdiction, but part of your money is held back so that the bank knows that none of the sub trades have put in mechanic’s lien on the house and that hold back can be your profit.
And so if your hold back is being retained for a month or two after you complete each job, as you might imagine, the operating capital demands on that kind of business can be significantly more than in many other types of industries. And that’s important.
A lot of the times, particularly in the United States, when people are buying a business in an asset sale, they’re not transferring the operating capital. And so, when you make that investment, you’re actually writing two checks to make a purchase of a business.
You’re writing a check to the seller to buy the equipment, inventory, etc. of the business. And then you often have to write a second check to your entity to provide the operating capital, or you have to have some other means of getting it like a line of credit or something like that.
And this is another part, another one of the twenty-one things that people forget about is understanding the operating capital position, because both of those investments represent what you’ve paid to acquire the cash flow and failing to understand how much operating capital is required is another way that people overpay for businesses.
Good point. And just overall, how different deals can be structured, as you mentioned, an asset deal versus a stock purchase because even a small business could be incorporated. So, each has their pluses and minuses, which we could probably talk about in a whole separate episode.
Absolutely, yeah.
I’m curious what your thoughts are about buying a franchise, because for some people that’s a business in a box. Would that be a safer route than buying a non franchise?
So, I did write a book about franchises called Franchise Warnings, and it reveals a lot of stories of my interactions with franchisees and franchise owners and some of the things I’d like to point out about starting a new franchise is that you’re still starting a new business.
So, imagine yourself opening a business. You still have the problem of finding your customers. And presumably the people in the market are being served by other people right now. So, you still have all the challenges of trying to find those customers and convince them to do business with you instead of wherever it is that they’re going right now.
And so, you’ve got yes, you have a brand name. Is the brand valuable in your market? Well, I don’t know. If you’re opening a Papa John’s in a major metro area that already has a whole bunch of them then people are going to be familiar with that name. There could be value in that name.
But if you’re the first new location of a franchise brand in your state, well, does the brand name really hold any value or are people going to recognize it? And so in addition to all the normal costs of starting a business, you also have that burden of the royalty and the franchise fee and all those extra costs.
And you still have the risks that a normal startup would have. So, if you like the format of a franchise, if you like having structure and a team and head office that’s working on different things that are difficult for you to work on, a franchise may be a good idea for you, but I always say buy an existing one.
That way you get the advantage of understanding what’s already happening there. So, it’s sort of a way of merging the best of both worlds: buying an existing business and getting a franchise. And it removes a lot of those surprises.
The big reason why people buy an existing business over doing a startup is to avoid the startup risk. That risk that you don’t end up finding enough customers and figuring out the systems quickly enough so that you can make money in that business.
Well, those are some great tips, David, for buying a business, whether franchise or some other existing type of business. Now, let’s flip the tables.
Let’s say we want to sell. We might be a serial entrepreneur who can’t wait to jump into the next thing. Or maybe we’re someone who spent an entire life building a business and now we want to retire to Boca.
What kind of advice? Would it be the same kind of tips, or would they be different given their ultimate end objectives. Yes, they want to sell, but there is a fork in the road for them as far as what they do afterwards.
Available at fine brick-and-mortar and online book sellers
And so when I talk with business owners and they talk about their plans to sell their business at some point in the future, I encourage business owners to be thinking about getting their business into a salable condition at all times because four out of five of those top reasons can happen at any time.
And if your business is more prepared for sale, then you have a higher likelihood of selling it. An amazing statistic is that 80% of small businesses that get put up for sale don’t sell. Really isn’t that amazing?
That is hugely amazing. And what is the reason for that? What do you think?
Because they’re not in a sellable state. So, there’s two questions a buyer is going to be asking. The very first question is what is the cash flow coming out of this business? Remember, we talked about the seller discretionary earnings before.
So a buyer wants to know what the cash flow is and that cash flow will determine the price. The second question the buyer is going to ask themselves is, will that cash flow likely continue under my stewardship?
And that’s the million dollar question, because it doesn’t matter what the cash flow is if the person can’t answer yes to question number two, which leads me back to the story with the homebuilder, because that’s the question that the buyer ended up wrestling with: is the goodwill associated with the name of the business or with the individual?
Because if everyone wants to do business with that individual, it doesn’t matter what the cash flow is. If I buy this business, people are not necessarily going to want to do business with me. And so, you’ve got to get your business into a state where the customers are dealing with your business and not with you.
And that means creating processes and systems and having tools in place so that employees can handle everything that needs to be handled with respect to the customers. And so that you have these systems in place so that when a buyer comes along, and you can show them how you can teach them how to run the business. Do we have time for a quick story?
Sure.
So, I was sitting down one day across with a buyer and seller of a restaurant back in my business broker days, and the buyer asked the seller, do you really think that all the employees are going to stick around?
I’ve never run a restaurant before. I’m really going to be relying on them to help me learn this business and help me run this business. And the seller looked at him and said, This is a restaurant. I guarantee in a year they will all be gone. And this is the process I use for hiring.
And he started to explain how he had developed certain advertisements that he used online in order to attract employees and the process he employed in order to sort out responsible respondents from people who are less responsible. And they started talking about all the packages he had put together to help train new employees so that he can take somebody off the street and make them into a productive member of the team within just a couple of days.
And so he addressed the fear that the buyer had, not by saying it’s going to be okay, the employees are going to stick around and you can count on them, but rather by saying I have systems and processes built that are built specifically to address this problem and I’m going to teach you those systems so that you will never have to worry about hiring.
And that’s the kind of thing that is really going to help that buyer answer yes to that second question, will this cash flow continue under my stewardship?
That’s a wonderful story. Thank you for sharing.
I’m just also curious, since yes, you have this business broker experience, but you also help businesses grow. In anticipation that one day somebody is going to want to sell, what kind of timeline should they be looking at?
Because I mean, especially a startup, there’s so many things happening they’re really not ready to sell. I mean, they’re still knocking down boxes in the back. So, at what point should they start thinking about these things?
And realistically, how long do you think it takes to put some of these systems in place in order to be in a good position?
Well, a lot of people out there talking about this will say that when you start a business, you should be thinking about selling it or have a plan in place for how your succession will go at the inception of the business. I don’t think that’s realistic.
I think that when you start a business, you really don’t even know if it’s going to succeed if your idea, if your execution is going to be successful. And so, when you start, you’ve got to do whatever it takes to get those sales in and serve those customers and try to create that stable cash flow.
And I would say that once your business is at the point where it’s able to pay you a fair market wage equal to what you would be earning if you were in that similar role for another company, then that’s the first major benchmark that you’ve reached where you can say, okay, this thing has probably got what it needs to be successful in the long term.
Now I need to start to create that operations manual and I’ve got to start building the robustness of the systems and the processes. And it doesn’t all have to be done all at once. You start with the most mission critical things, the tasks that are worth the least amount of money, which are the tasks that you’re most likely going to be passing on to employees at the beginning.
And so, you look at your own calendar as an entrepreneur and you say, what am I doing? And what is it worth? I sometimes encourage people to use some kind of calendar or time sheet to just record what it is they’re doing throughout the day and then to classify those tasks into the value they provide.
Earlier today, I was spending some time on the phone with a gentleman who was interested in one of my programs that costs a few thousand dollars a year to be a member of. Well, that’s really worth my time and makes a lot of sense for me to take time out of my day to speak to someone like that.
But it doesn’t make sense for me to schedule a week’s worth of tweets on my Twitter account. So, the process for scheduling tweets is something that I need to create a process around so that I can get my assistant to do it right.
And by removing all the low value tasks off my plate, it leaves more time for the C level work of the business, the long-term planning, the thinking about what I want to do next, the direction, new product development and doing the high value tasks like that sales call I was talking about. Right?
And so, as you grow, and that cash flow gets to the point where you’ve now built your business to the point it can provide you with a job that pays you what you’re worth. To me, that’s the point where you know you got something going. And as you’re probably aware, Hanna, a lot of small businesses don’t reach that point.
But in my mind, that’s when you really have to start taking things seriously about building this thing so that you have it in a salable condition.
Excellent. Well, thank you so much, David. I really appreciate all the tips for buying and selling a business that you shared with us today.
And this is really important work because so many people put so much blood, sweat and tears into a business. So being able to sell it and have more than just their paycheck come out of it, I think is very valuable.
And for the people who are buying, they want to make sure they get something that has real value for the dollars that they’re putting in.
And now if you’re listening and you’d like to know more about David Barnett and his books, there are several of them that we talked about here today. That information, as well as a transcript of this interview, can be found in the show notes at BusinessConfidentialRadio.com.
I really appreciate you all for listening. Be sure to tell your friends about the show and leave a positive review. We’ll be back next Thursday with another episode of Business Confidential Now.
So, until then, have a great day and an even better tomorrow.
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