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Buying Your First Company

Aug 17, 2007
As a professional M&A intermediary I am amazed when I hear others in my profession at industry meetings proclaim, "I don't work with individual buyers." They put it out there almost like a badge of honor or an indication of reaching a higher level of professionalism. My first reaction is, shame on you.

My second reaction is, how short sighted. My third reaction is to understand why and to advise buyers on the preparation necessary to gain credibility, traction, and support from a qualified business broker or M&A Professional. The purpose of this article is to give the first time buyer some action items to complete before they approach a M&A professional to improve the likelihood of garnering professional support.

First of all, please recognize that there is tremendous competition at the Main Street Level (transaction value under $1 Million) for business acquisition. This phenomenon is the result of down sizing and early retirement of mid level and senior executives in their forties and fifties. These people have exited with a war chest of a half million dollars and have vowed to never again be a victim of a corporate restructuring. They want to control their destiny, run their own show, buy and run a business. Most of these people are looking to buy a job.

You and 10 million other buyers:
I am looking to buy a niche manufacturer or distributor with $3 to $10 million in revenue and $500 K to $1.5 Million EBITDA and I don't want to pay more than a 3.5X multiple. I have about $350 K of my own to put into the deal and I have investors lined up for another $1.5 to $2 Million. Pleeeeeeese! Do me a favor. When you have a first meeting with an intermediary and you deliver this message, make sure you are on the first floor. I hate to see my colleagues leaping from tall buildings.

Do your Homework:
There are several things you can do to improve your chances of getting and keeping the attention of a broker.

1. Be Specific. In the example above, the category was so broad that you come across as being not focused, not prepared, and wishy-washy. Translation - this guy is a long way away from pulling the trigger. Your best bet in getting support from investors, friends and family, and bankers is to purchase the business you were employed by or a very close competitor. Specific industry experience improves the potential of the acquired company surviving and servicing debt.

Pick out a sample company of the size range and industry you are targeting and present that as an example of what you would like to acquire. Take it a step further and be prepared to articulate your area of expertise and how you would apply that to make this sample business perform at an improved level. This should be a one to two page summary document. Now that's focus.

2. Funding Preparation. Know exactly what you can put down on the business. If you are not prepared to supply your broker personal financial statements, you probably will not get any help. Go and have the specific discussions with the friends and family (take your sample business and your performance improvement plan). Present your expected returns/equity percentages and ask them what they are willing to commit.

A signed letter from these folks describing their backing is a very powerful attention grabber. Do not assume anything. Know your support level before you and everyone else does all the work to find a qualified acquisition candidate only to find out your investors did not materialize.

3. You are selling yourself. In a sense you are interviewing for a job. Bring the materials that support why you are qualified for the job. A resume is essential and written references are good to have. Remember, most of these transactions will require the former business owner to carry a seller note. They want to understand exactly to whom they are lending and the risks associated with servicing this debt.

4. Realistic expectations. A good business for sale will not be purchased at financial buyer pricing multiples. An attractive business - i.e. one that has a high growth rate or, proprietary technology, barriers to entry, contractually committed recurring revenue streams, blue chip customers, brand recognition, high gross margins or a combination of these will command pricing that is above a strict discounted cash flow multiple. The market will recognize some strategic pricing component and the company will get visibility from strategic buyers.

Even Private Equity Groups that are assumed to be strict financial buyers, do factor in pricing considerations that might reflect ownership of a portfolio company in the same market space. The better the business, the greater the universe of buyers. The good news is that a company that has attractive characteristics, but is small (below $5 Million in sales) probably will not interest the Private Equity Groups.

5. Network Network Network. A great way to improve your chances of successfully purchasing a business at a good price is to have an entree into a business that is not formally for sale. What I mean when I say that the business is not formally for sale is that the owner has decided that he wants to exit and has shared that information with a few close advisors, but has not engaged the services of an M&A firm or advertised on one of the popular Business for Sale Web Sites.

Put the word out to your network of professionals, industry sources, trade associations, vendors and suppliers, etc. Utilize the same preparation as described above and hand out your materials. Your banker, your lawyer, your financial planner and all of their associates are great sources of businesses for sale. Remember, if you do not establish your credibility with them in your preparation, they will not risk their credibility with another client through an ill-advised introduction. The good news from this approach is that you may be able to purchase a good business at a bidder of one price without price pressure from other buyers. If that seller's trusted advisor brings you in, the chances of this happening improve significantly.

6. How serious are you? Lots of individual buyers will pay a broker or intermediary a success fee based on a percentage of the purchase price. The most serious buyers, however, pay buy side engagement fees as well. This is a fee usually ranging from $2,000 to $7,500 per month paid to the M&A professional to formally search for you outside of the networking only approach they would take for no engagement fees. Corporations in acquisition mode almost always operate this way.

The benefit to this approach is that the intermediary will expand the universe of candidates to those companies that fit your buying criteria that are not for sale. It is a lot of work to compile databases and try to break through the difficult barriers to reach an owner that was not contemplating a sale and convincing him to entertain this process. Our objective is to buy his company as the only competitor. If we can do that, the transaction price will generally be 20% below a business that is formally for sale, represented by a professional, and getting many interested buyers. Saving you $1 Million on the purchase of a $5 Million business certainly will justify any monthly fees and success fees an M&A professional would charge.

The corollary to this is if you are a business seller, and you do not engage a professional, you most likely will leave that 20% premium on the table.

Most individual buyers are engaged in the buying process with either no current income or very limited consulting income. In other words, buying a business is their full time job. While one operates in buying mode, they are working for no income. The longer that buying process takes, the greater the erosion of their financial resources. It is in the buyer's interest to not only purchase the right business at the right price, but to compress the amount of time it takes to complete the process. Implementing one or several of these recommendations should help you buy smarter and faster.
About the Author
Dave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions.
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