In part 1 we covered the qualities you must possess to be a successful business owner, how to decide which business is right for you, and how to find businesses that might be for sale. In part 2 we will go into how to approach a current business owner about purchasing his or her business and how to negotiate the best deal for you.
Once you have a solid list of potential businesses that you are interested in purchasing it is time to make the initial contact by letter. It is not a good idea to make the initial contact by email. Most businesses owners receiving an email about buying their business will think it's some type of joke or scam and just delete it.
The letters you send out should be printed from your word processor on high-quality stationary. Proofread your letters to make sure there are no typos. The person selling the business probably has an emotional attachment to the business, so first impressions are very important. That is what your letter is, a first impression.
Keep your letters, short, punchy, and focused on your two objectives: First, to impress the owners that you’re professional and businesslike; second to have them say yes to a meeting.
After you send the letter, follow up with a phone call. The purpose of the call is to set up an appointment to explore your chances of buying the company. To clarify for yourself the points you want to get across in a call, make a sample script of what you want to say.
Writing it down will help you think through in advance what the owner’s concerns may be and how you might respond. Use the script only for rehearsal; reading it will sound artificial and you’ll loose credibility.
In my experience I have found that on average, for every 20 calls you make, you will be able to set up four to five meetings. When meeting with an owner, you should try to accomplish three things, First, size up the company as a candidate for purchase. Second, asses the owner as a potential seller. Third, get the owner to see you as likable, competent, and a serious potential buyer.
Before the actual interview make up a “Business Profile Worksheet,” Use it as a guide to structure the questions you ask. For example, your questions may focus on products and services, markets, business history, employees, revenues and profits, vendors, inventory, lawsuits and litigation, and the importance of the current owner to the business.
Always get detailed answers. For example, on business history, find out who started the company, when it was started, and what ownership changes have occurred. On revenues and profits, get figures not just for one year but for at least five years.
As you listen to the answers to your questions about employee history and current status, be alert for warning signs such as high turnover and low pay. It’s important here to determine revenue and profits per employee, so you can compare productivity with that of the competition.
On the topic of customers, pay particular attention to how the company generates revenues. Do most of the company profits come from a few key customers? What would happen to a new business owner if those customers took their business elsewhere. The final question, how central is the owner to the business, may be the most important one. In some cases, talented charismatic owners are the business and if they leave, revenues will suffer.
Your first meeting should last anywhere between three to five hours. If this first meeting ends promisingly, do a full business work-up; financial analysis, market survey, and industry assessment.
To do a full business work-up you’ll need to get the answers to questions such as: Where does this company fit in the industry? Is it a leader or a follower? What is its market share? What about the quality of its products, technology, and marketing? What is it’s growth rate?
After you get the answers to these questions, you’ll need to talk face-to-face with three key groups: competitors, customers, and employees. If the owner gives you a hard time about talking to customers, that’s a serious red flag.
Whether you ultimately decide to buy a particular business and what you determine it to be worth will depend largely on your analysis of the company’s financials. Your analysis of the company’s financials should have two goals. First, to look at the company’s actual financial history. Second, to price the business.
Working closely with your accountant, carefully examine two statements: a balance sheet that shows the business’ financial position and a profit-and-loss statement that details its income.
If you decide to make an offer to the seller, you want to prove that the amount you’re offering is fair. To do that, you should use several valuation methods to document your proposed offer.
One of the most popular formulas is called asset valuation. It is often used to value asset-intensive companies. To use this method, you need to know the market value of the company’s fixed assets and equipment. If necessary, have an appraisal done.
To get the fair market valuation, add the leasehold improvements; the additions, modifications, upgrades, and renovations that have been made to the property. Next, add the wholesale value of inventory. Then add the owner’s discretionary cash as calculated in your adjusted income statement. Add these numbers together, and you have the market value of the business.
Your offer should be fair and reasonable because when you buy a business you should not look at it as a transaction that will produce a winner and a loser. In fact, buying a business is like a marriage. Do you look at your marriage and ask, “Who’s winning?” Of course not. Marriage is a relationship in which both parties blend personal goals with mutual ones. Thus, rather than a win/lose, your aim should be for a win/win.
In pursuing that goal, proceed in a businesslike, professional manner. Start with a letter of intent, a proposal that outlines your thinking regarding the key issues of the purchase. Clear the letter with your accountant and your attorney. Spell out the proposal you’re making. For example, you may want to consider a balloon payment. Or perhaps a deal which offers a percentage of future revenues or profits as part of the payment. Or perhaps a consulting agreement.
Of course the most significant issue your letter of intent must address is the purchase price. Don’t start off with a ridiculously low offer, which could poison relations with the seller. Rather have the top price you’ll pay firmly in mind and a clear outline of what kinds of terms you’ll agree to. Business negotiators find that a proposed sale price about 25% below and an interest rate 50% below what you want is acceptable but gives you room to maneuver.
You should deliver your offer in person. But, make sure you do your homework ahead of time so you can anticipate every question and objection that could come up. In the meeting you want to gauge the seller’s reaction to key issues, eliminate any misunderstandings about the provisions of the sale, and advance your proposal with logical arguments about why the deal is reasonable and fair.
Don’t expect to reach an agreement at the first meeting. The second meeting is where the action really begins. This is the seller’s meeting. So don’t react. Just listen.
Once you’ve identified areas of agreement and have isolated issues that need to be negotiated, you might want to point out to the seller that you’re closer to a consensus than he or she thinks is the case. When necessary, work with your advisors to find options for resolving issues.
Always remember the golden rule in negotiating: the best chances for successful negotiations come when you and the seller genuinely like each other.
When you’re considering whether to make the leap into buying a small business, make sure that both your heart, and your accountant, tell you to go for it.