Whether you’re a first time buyer or a seasoned veteran, buying a business is a process. With so many factors and variables to consider, it’s easy to feel overwhelmed. If you’ve ever felt this way, you’re not alone.
As with most things in life, the process always takes longer than you expect with more twists and turns than you’d like. But there is a way to help you simplify the process to stack the odds in your favor that you’ll find a great business to buy. Let’s get started….
Avoid the “Falling in Love” Trap
The trap many business buyers fall into when they start their search is “falling in love” with one business. They devote all their time, energy and resources into getting this one business to the closing table only to find out at the end of due diligence that the business is a dud. Spending countless hours on research, talking to the broker and seller and then signing an LOI to find out later during due diligence that the business is not what you expected is frustrating and time consuming.
The 100/20/5/1 Rule
So where does that leave you, the business buyer? You guessed it…. back at square one looking for another business but with a lot of time and energy wasted in the process. But it doesn’t have to be this way. You don’t want to put all your eggs in one basket. In order to find a great business, a good rule of thumb to follow is:
Look at 100 deals/make offers on 20/narrow down to 5/buy 1
A good approach is to start your search with a set of criteria. Then, you can measure multiple businesses against one another in order to determine which businesses (not just one) are worth pursuing and analyzing further and which are not. The key to finding the right business is to start looking broadly at many businesses and then niche down and get more specific as you move further along in the process.
You Have To Kiss A Lot Of Frogs Before You Find Your Prince
Buying a business is a numbers game. You need to look at a lot of businesses before you find the right one. By starting the business buying process with a scoring system in place, you can drastically reduce your overwhelm and have an effective way to compare businesses quickly and efficiently. By using this approach, you can clearly see and score businesses in relation to each other to determine which ones to pursue and which ones to avoid.
11 Business Criteria To Consider
According to Ace Chapman, a veteran dealmaker and private equity investor who’s bought and sold over 100 businesses, there are 11 initial criteria he considers when evaluating a potential business to buy.
Once you rate a business on each of the 11 criteria in a simple excel spreadsheet, you then add them all together to give the business a “Final Score” . The highest possible “Final Score” would be an 11. This allows you to easily compare all the businesses you’re looking at against one another. You would then focus your time and efforts on the businesses that have the highest “Final Scores”. Below is the simple ratings to use when evaluating each criteria.
-1= Negative rating
0=Neutral rating
+1= Positive rating
Let’s review the 11 criteria and how you would rate each one (in no particular order):
1) Asking Price– The asking price is typically a function of the cash flow of the business multiplied by an industry multiple. The lower the multiple used, the lower the asking price will be.
Asking Price is less than a 2.5 multiple = +1 rating
Between 2.5- 3 multiple =0 rating
Greater than 3 multiple= -1 rating
2) Multiple– The Asking Price of the business divided by the cash flow.
Less than 2.5 multiple= +1 rating
Between 2.5-3 multiple= 0 rating
Greater than 3 multiple= -1 rating
3) Cash Flow– The earnings of the business. You have to decide what you personally need or want to earn from the business.
Cash flow is less than your desired amount= -1 rating
Cash flow is equal to your desired amount= 0 rating
Cash flow is greater than your desired amount= +1
4) Years in Business– The longer the business has been operating profitably, the better.
Operating less than 2 years = -1 rating
Between 2-5 years= 0 rating
More than 5= +1 rating
5-Reason for Selling– There are many reasons someone sells a business. Some reasons should be looked at more favorably than others. Some of the better reasons from a buyer’s perspective are: retirement, health issues, death and divorce. In these situations, the seller may be more motivated to sell and therefore you may be able to negotiate a better price and/or terms for the business.
Seller is bored or burnt out from the business/No time to invest in it = -1
Moving onto another business opportunity= 0
Retirement, health issues, death and divorce=+1
6-Growth Potential– You want to be able to determine how much you think you can grow the business with the skillset(s) you have.
You don’t have the skillset(s) needed that the business requires and they may be too complicated to learn = -1
You don’t have the skillset(s) but you’ll be able to learn them quickly = 0
You have the skillset(s) needed for growing the business= +1
7-Brokers– You start to rate them over time based on the following: how well the listing is written, their responsiveness, how easy/difficult they are to work with and the financing offered to name a few.
The broker is hard to work with and not responsive= -1
You’ve never worked with the broker or he/she just does the minimum required = 0
The broker is responsive, easy to work with and shows you listings before the general public sees them=+1
8-Financing– You want to see if the seller offers any type of financing or if the listing is SBA approved.
No seller financing is offered=-1
Some seller financing is offered but no amount is mentioned in the listing= 0
A specific amount of financing is mentioned in the listing (the larger the amount, the better) or the business is SBA approved =+1
9- Proprietary– Does the business have any unique aspects that differentiate it from its competitors (ie branded or patented products, services and/or processes)?
The products/services offered are commodities= -1
The products/services offered are not easy to replicate=0
The business has some proprietary products, services or other aspects that are differentiating= +1
10-Customer Base– This ranking factor is more subjective based on your personal preference. Who do you want to serve? What niche(s) interest you? You need to take the subjective and make it objective for comparison purposes.
Customers who you wouldn’t enjoy serving =-1
Customers who you wouldn’t mind serving but aren’t your dream customers= 0
Customers who you would love to serve and continually add value to=+1
11- Pride of Ownership– This ranking factor is also subjective based on your personal preferences. You only want to look at and ultimately buy businesses that you’re proud to be associated with. Try to stay away from businesses that may be very lucrative but are not aligned with your values.
Businesses that you would be embarrassed or uncomfortable
being associated with= -1
Businesses that you would be comfortable associating with = 0
Businesses that you would take a lot of personal pride and satisfaction being associated with= +1
Conclusion
Deciding which business to buy can be a daunting task. Although no system is foolproof or will guarantee that you’ll find the right business, you need to have one in place to help make your search a whole lot easier.
When you look at multiple businesses, use a scoring system to compare them all and then pursue only the highest rated businesses for further consideration, you put yourself in a much better position to streamline and expedite the business buying process, reduce your overwhelm and ultimately find the right business to buy.
If you have any further questions, please feel free to reach out to me at jennifer@digitalequityventures.com