Things to think about when buying a business #1

Buying a business is a potentially great way to become an entrepreneur. With a bit of luck the business you want to buy has got through the first couple of years and a lot of the early-stage risk is gone. Hopefully there are customers who love the product, suppliers who want nothing more than for you to succeed, loyal staff that want to work for a new owner, and the premises is locked into a nice long-term lease with very low escalation clauses, and of course we also hope you have a very motivated and honest seller who doesn’t have any unreasonable expectations of value or deal structure.

Have all that? Congratulations! You are one in a million!

For the rest of us, most times buying a business isn’t a smooth process nor is it cheap. In the next 2 articles we’ll cover some tips to help you buy the business of your dreams, without losing sleep in the process:

1. Keep emotion out of it:

Unlike buying a house where emotion often comes into play, you should buy a business because it represents a solid investment opportunity where the returns far outweigh the risks to your capital. A great tip I learned from a friend is to look at any opportunity three times: your initial assessment, then two more. One as if you are wearing an optimistic hat and another, on a separate day where you wear your pessimistic hat – the results are very different. Listen far more to your pessimistic voice – it’s going to be more accurate 90% of the time.

2. Don’t bet the farm:

We all love a rousing war-story by an entrepreneur who risked it all and made millions, but in truth most times when people risk it all they lose it all. You have to appreciate that no matter how much homework you’ve done and how certain you are when signing the purchase agreement, chances are something will go wrong or you’ll screw up in some unimaginable way and you’ll lose most, if not all the capital you’ve invested. Give yourself a fighting chance by not investing all your capital. Even better, put the rest of your capital into a very low risk investment that offers 100% guaranteed returns and lock it in there for a long time.

3. Have choices:

Make sure you consider where else you can put your money. Consider many different businesses before you choose where to invest. Seriously – unless you really know the industry you’re looking at and have also run your own business before, you want to get to see several different businesses in different locations and of different types before you make such a long-term decision. Take the time. Keep options open so you’re not forced into a deal.

4. Don’t buy a job:

There are many people who fall into the trap of paying a few million for a business where they then work 12 hour days only to earn what they could as a salaried employee elsewhere. Make sure the business you want to buy will pay you a market related salary (i.e. that it will pay you the same as what you’d pay someone else to run it for you) and make sure that it is profitable enough to make an investment return above that. If you are really just buying yourself a job then rather take your capital, invest in a financial product and get yourself a job.

5. Live the life & get advice from people in the business:

If you’re going to be hands-on in a business you need to know what the day-to-day demands are like long before you sign anything. People in corporates often complain about boredom or ‘chores’ but the entrepreneurial grass isn’t much greener – we still do boring stuff each day. We still talk to difficult customers, make coffee, clean up and do stuff that isn’t sexy. Don’t expect different. Speak to people in the industry about what life’s really like, and if you can, spend a week working in a friends business during their peak times to know what kind of hell you are about to pay good money to live in.

6. Do a deal that is almost certain to make you money: 

You make money by buying now and paying later, and by buying low and selling high. You also make money by taking steps to reduce risk. For this reason, most of the deals I’ve worked on involve the buyer paying only a small part of the agreed price as cash upfront, with the balance paid based on performance of the business over time. I’ve covered this in previous articles, but in essence the typical upfront amount is around 20-30% of the deal and the repayment term around 5 years. Bear in mind throughout that unless you are earning healthy dividends, the only time you’ll really make money when buying a business is when you’ll sell it to someone else. So you’re really looking for a business that you can grow at around 30-40% per year before you’ll make any kind of return…and only then if you can find a buyer in the market at that time.

We’ll cover the financial analysis side of buying a business in next weeks article.