What’s the biggest mistake a first-time buyer of a business can make? Any seasoned professional will tell you it’s an excessive focus on getting the lowest possible price.
Too many novices don’t give sufficient weight to other equally important factors, resulting in a poorer outlook for success. More experienced entrepreneurs will accept a trade-off on price to ensure the transaction addresses a number of other factors critical to the success of the acquisition.
After observing multiple successful and failed acquisitions over the years, I believe there are four critical questions that a would-be purchaser needs to ask himself in addition to the price.
1. Will I need the help of the previous owner after the buyout?
Unless you’re walking in with deep knowledge of the operations of the business, its key customers and the industry, it’s very likely you’ll need the help of the previous owner to manage a successful transition.
The previous owner will already know how to manage key clients and suppliers; what it takes to retain key employees; and the emerging threats and opportunities to the business. Thus, it’s critical to maintain a very strong and collaborative relationship with the seller.
An excessive focus on price during the negotiations, or being perceived as overly demanding during the due diligence, may sour the relationship and the seller will likely be less willing to help out during the post-purchase transition. This is particularly important because it could also potentially alienate key employees.
It’s in your best interest to maintain a good relationship from the beginning, starting with a strong sense of mutual respect, even if you’ve negotiated “after-sale support” from the previous owner in the contract.
To avoid being placed in a situation that could jeopardize this relationship, some entrepreneurs retain the services of an intermediary to negotiate the sale and due diligence.
2. How much of my own money am I ready to add to the transaction?
How much of your own funds are you willing to commit to the deal? The answer to this question will have an impact on the type and size of business you can purchase. Take a simple example. Say you’re willing to commit $1 million. It’s unrealistic to think you could purchase a business worth $25 million; $5 million to $7 million is probably a more realistic range.
This is because the more money you are willing to commit as a percentage to the total sales price, the more willing other funders will be to provide the additional resources needed to close the deal. In fact, committing more of your own money will give you greater leverage in negotiating the final price and the terms of the sale.
3. What is my tolerance for debt and sharing control?
Related to the previous point, another key consideration is how the financing will be structured. Ask yourself: Does debt keep me up at night? How much control over the business am I willing to give up? Another way to ask this: What portion of the total transaction will be based on financing secured by my own assets? How much will come from equity investors, vendor financing or mezzanine financing?
The financing structure will determine how much money you’ll have at your disposal. However, more importantly, the financing structure should be aligned with your answers to these questions.
4. What’s my vision for the business?
Your vision for the business will be another critical factor, particularly in determining the financing structure. Do you plan to expand the business? Upgrade existing equipment? It’s critical to ensure you have lined up sufficient financing to not only purchase the business but also implement your vision. If all your assets are tied up in financing the acquisition, it’s unlikely you’ll have the resources to pursue your vision.
Of course, this is not to say the price is unimportant. However, would-be buyers should be willing to make a trade-off on price to ensure their acquisition is on a secure footing for success.