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Leap Of Faith

Think there's nothing to buying a business? Then we've got a piece of the Brooklyn Bridge to sell you.
February 1, 1998
URL: http://www.entrepreneur.com/article/15102

Everything seemed to be sailing along smoothly in the summer and fall of 1996, when Norman Savage was negotiating to buy a small mortgage company in Ft. Wayne, Indiana.

Having owned nursing homes and restaurants over the past three decades and, most recently, a firm that brokered distressed mortgages, Savage was no newcomer to buying and selling businesses. This latest deal, to purchase North American Equity Corp., seemed just right. The seller had provided three years of audited financial statements, all of them pointing toward a bright future. The company was exactly the next step Savage wanted, a jump from distressed mortgages to conventional home financing. And a sharp, well-chosen staff was already in place. It looked as if Savage could just step in and glide along with North American Equity as it continued on its way.

Not quite. In the first few weeks after closing the sale on November 13, Savage was hit with a string of problems. The seller had given some employees 20 percent pay increases after the deal was made--effectively buying for himself the credit for being a generous boss and leaving the cost of that generosity to Savage to pay. One key employee was mulling over a job offer from a competing company. A printer stopped working, and in getting it repaired, Savage learned that one of the office computers had needed to be replaced for some time. Some of North American Equity's business licenses were about to expire, and the necessary documents to renew them weren't easy to locate. On top of all that, several important clients let Savage know they needed to meet with him right away to determine whether he'd be giving them the same kind of service they had been getting from the company under the previous owner.

Even after those rocky first few months, Savage still calls the purchase "one of my best moves." Although unexpected, the problems were all ones he was able to wrestle to the ground. "It was extra work I hadn't counted on," he says, "but nothing I couldn't do." Savage's experience was not catastrophic, but its stressfulness is typical of the business buyer's experience. No matter how wide open your eyes are during the shopping and negotiating periods, you're still in for some surprises once the deal is done.

That's why "wiggle room" should be built into every business buyer's plans, says Bill Yegge, a Moody, Maine, owner of five businesses and author of A Basic Guide for Buying and Selling a Company (John Wiley & Sons). Whether it's financial wiggle room--a little bit of capital set aside for unexpected expenses like a new computer--or managerial wiggle room--the chance to meet with key employees privately before closing the deal--it heightens the buyer's confidence that obstacles can be overcome and goals achieved. Entrepreneurial businesses are notoriously risky; planned wiggle room is a strategic way to minimize the risk.

"It's not exactly an arm's-length deal when a small business is being sold," says Yegge. "Because of the closely held, private nature of most small businesses, the buyer just can't know all there is to know until after the sale." Because pitfalls and delays are inevitable, planning for them should be automatic.


Dennis Rodkin is a writer in Chicago.

Risk Management

For some business buyers, the decision to buy an established business instead of starting a new one is the first step they make toward giving themselves wiggle room. In 1996, when Texan Michael Garrety was downsized out of the oil industry, he felt his time to run a small business had finally come. But he wasn't interested in risking everything he'd built during his 20-year career. "Everybody says it takes three to five years to build a new business from scratch, and during that time, there's a fair amount of uncertainty," Garrety says. "I'm a middle-aged guy; I'd rather buy an existing business and take that same five-year period to pay a note back, knowing I've got cash flow from the first day." Garrety bought San Jacinto Staple & Supply, a Houston-based commercial distributor of packaging and shipping supplies, in September 1996.

Caution is especially important when planning your debt load, Yegge advises. While it's tempting to buy the biggest business your financing will allow, that tactic doesn't leave much of a safety net if the business doesn't do as well as expected. "What if the seller inadvertently takes 20 percent of the sales with him because the customers loved him? What if Wal-Mart decides to build down the street?" Yegge asks. "The safe [move] is to buy less than you can afford, even though the real psychology of all of us is that we always buy more because of enthusiasm."

While there's no broadly applicable way to calculate precisely how much money to keep off the table for emergency use, Yegge advises buyers to use the tools of leverage to their advantage, thereby reducing their own cash investment. Finance as much of the sale as possible using the assets that come with the company. Whenever possible, he says, "get a list of the target company's assets, take it to your banker and ask what you can borrow on each of the components individually."

Getting detailed asset information from the owner of a small business can be difficult; that sort of data is held very closely in private firms. That's why Houston business broker Jeff Jones explains to prospective buyers that they're not the only ones who need a little wiggle room; the person on the other side of the table, the seller, needs some, too.

"It's a big mistake on the very first meeting with a seller to start asking for tax returns, leases, maintenance schedules, and the rest of the laundry list of documents the bank has told you to get," Jones says. "The seller won't release that information to somebody who is just starting to snoop around. He doesn't want to end up seeing his tax returns floating around the countryside." Even the broker who lists the business may not provide all the financials right away, Jones says. "I may have that information in my files," he says, "but I won't give a buyer copies until things get serious."

Instead, Jones recommends an approach that is almost courtly in its deference to the seller. Understand that reputable sellers know all the financial data has to be provided and will eventually hand it over, Jones says. But first, they need to feel confident that you're examining their records in earnest. Once they trust you, he says, they'll open their files.

You can accelerate the process by opening up first. Yegge advises buyers to prepare a document that is a cross between a resume and a personal financial statement. Typically, it should include a one-page write-up of your financial condition, including how much money you have on hand for a down payment, the value of your assets and other relevant figures. It should also include a one- or two-page summary of your own education, training and work history. "Offer it to a seller as a way of saying `Here's a little something about me,' " Yegge says. "Once you've shared something about yourself, the seller is more inclined to believe you're genuine."

To determine how much down payment you'll need, most experts say you should calculate what your rock-bottom annual income needs are. That figure is roughly equivalent to what you should expect to have for a down payment, except in industries with high operating costs due to big equipment needs or other special circumstances. In other words, says Ron Hertenstein, president of Anthony Wayne Business Exchange in Ft. Wayne, Indiana, "if you need $50,000 a year to keep your family afloat, then you'll probably have to spend about $50,000 of your own money to get a business that will pay that [much]."

Buyer's Market

Choosing the type of business to purchase is another part of the process where the experts advise giving yourself some breathing space. Too many new buyers, they say, decide in advance that a particular field is the only one worth pursuing. The buyer might have a background in that field or may have daydreamed about being in that industry for years. That doesn't necessarily mean it's the right field to buy into. Jones estimates that while as many as 95 percent of business buyers who come to his office arrive with a specific field in mind, only a handful of those who actually buy do so in the area they initially had in mind.

Why? Mostly because the vast majority of buyers all have their eyes on one field--manufacturing, according to Yegge, Jones and Hertenstein. "There are so many buyers looking at so few deals in manufacturing that the market pushes a lot of buyers out of the ballpark," Yegge says. Other buyers migrate to different fields because they find their financial expectations for the first field were out of whack with reality or because while shopping around, they find a business they never knew about appealed to them.

When Garrety went shopping for a business, he didn't look in areas he was familiar with, such as the oil industry, but opened himself to whatever kind of business could match his mix of managerial talents and financing. "I ruled out anything retail because my work had always been industrial," he says, but other than that, "I didn't have a specific target. I felt I could apply my background to a broad range of businesses. I just waited for the one that I felt most comfortable with." The one he eventually bought fit his needs in a variety of ways, from his instant and easy rapport with the seller to the company's location in an industrial park just a short drive from Garrety's home.

Comfort is crucial. Once you decide to slip outside the industry you originally had in mind, the experts say, be careful not to roam so far afield that you lose yourself. Sometimes, Hertenstein says, buyers "get so frustrated when they can't buy their dream business that they end up buying something they know nothing about. Then it's a struggle to learn how the business operates, and even if you have a contract with the seller to stick around for 90 days until you learn the ropes, that's just not the same as knowing from long-time experience." With so much money on the line, Hertenstein advises, it's better to hit the ground running in a business you at least have some feel for.

"You don't want to be in the painful position of trying to learn the business as you go, because the customers already know the business and if you miss a step because you just didn't know, they'll leave you," Yegge says. If you find yourself investigating an industry you don't know well, he suggests you contact the industry's trade association or a local leader in the field for inside tips. "Ask what a typical workday is like, how the year is arranged, if there are unique things nobody outside the business ever understands," he says. "Anything that can help you understand the culture of that business will help you establish your own comfort level." The same kind of research would be valuable for someone who's always dreamed of being in a certain field but hasn't yet started looking at actual prospects.

Should you buy through a business broker? Garrety believes that, as with buying a house, it's the only way to know what's out there that suits your needs. "There's an awful lot of legwork you'd have to do to find out what's for sale," he says. "If there's only one business you want to be in, a broker isn't necessary, but if your target is broader, like mine was, it's good to have a broker who can show you what's out there." A broker can also nudge you outside the field you had been targeting and help you determine which businesses suit you.

But not even the best broker, Savage emphasizes, can prepare you for the first few inevitable surprises that lie in wait for new owners. Still, that shouldn't be a problem, he says: "If you have any spirit at all, you're buying a business because you operate at a different anxiety level than most people do anyway."

Contact Sources

Anthony Wayne Business Exchange, (219) 485-1990, http://www.anthonywayne.com

Jeff Jones, (713) 680-1200, http://www.certifiedbb.com

North American Equity Corp., (219) 426-0404, fax: (219) 420-7218

San Jacinto Staple & Supply, fax: (713) 690-7753

Bill Yegge, wyegge@cybertours.com