What are some things you need to keep in mind as you think about buying a business? (By the way, this series on buying a business is from the buyer’s perspective but is helpful for owners. It’s always helpful in negotiations to know what the other side is thinking!) Here are some foundational ideas I think are crucial to keep in mind as you move forward:
PAY FOR THE PAST.
Unless you are buying a rapid growth technology firm like those typically financed by venture capitalists, you want to pay for past performance. You are buying the company for what it is now – what it’s accounting records show. Accounting/financial statements such as balance sheets, income statements, and cash flow statements show the performance over a period of time (income statement) or at a snapshot of time. These statements are HISTORICAL. You buy based on what these statements show. Hence, you pay for the past. You pay for what the company has done to date under existing ownership and management.
BUY FOR THE FUTURE.
You are buying the company because you believe it will perform steadily in the future or achieve rapid growth – depending on your reasons for buying. You either intend to grow it significantly and sell again at 5, 10, 20 years or more in the future (or pass it on to heirs) or you intend to pull a regular distribution from the business. By whatever means you intend to recoup your investment and reap the benefits from that investment, these are all future expectations. You believe that the industry is a great industry to be in, that the market is stable or growing, and that there is a great likelihood that your business will flourish and grow.
FOCUS ON THE BUSINESS, NOT THE PRODUCT.
If the company makes a great product, it can be easy to get sidetracked with that. But the market can shift and the demand for the product could dry up. If you focused on how wonderful the product is but neglected to look at whether or not it was a really good company, you could be doomed. A good company can create other products. A mediocre company could have a one-trick pony. So do like private equity groups and focus on the existing management team and employees, the operational procedures in place, the level and quality of sales and marketing, and all the other things BESIDES the product that make a company great. Otherwise you could end up with a warehouse full of unsold miracle product and $0 cash.
BUY A BUSINESS, NOT A JOB.
If you are buying a business and investing your (or others’) hard-earned money, buy a sustainable asset. If the only way you can make money from the business is via your salary, you are buying a JOB, not a business. A business is a performing asset that should generate income for you outside of your salary, via distributions (whether or not you take them), increasing shareholder equity, increasing revenue and profit and cash flow. The latter all lead to a higher sales price in the future should you wish to sell all or part of the business you buy. If you made $100,000 annually before and now you make $100,000 with no likelihood of distributions and no increase in shareholder value, you just bought yourself a job. Think about this in advance so as not to make that mistake.
BUY A BUSINESS THAT’S DRIVEN BY WHAT YOU’RE GOOD AT.
This is very important. I bought a newspaper that was driven by sales – short cycle, ad sales. I’m not a sales person. No way. No how. I’m excellent at business partnerships and other similar long term, mutually beneficial development, but I’m not good at sales. But I learned an excellent lesson. I learned what it takes to build a strong sales team through 100% trial and error. An expensive way to learn but it stays with you. I then pursued a distribution company whose driver was tight operational management. That company sang my song. It was an excellent fit. (Unfortunately, the company’s revenues dropped nearly 30% over the year and the owner wouldn’t reduce the price so I had to walk away.)
You will be driving the business. Yes, you can hire an excellent management team. Or there may be one in place. But you will be devising and executing the business plan. You must ensure that you have the ability to execute the plan well. To do that, what you’re good at must be what drives that particular business. Know your strengths (and weaknesses). And know how they align with the business(es) you’re looking at.
As always, good luck!