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Tip of the Spear Ventures

Venture Capital | Business Transformation Consulting

acquisition

30 Days to ETA | Day #22 – ETA Deal Flow | Brokers

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If you’ve been reading along in this 30 Days to ETA series, you know that in the Day #21 post I discussed how as Acquisition Entrepreneurs you can bet that there will be mistakes made, something I call ETA Mistakes. You can make one mistake, or you can make one million! Regardless of how many mistakes you make, how you recover from them will make a massive difference (You can read the previous post by CLICKING HERE). One mistake that I see time and again made by Entrepreneurs Through Acquisition (ETA) is not having enough opportunities in the Mergers & Acquisitions pipeline. So, in today’s 30 Days to ETA post, we’re going to explore ETA Deal Flow | Brokers… Enjoy!

30 Days to ETA - ETA Deal Flow | Brokers

ETA Deal Flow | Brokers

At Tip of the Spear Ventures, we’re often asked our opinion on broker utilization. A Broker can help you more than you might be thinking in an acquisition. On the one side — The Sell Side Broker — they represent the seller of the business. On the other side, and this one is often more rare — The Buy Side Broker — represents the buyer (you, the ETA or Acquisition Entrepreneur) with the purchase of a business. We mostly think of brokers as only representing the seller — Sell Side Broker. Mostly, they initiate and mediate the interactions between the buyers and sellers. In fairness, each one provides a similar service. However, each has a different skill set that provides different advantages and disadvantages for particular buyers and sellers. So let’s identify the players, look at their skills sets, and decide how you will work with each broker as you look to conduct ETA in 30 Days!

#1. The Sell Side Broker

Also known as a business transfer agent, or intermediary, a Sell Side Broker acts as a mediator between buyers and sellers.

Who Do They Serve?

Typically, the Sell Side Broker serves smaller, local or regional “mom-and-pop” companies that gross less than five million dollars in yearly sales. According to the Exit Planning Institute (EPI), around five million companies fall into this small business category. Those companies usually sell for less than five million dollars and sell to individual buyers. For the most part, they also have less than one million dollars in EBITDA, or Earnings Before Interest, Tax, Depreciation, and Amortization.

How Do They Get Paid?

Sell Side Brokers do not tend to charge sellers an upfront fee for services. If they have to clean up a huge mess to get the seller positioned to sell, however, they may charge an initial set-up fee. But most of the time, they don’t. Instead, they often charge a commission that funds and pays them at the time the business sells. So no fee for you as the Acquisition Entrepreneur!

What Do They Expect?

The Sell Side Broker requires the seller to compile a multitude of materials to prepare for the sale. Those could include marketing materials used, past and present financial reports, or financial forecasts. In medical fields, a business broker might ask for total patient counts and demographics. Sellers may even have to list what types of procedures, services, or products they offer and how many they provide or sell on an average day. Although sellers will have to provide quite a bit of documentation to the broker, they don’t usually have to go to an accountant for help or additional compilations. What are they looking for the Buyer to do? You probably guessed it, the higher their commission is a direct relative of the sale price of the business. So, they want you to show up at closing with bags of cash!

What Benefit Do They Provide?

Similar to a realtor, the Sell Side Broker walks sellers, and sometimes buyers, through the sales process. The facilitating broker can list the business for sale, develop marketing strategies to attract buyers, arrange business walk-throughs, meet with buyers’ agents, answer questions, and help negotiate sales terms and conditions if issues arise. Essentially, he puts polish on the business to make it look better to attract a buyer. He also acts as a cushion, or an emotional barrier if you will, between the buyer and the seller. His objectivity and creativity repairs hurt pride and dampens fiery tempers if the sales process does not go according to plan. For the buyer, they can also be a pollyannaish resource and their advice/counsel should be seen as such.

#2. Buy Side Broker

The converse of the Sell Side Broker is that of a Buy Side Broker, who acts as a mediator between buyers and sellers but acts in the best interest of the buyer who hires them.

Who Do They Serve?

As stated above, the Buy Side Broker represents you — the Acquisition Entrepreneur — throughout the Mergers & Acquisitions process. You find them and hire them, they then work for you.

How Do They Get Paid?

Buy Side Brokers charge buyers an upfront fee for services. Think of them as a key member of your ETA Professional Team, and unlike the Sell Side Broker who works for the seller and their best interest, they work for you and your best interest.

What Do They Expect?

I’m often asked why would an ETA want a Buy Side Broker? Simple — Most ETA or Acquisition Entrepreneurs are likely buying their first business. With this heading into often unknown spaces, a Buy Side Broker can help explain what the process is and act as a Sherpa if you will. They expect you to follow their guidance (and you hired them, so why wouldn’t you?)

What Benefit Do They Provide?

With this first business comes much upheaval! Think of an acquisition as an ocean with several highs and lows of the wave — or the waves trough and crest. A good Buy Side Broker will help calm those waves, making the acquisition a more expensive one for the buyer, but a better one with less frayed nerves!

SUMMARY

Iin today’s 30 Days to ETA post, we’re going to explore ETA Deal Flow | Brokers. Having a broker may be vital whenever you’re getting ready to acquire a business. Whether to walk you through the entire process and make the business look good to you as the potential buyers or to guide and direct your actions and temper emotions on both parties — Buyer and Seller. Just like the importance of having a sharp attorney when creating a Letter of Intent (LOI) or Purchase Agreement (PA) contract, you will want sharp brokers when implementing those contracts.

Sam Palazzolo

Startup vs Acquisition – A Comparison of Two Entrepreneurship Models

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Often, when entrepreneurs ask the difference between startup vs acquisition, they are confounded by the differences and can’t make up their minds about which choice is right. They often think that there are clear winners and losers in terms of an entrepreneur’s success or failure. The truth is that there are subtle differences between startups and acquisitions. For starters, it’s not the size of the company that makes the difference between a startup and acquisition; in many cases, it’s the lack of a market or the size of the market that makes the difference.

Startup vs Acquisition

The differences between a startup and an acquisition vary primarily based on the size of the target market. A startup may be started to fill a need in the marketplace; that is, it was created to address a problem that existed in a segment of the population that had not been well served by established companies before. For instance, many new food stores started as franchises that expanded to meet the needs of a local market. In such cases, the company’s success came from its ability to serve a specific segment of the population.

The Acquisition

With acquisitions, on the other hand, the objective is much different. Buyouts are done primarily to acquire control of already mature companies with long-standing operating systems, market shares, and patents. While these companies may have the necessary attributes to be attractive targets for a startup, they are unlikely to have strong market shares or a profitable business model.

Sustained Growth & Profitability

An acquisition occurs when a business owner takes control of a company that is doing well in the market but lacks the ability to sustain growth and profitability. As the buyer, you typically don’t acquire a startup with the intention of developing it into a successful business yourself. Instead, you look for a business that can help you realize your financial goals. This can mean developing the company further to bring it closer to the goal you’ve set, or it could mean acquiring a company with complementary assets.

Startup vs Acquisition: The Key

The key to both startup and acquisition is finding the right partners. Acquiring a startup is easier when you purchase a successful company because you already know what it’s capable of. On the other hand, you’ll have a lot of work to do when buying an established business. Take for example the purchase of an organization (and we see this all the time at Tip of the Spear). At the time when the purchase was made, Company #1 was the largest company in their sector and had already demonstrated its ability to grow and profit. Therefore, making Company #2 in a desirable position to purchase/acquire Company #1.

SUMMARY

Because of the Startup vs Acquisition — A Comparison of Two Entrepreneurship Models, it’s easier for one company to acquire another company. By using a strategy for its acquisition, an organization can quickly became a dominant player in the industry. This type of acquisition will work best for entrepreneurs and venture capitalists with a proven track record in developing successful businesses. However, if you’re starting from scratch, it’s probably a better option to go for a startup rather than an acquisition (Don’t get me started on how hard it is though!)

Sam Palazzolo

Buy a Business – How to Make Sure You Are Acquiring an Industry Leader

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The Point: In most instances, purchasing an existing enterprise is less expensive than beginning from scratch when you buy a business. However, on the other hand, purchasing a business is also frequently far more expensive than starting from scratch in almost any other industry. This is because most businesses start out small and have only a slight chance of becoming profitable before they expand beyond their initial premise. For this reason, there is a substantial risk of losing money when you purchase a business. Therefore, a geographic location is one of the most important business attributes to consider when you are deciding whether to purchase an enterprise or not.

Entrepreneurship through Acquisition (ETA)

An enterprise, on the other hand, is a company with existing assets such as accounts receivable, inventory, and franchises. A business typically generates these types of assets from customers who pay their bills by credit card or electronic check. Generally, the longer it takes to bill a customer, the more profit that the business will generate. Therefore, if your customers are able to pay their accounts receivable on time, you do not lose money when you are buying an enterprise. On the other hand, if customers run away from your company, you could be faced with a flood of checks and a loss of revenue for several weeks, even months.

The Financials Matter in Entrepreneurship

Because the amount of profit generated from each sale is directly related to the amount of cash flow that you have available, it is essential that you make sure that you can service all of your customers within a reasonably short period of time. In addition, it is essential that you make sure that you have enough cash to service all of your current accounts receivable balances. If you do not have a strong cash flow performance, you may encounter difficulty in meeting your financial obligations. Therefore, it is imperative that you do everything possible to improve your cash flow if you are going to buy an enterprise.

Financing the Acquisition

In many cases, business owners try to buy businesses even if they do not have enough financial resources to finance the purchase. It is essential that you carefully consider your ability to pay cash for the asset that you are buying. For example, many business owners are willing to spend more than ten percent of their net worth just to purchase an industry leader. It is important to remember, however, that this purchase will cost them at least ten percent of their net worth at the end of the term. Therefore, if you are willing to pay more than ten percent of your net worth just to buy an industry leader, you should also be prepared to lose ten percent of your net worth when the industry leader decides to file bankruptcy.

Entrepreneurship through Industry Leader?

If you are going to purchase an industry leader, it is important that you do not rely on your accountant’s preliminary analysis as you do with many commercial purchases. The preliminary analysis provided by your accountant will provide an overview of the company’s financial results for the last three years. However, this analysis is not a full analysis and it does not take into account all of the relevant information related to the company’s business model. This means that the preliminary analysis can be quite wrong. As a result, you should make sure that you have the final analysis from a reliable source and that you understand what the company’s liabilities and assets are.

SUMMARY

When you are looking at purchasing an industry leader, it is also important that you consider the costs associated with the transaction. For example, if the transaction is expected to result in annual recurring expenses of ten million dollars or more, you should use the services of qualified accountants who can provide you with the financial statements and other documentation that you need to make an informed decision. Also, it is imperative that you understand how the tax returns of the company impact its acquisition and whether the acquisition will have a significant effect on the company’s ability to obtain financing in the future.

Sam Palazzolo

Acquisition Entrepreneurship – Selecting Professional Advisors

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If you’re a leader thinking about making a change in your career, a new MBA looking to launch into leadership, or maybe a seasoned entrepreneur through acquisition you know that the road to identifying an organization to purchase is littered with the corpses of  those that did not conduct thorough enough due diligence. In this series, Acquisition Entrepreneurship, I’ll tackle the topics that will make your journey on that road less risky on the way towards successful acquisition of a new entity. In this post, we’ll explore the Professional Advisors recommended to assist you towards acquisition… Enjoy!

Acquisition Entrepreneurship Selecting Professional Advisors

Selecting Professional Advisors

An Accountant and a Lawyer are two of the most important advisors you’ll want to engage during your due diligence phase in acquisitions. You should look for those accountants and lawyers skilled in working with similarly sized firms as the one you’re exploring (Typically, those that work with smaller firms).

The accountant should have familiarity with smaller firm’s accounting practices, including payroll taxes, sales tax, and noncash expenses such as bad debt reserves or accruals for sales force bonuses earned yet paid. The accountant should have well established protocols to quickly determine if the company has accurately accounted for these expenses.

The lawyer should know which contracts are successfully in play at the acquisition and typical terms and conditions therein. This could be the same lawyer that assisted with creating your Letter of Intent (LOI) as well as prepares the final acquisition documents.

Professional Advisor Fees

While accountant and lawyer fees typically vary, depending on geography and especially with the purchase of an organization that can last several months to a year, you could expect that accounting due diligence will cost somewhere between $20,000 to $50,000. The reason there is such a large range provided is that the cliché “it depends” is in play regarding how much work needs to be done to understand the company’s true financial picture.

Legal due diligence is more tightly focused and includes the cost to prepare purchase agreements and related documents. The fees one can anticipate typically are in the $50,000 to $75,000 range.

One last note on professional advisor fees, specifically contingency. In other words, you may want to see if both accountants and lawyers will work on a contingent basis and therefore get paid at the time of closing so that you won’t have to come out of pocket during the due diligence phase. Keep in mind that some professional advisors will do so, some won’t work on contingency. The bottom line is that you typically get what you pay for so select wisely but don’t eliminate these all too important professional advisors!

Other Professional Advisors to Consider

In addition to accountants and lawyers, there may be other professional advisors that you want to bring in while conducting due diligence. I’ve hired engineers to come and inspect manufacturing equipment, IT consultants to inspect software development, Environment consultants to gage appropriateness of the wet excavation procedures, and Marketing consultants to ensure accuracy in market potential was accounted for. Depending on your entrepreneur through acquisition strategy and the organizations you’re considering, it’s important to bring in the professionals at time of due diligence well before you officially take ownership (Again, it’s better to walk away from the acquisitions table because of issues identified by professional advisors than to sit at it and go hungry for a period of time because you didn’t employ them!)

SUMMARY

Acquisition Entrepreneurship is a great way to explore your entrepreneurial spirit and look to “buy then build” an organization (As opposed to the typically thought of entrepreneurial methodology of a startup). Regardless of the industry you’re looking in and the size of the organization therein, you want to ensure that you have the best team of professional advisors employed to serve you. This will help with risk mitigation regarding your entrepreneur through acquisition strategy.

Sam Palazzolo

PS – I’m typically asked what our Acquisitions Strategy is at Tip of the Spear. As such, we have summarized our Acquisitions Criteria here on our website: https://tipofthespearventures.com/acquisitions/. Please review and let me know if I can be of service.

Business Acquisitions – Initial Due Diligence Considerations

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I recently participated in a Business Acquisitions roundtable discussion. The roundtable was made up of acquisition entrepreneurs well known for their roles in company growth and market consolidation. As a result, these successes have afforded these entrepreneurs to live lives with considerably more independent lifestyles (especially for the more well-capitalized entrepreneurs present – perhaps a topic for another post). One of the topics discussed at the roundtable was from a participant’s question, “What considerations should I have when conducting due diligence during the business acquisitions process?” Often times, failed deals are the result of a lack of conducting thorough due diligence on key information items on the buyer’s part. The questions like those below in the areas of Seller, Market, Financials, Legal, Environment and Personnel are initial considerations that should not be overlooked:

About the Seller

Learning as much as possible about the seller’s motivation for exiting in order to provide important insight into what their exit target is. Questions to ask regarding seller due diligence include:

  • How was the business started?
  • Why is the business for sale?
  • Is the seller selling the entire entity or just the assets?
  • Is there a business plan in place?
  • What keeps the seller up at night?
  • If the seller is involved in the business: How much salary does the seller take (now/after acquisition)?  How much vacation (now/after acquisition)?

About the Market

A few questions about market due diligence:

  • What is the size of the market and what market share does the acquisition target hold?
  • To what level can the acquisition be grown to?
  • What are the biggest challenges to growth?
  • Who are the industry leaders (local/national/world)? Is the company considered a market leader in any aspect?
  • Does the product or service have a life cycle, or seasonality?
  • What would the business’ customers and competitors say this business does best?

About the Numbers

More than anything else, it is important to thoroughly understand the financial due diligence of the prospective business acquisition. To determine if the seller’s claims are supported by the figures, ask to review three to five years of history and future projections:

  • Sales
  • Revenues
  • Gross margin
  • Cost of Goods Sold (details)
  • Earnings before interest, taxes, depreciation and amortization (“EBITDA”)
  • Capital investments
  • Taxes
  • Accounts receivables
  • Accounts payable
  • Inventory

About Legal Issues

To avoid hidden surprises, it is important to dive into legal due diligence issues in the company, including:

  • Any possible future lawsuits (If so, due to what?)
  • Is the business location owned or leased (If leased, what are the terms?)
  • Is there proof all taxes have been paid?

About the Environment

Conducting environmental due diligence is a crucial initial step. Governmental guidelines can levy responsibility for environmental issues that existed prior to the current ownership. Find out about any hazardous materials/waste disposal or other environmental considerations that must be taken into consideration.

About the People

If purchasing more than just the physical assets of a company, a potential buyer should understand key personnel issues such as:

  • Who else (besides the seller) has equity ownership in the organization?
  • What employment agreements are in force (FTE/Contract)?
  • What role do other family members play in the business?
  • Who are the key people, what do they do and why?
  • Which key employees are most likely to leave if there is a sale, and why?
  • How well documented are the business processes?

Summary

Business acquisitions are a better way for entrepreneurs to go into business versus startups. However, with that said the business acquisitions market still is littered with deal casualties (Even with showing considerable upside versus startup entrepreneurship). Taking the time to conduct the proper due diligence is the key. Due diligence in the areas of Seller, Market, Financials, Legal, Environment and Personnel are initial considerations that should not be overlooked.

Sam Palazzolo

PS – My firm is actively pursuing business acquisitions of small businesses ($1-$10Million Annual Revenue). If this describes you/your business and you’d like to inquire about our business acquisitions process, email selections@tipofthespearventures.com.