Perhaps you are in your 30s – 50s and have either had a successful professional career or been an employee of a large company, but you’ve always wanted to pursue an entrepreneurial venture. If you fit this description you may have contacted business brokers, searched for businesses for sale, or put together a business plan for a new venture, but ultimately haven’t pulled the trigger because of what you will be giving up: a high salary with low perceived risk, predictable paychecks, and a life/career you have already “figured out”. Maybe you also wonder if you are too old to be switching careers and putting hard-earned capital at risk.

Those are all natural concerns, but I think that many people limit their thinking to what can go wrong, and don’t spend enough time focusing on what may go right. If this describes you, may I suggest reading an inspiring interview with the founders of California Pizza Kitchen in the Wall Street Journal, titled “Ditching the Courtroom for California Pizza Kitchen“?

The founders of California Pizza Kitchen gave up a successful criminal defense law practice in 1985 while in their 40s to start their restaurant empire. Now, 24 years later, California Pizza Kitchen is a publicly traded company that operates more than 250 restaurants in 33 states and nine countries; sells frozen products through Kraft Foods Inc.; and reports annual revenue of $677 million.

I was just reading an article titled “Agenda 2010” on ChiefExecutive.net, and was struck by how many of the CEOs were concerned that new government regulation, programs, spending, and tax increases could send the economy off the cliff in the coming year or two. They also commented about what they would be focusing on with their businesses in the coming year. One comment made by Mathur Kent, CEO of Coca-Cola, was “In a world of constant— not cyclical, but constant—cost pressures, our productivity efforts have never been more important.”

One of the ways to increase productivity is to focus on implementing a Lean focus. As a business broker I rarely see small companies that have adopted Lean principles so I suspect that the majority of businesses out there would benefit from learning about and implementing a Lean focus. Yet, there are many misconceptions about Lean, such as that it is solely focused on pushing employees to work harder so that you can get by with a lower level of staffing. Here are the primary principles of Lean as provided by Lean Enterprise Institute (lean.org):

1. Specify value from the standpoint of the end customer by product family.

2. Identify all the steps in the value stream for each product family, eliminating whenever possible those steps that do not create value.

3. Make the value-creating steps occur in tight sequence so the product will flow smoothly toward the customer.

4. As flow is introduced, let customers pull value from the next upstream activity.

5. As value is specified, value streams are identified, wasted steps are removed, and flow and pull are introduced, begin the process again and continue it until a state of perfection is reached in which perfect value is created with no waste.

While the Lean movement began in manufacturing, there is no reason that the principles can’t be adapted to any other type of business. Some of the benefits of Lean may include: 1, an easier to manage business; 2, higher profits; 3, less waste; 4, lower quality deviation; and 5, when you want to exit, your business broker will have a higher probability of selling the business for a good price.

Often small businesses aren’t highly systematized.  Those that are tend to be more marketable and attractive to buyers because there is a clear road map about how to operate the business.  If you are buying, or have bought a business that lacks good systems then improving the systems will not only make the business easier to successfully operate, but it is also a good way to make the business more marketable and valuable for a future exit.

If you’ve read many of my blog posts then you know I’m a strong advocate of strong business systems.  For business owners that aren’t sure how to do that I suggest they read the E-Myth series by Michael Gerber, Sam Carpenter’s “Work The System”, and become familiar with how to use a database program like Filemaker Pro to automate and systematize business functions.

A short article in the Wall Street Journal titled “How to Write an Operations Manual” provides a concise framework on how to structure writing an operations manual that makes the task less daunting – if you are trying to tackle that task I would recommend the article.

Last week there was a good article in the Wall Street Journal titled “Five Year-End Tax Strategies for Small Business” that has some ideas to slash your tax bill that are worth considering if your company’s fiscal year is the same as the calendar year.  However, if you are considering contacting a business broker to sell your business within the next three years you will want to think carefully about how managing your financials for a tax benefit may impact your business’ perceived value and marketability.  When you more heavily burden a year with expenses it generally has the effect of lowering the business’ value (particularly in the year prior to a sale).  It is unusual to be able to spend an additional dollar in a tax year and receive a tax benefit that is greater than the dollar spent.  Yet, reducing profits by that $1 usually has an impact of lowering business value by a multiple of that $1 spent.

So, if you are planning on holding your business for several years, then these tax avoidance strategies may provide some significant financial benefit, but if you are thinking of selling in the next few years you may want to talk with your business broker to discuss how taking advantage of tax avoidance strategies may impact business valuation.

Following is a link to a short video that is a brilliant defense of Capitalism by the late Milton Friedman that merits attention:

The Wall Street Journal has an interesting short article, “How do I Pick a Successor?“, which contains some suggestions on identifying a new leader for your family owned business if you want to step down.  While the advice is sound, I think the writer, Colleen Debaise, should have asked an additional question:  instead of focusing on a successor and retaining ownership of the company, does it make more sense to sell the business?

Unfortunately, many businesses decline during a second or third generation of family ownership.  There are a variety of reasons this may occur.  Regardless of the reason, it may be better for the well being of the family to sell the business, rather than dealing with the family politics and financial issues of succession.  It is not uncommon for a business buyer to retain well-performing employees who would like to continue working in the business, so a sale of the business doesn’t necessarily mean that family members will be without jobs.

Capital formation has never been more challenging for small businesses.  Banks have become ridiculously restrictive in small business lending, friends & family have less capital available and are more conservative about investing it, and angel investors & VCs are more selective than ever about the deals they are willing to do.  Consequently, if you are trying to build a business right now and have limited capital you will have to be more creative to achieve growth.  Some call this “Bootstrapping”.

Garage Technology Ventures, an early stage technology venture capital company, produced an audio (mp3) broadcast, “The Art of Bootstrapping,” that has some excellent ideas on how to bootstrap a business.  Check it out!

With all of the layoffs and high unemployment rate that is projected to continue for many months, many people are considering business ownership as an alternative to looking for a job.  While I’m a HUGE proponent of entrepreneurship, it isn’t for everyone.  Here’s a link to an article in the Wall Street Journal that has some interesting things to think about in deciding whether business ownership is for you:

How to Decide if Entrepreneurship is Right for You

Codiligent business brokerage primarily represents business sellers.  Usually when active buyer representation is provided it is for companies who are seeking to acquire specific types of businesses as strategic acquisitions, and have concrete acquisition criteria.  However, during the recession it has been more of a buyer’s market, so in recent months Codiligent has provided more general buyer representation than usual.

It has been interesting to deal with a variety of business brokers who are representing sellers of businesses.  It has confirmed to me that business sellers should be very careful about who they choose to represent them.  Here are some of the things I have experienced:

1.  It is very common to have to be persistent and work hard at getting many brokers to provide information about a business (this shouldn’t be the case – they should make it relatively easy for qualified buyers).  Often, after submitting a confidentiality agreement, days or even weeks will go by before receiving additional information despite follow-up calls and emails.  I’m pretty certain that these brokers’ seller clients have no idea how unresponsive they are.  In contrast, Codiligent responds to about 80% of all inquiries within a few hours, 97% of all inquiries within 24 hours, and of the 3% that aren’t responded to within a day it is because of a weekend, holiday, or travel and will still be responded to in a relatively timely manner.

2.  The information that most brokers provide is insufficient to make an informed decision about whether a business may be appropriate to explore further.  Even after signing a confidentiality agreement, most brokers provide little more than 1-7 pages of qualitative information and financials or tax returns.  When you ask follow-up questions, those brokers immediately want to schedule a meeting with the owner rather than answer the questions (I suspect because they don’t know the answers).  Yet, meeting with an owner when unknown basic information may make the business an inappropriate fit  is not a productive use of the seller’s or buyer’s time.  In contrast, Codiligent provides a 3-6 page overview of the business upfront, and then after receiving a confidentiality agreement a 60-200 page comprehensive confidential package of information is provided to qualified buyers.  While some business sellers would prefer not to spend the time up front compiling information necessary for the package, it will save them significant time during the business sale process by avoiding inappropriate meetings, answering follow-up questions, and having a deal fall apart during due diligence as a result of the buyer discovering facts about the business that should have been disclosed earlier in the process.  Having more complete information also gives buyers more confidence in the business, lowers their uncertainty, and increases the probability of a deal successfully being completed.

3,  Unfortunately, some business brokers really don’t have the knowledge or background to be selling a business.  This week I talked with a broker who didn’t seem to understand even basic financial statements or the difference between Inventory and Furniture, Fixtures, and Equipment (FF&E).  I asked him for a current balance sheet.   He faxed me an income statement and said, “here’s the balance sheet”.  I thought that maybe he simply had missed a page and was providing me with an updated income statement in addition.  So, I called him and told him I didn’t receive the balance sheet.  He said, “I thought that’s what you wanted – the P&L.”  I told him, “No, I wanted to see the balance sheet”, he then replied “well, the P&L should have all the information you need.”  I explained to him that it didn’t – my client wanted to see how much inventory the business currently owned.   So, he starts telling me about all of the FF&E of the company.  I told him that I wasn’t asking about equipment, I wanted to know what the inventory level was.  He said, “what do you mean by inventory, how is that defined?”  I don’t even know what to say about how inappropriate it is for someone with this level of a lack of knowledge to be representing someone trying to sell their business.

So, how do you go about choosing a broker?  I’ll cover this in more depth in another posting, but a few of the most basic things I would suggest you look for are: 1, the quality of the broker’s analysis and packaging of a business (look at samples or work they have done for other clients); 2, a broker who is very responsive to not just potential clients but also to buyers’ requests for information; and 3, a broker who has the right educational and professional background (i.e. formal education in business and finance – likely an MBA, CPA, or JD; and a professional background that is closely related to buying and selling businesses).

Someone asked me the other day what the genesis of the name “Codiligent” is for my business brokerage.  This is a relatively common question so I’ll answer it here.

Partnership

The “Co” in Codiligent is suggestive of the fact that there is a trusted partnership between my company and its seller clients.

Persistence

The “Diligent” part of Codiligent has a dual significance.  The first part of the significance comes from the dictionary definition of “Diligent:”  1.  constant in effort to accomplish something; attentive and persistent in doing anything; and 2. done or pursued with persevering attention; painstaking.  Selling a business is a very challenging process that requires constant, persistent, effort and attention.  Past clients agree that Codiligent is extremely persistent in doing everything it can to increase the probability of a successful sale.

Preparation

The second part of the significance of “Diligent” is in its relation to “Due Diligence” which is a very important part of the business sale process.  Due Diligence is the investigation or audit of a potential investment to confirm all material facts.  Many business sale transactions die when they get to due diligence because the business broker or investment banker has done a poor job of presenting the material facts of the business consistent with the reality that a buyer will discover during Due Diligence.  By doing a comprehensive analysis of the business and reviewing due diligence materials up front, and developing very high quality packages the Due Diligence process becomes a relatively easy process of verification, rather than a never-ending deal-killing process of discovery.  In fact, it is rare for a Codiligent deal not to survive the due diligence process, and it is rare for a price to be re-negotiated as a result of due diligence.

Partnership, Persistence, and Preparation.  These are the promises to clients that are in Codiligent’s name.

I had the opportunity to visit East Berlin in 1989 shortly before the wall separating east and west came down.  It was fascinating and something I wish every American had experienced.  Unlike the purpose of most walls and fences put up on government borders, the intent wasn’t to keep people out of East Berlin, but instead to ominously keep people in against their will.  It was a prison, of sorts.

When I first entered East Berlin I was encouraged to go to a “tourist” square where everything had been “dressed up” and relatively well-maintained by the government.  The government wanted to create the illusion that it wasn’t so different from West Berlin – and they did a decent job.  I recall thinking, “this doesn’t seem too bad.”  I had lunch at a restaurant and it cost me only a few dollars for a three course meal and a liter of beer.  The meal was good, but the beer was the worst I have ever had, to this day.

After lunch, we were encouraged to stay in the “tourist” area, but we weren’t restricted from going to other parts of town.  So, of course, I explored.  That’s when things started to get more interesting / disturbing.  A few observations:

1.  All of the cars (mainly Trabants) looked like they were built in the 1950s, despite the fact that many were recent year models.  When I asked about it I was told that since the government controlled the production of cars, there was no incentive for them to improve the vehicles – there wasn’t competition or choice – so why improve them?  I also learned that a used car usually cost more than a new car.  The reason?  If you want a new car you have to go on a waiting list for a few years before you could get one, because the government had no interest or incentives in meeting market demand.  Yet, there was immediate availability of used cars.

2.  Once you got away from the tourist area, the buildings became very run-down, dingy, and dirty.  Since there was no competition there was no advertising, no motivation to make stores more attractive or enticing to shoppers.  Everything was drab.

3.  I met someone who invited me to his apartment.  His family of four lived in about a 600 square foot apartment in a run-down, projects-style, building.  If you waited long enough and/or rose to a high enough position in the government you may get your housing upgraded eventually.

4.  I went to a small retail store that had a poor-quality walk-man-like cassette player that looked like something in the US that you’d get by sending in three cereal box tops and $2.  It was priced close to $100 (US).  I later asked someone about this.  They explained to me that such an item was considered by the government to be a “luxury” item.  The government didn’t want to prevent someone from getting one who really wanted it, but wanted to price it in a way that it would be a “splurge” while maintaining prices for housing, food, and other necessities at a very low level.

5.  I was on a bus, and at one point the bus driver stopped the bus and, while looking very paranoid (constantly looking out the window) he informed me that he was a medical doctor by training but because he had tried to escape, the government no longer allowed him to practice medicine and instead required him to be a bus driver.  He was blacklisted and was not allowed to communicate with people outside of East Berlin – even his mail wouldn’t make it to intended recipients.

6.  No one was smiling – everyone looked glum.  In fact, East Berlin looked like a horribly depressing place to live.  Sure, most people were “equal” (although some in the government were more equal than others), but the equality was one of poverty and subsistence not of abundance.

Lately there has been a lot more talk about shifting from a free market economy where  there is voluntary co-operation of individuals, to a system where there is more central direction involving the use of coercion by the government (think government ownership of automakers & banks, health care, etc).  I wonder if people realize that this is a move in the direction toward the failed models of post-WWII eastern Europe?  And, probably more important, do people really understand what this means?  Have they thought through the consequences?  Can they even fully comprehend what that feels like, if they haven’t experienced it first hand?

The late, great economist, Milton Friedman said, “The possibility of co-ordination through voluntary co-operation rests on the elementary — yet frequently denied — proposition that both parties to an economic transaction benefit from it, provided the transaction is bi-laterally voluntary and informed.  Exchange can therefore bring about co-ordination without coercion. A working model of a society organized through voluntary exchange is a free private enterprise exchange economy — what we have been calling competitive capitalism.”

Capitalism is by no means perfect, and is open to abuses, but I believe that it is a far more moral system than socialism, communism, and other systems that employ central government planning because there is no “coercion”, instead everyone can pursue whatever economic activity they choose “voluntarily”.  There is no doubt that there are many stories of corruption and greed in our capitalist system, for example the CEO that receives a $100 million bonus despite his company performing poorly and laying off 1,000 employees making $50,000 a year.  Yet, there are many stories that are taken for granted – the story of the entrepreneur that develops a new life-saving, medical technology that saves thousands of lives a year; the woman who created your favorite restaurant; the company that produced the I-Phone and I-Phone applications that make your life a little more efficient and enjoyable; etc.  I believe that Capitalism is responsible for far more good in the world, than evil.  Let’s not throw out the baby with the bath water.

It is natural for business buyers to become more cautious and conservative during a recession.  However, there is also the risk of being too conservative and missing out on the ability to acquire a business at the bottom of the market.  Warren Buffett is famous for declaring that he loves the buying opportunities during a recession “when everything is on sale”.  We have just been through the worst recession likely since the great depression.  Even if you disagree with that assessment, I think you’d agree that it is one of the four worst recessions of the past 100 years.  Often there are many people who do very well financially IMMEDIATELY FOLLOWING THE RECESSION.  Why?  Because they had the foresight and confidence to buy at, or near, the bottom of the market when nobody else wants to buy.

Many business buyers seem to be looking only for businesses that are performing well financially despite the down economy, but still want to buy at an excellent price.  While that may be possible with some businesses, unless the business owners are in an unusual personal situation that necessitates an immediate sale (such as health issues, or a death) it is unlikely that they will be motivated to sell at a phenomenal price.  Instead they will say (and rightly so): “why would I sell my business at a bargain price?  It’s performing well despite the recession!  If anything, this is proof that my business is a true winner with little downside risk, and should command a higher price.”

However, there are lots of businesses that have had strong past financial performance, and will likely have strong performance again in the future, but have more modest performance right now (or even are struggling) that do present some amazing buying opportunities right now.

Will you congratulate yourself three years from now for buying an excellent business at a very low price at the bottom of the market, or will you instead look back and say “if only I had bought that business?”

Some prospective business sellers tell me, “I don’t want to put in much time up-front in the business sale process, or provide much information.  I’ll give you my tax returns and current financials and we want you to come up with a value, and put together a couple of pages of information about the business that can be provided to buyers who submit a confidentiality agreement.  Let’s just see if there are buyers out there and then we can deal with getting them more complete information if they are interested.”  This is a terribly short-sighted way of marketing a business.  I believe that doing so significantly decreases the probability of a successful sales outcome, and is in neither the best interest of the business owner or the business broker (for this reason, Codiligent will not provide this type of representation).

Here are a few of the reasons why:

1.  You want your business broker to become intimately familiar with your business so that they can effectively sell it.  If a business broker does a comprehensive review of the business they will develop a far more intimate and comprehensive knowledge of the business which will allow them to more effectively promote your business, confidently answer buyer questions, and respond to objections.  A business broker who is provided with only limited information and/or who doesn’t do a complete review of the business is unable to represent you as effectively.

2.  There are a variety of issues that could impact value and marketability that may not be discernible by simply reviewing the past two years tax returns.  For example:  Are there proprietary systems or other types of intellectual property that give the business a significant competitive advantage?  Is there a high concentration of revenue from a few key clients where if one were lost it would have a disproportionate impact on the business?  Are there any key contracts that are expiring?  Are there any outstanding claims or legal issues that may cause the business to change its operations?

3.  Doing a comprehensive review of the business helps in establishing a defensible, realistic value and an appropriate pricing strategy.  A simplistic multiplier approach or rule-of-thumb for valuation may significantly under-value or over-value a business.

4.  Any serious buyer who considers moving forward with an acquisition of the business will insist on reviewing far more information prior to buying the business.  Consequently, you will have to provide the information eventually, anyway, so why not take the time to do it right by providing complete information up front.

5.  A large part of having a business sale succeed is in establishing the buyer’s confidence in the business and reducing uncertainty.  Providing solid, complete information without delay decreases buyer uncertainty and increases confidence.  Contrast this to a buyer asking a broker a question that requires information from the business owner.  Perhaps the business buyer emails the question to the broker on Thursday morning, but the broker doesn’t get it until Thursday afternoon due to being in a meeting with another client.  The business broker doesn’t have the information requested so they contact the seller.  The seller says he will have to get the information requested from his CFO.  The business broker reports back to the buyer that he should have the information within the next couple of days.  However, unbeknownst to the broker the CFO is traveling until Tuesday.  On Friday the broker still hasn’t heard anything back, so he calls the business owner but only gets voice mail and doesn’t hear anything back, since the business owner assumes his CFO is dealing with it.  On Tuesday the CFO gets back, but is buried after being gone for a couple of days and doesn’t get the information back to the business broker until the following Thursday.  So a week has gone by.  What’s going through the buyer’s mind?  ”Gee, I thought I made a pretty simple request for information.  Why is it taking so long to get it?  Are they serious about selling?  Are they disorganized?  Is there a problem with the information I requested that they are trying to fix?  Maybe I should give more attention to another business I was considering.”

6.  You run a greater risk that the price and terms will be re-negotiated as a result of due diligence, or worse – that the deal will die.   If a buyer makes an offer based on incomplete material disclosure and then during due diligence discovers new information, there’s a good chance that they will use it to negotiate a lower price than they originally offered, or, if the information is significant enough, they may back out of the deal.  This is problematic for another reason:  most Letters of Intent call for an exclusivity period for the buyer from the time the Letter of Intent is signed until they complete due diligence (often a 2-4 week period).  This means that active marketing and communication with other buyers must cease during this time frame, so in essence the business is off the market for 2-4 weeks.

Codiligent strives to do everything possible to increase the probability of attracting the right buyers, getting them to complete a transaction, and pay the best possible price and terms.  As a result, the business selling process is necessarily front loaded with information requests, analysis, packaging of the business, and researching logical buyers.  This is often one of the most important transactions of a business owner’s life, and it deserves to be handled as such.  Yet, just because the process is comprehensive doesn’t mean it will take significantly longer than if handled by a broker who fails to do a similar up-front process.  Codiligent has developed a proprietary process and methodology that makes the collection, analysis, and packaging of the business VERY efficient.  It is not uncommon for a 60+ page analysis, initial information package, and a 100+ page confidential information package to be developed within two weeks.

Many small business buyers, sellers, and business brokers like to utilize a Seller Earnings Multiplier to arrive at an estimate of value.  Using this approach you would look at the sale prices of other similar sold businesses as a multiple of their seller earnings.  This would then be multiplied by the seller earnings of the business being valued to calculate an estimate of value.

There are many reasons why I believe this simplistic approach to value is problematic.  I’ve written about some of these reasons in other blog posts.  Today, I’d like to focus on one of the most common problems I see with this approach in businesses that have two or more owners who work in the business.

First let’s define “Seller Earnings” or “Seller Discretionary Earnings”.  These terms refer to Earnings Before Interest Taxes Depreciation and Amortization (EBITDA) with any expensed compensation for one owner added back.  The end of the last sentence is very important – notice how I said “ONE OWNER”.  A common mistake I see made is that businesses with two or more working owners will add back the expensed compensation for all owners.  The problem with this is that it overstates the Seller Discretionary Earnings, since the Seller Discretionary Earnings reported in sold business comparable databases includes the expensed compensation of only one owner.

For example, let’s say that for a particular industry the average Sale Price – to – Seller Discretionary Earnings (SDE) is 2.50.  If Business XYZ has $150,000 of EBITDA and there are two working owners who are each taking expensed compensation out of the business of $70,000, some people will mistakenly report the business’ SDE as being $290,000.  However, the correct SDE should be $220,000 if including only one working owner’s expensed compensation.  Using this example, if a person incorrectly adds to EBITDA both of Business XYZ’s working owners expensed compensation the estimate of value would be $725,000, but if calculated correctly with only one owner’s expensed compensation added back it would $550,000.

I find that many of the business sellers I work with don’t really have plans to totally retire after a sale of their company.  Instead, many have other entrepreneurial ambitions or philanthropic endeavors they seek to pursue.  Regardless of whether you plan on playing golf, starting a new business, spending more time with your family, writing the great American novel, or leading a non-profit my question is “what are you going to do IMMEDIATELY after the sale of your business?!?”

After spending years of hard work building a successful business, you deserve a break.  Here are a few suggestions for vacations based on some of my favorite vacation spots in the world:

The Boulders at Singita, South Africa

This African Game Resort has only 12 bungalows on the property.  The bungalows are a spectacular blend of traditional African design and materials with a modern feel.  Each has an enormous private deck with outdoor shower and private soaking pool, and a wall of glass separating the interior from the exterior.  The gourmet food is excellent and the game viewing is abundant (leopards, cheetahs, hyenas, lions, rhinos, elephants, hippos, etc.).  Don’t just take my word for the quality of this resort.  It has been rated number 1 or 2 in the world by many of the leading travel magazines including Travel & Leisure’s #1 Hotel in the World for 2008 and Conde Nast Traveler’s Reader’s Choice #1 in Africa and the Middle East in 2006.  Looking for a tented safari?  May I suggest contacting Ker & Downey Safari Company for assistance with planning a tented safari in Botswana?

Kea Lani Resort in Maui, HI

While the island of Maui has lots of great things to do, I could easily spend a week at the Kea Lani and never leave the property.  With five excellent restaurants on site, a private beach, 3 swimming pools (including an adults only pool), and a full service spa it’s a great place to unwind at a leisurely pace.  If you want a little more activity the award-winning Wailea Golf Courses are a stones throw away.

Fusion Suites, Amsterdam

This is my ultimate boutique hotel.  Some may consider it a bed and breakfast because it only has four suites, but referring to Fusion Suites as a bed and breakfast doesn’t do it justice.  This is more like staying in a friend’s mansion.  The decor rivals that found at the finest hotels in the world.  The proprietors, Sharmilla and Alex, demonstrate exceptional attention to detail that leads to an unparalleled customer experience.  The location is in a tony neighborhood next to beautiful Vondelpark – removed from the seedy areas of Amsterdam, but still close to many tourist sites and excellent restaurants.

I’d love to hear some of your favorite vacation spots.  It seems like it can sometimes be difficult to locate resort and hotel properties that are truly unique and special.  One hotel/resort website directory that seems to have done a great job of screening quality properties that I would like to share with you is Kiwi Collection, www.kiwicollection.com

While I believe that our economy is starting to show signs of recovery, I know that many economists believe that the recovery will be slow and gradual.  Consequently, I know that many business owners are eager to accept any and all business that they can get, consistent with the old adage, “beggars can’t be choosers.”  However, pursuing all business that is available is not necessarily a wise move.  Growth has its own set of challenges, and prospective clients who compromise or complicate a business or aren’t consistent with a company’s long-term strategic goals may not be worth pursuing.

Recently, this has become an issue for some small businesses that may be able to achieve a significant, but temporary, increase in business as a result of government stimulus spending.  To accommodate that growth a business must be able to ramp up, but then also successfully ramp down when that stimulus money is no longer available (unless there are replacement clients).  That is often easier said than done.

In the September 3, 2009 issue of The Wall Street Journal, there is an article that describes some of the challenges and concerns about ramping up a business to meet temporary demand.  The article is worth reading (follow the link).  It is written by Michael Sanserino, and is titled, “Stimulus Holds Peril for Firms: Burst of Government Spending Complicates Planning.”

One of the things I enjoy most about being a business broker is that I am exposed to many different business models.  I am able to look behind the curtain of many privately held businesses and intimately learn about how entrepreneurs are running their businesses.  I recognize that most people don’t have this opportunity – yet, there is much to be learned by understanding how other entrepreneurs are doing things.

If you would like to learn a little more about some of the most successful entrepreneurs out there, may I suggest subscribing on iTunes to the free Venture Voice podcasts?  You can also listen to the audio interviews directly on Venture Voice’s website:  www.venturevoice.com

It is an exceptional time to be buying a small business.  Here’s why:

1.  Many businesses have experienced lower financial performance than in the past due to the general economic downturn, and this contributes to lower values / prices.  For example, if you see a business that had $250,000 in cash flow three years ago, $200,000 in cash flow two years ago, and $100,000 in cash flow last year it initially may look like a troubling trend.  However, if the business is still a sound business, the competitive environment is still relatively similar to how it has been in the past, and the product/service offered is still viable then there’s a good chance that the reason for the decline in financial performance is more directly related to the decline in the economy.  If you can develop a comfort level that this is likely the case, then it is reasonable to believe that there’s a decent chance the business will recover along with the general economy.  However, you should be able to acquire the business at a price that reflects the most recent financial performance.

2.  It appears that our economy has hit bottom and is starting to show signs of improvement.  Have you ever looked back at times when you could have bought something at the bottom of the market, and said, “If only I had bought at that time . . .”  Well, this is likely that time.

3.  There is less competition for businesses right now.  While there are many people looking at businesses right now, many are not buying, which I believe is a reflection of being concerned about downward trends in recent company financial performance and a general uncertainty about the economy.  If we were in a strong growing economy and a business was trending down, then I would be very concerned.  However, if a business is still having decent financial performance despite being in the worst recession since the great depression, I believe that a downward trend is something that buyers should be less concerned about if they anticipate that the economy is now on the mend (even if a slow gradual improvement is expected).  Lower competition from other buyers should translate to attractive prices and better deal terms.

4.  Interest rates are low.  Sure, I recognize that obtaining bank loans for business acquisitions is more difficult right now.  If you can get a business loan it will likely have a historically low rate on it, though.  If the business isn’t financeable with a bank loan, then perhaps a seller is offering to carry a note to finance a portion of the price.  If that’s the case, then sellers will tend to have a lower expectation on interest rate than at other points in time.  You may be able to get a seller to carry financing at a 7%-9.5% rate rather than a more common historical range of 9%-14%.

Have you watched the HGTV show “Designed To Sell”?  It’s one of my favorite TV shows.  In it, someone is getting ready to try to sell their house, and a professional stager is employed with a budget of $2,000 to use for fixing up the house and staging it to increase the probability of a successful sale.  I’m always amazed at how much better the houses look after the professional stager spends the $2,000.  However, there are a few things that no matter what the condition of the house the stager almost always does:  get rid of junk and clutter, properly store and organize things, and simplify the look and feel.  While a business sale is far different from selling a house, prospective buyers will still develop a strong impression of the business based on how it physically looks and feels when they visit.  So, just like on Designed to Sell, when you are preparing to sell your business you should do some physical clean up of your business.  You should ask your business broker for advice on what should be done to make the business physically more marketable.  Here are a few suggestions of things to consider:

1. Do you have obsolete, worthless, or unneeded equipment or furniture cluttering your office, manufacturing facility, store, or warehouse? If so, and it won’t have any value to a buyer, get rid of it.

2. Is your business in need of interior painting? Even if you have a manufacturing business or a warehouse-based business, if the walls are scuffed or dirty, it will create a less positive impression than if the business looks clean.

3. Are desks and work spaces clean and organized? If employee desks and work spaces are cluttered buyers may get the impression that the business is chaotic, confusing, poorly run, and possibly under-staffed.  Implementing and/or enforcing a policy for employees to keep desks and workspaces organized and clean is a good use of time and energy prior to selling a business.  If there is inadequate storage space, consider getting more cabinets / storage containers or using off-site storage for items that aren’t utilized on a daily basis.

4. How do your employees look? How employees dress and are groomed can vary dramatically from one business or industry to another.  Before selling a business it may be worthwhile to assess whether your dress code is appropriate and being adhered to.

5. What music is being played in the work environment and at what level? Notice that when you go into a nice retail store that has the “shopping experience” down pat, or a Starbucks there is usually pleasant music playing in the background at a low enough volume that you can easily have a conversation.  These businesses have figured out that sound is part of the customer experience, but that appropriate volume is critical.  It is not uncommon in warehouse and production businesses with loud machinery for employees to have music loudly playing.  I would encourage you to require music to be non-offensive and be played at a low level when giving prospective buyers a tour of the business.  Better yet, select music that you believe is a good complement to your business.

6. Are the bathrooms and break room clean? Bathrooms and break rooms that are dirty can produce a visceral turn-off for buyers.

7. Do the carpets or floors need to be cleaned? Have you ever noticed how Les Schwab Tires’ gleaming floors convey a sense of quality and competence?  In contrast, if you’ve ever been in a grocery store where there was an obvious spill that didn’t get cleaned up and has left a dry ugly spot on the floor, the perception of that store’s quality is often impaired.

8. Are there burned out lights that need to be replaced? Not only do burned out lights create a negative quality impression for a buyer, but they also may make it difficult to see what the prospective buyer may be acquiring.

9. Is the landscaping and exterior of the building clean and in good repair? As a buyer approaches your building they will begin developing their first impression of the physical business, and will subconsciously determine whether the information they have reviewed in the package seems consistent with the quality they are observing.  Cigarette butts or garbage in the parking lot, overgrown landscaping, or chipped paint can all lead to a negative first impression.

10.   Is there any minor maintenance or repairs that are needed for the building, furniture, fixtures, or equipment? Deferred maintenance may send the signal to a buyer that the business is not producing enough cash flow to take care of necessary repairs or that the business may not be well managed.

In today’s (August 19, 2009) Wall Street Journal, an article titled “Private Equity Holds Its Cash . . . And Waits”, reported that the private-equity industry manages $2.5 trillion in funds, a 15% increase from 2007, and of those funds about $1 trillion are available for investment (i.e. they are sitting on cash rather than invested in portfolio companies).

The article says that last year private-equity firms attracted new funds at more than twice the rate they made investments, and “The accumulation of cash could signal that private-equity firms expect the pace of deals to pick up soon or that they want to avoid a scenario in which they don’t have the funds to exploit an economic recovery while rivals ride bargain prices to stellar returns.”

I believe that with the majority of economists stating that the economy has hit bottom and is now slowly starting to recover that we will start to see a significant increase in the number of acquisitions made by private equity groups.

I represent business sellers whose companies have between $500k and $20 million in annual revenue.  This size range is too small to be of interest to the majority of private equity groups.  However, as the private equity industry has grown over the past several years, increasing competition for the limited number of large company deals has caused more private equity firms to start looking at smaller deals.  In my buyer database I have several private equity firms that have expressed interest in acquisitions of companies with less than $20 million in revenue.

Over the past 12-18 months, there have been lots of buyers sitting on the fence – from private equity groups to acquisition-minded companies to individual business buyers.  The economic and political change and uncertainty has left many of them preferring to do nothing.  As things begin to stabilize and mild recovery is perceived, I believe serious buying activity will substantially increase.  For business owners who would like to sell, but who have been also sitting on the fence, it may be time to start preparing to market your business.

If you’ve looked at buying a business that has been represented by a business broker you will undoubtedly have been required to sign a confidentiality agreement or non-disclosure agreement before obtaining confidential information about the business.  As a business broker, sometimes I receive resistance from buyers in signing these.  Quite frankly, I find that a bit puzzling.  I think it is very reasonable for a business broker and business seller to expect that a business buyer will hold information disclosed in strictest confidence.

In addition, many brokers (myself included) will require that prospective buyers submit a certified statement of personal worth.  Sometimes there is resistance to this from buyers, as well.  Yet, if a business seller is going to provide an abundance of detailed confidential information on their business, it isn’t asking much to require a certified statement of worth to make sure that it appears that a buyer has the financial ability to do the deal if they choose to move forward, before releasing confidential information on the business.

A less commonly requested document from business brokers is a resume or bio.  Yet, when a buyer submits such a document it can give a seller more comfort with the buyer and helps the seller understand the buyer better and whether their background is likely a good fit for the business and what type of transition training would be needed.  For example, if a buyer has an accounting background then the seller and business broker may not need to spend as much time explaining the financial statements or the accounting system (and training on these issues), but may need to spend more time discussing marketing challenges and opportunities.

I would encourage all serious business buyers to have a current certified statement of worth on hand, as well as a bio or resume, and to willingly provide these documents.  They serve a productive purpose, and it also helps in building the buyer/seller trust relationship which is essential to getting a business transaction completed.

In the Wall Street Journal today, there is an article titled “Economists Call for Bernanke to Stay, Say Recession is Over” that may be particularly interesting to business brokers and business owners who are considering a sale of their companies.

The WSJ surveyed 52 economists and 47 responded.  Out of those surveyed, 28 believe the recession has ended within the last 2-3 months.  Another 10 economists believe that the recession will end by the end of September.

Another important issue is that 27 of the economists believe that the Fed will raise interest rates in 2010, with the majority of those thinking the rate increase will be coming in the second half of 2010.  If you’ve read my past blog posts, such as the one titled, “Start of the recovery? Time to think about selling your business“, you will understand why this is important, but allow me to reiterate the primary reasons that it may be an excellent window of opportunity if you are planning on selling your business.

During the recession most buyers were naturally very conservative about whether to buy a business and the price they were willing to pay.  This makes a lot of sense, because in addition to normal specific business risk, they were also uncomfortable about the risks associated with further declines in the economy (i.e. “where’s the bottom?”, “How much worse are things going to get?”).  However, once buyers feel comfortable that the economy is improving, even if not dramatically, they will become more comfortable with buying a business.

Those businesses that have performed well despite the recession will stand out even more in comparison to those that didn’t fare so well during the downturn, but that comparative advantage will start to erode as the economy improves and more businesses start showing improved performance.

Yet, as the economy improves the Fed will eventually increase interest rates.  The prediction that the Fed will raise rates in the second half of 2010 will have an impact on business values.  Aside from simply costing buyers more money to use debt financing, the increase in interest rates will impact the cost of capital which has a negative impact on business valuation.  All other things equal, an increase of 1% in US long-term Treasury Bonds may reduce the all-cash price that a business seller will achieve by about 5%-7%.

Consequently, I believe that between now and July of 2010 will provide an excellent opportunity to sell a well-performing business.  Since an average marketing time-frame for a small business being represented by a competent business broker is 6-9 months, I would encourage those who are considering a sale to start the process sooner rather than later (my recommendation would be to start the process now, or at the latest by December) in order to take advantage of this window of opportunity.

Frequently I interact with prospective business buyers who report that they are having trouble finding appropriate businesses to acquire and when they do find ones they like they can’t get a deal done.  A few prospective buyers I know claim to have been aggressively looking for 2-3 years during which time they haven’t bought even one business.  There’s no doubt that finding and buying a business can be a difficult process.  However, there are some business buyers who manage to find and successfully buy multiple businesses within a short time frame.  In the July/August issue of Inc. Magazine, there is an article worth reading titled “How I Did It:  Richard Heckmann“.  The subtitle reads “Buy Fearlessly, Sell Ruthlessly; Repeat Regularly.”  Richard Heckmann was the largest shareholder and CEO of U.S. Filter in the 1990s.  The business was a struggling company with $7 million in sales, until he pursued an aggressive acquisition strategy, completing 260 acquisition, after which he sold the business for $8 billion in 1999.  He then went on to do 26 acquisitions to expand sporting-goods maker, K2, after which he sold that business for $1.2 billion in 2007.

I’ve never met Richard, and I don’t know what his acquisition criteria and strategy are.  However, I do have some suggestions for those who want to acquire a business, but may not be having success:

• Utilize a system / method of analyzing businesses.  While every business is unique, I find that most small business acquirers don’t seem to follow any consistent process for analyzing a business.  In the future, I will be writing a series of articles or a book on a suggested methodology for analyzing a business and determining whether or not it may be a good acquisition.
• Be comfortable with paying an appropriate price and terms.  Many business buyers seem to be looking for a business that appears to have a low price and significant seller financing terms.  While everyone likes to get a good deal, sometimes the best deal is to pay a good price for a great business, rather than paying a low price with seller financing for a mediocre business.
• Develop a positive relationship of trust with the broker and seller.  Some buyers seem to think that an effective negotiation strategy for buying a business is to berate the business, feign disinterest, and employ aggressive negotiation tactics.  In the acquisition of a small business where the seller is the founder of the business, this usually backfires.  Remember, that the seller often has a lot of ego tied into the business.  Usually a better approach is to build a positive relationship of trust with the seller.  Many sellers would rather be flexible on price and terms with a buyer they really like and think would be a good match for the business, than someone they feel is disrespectful, arrogant, and trying to nickel and dime them.  If there are pricing or deal term issues, a buyer will usually do better if they continue to express all of the things they like about the business, but objectively point out why the risk/reward relationship isn’t consistent with their expectations, while suggesting changes to pricing and terms that would make them comfortable and why.
• Utilize CPAs and attorneys correctly.  Sometimes business buyers expect that their CPA or Attorney’s role should be to tell them whether or not they should buy the business.  If that’s a buyer’s expectation then they will probably hear “no” on most businesses they are looking at, including those that may be excellent acquisition opportunities.  I would suggest that a better use of advisors is to ask them to help understand the financial performance of the business better and to identify risk factors.  The business buyer should make their own decisions about whether the business is an appropriate acquisition based on their preferences, criteria, and risk tolerance.
• Don’t expect perfection / have realistic expectations.  Some business buyers remind me of the guy in his early 20s who is looking to date a woman who has super-model looks, is ivy league educated, has a high-power career, comes from tremendous wealth, enjoys sports, likes action films instead of the ballet, is laid back, family focused, a great cook, very domestic, likes doing housework, caters her schedule to his, is faithful, and has great values.  Such a woman may exist, but good luck finding her!  No business is perfect or will likely meet every acquisition criteria.  Businesses are always in a state of flux and will always have challenges and areas that can be improved.  A buyer who shuns businesses that have any challenges or problems will likely be forever looking for a business to buy, but never finding one.
• Be decisive.  After marketing a business for about a month last year, a buyer, we’ll call him John, expressed serious interest.  John, asked all of the right questions, and spent significant time analyzing the business, its operations, its market, and its financial performance.  He liked the business, but wasn’t ready to make an offer.  There were no additional questions asked after that, John was simply trying to decide whether to make an offer based on his evaluation of the business.  About a month later he made an offer: coincidentally on the same day that another offer was received.  The seller ended up going with the other offer.  Had John been more decisive, he would have likely succeeded in buying the business.  The delay in submitting an offer, accomplished nothing – no additional information was gained during that time, but what it did do was allow enough time for a competitor to submit an attractive offer.
• Submit an offer.  Suppose you are looking at a business and the asking price is $3.2 million, yet after doing a careful evaluation of the business you find that you are not comfortable paying more than $2.5 million.  The broker has said that the price is very firm.  The only way to really test whether that is true or not is to submit a Letter of Intent.  Putting an offer in writing with as many of the anticipated terms outlined as possible is the best way to determine if there is any common ground that can be found.

A friend of mine who has been involved with many large private company and public company mergers and acquisitions shared with me some very relevant advice a few years ago:  “Time kills all deals.”  His point was that no mater how motivated both a buyer and seller are, if enough time passes after a buyer becomes interested in a business but before it closes, the deal will die. My experience has been that he is correct – business sale transactions, are, indeed, fragile.

So what happens that can cause a deal to die despite an initially motivated buyer and seller?  Here are a few examples:

• The financial performance of the business changes.  This can be either an improvement or a decline in the business.  If it is an improvement, the seller may no longer be willing to sell for a price and terms that the buyer is willing to pay.  If it is a decline in performance, the buyer may be nervous that the business will trend downward and may become uncomfortable with moving forward, or may try to renegotiate price.
• There could be a change in the buyer’s ability to fund the deal.  A buyer’s investment that went awry, other more pressing cash needs, or a lending relationship that soured could all result in a buyer having less capital available than anticipated.
• A shift in the market, economy, or either the buyer or seller’s industry could impact a buyer’s strategic and investment goals.
• A more attractive opportunity may be discovered by the buyer.
• Deal fatigue.  Buying or selling a business can be a very time-consuming, stressful, and distracting activity.  Over time one or both parties could decide that doing a deal just isn’t worth it.
• Unexpected litigation, a claim, or another significant problem could arise for either the buyer or seller.
• The death or ill health of either the buyer or seller.
• Passage of new regulations or laws that could impact the business.

The best way to handle the risk of time killing all deals is preparation.  At Codiligent business brokerage it is my aim to make sure that we have prepared as thoroughly as possible for the sale before a business is actively marketed.  This way, when we do receive an offer, we aren’t usually causing delays by waiting for significant information requested by a buyer.  A business owner can help avert this problem by making sure that they are highly responsive to requests for information from the broker and buyer.