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How to Buy a Business

Apparently sellers of businesses are far more gullible than buyers of businesses.

Businesses may want to be a bit more skeptical when dealing with potential suitors. That’s because a new study in the Academy of Management Journal has found that acquiring companies tend to trust less and deceive more than the businesses they buy.

The study examined the issue of trust between 12 entrepreneurial businesses and eight acquirers, and found that tensions between buyers and sellers appeared to start right at the screening phase and continue throughout the deal process.

“Sellers tend to eliminate partners they distrust, while buyers did not,” the study’s author, Melissa Graebner of the University of Texas at Austin, said. “So this creates a fundamental asymmetry in which most sellers trust their buyers, but most buyers distrust their sellers.”

Such material deception includes misleading sellers about post-integration plans like layoffs, relocation of personnel, changes in strategic direction or diminished roles for senior managers, the study finds.

These deceptive tactics tend to be very distressing to the seller after the deal is complete, as they tended to be extremely trusting, according to the study. That’s because the sellers often did not heed the advice provided by their own bankers and lawyers to protect their businesses and hold the sellers to their word.

“Unlike buyers, they believed they were dealing with trustworthy parties,” Professor Graebner said. “Due diligence and contractual safeguards simply did not seem necessary to sellers when dealing with trusted buyers.

As I was reading this my hunch was that these were small business sellers divesting themselves of companies under $10,000,000 in price. Turns out that the average transaction studied was $175 million. How does anyone build a company to that size and still remain naive?

Based on my humble experience, both sides need to exercise a healthy dose of skepticism when negotiating a transaction. Sellers of small businesses (<$20 million) are frequently tempted to exaggerate the facts about their business’s profitability. For example, it’s rare that an owner doesn’t confess to additional, yet unverifiable, income which he then expects the buyer to pay for.

How accurate are the numbers the broker gives you on the business?

It all depends. In some cases, they may not represent an accurate picture of the present condition of the company. There are two reasons for this. First, the broker relies on the seller for all the information that he passes onto prospective buyers.The point I am making here is that a broker doesn’t verify any of the claims of the seller. He simply packages the information into a standardized format and releases it to qualified buyers. In other words, he is trusting that the seller is being honest about the business. It’s totally up to the buyer then to conduct a proper due diligence on the company and unearth any discrepancies in the information, outright lies, as well as potential threats the owner may not even be aware of.

Second, the seller may be supplying accurate information to the broker but dragging his heels about doing so. With some sellers it’s very difficult to get the last month’s numbers in a timely fashion in order to update the 12 month trailing average results. This can be because they’re simply too busy or because they are resisting disclosing numbers that show their business to be declining.

The only way to get accurate numbers is with access to the tax returns.

The Hot Sector in Business Sales

Main Street businesses are the the best selling sector today. This category includes small specialty retailers, restaurants, gas stations, coffee shops, and diners. Basically any business that you might find along Main Street in Anytown, USA fits into this category.This is happening because people who have been laid off are now looking to basically buy “jobs” for themselves in order to have reliable source of income.

When you’re looking to buy a job, your criteria tends to be the following:

  • An affordable down payment in the $50K to $100K since outside capital is almost impossible to obtain these days.
  • Seller financing in the 75% to 80% range.
  • Owner’s income of at least $4500 to $5000 per month after the debt payments are covered.
  • The ability to pay oneself starting with the first month of ownership.

As I have said elsewhere in this blog and the newsletter, now is the time to buy.  Not only are Baby Boomer entrepreneurs and small business owners seriously thinking about selling, but the economic conditions have made it a buyer’s market.

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