ATTENTION: Residency requirements are changing! Non-Colorado residents and foreign nationals will soon be permitted to own portions of Colorado marijuana businesses. This law takes effect January 1, 2017. It requires an owner to be a one-year resident, and for at least one owner to always be a resident of Colorado. After those requirements are met, other owners may participate regardless of residency. Read the text of the bill (SB 40) here.
We appreciate your frustration. When you first became interested in buying a business you likely went to listing websites, searched for businesses that met your criteria (likely cash flow being the predominant factor) and contacted the broker who had the listing. You signed the confidentiality agreement and then received the information from the broker. The information included financial statements and some summary information on the business. You likely even traveled to and met several business owners. What did you learn over several months?
You probably discovered something like this:
- Cash flows presented on websites are overstated. This is by far the most common complaint mentioned by buyers. We have seen brokers counting unreported cash, rent, inventory, family members’ compensation, and more in cash flow. You’ve likely even found proformas used to support cash flows. What?! You’re expected to pay for a business based on what money the business could make?
- Key facts are hidden from the information provided on the business forcing a caveat emptor situation. For example, you find out weeks into your analysis of the business that there is one customer that accounts for half the sales.
- Many of the key employees are related to the owner of the business.
- The owner works 80 hours a week and you’d have to do the same.
- The statements used to report cash flow are from the prior year and the sales in the current year are down.
- Other negatives in the business were not disclosed.
We even know of a situation where a broker forged a business owner’s signature (he was sued and is out of business). Our recommendation is that when you encounter the first situation of suspicious ethics on behalf of a broker, stay away from him or her forever.
There is good news. Ideally, you can build a relationship with a broker or two, explain what you are looking for and convince him you are serious and well-funded. Follow up frequently and be patient. If what you are looking for isn’t available (and it probably isn’t), you are better off waiting than talking yourself into buying a business that isn’t a fit for you. What is a fit? The biggest mistake we see buyers make is chasing cash flow. They search on-line and are attracted to businesses with the lowest multiples (Price/Cash Flow or EBITDA). The lower the multiple, the more interested they are.
We recommend each buyer to first understand themself. Figure out the type of business that is the best fit for you. Best fit includes:
- Location, though you need to be flexible and not require a business within 15 minutes of your house.
- Owner duties. You will essentially be doing what the current owner is doing. If the current owner is a vivacious, outgoing, extroverted sales type who knows everyone and you are an introverted technical or numbers person, you will probably be frustrated trying to be someone you are not. Your strengths need to match the skills the business needs.
- Risk level. Some buyers are simply looking to replace a job. These types need to look for very stable and predictable businesses, not high-growth risky situations.
- We recommend talking to bankers before looking at a business so you know what size business you can afford. Thinking that the owner will finance your shortfall is a big mistake. If you require owner financing you will likely be paying a higher price or the owner will be selling to someone else.
- Businesses within an industry typically have similar cultures. The construction industry has certain attributes that are different from the telemarketing industry or the accounting industry. Understand what type fits you.
We can cite numerous cases where people purchased businesses that fit them and they were not just highly successful, but made many times their investment. What can be even more important is that these people enjoyed the journey. We have also seen cases where accountants purchased sales type businesses (like a swimming pool business) and the accountant hated going to work because he was forced to sell to people all day when he really didn’t like dealing with new people.
Patience is at times the hardest quality for a buyer. You get the impression that there are thousands of good business for sale on the listings websites. The reality is that the best businesses never get listed online. The vast majority of businesses we sell never show up anywhere. We have a bullpen of aggressive buyers that we contact with our best businesses. One of them typically pulls the trigger. The market never hears about the business being for sale–an ideal situation for the seller and the buyer.
Being a good buyer entails having a few special attributes. First, you need to be seriously interested and willing to make a purchase. We see a lot of window shoppers and once they are identified as such, they see no more opportunities from us. Second, you need to be prepared. Just like going to an interview for an executive position, the more research you have done on the business and industry prior to meeting the owner, the more respect the owner will have for you and the more interested he will be in selling to you. Owners are able to choose their buyers; you need to make yourself stand out. Third, know your limits–what size business you can realistically buy. Looking at a business that is worth more then you can ever buy will frustrate everyone and take you out of the running for future opportunities. Finally, you need to be able to convince the owner that you can replace him. We have seen so many situations where an owner will not sell, at any price, to someone because the owner is convinced the buyer could never run the company. Remember, this is not real estate where people don’t care who the buyer is. You will be taking over an owner’s business and employees, it matters to sellers that they are putting what they built into good hands.
We get calls a lot of times from buyers who are looking for situations where they can work in a business for up to a year and then decide if they want to buy the business. These people declare that they want to “test-drive” the business and then make a decision, but what they are really looking for is a job. The only place this type of situation exists is if your parents own a business (and if you can do this, by all means do so!). No other business owner who is interested in selling is going to do this. In our years of selling businesses it is readily apparent that the difference between window shoppers and people who complete a transaction has nothing to do with intelligence but has everything to do with guts–the constitutional fortitude and ability to assume risk. You need to be in a situation where you are willing to take on the risk before moving forward. Our clients to whom we sold a business, and then sold it for them for five to ten times their original purchase price later, were also scared when they initially bought the business! It takes guts to make the first transaction, but there is no big pay day without making the initial purchase.
There are items to never tell an owner of a business if you want to buy their company. We would recommend never saying you have friends with money who will support you. That almost never comes to pass. Second, it is a mistake to ever say you are looking at buying a business or getting a job. We, and any owner, hear this as: “I’m unemployed and need something to do.” You’ll never buy a business; you’re just hoping the owner hires you. Third, it is typically a mistake to talk about buying the business and running it on an absentee basis. If the current owner is working a lot of hours and you will buy it and not work, the current owner concludes that she must be wasting her time. The current owner will believe you have no idea what it takes for the business to be successful, and is probably correct in her thinking.
We’ve presented you with some of our observations, mostly on what not to do. The best buyers we have seen also have common traits. These buyers:
- Arrive at meetings prepared, with questions already written down.
- They have researched the business and industry, including competitors, and ask intelligent questions about the prospect company in order to ascertain what differentiates it from its competitors.
- Explain to the owner their situation, why they are interested in buying a business, and make it clear that they are ready to move forward, for the right situation, and have the supporting team (accountant, banker, attorney) already in place.
- Focus on the business, its critical success factors, how to grow the business, the management team, and so forth–not asking detailed questions about financial statements. For some reason more people ask questions like “Why did ‘supplies expenses’ increase ten-percent last year” than ask about what skills or resources the business needs to grow to the next level.
- Focus on asking questions and listening, not talking.
We also recommend having a solid understanding of the current financing market. Serious buyers know how much financing they are able to secure on each business. The financing market is dynamic and lenders change their underwriting requirements frequently. Having a good relationship with a few lenders will give you an edge on other buyers.
We wish you the best of luck in your search!