Small business owners are a cornerstone of our society. But what COVID-19 and 2020 showed us is that small business owners are the backbone of our economy. Though filled with both good and bad, business owners saw a huge shift in how they must run their business. And under such challenging circumstances, with trials and tribulations aplenty, many rental business owners made the difficult decision to close their doors or leave their company in someone else's hands.
The act of retiring or selling your business is an impassioned decision in and of itself, but many fall prey to ulterior business motives in the closing processes. Financial predators and corporate giants eagerly wait to pounce, using sleazy tactics to take advantage of owners lack of experience when it comes to mergers and acquisitions.
Here is a brief intro from Warrillow himself, followed by an excerpt from Chapter 6, entitled "Playing the Field: Understanding the Three Types of Acquirers."
If you’re in the construction business, 2020 might have been a pretty good year for your company. You may be wondering if now is the time to sell. The first step is to understand the landscape of potential acquirers for your business. In the following excerpt from my new book, The Art of Selling Your Business: Winning Strategies and Secret Hacks For Exiting on Top, you’ll discover two of the three unique types of acquirers, and the pros and cons of selling to each.
Chapter 6: PLAYING THE FIELD: Understanding the Three Types of Acquirers
David Chang was lost.
He had just returned home from his tour of duty in Iraq and needed to figure out what to do with his life.
Chang had a knack for numbers and had learned a lot about operations through his military training, so he decided to go into business with some friends. They started a home renovation company called CS Design Builders, which began by installing granite countertops and quickly expanded into a full-service home renovation company.
Chang helped build CS Design Builders up to a dozen employees and a little over $1 million in annual revenue when he decided it was time to sell. Chang hired a broker who found a buyer willing to offer $1 million cash for CS Design Builders. Chang was thrilled, but as the transaction marched toward a close, the buyer asked to restructure the deal.
The acquirer proposed to raise his acquisition offer to $1. million—with a catch. Under the terms of the new deal, Chang would now get just 20% of his sale proceeds up front, and the rest would be paid in monthly installments over a few years. The agreement included a provision that if the buyer ever missed a payment, Chang would get his business back.
Chang preferred the sound of the all-cash deal, but since that was no longer an offer and he was keen to move on with his life, he agreed to finance the new owner.
It didn’t take long before Chang realized he had made a mistake. The new owners missed their first payment, then their second. In the meantime, Chang heard that his former employees had started to leave the company. He also began fielding calls from his former suppliers who hadn’t been paid.
Back when Chang had started CS Design Builders, he’d signed personal guarantees with his bank and some key suppliers. What he hadn’t realized at the time of sale was that even though he had sold the assets of his business, he was still personally liable for the outstanding debt he had incurred while operating it.
Chang ended up taking his business back, but it was not much more than a shell of its former self. Most of the employees had left, business had dried up, and suppliers were hounding Chang for their money. Defeated, Chang shut the business down and worked out a payment plan with his suppliers to settle his many debts.
David Chang’s story is a cautionary tale of what can happen when you sell your business to an unprepared buyer. Individual investors are one of three types of acquirers, all of which offer positive and negative aspects. This chapter provides a brief look at the most common types of business acquirers, their typical motivations, and the pros and cons of selling to each.
Rather than close your mind to one type or another, remain open to all of these options to maximize the odds that you can create competition for your business.
ACQUIRER TYPE 1: INDIVIDUAL INVESTOR
If your business is on the smaller side—less than a few million dollars in annual revenue—it might be intriguing to an individual looking for an investment or seeking to replace a job they have recently lost or left. People who are downsized or who leave a company midcareer often bristle at the idea of going back to work for someone again and therefore look at acquiring a business as a way to be their own boss. They are usually somewhat established financially and have some experience, so if your business is relatively small and consistently profitable, an individual may be able to borrow the money to buy it.
Individual investors are generally less sophisticated than strategic acquirers or financial buyers (such as PEGs), which means you may be able to drive a better deal with less scrutiny over the details of your business than you might endure when selling to a strategic investor.
It’s rare that an individual investor pays cash for an acquisition. Typically, in order to gather most of the money to buy your business, individual investors borrow from two places: a bank and you.
Instead of taking all of your proceeds in cash, when you agree to finance some of the sale, you offer to accept some of your money over time while the buyer uses your business as collateral for your loan. When it goes well, the buyer takes some of the profits from running your company and pays you back—often with interest. If the buyer fails to pay you, as in the case of David
Chang from CS Design Builders, you are almost always second in line behind the bank, which will ensure they get paid before you see any of your money.
The art of negotiating with an individual investor
Along with typically being less sophisticated buyers, individual investors are also usually the least well financed. In some countries, the government will guarantee a bank loan to an individual investor to buy a business (e.g., an SBA loan in the United States), provided the deal meets a set of criteria. Make sure you understand what makes an individual eligible for a government-backed loan to buy your business.
Some individual investors are trying entrepreneurship for the first time, so they might end up being hopeless at actually running your business. Others may fail when they try to graft their big business strategies onto a company like yours. Running a small business is less strategy and more street fight, and if the buyer doesn’t get that, they will struggle with the messy work of actually running something.
Therefore, strive to get as much cash up front as you can, and be clear on what you’re willing to do to help the new buyer learn your business. Plan to stay involved for a while to show them the ropes. Aim for a deal where you consider the portion of your proceeds from a sale that are being paid overtime as “gravy,” so if the buyer fails, you’re still satisfied with the transaction.
Remember, your goal at this point in the process should be to maximize the number of offers you receive (and by extension, your negotiating leverage) by remaining open to all types of potential acquirers.
ACQUIRER TYPE 2: PRIVATE EQUITY GROUP
Another possible acquirer for your business is a PEG. This category can be further divided into three types:
1. A fund, usually with multiple shareholders, that is set up to buy, improve, and flip companies (typically within five to seven years).
2. A family office that is interested in investing money in a sector, usually on behalf of a wealthy family (or families), and often with no immediate plans to sell.
3. A fundless sponsor—an individual or individuals who think they can raise the money to buy a business. This is usually someone who wants to own a business, thinks they can add value by operating it better than it’s being run today, and has contacts willing to financially back them if the terms are favorable enough.
There was a time when PEGs considered investing only in
companies with a few million dollars of EBITDA. But as more money has flowed into private equity, acquirers have gone “down market,” and now some consider buying companies with less than $1 million in annual profit if those companies meet their other investment criteria.
PEGs are generally run by people who have already sold a business or have gone to a fancy business school. Their game is to find a business that is scalable or, in their view, is underperforming and could benefit from additional capital and more sophisticated management.
The idea is usually to bring some business school rigor to running your company, maximize its value, and turn around and sell it for much more than they paid (or occasionally, as is the case with many family offices, keep it to spit out cash for the long run).
One of the tricks PEGs use is to apply a lot of debt to maximize their return. Similar to buying a house with a small deposit, the leverage allows the buyer to amplify their returns for shareholders if things go as planned. To borrow money using your business as collateral, your business has to be what industry insiders call “bankable,” meaning it is a business that consistently generates profits that would allow a bank loan to be paid back with some wiggle room if things go south. That’s why PEGs are usually looking for larger, more mature businesses that have a consistent track record of making money.
This excerpt is reprinted from the new book, "The Art of Selling Your Business Winning Strategies & Secret Hacks for Exiting on Top (An Inc. Original)” by John Warrillow, released Jan. 2021 everywhere books are sold. To read the rest of the chapter, keep an eye on Rental or grab your very own copy today.
