Here is something not everyone understands about Small Business Acquisitions. There are really two major phases of the process which need to be dealt with separately. There is the first phase. This is the part where you are just starting out and must find deals, collect information, analyze information, conduct visits, meet people, network, make offers and ultimately get to a signed letter of intent. Then there is the second phase where you have to perform! You perform due diligence, you draw a contract, you raise money and you close. So let’s go over basics.
Small Business Buyout
Five Steps of the First Phase of a Small Business Acquisition:
- Find deals. We start out by establishing our image, setting forth our deal criteria and begin contacting brokers. We start making the numbers work for us. We have a system on an excel spreadsheet to collect names and other information on each deal we look at. We network with other professionals and use databases to reach out to other sources besides brokers.
- Collect and Analyze Information – this is where we narrow down our search to a handful of deals which we want to pursue. We then obtain information or a “package” on each deal and look for certain key metrics. We value the deal based on the assets, income statement and EBITDA.
- Conduct Visits, Meet People – We set up meetings with sellers, brokers and lenders. We do not visit every company we have information for. We network and select certain sellers to visit based on location and the quality of the company.
- Make Offers – We value the company based on the current financials, then we put it though our black box. My coaching clients have access to a program I invented called “Instadeal” which helps structure deals in a handy excel format. But the process can be done by hand. We need to have a template for an LOI and be able to plug in our offer into a professional looking format to get it in front of the seller and brokers.
- Negotiate to a Signed Letter of Intent. This may be a short or a long process. You need the seller to be on board with your deal structure. This will take some back and forth negotiations. Many sellers will reject your offers out of hand and you must move on to other deals.
Ok so this is the first phase in a nutshell and in the deal business the above process is a business unto itself. You never really stop conducting the first phase if you are in the deal business. You are essentially running your own mini private equity group and this should continue until and after you have deals under your belt.
You can develop a simple system for carrying on the above activities to make sure that you get deal flow and company information on a regular basis. Now once the letter of intent is signed everything changes. Dramatically. In fact you may have already gotten a whiff of this by pulling the trigger on your offers. You send out an offer and lo and behold, one day it comes back and it is signed. There is a degree of magic in this event but it will also scare you because now your will change. You are under the gun to perform within a finite period of time.
Now let me say this. You can always pull out. We structure our LOIs and contracts with minimal exposure and liability should a deal go busted but you didn’t come this far to mess around, you are going full tilt to close the deal – and this is now the second phase. So you will be in a position where the seller and everyone else involved will expect you to round up the financing and go to closing. So what exactly is next?
Five Steps of the Second Phase of a Small Business Acquisition.
- Due diligence. This is a process that is the very first thing to start and the very last thing to finish. It continues right up until closing. It doesn’t just end because your audit is done or because closing is near. Sometimes problems are discovered right at the closing table and something has to change before a deal can get done. Always wear your due diligence hat and keep an eye out for things that the seller might have misrepresented.
- Legal and Contract – You will have lined up a transaction savvy lawyer to produce a contract for the deal (aka Purchase and Sale Agreement). He will also conduct legal due diligence as necessary. He will help you through the negotiations and try to smooth over any rough spots with the seller.
- Auditing and Accounting – at some point, usually when you receive back all the relevant financial due diligence documents, your accountant will look over the information and conduct a basic review of the books. He will also will work with the seller’s accountant to work up the best tax and reporting structure for the deal.
- Financing – this should be the hardest part by far. Finding financing should have been started in the first phase. However, in the first phase you didn’t know what kind or how much financing you needed. So the mad scramble for money starts with a signed LOI. You now need to run out and make sure you have lined up a lender and, if necessary, any additional capital to complete the deal.
- Closing – once the financing has been lined up there usually are no more additional obstacles to closing. Assuming everyone still wants to close. The lender may need to do a pre-closing audit but things are ready to go. The lawyers may do most of it through the mail or just sitting down at a closing table. Probably both.
This second phase is where your life changes. You start to add a significant money commitment (lawyers etc) and will need to commit to the completion of the deal before you get underway. You also are under time pressure. We structure the deal so there are few hard and fast deadlines but the longer you wait the more the seller will get cold feet or (gasp!) seller remorse. The main thing that can go wrong in the second phase is that for some reason you can’t get the money for the down payment. This is why you structure a favorable deal going in – so that you can find a group of lenders who will be interested.
So the reason you need to keep these two phases in mind is that they are worlds apart and the level of commitment ramps up in the second phase. I am essentially tailoring my coaching structure to this dynamic. In the second phase buyers need a higher level of support, for example with financing, legal and tax issues – and to close the deal. In any event you will most certainly be aware of when you are proceeding into higher levels of commitment and can adjust accordingly. We can go into some of the techniques of how you can buy yourself more time and stretch out the process, if necessary, in future posts.
