BizQuest's Business for Sale Blog

When You Buy or Sell a Business An Effective Training Period Benefits Everyone

Having a reasonable and effective transition time when you buy a business can sometimes make the entire difference between whether or not the business remains successful after you take over.

Similarly, every seller should want the business to be turned over to a competent individual.

While there are no hard rules that dictate how long the former owner should stay, there are some guidelines.

The first thing a buyer must understand is that the seller cannot remain to perpetuity. If a buyer is too worried about taking over the company, and believes the seller must remain on board for an unusually long time, chances are the buyer is not suited to operate the company and may want to reconsider their decision altogether.

On the flip side, some of the training periods offered by sellers are completely ridiculous.

Unless you are acquiring a very basic business (i.e. a sandwich shop where the seller has very little impact day-to-day), a two week post closing training period is nonsense. I have always wondered why any seller or broker would remain inflexible on this point. If the seller truly wants to see the buyer succeed, if the business is what they have represented it to be, unless there is an extraordinary issue forcing them to be completely removed from the operation in short-order, and especially if there’s a seller note involved, then for goodness sake, offer an ample transitional period!

While two weeks may not be enough, it does not have to be for a year either; nor does the transitional period have to be free. But it does have to provide the buyer with adequate time and instruction to get settled in and avoid being overwhelmed.

In my experience, it typically takes a buyer about three months to really get a grasp on the operations of a reasonably straight-forward business. This does not mean that every seller has to remain on board for three-months, but they may need to be available, if necessary.

A buyer must negotiate a transition period that will allow them to at least have the seller accessible during ownership change. Keep in mind that employees, suppliers, customers, landlords and all other stakeholders in the deal will be apprehensive initially and it will take time for the buyer to alleviate any concerns they may have.

By the same token,, the buyer must understand that in some cases, having the old owner around can cause more harm than good. The buyer may not be perceived as the real boss while the old owner is still in the business.

Often times, it makes sense to have a short-term, full-time transition immediately after closing (i.e. one month), and then reduce the amount of time the seller is involved. Having the option of them being available either part-time, or with diminishing hours, or on an as-needed basis after the initial term, will likely provide you with some security and certainly make for a more effective changeover.

In some businesses where the seller is “the business”, or perceived as such, you may simply want to have them perform a diplomatic role long-term. In other words, they will be available for any key meetings, or to perform other tasks that will provide the impression that they are still involved.

In all of the businesses I have purchased, I had the seller tied to the business for anywhere from one month to two years. I must admit however, that they never made it the full term. I usually found that after a short period of time they were more of a hindrance than an asset. These were in companies where I took over the operations, and I certainly did not have the seller exit until I felt relatively comfortable assuming their role.

Equally important to the amount of time you negotiate for training, you must have a plan in place for what you need to cover and accomplish during the training period. As the buyer, it is incumbent upon you to map out a detailed training schedule. This should include of the questions you want them to answer during your training. Break it down to employees, customers, financials, sales, marketing, suppliers, competition, etc.

To make the point more candidly, your goal during the post-sale closing period is to conduct a form of training due diligence.

Having the option of a long transition is a good thing. But the quicker you get in, learn the company, establish mutual respect with all of the parties involved, and put your stamp on the company; the better off you will be down the road.

Some Business Buyers See Problems.....Some See Opportunities

I just returned from a weekend in Orlando, Florida with my wife and youngest of our four children, our six-year old son Jake. He is a Sponge Bob Square Pants fanatic and he wanted to stay at the new Nick Hotel - a Nickelodeon Studios themed property.

It is operated by Holiday Inn. It’s a tremendous facility – huge, with a ton of activities (that was a good thing because two days of torrential rains got us drenched at our short-lived excursions to Universal Studios theme park).

Imagine that you were a prospective buyer looking purchase this hotel and experienced the following (which we did):

The check-in was incredibly slow, throughout the hotel there were staff members not uniformly dressed, I came across at least five employees using their own cell phones while manning work stations, signage was poor for the various venues, the layout of the buildings was inconvenient, guest service stations had staff members who were poorly informed and couldn’t answer inquiries or provided conflicting information, at least a dozen games were broken in the arcade, the parking was unbearable, transportation to other venues was nowhere to be found, the restaurant lineups were completely disorganized, it took over an hour to pick up character photos (what we do for our kids) and the phone system was abysmal.

Room rate: $356.00 per night 

You could easily draw the opinion that the place is a disaster.

The facility is new, and Nickelodeon has been promoting it non-stop, which is clearly why the place was full. There’s no doubt that over time, vacancy will diminish given these problems.

On the flip side, the hotel was packed – no availability whatsoever. We had an absolute blast (my son went crazy) and there’s no doubt that so did all the other kids. Of course, that is all that matters, although I am certain plenty of parents were not very impressed.

Compare this to what you experience at a Disney property. They never miss a trick. Their parks are spotless, the staff superbly trained and almost brainwashed friendly, their systems, transportation, and guest flow at every venue is beyond reproach. Even the garbage cans are themed throughout their parks and hotels to match the characters (not to mention the toilet paper has Mickey’s famous ears printed on it).

So here’s the question: If you were a buyer looking to acquire The Nick Hotel, would you pursue the business given all of the issues identified?

Any buyer who looks to find only problems in a business would run from the deal.

However, the savvy business buyer would see this as a massive opportunity. While there are issues, they’re all correctable. Signage can be improved, staff members better trained, systems, policies and procedures can be easily implemented to remedy every item identified as problematic. 

The educated, well-informed, and committed business buyer determines that despite the issues, the place was full, and with some focus, this is a good business that could easily become great. All it needs is a good Disneyesque make-over. The foundation is there. It has a great brand. The location is solid.

This scenario happens every day. You are going to come across businesses that are less than perfect. Your entire success hinges upon your ability to recognize the one that you can build upon and improve. The goal behind buying an existing business is to have access to a platform that you can grow.

If you focus on all that is wrong, you can find fault with every business on the market and you can easily convince yourself to never buy any of them. Don’t take that approach.

There’s no such thing as a perfect business. If you only pay attention to the landmines, you will never find the goldmines.

Hey Buyers and Brokers - Can't You Guys Get Along?

The the last few weeks I have received an unusually high volume of comments from business buyers and brokers. I thank you for all of your comments; that is what makes a great online community.

Nevertheless, I am disturbed by what appears to be two drastically different opinions between the two groups. Buyers slamming business brokers and brokers claiming the buyers are all wrong. Guess what - you're both right and both wrong! Although I never like to draw any general conclusions, there is clearly a miscommunication here of grand proportions.

I am certain that my comments today will please some and irritate others. I welcome any constructive comments.

First, let me state I’ve seen the business buying space from all sides. I’ve purchased ten businesses myself, sold nine of them, written seven books on the subject, I’ve worked as a buyer’s representative and I still do mid market business brokerage.

I remain astounded by the sheer numbers of emails I get from business buyers that literally trash the business brokerage community. I am not going to defend brokers. I will say though that over the years I have met, worked with and spoken to hundreds of terrific brokers. They are smart, successful, know how to get a deal done and they take countless courses to improve. However; just like any other professions that survive strictly on performance, there are always going to be good ones and bad ones. Unfortunately, like other "similar" fields (real estate, insurance) with thousands of brokers, the numbers of true professionals may be the smaller of the two groups. I also know that it is understandable that after dealing with vast numbers of prospects that never buy, it is easy (but not right) for any business broker to become disenfranchised.

Personally, I don’t agree all of the philosophies or methodologies that I hear some business brokers practice but as a buyer you really should not pay too much attention to it. It just doesn’t matter. This is where I think some business buyers completely miss the mark.

Buyers get too hung up on the broker’s role and forget what their goal is in the process.

The business buying process has plenty of blemishes, of that there is no doubt. Anyone who disagrees has their head in the sand. However, I am convinced that a fundamental misunderstanding of how this process is "supposed" to work is at the core of what causes the friction and lack of communication between buyers and brokers.

Let me first address prospective business buyers and provide you with some insight to business brokers. I will touch on a few points that are basic yet fundamental reasons that cause a lot of wasted time and misunderstanding. I am also going to discuss some issues related to business brokers and their world in the next newsletter which will clearly help anyone who is buying a business understand this process better.

First, most business buyers begin the process thinking that business brokers operate like residential estate sales people. You figure they’ll respond to every inquiry with rapid fire speed, they’ll show you tons of businesses and take as much time as you need to find the "perfect" business. Unfortunately, that’s not the way it works.

The only common thread between business brokers and real estate agents is that they are both paid on commission – end of story. Real estate sales people will generally work more favorably with buyers and there are a number of perfectly good reasons why this happens.

I once read a statistic that said any individual or couple that contacts a real estate person will likely purchase a property within twelve months, seventy percent of the time. Contrast that to a prospective business buyer whereas over ninety percent will never buy a business. That alone could cause some business brokers to proceed cautiously before becoming too involved with any buyer. I know I do. Wouldn’t you agree?

To further complicate matters, the market is absolutely flooded with buyers; always is; always will be. Unless you separate yourself from the crowd, you are simply in a pool of tons of others who, in the minds of sellers and brokers will probably never buy. Here’s a great article on how to separate yourself from the crowd .

Since business brokers are not going to take you to see countless businesses for sale listings, a good part of the search falls to you. Now, this does not mean there’s any excuse for a broker to not return your calls or emails when you inquire about a business (a frequent complaint) and I know how aggravating that can be. On the other hand, if you are able to search more effectively, and ask the right questions (especially in the first contact) you will be miles ahead of the other buyers. Business brokers are not going to do your work. Don't expect them to.

Second, the misconception exists that banks have their vaults open ready to lend money to small business buyers – not true! And so, many inexperienced buyers who simply do not have the financial resources to complete a transaction go down the wrong path thinking that every business listed for sale is within their reach. Unfortunately, that is not the case.

Financing a business is not as simple as getting a mortgage on a home. While there are many options available to finance a business, you certainly want to understand these early on so that you don’t chase the wrong deals. If not, the only result will be wasted time and frustration. If you do not have the financial resources to execute a sale, a business broker is not going to indiscriminately distribute a company’s financials to you. The lesson is simple - know what you can afford. Be prepared to share your financial information with a broker and provide them with the proof they need to deem you qualified for a particular listing.

Third, learn the business buying process. If you’re really serious about buying a business, then don’t become a "looker". Educate yourself, hone into a few businesses, present yourself properly, ask the right questions, do your research, and be prepared to make offers. It's quite simple and the only way to get any deal done.

I know these few points sound relatively simple, and perhaps even obvious. I also know and hear first-hand how frustrating it can be to work with an uncooperative business broker. Yes, those situations do arise. Yet, one thing is certain: every single business broker wants to sell you a business. If not, they don’t eat. They will help you. They will move the deal along. But they are not going to do your work nor will they spend time with you on listings they know you cannot execute.

The business buying process is not perfect; far from it. However; the blame can not rest solely with brokers. I know there are plenty in the profession who should not be there. Chances are that they won’t be in twelve months. Nevertheless, you cannot possibly rely on a business broker to dictate your success and whether or not you complete a transaction.

Brokers have their role but deals get done between buyers and sellers. Placing your destiny in this process in the hands of a broker and then becoming discouraged or worse yet, aborting the project because of their inefficiencies simply does not make sense. That would be like you deciding to take the bus and not buy a car because you did not like the salesman at a particular dealership.

The bottom line here is that business brokers will not pay any attention whatsoever to unqualified buyers. I’m not saying that their methods for qualifying a buyer are always right by any means. However, if you truly want to get the level of cooperation you believe that should be bestowed upon you by a business broker, then you need only follow a few simple steps.

Come to grips with whether you have a real need to buy a business or you are just looking. When you arrive at the former, you’ll be successful.

Get a handle on how much you are prepared to invest of your own money. Buying a business is not like the "no money down" real estate infomercials. Be willing to share this information with business brokers. They will help steer you to businesses they know you will be able to purchase.

Be prepared. I don’t care how smart you are, or what your prior business experience may be, those are attributes that will help you AFTER you buy a business. You absolutely need to educate yourself. In my publishing business where we offer how-to guides on buying a business ( www.diomo.com ), I like to ask prospective clients the following questions (think about this for a second): If you are going to invest your money to buy a business, and especially if you have never bought one before, shouldn’t you first learn how to buy the right one? If not, that would be like your college bound child telling you that they want to become a doctor but they aren’t going to buy any of the books or even attend most of their classes. How would you respond? Buying a good business is well within your reach. We are not talking about sending men to the moon. However, if you fail to prepare; prepare to fail.

So here’s your homework:

1. Compile your personal financial statement and be prepared to provide it to brokers.

2. On your next inquiry to a business broker follow the steps we discussed in the article separate yourself from the crowd .

3. Commit to buying and not looking.

4. Get hold of the materials you need to learn how to become a savvy buyer

5. If you can’t make headway with a certain broker, move to the next one.

Good luck and please send me your thoughts.

Richard Parker

FAQs About Business Leases - Frank answers about handling leases in business for sale transactions.

Question:
I think not enough information is talked about dealing with business leases. What are your thoughts on taking over a lease versus getting a new lease? What is a triple net lease? If your company goes under, how do you get out of your lease? What is the proper amount for a security deposit? Thanks.

Answer:
I agree with you that there seems to be a bit of a void of good information regarding leases when buying a business. You raise a number of interesting questions so let's look at each one:

Taking Over a Lease Versus Signing a New One

On this topic, I am neutral. The key with any lease when buying a business is to have one in place that reflects what you, the buyer, need for the specific business. For example, if you are buying a retail store that relies heavily on the location to drive customers, and is not a destination location, then clearly you will want the longest lease possible in place to ensure your future success. However, what if for example the business is located in a plaza where an anchor tenant drives the traffic? In this case, you'd want the ability to either renegotiate or break the lease should that key tenant leave. Sticking with the retail example, if the current lease has less than five years you would surely want to either have an option added or a new lease negotiated with the landlord.

On the other end of the spectrum, if the business does not rely on its location to drive revenue, and you are confident that you can easily find other space (and it will be cost effective to do so) then, outside of the nuisance of moving, as long as there's a year or so remaining on the lease an assignment is fine.

Triple Net Lease

A triple net lease is exclusive of insurance, taxes and maintenance. A base rate is applied and then the annual costs for these three components (or an estimate thereof) is added to the base and reconciled annually in most cases. In a NNN lease, the landlord will provide you with an estimate of these costs so you are not going into this blindly.

Conversely, a gross lease will include all these components in your monthly rent at a fixed rate (there can still be a year-end adjustment for common areas or extraordinary items).

If Company Goes Under - What Happens?

This depends entirely upon the terms of the lease and whether or not you have signed for it personally and personally guaranteed the lease. It is not uncommon for this to be a condition for a small business lease, and some landlords may even implement this as a condition to an assignment. We are seeing more of this in more volatile businesses such as restaurants.

If you are required to provide a personal guarantee, you should negotiate a condition that releases you after a certain period of on-time rental payments. For example, after you own the business for 12 months or so, as long as all of your monthly rent payments were made on time the guarantee is eliminated.

On this note, I urge any new business owner to make it a habit to always pay their rent on time and not even a day late. In fact, get it to the landlord a day or two early. You will always stick out as being a good tenant with the landlord and rest assured they know how each tenant pays. By establishing a reputation of being on time, all the time, if for any reason the business runs into any difficulty in the future the landlord will be far more inclined to work with you because of the credibility that you have established.

Although not part of your question, the same philosophy should be established with all of your suppliers - garner a reputation as someone who pays on time without any problem. It will pay huge dividends in the future if you need some relief.

Proper Amount for Security Deposit

There are no hard rules and each lease is different; however, you can count on it being the equivalent of anywhere from one to three months of rent.

What Happens When Seller Financing Goes Bad? - Short answer: Everyone loses

Question:
I was wondering if in one of your newsletters you can address more detail on seller financing. More specifically, what typically happens if the new owner is late on payments or stops payments? Most sellers would not like to take the business back, and I would assume most buyers do not want to put up personal collateral. If there are tangible assets the business has, could the seller use that as collateral without being responsible for the lease of the business?  In general, how does this play out when things go bad?

Answer:
This is an excellent question and I'm surprised that it has not been brought up earlier. In a nutshell, it isn't pretty when seller financing, or any financing for that matter "goes bad". Let's keep in mind that in most seller notes the business assets are the security. While these notes are generally signed for personally by the buyer, they usually do not have personal assets pledged. Plus the fact is should it get to the point where the buyer isn't paying the seller, it's unlikely that they (the buyer) have any assets at all to cover the loan regardless of having signed personally.

Typically, a buyer and seller will have a note between them specifying the remedies and cures for a breach in payment. Generally, if the seller does not receive their regularly scheduled payment within a certain number of days after it's due, they are required to notify the buyer that they are in breach, and the buyer has a set number of days to cure it. If not, the remedies per the contract will be triggered.

If the buyer simply cannot pay the loan, and the note is secured by the business assets, then yes, the seller can take the business back. Unfortunately, the business is usually not in anywhere near the shape it was in prior to being sold. It usually resembles a house that has been in disrepair for quite some time. Nevertheless, this is generally the mechanics of what transpires. Regarding the lease, it can get complicated but in essence unless the original seller has remained on the lease as a guarantor when it was sold, they are no longer responsible and they can in fact take possession of the business assets and either sell them or run the business. However, should they choose the latter, and require a location to operate the business, then they may have to take over the lease as well. Now, it can get complicated if for example the buyer had been paying the note, but not the rent. If there was no lien filed against the assets the landlord may have taken possession of the property.

Often in a note of this nature, there will be a subordination agreement between the lender (the seller) and the landlord that provides for a mechanism for the lender (seller) to take over the business in the location without the landlord's interference so long as the seller pays any back and future rent.

As you can see, when deals go bad there can be lots of moving parts, and rarely is the outcome good for any of the stakeholders.

Having said all of this, the good news is that, with seller financing, if a buyer runs into difficulty and is upfront with the seller, most of the time the big "plate of spaghetti" outlined herein can be avoided. Sellers almost never want the business back. Buyers don't want to lose it. With both parties having exposure, the situation can usually be worked out either by the seller providing a brief holiday from payments, or some other concession to reduce the cash flow crunch that may be the catalyst of the problem. Also, if the buyer is open with the seller and makes them aware of the situation (hopefully before it starts to deteriorate) the seller may even be willing to spend time with the buyer trying to address and repair the business difficulties. After all, unless the buyer has run the business into the ground, who better to provide counsel to the buyer than the prior owner?

Should buyer walk away from business with no contracts in place? - How can the buyer protect himself when purchasing a business that has no contracts in place with its customers?

Question:
The business I am interested in has no contracts in place, and the seller is not willing to ask the customers to enter one before selling. How secure is this and what can I do to protect myself?

Answer:
Great question. Unfortunately, the vast majority of businesses you will review will have the exact same predicament. Even ones with contracts will generally be pretty loose and easy for the clients to cancel. While there are some businesses where contracts are the norm, and there are penalties involved for cancellation, these are usually ones with ongoing maintenance or service or in high priced manufactured products.

As far as the seller not wanting to contact the customers this is certainly understandable from their point of view. The last thing they want is word getting out that the business is for sale. If there are no major customer concentration issues, this is not a big problem BUT, if only a few clients represent the bulk of the business then you may want to consider the following:

Add a contingency in the contract whereby you can interact with the client and the seller but only after you have signed off on all other contract conditions; Or, include an earnout where part of the purchase price is contingent on you maintaining the customer for 12 months or so after you acquire the business.

Should Buyer Consider Relocating Business to Avoid Expensive Lease

Question:
We are completing our due diligence on a small "OFF-PRICE" apparel business. Through the process it was disclosed that the owner of the property will be raising the rent when the lease expires in 6 months. Since the current lease was 5 years the rate of increase is substantial. As such we are considering moving the business and have found a better property just a couple miles away in a very busy retail center anchored by a couple of "Majors" My question is this:

One of the anchors is similar to our operation and we share some brands. Is it a good idea to place a small business near a major? The two schools of thought are: We will benefit from their traffic, but the other is that their customers will ignore us altogether and perhaps siphon off ours.

Your thoughts please

Answer: This is the million dollar question. Personally, I am against any business relocation immediately after an acquisition if it's the type that relies on location to drive the revenues. As you know, the three most important factors in determining a retail operation's success are: location, location, location.

This is a very difficult situation. My first preference would be to try and negotiate a reasonable lease extension with the current landlord. Keep in mind that the cost of a move alone may wipe out any first year lease savings or more. As well, it has been proven over and over again that businesses that undergo big changes with a new owner usually go under altogether.

Plus, there is absolutely no way to predict what will happen in the new location. The anchor tenant may not have any impact on your business or, they could be terribly detrimental. If the business has a loyal clientele, will they follow you to the new premises? Moreover, will a move instill the perception in your clients that the business is no longer the same with new ownership?

While I wish I could gaze into my crystal ball and tell you what to do, that is simply not the case. I think you need to take a very hard look at what the consequences of a move can be. As mentioned, drastic initial changes usually are met with poor results. If forced to suggest anything, it would be to try to work out the lease in the current location. As the old saying goes: "The devil you know is better than the one you don't."

Recent College Grad Getting Cold Shoulder from Sellers

Question:
What is my best approach for purchasing a business? I have found a few businesses with great numbers and an existing clientele. The problem I am running into is when asked for my financials to determine my buying power the process then ceases. I have very little credit because I recently finished college. What do you suggest that I do? I appreciate any help you could offer.

Answer:
I am pleased to learn at least that your search has produced some interesting opportunities and I understand your predicament. Certainly it makes sense from the seller's side, whether the business is being sold by the owner or through an intermediary, that they want to be sure that a buyer prospect has the financial ability to complete a transaction.

I think this is where you may need to take a step back from the search process and honestly evaluate your expectations and determine what type of business you can realistically acquire.

While it would be great if buying a business was similar to the real estate infomercial world where you can (apparently) buy significant assets with no money down, the same does not hold true in small business acquisitions. Having available funding is, however, more important than your credit rating if you look to seller financing as a means to complete a transaction.

Credit-wise the hang up will be if you approach traditional lenders. Unfortunately, you may be penalized on two fronts: your credit rating and your lack of experience. These two criteria are crucial to any lender.

As such, my recommendation is for you to first get a true handle on how much money you have available for a down payment and for working capital. Then, you should focus your attention on businesses where the seller is either offering to finance part or where you feel confident that you can negotiate these terms.

If, however, you are in a situation where you simply do not have any assets that can be used for the down payment, you may want to look to the "Angel Investor" community. These are individuals that usually finance start-ups but they do participate in financing existing businesses. Quite often these individuals have groups/associations in cities that can be located through the chamber of commerce or online. You will be required to meet with them and present a business plan but that can all come as step two. The first thing to do is locate these individuals/groups and arrange to meet with them so that you can educate yourself about what they expect. Generally, they want to see you as a savvy manager and someone who they are prepared to bet on to operate the business successfully. If you can impress them they will surely be open to any proposals/opportunity you may present.

Purchased Small Restaurant, Then Learned Competitor is Opening Across the Street

Question:
I just completed the purchase of a small restaurant in the Los Angeles area. About three months after I took it over construction began directly across the street from us for a major national restaurant chain that caters to the same clientele as us. They're scheduled to open in nine months. I'm worried they will drive us out of business. I have reason to believe that the seller knew about this but didn't disclose it to me. What remedy do I have against the seller? Also, should I sell the business now?

Answer:
While I can understand your concerns about future competition, I'm not certain how you would go about trying to prove the seller knew. Even if he did, is there anything in your contract that would have obligated him to reveal this (besides being the honorable thing to do)?

I think you need to attack this situation from two perspectives:

Regarding the seller, the first thing you can do is find out when the competitor filed for its building permits or other required filings. You may find out it was after your sale and that's the end of it; but chances are it was prior to three months ago. Next, you should consult with the attorney who drafted your purchase agreement and see what representations and warranties are included in the contract. Specific attention should be paid to any language indicating whether the seller was obligated to disclose any material facts that could have an adverse effect on the business. This does not necessarily mean that had he known about the pending construction he was obligated to reveal it. This is something best left to the interpretation of a competent attorney. Personally, I hate the idea of litigation, unless every other avenue is explored, so before you go after the seller with "guns-a-blazing" do your research.

Selling the business is not an option. How do you think a prospective buyer would feel about the viability of the business if you put it on the market so soon?

The bigger issue here is the fact that you now own the business, and your focus is far better spent on successfully operating it. There's always going to be competition and the fact remains that in less than a year, they'll be there. How are you going to position your business so that they're a non-factor? What are you going to do to keep your clients loyal to you? Sure you may see a drop off when the chain first opens, but a good restaurant can thrive amidst heavy competition. Turn your attention to making your restaurant the place to be. Don't operate defensively. Use the new chain as a vehicle to bring new people to your location as well.

Buying a Business with Customer Concentration Issues

Question:
I am thinking about buying a local transportation and storage company. They have been around for about eight years and specialize in commercial accounts. Only about 25% of the business is residential relocation. The business has grown every year and nets about $175,000 to the owner (including everything). They lease all of the vehicles. They are asking $525,000 for the business and will finance about 50% for a qualified buyer, which I am. The problem is that three of their accounts represent 65% of the business. Of this, almost all of this revenue is related to long-term storage and moving of their stored merchandise. How can I possibly protect myself and what should I be aware of in this situation?

Answer:
This is a GREAT question. In many businesses, one does come across customer concentration issues. However, one must consider the specific nature of the business itself to determine:

1. Is customer concentration the norm in this particular industry?
   
2. What is the impact on the business should the customer(s) stop buying?
   
3. How "easy" is it for the customer to go to a competitor? Why would they?
   
4. Is there a special relationship between the current owner and the customer that keeps the business safe?
   
5. What can be done in the future to lessen this percentage of concentration?

Let's examine all of these points:

• In the commercial storage business, it is quite acceptable to have a higher than average degree of customer concentration. If you were selling a highly competitive product rather than a service, I may be inclined to be concerned, but not necessarily in this case.
  
• Clearly, you'll want to determine the impact should one of these key customers stop buying from you. To this end, you should do a Pro Forma budget isolating each one of these accounts both from a revenue and net income perspective to understand your exposure.
  
• In the commercial storage business, you will be providing the pain relief to your customers. The service you provide eliminates a headache for them. If the business is like most commercial storage businesses, where you charge every time you handle the goods for them, it is not really easy per se for them to go to a competitor, nor do they usually want to. All these clients want is for you to do what needs to be done, when they need it done. This means picking up on time, and delivering on time. This is very much a business that is yours to lose. So, do your job well and you won't give them a reason to even consider switching!
  
• You will certainly want to review any contracts in place to understand what is involved in the event of a change in ownership. They may simply be able to roll these over to you. Or, they may require written permission. Some can even have far stricter language that doesn't allow these to be assigned. In any event, you need to know the details and also what is the relationship between the sellers and the clients that keeps the business secure.
  
• I would absolutely recommend that you look to increase the client base. This may be time-consuming because just like these customers won't be quick to place their goods elsewhere if you do your job, neither will other prospects be quick to give you their business. It takes time to secure new business in the industry. So the lesson here is to take very good care of what you've got because it won't come back easily if you lose it.

As far as protecting yourself, the most effective strategy for any business with customer concentration issues is to establish part of the purchase price as an earn out or performance based purchase. You should also keep in mind that the seller cannot guarantee the revenue to you for perpetuity. If the new owner messes up the business, it is not the seller's fault. However, they should be able and willing to effectively guarantee the business for at least 6 - 12 months. You will need to determine the percentage of revenue/profit each major client represents and then factor this by the multiple being paid for the total business, and then this amount should be evaluated and paid at a future date.

As an example, if you are paying $525,000 for the business on $175,000 owner benefits then this is a three times multiple. If the key accounts represent around $113,000 of the $175,000 this would equate to $400,000 of the purchase price. In 6-12 months you revisit the numbers and if the revenue/profits are still in place, then the seller earns this $400,000 and, ideally, you should build it into the note. If business declines, the $400,000 is adjusted accordingly. In this business, I would suggest a 12 month period since the customer turnover rate is quite low and the clients may take a little longer to evaluate you as well.

Buying a Competitor

Q: I came across a listing on BizQuest that I'm pretty sure is for a competitor of mine. If so, I would be interested in making an offer. But I am afraid that he is not going to want to divulge any details of his business to us for competitive reasons, or maybe won't talk to us at all or even admit that he is for sale. How can we work around this hurdle? I am seriously interested in buying the business, but I understand his concern about divulging any details to a competitor.

A: The most important thing is that you want to do everything above board here and not mislead anyone.

First let me ask you if the business is listed by a business broker? If so, you will be required to complete a non disclosure agreement on the business, and often these agreements contain a provision that you do not represent a competitor. The same holds true if it is a business being sold directly by the owner. In any case, whether a FSBO, or through an intermediary, I would suggest that you have your attorney call him/her and simply tell them that they have a client (you) who has seen one of their listings, you think it may be one of your competitors, you are very interested but you don't want to put anyone in a difficult position and you need to know how to proceed.

There may be a bit of wrangling that can go on between attorneys until all parties are comfortable but companies buy out their competitors all the time so this is nothing new. The main concern the owner will have is in providing confidential information to you. However, you should be willing to sign a rigid confidentiality agreement that goes so far as to detail the competitive nature of your relationship and possibly even a clear remedy for any breach.

I am not certain what your relationship is with the seller; however, if you act honorably, and your intentions are sincere, then it is simply a matter of conveying this directly to the seller. If he/she is really motivated to sell the business, a trustworthy understanding will be reached quickly.

Seller's Agent Will Not Release Financials

Question:
I've recently looked at a business here in Dallas that I like but I don't have the financials yet. The seller's agent won't release any more details to me until I sign a letter of intent or offer. Is this normal? How can I possibly offer to buy the business if I don't know how much it's making?

Answer:
I've seen brokers try this tactic and it drives me nuts! Keep in mind that in today's markets good businesses sell fast and so you may at times feel a bit handcuffed when the right business comes along but you simply do not have enough information to move to an offer.

However, there are three ways to overcome this:

The first is to try and set the ground rules - meet with the broker and the seller. Let them know you're very interested in the business but there's just no way you can make an offer until you see the financials. Advise them that making an offer without this information will only result in having to revise the offer (most likely) so rather than drag things on why not let you see the numbers and if you want to proceed you'll put forth an offer immediately.

The second approach is more aggressive and one that should only be considered if there's absolutely no "give" by the broker and you do not feel ready to move forward with an offer as yet. Tell the broker candidly: "unless you're planning on buying this business for me with your money, don't dictate to me how we're going to work. Do not spend my money! Until it's your personal money on the line, I'll be the one who determines how and when I'm going to make an offer". You may find this a bit too bold but trust me; it works...plus you can always revert to the other strategy if you don't make progress.

The third option is to simply make an offer stipulating that the financials you require must be produced within 3-5 days. You'll then be able to review them properly, plus a well written buyer friendly contract will allow you a reasonable period for inspection and the ability to withdraw your offer for any reason whatsoever, up to the last day of the due diligence/inspection period.

Dealing With "Cash" Business

Question:
The seller tells me there's about $25,000 a year in cash business. How can I verify this? The seller is insisting it exists and he is factoring it into the price. I'd like to believe him but what happens if it's less than that in actuality?

Answer:
If they can't prove it - you cannot pay for it. End of story!

Here's the approach: tell the seller that you'll agree to factor in the cash to the purchase after you've had a chance to run the business for a year and see how much it is. The seller will typically say: "how can I possibly know if you're going to tell me exactly how much you take in and how can I ever verify the amount?" To which you'll reply: "that's exactly my point".

This is always a bothersome issue for me. The seller has effectively avoided taxes on all this money year after year. Yet, here they are again expecting to get a second bonus for it..that's craziness. You cannot have it both ways Mr. Seller. No proof. No money. Sorry!