If you’re planning to sell your business, it is important to put yourself in the buyer’s shoes and know what makes them tick. What do buyers look for when buying a business? Whether you’re dealing with a first time buyer or a more experienced one, one thing is for certain: they are going to vet your company for certain things. In this episode, take a look at the five questions every buyer asks before purchasing a business with Michelle Seiler Tucker. Plus, learn about the five different types of buyers and the Seiler Tucker 6Ps of a sellable business.
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Buyer Sanity Check: 5 Questions Buyers Ask Before Buying A Business
In this episode, we’re going to talk about the Buyer Sanity Check. What a buyer is looking for when they look at purchasing your company. On our past episode, we did the Seller Sanity Check. It’s important that you put yourself in the buyer’s shoes and look at buying your business from their perspective. Let’s recap and talk about the five different types of buyers first. The first type of buyers are first-time buyers. Ninety percent of buyers are first-time buyers. These buyers are typically slow to pull the trigger, uncomfortable when making a decision and may never pull the trigger and buy a business. They typically look at smaller companies like restaurants, bars, car washes and things of that nature.
There are some first-time buyers that will use their 401(k), their retirement fund and wish to purchase a business and they might look at a much bigger business. When I say much bigger business, maybe $1 million to $3 million. With first-time buyers, you have to reassure them. You have to help minimize the risk for them. They do like seller financing because they feel that that helps minimize the risk. Most of them will be willing to give a personal guarantee and they typically want you to stay around for a little bit longer than other buyers typically want you to stay.
You then have the sophisticated buyer and these are serial entrepreneurs. These buyers are industry agnostic and they buy EBITDA. They buy cashflow. They’re very quick to pull the trigger. They typically contact a mergers and acquisitions advisor like myself because they know we have the good businesses for sale on the market and they are looking to buy a business that runs on all six cylinders, all the Seiler Tucker 6P’s. They are good buyers and have money available. You also have the competitors and strategics that buy synergies. They’re looking to catapult their business to the next level by buying talent, management team, contracts or a well-branded company.
They’re looking to buy a company that has patents, trademarks or something that they don’t have. A database that could catapult their business to the next level. These are competitor and strategics and they too pull the trigger quickly. You then have PEGs, which are Private Equity Groups and they buy in two ways. They buy based on platform or add-on. Let’s say you are in food manufacturing and they want to get in food manufacturing. They won’t look at a business in food manufacturing for less than $3 million in EBITDA. However, if they’re already in that platform in food manufacturing, then they will look at ad-ons for less than $1 million in EBITDA. PEGs look at a lot of deals, probably 100 or a couple of a hundred deals a year. Due diligence is quite extensive with PEGs. They’re not as quick to pull the trigger, but they are certainly good buyers as well. You also have turnaround specialists. Turnaround specialists buy under-performing businesses. They typically want to buy that business for no money down. They want to leverage the assets to buy the company so that they can fix it, grow it and flip it.
Those are the five different types of buyers. What are buyers looking at when they buy a business? Most buyers want to buy synergies and they don’t necessarily want to buy a job unless it’s a first-time buyer leaving Corporate America and they’re looking to be their own boss and run the company. Most buyers are not wanting to run the company. When they evaluate businesses, they evaluate congruent revenue streams. They evaluate synergies and they look at what I call the Seiler 6Ps and this is how we evaluate everyone’s business.
Number one, they want to make sure you have people. They want to make sure you have tenured employees and management team in place and not 1099s. There are a lot of companies out there in manufacturing and distribution that have 1099s that should be classified as employees. These 1099s are working in a shop, in a manufacturing plant or working in the field. If one of these 1099s has a catastrophic event, it could literally shut down your business. It could literally put you out of business. If it doesn’t put you out of business, it’s going to cost you a tremendous amount of money, time, energy and effort. When a buyer comes in to evaluate your business, they’re going to say, “You have 1099s working in a manufacturing plant. If they get hurt, we’re in big trouble. They needed to be converted at W-2s. It’s going to cost $50,000 more a year to convert them.” That’s going to change the EBITDA by $50,000. That’s going to decrease the EBITDA by $50,000. People are important.
They don’t look at the product. They want to know, “Is your product thriving or dying?” A lot of industries that were thriving before COVID are now taking a nosedive. There are a lot of industries that were dying before COVID that are doing well like HomeGoods. Landscaping, swimming pools, and anything home-related are doing great. Online education is doing great. Home fitness is doing great. All those industries have skyrocketed. When a buyer buys a business, they’re going to evaluate that industry to make sure that it’s sustainable and it’s thriving, not dying. Not only that, if they have to get financing, the lender is going to make sure that if they lend money on this company and its specific industry, that it’s going to be sustainable and the owner will be able to pay back the loan or debt.
It’s important and also processes. Processes are under-evaluated and most people don’t think about it, but processes can make or break a company. If you don’t have efficient and productive processes and you don’t have them well-documented like SOPs, Standard Operating Procedures, your operating handbooks and employee handbooks. If you don’t have that in place and have your employees well-trained, it could hurt the sale of your business. Buyers want to make sure that the processes are efficient, productive and well-documented. They then look up proprietary and it is huge. It’s the number one value driver. Buyers want to make sure that you have a federal trademark on your name. Is your logo trademarked? Do you have any contracts in place?
When a buyer buys a business, they’re going to evaluate that industry to make sure that it’s sustainable and it’s thriving, not dying.
I’ve been working with some manufacturing companies and distribution companies and there’s this one company that has a manufacturer with no agreement whatsoever. I have another company that has a manufacturer and a distributor but they don’t have agreements with any of these suppliers. If they lose their manufacturer or their distributor, they could be completely out of business. It’s important that you have agreements in place. If you have one person manufacturing your product and you have no backup and no agreement, it could put you out of business. Make sure you’re tying up those agreements.
The other thing that’s an issue sometimes is a way companies are structured. A company will have its LLC filing it as an S corp or C corp, but here’s the issue. They might have a second company that is a real estate company, a third company as an equipment company and the fourth company as maybe a transportation or logistics company. That’s great to have all these separate entities. The problem is that if one of those entities is a sole proprietorship reporting on your tax returns, you pierced the corporate veil. Buyers want to make sure that the structures are intact and it’s going to protect them going forward.
We talked about agreements, also customer contracts are important to buyers. Buyers are willing to pay more money if you have more contracts in place, especially if they’re renewable contracts with residual reoccurring revenue streams. However, those contracts have to be transferable. If they are not transferable, the buyer may have to do a stock sale versus an asset sale and most buyers, 99% of the time prefer an asset sale. You want to make sure your contracts are transferable. Databases, buyers look at databases and they’re willing to pay more money for the database if those clients can be retargeted and repurposed.
They also want to know how well-branded the company is. Proprietary is huge. It is the number one driver in value. We then have patrons. Buyers want to make sure there’s not customer concentration. They want to make sure that when they come in, 80% of the revenue is not tied up in 3 to 5 customers. We also have profits. Everybody wants to make money. Nobody wants to buy a business and lose money. All we say is profits are never the problem. Lack of profits is never the problem. It’s always the symptom of not operating on one of these 6P’s.
Buyers are going to evaluate your business on this. This is called the Buyers Sanity Check. There are five types of buyers and all buyers, no matter what type of buyer they are. If they are a private equity group, if they’re a strategic first-time buyer, they all ask themselves the five basic questions and this is the Buyers Sanity Check. If they can’t answer positively to these questions, they will not buy your business. Number one, they want to know how much they have to put down. Number two, will the cashflow of the business support the debt service? Number three, after the debt service is paid, how much is left for them to live on?
Number four is, “How soon can I get a return on investment?” Most buyers want their initial investment back within 2 to 3 years. Number five, does the business have potential? I can’t even begin to tell you how many sellers come to me and say, “Michelle, I want to sell my business for $20 million.” We have lots of buyers that will buy great businesses for $20 million, but what’s your EBITDA? “It’s $100,000.” Nobody’s going to pay 20x earnings. We always back into it and we tell our clients again, you want to sell your business for $20 million. Your EBITDA is $100,000. How much would you have to put down? How much is left to live on? Will it cover the debt service? How soon can they get their ROI back? That company will never pass the Buyer Sanity Check because the EBITDA does not support the asking price.
We always go through this with our buyers and clients. What we try to explain to our sellers and readers is when we take our clients through the Seller Sanity Check, we ask them, “How much money do you need to live on so you don’t have to go out and get another job? How much money do you need to afford your lifestyle?” That’s how sellers come up with what they want. They say, “Michelle, I want $20 million because that’s what I need to travel the world. That’s what I need to retire.” Buyers don’t care about what you need to enter the next phase of your life. They don’t care about what you need to retire on. They care about value. They care about synergies. They care about what’s going to benefit them. What’s going to benefit their business and their family and that’s what they’ll pay for. Value is in the eye of the beholder, of the buyers, and what it means to them.
To recap this, buyers are going to look at your business as a whole. They’re going to look at the 6P’s. They’re going to make sure you have people in place. They’re going to make sure that the product is thriving and not dying, the processes are efficient, productive and well-documented. They want to ensure that you have proprietary and everything’s intact. The more proprietary you have, the more they’re willing to pay. I will tell you this, if you have proprietary, if you have contracts in place and they are transferable and you have patents, I can bring enough buyers to create a bidding war to get you a higher price in your business.
They’re going to look at customer concentration, which is patrons and ultimately everybody wants to make money. The Buyer Sanity Check is, does the business meet these five criteria that we went through and can that buyer get their money back? Can they ROI it? Can they catapult to the next level of their current business? We once sold a manufacturing business. We priced it at $9 million range. This particular business had customer concentration and most buyers were fearful.
We have about 500, 600 buyers for this particular business. We had several LOIs. We found a strategic that had a similar product, but different. This buyer was willing to outbid everybody else because they had a contract with BP. This buyer knew, “If they’re with BP, I’ll have some more products and services. I’ve been trying to get my foot in the BP door forever and haven’t been able to. Here’s my way in.” They bought this company and they paid $15 million for 70% of the company. The company was appraised in the $9 million range. It’s all about what’s important to a buyer and what a buyer is willing to pay more for synergies that will catapult their business to the next level, but it must meet the Buyer Sanity Check for them. Those who hold the gold makes the rules. Thank you very much for reading. I can’t wait to see you next time.
Important Links:
- Seller Sanity Check – Past episode
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