[Notes] HBR’s Guide to Buying A Small Business

There are a couple professors at HBS encouraging MBA students to achieve entrepreneurship through acquisition rather than through startup. They even propose it’s a more reliable route to career success & satisfaction than through a large organization. They’ve distilled much of their course into The HBR Guide to Buying a Small Business. It’s the first “The HBR Guide” I’ve read and was impressed with how concisely useful it is.

This collection of highlights might not be as useful, but it’s certainly more concise.

Everything that follows are quotes from the book. Enjoy!

Skills & Traits

“Of course, not everybody has the skills to manage every business, and you’ll need to find a company that you believe you can successfully manage after a proper transition period with the seller coaching you along the way.” — pg 30

A convincing attitude and confidence

Great communication skills are critical to an acquisition entrepreneur. You need to feel comfortable reaching out to people you don’t know — sellers, business brokers, investors, your employees — and when you do reach out, you need to project an air of confident optimism. All of these people are deciding whether to believe in you.” — pg 30

Persistence …

When you are seeking out a business to buy, you might face months when you work 12 hours a day and simply not find a desirable prospect. It’s a frustrating experience with lots of effort and no reward.” — pg 31

“As you contemplate your choice, consider this: While there are opportunities for personal wealth in this path, don’t confuse prospects for your financial success with your satisfaction in the journey. Success is always hard to predict, particularly in a relatively unstructured career like entrepreneurial business ownership. Instead of banking on the numbers, focus on what your everyday life will be like in the different roles you are considering. Your vision of the journey in more knowable — and ensuring that you enjoy the journey will mean that the reward becomes icing on the cake.

Consider too that entrepreneurship through acquisition is, of course, the road less taken. Out of approximately 180 million Americans who work, fewer than 2% own their own businesses. But almost all of the successful entrepreneurs we know are happy with their jobs, while we know that many successful executives in big companies are not happy with theirs. And in our experience, we’ve never seen an entrepreneur who wants to return to working for somebody else in a large organization.” — pg 32

Anticipating the Cost of Your Search

How You’ll Source Prospects

“On its face, using brokers is much more economical than direct sourcing. Moreover, it is critical that you minimize the time and expense devoted to simply indentifying prospects. However, some smart, successful people do source directly. Many of these pursue a hybrid approach that combines both brokered and direct sourcing. WIth such an approach, you first learn a lot about the big picture by looking at brokered deals: for example: identifying interesting market niches. Focusing on those niches can then make direct sourcing more productive since you’ll be more familiar with the industry and, consequently, better at evaluating prospects. You can use your network within the industry to connect with potential sellers, and you’ll come across as a more credible buyer.” — pg 52

Legal Fees

“You first need to form a company that you’ll use as a search vehicle, because it broadcasts to brokers and potential sellers that you are serious about your search. It also helps keep search-related expenses organized and keeps the legal and financial aspects of your search separate from your personal life.” — pg 53

Finding Company Data:




Budgeting for Your Search

Forgone Salary & Benefits

“We recommend you conservatively budget for a two-year search. You are likely to close sooner, but budgeting for two years will help you focus on buyin a quiality company rather than racing against the clock.” — pg 61

Broken-deal costs

“Once you find the company you want to buy, you will start incurring costs directly related to the deal — such as fees to lawyers, accountants, and other outside professionals. These costs can total well over $100,000. When you complete the acquisition, they get rolled into the total amount you finance to buy the business. But when a deal falls apart late in the process, you are responsible for the fees incurred by these professionals.

Some estimates suggest that about half the deals for smaller firms fall apart for one reason or another. If you follow the recommendations we make later in the book for staging your use of outside professionals, you can minimize broken-deal costs, but it is unlikely that you’ll avoid all of them. To that end, we recommend budgeting a reserve of $50,000.”

Raising the (Search) Fund

“By the end, Greg and David had commitments for $550,000 of search capital from six investors. This was a smaller group of investors than is typical — a more common number is 10 to 15 investors, each contributing $30,000 to $50,000, but more importantly, the two partners assembled the capital they needed to fund up to a two-year search for a business.” — pg 68

Negotiating the Terms

“If an acquisition was completed, the investors’ original search investment would be “rolled in” to the acquired company, and shares would be issues for that capital. Even if an investor chose not to invest in the acquisition, they would receive shares for their earlier round of capital. Most commonly, the initial search capital is rolled in at a 50% premium to reflect the risk of being in the initial round, so the entrepreneurs would have to repay $825,000 rather than $550,000 before participating in the profit pool.”

Tune Into Their Language

“If the investor isn’t familiar with the business, brandishing buzzwords will signal to them that they are getting involved in something they don’t fully understand, rather than proving how expert you are.” — pg 73

Tell Stories

[Interesting barrier to entry.]“The pipe is really bulky and hevy, so moving it around costs about six times what the actual threading costs, and as a result, competitors from outside the region are way more expensive.” — pg 75

One prospective entrepreneur we know illustrated for investors each of the characteristics she was seeking in an acquisition by briefly describing a business that she had screened and that had the characteristics. Later, when she described her proposed acquisition, investors often jumped in to say, “I see why you like that business — it has all the criteria you are looking for!”

Finally, weaving relevant business anecdotes into your presentation signals your own breadth of experience. A common question asked for every first-time entrepreneur is whether they have enough experience to become CEO of a business now. At some point in your discussions with investors, you will have to address this question directly, but before you do, it’s valuable to create confidence that the answer is yes.” — pg 75

Chapter 6: Identifying the Characteristics You Want in Your Business

“As you begin your search for smaller company to buy, you might be tempted to think big thoughts about the future of humankind to identify the shifting sands of the business environment. You’ll wonder, What is the next big thing? Where are the opportunities for big growth and fabulous profits? These kinds of musings make for wonderful conversations but rarely lead to good business decisions. In fact, we’ll explain in this chapter that you should look for what may seem to be a dull business: one that has the same customers from year to year and is growing slowly — a business that is what we call enduringly profitable.” — pg 79

An Established and Profitable Firm

“It is tempting to imagine buying a troubled business or one with uneven performance, because the purchase price would be very low. But we strongly advise against it, because you’ll have to reinvent the business model and doing so is a very difficult and risky endeavor. Instead, buy a profitable business with an established model for success — one that is profitable year after year.

The essential characteristic of enduringly profitable businesses is recurring customers.” — pg 80

Slow Growth

“Although high growth would seem like a wonderful characteristic of a business, it comes with high risk. High growth means that your new customers will quickly outnumber your existing ones. Because new customers bring new demands, there are many ways to get in trouble. New customers are, well, new; they have no loyalty to the company and no history. HIgh growth requires great management effort. It also absorbs money rapidly, and raising that money puts a strain on the business and its owner. A rapidly growing firm also attracts competitors , which see the expanding market and the opportunity to attract new customers. So, in a high-growth business, you could work hard and still fail if you cannot keep pace with your competitors. And even if your business survives, you might find that competition has forced you to sell at low prices, so you enjoy little financial reward after all. Making this all the harder, the seller will demand a much higher price for a business that has the potential to grow quickly. Buy a high-growth business, and you’ll work harder, face a bigger risk of failure, and pay more for the opportunity.

Low growth, in contrast, menas low risk. ANd low risk is great because it is your money at stake.” — pg 81

Appropriate Size

“We think it makes sense to buy a business with between $750,000 and $2.0 million in annual pretax profits. … At the upper end of our size range — $2 million or more in profitability — we find that institutinoal investors, like smaller private-equity firms, start to become interested and that competition raises the purchase price, reducing the financial benefits of owning the business.” -pg 84

Buying a Business, Not a Job

“You can add assistants who might extend your reach, but as long as the customers value most the contributions of a particular person (you), it is a job, not a business. In a successful business, customers value the products and services for the company. The company develops systems and policies so that individual providers can be substituted when one person moves to another position. The customer recognizes the importance of the company, and that is what makes a business more than a job.” — pg 88

What to Ignore

“Our shopping list of the desirable features of a suitable business acquisition excludes some items that you might have expected. We did not suggest, for example, that you restrict your prospects to businesses that you are passionate about. Wooden boats. Old cars. Windmills. Music. Rare books. Fine foods. Wine. The list is long and different for each of us. Some searchers believe that the business they run should have a social purpose, for example, reducing carbon emissions. We appreciate all of these desires to mix a professional career with a larger passion, but passion for a business is an elusive concept at best and, at worst, will cause you to overlook problems with a business and overpay. You should be passionate about making money and building the professional life tht you desire. Hobbies and social causes rarely make good businesses. It doesn’t make sense to you require that you love the products or services of the company you buy. Remember: Dull is good. We also excluded prie from the shopping list. The price of the business you buy isn’t restricted to the amount of cash you have in the bank.” — pg 90

Managing Your Search Effectively


“As you search, don’t get so excited about a particularly attractive prospect that you devote all your time to it and stop sourcing new prospects. Most exciting prospects eventually become far less exciting: Perhaps you discover that the historical results are much weaker than originally represented, or perhaps the prospect has lost several large customers, or perhaps you and the seller cannot negotiate agreeable terms of the sale. Whatever the reason, sometimes it takes months to eliminate a prospect. If you stop sourcing, you’ll have to restart sourcing.” — pg 96

Initial Filters

“Your initial filters should answer these simple questions:

  • Is the prospect consistently profitable?
  • Is it an established business instead of a startup or turnaround?
  • Is it in the right size range?
  • Is it located in a place you are willing to live?
  • Do you have the skills to manage it?
  • Does it fit your lifestyle?” — pg 98

Deeper Filters

“Here are the two most important questions that you want to answer when applying your deeper filters:

  • Is the prospect enduringly profitable?
  • Is the owner serious about selling the business?

While it’s too early in the process to expect definitive answers to either of these questions, you are trying to make a quick preliminary assessment, which will require a closer reading of the materials or a conversation with the broker or owner and some judgment on your part.” pg 99

“Try to figure out why customers buy from this company instead of its competition and why they don’t use the presence of competition to drive down the company’s profit margin.” pg 100

Sourcing Prospects Using Brokers

Finding Business Brokers

“Brokers are not hard to find; in fact, they want to be found. Most are members of the International Business Brokers Association (www.ibba.org), the Association for Corporate Growth (www.acg.org), the Alliance of Merger & Acquisition Advisors (www.amaaonline.com), or the Association of Professional Merger & Acquisition Advisors (www.apmaa.com) and these membership lists are easily accessible.

Many earchers find the online system Axial (www.axialmarket.com) useful, because brokers can use it to find likely buyers and can send them potential deals based on the characteristics the searchers identify.” — pg 105

Introducing Yourself to a Broker

“You should expect to call hundred of brokers as Patrick and Michael did during their search. When you introduce yourself to a business broker, these are the most important things to communicate:

  • You have access to the capital to acquire a business.
  • You are determined to buy a company and expect to complete a acquisition soon.
  • You are a professional and a credible business buyer.
  • You are looking for a specific type of company to buy (describe the size, industry, and type of business such as manufacturer, distributor, or services provider).

Marketing yourself to brokers is an important part of you communication with them. As Patrick recalled, “They get a lot of calls from tire kickers, so we have a short pitch we make about how we have the determination, expertise, and capital to close on a company.”” — pg 106

Evaluating Businesses Introduced by Brokers

The Confidential Information Memorandum (CIM)

“When filtering prospects, however, you can assume that all of the rosy assessments and descriptions in the CIM are accurate and, in light of this information, evaluate the company using your deeper filters (you will do more due diligence later).” — pg 112

Further Conversations With the Broker

“If the prospect survives the deeper filters in light of the information in the CIM, contact the broker to get more information, particularly around areas where you have the most concern about the memo’s accuracy or completeness. Here too, try to find reasons to say no.” — og 113

Ch 9: Sourcing Directly

“Ari explained why he chose to reach out to sellers directly as part of his sourcing strategy: “We did some outreach to brokers. But by directly approaching owners, I was able to see opportunities before they were widely shopped. I also avoided the competition of broker-run auction.”

Searchers who focus on direct sourcing often say they get better pricing and find better companies. They also form a stronger personal relationship with the seller.

There are two early, essential steps when you are sourcing prospects directly. These steps are not required when you source through brokers. First, direct sourcing requires that you find owners who are interested in selling their businesses, while with a brokered search, the fact that the owners have retained a broker is a t least some evidence of their commitment. Second, direct sourcing requires you to collect, on your own, enough information about the prospects so that you can reject some of them. IN a brokered search, on the other hand that information is contained in the teaser and confidential information memorandum (CIM). “ pg 116

Finding Interested Sellers

“With a direct approach, you use business directories and online databases to identify the thousands of businesses you’ll need to contact to identify the thousands of businesses you’ll need to contact to identify just a few interested parties. Once you have selected the prospective businesses, use some combination of emails, direct mail, and phone calls to reach out to them. Email has a practical advantage over trying to cold-call business owners by telephone, even though the latter might at first seem like a more personal approach: Business owners tend to have receptionists or voicemail as gatekeepers on their telephone; your email, on the other hand, is likely to reach “owner eyeballs.”” — pg 117

Your Message to Owners

[Example email:]

[Seller’s Name]:

You probably receive lots of letters, phone calls, and contacts from brokers, investment bankers, competitors, accountants and “deal makers.” This is different.

I’m an entrepreneur backed by a number of prominent investors and private-equity groups who is looking to purchase and run one company. I would move to [Seller’s City] and become the manager of [Seller’s COmpany Name].

If you’re thinking about exiting from your business and want to explore a quick, flexible transaction, please call or email me. My information is below.

Thank You,

[Your Name]

[Your Telephone]

[Your Website]

Over the several months of this generic but far-reaching campaign, Ari saw a response rate as low as 0.5% — similar to the average response to direct mail. [Example to customize further on pg 119].” — pg 118

Filtering Prospects

The First Call

“Therefore, with this first call to the owner, focus on three goals.

First, as with a brokered search, you need to establish your credibility as a buyer. You need to quickly make the owner feel that you are someone to whom they could imagine selling their business. You should leave the person with an impression of your management skills, humility, willingness to learn, and energy — and access to capital. For Ari, his geographic focus helped: “I found that owners all took me more seriously when they learned I was from the local area.”

Second, you need to assess the owner’s interest level in selling the company. The risk of an uncommitted seller is far more acute than it was with a brokered approach — you are not, after all, dealing with owners who may have never thought about selling, not ones who hired brokers to sell their businesses. Gently probe the owner’s interest in selling. Although an assessment of the owner’s commitment is one of your deeper filters for prospects sourced through brokers, there is a much higher likelihood of an uncommitted seller among directly sourced prospects. Consequently, getting information early about the owner’s reasons for selling is especially helpful. Selling is a big decision for business owners, and real sellers are usually able to specifically describe their motivation. We’ll provide guidance on elucidating and examining these reasons in chapter 12, “Filtering for the Owner’s Commitment to Sell.” Although you also want to learn early on if the owner has a realistic valuation for the business, this first conversation is too early to accomplish that. Before you can discuss value, you will need to obtain the company’s financials and determine the annual cash flow it generates.

Third, you want to begin to gather information to apply your initial filters. For example, make sure that the business is in the size range that works for you. If it is too small — profits below $500,000 — -it probably isn’t worth your time. If it is too big — profits above $3.0 million — you’ll probably be unable to acquire it for a reasonable price and the acquisition will require more fund-raising and associated complexity than we recommend for a first-time buyer. Of course, prospects are not going to reveal their company’s profits to a stranger, but you can get around this by asking some general, high-level questions about the business: How long has the company been in business? Why do customers select it? What are the competitors like? How many employees does the company have? From the owner’s answers, you can extrapolate whether the company is likely to fall into your size range.

Armed with the information you gathered in the first call and the information about the prospect’s location and industry that you gathered before the call, you should be able to apply your initial filters. As the call ends, if it seems that the prospect passes the initial filters, be sure to keep the momentum going. “This has been a good call. I really appreciate your time, and I’m excited about your business and its potential. Why don’t we both give it some thought? May I call you next week? We’ll probably both have some questions we’ve thought of in the meantime.”

If the prospect does not pass your initial filters, try to use the conversation to generate additional leads. Small-business owners know other small-business owners and may well know other businesses that might be good prospects.” — pg 121

Ch 10: Enduringly Profitable Small Businesses

“Since recurring customers are the foundation of an enduringly profitable small business, we suggest that your first deeper filter be whether its customers buy from your prospect again and again.” — pg 125

“Look for indications that the business has an outstanding reputation: That is the simplest reason why customers would keep returning. Other reasons should also be reasily apparent from business descriptions: Some businesses integrate with their customer’s internal systems in a way that makes it expensive for the customers to shift suppliers, for example. Other companies have an important role in the customers’ businesses but constitute a small expense for customers, so that there is no reason for the customer to seek out a competitor with a lower price. All of these characteristics create a bit of pricing advantage for the business while also reducing risk that competitors could poach customers.” — pg 126


[Interesting limit to round ups]

“BOG [Be Our Guest, a party equipment rental company] is a business that is small for a good reason: The market it serves needs to stay relatively small. The party equipment rental business is regional because it requires intensive management to constantly solve little service problems (before they become big). This sort of managemnt does not lend itself to a geographically distributed operation. If the business starts serving caterers too far from its warehouse, its ability to respond quickly deteriorate while its transport costs rise and eat into profit. BOG’s scale may be limited, but it has a great reputation. So, despite its small size, it is an enduringly profitable business because of this solid reputation.” — pg 127

No Competitors

“The pipes the company works with are typically 40 ft long; on average, one unthreaded tube costs roughly $1,000 to manufacture and $300 to transport, while threading it costs only $45. As a result, customers care much more about transportation costs than threading costs. What makes Castronics is the only company providing this service in a 500-mile radius. Its location thus gives Castronics a substantial advantage over its more distant competitors. So customers continue to buy threading services from Catronics, year after year, and the company faces little price pressure from competitors. That is a recipe for a company that will be profitable for the foreseeable future.” — pg 128

The Importance of Being Unimportant

“Thus the importance of being unimportant: If the small business you buy provides something that only makes up a small portion of its customers’ expenses, then those customers are much less likely to switch to other suppliers.” — pg 129

Businesses Without Enduring Profitability

“Companies whose profits are less likely to endure also share some common traits:

  • Technology-driven companies: As the technology changes, so will your customers. You’ll need to reinvent their products and find new customers frequently.
  • Cyclical business: If your customers are able to defer purchasing from you when their business gets soft, your revenues will drop like a stone. Because you will be responsible for regular payments on your acquisition debt, this volatility creates a big problem.
  • Huge competitors: Avoid any business that a large national chain could compete with.
  • Specialized assets: Avoid any business that requires you to buy specialized equipment that can only be used by one customer. Once you acquire the equipment and the debt that goes with it, the customer can use your weak position to drive prices down.

Another example [of someone buying a company NOT initially enduringly profitable] is Greg Mazur, who purchased a pet food distributor after graduating from Harvard Business School. The company and no exclusive distributorships, and manufacturers and customers could easily switch from one distributor to another, squeezing margins from both directions. He took a business that wasn’t enduringly profitable and transformed it into one that was by shifting product lines and growing it into a very successful company selling exclusive, specialty products to the same retailers year after year. Just like startups and turnarounds, we believe businesses that are not enduringly profitable are riskier for the buyer and more difficult to manage and require transformation to be successful That doesn’t mean it isn’t possible, but we prefer safe and easy to risky and difficult.” — pg 135

Filtering for Enduringly Profitable Prospects

  • Does it have a strong reputation?
  • Does it lack competitors?
  • Is it a small part of its customers’ costs and an essential input to the customers’ success?
  • Is it integrated with its customers?

Ch 11: Using Financial Information to Gauge Enduring Profitability

“At this filtering stage, you want to spend no more than a dy on any one company that survived the initial and deeper qualitative filters.” — pg 138

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) Margin

“EBITDA margin is simply EBITDA divided by revenue.

If a prospect steadily earns a superior EBITDA margin, that’s a clue that it possesses some critical quality that keeps competitors and customers from pushing down the margin. Look for large EBITDA margins of at least 20% for manufacturing and service businesses and 15% for higher-volume businesses like wholesalers and distributors.

The EBITDA margin is very easy to calculate. Just divide the EBITDA by the revenue:

EBITDA margin = (EBITDA/Sales) ≥ 20%for services and manufacturing or 15% for distribution and wholesale”

-pg 138


“Does this business have recurring revenues? Do the same customers purchase from the prospect again and again?

We suggest looking for business with churn rates of 25% or less. If the broker or seller has not calculated the business’s churn rate, you can calculate it from a customer list by just counting the names that drop off the list each year.

Do the company’s top five customers account for a lot of its revenues? … High customer concentration — if one customer provides, say, 40% of revenues, or three customers provide 70% of revenues — is a substantial risk to enduring profitability because those important customers have a significant impact on the fortunes of the company.

Is year-to-year sales growth coming from the right places? If you believe that the company’s customers are sticky, then most of the business’s revenue increases should be coming from market growth, price increases, or new product introductions rather than new customers won from competitors — because it should be hard to poach customers in this industry.

Are sales cyclical? … Examine revenues in 2008 and 2009, the last very deep recession, to see a worst case scenario. If EBITDA dropped 30% or more, this should be a deal breaker.” — pg 140

Quantitative Filters

“In this chapter, we have added some quantitative filters to help you assess the enduring profitability of a prospect:

  • Does it have a high EBITDA margin?
  • Does it have recurring customers?
  • Does it have fragmented customers and suppliers (no concentration)?
  • Does revenue growth come from the right places?
  • Does it have steady sales (not cyclical)?”

-pg 141

Remember, though, that filtering is iterative: As you learn more during the preliminary due-diligence stage, you’ll likely update your earlier conclusions, especially your assessment of enduring profitability.” — pg 142

Ch 12: Filtering for the Owner’s Commitment to Sell

External Factors

“Our experience is that most owner of high-quality smaller firms sell because they have to, not because they want to.

Still, we believe you can glean some real sense of that commitment if one of these situations — or something like them — is forcing the sale:

  • Retirement
  • Poor health
  • Divorce
  • Inability of business partners to get along
  • Death of the owner, and sale of the business through the estate.

-pg 145

“… without a compulsion, the risk that a seller might abandon the sale is always present.” — pg 146

Filtering for Commitment to Sell in the Absence of External Factors

“Some owners are healthy and energetic but just want to take a break from the constant demands of running a company. Maybe the value of the business has hit their magic number and they want to cash in on their success. Others want to focus their time on a different business, their families, a charitable cause, or a hobby.

We especially distrust owners who tell buyers they are selling because they’ve taken the business as far as they can and that they believe a new owner can take the business “to the next level.”

-pg 147

Cash Flow Consequences for Sellers

“As you try to filter on the commitment to sell, seek to gauge whether there is an employee who could be successful as the general manager for an absentee owner; if so, you shoulld be more concerned about the commitment to sell.” — pg 150

Unrealistic Price Expectations

“But you can still suggest a general valuation range: “I’m looking to buy a business at 3x-5x pre-tax EBITDA.” The response should help you gauge whether the owner’s idea of the purchase price is within the prevailing market range and thus whether the owner will remain committed to selling at that range. It is essential that, early on, you filter out the owners who have unreasonable price expectations; you cannot waste time pursuing a deal that will never occur.” — pg 152

Misunderstanding the Sales Process

“To filter out these misunderstandings, we recommend that you talk with the owner about these terms repeatedly throughout the sales process, certainly beginning no later than when you submit your first offer. You can also, earlier on, get a sense of what the owner understands would “go with” the business.” — pg 154

Ch 13: Preliminary Due Diligence

The Questions

“Remember, it is an iterative process so that many of the questions you focus on during this stage will be the same as those you examined during filtering. But now, you are looking to answer those questions more fully and to be more confident in your answers. So, as you create your list of the two or three most important things to focus on, also ask, How can I satisfy my concerns? What data can I ask for? What could I ask the owner? Each business is different, and you will have different questions about every one that you investigate. Here are some examples:

  • I think the business has many recurring customers. But does it? WHat is the history of customer churn?
  • I think the business has good growth potential because the current owner hasn’t done much selling. But is the growth potential real? How big is the market? How would the business compete for new customers?
  • I think the business has been enduringly profitable with steady cash flows. But has it? What were its profits and cash flows during the last recession? Is it cyclical?
  • I think the business does not rely on particular customers, suppliers, or employees. But does it? What is the customer concentration? What is the supplier concentration? Are there key employees?
  • I think I can run this business at least as well as the seller can. But can I? Are there some key relationships between the seller and customers or suppliers? Is there some certification or expertise required? Do I need a license? Is there a preference for an attribute (veteran, women, and underrepresented minority) that I lack?

Whatever your questions, order them so that you first focus on the ones more likely to kill the deal.

How Much Should You Pay for a Small Business?

“Large companies often cost much more — more like 6x-12x EBITDA.” — pg 176

Adjusting the Multiple

“You’ll need to base the offer price both on the general range of 3x-5x EBITDA and on factors that make the firm more or less valuable within that range. Such factors include the following:

  • Growth: A company with increasing EBITDA is worth more than a company with flat or shrinking EBITDA. The faster the growth rate, the higher the multiple.
  • Predictability: A company with a predictable, reliable EBITDA is worth more than one whose EBITDA is worth more than one whose EBITDA is volatile. And the longer the track record of predictability the better. Predictability enables an owner to more efficiently plan spending levels — a practice that should produce higher profits.

…few small business sales make their details available, so it is unlikely you’ll find a similar company that you can use to benchmark your price. But if you can find comparable transactions to guide your offer, it is usually very helpful because the seller is probably also aware of those transactions and has anchored price expectations to them.” — pg 177

Using Your Financial Projection to Value Your Business

“A normal market return to equity investors in a smaller firm is around 25% annually. Of course, if you can do better, that’s great. Also, note that your reward comes after the investors earn their return, so the projected return on the cash flows that you and your investors will share would need to be well above 25%.” — pg 181

“Don’t expect that you can buy a business at 4x EBITDA and sell it at 6x EBITDA.”

Deciding on an Offer Price Strategy

“FInally, there is an even more extreme approach: Bid more than you are willing to pay to lock in the LOI — get the seller to sign off on the basic terms of the acquisition — and then plan on a downward renegotiation.

While theories on price negotiation vary, we suggest leaving a bit of room to adjust pricing and terms as the deal evolves. Don’t bid your highest possible price at the start; just offer a fair price and terms.” — pg 188

Deal Terms

How You Are Financing the Acqusition

Seller Debt

“Beyond providing financing, seller debt creates an economic incentive for the seller to help the business succeed after its sale. Seller notes are an obligation from the company to the seller and generally have interest rates that are slightly higher than bank loans. They are subordinate to any senior loans, so if the company defaults, the senior loan gets fully paid before the seller note collects anything.

Earn-outs are similar to seller notes in that in these arrangements, part of the sales price is paid on a deferred basis. But in the case of earn-outs, that payment is pegged to company performance.” — pg 19

Ch 17: Confirmatory Due Diligence

Honesty and Character

“No matter how thorough your due diligence, sellers always have an information advantage over buyers; your odds of outsmarting a dishonest owner are low.” — pg 213

“Truthfulness is a habit — if a seller has covered up one thing, it is likely that the seller has covered up one thing, it is likely that the seller has covered up other things that you haven’t found.” — pg 213

Accounting Due Diligence

Proof of Cash

“As you review the financials, keep an eye out for various discrepancies:

  • Timing between the reporting of revenues and associated costs (resulting in inaccurate EBITDA during the period on which the sale price is based)
  • Actual cash flow as shown in bank statements cersus reported figures for revenue, expenditures, and owner distributions
  • Pretax income as reported in financial statements versus that in tax returns
  • Big fluctuations in year-to-year revenues, expenses, and EBITDA.” — pg 217

Legal Due Diligence

“Contracts such as leases or distribution agreements often have change-of-control consents, which mean that if the firm or its assets are sold, consent is required from the other party to transfer the contract to the company’s new owner.” — pg 221

Ch 18: Raising Debt

“Buyers typically pay for their acquisition of a smaller firm by borrowing about two-thirds of the purchase price.” — pg 231

“Having debt is much more important than having cheap debt.” — pg 236


“As a borrower, you should always negotiate the covenants to ask for a bit more leeway. If the lender registers concern at your lack of confidence in your own projections on which the covenants are based, remind the lender that the purpose of a covenant isn’t to test how good a forecaster you are; it’s to make sure that the loan is very safe. At 2x debt service coverage for example, the loan is perfectly safe, even if that represents a considerable discount from your financial projection.

The ratios can also change over time. Generally, early in the loan, your company’s profitability should be able to drop at least 15% to 25% before hitting a covenant. The covenants natiurally become looser in future years.

Payment Schedule

“It’s a good idea to try to negotiate smaller amortization payments in the early years of the loan;

Banks will also often request an excess cash flow sweep: At the end of each year, if the company has generated cash after paying all operating expenses, interest expense, tax distributions, capital expenditures or other investments, and scheduled debt repayment, then a portion — -usually half — of that excess cash is swept to the bank as a loan principal prepayment. Usually these prepayments are credited against the last scheduled amortization payments, so that your required repayments are not reduced until you get near the end of the loan life.” — pg 241

Seller Debt

“The amount of seller debt is typically 20% to 25% of the total purchase price, the term of the note four to five years, and the interest rate 5% to 8% and usually fixed.” — pg 243

Ch 19: Raising Acquisition Equity

“[T]here are many more people trying to invest capital than there are good investments. … In our experience, the payoffs need to provide investors with at least an annual rate of return around 25%.” — pg 247

Assembling the Investment Memorandum

“The investment memorandum, a detailed packet of information about your target company, should be sent to potential investors. Start putting this memo together once you have a signed LOI.

Deal Terms

“If you self-funded your search you determine the terms of the equity you’ll offer to investors now that you know the prospect and its attractiveness; the better the prospect, the better the deal you’ll be able to structure for yourself. This flexibility is the primary benefit to self-funding your search.” -pg 253

“For example, start with a payout sequence like this:

  1. The investors get back all their capital.
  2. They then receive a 7% annual return on their invested capital (the preferred return).
  3. Then you receive 25% of the amount paid to the investors as the preferred return (the catch-up).
  4. Then the remaining profits are divided 75/25.

Review what level of return this deal provides to investors. If it is much above 25%, increase your ownership to move projected investor returns to about 25%.” — pg 255

Approaching Investors

“As with your earlier pitch for search funding, you should prepare thoroughly and stay focused on delivering your pitch in the call. Everything about your acquisition opportunity, your own preparedness, and your manner is being evaluated.” — pg 258

Ch 20: Negotiating the Purchase Agreement

Your Acquisition Entity

“This acquisition company will also be the borrower if you are using bank debt or seller debt in the acquisition.” — pg 262

“While each deal is unique, typical indemnification terms are as follows:

Size of escrow account or setoff: 20–30% of purchase price

Survival period for claims: 12–18 months

Basket size: 0–1% of purchase price

Total cap on claims: 20–30# of purchase price

Ch 21: The Closing Day and Beyond

“The most common reason smaller firms run into trouble is that they run out of cash. The prior owner probably ran the business largely debt-free, but you will be running the same business with acquisition debt to service.

When business partners Patrick Dickinson and Michael Weiner bought Castronics, the pipe threading company in Nebraska, they interviewed every major customer. Patrick later commented: “Every single one of our new product and service ideas came from these interviews. We didn’t implement every idea the customers suggested, but every idea we did implement originated in this set of interviews.”

Finally, don’t rush into making decisions in the first few months.” — pg 275

“The best way to address this question is not by asking yourself, “Do I want to be an entrepreneur?,” but by asking, “Do I want to do what an entrepreneur does?” “ — pg 277

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