In the blog post on Finding Business Ideas we said that buying a business is often the quickest and easiest way to become an entrepreneur. Well, like buying a house, you don’t want to pay for fancy fixtures or a fresh lick of paint. You want the cheapest house in the best area. This typically means you’ll buy something beaten up that needs loads of TLC. The same goes for businesses and so being able to execute a turnaround is a key skill.
Back to our house analogy, be very careful what you buy. A few superficial cracks are okay but you need to ensure that the house is structurally sound. With established companies, you need to ensure that the fundamentals are still solid and then find out why it failed. These are 3 common reasons for failure:
- Over leverage / under investment — if you buy this business then you better have some serious financial firepower because it will be cash hungry for an indefinite period.
- Poor management — I think these are the best kinds of businesses to buy, especially if you know of a great management team or you will be the CEO yourself. This is a good time to say that you should sack the directors not the cleaners and admin staff, its cowardice to do it any other way. You know what cleaners do but directors in a failing business usually lie. The mid-management will probably tell you 80% of the truth, so only keep the 20% that are honest and will contribute to the future of the company.
- Declining market / trend — I would only consider this type of purchase if you intimately know the sector and have a solid thesis on why you’ll outperform against the odds.
It goes without saying that if you choose a business with more than 2 of the above characteristics then you’re either more talented than the rest of us or have more money than sense, for this fleeting moment…
Information is never going to be complete or perfect so at some stage you’re probably going to need to take a leap of faith. Fortunately, you can de-risk the situation to some extent.
Here’s 5 important strategies that will probably save your skin:
1. Do your homework on what you’re buying
The seller is unlikely to volunteer much information. If you’re an individual you probably won’t have access to expensive resources to do due diligence. So you may need to be quite cunning in your approach — try speaking to ex-employees, suppliers and former investors. There’s a long list of things you’ll need to lookout for but I’ll cover that in a dedicated blog post. For now, it’s probably best to approach this as if someone is paying you to do a ‘business rescue.’ What information and metrics would you need to assess the health of the business in order for you to take the job?
2. Buy the assets of the business, not the shares
Failing businesses have lots of skeletons in the closet. Unpaid bills, lawsuits, pension liabilities…the list goes on. Buying the assets-only means you start on a clean slate so you can focus on driving the business forward rather than cleaning up someone else’s mess. This means you are buying the business free of cash and free of debt — don’t do it any other way, even if you do decide to buy the shares for some reason. Lastly, if you’re only buying a portion of the company then remember the time you’ll get the most equity is when things are going badly so don’t want until things start turning the corner until you ask for your cut.
3. Opt for a deferred payment structure so you don’t overpay
This probably won’t be easy as the seller definitely doesn’t want this scenario. However, when a business is up for sale, the numbers have often been ‘massaged’ somewhat and it can take 12 months to pull the wool away from your eyes. Even if the price is 10% more on paper but this allows you to negotiate a 40% deferred payment scheme then I would strongly consider this option.
4. Do not give personal guarantees, no matter how optimistic you are about the business
Do not re-mortgage your house even if you really really need the money for only 2 weeks. I can introduce to you to a few people who will vouch for this — akin to visiting the hospital accident ward before deciding to buy a motorbike…
5. Under-promise and over-deliver for the first 6 months
Whether for investors or for your personal sanity, set realistic goals. When buying or starting a business, I like to create a 100-day plan on everything I think we’re going to fix. When doing this, the idea is to try ensuring that the plan is realistic or it should be deferred until a future plan. My experience is that 100-day plans are inevitably overly-optimistic so don’t fall into this trap.
Turnarounds guzzle more cash and take longer than you think. Don’t expect any cash to flow out of the business and be ready to dip your hands in your pocket again. So be honest about your financial position and needs before being the business’ next victim.
Lastly, what is the opportunity cost of this investment? What are the returns going to be? Is the juice worth the squeeze, viz-a-viz will this produce a risk-adjusted return? If not, you might be better off putting your money elsewhere… Or just a buy a boat, it’s a much more fun way to burn loads of cash.
Turnarounds are not for the feint-hearted and the experts often get it wrong so don’t bet your career or pension fund on it.
This may all sound very daunting but if you’ve ever launched a business from scratch, you’ll know the grind involved in getting basic systems in place. In start-ups, you have to create everything from letterheads to supplier relationships and filing systems. This involves a considerable amount of effort and there may not be any customers waiting at the other end of the tunnel. With a turnaround, the demand is proven and the ingredients are there. You just need to make sure the cake doesn’t flop again.
What you may in fact find is that fixing businesses is often more fun than starting and running them and so turnarounds might turn into an interesting and hopefully lucrative hobby…
Alexander Leigh is a Technology VC Investor — Helping entrepreneurs succeed through mentoring, advice and money. He currently works at the Development Bank of Wales as an Investment Executive and is also an active mentor at TechStars London — the worldwide network that helps entrepreneurs succeed.
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