Growth by acquisition is not necessarily the cheapest or the best way to grow your business but it is the fastest way. The biggest mistake I see is that advisors often see it as a cure all. They do not consider if they have capacity or if it fits into their business model. They want a business so badly that they will buy anything at almost any price.
Here is a basic graphic that shows how to structure a deal. Terms that benefit the seller = lower price and terms that benefit the buyer = higher price.
“Determine Value and then Negotiate Price”
Negotiating strength favors seller (e.g. better knowledge, skill and quality of counsel)
Seller perception of business risk is low/growth is high
Highly motivated buyer (e.g. strategic buyer seeking synergies)
Tax Structure favors buyer (e.g. an asset sale)
Deal structure favors buyer (e.g. small cash down, seller financing terms favor buyer)
Highly motivated seller (e.g. a distressed personal situation)
Tax structure favors seller (e.g. a stock sale)
Deal structure favors seller (e.g. large cash down, seller financing terms favor seller)
·Negotiating strength favors buyer (e.g. better knowledge, skill and quality of counsel) Tax Structure favors buyer (e.g. an asset sale or income)
Buyer perception of business risk is high/growth is low
DO NOT NEGOTIATE PRICE AND THEN NEGOTIATE TERMS
I see this all the time. “Okay I will accept X for my business – now I want you to pay 100% up front, pay severance for all my employees, take over all my leases and also pay me a salary to introduce you to my clients. And by the way it is a share sale.” At this point the buyer proceeds to negotiate the terms without adjusting the purchase price.
Most transactions without a qualified professional are done without addressing all of the important steps in the process. Most deals are done without proper due diligence.
BUYING BASED ON RUMORED MULTIPLES
PLEASE do not just use multiples you have heard bandied about. The multiple means very little and frequently is BS.
First consideration – multiple of what? Gross to Dealer Revenue? Revenue after Dealer fees? Recurring revenue? Owner’s Earnings? EBITDA?
Second – what are the terms? How much up front? Vendor take back and how long? Share sale? Asset sale? Income stream? Earn out? What about employees? What about leases? The list is endless.
All of these variables influence the final deal.
AGE OF CLIENTS
Many advisors are not selling until they are in their 70’s ++. If the advisor is in their 70’s good chance the clients are in their 70’s. This is a service book with more money exiting than entering. Using an actuarial table approximately 50% of these clients will live 15 – 20 years so there is revenue but your responsibility will be to service these clients. Clearly a business with an average age of 55 has more potential for growth and therefore worth more.
One of the first clients I had hired me to put a value on a business they bought where the selling advisor was 80 and the whole “book” was GICs. In my view the fair market value was ZERO. The only way to structure this deal equitably was with an earn out. I see this all the time where buyers over pay for a clientele that is more likely to shrink than grow.
What market are you in? Usually that is the market where the advisor feels comfortable. If most of your clients are blue collar – a great market – does not mean that you will feel comfortable dealing with Doctors or vice versa. This is more important than most advisors realize as if you are not experienced and comfortable you will lose many of the clients in the purchased business.
Another way to look at this is savers and high net worth clients. Dealing successfully in one of these sectors does not necessarily transition the skill set to the other.
I saw one advisor in a large city buy a great business that specialized in the rural / farm market. The average household assets were very high and this advisor thought since he was in the high net worth market he could handle this market. He sold 2 years later as he had lost 25% of the clients and realized he was going to lose more. He did not understand the specific issues of those clients – expectations, comfort level, and income tax issues.
LOCATION – LOCATION – LOCATION
What is driving the current seller market? High markets, low interest rates, size premiums, etc. BUT the main reason is demand. Lots of buyers. If the business is located where there are fewer advisors or the advisors are older and not in the buying market – where is the demand? In the GTA we have a 100+ buyers for every seller but that is not the case in Whitehorse. Yet in many of these smaller markets where there is few qualified and interested buyers should they pay the same multiple as a buyer in the GTA? You would think not but it is happening frequently.
The biggest risk in any business purchase is the risk of clients leaving because their advisor is leaving. If the transition of advisors is done properly few clients will leave. Unfortunately, this is not negotiated in the terms of the deal. How long should the seller be involved. Will the seller do what he has promised. The best way to insure this is hold back payment. That is why I strongly recommend NOT putting a large percentage up front. In fact, make part of the payment after the top clients have been introduced and successfully converted to new advisor.
I know of a deal where the buyer paid 80% up front with lots of promises to introduce clients. The seller literally moved away after the first month. Many clients left. The buyer stopped making payments on the balance – 20% was now down to 10% – and the seller sued and the buyer gave up and paid him out.
This is more common than you realize.
GET ADVICE FROM EXPERIENCED PROFESSIONALS
Part of the issues identified above can be mitigated with qualified and experienced professionals working with you. Most advisors think they are invincible and no harm can be done. (nice way of saying cheap!) Go through the proper steps and you will greatly reduce the risk in a transaction.
I know of one case where the seller was getting a ridiculous price to sell but here is the kicker – he was not getting one dime for two years. He sold to inexperienced advisors with very very small businesses. You guessed it after two years – no money. He called me to see if I could do anything and I said yeh sue your lawyer. That is when he told me he did not have a lawyer.
Queenston has worked with over 200 businesses in ten years. We are experienced and qualified. Let’s book a time to speak.