The Tricky Business of Selling Small Businesses

[Music] hello everyone welcome to the 21 hats podcast I'm your host Lauren Feldman this week special guest David Barnett who started helping owners buy and sell businesses in 2008 offer some guidance on an often misunderstood sales process early on David was a business broker I sold over three dozen companies for other people he tells us and it was very interesting and exciting it was also a terrible business so he changed business models but has continued to do pretty much the same work as a result he's amassed a lot of firsthand knowledge much of which he shares in our conversation including why many owners fail to think of their business as an asset why sellers shouldn't be too quick to reject earnout why buyers should consider making multiple offers for the same business how buyers can protect against the post-p purchase loss of important customers why businesses are selling for less than they were a couple of years ago why there may be a smart way to buy a business than by scouring business for sale websites and why there really isn't a true market for buying and selling businesses even in Good Times owning and running a business can be a lonely Pursuit our hope is that these weekly conversations will let owners know they are not alone in facing challenges in fact that's the whole idea behind the 21 hats Community engaging with other owners to get the kinds of insights only another owner can offer if you're interested in learning more step one is to sign up up for a free trial of the Morning Report which highlights the most important news of the day for business owners so you don't have to go looking for it step two is to get on our slack Channel where you can ask questions get vendor recommendations and tap the wisdom of a very impressive crowd just search the 21 hats Morning Report to sign up for a free trial joining me this week on the podcast is David Barnett who is based in New Brunswick Canada and helps people around the world buy and sell businesses the episode is titled the tricky business of selling small businesses before we get started I want to note that we do still have a few slots left for our third annual 21 hats live event if you like this podcast you're going to love our live events for one thing almost all of the regulars on this podcast including Jackie Jay sha Paul Laura Lena Liz Sarah and William will be there but think of the event as a 3-day peer group conversation where we share wins and challenges tour local businesses eat good food make friends and connections and leave inspired the next event will take place in Ann Arbor Michigan and run from Wednesday May 14th to Friday May 16th on Wednesday we'll gather in a private setting at Zingerman's Roadhouse where we will introduce ourselves our businesses and our challenges on Thursday we'll vote on the top topics we're most eager to discuss most likely questions like would you take outside Capital what are you doing with AI is your business as profitable as it should be and then we'll tackle those topics one by one we'll also take a tour of mat tile works we'll pick one business for a deep dive brainstorming session and we'll eat some more good food on Friday we'll have a Q&A session with Ari wiin co-founder of Zingerman's the original small giant that inspired the book by Bo Burlingham we'll conclude our peer group conversation and we'll finish up with lunch for those who are able to arrive early Andor stay later there'll also be small group dinners Tuesday and Friday evenings and here's my guarantee if this event doesn't feel like a family reunion after about 30 seconds even if this is your first time or if you're not fully satisfied for any reason you get your money back to register go to 21h hats.com and now on to the show welcome David our special guest today it's great to have you here I've really been looking forward to this conversation for a lot of reasons but especially because you're a consultant who helps people buy and sell businesses and my sense is that as important as those activities are the buying and and maybe especially the selling of businesses I think are not nearly as well understood by business owners as perhaps they should be and you know for some understandable reasons but it's still an interesting dynamic do you agree with that yeah I do and and uh it aligns perfectly with uh with my experience you know I've been involved in this for a long time um you know I I was a business broker uh back in at the end of 2008 for three and a half years before I left that and eventually ended up doing the same kind of work as a consultant but I would probably suggest that about 90% of business owners are not really thinking about their business as though it were any kind asset the person that owns the roofing company for example that uh that has several Crews and they go out and they they you know replace shingles on people's homes a lot of the people that run that kind of business they consider themselves roofers they don't consider themselves business owners and I think it's when when people consider themselves to be a business owner they start to think of this thing like a sort of a thing they own that creates a cash flow and I think that it's probably you know 10% or so of of business owners that probably have that sort of attitude and that's the attitude I think that is required in order for somebody to start to proactively start to think about the future and what their plan is going to be as far as an exit and and worrying about things that they could do in the business to actually make it better to or or more valuable or easier to sell you know it's not like anything you just said is a deep dark secret um this conversation has been ongoing for a long time do you have have any Theory as to why it's not sunk in more deeply yeah I think it's perfectly rational that for most people it has not and and and let me justify that why I'm saying that U the first thing we need to understand is that businesses sell for relatively low valuations uh we typically talk about businesses being sold as a multiple of cash flow to the owner and so right now in the stock market you know business there there are several highflying stocks that we hear about all the time that are selling for many dozens or hundreds of times their their annual cash flow but you know traditionally stock market public companies would sell for you know I don't know 15 to 20 times earnings and small businesses small privately owned businesses will sell for like you know sometimes less than two times earnings up to two and a half three-ish so a really great well-run successful small business that's owner operated um if the owner does everything right and exits and you know achiev all these things we're talking about uh they basically are going to be able to walk away by pulling forward just a few years of earnings into their pocket and so if a if a business is really small if it's not that profitable if it's kind of marginal like there's all kinds of reasons why somebody rationally might not put the effort into making those preparations because they may realize you know in in their own introspective way that those preparations and the work may not really pay off for very much does that make sense it does it makes perfect sense the biggest challenge I've seen for for owners looking to sell is that they have not figured out how to remove themselves from the day-to-day of their business is that what you see as well well it depends on what you think your challenge is going to be so if your challenge is selling your business quickly or if your challenge is selling it for the highest price those are are two different challenges and to sell a business more quickly you need a bigger pool of buyers and in order to get a bigger pool of buyers you need to be able to show the greatest number of people that they too can run the business if you have that to use the roofing company example if you can show a guy who works at the post office that you have systems for marketing and systems for quoting and systems for organizing the schedule and the payroll and systems for ordering the product and how you get it all delivered to the right house on the right day with the crew showing up you know the person who works at the post office is going to be more convinced that they can run the business too but if you don't have any of that stuff your business may still be sellable but it's probably only going to be sellable to some person who works in the roofing trade and they already have some insight into what it is that they're going to have to do every day when they own your business and so uh when we get to uh trying to get the highest price price is usually a function of the cash flow so if you can make your cashow flow from your business as high as possible that's going to justify a higher price the buyer is always going to ask themselves the next question and the second question is always great now that I understand this cash flow exists what is the likelihood of it continuing under my stewardship so the systems and things may be important in that question but what's really important that in that question is who are people really doing business with are they doing business with this company with the brand name or are they doing business with the owner that people know like and trust and if it's the owner if the owner is front and center and we've all seen these local businesses where the owner in the advertising and you go to the business and the owner's there helping customers and shaking hands and stuff now that owner is going to be creating a harder time for them to transition the business to somebody else because the buyer is going to be worried that in once that seller is gone um that the people won't want to come and do business with them do you have a checklist that you use if someone comes to you looking for help selling their business I'm guessing you have a series of questions that you ask to understand what's going on in that business could could you walk us through that a little bit yeah so when we start helping a business owner with the whole process the very first thing we do is an evaluation of the business and we have um a system that we use that has a this big questionnaire uh and and they're general questions and there's over 100 questions and we go through it we actually try to call it a little bit before we send it over to remove the questions we know just won't be applicable but we try to get our heads around all the different areas so there's operational stuff there's marketing stuff there's um you know customer concentration there's you know employee uh concentration issues labor market issues all kinds of factors that we look at and at the end of the day the value comes from the cash flow but we have we're able to then modify um is a tool we have which allows us to subjectively modify the output of our analysis so uh we grade it the output is a polar graph actually and you kind of see sort of the the area change as you score things above or below average and it helps to quantify what those different sort of qualitative factors might imply and sometimes we actually have to deal with things that are that are such a big problem we deal with them in the actual deal making itself so if you had a business for example where the top five clients were over like you know 50% of your Revenue you could expect as a seller that there will be some kind of tie between the ultimate amount of money you get paid for the business and the retention of those top five clients and that tie-in could last for several years because at the end of the day what a buyer is buying when they buy your business is they're buying its cash flow they need a cash flow usually usually to replace the job they're leaving or uh or maybe they're already in the industry and they want to grow strategically by buying your business and they're acquiring the cash flow and the cash flow is required to service the debt they've taken on likely to buy the business and so to have that cash flowing they need all those customer relationships and if some of that falls apart shortly after the Takeover um then they won't be able to service the debt with the reduced cash flow and so a lot of the times sellers have an issue with this you know they say I found those customers I nurtured those customers you know what happens if I hand this business over to you and you don't take care of those customers and you lose them you know I don't want to be held responsible for what you're going to do once you own the business but the reality is is that every part of business ownership is is risky and people face risks in the startup they face risks in the operation and there are also risks in the sale and when you when you tie sellers and buyers together with these kind of features in the transactions what you actually end up doing is you end up creating these temporary Partnerships where both the buyer and the seller in are in alignment of their needs and goals so if the seller needs the buyer to be successful in order to get all of their money that helps the buyer have the confidence that they should actually do the deal because they can see that the seller is willing to expose themselves to certain risks and that shows the buyer that the seller who understands the market the business and can appreciate who the buyer might be the seller has confidence in that person and the business in the market so the two of them then move forward and I've seen many instances where we have these big customer concentration issues and the seller ends up you know being somewhat responsible for those continuing for several years and that means that the seller always makes themselves available to coach and consult with the buyer to talk about that customer relationship sometimes even to show up on the golf course you know two years after the sale when the buyer is taking that customer out for a round of golf and the seller shows up just to help cement that Handover to make sure that the cash flow continues and that ultimately the buyer gets what they paid for one of the things Lauren that I that I often talk about when uh when I'm asked to do an interview is that you know business owners spend an awful lot of time thinking about their customers what they want what they need what they'll pay for you know what features they might enjoy in the product or service Etc and then something weird happens when people start to think about selling their business they suddenly become very self-centered they think about only themselves and the money they're going to get and the reality is that when you when you sell a business you're still in the business of selling something and your customer is the buyer and business owners need to think about that buyer and what the buyer needs and and what the buyer needs is they need a cash flow that's going to allow them to take home a salary to support their family they need to be able to pay their taxes they need to be able to service their debts they have to be able to you know replace Machinery as it wears out and breaks down and I just find it very surprising how few business sellers ever you know sit down and look at their business and say if I was the buyer what would my situation likely be how much would I be borrowing what would my payment be and just kind of walk through it from the buyer point of view to see what exactly they're asking someone else to do there's a lot there one of the things that strikes me is I know it's very common conventional wisdom that sellers are told to try to get as much of their payout as they can on the day the deal is closed and not to rely on the performance of the business going forward for the rest of their payout because you don't know how well this person you're selling to is going to run the business and it's kind of coming at it from the opposite direction that you just described and and I'm curious what you think about that advice it's interesting I just recorded a video that's going to come out in the next couple of weeks on this but the value of a business it's like a machine with two knobs and there's a price knob and there's a terms knob and if you adjust one knob in One Direction the other knob automatically goes in the other they're linked together with some kind of weird uh belt inside the machine and so if you you know want the highest possible price what you're doing is you're stretching everything so to the point where everything's got a function just perfectly for that buyer afterwards and it's really hard to gamble on everything working out just right and so a buyer will then see that they're getting into a riskier scenario and they're going to want to try to offset part of that risk and the easiest way to do that is to get more seller financing or some kind of earnout provision if you want you know all cash closing the simplest way to achieve that is to get a lower price right and then it's easier for somebody to stomach the risk of what might happen in the future because they're going to have a lower debt obligation Etc I've just seen these negotiations go back and forth and when I'm working with buyers for example one of the things that I I'll often you know suggest to many buyers is that they make more than one offer at the same time so you know what happens in that scenario well the buyer gets three different offers with three different prices and three different sets of terms because it is worth money to a buyer for a seller to solve part of their problem let's take the conversation to the car lot okay so you're at the car dealership and you want to buy a $50,000 car and the car dealer knows that most people do not have $50,000 in a bank account right so what the car dealer does is they go out and they make relationships with leasing companies and finance companies and Banks so that there's somebody there at the dealership who's already got all of those problems solved so that they can then say to you hey you don't need to have $50,000 we can help you get a loan and that helps them sell more cars so when you're selling a business the issue is is that it is sometimes difficult for buyers to get the money they need to buy a business and so by being willing to be part of that financing solution like you know like the car dealers getting those those banking relationships lined up if you say you know I know it's going to be hard for you to pay this really high price so I'm going to help you I'm going to invest money by lending you money to buy my business then you're going to make it easier for the buyer to do the deal and by extension if you understand going in that you are likely going to do this kind of deal what it's going to do then is number one you can attract a greater number of buyers which is going to give you more options as to who you're going to sell the business to and you can make sure you pick the right buyer who's got the qualities skills and experience that you think are going to set up for success and um ultimately who's willing to pay a higher price because of your help I was also really intrigued by what you said about client retention obviously you know we've all heard of sales that involve an earnout but it sounds like you were suggesting a kind of a specific kind of earnout where the future payments to the seller aren't just dependent on the general success of the business but tied specifically to whether they the business is able to retain clients yeah I've never heard of that is is that a common practice it's not very common but it that many of my clients have ended up doing this one thing to understand is that um you can get as creative as you want to be in any of these business deals if there's no Bank involved if there is a bank involved then you might have another set of rules kind of Applied onto the deal so for example if someone's buying a business and they're using an SBA loan SBA does not like these earn outs they want the business sale to have a definitive price you know written down like this is the price of the business so I've had deals before where there has not been one seller financing note but there's been six so there's been the buyer puts some money in they borrow some money from a bank and they give that money to the seller as well and then there were six different seller financing notes and each one of them was tied to a specific customer and so the buyer was paying those loans but the the rules of those notes said that if the sales to the specific customer fell below a certain threshold that the the note payment in that month would be forgiven so in that particular case it's almost like an earnout in Reverse where um you know there there is a specific price this is what's being paid for the business but if for some reason one of those customers you know fails to continue buying then the seller ends up losing a little bit of their sale price the amount that was tied to that client and that's just one example of how you can do this ultimately like I said and we're talking about a case where you could have five customers or six customers with half the revenue of the company um it would be significant in most small businesses if they lost one of those big five clients in that kind of scenario the entire profitability of the business could evaporate that's all really interesting uh you obviously have a tremendous amount of experience doing this let's take a step back how did you get into this oh so I'm just one of those kids that's always been interested in business and walking into every business as a kid I always thought about how they could do things better or or what they could do to make the experience better and eventually got into sales and my real education though I went to business school because I thought I would become a business person there but you know that's not what they teach they teach you how to you know be a middle manager in a big company there my real education came when I got out of University and I went to become an advertising sales rep with my local Yellow Pages publisher because I I literally spent all my days meeting you may have to tell some of our listeners what the Yellow Pages are well the Yellow Pages was a printed version of Google before Google right and and so you know everyone had a telephone that was tied to the wall and under the phone was this big book and the front half of the book was everybody's name and address you know wouldn't pass any kind of privacy laws we have today and the back half of the book was yellow and it was by classification so you know the accountants were in the front and then the the you know the plumbers would be under p and the tow trucks would be under T and you would go and there would be advertisements there and so it was my job to visit all these businesses and talk with the owners and managers and ask them what kind of customers they were looking for and figure out how they made money and how they could take advantage of additional phone calls coming from the Yellow Pages that would have been great training for a business journalist too well you know it would have uh because I I I I learned so much about these different businesses and for some of them it meant you know more customers meant putting a bigger ad in the local book or or maybe there were a lot of ads so maybe the The Right Move would be to put color in their ad so their ad would stand out and for other customers you know who were dealing more regionally the solution was to put ads into many different books in other cities around us right and so I got to learn uh about what they were looking for how they made money eventually though you know things changed gole did come around we got smartphones with the internet and so I left to start my own business and eventually sold that and got into broker and Commercial debt and this is where I first started to meet people that were looking to get money to expand their business so I was helping with lease uh Arrangements I was doing factoring facilities which is when you sell your accounts receivable to to try to raise money I was also helping people getting you know you know business loans and things like this and um the the Great Recession came and so aot a lot of my sources of capital kind of dried up and I also met several people who were trying to get money to buy entire businesses in that time and that was my first exposure to this whole idea that you could buy and sell a business so I I decided you know what I'm going to get into this because I saw some pretty awful things Lauren I saw people trying to intermediate these deals between buyers and sellers who didn't really know what they were doing like uh you know people like uh like real estate agents trying to sell a business and you know the contract wouldn't contemplate anything to do with inventory or operating capital or there was one case where uh uh some people bought a motel and restaurant and just before the sale the the sellers went and sold thousands of dollars worth of gift cards to their restaurant at a discounted price and they pocketed all that cash and the buyer shows up and all of a sudden all these people want to use these gift cards and he realized oh my goodness I've been screwed and and you know he went and got a lawyer and then the lawyer got me involved and was like can you comment on this and I said yeah this was a person who didn't have any understanding of what they were doing trying to broker this transaction and so I ended up joining a big International franchise chain so that I could get access to training through a through an association of business brokers and I did that for three and a half years I was a business broker I sold over three dozen companies for other people and uh it was very interesting and exciting it was also a terrible business you can talk with a business owner for over a year about selling their business and then when they decide to sell you can get them to sign an agreement with you and then it can sometimes take six or eight months for them to deliver all the paperwork you're looking for because they're busy running their business they're not that organized their accountant still has to do some thing or another from last fiscal year you know how it goes and then you when you finally get everything you need you package it together and you start to confidentially advertise the business and it can take you another year or more to find the buyer and once you find the buyer then you have to help the buyer so the buyer's got to put together a business plan and a cash flow forecast you have to bring them to A lender you have to help them arrange their debt there's so many moving parts and so you can get down to the 11th Hour on one of these deals after having invested two years in the transaction and then things can fall apart for reasons entirely outside of your control I had um deals fall apart for uh like franch businesses where the franchisor was just a total jerk to the buyer and and totally turned them off from the opportunity I had situations where Banks issued funding letters and later rescinded them I had businesses that operated within licensed Industries where you know government agency had to issue a license to the buyer and didn't uh all kinds of things that can't really be foreseen but when you're when you're putting these deals together entirely for a commission uh you need it to close in order to get paid and and you know bring home the bacon as it were you know that's so fascinating to me because I've always heard a version of that story that comes from the perspective of the business owners who say you know the problem for us is there are lots of brokers who want to help big businesses do deals there aren't that many qualified people who are looking to broker deals with businesses the size of mine and I think you just explained why that is absolutely and most business brokers are charging you know 10 or 12% commission when I was a broker I was charging 12% of business value and 6% of real estate value if the business-owned real estate when it was being transferred and those end up being pretty big commission checks when you sell a business that goes for 800,000 or a million dollars right when you're when you're talking about a business that could be worth a couple hundred thousand then obviously you were talking about a much lower check and but it seems like a lot of money to that business owner the first business I listed for sale was a fried chicken franchise and I sold it three times the first two times didn't work out at the 11 hour and the last time I sold it was December of of 2011 so I had that listing for over three years I worked on that file and at the end the the seller said to me wow you know must feel good getting that big commission check and I remember I said to the guy I said look the the person that works at your front counter that asks people if they want fries with their chicken has earned more money since I met you than I have was that literally true it was literally true and ultimately that was the the the frustration that beset me was this roller coaster cash flow in my personal life and I thought I've got to get out of this so so I left the industry and I became a banker Lauren uh and I worked with uh with much larger businesses in my banking career but my phone just kept ringing of of people that were working on these transaction ACS they were looking for help and guidance and I would say to people you know I I can help you but I'm not in that business anymore uh uh I I guess I could charge you a consulting fee you know um I'll I'll charge you $100 an hour or something and people just said oh great can I meet you Saturday and and I re I realized slowly that you know the stuff I used to do on the hope of someone one day paying me a commission that you know people wanted that help and they were willing to pay for it and eventually the bank organized and I was able to get a package when my position was eliminated so I use that opportunity to build the business that I have today that I have had now for almost 10 years and um I wrote a couple books I started the YouTube channel uh and got myself out there more and today I work with people all over the world that are buying and selling we help buyers analyze deals and give them an idea of what reasonable offers might be we work with Sellers and help them do an evaluation that we do the packaging and we help them advertise just like a broker would but the difference is you know I learned from my first time around the difference now is we act as consultants and we have sort of a menu of services and a road map and we just charge people for the things we do along this path and ultimately what it means for the business sellers is a much lower Bill than if they sold through a broker however it's not contingent so I'm issuing invoices to people every week and so it's it's changed the the sort of cash flow character of my business and it's allowed me to give that better level of service and provide for the the people you're talking about those smaller businesses that can't seem to get the attention of a you know a good qualified broker where they are it's a sort of another alternative model so you're essentially doing the same thing you're just charging for it differently L and in other words your clients don't have to also hire a broker along with you as a consultant correct no that's right and and the other big difference would be uh agency capacity so a business broker is an agent they they have an agency role and that's important to understand under law because they represent the business owner and so we never take on that agency capacity so what we do is we provide the services and Coach the business owner and and and help them along the way without you know standing out in front and kind of being their their their face and representing to the other parties you said you you help businesses all over the world yeah how is that possible I assume the game is played differently everywhere and I should point out you're you're based in Canada I assume there's some differences between Canada and the US let alone you know around the world tell me about that well sure and and so you know back when I learned my business brokerage practice when I when I learned how to be an intermediary all the training that I took was based in the US the United States being the leader in this kind of stuff around the world It generally follows a couple of basic rules you know the negotiation for businesses is between people the sort of rate of return or what a buyer needs to get out of the deal numerically works out to be kind of the same sort of solution no matter where you are in the world there's a very big difference when it comes to the financing and that's probably the only exception and you know the United States has the SBA and so the SBA program allows for a higher degree of financing on something like a business business acquisition everywhere else in the world people are more limited in how much they can borrow to do a deal and that just means the terms end up being different so uh in another country like in Canada uh sellers have to carry more paper as they say you know they have to finance more of the deal just because the buyers can't get their hands on the money Canada doesn't have the equivalent of an SBA it has different programs so for example there there is a government guaranteed program but it's tied to financing the value of assets so the more tangible Assets in the business the more someone can borrow whereas the SBA looks at the value of the business almost like you'd value a house you know if the if the business is worth a certain amount of money that's what they're going to base their lending on and that's what's unique about the SBA is that they kind of bundle together the the Goodwill and the tangibles into one lump as it were whereas in other places they they look more specifically at the the collateral inside the business but I want to further comment because you you made the you made the comment that you know sellers are told get as much money upfront as you can and you know that has a lot to do with what the terms of the deal are so if somebody is uh borrowing from the SBA to buy a business and the seller is being asked to finance part of the deal people in the US understand that the SBA will finance up to say 80 or 90% of the deal depending on certain conditions and so the sellers know that the buyers have access to Greater leverage the sellers also know that if the buyer defaults on that SBA loan that they're going to have very little in the way of rights to be able to to get recourse and try to recoup the money that they're owed so that advice can make sense if that is the scenario right if there's no SBA deal if there's no SBA loan involved if the buyer is using more conventional financing or uh you know and and mixed with their own money as far as a down payment it can be a very different kind of scenario and the sellers position as far as their security against the assets of the business and the position they are with respect to a bank for example can be very different a seller can have a lot more options if that buyer who's using conventional financing were to default on their loan so there's an awful lot of uncertainty at least in the US but I suspect in Canada as well involving you know the business outlook for small businesses in particular what are you seeing uh what's the market look like to you it's a great question because businesses small businesses are very unique and a lot of small businesses need a certain kind of buyer with certain background and skills and so I used to believe that there was such a thing as a market for small businesses and now what I've come to understand is that you know very few small businesses have a market you know if you if you define a market as being a place where there are buyers and sellers and many objects being bought and sold you can say that there's a market for three-bedroom homes in Columbus Ohio and there's a market for four-door used cars in New York City but within the world of small businesses you might be able to say there's a market for gas stations or convenience stores but when you get out of those kind of General kind of categories each one starts to become very unique you can have a really great profitable flower shop and a whole bunch of Engineers trying to buy a business and none of them will buy the flower shop because it doesn't fit within you know their area of expertise understanding their ability to improve the business right and so um what what I've seen over the course of time is just stop you there because if private Equity is interested in flower shops then there's a market yeah but you know private Equity isn't going to go buy a corner flower shop they're they're only going to buy what they call a platform business and then they might go acquire some boltons we'll see how successful they are in the long run we're we're in the middle of a really big experiment that started with the Z interest rate policies a few years ago uh a lot of these private Equity people never dipped their toe into the world of small business they were driven here looking for yield by the fact that they couldn't make any more money on the stock market or through bonds like I remember when I started out you would never hear of a of a private Equity company you know coming in and and chasing after some of these small deals and then you know probably five or six years ago I started to have clients who started to compete with them on businesses with cash flow under a million dollars which I'd never seen before and now you're hearing about some of these private Equity groups go after businesses that have you know cash flows of half a million dollars usually to roll them together correct well they're they're trying to roll them together but usually they've made a promise to their investors that they're going to get the money back out to them in five or seven or 10 years right and so the reason why I say we're in this experiment is that well we're kind of just now coming to the point where some of these people now have to exit now now they have to demonstrate that their plan actually worked right and that they were able to achieve the efficiencies and everything that they had gone looking for and we'll see like you know if it if it can work out or not do you have a standard piece of advice that you give to a seller who's considering selling to a private Equity Firm well you know if if somebody got big Bank roles of cheap capital and they're willing to pay you more than you think you can get it from someone else and you just want to cash out and you don't really care about how your business is going to be run after you're gone then then go for the money a lot of sellers though do have some kind of concept of business Legacy or desire to see their business carry on in some way that you know is congruent with the way they operated it and one of the bits of advice that I say to people is I say look if if you want someone to be able to afford to live up to a legacy it means that they've got to have the cash flow to be able to afford to do the things that you thought were important and so that often means that that Legacy carrying on buyer who's going to come in and operate the business in the same fashion that the seller has they've got to have meat on the bone after the deal and often that buyer won't be able to pay as much as the private Equity Firm but the private Equity Firm if they're going to pay top dollar or even you know more than quote unquote the business is worth then they have to have some kind of plan to either grow or cut expenses and that means change we don't know exactly what the change is I know people here in my own community that work for small businesses that have been bought up by private Equity companies and you know the changes don't take long to start happening it usually means prices go up it usually means that you know they try to keep wages as low as possible that they try to make the the schedule as thin and lean as possible they they maximize you know all the different things that they can as far as technology and everything to try to squeeze as much as they can out of it and what the private Equity Group is trying to do is they're trying to show the next owner of their portfolio that not only is there a greater cash flow but there there's a growth pattern to the cash flow and as long as they can keep that growth pattern going their hope is that they're going to be able to exit at a higher value themselves to whoever the next buyer is going to be so that's what's going to happen to the business if it's sold to private Equity sorry I threw you off track I had asked you what you saw in the current market and you were in the process of explaining why there really isn't a market for small businesses but I interrupted you can you finish that thought yeah so so whether the macro conditions are positive or negative you know most small businesses tend to trade within the same range of value and because it it it really has more to do with the buyers and what they need to get out of it and and what they think they're going to do with the business and there was a brief period of time there back in 21 22 where people were paying a higher price for small businesses and it was driven entirely by the very very low interest rates that we had and now that interest rates have come back to normal people are not able to pay as much we're still seeing some sellers that want to get those really high 2021 22 prices and the way that they're achieving it Lauren a lot of them is by willing to hold a higher degree of seller financing at a discounted rate so I I've seen plenty of deals where sellers are carrying 30% of the transaction at 5% interest because that's what they have to do in order for the buyer to be able to afford the price that they're asking for and so anyone who understands time value of money will realize that they're really just kind of selling at a discount it it just looks differently they're discounting the interest rate instead of discounting the price what does that mean for you and your Consulting business it doesn't really mean a whole lot I mean we get a pretty consistent steady flow I guess as the number of people who hear about us and meet us online grows the number of inquiries grow um but I wouldn't say that we we're seeing any kind of change in our business with respect to what's happening in the macroeconomy it's it's really just as we grow we meet more clients you know there have been a lot of conversations in the last couple of weeks about uh the the threats from president Trump about tariffs right sure from both sides of the Border uh there are a lot of americ American companies that are reliant on stuff that comes from abroad there's lots of Canadian companies that export to the US Auto companies where the car goes back and forth multiple times and so it's funny that you mentioned the auto companies you know you've got to imagine those people have a powerful Lobby group don't you sure like there are some pretty big vested interests who who would be opposed to this kind of thing so I would be very surprised if it really happens I think that uh you know he's got a a track record of saying outrageous things in order to try to set a peg for negotiating and you know if his goal is to get the attention of people in Canada and Mexico with respect to border control he I think he succeeded uh I can tell you on this side anyway there's all kinds of news about changes in investment and way ways that the border is going to be managed and things like this uh and I think that's positive if it really came to pass I just think it would be absolutely catastrophic our time is running short there are a couple things I want to try to run through quickly you wrote a book uh about the the choice between starting or buying a business can you give us a a hint do you believe that one is better than the other no I I believe that there's two different paths to ownership you either start or you're buy and in the book one of the main thesis is is simply that you cannot lose track of the other path so we talked about business values and the prices people are willing to pay for small businesses I get a lot of deals where people will take a hot sector uh for example HVAC companies are very uh exciting right now there's a lot of talk about them in the in the world of of buying and selling businesses with this idea that it's a business that won't be taken over by Amazon or can't be delivered from China and you know all these other factors that make it great and so people are paying a higher and higher price for these things and you know you have to stop and ask yourself you know this business I'm looking at buying could I actually build it and and finance a couple of years of startup losses for far less than I'm than what they are looking for as far as an acquisition price and sometimes the answer is yes and so one of the things that I do with my buyers when we're looking at a particular business is we will take a step back and say what if you tried to build the same thing and what if you had to finance losses for a couple of years while you built it up and hit that break even Point what would that look like you know if it's a third of what the seller wants for their business you really have to stop and consider whether it makes sense to do that deal right how close do you think you can come to estimating what it would actually cost to to replicate the business that you might otherwise buy well I'll just give you an example I was talking with someone who wanted to buy a plumbing company and uh you know we looked at the number of people on staff and we estimated their salaries uh and we looked at the number of trucks that they had and I just added it up I just said if we bought the trucks If you hired the same number of plumbers and you paid them for a year and then you ran a promotion saying we do plumbing for free just pay for the parts would you build a clientele and that expenditure was far far less than the asking price of the business and I'm not suggesting somebody should do that but it's just it's just a sort of out of left field way of looking at something which really can make you think in different ways what do you typically hear from your clients do they lean one way or the other in terms of starting or buying I mean most people come to me because they find me online because they're looking for information about buying a business and the reason that they're looking for information about buying a business is because they believe it's less risky because what they're thinking about is they're thinking about customer acquisition and the riskiest thing about starting a new business is not finding enough customers that are willing to pay the price you need uh to be able to make money if you buy a business though you get the customers right that's the conventional thinking but here's the problem if you overpay for that business and you end up with a huge debt and you have to service that debt then it means that if you lose 5% of the customers you might have trouble paying your bills and paying yourself well isn't that the same problem it it's still Market risk but from the other point of view from your risk now comes from erosion and your in a worse situation because if you start a business you're going to risk whatever Capital you're able to put into it to get started but if you buy a business you could have a personal guarantee on a million-- dollar bank loan and so so it it uh changes the way you sleep Lauren it's pretty commonplace in the US for business owners in those kinds of situations to take out a loan which requires them to use their home as collateral is that common around the world well what's what's more common around the world is just that they can't get the business financing so they end up using things like home equity as an additional source for financing the deal so it's it's not that the bank you know puts a lean on their house because they are they're doing a business loan it's that the bank is only willing to do a smaller business loan so then they end up accessing the home equity and putting that into the deal themselves so if you do decide you want to buy a business what's the best way to find a business to buy well I guess it depends on your timeline the businesses that get advertised online on these business for sale websites uh a lot of them are being put up by Brokers and the value proposition that a business broker brings to a seller is that they will try to create competition amongst buyers for the business so a really great profitable growing small business that is very desirable when it hits those websites it's going to get a flood of inquiries and that buyer competition is going to make the price go up but you can do a deal relatively quickly in in that kind of path right if you're trying to you know get a more reasonably priced deal and you already know exactly what kind of business you're looking for then you can also do what's called a proprietary search where you go out and create networks amongst business owners in that Target industry that you want to go after so that they know you see the the problem in the business for sale Market is one of visibility it's really easy for someone who wants to buy a business to to see businesses I mean businesses adverti they want to be known to the public but a business owner cannot look out over a crowd of people and identify which ones want to buy a business there's no visibility from that point of view and so so that's why we have these Market places online and people like business brokers but if you want to buy a business if you want to buy a machine shop in Upstate New York with revenue between $2 and $5 million and up to 12 employees well all you need is Google or or if you can find a copy of the Yellow Pages you can go find all the machine shops in Upstate New York and then you just have to find out who their owners are and then you have to talk with those people and let them know you want to buy a machine shop and most of them will have no interest in selling to you but the top five reasons why businesses go up for sale small privately controlled businesses go up for sale Lauren are burnout boredom and fatigue divorce poor health the need to relocate and retirement and if you consider that list you realize only one of those items is something that's planned for the other four are a circumstance of life and so you work your network you work your list you create your contacts and you wait for somebody to end up in one of those situations and then they need to sell their business and now they already know you and that's how a proprietary search kind of works it's all about figuring out you know who you want to do a deal with and trying to create a relationship ship with that person uh and and and hopefully go there and make a deal with them before um maybe they go to a broker who's going to bring in other buyers David I think I could talk to you all day I have lots of other questions that I would have loved to have gotten to but maybe we'll do this again someday oh I'd love to it's a lot of fun my thanks to David Barnett thanks so much for sharing David I really appreciate [Music] it one thing before you go everything we do at 21 hats is created by entrepreneurs for entrepreneurs to help us all learn together if you get something out of listening to these podcast episodes consider joining the conversation you can do that by joining the 21 hats sounding board a slack Channel where you can tap the wisdom of a very smart crowd or by becoming a founding member and joining our monthly Zoom Forum where you can be part of conversations much like the ones we have on the podcast you can sign up for both by subscribing to the Morning Report if you have any questions you can email me at Lauren 21h hats.com and if you get something out of this podcast or out of the morning report please tell a friend tell an enemy tell every business owner you know your word of mouth owner to owner will always be the most effective way to build this community for all of us thank you it means a lot this episode was produced by another entrepreneur Jess steron founder of blank word Productions thanks for listening everyone [Music]