How To Buy A Business In Steps

Comprehensive step by step guide to buying a business

How To Buy A Business In Steps

There are two models of entrepreneurship. The first is to start your own business from scratch. The second is Entrepreneurship through Acquisition (ETA).  Some entrepreneurs choose to buy an existing business because they want to avoid having to deal with the headaches associated with starting from scratch. There are other reasons why you might want to buy a business, like acquiring an up-and-coming competitor to start a holding company for a portfolio of businesses, or maybe becoming a CEO and running the day-to-day operations of the company you acquire. 

The process of finding a business can be quite long and difficult, with the average searcher spending an average of 19 months trying to find the right business to acquire. 

Hopefully, by the end of this article, you will understand the process of buying a business, and use these steps to buy your own. 

 
STEP ONE: FOCUS ON INDUSTRY OF INTEREST 

The first step in the business buying process is to narrow down which industries you are either passionate about or have an interest in. It will be harder to find a specific business if you have not defined one to three industries you want to focus on. For example, let's say the majority of your career was in software sales. Maybe focusing on acquiring companies in the software industry would be more advantageous. 

At iGOTHAM we have tools to help. For example, we have categorized 343 industries by historic growth rate and profit margin. Reach out to learn how you can get access to this data as well as in-depth reports on various industries.  

 
STEP TWO: ESTABLISH A CRITERIA/IDEAL BUSINESS PROFILE 

Once you have figured out one to three industries you will pursue acquisitions in, you should establish set criteria of what the ideal business you want will look like. 

Criteria example:
1. 10% of top-line revenue cannot be coming from only a handful of the customer base. (You need a diverse customer base) 

2. Purchase price no higher than 3X - 6X EBITDA

3. Seller must be willing to provide some seller financing 

4. EBITDA of $1.5 million+

5. Reason for business sale  e.g, The seller must be retiring 

 
STEP THREE: FIND A BUSINESS TO PURCHASE 

Once you have established a couple of industries you will focus on and an ideal business profile, the next step, arguably the hardest, is the search process. There are multiple methods of generating deal flow. Below are a handful of ways of generating deal flow:

 
1. Sourcing deals yourself. If you will be sourcing deals yourself, you should create a list of companies and find the business owners' contacts whom you wish to pursue. The ways you can reach them are by cold calling, emailing, social media (LinkedIn), and handwritten letters. 

2. Business Brokers. Business brokers are usually individuals who assist small businesses in the purchase and sale of their companies. 

3. River Guides. River guides are individuals who provide searchers with warm introductions to business owners interested in selling their businesses. River Guides are usually made up of industry professionals such as  CPAs, attorneys, wealth managers, and other professionals who work closely with business owners. 

4. Technology Driven Search through iGOTHAM. We would be amiss if we forgot to mention our technology driven automated method of finding proprietary deal flow.  

Ideally, you should create a database of contacts in your network that you can leverage and connect with them regularly. If you don't have a wide database of industry contacts to leverage, it is never too late to start networking! 

 
STEP FOUR: RECEIVE A TEASER OR EXECUTIVE SUMMARY 

Once you have an initial phone call with the seller, you should have the seller write up a short executive summary or "teaser" that will provide basic nonconfidential information. This will give you enough information to know if the seller's business at least meets your buy box. 

 
STEP FIVE: EXECUTE AN NON-DISCLOSURE AGREEMENT  

 If you decided to move forward after reading the executive summary, the next step would be to execute an NDA between you and the seller. Essentially, the buyer cannot disclose any information that has been given to him verbally or written by the seller as defined by the contract. 

 
STEP SIX: RECEIVE THE CONFIDENTIAL OFFERING MEMORANDUM (CIM)

The  CIM is a document that will provide the prospective buyer with more detailed information on the business entity. The information will usually include financial statements, business assets, information about the customer base, liabilities, and property owned by the business entity, employee information. Essentially the CIM gives the buyer enough information to perform pre-due diligence on the business and give a rough valuation, so the buyer can decide to proceed to the next stage of the deal. 

 
STEP SEVEN: VALUATION OF THE DEAL

The most common method of determining the valuation of a company is multiples of  EBITDA. Most valuations come down to what the buyer can negotiate. Other valuation techniques include asset value, gross profit, multiple of revenue, DCF, etc. While these other valuation techniques can be beneficial to use, the most common method is determining what EBITDA multiple you are willing to pay for that company.  The standard acquisition multiples usually range between 3X and 8X EBITDA. For example, if you bought a business for 4X EBITDA of $1 million that would mean you bought the business at a $4 million valuation. 

Other factors you should keep in mind are how well the company's industry can perform in a recession, industry growth, and employee turnover in the business. 

 
STEP EIGHT: NEGOTIATE/SUBMIT AN INDICATION OF INTEREST (IOI)

After reviewing the CIM, and determining a rough valuation range, you would negotiate and submit an Indication of Interest(once both agree to the terms of the deal). An IOI covers what price range you would pay for the business as well as other details such as buyers' source of funding, valuation range, and your purchase price. The IOI is a non-binding agreement, so it cannot be enforced in a court of law. During this phase, the buyer should see if the seller is willing to carry part of the note (seller finance). That way the buyer can put less capital down, and gain a higher return on capital. 

Most business transactions involve going back and forth between two parties, and negotiating different purchase prices, and terms until you reach an agreement. You can change these terms later if you find something that changes your opinion on a company’s value during due diligence.

During the negotiation, you’ll decide if you want to approach the business acquisition by purchasing the assets of the business entity or if you want to make it a  stock purchase, or both. 

 
STEP NINE: MEET WITH MANAGEMENT 

After the IOI is accepted by the selling party, then the buyer can meet with the seller. During this period, the buyer and the business owner can get to know each other, and the buyer will get more acquainted with the different business operations. The buyer will also be able to engage with other key members of the target business such as the CFO and COO (if the buyer is acquiring a business that is big enough to have C-Suite executives).

 
STEP TEN: SUBMIT A LETTER OF INTENT 

Once you have a good understanding of the terms and structure, you’ll send a letter of intent. This is a letter outlining everything you've previously negotiated, including the sale price, and stating your intention to buy the company. The LOI is a nonbinding agreement that includes the purchase price and final steps to close the deal. 

 
STEP ELEVEN:  DUE DILIGENCE 

The due diligence process is arguably the longest phase in the acquisition process. This is the stage where the seller gives all the information required by the buyer to become well enough acquainted with the business to decide whether he will decide to proceed to close the deal.   

During the diligence process, the buyer will get access to key sellers' documents including customer lists, financial records,  previous three years' business tax returns, intellectual property, marketing, advertising materials, documents related to debt and financial dealings, an organizational chart of the entire company, inventory and contracts that will be assigned to the new owner, financial statements, sales records, business inventory, and current ownership info. 

Essentially the buyer will collect everything he needs to close the transaction and justify the business valuation.  

During this phase, it's important to also start looking for C-Suite executives you can bring on to manage the company or advisors you would like to add to the board. The buyer should also identify which key executives should be let go or retained.  (This only applies if you are acquiring a company large enough to need other executives) 

 
STEP TWELVE: OBTAIN FINANCING

Many business buyers believe that they need to use 100 percent of their funds to acquire a business. If a person is using a majority of his/her capital, the business, they would be discounting the beauty of the use of leverage. The benefit of using other people's money i.e. banks, friends, family, or private equity firms' capital, is that it spreads the risk in case the business goes under. Also, the less money used by the business buyer the higher the ROE (return on equity). 

 Financing is usually done by taking out a loan. There are many different types of business loans available. Some are offered by banks while others are offered by government agencies. Common financing options for a business purchase include: 

1. Seller Financing: This is where the seller agrees to act as the bank, and carry a portion of the loan. 

2. Bank loans

3. Institutional investors

4. Other individuals

5. Leveraged Buyout (LBO)

6. Asset-Based Loan

7. Joint Venture (JV)

 

STEP THIRTEEN: CLOSE THE DEAL

 Once the buyer is satisfied with the due diligence process and doesn't need to renegotiate anything, the next step would be to close the deal. After both parties sign the purchase agreements, the buyer is ready to choose closing dates and have the lenders fund the purchases. The buyer's funds will typically be held in escrow (meaning a bank or law firm will hold the money for a while) on the day you're supposed to close until both parties approve. Once both parties approve, the money will be given back to the seller and the business will be then owned outright by the new buyer.

 CONCLUSION

These are the main steps involved in buying a business. Arguably the hardest step in this process is sourcing the deal. This is why private equity firms and family offices have individuals on their teams solely dedicated to making connections with entrepreneurs and industry executives that can help source opportunities for them. 

At iGOTHAM, we realized that closing the gap between NDA and Closing would expedite the search process and increase ROI. As advisors and principle investors with a wide range of PE firms and family offices, we align our interests with yours to do the right deal. We accelerate the deal flow through our multi-channel outreach, the value-added network of over 1,000 legal and accounting firms, and our propriety technology that brings us deal flow.  

Here at iGOTHAM, we help individual investors, private equity firms, and family offices accelerate their deal pipeline by deploying data and technology-driven investment strategies to shorten the time it takes to acquire a business. 

 

Set up a meeting below to learn how iGOTHAM can help accelerate your deal flow!

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