Entrepreneurial statistics underscore a significant shift toward independent work. According to census data that dates back to 2004, Americans applied for a record-breaking 5.3 million business ID numbers in 2021, and 2022 is already on track to be a record-breaking year as well, according to projections from QuickBooks. What many future entrepreneurs may not know is there is ample opportunity to become a business owner through acquisition of an existing company. In this episode of The Agent of Wealth Podcast, host Marc Bautis is joined by Elliott Holland, founder of Guardian Due Diligence, a company that specializes in helping everyday people acquire businesses as investments to optimize ROI and create new millionaires. Together, they walk through the process of acquiring a business through the lens of a first-time buyer.
In this episode, you will learn:
- Where to locate businesses that are for sale.
- How to put in an offer on a business, including tips for business valuations.
- How first-time business buyers can secure funding for the acquisition.
- The do’s and don’ts of becoming a business owner.
- And more!
Disclosure: The transcript below has been lightly edited for clarity and content. It is not a direct transcription of the full conversation, which can be listened to above.
Welcome back to The Agent of Wealth Podcast, this is your host Marc Bautis. On today’s show, I brought on a special guest, Elliott Holland. Elliott is a Harvard MBA alum and the founder of Guardian Due Diligence, which specializes in helping everyday people acquire businesses as investments to optimize ROI and create new millionaires. Elliott, welcome to the show.
Good to be here. Thanks for having me, Marc.
In recent episodes I’ve covered asset classes such as franchising; different types of real estate like self-storage and mobile homes, laundromats, and so on. But I’ve never gotten into the nuts and bolts of how to acquire – or purchase – a business. So, let’s get started. Can you tell me about Guardian Due Diligence and how you got into the business?
Sure. Guardian Due Diligence helps facilitate business acquisition, most commonly for first-time buyers who are outside of a fund. Typically these are regular investors looking to do deals themselves. I named the company “Guardian Due Diligence” because the hardest part of getting a deal done is the financial diligence involved. You have to make sure the numbers are solid.
I got into due diligence as somewhat of an accident. Previously, I worked at two different private equity firms that were more oriented in long-term value investing, and a bit more strategic than traditional financial engineering. When I left, I branched out with a mentor of mine, and started an independent business buying outfit. We bought companies that were $1-5 million in EBITDA – which stands for earnings before interest, tax, depreciation, amortization. During that time I had to check out dozens of CPA firms that were doing due diligence, and I really didn’t like the solution for smaller deals for a lot of reasons.
So I started Guardian Due Diligence to be the service firm that I wish I had when I was buying companies, particularly to help facilitate first-time buyers. These buyers are spending a year or two buying a company, and then may spend four to five years either passively investing in or operating the business. So the benefit of understanding the deal process is low… therefore I can help with that. Our service enables people to get deals done.
That’s great. How do people find businesses for sale? Is there an MLS, similar to real estate, where businesses are listed?
The Acquisition Process
Locate a Businesses for Sale
Most seasoned investors will come across opportunities through their social networks – whether that’s their country club, social club, group of friends, places they go, or their local area. A lot of that is informal, because a lot of it is trust-based.
But to answer your question, there are websites like bizbysell.com that are not as comprehensive as a MLS, but are a place to start looking at businesses for sale. They’ll list companies like a local laundromat and car wash, to a national long-distance trucking company and an oil and gas service company. There are dozens, if not more, websites like bizbysell.com, where you can find businesses for sale. That’s typically where the first-time buyer starts.
How do you recommend that a first-time buyer approaches the process, in terms of what kind of business they should look for?
Well, the first thing to do is find out if you’re an industry person, a function person, or a location person.
- An Industry Person: If you know metals, chemicals or SAS, you’re an industry person, and you probably want to anchor on that when looking for a business to acquire.
- A Function Person: If you know sales really well, you’re a function person, and you might want to look for a company that needs a sales boost.
- A Location Person: You might live in Manhattan, and want to purchase a business no more than an hour drive from your front door. So you’re location-specific.
If you’re searching for a business on bizbuysell.com, you can filter your search. Now, location and industry are far easier to filter. In terms of function, most small businesses need sales and process (operations) improvements. If those are your strong suits, then almost any business is good for you.
You can also meet with local business brokers. To do this, go to the International Business Broker Association’s (IBBA) website and get a list of brokers in your area. Start calling those folks, saying you’re looking for a business with whatever criteria: for example, $1 million dollars in EBITDA, $5 million in revenue, two hours from Boston in these five industries. You won’t have a lot of options on day one, but more will come as time goes on. You can start building up a funnel of deals that way.
That makes sense. So, fast forward, and let’s say someone finds a business for sale that looks appealing. What do they do next?
Submit a Letter of Intent
So the next step is the offer, which is a letter of intent. The letter of intent for a private business is typically longer than in a real estate transaction, because there’s more terms you need to iron out. First-time buyers can use Google to find a sample template, or even email me – I have a template I can share.
Negotiate a Purchase Price
Then, you negotiate with the seller for what offer they’re willing to accept for the business. It may take a couple of back-and-forth conversations before the seller accepts your offer.
Complete Due Diligence
In real estate, you may have two weeks for due diligence. In private businesses, you typically get about 90 days.
Why is it so long?
Because after the negotiation is complete, you typically get way more data on the business than you had before. It’s going to take a diligence provider, like myself, about four weeks to complete our process. Then it’ll take another two to four weeks to get through the asset purchase agreement, which are all of the documents that need to be executed for the deal.
Hopefully everything in the due diligence process goes well. The numbers will never end up perfect… or the way you thought they would, but if you manage to get through that process in a solid way, you’ll become the owner of a business.
How does a first-time business buyer put their offer together if they have limited information in terms of financials? How do they decide on an offer that’s accurate?
How to Value a Business
Most times a prospective buyer will be able to review tax returns or a 10 to 30 page confidential information memorandum on the business. The confidential information memorandum contains information like revenue, profit, operations, what the business does… those kinds of things. Whether a prospective buyer has the taxes or the memo, they’ll be able to determine the average profit of the business in the last three years.
EBITDA is typically the metric that people use. It’s pretty close to profit. So for companies under $1.5 million in EBITDA, for example, the valuation is typically three to four times EBITDA. If you don’t know where to start, just remember that it’s three to four times EBITDA.
The buyer can also ask their network, friend and the broker.
Okay. So back to the offer. Let’s say it gets accepted and the due diligence starts. How does someone find the best advisor to help with due diligence?
How to Find a Strong Transaction Accountant and Attorney
The CPA that does your taxes is not a good transaction CPA. They may not tell you that, but you don’t want to hire a heart surgeon to do brain surgery, right? Just as you don’t want the guy that does contracts on real estate to be executing a business transaction.
You want to find a strong transaction accountant and attorney. If you don’t already have these professionals in your network, start by asking your friends if they know anybody that does this kind of work – specifically in transactions. If that doesn’t pan out, look on LinkedIn, then Google. Find people that have good ratings or who you have mutual connections with.
Is there anyone else you need at that point, aside from a CPA and an attorney?
Not at this point. At the end of the transaction, you’ll need an insurance broker. But if you put a post on LinkedIn that you need an insurance broker, you’ll get 10 calls in one day. They’re not hard to find – but that doesn’t mean that they’re a dime a dozen. Finding a good broker is a lot of value, but it’s something you can do quickly.
Of course, there may be other things you need to do. For example, in a manufacturing business, you have to make sure the facility isn’t leaking oil into the ground. You may inherit those kinds of liabilities. So you may need to hire someone to do a spot check on the land to make sure it’s solid.
But getting a good accountant and attorney is 90% of the ballgame.
You just brought up a good point. Who is the person that is responsible for quarterbacking the transaction, the attorney or the buyer?
That’s a great question. Typically, the buyer would quarterback. Reason being, you have to select all the advisors, pay them and tell them what you’re most sensitive to. You’ll have to be in discussion with them around what you’ll take and what you’ll accept, right?
One of the things that we do at Guardian – and a reason why we focus so much on first time buyers – is we have a done for you diligence service where we quarterback the deal for the buyer and check in with them once a week (or as much as they’d like) to update them on the process. It works really well for first time buyers, as well as those who have full-time jobs.
Now remember, I’m a deal person that has come into the due diligence space. That’s really what sets my firm, Guardian, apart from our competitors: we have the capacity to bring a diligence package to you.
That’s great. Now, during that due diligence period, what kind of “out” does the buyer have? Are there specific clauses in the LOI that have to be met for the deal to fall through?
Does the Buyer Have an “Out,” If Necessary?
The buyer can go out for any reason at all.
Here’s the reality: it’s a trust walk from day one to day 90. On day one, the seller and the buyer meet through the internet, or through a broker. They’ve never been to each other’s house. You’ve never eaten a meal together. They don’t even know if the other is a real person with teeth, right? On day 90, they’ve done all of those things. They have been to each other’s houses. Each other’s town. The buyer has walked through the business. The buyer has completed financial diligence. By then, the buyer probably knows what the seller likes to do in their spare time. They probably know each other’s kids’ names.
So from day one to 90, a lot happens. At any point along that process, either the buyer or the seller can back out.
You may say, “Elliott, that sounds like a lose-lose proposition.” Well, no, because both the buyer and seller have invested a lot of money into this process. The seller has a broker, more than likely, and the buyer has paid for due diligence and has a CPA and attorney on a retainer, right? Not to mention the time component.
Although there are no guardrails that prevent people from walking away, once the letter of intent is in, there’s external factors keeping folks in the process within reason. Does that make sense?
Yeah. Makes sense. Well, let’s talk about funding. Are people buying businesses in cash, or are they securing some kind of funding?
How to Obtain Financing
Marc, if you know folks buying businesses in cash, please let me know. I want to talk to them right away.
The name of the game is leveraged buyout. That means leverage, which is debt. There are many ways to do it. You can do it with cash. That has less risk, right? If you can put $2 million up for a business, you can operate that business at your pace. But with that same $2 million, you could potentially put $500,000 down on four deals, and buy $3-4 million companies four times. So what do you do that with? How do you do it?
For smaller businesses – I’m talking about under $5 million in purchase price – the SBA has a 7(a) loan program. I won’t get into the specifics, but essentially the government will back up to 75-90% of the loan so that the bank is on the hook for 10%. In that case, the bank will make the buyer and the seller put up 10% of the transaction so that they’re covered. This allows banks to take somewhat riskier bets on smaller businesses with first time buyers, because the government’s stepping in to back stock the debt.
So first-time buyers should look at the 7(a) program through the SBA. Most deals under $5 million are done using SBA loans.
When the banks get involved, they do their own due diligence, right? How can a buyer avoid an error from their due diligence compared to the bank’s due diligence?
Yes, you’re right. When you go to a bank for a loan, you don’t want to go in with data all over the place. And small businesses can have messy finances. The function of your diligence is to take the messy financial sack of stuff and put it into a financial package that a bank can use for consideration.
But as you suggested, your due diligence provider may catch things that the bank misses. The bank may catch things your due diligence person missed.
What kind of things?
For example, a non-physician can’t run a physical training business in certain states. So if a non-physician wants to purchase that business – even if they have the financials – they can’t, the bank won’t back that.
Another example: You may find that the seller said the business did a million dollars of profit in their financial records, but they told the IRS they made $100,000 in profit – one tenth of that $1 million. That would create an issue for the bank, around how much profit they will expect the business to make to fund it.
Anybody who’s dealt with banks in any capacity, like real estate, knows that there’s about 20 things that can come up. But let me tell you why the stakes are a bit higher here.
Because the buyer is paying three to four times profit, the seller has three to four times the incentive to misrepresent the business – meaning they don’t get a dollar for dollar benefit for fudging the truth… they get a four times benefit. $100,000 becomes $400,000. So even honorable people are put to the test at this time.
Makes sense. Are you seeing any instances where the seller will finance part of the transaction of the purchase?
Yes. In the typical SBA 7(a) loan, the bank covers up to 90% so the seller and the buyer have to cover the remaining 10%. Typically, they split it half.
However, in a deal with more risk, that might not be the case. For example, a professional service business – like one we both own. If someone were to buy our businesses, they’d need to tie us to the business for some period of time to understand processes, the clientele, etc. In that case, the buyer may ask the seller for a larger note, meaning they finance a bigger part of the transaction. This way, the seller is more invested in the buyer’s positive outcome, helping the buyer as much as possible.
Okay, so what you’re mentioning here… do you see those types of transactions working, where the seller remains in the business for a period of time?
Does it work? Here’s how I talk about it with my clients. Let’s say you pay a woman $5 million to buy her business. Let’s just say, you’re like, “Oh, I want to be sure. So I’m going to have her hold back 5%.” So $250,000 on a $5 million deal, right?
What you have to think about, as the buyer, is if they work for you for six months and things get really hot 60 days in… and they took home $4.75 million… and they went to The Bahamas… Are you going to get them on the phone for a quarter million dollars when they took home $4.75 million 60 days ago?
The other thing that happens is in terms of leadership. Typically, a buyer is not going to do every single thing the seller was doing in the business. So if the seller is still working in the business, and the business is changing, there can be a lot of tension.
You have to be hopeful that the relationship post-close will work out, and that the seller will honor and finish their agreement. But as a prudent buyer, you need to be ready for those things to deteriorate, and still remain whole.
It’s interesting that you mention the involvement in the business. I talk to a lot of people who want to buy businesses, and their mindset is mixed: some want passive income, some want active income. I even argue that there’s an area in between passive and active, like some forms of real estate. Some people argue that there’s no such thing as passive income. What do you think? Do you see businesses that are truly passive?
Is There Such Thing As Passive Income?
Yes, I think there is. The nerd in me wants to walk through the different options, but I’ll keep it simple.
The least risky way to become an entrepreneur is to find a fund that invests in small businesses, and invest in that fund. Examples include Permanent Capital out of St. Louis, Brent Beshore, Pursuant Capital in Florida, Sam Rosati, Broadtree Partners, and so on.
You can also buy a business and find an operator to run it, which is passive. An example would be buying a manufacturing business and finding a 30-year veteran of manufacturing to run it. The business owner then pays that person a salary, but they work for the owner and the owner doesn’t step foot in the business. Now, this is a little bit more risky, right?
Do you see the success rates differ between those two groups at all?
Great question. It all depends, right? If you hire an expert in the industry who is motivated to run the business, who is compensated appropriately – both salary and bonus – to keep their incentives aligned with yourself, that’s honorable. Those deals do very well, because both you and the operator have a huge incentive for things to be successful. If things go poorly, you’re both highly incentive to roll your sleeves up and get some work done.
On the side of investing in a business ran by the owner, I will say that I’ve never seen motivation quite like it. When it’s your business, every ounce of your energy will be exhausted to get it running successfully.
I think there’s pluses and minuses of both scenarios.
That makes sense. You know, one of the things I hear a lot is that purchasing a home is your biggest purchase. For a majority of people, that’s true. But for someone buying a business, this it’s a whole nother level of responsibility. What are three of the biggest mistakes you’ve seen people make when buying a business?
The Do’s and Don’ts in Buying a Business
Mistake #1: Misunderstanding the Time Commitment
Great question. Number one is if you think you can do this part-time – with hired help – but none of your energy or guidance, you are going to miss the boat. It’s your risk, so you need to be involved. Whether that means taking a sabbatical from your primary employer or spending nights and weekend time, you need to be present, available and focused on the outcome for it to go right.
Mistake #2: Not Focusing on Primary Documents
The second mistake people make is not focusing on primary documents. We all saw what happened with Theranos out in Silicon Valley… Billions of dollars lost from very smart investors who should have known that the financials weren’t on pace with what was presented, but never checked.
In small business, the financial system most commonly used is QuickBooks. When reviewing primary documents from QuickBooks, make sure all of the files have the QuickBooks header, in PDF or Excel. If you’re looking at taxes, don’t allow a broker to copy the tax information into a cute document with their header, without a signature. That’s not good enough. You need to be going to the primary documents. The bank statements. Don’t allow somebody to send you an Excel that says Bank of America at the top and not make sure that that came from Bank of America.
Mistake #3: Not Negotiating In Free Space
The third mistake is not negotiating in what I call free space. When I was working in corporate for firms like Accenture and Workday, I went into negotiations understanding there was a plus or minus 5-10%. You could get something 10% less expensive than the sales person came in with, or you could negotiate a 10% better deal on your salary.
In private business negotiations, it can be plus or minus 50%… or even 100%. So when people get into business buying for the first time, they need advisors to help them understand the market, in terms of the purchase agreement. On the nuanced pieces, like calculating profit and EBITDA for small businesses, how is it typically done? How do you get hard in that transaction?
So not having enough experience can be critical for things like negotiations.
Yeah, that makes sense. That’s some great advice, Elliott. Well, we’re just about out of time. I want to thank you for being on the show and giving some great tips on how to buy a business. How can someone reach out to you to find out more information about Guardian Due Diligence?
So you can Google me or look me up on LinkedIn, Elliott Holland. You can also visit my website, guardianduediligence.com. For Agent of Wealth listeners, I’m offering a complimentary review of your letter of intent and your company valuation. Go to offerfromelliott.com to get your letter of intent and valuation reviewed for free!
That’s great! We’ll link to all of that in the show notes. Thanks again, Elliott. And thank you to everyone who tuned into today’s episode. Don’t forget to follow The Agent of Wealth on the platform you listen from and leave us a review of the show. We are currently accepting new clients, if you’d like to schedule a 1-on-1 consultation with our advisors, please do so below.