Lessons learned from buying businesses

This is a quick article based on a comment I made on Rubric Laws recent post here on Linkedin about buying a business.?

I’ve linked to that post and article at the bottom again, well worth a read and they’re top guys if you’re in the M&A space and need a legal team.??

The original article covered the basics, the subtitle was “a simplified legal guide”.?

I wanted to add some thoughts as a buyer that were less simple and added some colour. It goes outside the basics of legal and are more culture based and soft skill based.?

This is a bit of a brain dump from my previous acquisitions. Things that can go wrong, impact your plans or simply weird scenarios you never thought you’d be dealing with.

Some opinions will be unpopular.?

Culture

The first point I thought was important to add was looking at the company culture of the target company team.?

Whilst you’re going through Due Diligence the common areas of focus are financials, structure of the deal and getting all of that agreed within legal documentation.?

Whether it's a standalone acquisition/platform company or a bolt on/merger looking at the target company culture is an often overlooked aspect of buying a company.?

If you get this bit wrong, everything can go wrong and it can be expensive. More on this later.

My experience lies in smaller deal sizes (￡1m-￡5m revenue businesses). Company culture in smaller businesses, is in my opinion, even more important than with larger businesses.?

There are less people and therefore more responsibility per head. Everyone has to muck in.

Often wearing multiple hats. It’s a real team game, it’s scrapy and it’s full on.

It’s part of the dynamic of being an SME.?

If you get this bit wrong during the pre takeover of an acquisition and think that person A has X responsibility and is competent and pulling their weight but find out that is not the case then you can have an expensive decision to make.

Secondly there’s the knock on effect of bad feeling and resentment that’s been allowed to build up within the organisation.

Let’s explore:?

If you have someone that does not pull their weight I can almost guarantee it will be the longest serving member.

Oh and guess what they are usually on the highest salary.

Why has this happened?

Their role has been viewed as “indispensable”.

Rightly or wrongly (usually wrongly) this has led to someone being allowed to take the proverbial and they are a heavy cost to the business in every way possible.?

The owner doesn’t want to rock the boat.

The owner almost always will tell you (the buyer) that you can get rid of Person A and save ￡X straight away.

That’s not the full story though.?

There’s a knock on effect that has been allowed to grow.

Bad culture spreads like a disease and if there’s one of these bad apples there’s likely two or three.?

The novice business buyer will say, okay well we’ll manage them out.

Buying a new business (a smaller one) is a delicate balance, you likely need some support from the old owner, managing out one person is doable but slow.

But you’ll start to see cracks appear when the trust is broken, everyone thought they were going to be sacked and now they can see it happening.

The old owner tries to be on your side but they’re less interested day by day.?

A clean break is how the big boys play in Private Equity, be the bad guy for the first 30 days, then build bridges over the next year to show you’re not so bad.

But the cost restriction on a business doing ￡2mm to ￡3mm when you might need to do 2 or 3 redundancies and take HR advice and then instruct a recruitment firm with their fees, it all starts to add up.?

The delicate balancing act, quickly becomes a tight-rope walk with people looking to get out as new ownership “don’t know what they are doing”.?

So we go back to the start, during due diligence an audit on key players in a business is essential, meeting with them is a must and when an owner hints (or straight up tells you) that Person A could go.

That has to come into your valuation.

Why didn’t the current owner get rid of the person that doesn’t do what they’re supposed to be doing??

Often it’s out of a blind loyalty.

They were there from the early days.

They stuck with the company, the company stuck with them.

They didn’t keep up with their skill set, they don’t want to deal with clients, but that’s okay because they’ve always been there, they’ve always been that way.?

They’re part of the furniture.?

I may come across as cold, but when you’re buying a business you’re playing with leverage.

You can’t afford any expenses that don’t need to be there.

You need to run a very tight ship and you need to grow to remove the risk of getting too close to no debt coverage ratio.

It can happen and when or if it does it’ll be too late to tighten up.

You’ve got to keep profits up and make sure that cashflow is still positive.?

A property investor wouldn’t have a mortgage but let tenants stay for free.?

A business buyer needs to be as analytical.??????

It could also be a sign that there’s unrest in the company.?

Example One

I bought a company where the former owner had been having an affair with one of the team.

Needless to say that employee was overpaid, spent most of their day running a multi level marketing business from the office downstairs and could turn up when they wanted.?

Everyone had to look past it because, well, who can you complain to.

It caused unrest amongst the whole team.

That person had to go.?

That created a brief increase in trust between the team and us the new owners, but it created distrust between the former owner and us.?

We still needed their support for the initial handover but they didn’t like it.

Maybe they were embarrassed it had come out and all the staff had reported the same thing on first meeting us.

But suddenly you unlock this pandoras box and see why certain people were allowed to get away with things.??

Culture is important.??

So, not only can this be an expensive area to overlook.

It can cause headaches that are not productive.

Not all of these things can be discovered until you’re in the business of course.

But they are things to look for.?

Value Add?

I would also encourage first time buyers to use the Due Diligence timeframe to really think about how they are going to add value.?

A lot of buyers are so excited to be "doing a deal" they just want to get it over the line.?

Going in with a clear business plan will really help.?

Sounds obvious but it's not always the case.

Knowing you can add value in year one through three will really help you.

It also helps your post acquisition trust building with the team.?

If you’re doing an LBO how are you going to add value?

Do you need to add value??

I would argue yes.?

You’re taking the cash flow and using it to pay down debt/pay off the former owner.

That will leave you with far less cash to reinvest in the business or build a cash reserve.?

That can be okay and the argument for buying a business is that you get a business that is already working, has cash flow etc.

However, the cost of running that company needs to be really thought about.

If revenue is highly concentrated on one or two clients it’s a huge red flag.

It can still work but again, you need that value add plan in your head so you can implement it straight away.?

This again means having a team of growth mindset individuals.

Learning about the culture will really help you know if this is going to be a task that the team is suited to or are they happy plodding along doing the status quo.?

Expectations

Expect the deal to fall over at least 7 to 8 times.

It's normal.

The key is to hold your nerve, not give in or give up loads of concessions.

Help walk the seller through the process, stay calm and be respectful that they are selling their "baby".

Always be over communicating, don't be annoying obviously, but every deal I've worked on I've always made it a point to have regular check-ins with the sellers.

This is so important, deals die because of time.

Something comes up, someone changes their mind on one thing, the team wins a new client and suddenly things feel rosier or the believe the value of the business just increased ten fold.?

Constantly talking and knowing what’s happening keeps things on track.

You’re more likely to pick up on things before they even become a problem.

You can get ahead of hurdles.?

Always be one step ahead

As mentioned above with culture, I've also made it a point to meet key players in the team pre-takeover.

This can be a tougher sell with owners that don't want to rock the boat before it's a done deal.

It can be very helpful in gaining more insight into how things "really are" and give you a smoother takeover on day one.

This leads nicely into the final point.?

Prepare for panic

When you do take over, staff will panic, there's almost nothing you can do to avoid this, it's par for the course.

It’s vitally important that you do what you say you are going to do.

You have to build trust one day at a time.

Again communication is key here.?

This is why trying to really understand the culture early helps you, the buyer.

If you know there are going to have to be some casualties you can go in early and rip the band-aid off.

This again, might seem cold to people outside of acquisitions but it is part of the process of streamlining and optimising a business.???

Holding on too long, hoping that you will be able to get more out of people simply doesn’t work.?

Here's the original post again, well worth a read.