Case Study #23: Wash, Rinse, Repeat

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magazineTom Hannon had not one, but three exits out of businesses. Not just in the same industry, but in the same type of business.

The original company was named FPD and it published and distributed free publications both to retailers and direct to consumers.  

Think of any printed material you could see in free outdoor vending machines or in entryways of local businesses. That’s what Tom’s company focused on.

This type of business primarily focuses on having a strong distribution capacity (clients would want to know that their publications would be seen in many places) and on good relationships with printers (the better the prices on the printing, the more margin FPD could keep).

Beyond that, Tom also created, developed, and managed his own accounts instead of just waiting for business to come to him. This led to a successful pitch to what, at that point, had been a purely online business, ISoldMyHouse.com, for a companion printed piece in the field.

What started as a 50,000 copy pilot grew into eight regional distribution points and over 1M copies of the magazine.

First Exit

In addition to hustle, Tom had grown the business through acquisitions, primarily on an earn-out basis. When enough of the competition had been bought up, FPD itself became an attractive acquisition target: a strategic purchase from its single biggest customer.

Tom had a two-year non-compete he had to sign and he went on to work for the new owners. During those two years the buyer itself was acquired. With his noncompete finished and unhappy with the new direction of the company, Tom started another company with the exact same name as he used the time before: FPD.  

He’d benefited from even more education and relationship building in the years he’d worked for his acquirer…and it showed. In 18 months he went from zero to $3M in annual revenue, on an 8% margin.

Here Tom stalled, as he lacked the ability/time to find a serious number two. Because of that, he spent a lot of time working in the business instead of on the business.  

Despite a strong revenue number, he couldn’t get a valuation beyond $1.8M. This was in part due to it being a service business, but mostly because 50% of his revenue came from one client, leaving him vulnerable.  

He did manage to sell for $1.5M, due to his taking his eye off the ball (as he put it) as the deal drug during the due diligence phase, and he lost some accounts, thus forcing him to accept a haircut on the valuation.

Third Time Lucky

Once the sale closed and Tom signed another non-compete, he took some time off and built a house on a plot large enough for a whiffle ball field (about ¼ the size of a baseball field).  

He ended up selling that property years later but recalls many happy summer evenings when hundreds of neighbors came over for games of whiffle ball.

You can guess what happened…he got the itch again, particularly after his non-compete expired. He ended up starting Hannon Distribution, his third company, doing precisely what the last two iterations specialized in.  

The company was growing nicely, though Tom ended up injuring himself very badly, almost fatally, during Ironman training. He chose his health and recovery over continuing to build the business and sold this third company to a publicly traded firm for undisclosed terms.

Lessons

While you may not end up starting three very similar businesses, there are still two excellent takeaways from Tom’s interesting story.

  • There’s no shame in going back to what you know.
    A lot of first-time sellers get it into their heads that success in one field means the probability of success in another field, and they spend quite a few tears and not a few dollars learning that delusion is precisely that. If you still have fire, expertise, and desire in a field, why fix what ain’t broke? Do what you know.
  • Non-competes aren’t forever.
    Non-competes are primarily there to protect the buyer, but they don’t foresee what Tom did each time. He had the patience and time to wait it out. Sometimes he got paid to do so by the acquirer themselves! Non-competes are there to make sure that you don’t undermine the new buyer, but with the right amount of time, they’re also your legal freedom to do what builds great businesses and economies: compete.

Three Things Buyers Need to Make a Great Start

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threeBuyers have different reasons for buying businesses and even more varied ways they wish to operate them once they take over.

In this article, we won’t be discussing those businesses that will be near 100% absentee or will require a complete tear-down and reboot. 

Instead, we’ll be talking about the sort of business that we see very often. One that is running fairly well and can benefit from new ideas, energy and direction from a buyer humble enough to engage with the process.

1. Knowledge

No matter how well a buyer knows the industry, he/she will not usually know your business inside and out.

In those early days, and even towards the end of due diligence when it looks like any obstacles towards a successful closing have been dealt with, it’s important to learn everything you can about a business.  

This doesn’t just include information from the seller, but whatever you can read or discover: books, articles online, blogs, videos on YouTube, quiet conversations with people in the industry who you’ve networked with, etc.

Don’t be that unfortunate buyer who thinks he’s got nothing to learn and will be doing all the teaching. We can’t think of any circumstances where that worked out well in the end.

2. Employees

Confidentiality, as we consistently point out here, is key, and so a buyer will in all likelihood not have had the chance to get to know them or hear their future plans before the transaction closes.  

Therefore, after the sale is officially completed, the new owner should take every opportunity to get to know the employees, especially the key personnel, as well as possible.  

During this phase there should be a lot of listening and a lot of asking for feedback. “What is one thing you would change if you could?” or “What’s a way we could save money/earn more money?”

There’s literally been a regime change so there’s no better time to get a frank and honest opinion, and that can only be done if you come to them with a spirit of trust and openness.

3. Now, Plan

Once a new owner has had the chance to know intimately the business and the people who help run it on a daily basis, he/she can start to put together a plan that goes deeper than “cutting costs” and “new marketing.”  

Every business, no matter how old and established, always has opportunities to grow and make even more income. But those opportunities always become clearer with knowledge and time.

In a certain sense, the financial investment in the purchase of the business is the least expensive and least important part of the process. It only cost you the money and it’s only the beginning.

Now comes the part where you will be asked for your time, which, unlike money, you can never make more of. And now the journey begins where it’s not enough to simply stay in place but to grow, and that comes with risk.

But it’s that risk and that investment in time that makes the journey so rewarding. It’s also why the seller of these businesses is much less likely to go off and swim, Scrooge McDuck-style, through his/her gains. And it’s why he/she is probably going to go through this same process all over again before too long.

Have you been thinking about starting a business journey of your own?  Give us a call. We’d love to share our centuries (literally) of experience with you.

The Profit Needs of Your Buyer

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profitPart of the process on the seller side of a transaction is deciding to sell and getting a valuation.

As buyers scrutinize the businesses they examine, there are three questions we encourage them to consider. All of them are centered, understandably, around profit.

Profit to Pay Salaries

Whatever goodwill you’ve generated over the years with your employees will not transfer to the new owner. You can’t sell it, not just because it’s not legally or practically possible, but because the odometer will reset with the new owner.

He/she will have to earn goodwill and trust, and if your employees (or yourself!) have been taking below-market salaries, the buyer will need to put together a financial plan that ensures that staffing issues will not be a problem.  

Happy employees are one of the cornerstones of any business. While money isn’t everything to your staff, passion for the work always works best side-by-side with a feeling of being properly valued.

On the other hand, let’s say a business is valued at $500,000 and the owner has been paying himself/herself over market value to run it, let’s say $200,000. 

If it could be reasonably run by a manager for half that (or if the buyer is willing to work for that amount), there’s an extra $100,000 of free cash flow which can be used for investment in the business or debt service.

Profit to Pay for Financing

Continuing on with our $500,000 example, let’s say that the bank requires the buyer to put 25% of his/her own money in the deal, which would be $125,000. Knowing that interest rates always vary, for purposes of this example, we will use a rate of 5% on the $375,000 that would need to be borrowed.

That would give us, on a ten-year term, a monthly payment of $3977.46, which we can round up to $4000 to keep the numbers simple.) In the example above, this number could be easily handled by the extra cash flow from the lower salary the owner is willing to take or delegate.

Conversely, if there’s no cash flow to support the debt service, there’s a problem – not just for the potential owner, but for the would-be financiers.  

Profit to Return an Investment

Ultimately buying a business is an investment, and a reasonable rate of return should be expected above and beyond salaries and debt service. Let’s go back to the $125,000 that our potential buyer invested in the business.

He or she could have put that money into stocks, bonds, cryptocurrency, real estate, precious metals, etc.  To keep our numbers simple and conservative, let’s offer the same rate of return, 5%, on that money.

That payout would be equal to what the debt service is, and in our example, that need would be met, with even a bit of a cherry on top.

Final Thoughts

Now, let’s be clear, not every buyer comes in with such an agenda. Some are happy, after years of corporate life, to just “buy a job” where they don’t have to answer to anyone anymore. And, that works for many people.

But running a business is transformational. If all you bring is a job mentality, you’ll never be successful. If you scrutinize the numbers and stay grounded first and dream later, you’re on the right road to business ownership: calculated risk, colored with a bit of hope, and powered by a lot of elbow grease.  

When you meet our sellers, they might tell you that at the beginning of their journey they would’ve been happy for a 5% return on their years of hard work. But they often smile when they realize it’s many times more, and it’s because they brought the right attitude and they knew their numbers.  

Regardless of your vision for business ownership, you should know yours too.

Why Buy a Franchise?

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WHYIn a previous article, we’ve made the case for buying instead of building.

However, you may be interested in buying a business run by a franchisee who has multiple locations in place. Every franchise is different as to what they expect from someone who is buying from an existing franchisee. 

Our goal in this article isn’t to explore those, but rather to discuss how running a franchise-type business is different from running an independent one.

Start with the Good News

We have discussed previously how important systems are to any business. In a franchise, those systems haven’t just worked one time…for one person…in one place.

They’ve literally been “field tested” many times, with many people, in many places.

They have extensive manuals for “how to run the business” which are written in the “for dummies” format.  You’re primed to open multiple locations in the future, thus expanding your cash flow against an existing back-office infrastructure.

You also have the power of an established brand and the ongoing publicity-spend pushed by the franchisor. Sure, you have to pay for part of that, but you often get a disproportionate benefit for this spend because of the lower costs. With many franchisees participating, better rates can be secured.

The “Bad” News

The “bad” news is that you have a limited sphere in which you can be creative. Unlike an independent business, in which you’re free to pursue new business opportunities or avenues of marketing, you generally have a rulebook which tells you what you may and may not do without consulting with the franchisor.  

This is only “bad” for those very creative entrepreneurs who buck at even the idea of running something by someone else in their own business. Whereas those who favor collaboration or who want ownership, but with a lot of help and guidance, can find great comfort in knowing they aren’t simply throwing spaghetti up against a wall.

However, these systems do come at a cost. You won’t be able to circumvent the obstacles the original franchisee went through just because you’re buying a mature, multi-unit operation.  

You will likely have to pay an upfront fee, demonstrate net worth, and pay ongoing royalties, the last of which you’re unlikely to have to do in an independent business.

What Matches You?

Ultimately, buying a franchise involves many of the same questions all potential buyers must answer. You need to begin with the end in mind and consistently ask yourself why you’re doing what you’re doing (in pursuing the purchase of a business) and how well this particular opportunity (the businesses you examine and screen) will aid you in accomplishing your why.

Our goal isn’t just to counsel you on the paperwork and financial questions, but on questions about personality as well. We have the experience to advise you on franchises vs independent businesses.  Give us a call!