Tired of the 9-5? Want to work for yourself? While being an entrepreneur can be a rewarding career, it does not always lead to a better lifestyle. Working for yourself is a goal people strive for. 99% percent of people don’t know this, but you can purchase a small business with very little upfront investment.
This article will provide a high-level overview of the 8 Step Acquisition process. For more specific/detailed questions, please comment below or Ask Baba.
The 8 Steps to Owning Your First Company
The playbook for buying a business
- Find a Business to Buy
The first step is finding a business that interests you enough to learn more. You can find businesses for sale on sites like BizBuySell and QuietLight are a couple of popular sites. There you can find listings for sale based on your selected criteria such as valuation, industry, location, etc. You can also cold email a business owner that you are interested in.
- Sign NDA
If you find a business that looks interesting, the next step will be getting more information to do your homework. Companies will not provide financials on the business without first signing an NDA.
- Begin Initial Diligence
For the purposes of this article, we assume you know how to do basic diligence. I will provide a step by step walk through of the above steps in an upcoming article.
- Execute Letter of Intent (LOI)
Assuming you are still interested after reviewing the basic materials. Your next step would be your non-binding letter of intent, sometimes called Indication of Interested (“IOI”), which is a written document detailing who you are, your proposed valuation for the business, the assumed legal structure, diligence required, and other deal-related components. There is not a standard template, you can use any structure as long as it includes the key components listed above.
- Post LOI
Once the LOI is executed by both parties, you will want to send over your DRL (diligence request list) to get all the material you’ll need to conduct your homework. This DRL will vary in length depending on your comfort level with the business.
In my private equity career, I’ve sent a list of 140+ request items and I’ve sent a list with 5 requests. You’ll want to make sure you ask for updated financials for the last 2-3 years (ideally monthly), access to their Shopify/Google Analytics if this is an online business, the material around advertising spend and return, employee data and contracts, and legal structure, etc. - Financing Sources
Once the LOI has been executed, you’ll want to involve your debt providers so that they can complete their work in time for closing.
- Confirmatory Diligence
Post LOI diligence. Conduct homework on the material you requested in your DRL.
- Legal Docs/Closing
If all goes well in your diligence and the debt provider approves the transaction. You’ll work towards a closing.
Common Questions
This is a question you need to ask yourself. Are you okay with a little risk? Debt is useful for a few purposes: it allows you to purchase a larger business than you would be able to with all cash and it increases your IRR.
Let’s run through some oversimplified basic numbers. Let’s assume you are looking at a business with $300k in EBITDA, and businesses of this size, risk, and industry trade at 4x EBITDA. The total purchase price will be $1.2mm. Well, I don’t want to put up $1.2mm in cash, it will take me 4 years to make my money back.
If you finance the purchase with debt, let’s assume 70% debt and 30% equity (cash), you would only need to put up $360k. Using THIS SBA Calculator, our monthly payment would be $9,116 or $109k a year.
This is a rough calculation and does not include interest expense being written off. After paying your loan, you’d make $191k a year pre-tax, making back your initial $360k investment in 1.8 years. In some situations, debt can be very beneficial to an acquisition.
Use the tactics in this article.
The magic question. There is no perfect answer and it will be subject to diligence. Looking at comparable company valuations is a good metric. A good rule of thumb, a small business that is stable or slowly growing making less than $1mm in EBITDA will usually trade between 3x-5x without real estate.
The 8 Steps to owning your first company take anywhere from 1 to 3 months from step 1 to closing
The company you are purchasing can be financed through a seller note. I prefer transactions like this because that means the seller believes in the future of this business and still has skin in the game.
