REFLECTIONS AND ADVICE 1 YEAR POST ACQUISITION
Hey Everyone, Wow what a crazy year this has been, to say the least. I certainly knew that taking over a company would have its fair share of challenges, but I'd be lying if I said I planned on dealing with a global pandemic. I worked longer hours and was under more stress than I'd ever been in my life (and I've lost $5mm in 10 minutes on multiple occasions in my prior jobs), but I've learned more than in a shorter amount of time than I ever thought I could. With this year firmly in the books, I'm relieved and proud that I've made it out relatively unscathed, and given everything that happened, the business is everything I'd hoped it would be when I first bought it.
I'm shocked and humbled by the overwhelming response to my earlier post about my experiences leading up to the close. I sincerely apologize that I couldn't respond to a lot of you, but hopefully you can understand. I hope for the ones seeking my advice earlier in the year that the pandemic hasn't dampened your enthusiasm and determination! One of the more common requests was for a post-acquisition recap, so here it goes. I hope you guys find it as helpful and informative as the other post!
Things to be Aware of during the Due Diligence Process:
1. From my own experience, the aspect of DD that I spent the least time on and turned out to be the biggest challenge is labor. If I can triple underline and triple bold this point I would. Good labor is HARD TO FIND, and I urge you to spend a good deal of time making sure you are comfortable with the target's current labor needs, as well as future ones should you need to replace/hire additional workers. During DD, brokers/sellers will often tout something like "Experienced employees with over 35 years experience" as a selling point for the company. In many cases it is. However, it's also a huge potential pitfall -- someone who's worked at a company for 35 years might consider retiring very soon. If he does, how will you replace his expertise? Or his contacts/relationship with customers? If he's been working at the same company for a while, is he underpaid? If you need to replace him, will you need to pay 20% higher salary + benefits? What if all of the managers/supervisors are 30 year veterans? Will you be able to replace them all within the span of a year? You can see how from this context, having a "longstanding employee base" might actually be a detriment. Therefore, I urge you to get a good handle on the specific employee situation, at least for key employees. A lot of the time, this isn't possible due to confidentiality and the seller not wanting his employees to know (this was true in my case). In that case, you just have to do your best, and it might seem stupid, but ask about their age/marriage situation/etc to get a sense of where they may be in their life.
2. This point may be obvious, but it's really been driven home by the pandemic -- customer concentration. I know you all know that businesses overly reliant on a small group of customers is potentially problematic. However, think about other forms of "concentration." Unless you're Apple of Google, we all are bound to some kind of limitation, whether that's geography or industry. Certain ones are completely unavoidable (think....medical device servicer), but if you had bought any kind of restaurant or travel based company, you may have been in trouble. Other ones, making a chemicals or fracking company tied to oil/gas, are super cyclical. And then there are other companies like, say, a residential mold remediation or pest control company that are about as unconcentrated as it gets. Make sure you think about what types of general trends maybe hurt or help your business.
3. Carefully document and track the value of PPE/inventory/etc that gets included in the transaction. When you go to negotiate the deal, you will invariably go through a discussion about the value of current assets being transferred. If there isn't a dollar amount attached to them (say, the seller just says "all inventory/raw materials are included"), that makes things a bit easier. But make sure you look at the state of the PPE being included to determine if there are additional capex needs you need to budget for and potentially factor into your pricing. Maybe the seller accelerated growth and has woefully underinvested in equipment, or overused his equipment and now they're all breaking down. Or, like in my case, there are several trucks he neglected to mention are on their last legs. When you come across this, don't be too alarmed. Equipment all have a life cycle, and it's natural to find stuff that need to be replaced. Just make sure you are able to have a reasonable conversation about how that may impact the purchase price. Also, if like me, you negotiate a dollar value to a transfer of working capital, make sure you take a close look at what he's sending over. For example, I negotiated a transfer of 100k of working capital in the form of purchased materials that are needed for my business (fertilizer, chemicals, etc). Perfectly reasonable. At closing, he told me the value of the transferred working capital was actually 115k (he had bought all the stuff already), and I needed to pay the difference. Again, perfectly reasonable since it's stuff I have to buy regardless. In my own carelessness, I didn't look at his spreadsheets too carefully, as he had included ~15k worth of stuff like, printer toner and customized stationary and stuff. I don't know about you all, but I don't consider that "working capital." I certainly don't feel he was trying to pull one over me, as I think he genuinely thought they counted. At the very least, I wish I had taken the time to go through the list and had the conversation instead of just writing the check.
4. Do not underestimate your initial working capital needs. There are just so many random expenses that may pop up during the initial transition phase. You want to make sure that's adequately accounted for either in initial working capital, or a readily accessible LOC. Make sure you properly discuss with the seller exactly what is needed to run the business during the transition and the first several months, and exactly how that would be funded. Is he giving you raw materials? Are you expected to buy it from him? From his vendor? My suggestion is, whatever you think your actual initial working capital needs are, double it. I thought I had a good estimate for initial cash outlay, but my bank strong armed me into having a bigger credit line. They were right. I needed like 50% more. Good thing I listened to them. Which brings me to my next point.
5. Get a good bank/funding source. Most established businesses don't go bankrupt because of loss of revenue. They go bankrupt because of loss of funding. Make sure your financing partner is dependable, responsive, and on top of their shit. Don't go with the random funding source just because they may be 50bps cheaper or won't force a PG on you. Shit hits the fan often and unexpectedly, and you want a financial partner you can count on. I used ^[redacted] and Live Oak Bank, and I have nothing but good things to say. They funded my SBA loan professionally and have fantastic turnaround times on drawing on LOC. Plus, while Chase and other banks were busy screwing small businesses, I got my PPP loan deposited in my account a week after the loan program went live. How's that for efficiency??
6. Build in a healthy haircut for your financials. No matter how good of a DD job you do, at the end of the day you are dealing with a motivated party looking to get top dollar. Be suspicious of all their numbers, even filed tax returns. Ask for as much detail as you can. And when you've got to an EBITDA you're comfortable with, question everything all over again. Then when you are comfortable again, take a 20% haircut on that number. Are you going to be OK if, after you take over the business the true EBITDA is that 80% number? For example, if the marketing materials claim $1.2mm in EBITDA and it's a 5x multiple. After your DD and a lot of negotiation, it appears a sale price of 5x on $1mm EBITDA is what the seller is willing to accept. Ask yourself -- are you OK paying $5mm if the true EBITDA is only 800k? I point this out because, I would imagine the true EBITDA is always going to be lower than whatever the seller "accepts" as his EBITDA. Make sure you are ready for this. I paid a price for my company knowing that I'd be OK if the true EBITDA was 10-15% lower than what the seller accepted (it was, though I imagine some of it no doubt is due to COVID).
7. I think I mentioned this in my prior post, but let me stress again. Your relationship with the seller is extremely important. No one knows the company better than him, and no one is better equipped to help you if you run into trouble. Be wary of sellers who want to disappear or be completely detached after the sale. Other sellers might only make themselves available for help if you pay them a consulting fee. That's up to you. But I highly recommend you deal with someone who is trustworthy, honest, and willing to help. Make sure you negotiate an adequate (free) transition period. Take advantage of it by asking as many questions and observing as much as you can, but know that you are going to need his help later.
*******************************************************************************************************************************************I leave you with these words. Despite the incredibly rough year, I'm certain I made the right choice to pursue this path. I find it rewarding, fulfilling, and I have big plans for more wheelings and dealings in the future.
However, It's HARD. Let me say this again. Let me bold it again. It's HARD. This isn't something you do because it's what your friends or fellow MBA grads are doing. This isn't something you do because you're not sure what to do with your life and just need something to fill the hours. This isn't something you do because you believe it's a straight/easy path to riches. Even though it's not starting Apple in a garage, it still requires a tremendous amount of time, energy, and dedication. And if you choose to do this, know that this isn't something you can just quit 6 months later if you decide it isn't what you thought it was. You're responsible for the livelihood and wellbeing of human beings now, plus you're stuck with your giant PG'd loan. I work more hours than I've ever worked in my life, and it's not like I had a slouch of a job either. During COVID, I was working well over 100 hours a week, and I still work 10-12hrs a day. Please don't think the learning curve will be short and sweet, or that you can immediately step back and start collecting dividends. Be prepared to put in a lot of work.
With that, I hope everyone stays safe, and happy hunting. If there are any other topics you guys feel would be helpful, let me know and I'll see if I'm able to be of any assistance. If you have any other questions, feel free to reach out but I apologize in advance if I don't respond in a timely fashion (or respond at all). The best thing to do would be to leave me your number, and I'll try to call when I can.