THE COSTS OF SEARCHING
One of the key decisions in buying a business is how to pay your bills while you are searching for it. You will have search expenses, living expenses and perhaps some substantial personal debt to cover. Having investors pay your salary and expenses for two years while you search is a solution, but may not be feasible if you have geographic restrictions or cannot relocate. If you decide to self-fund, it is even more critical to understand the potential costs you will be facing as you move through the process and get to a final closing.
In September of 2016, 16 searcher/CEO’s, both funded and self-funded, shared data on their search process costs. Each search was different and there was a range from $43,000 to $780,000 for all in-costs by the time closing arrived. The average cost for a funded-searcher, excluding the back-end deal expenses for legal costs, was $86K while self-funded searchers were $41K, who were more geographically constrained with lower travel costs.
Costs in the search process
Most searchers reported minor startup costs that included business cards, domain name registration, incorporation papers to be an average $2,500 and a low of $250. A few reported higher costs because they held foreign passports, with the highest cost reported at $13,000 to kick off their search.
For office space, a some worked out of a home office (3), or utilized free common work space (2) at a University in a start-up incubator or working out of open space in a library with enough space for a half dozen interns. On the high end, monthly rent was $750/month while the average was $515/month and the lowest $330. Locating within easy access of a college area and having enough space to accommodate 5-15 interns is an important planning consideration.
Office supplies and internet/utility services typically came in at $255/month on average and included both variable costs such as envelopes, snacks/beverages for interns and also some fixed costs for a printer, desks, chairs and tables. Postage and mailing costs varied widely depending on the use of snail-mail vs. email for outbound prospecting. One searcher spent $7,500 and the average was $3,500 for an entire search. Length of search has an impact on these variable costs, and the sample ranged from 11 to 28 months with an average of 19 spent searching.
Software CRM and Bulk-email systems, were reported to be as low as $200 and a high of $3,750 with the median at $1,060. Costs for databases and broker aggregators were carefully assessed and many reported dropping these services after a year. One searcher found that “Axial allowed me to build my broker database further and to get a deal flow, but the deals are competitive and not of the highest quality. I don’t think it is worth the $7,000 annual cost. Deal Nexus costs between $2,000 and $2,500 per year with smaller deal flow and was less competitive – I thought it was worth it”. One searcher spent $12,000 total for these services with the average being at $2,250. Annual costs for tax preparation cost searchers $500 to $3,000 per year.
The largest variable cost during searching is related to travel, motels and meals (T&E). Most searchers reported that early in their search they traveled too much and found that travel costs rose as they approached closing if the seller was not located in their search geography. They learned to group their travel and fly at off-peak times, avoid hotels in favor of couch surfing, and book rental cars/air travel far in advance to avoid the steep short-notice costs. As would be expected, funded searchers with a nationwide focus averaged travel costs at $37K, with a high of $67K and low of $11K, while the self-funded searchers, some of whom did search broadly, spent an average of $7K with one as high as $10K and, amazingly, a dual team recording only $330 for gas during their entire 11 months searching!
75% of searchers offered to pay “finders fees” for introductions using variations on the Lehmann Formula. However, none ended up paying any fees during their process. One searcher said, “in retrospect, it was just not worth dealing with them, since our own net was wide enough to capture enough potential sellers”. For the most part, searchers, all of whom prepared a 2-year budget, were not surprised at where their spending levels came out. A few reported that they had spent less than they expected on travel costs.
Unpredictable costs raise risk factor
The most significant swing in search costs were legal fees at the back end of the process. Adam Barker at New Forest claimed that “legal and busted deal costs were the most difficult to manage because they require tough risk/reward tradeoffs.” Generally, searchers can work with attorneys who understand the search model and are willing to defer their fees until a transaction closes. Paul Thomson at Scottish American declares that “you should be able to get the lawyers to agree to a ‘no deal, no cash’ but 150% of hourly rate for taking risk.”
This helps cash flow before closing, but don’t forget that these are real cash costs that will impact cash-on-cash returns in future years. Altogether, including ‘busted deals’, legal and other professional services represented about 40% of the all-in search costs, and ranged from 24% to as high as 75%.
The least expensive legal fee at closing was $8K and the highest $690K, with an average for funded searchers at $295K, and $57K for self-funded searchers. The size and complexity of the funded search deals coupled with “name brand” law firms contributed to the higher fees. Self-funded searchers kept costs low by utilizing smaller, regional legal advice. Some clever searchers reduced legal costs by asking the lawyers to start from templates provided by other searchers or by negotiating a fixed fee for the transaction rather than billing hours.
There is significant risk in predicting ‘busted deal’ expenses. These very real costs generally can’t be deferred, and are specific to the transaction. Examples include a bank charging $10K an up-front commitment fee for getting through their credit committee, a $10K QofE (Quality of Earnings) review by an accounting firm payable on completion, and a targeted IT forensic review for $5k. Ben Murray of New Forest observed that they “learned the hard way never to send in financial auditors without having them first review the numbers from their home offices- after spending three billing days going to visit, and discovering something in the first 15 minutes.”
Busted deal costs ranged from $15K to $85K and in 70% of the cases, searchers managed to roll these costs into their final closing. However, only 30% of searchers reported any costs for broken deals, being very cautious about spending money until a sure closing. Of course, the 25% of searchers who fail to close on a business per the latest Stanford study, have to find a way to negotiate these deal costs downward or face some large invoices when they wind down their search.
Living Expenses are unique to every searcher
Each searcher comes to their search with their personal cash requirements to support their lifestyle. Some have significant-others to support and perhaps additional commitments to family or community to consider. On the other hand, a few (38%) reported that a spouse’s salary and health plan were major contributors to their living expenses during search.
75% of self-funded searchers did not inject additional personal equity into their transaction. Their ‘sweat equity’ from paying their search costs was enough for the banks, seller and outside investors – allowing them to keep 60-100% equity for themselves. For these self-funded searchers, living lean also allowed them an extended search time. One searcher observed, “I think it would have been easy to spend more if we had a “fund.” We would have just flown to visit companies because it was an option for us. Not having a fund forces us to be conservative and operate on a tight budget, and it pays off when you ultimately get much more ownership of the business that you acquire.”
Many searchers are very uncomfortable living too ‘close to the line’ and with financial discomfort and risk. One searcher abandoned the self-funded plan when the family dogs needed an expensive set of treatments that tapped cash reserves, causing a reconsideration of the need for financial stability. These decisions become very personal.
One of the benefits of a funded search is salary and benefits for up-to-two-years. A review of 17 PPM’s circulating in 2016 identified 60% solo searchers raising an average fund size of $423K with a high of $480K and a low of $384K, seeking salary ranges from 96K/yr to $125K/yr. Dual searchers averaged $650K in fund size with a high of $950K and a low of $540K seeking salary ranges from $64K/yr to $160K/yr. Most included the 10-20% additional cost to cover employment taxes and health benefits. This funded support comes at a cost to the searcher, who may achieve a maximum equity share of 25% for solo and 30% for dual searchers, considered a fair trade-off for being able to start a search so early in their career with financial support.
No matter the funding source for search, there is a lost ‘opportunity cost’ as the funded salaries may be below market rate. Some searchers project out the costs and benefits over future decades, while others are driven less by the monetary trade-off than the appeal of being a “CEO” very early in their career.
How much cash you able and willing to commit to funding the search process may depend on where you are in your career or perhaps just good fortune. In any case, managing the expenditures during your search is the first step toward being a CEO, where the magnitude of the numbers will be a lot higher, but the priorities, tactics for reducing costs and accountability are all the same.
Developing an understanding of a realistic range of costs will help you assess some of the critical choices in your search about timing, geography, control, financial support and autonomy. Best to understand what they are, populate them into a spreadsheet and get comfortable with the variables and ranges before you march down this path.
This article and others like it can be found on my home website: www.jimsteinsharpe.com.