Tips for acquiring a competitor

by carly_mchugh | 22 July 2022 5:36 pm

By Luc Michaud

If you are anything like my business partner and I, you are a tradesperson running a business and not a business guru running a sign shop. Indeed, learning how to make great signs is important, but so is learning how to make a profit.

The barrier to entry for this industry is low. The stream of new shops popping up, existing shops changing hands, and others closing their doors, seems endless. All this flux creates regular buying and selling opportunities. Maybe you are actively seeking out your competitors or someone has handed you an unexpected deal; either way, there is a lot to consider when looking at purchasing another business. This article will look at many of the variables you will need to assess before making a decision.

My goal here is to share some of the lessons we have learned by looking at and completing a few different purchase deals over the years. I am not a business guru, a millionaire, or a lawyer. The points below are nothing more than insights that we have gained from the bumps and bruises doled out by the school of hard knocks.

Reasons for buying

There are many different reasons one might consider buying a business. Maybe they specialize in a niche product line or geographic area that has a small footprint. Do they have good quality equipment and materials you can acquire for pennies on the dollar? Do they have several key customers you have been trying to win for years? Possibly, most important in our self-trained industry, can you inherit experienced and capable staff?

Even in a situation where someone is on the verge of closing their doors, there may still be benefits to buying them out. If you leave them to bleed dry, you don’t necessarily know how it is going to play out. How much trouble is a motivated and persistent new owner going to cause for you if he rescues the company from death’s door? What if those capable staff move on to work for a competitor? If you buy out a company that is on the brink of shutting down, you have control of the outcome.

Types of deals

There are two different types of deals. An “asset” sale is the most common type. This involves you buying the “stuff” your competitor owns, but not the business itself. This “stuff” may include the business name, files, phone number, real estate, website, equipment, inventory, goodwill, customer contracts, etc. Note that receivables and work in progress may be negotiated into the purchase, but do not assume they are coming with the deal. The business will sell you all their stuff and the previous owners are responsible for paying off any liabilities and closing the business entity on their own.

The second type of deal is a “share” purchase and involves purchasing the entire business itself. This is different because it includes all assets and liabilities owned by the business. This means employees, receivables, payables, short- and long-term debt, taxes owed, warranty obligations—everything. You assume the whole business entity from the old owners.

An asset deal is most common because new owners typically do not want to assume the payables and other debts the old business may have accumulated. Try as you might to unearth as many dirty details as possible, all it takes is one surprise for things to take a nosedive. How excited are you going to be if you find out you must now pay cash up front for all your materials because the previous owner ran up huge unpaid bills with suppliers? Small detail, huge pain.

Bursting the bubble

This is a good thing for buyers, but as a seller, if your retirement plan is to sell your mom-and-pop shop and retire to the Bahamas with millions of dollars left over from the transaction, you will be sorely disappointed. I was surprised to learn what small businesses actually sell for. If you know your own business and how much you take home each year, it only makes sense. Many of us put in long hours, underpay ourselves and there is still no money left over at the end of the year. If this is hitting too close to home, really pay attention to the next insight.

Understanding your own business

Back in 2014, we had been putting in minimum 14-hour days seven days a week for a year-and-a-half, often stretching to 18 or even 20 hours. I barely knew my one-year-old daughter and both our wives were very frustrated because we were never home. One of our customers was in the shop to pick up some decals and we were talking about how crazy busy we were and how we were struggling to keep up. He did not talk about how awesome that was or give us the old “well, that’s a good problem to have.” He looked us dead in the eyes and asked, “Yeah, but are you making any money?” The question nearly knocked me on my rear end because I knew the answer, and I knew I was not going to be proud to have to say it out loud.

How are you going to buy a competitor if your own business isn’t making money? If you do not have the capital to purchase equipment or property, or have the cash to support a new hire, you are likely under-charging for your time and/or products. There are many other ways to help the bottom line, but the one big mistake small business owners typically make over and over again is not valuing their time and not understanding their business. You need to understand your business and that does not mean knowing which vinyl to pair with which substrate. It means knowing your wage to gross ratio. It means knowing your burden rate. It means knowing how to read and interpret what is going on with your income statement, balance sheet, and cash flow statement. If you thought about copying and pasting those last couple sentences into Google translate, you may not be ready to tackle the purchase of another business.

Ask questions

Ask questions of everybody you have access to (the seller, lawyer, accountant, employees, customers, business mentor, your mom). You may be surprised what sort of information the seller will divulge to you in casual conversation. Find out as much as you can about the operations, staff, products, pricing, clients, and their motivations for selling. You can use the information you gather to create as clear a picture as possible of the business. If you find yourself wondering, don’t be timid, ask the question.

Know the numbers

Remember when I told you to know and understand your own business? Putting in that time and effort starts to pay off. When you see the numbers, you want to know and understand them intimately. What seems low? What seems high? What jumps out at you right away? Compare their numbers to your own. What is the same and why? Does it make sense their wages are similar to yours even though they have three fewer employees? What is different and why? Does it make sense their material expenses are 40 per cent of their gross revenue when yours are only 23 per cent? Why are they breaking even this year when they lost money the two previous years? What did they change to make the business look more attractive to sell? Are those changes sustainable, or even legitimate? Most of the answers to these questions should come from the knowledge you have about your own business numbers. You should be able to answer the rest of the questions based on the information you gather about the business operations.

We have looked at the numbers of three different competitors over the years. One of them on two separate occasions. We found on three of the four occasions that we knew the business better than the owners after reviewing their income statement for 10 minutes. Believe me, this is not a slight to the sellers we dealt with as we have been in their shoes in the past. The point is you understand their business on a deep level without ever having to set foot in the building. You are also getting answers to the questions business owner themselves cannot even answer. That is the strength of knowing your own numbers.

Look for improvements

There are many reasons to sell, but most of the deals probably involve the seller unloading their problems on the buyer. You need to know what those problems are and how to fix them before you buy.

Once you have seen the numbers and asked all the questions, you should have a good understanding of what changes can be made to improve the bottom line. Are they still writing up invoices by hand? Are they overstaffed or understaffed? Are you going to be able to eliminate some expenses (accounting, legal, utilities, etc.)? Do they have old inefficient equipment? Are they undercharging? Does 30 per cent of their business come from low-margin products that can be cut from their services?

In our recent acquisition, we immediately cut vehicle tint and PPF from the services offered. Combined, they only accounted for 11 per cent of their gross sales. The pricing in our market is incredibly low, and our facility is not set up to do either properly. It was an easy decision to let everybody else in the market lose in a race to the bottom. Some days we refer five-plus calls a day to one of the tint shops. We would make the same decision again and again. No sense working for the sake of working. We will focus our time and energy on things that make money.

Run projections

Once you have a handle on where things are now and what improvements you would like to implement, you should run some projections. What are the numbers going to look like after you take over? Are you going to be able to maintain 100 per cent of gross revenue? Are you adding marketing expenses? Is your material cost going to go down because you will be ordering more volume? Take your income statement and balance sheet, plug in the new numbers, and see what the new bottom line might look like. Does that number look juicy or scary? Now punch the numbers in again, but be more conservative. Would it still make sense to make the deal if things are not quite as rosy as you expect?

Don’t forget to include future expenses from the purchase in your projections. Are you going to have to replace the aging equipment soon? What is moving going to cost you? Are you going to have to hire more bodies to deal with the volume? What are your financing payments going to look like? Do not forget to include the big chunk of change you are going to have to pay the tax man—13 per cent on a $500,000 purchase is going to hurt.

Understand what you are buying

Buyers and sellers are often not on the same page about what is being sold/purchased. In the 2015 deal, we were primarily after their files, phone number, and the website. The seller was trying to sell the whole shop, but we generously paid about a third of the asking price for the assets we wanted and left the rest so he could try to recoup as much as he could out of it. In hindsight, the biggest value in this deal was the phone number. We forwarded it to our shop and most of the customers did not even realize they were dealing with a different shop until we gave them the new address for pickup.

In the recent acquisition, we bought all sorts of “assets” that went straight in the garbage, including an operating flatbed we paid a good chunk of change for on paper. We were after the experienced staff, the fabrication division (missing piece for us for a long time), market share, website, and phone number. Everything else on the asset list was of zero value to us. Note that the staff did not come as part of the purchase price, but we would not have paid the purchase price if we did not secure the signed employee contracts.

The sellers will try to assign value to things you care nothing about. Understand what is of value to you and pay what you are willing to pay for those assets. You can still buy the whole operation, but do not pay more than what the assets you want are worth.

Don’t get caught up in the moment

The idea of purchasing a competitor is exciting. It could be easy to hop on the dream train and ride it all the way to bankruptcy. Make sure the deal really has value. Identify any risks that might be present in the deal. Are you going to be over leveraged because of financing? Is their last profitable year the result of an anomaly like the COVID boom some of our shops experienced? What are the possible outcomes if you do not go through with the purchase? Do any of those outcomes benefit you in a different way?

[5]

Initially, the third shop deal we looked at was very appealing and we went in guns blazing ready to make it happen. As we got further and further into looking at the deal, the shine started to wear off and we realized it just really was not worth anywhere near what they were asking. We would have had to make an insulting offer to get close to what we thought it was worth, so we opted to bow out rather than rocking the boat.

Secure financing

We have covered a lot of topics up to this point, but this is where the rubber hits the road. If you have evaluated everything above and you want to proceed with an offer, you must be able to back it up with cold hard cash. Given most of us are not drowning in money, this usually means some sort of borrowing. Let’s look at some options.

Banks

Bank loans are the most obvious and simple route, but as we all know, banks are not willing to lend you money until you no longer need it. You must be able to pony up a decent deposit, have some healthy business numbers of your own, and potentially some collateral to qualify for this option.

Government funding

Community Futures and BDC are both government-funded entities whose mandates are to support and grow small businesses provincially and nationally. Their loans and grants often have less stringent qualification measures but there are trade offs. These include smaller loan amounts and higher interest rates, often with a longer term, just to name a few.

Venture capitalists (Angels)

Venture capitalists (think Dragon’s Den) are private lending companies that can be quite flexible in the lending agreement. The cost of doing business here is higher interest rates and possibly a share of the company itself. This means after you pay off the initial loan you will still be paying the lender dividends in perpetuity until you buy your shares back.  

Private investors/partners

Similar to the venture capitalists mentioned above, private investors can be very flexible and accommodating. On the plus side, you may have a personal relationship with this lender, or they may be a prominent local business owner. Given their personal stake in your success, they may be willing to help coach and guide you to the promised land. A stake of your business and some loss of control may be your trade off in this scenario.

Whatever route you go, keep in mind that you are only receiving money so that others may also profit from your achievements. Banks are unwavering, interest rates do not play favourites, venture capitalists are known for being ruthlessly aggressive, and who hasn’t heard about a partnership nightmare? Make sure the financing you arrange will not keep you up at night.

Even though I have mentioned it late in this article, you should initiate the financing process well before this point in the deal. If you think the deal could go somewhere, start the application process early. You do not want to cause the deal to stall while you wait to find out if you can get funded.

Use professionals

Lawyers and accountants are expensive, but their knowledge and expertise can save you tens or hundreds of thousands of dollars. Do not fool yourself into thinking you know the ins and outs well enough to make decisions without proper guidance. We saved ourselves serious trouble on both purchases we made thanks to our lawyer’s advice.

In 2015, our lawyer saved us $10,000 by doing due diligence on the seller and discovering the seller did not have the legal right to sell his equipment until he cleared a $10,000 charge against it.

In our recent transaction, our lawyer pointed out there was significant severance pay implications for the transitioning employees. He helped us iron out the issues in the purchase agreement before we signed it. We could have potentially been on the hook for some big payouts for employees that may not have panned out.

Your lawyer and accountant have likely done dozens of deals. They have seen many different scenarios and can help you find creative and effective recommendations to protect your business and wallet from the law and the tax man.

Find a mentor

Find a business mentor and consult with them. In our case, we reached out to a customer we knew had made a few acquisitions himself. We brought him into the last two deals we looked at and his knowledge and experience were of immeasurable value. The advice you get from your lawyer and accountant is necessary, but they speak from a focused perspective. A business mentor will often have a better grasp of the big picture from all angles. They will challenge your ideas, point out inefficiencies or improvements you missed, and give insight from mistakes and wins they already went through themselves. We have made a point to start taking him out to lunch every few months as part of our own personal business development.

Be patient

Both deals we ended up doing took way longer than expected. The sellers are going to get hung up on weird details. They are not going to understand why you want certain things dealt with. The lawyers and accountants always take four business days longer to get back to you than you would like. There are a lot of details to sort out, particularly in larger deals. There are a lot of moving pieces, and it can take time to massage all of them into place. 

Be a sponge

Each experience brings something new. Even if you do not end up moving forward with the deals you look at, you will learn a lot. Your business vocabulary will grow. You will know what is going on under the hood of your competitor and you will be able to take each experience into the next opportunity. I strongly encourage you to explore every purchase opportunity that crosses your path simply for the educational benefits that come from the interactions.

Travis Sewell and Luc Michaud (author) own and run Signtek Industries Inc., in Prince George, B.C. They have an experienced team and a full range of services. Special thanks to Travis and Jamie Mayer of CanCADD for their valuable input for this article.

Source URL: https://www.signmedia.ca/tips-acquiring-competitor/

---