Pulling out of buying a business

First off, I’ll start by saying that I’m a little disappointed that the user base on here isn’t very entrepreneurial. Those interested in entrepreneurship seem interested in the next start up, technology business, or think they have to invent a product to be successful. To me cash flow is sexy. I’ve always wanted to own my own business, and felt a little that I had cheated by going into the real estate business for myself. I’ve done well with that, but always wanted to learn another craft in a different field. I have been searching for small businesses to buy over the last 2 years or so, but recently have decided to get more serious about it. An opportunity came up to buy a small junk removal/moving business about an hour away from me for about 2x EBITDA. The whole concept wasn’t too foreign to me because I’ve moved myself several times, hired movers before, and have used junk removal for several real estate remodels and flips. I call the owner on the phone and agreed to meet. He was a super nice guy and we got along. He sent me the financials and everything looked good. He sends me his tax returns and that all matches up to what he had advertised. Then he sends me his quickbooks financials. Revenue had increased by about 100k the last year, so that was good. Profits had increased too. But I start to notice a few things on his line item expenses. His line item insurance amount had $0 next to it. His line item rent had $1600 next to it of what should have been higher (his rent was $1600/month), and his meals were $11,000. I point it out to him and he tells me that sometimes he rushes through categorizing his expenses on quickbooks. No big deal, a lot of small business owners don’t manage the books that well. He fixes it and resends it to me. It looks a lot less suspicious.


We finally negotiate an LOI. He wants a two week due diligence, I say No Way. I don’t budge (it was a non-negotiable). We finally settle on a 30 day due diligence , I agree to pay his asking price, he agrees to sign a 5 year 100 mile non-compete, and in return he asks me to sign a 2 year noncompete in the event I back out. I roll my eyes a little and agree to sign. $1500+ in legal fees later, I am under contract and beginning the 30 day due diligence.


Around this time, I have been diving into small business reading and start learning more about the pitfalls of buying a business ex. Low revenue, high margins, buying too small, etc. All characteristics that kind of make me question myself on the purchase of this business. Anyways, he eventually sends in all the requested info. The first thing I look to is the bank statements for my suspicions. Sure enough, expenses basically matched deposits. In fact, a lot of the deposits were him transferring money from his real estate business to this business account. His wages and payroll were way higher than he had advertised, and a lot of the expenses were from him sending money to his employees via CashApp (lol). He essentially would take his quickbooks and cherry pick his expenses, deleting a lot of them. Basically his profits were bogus... Anyways.. I figure that basically the guy was propping up his tax returns in order to get more loans from the bank for his real estate deals. Overall, I’m a little bummed that I wasn’t able to find a successfully run business, but at least I didn’t buy a money losing business. 


Anyone have any cool stories about buying businesses?

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no I tried to start a company (and had this other thing that was kind of entrepreneurial that I was working on at the same time), it was more of a tech company, bootstrapped it, got the product built but struggled to sell it to people and the product worked from a technical standpoint but the product market fit maybe wasn't really there.

with the other thing that was kind of entrepreneurial that I was working on, I had some sense of 'fit' in terms of getting people to do something I wanted them to do (basically started a super niche group and got 300 people to join the group but then wasn't able to do anything that cool with the niche group or make money from the project).

realize that none of what I wrote related to buying businesses as it was all about starting businesses but still thought that it could be interesting.

 

more recently I've been working on this music project that I've had for like 6 months and I'm gonna try and keep pushing on that until I can figure out how to make it successful on some level - it's pretty much not successful at all yet but I've been starting to at least make a little bit of progress lately - I would be willing to plug money that I've saved up into the project (already have plugged like $4k into getting songs produced) but I haven't found a marketing solution yet that seemed to produce a good enough ROI (experimented with this one music marketing company which didn't produce very good results at all, tried some IG story ads on a very small scale but didn't really know what I was doing there and don't want to blow a ton of money trying to figure it out). right now I'm trying to figure out how to find some kind of partner to align with to commercialize the project I guess, whether that be a record label or artist manager who knows his shit or a distributor that you can push marketing spend through or a music marketing company that can actually produce results.

the above also doesn't relate to buying businesses but also thought it still might be interesting.

 

You're on a finance forum in the PE section. Maybe Reddit or some entrepreneurial focused forum is a better place

First off, I'll start by saying that I'm a little disappointed that the user base on here isn't very entrepreneurial. Those interested in entrepreneurship seem interested in the next start up, technology business, or think they have to invent a product to be successful.

 

Your story is one reason why finance professionals like ourselves will more likely stick with our hierarchal yet high-paying jobs with timely promotions than disrupt our peace and spend a tremendous amount of opportunity cost for a project that is temporarily self-fulfilling but very likely to fail. Not knocking you for trying but just responding to your initial line of why most people on WSO are not entrepreneurial. 

 

From another thread I posted in about search funds: 

"The "odds are more likely to end up with $5-20 million" is more so an exception than the norm.  

If you read the Stanford search fund study, only 64% of searchers find a business, of which only 73% see a gain. This probability of running a profitable search fund in itself is around 46%.

Furthermore, only 50% of profitable search funds provide a an equity payout of $4-10m + to the searchers.

So roughly only 25% of searchers hit a $4 million+ payout. For $10 million payout, its around only 10%. 

If you have a good buyside seat, I would say its way more valuable than doing a search fund. 

The stars really need to align to find a good and lucrative deal, vs in PE your risk is spread out around many different deals. 

The only people getting rich in search funds are the investors who demand a 35% IRR hurdle before paying their searchers..."

 

Thanks for the stats. I can attest to finding a good business of something I could see myself doing, at a location I could see myself living (I'm not trying to do an online business or relocate another day 1) has been difficult. Also, I'm not looking at hitting a home run, what I describe to be a $4m exit, although that would be nice. The goal here is to have a few different businesses, real estate, etc. that pays me enough to live on and enjoy the things I enjoy doing in my life. A plumbing business, laundromats, car repair businesses, oil change stations, heck I'd probably buy a strip club if it was for the right price and I could keep it secret from certain people..

 

I’ve acquired 20 small businesses for a couple roll up platforms. I’ve seen acquisitions where the entire employee base of that acquired company walked out the door, and I’ve seen one where the seller who came to work for us violated his non-compete by secretly starting a competing business on the side and stealing his customers back from us. 

 

$1m-$5m 

10-35 employees

of course we sued the guy but such litigation takes a surprisingly long time. We sent cease and desist letters to him, his staff, and to the customers he stole from us. Last thing he’d want is for his customers to get spooked being caught in a legal battle. We made sure to make it hurt as much as possible in the interim

 
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Was in college working in retail and went out the back to check some stock. Was friendly with the warehouse guy, first gen immigrant with a crazy work ethic who flipped cars and drove trucks on the side. Super nice guy, even helped me buy a car once after work. Anyway I was looking for this box and he comes up to me and asks if he can borrow 70 grand. I don't have that sort of cash. Turns out he offered to buy his bosses truck company (at a good discount) because his boss had some sort of 3/4 life crisis and warehouse guy needed to front the money in two days - didn't have time to get finance. Having recently sold a car, I loaned him my entire liquid net worth, 20 grand, at a silly rate secured against the two trucks he bought. He sourced the remember from his local church and came to a vendor financing arrangement. Upon purchase, he got better delivery contracts, would hire and upskill/train Uber/taxi drivers, bought another 4 trucks, and had a crazily cashflow generative business. Ended up buying a couple properties, recently sold the company and is currently traveling.

​​​​​​Was amazing watching this guy take a lot of risk but going from being worth 5 figures to almost 7 figures in a few years as a first gen without a highschool diploma. 

 

Cheers, similar to you I've recently been trying to get some ideas to stick with a couple SWE friends, but nothing past the product-market fit stage yet. Currently working on an ERP and business consulting package for SMEs in a specific, very paperwork intensive industry. 

Having undertaken some angel investments and assessed a bunch more deals, I see why it would take a lot for us finance types to jump to being a business operator. I personally prefer the analytical support and hands off roles, but this caps my upside.

I'm curious how much of the music business is the content vs the marketing.

 
TheDebtStar

Like you personally met them in person?

There are a few. But most of them are too busy doing things I reckon hah.

Yes, I also went to a few local WSO meets from the chat groups.

The entrepreneurs are less vocal on WSO, they don't have time. they are still in finance (mostly) and run businesses on the side or are in property management. this takes a lot of effort.

 

Awesome post, really enjoyed reading it! I also started investing in real estate and have been toying with the entrepreneurship through acquisition idea. In terms of your diligence curious how you ran it, did you bring in an accounting firm/cpa to look over the books, how much legal DD did you do etc.? What resources did you use to find companies, bizbuysell, cold outreach etc.? Any other things you wished you knew when you started looking. Thanks!

 

I tried to bring in the CPA firm that I use in order to look at the books, but they told me they don't really do that stuff. Maybe it's a liability thing, maybe they just don't want the hassle, or maybe I'm not that important of a client to them (lol). 

The things I requested under LOI were -

  •  2022 YTD financials as well as the 2019-2021 Financials via Quickbooks
  • 2019-2022 Balance sheets  - I later found out this was kind of a joke to ask a guy with barely a high school education to create a balance sheet on his business
  • Employee benefit plans if any
  • List of employees, their roles and responsibilities, salaries, and tenure at the firm
  • Breakdown of client concentration (without client names) if representing more than 5% of the business
  • Breakdown of revenue and pipeline (such as junk removal vs moving). I was curious about this piece.
  • List of any non-recurring expenses
  • Required insurance info for business transfer and registration
  • 2022 Monthly Bank Account Statements for the business account ***** THIS WAS HUGE
  • 2022 Monthly statements of revenue and expenses for each month (this was basically provided through the bank statements) 

I found the listing on bizbuysell. The owner had listed it. I doubt a broker would have listed it, but seeing so many shitty companies and bad valuations, I'm not sure.

Basically when I started going through the business and seeing a ton of cash app expenses to pay workers in addition to payroll, other expenses, and transfers from his personal account to the business account in order to fund the business, I knew that this was a money losing business.

Now if he had offered the business at the asset value, I may have considered buying it. Revenue was indeed strong and growing, his marketing expense was less than $1,000, he had over 100 five star google reviews, and he had no website presence. During negotiations, I learned from youtube how to create a website and I was starting to get some traction from that (although I have since shut it down lol).  

In terms of things I wish I knew, listen to some entrepreneurial podcasts such as Acquisitions Anonymous, Acquiring Minds, and Let's Buy a Business. Read HBS - Buying a small business as well as the book Buy Then Build. Assuming the business is a good one, you can buy a business through the SBA and they are willing to provide 70-85% financing. Get a seller note of 10-15% and you may only have to come out of pocket 5%. So you could theoretically buy a $3-$4M business producing cash flows of $1M a year, for just $150k-$200k out of pocket... now of course finding the business is the hard part, but there have been buyers on the podcasts that have done this exact scenario.

 

The valuations I’m seeing are crazy. I’ll see SDE of $350,000 asking $900,000 no real estate, not really capital intensive. Back out even a modest general manager’s salary of 100-150 to get to adjusted EBITDA and they’re asking way too much for a small business. 4.5x for a really small business in a non-sexy industry with GDP or maybe GDP + growth is too rich.

 

Agreed. Doesn't really sound like a seller that needs to sell in my opinion. More like "I will sell at X". I had a phone call with a broker and owner of a botox med spa business. The business was only 2 years old, doing 178k in EBITDA ($337k in SDE) with an asking price of $1.1M. I decided that I didn't want to be the first buyer to beat her up on asking price. 

 

if you don't want to start a junk removal business then why would you buy one? I know there is a non compete just trying to challenge your thinking a little bit and present the hypothetical situation of if you weren't bound by it, with a more simple business like that it's probably cheaper to build vs buy if you do it right. also I realize that many sellers have unrealistic price expectations (probably more so than buyers) but many buyers have unrealistic price expectations to, when you read that there are search fund type people looking for a business for a year or two you've got to wonder why they didn't just close on a good deal, there are so many businesses for sale why couldn't they close on one at a good price, some of those people probably just had unrealistic price expectations or were trying to find the golden goose - there is no golden goose. either build and have a higher risk of failing (edit: and more headaches and time and learning curve, etc.) or buy and pay more. pick one.

sounds like you don't want to start an internet business so you're probably out on this but if you want to start a record label hit me up. we could be music business moguls. I'm not sure if I would even need another partner on this project, just throwing it out there cause it's something that I'm sort of exploring maybe someone else will see this comment and hit me up even. might seem like an idiotic business to start but I have a call set up for next week with this artist manager in the genre that I make music in, I'm going to maybe float the idea of seeing if he has connections to the better music distributors and if he would be interested in setting up a label to just release my own music to start but maybe music from other artists too if everything goes well. advantage for me is it'd help me grow my project advantage for him is that he'd own part of the label and manage all of the bands on the label and he doesn't have to put up any of his own capital or anything he can just leverage his knowledge and connections and I can leverage my capital (and having a serious project to market). I would probably just do this with me and this other guy if I have enough capital to get this other guy interested in this record label idea to be perfectly honest cause if it works for making my project successful then I could find cheaper money later to do the same thing with more artists but who knows maybe it's worth having a third partner now if there is a third person out there with capital and interest in running a record label then hit me up if you see this, there are probably reasons why having more money up front would be a good thing, like in terms of trying to get a good deal done with one of the distributors where they would pay attention to the project or even trying to start an imprint label with one of the bigger labels. (edit: yeah maybe I should wait until I have the call with the guy next week to know what kind of $ it would take to do something like this and if that other guy - who would be the key man that it would be impossible to do it without - is even interested, but who cares I'm just throwing ideas out there).

 

I'll add my two cents-

Coming from the tech world, lurker here with a little bit of venture experience. Had a side businesses started from scratch and sold for low 6 figures. When I went to look to sell it, I realized I could buy a business for 2-3x EBITDA and realize a 40% ROC just by maintaining cash flows and be in control. Sounded too good to be true.

Set out to do an independent sponsor/non-sponsored search fund. Left my job to do FT in 2021. Found a small software business - significantly underutilized asset - off market. Typical search fund profile - owner was old, wanted to retire, cash flowed $600k/yr on a shitty ass product with him and two contractors generating ~$1m in revenue. B2B, unsexy space. Didn't even know his retention/churn, would send out manually generated PDF invoices. Lot of key-man risk, but the net revenue retention was good enough to take the chance. 

Was going to buy it at 2.5x SDE. Raised debt and equity. Paid out of my own pocket for QofE, tech due diligence, and legal fees, which afforded me strong economics on the deal, but was certainly a meaningful cost. Had the PA drafted, planning to close in a few weeks. Last minute, seller walks from the deal. Few months later, got the deal back, but by then felt too burned and given the key man risk, wasn't sure I could trust him. At the same time, started recruitment process for Google so decided to jump back into a W2 to give myself cash flow again.

Might do it again. Believe in the model, just weakened my position by leaving job to do it FT (working remote is the greatest God send to do this on the side) and coincided with perhaps the greatest asset bubble that made it hard to be competitive (thank COVID and the fed to leading to 20x revenue multiple valuations).

There are a handful of software PE-like shops doing this FT and have a number of port co's. I thought it'd be fun to be part of those, we'll see what the future brings.

 
TheDebtStar

Nice. Why do you think the seller walked, only to come back?

My only other question would be why did you get a QofE before getting it under contract? I guess it's easier to raise equity having that done, but that's a substantial cost before both parties have agreed to do the dance.

It was under LOI by the time decide to do the QofE. Need to do that to raise equity/debt, essentially a requirement. 

My DD implicitly showed the owner what he needed to do to make the business better. He later realized he just didn't have the energy to execute upon it and would rather sell and check out. 

 

OP you say this, "First off, I'll start by saying that I'm a little disappointed that the user base on here isn't very entrepreneurial. Those interested in entrepreneurship seem interested in the next start up, technology business, or think they have to invent a product to be successful"

The reality is that entrepreneurship is not very sensible for most of the people on this forum. If they can make ~$400k+ a year in a very scalable career, then entrepreneurship is far less appealing. Which makes total sense.

Entrepreneurship also fucking sucks until you are at ~$3m+ in EBITDA. That's ~when you can afford to start hiring competent people and not be depressed because you are talking to idiots all the time. Most people do not have what it takes to build a business to $3m+ in EBITDA :)

 

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