WHO BUYS COMPANIES AND WHY

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If you are buying a business for the first time, you will find that buying a business is a unique experience that requires extensive knowledge and skills in a broad spectrum of areas–legal, accounting, banking, financing, understanding of government regulations, especially in areas of environment, safety and employee relations.  You must learn how to obtain and screen leads, how to evaluate and price prospective companies, and how to conduct due diligence. But even highly experienced entrepreneurs who have completed dozens of deals still rely upon professional expertise for certain phases of the process.  Thus expect that even after you learn more about the deal-making process, you will still need to hire consultants to assist you in making a successful purchase.

Buying a company is very demanding because it is an intellectual, pragmatic and emotional process, all in one. It is an intellectual process because to be successful you have to think it out.  It is a pragmatic process because you have to be realistic about the company you are looking to buy, whether it is worth buying, what its real value is, and what it should be priced at. And buying a company, finally, is an emotional process.  Throughout negotiations, beginning with first contact with the seller and continuing through to the closing of the sale, you experience tremendous highs and lows. You must be able to handle both extremes of emotion. You must handle the highs, so as not to reveal your enthusiasm to the seller, and after the lows, to be able to come back and find a solution to the problem that might otherwise kill the deal.  The emotional component holds true even after many deals but you do learn to control those emotions with practice.

Reasons for Buying Your Own Business

Some of the reasons for buying your own business are similar to those of any entrepreneur: to control your own destiny; the personal challenge, making money, the satisfaction of building and running something on your own.

In addition, some individuals may find buying an established business more appealing than starting from scratch.  These issues are explored in the following section.

 

Buying a company holds less risk than starting from scratch

 

Three avenues are open to the budding entrepreneur: starting from scratch, buying into a franchise, or buying another established business.  Although most books on entrepreneurship devote a chapter, at best, to buying a company, it is becoming an increasingly popular avenue to business ownership.

Some evidence suggests that buying a business is less risky than starting from scratch.  According to business brokers, 4 out of 5 small businesses that change hands are still in business 5 years later, by contrast, the Small Business Administration claims that 2 in 5 individuals survive for six years 1. And although franchising is a popular direction, recent reports suggest it may actually be more risky than starting from scratch.2

Other research that compares start-up ventures within larger organizations to acquisition of firms points to another important reason for buying a company.  Ralph Biggadike of the University of Virginia found that on average it takes eight years for a new venture to reach profitability. It takes ten to twelve years before the average venture equals that of a mature business. Cash flow typically remains negative for the first eight years. By contrast, it is possible for a company to purchase a market leader in a strong cash position overnight.3 In another study, Edwin Mansfield of the University of Pennsylvania concluded that only between 12 and 20 percent of research and development based new ventures actually succeed in earning an economic profit at all. 4

Of course, the individual buying the smaller company may have a different experience base but the general pattern remains. Most new ventures take years to pay off. With careful screening, you are likely to obtain far more rapid return on your investment via acquisition of an existing company if you are careful to purchase the right company in the first place.

Timing: When Should You Start?

Because of the lack of existing research on the topic, most of what we assume to be true about entrepreneurs who buy businesses is based on the larger sample of all entrepreneurs who start and own their own businesses and based on our own observation.   Adults, young and old, may buy and start a business but some of the key issues will be different for those in different age brackets. Figure 2.1 summarizes some of the key issues typically faced by adults at different stages in adulthood.5

As indicated in Figure 2.1, the typical adult acquires relevant business and work experience beginning in his or her early to mid 20’s. Thus an adult of about 35 years of age can be expected to have about 10-15 years of meaningful work experience. This is the average age for males starting their first venture with the average age of females being slightly higher, at about 38 6.  Recent research evidence suggests that business education and experience in general managerial positions is associated with a greater likelihood of success as an entrepreneur 7.

Figure 2.1 also assumes that as we get older, we typically take on responsibilities such as a house mortgage, spouse, or children that may reduce our perceived ability to take risks or change jobs. And as we age further, even when some of those responsibilities lessen, radical change in our lifestyles becomes more difficult.

 

Age is also likely to impact the credibility that the would-be entrepreneur is likely to have, and the related ability to obtain financing from the bank.   It usually takes several years for most adults to accumulate savings, contacts, and access to financing unless inherited from a parent or other family member.  Although these are factors to consider however, none is probably as important, in determining the appropriateness of your own decision to buy a company, as is your strong desire to be the owner of a company.

The young company buyer

The youngest group of company purchasers, typically, those in their twenties, are most likely to encounter problems of credibility because they simply haven’t had the time to develop the expertise in business. They are also less likely to have adequate monetary resources to finance their acquisition.  And they are likely to have a less effective network for obtaining leads, for obtaining funds, and for obtaining professional assistance needed to assist in the buying process and later to manage the business.

On the other hand, the young person is more likely to feel comfortable taking risks. He or she often has fewer family obligations. The younger individual is likely to have a higher energy level and perhaps a higher level of need to succeed.  However, it is important to keep in mind that greater willingness to take risks does not necessarily mean a greater probability of success.  However, when the right deal comes along, the younger person may be less likely to hesitate and let the deal get away.

Key to preparation for the younger buyer is credibility and financing.  Although people generally view a younger person as having less experience and therefore less credibility, there are ways to offset this perception.  And although, other things being equal, the banks might be reluctant to lend to an inexperienced individual, a carefully developed business plan, a sound group of advisors and credible investors can go a long way towards changing a banker’s mind. The topic of credibility will be revisited in greater depth in Chapter 3.

 

The more mature company buyer

The more mature company buyer (anywhere between 40 and 60, depending upon years of actual work experience), that individual with 15-20 years of experience in business or a particular industry, is likely to have more credibility with both the broker and banking communities, access to greater monetary resources, and a more well developed network to draw upon for business leads, investments, and professional assistance.  The more senior company buyer may also be more focused, having had more years of experience learning about the types of work and industries he is interested in.  But he or she is also, at least psychologically speaking, running out of time.  Although people are certainly keeping fit and continuing to work longer than before, there is also the likelihood that the 50 year old has fewer years before retirement than does the 20 year old. This might affect the interest of certain investors, but more importantly, it may limit the number of years available to the prospective buyer to make a firm profitable.

The optimum point of departure

There is no one perfect time to buy a business. However, the prospective buyer in mid-career (perhaps 35-40 years of age) may have the ideal balance of work experience, credibility, networking, and access to financing to step out and begin to buy existing businesses. The married individual will have to pay careful attention to a personal family plan to prepare himself or herself and his or her family for possible financial and non-financial sacrifices for a period of time before and even after the business is purchased. This is not to say that someone younger or older cannot do very well. But the youngest individuals will have to address credibility issues much more vigorously. And more senior individuals, generally speaking, may have to overcome greater inertia toward change, although sometimes downsizing and restructuring within companies forces people in mid-career and late career to reconsider their career choices anyway.

The most important thing to keep in mind, regardless of your age, experience and circumstances is your strong desire to go into business.  Otherwise, the rest won’t fall into line.  You need tremendous motivation in order to generate the enthusiasm and to put the necessary time and work required into your business to assure its success.

You must articulate certain critical Guiding Rules. These Rules must be specific not general. They must reflect your vision, your experience, yours and your team’s abilities, and must follow them with discipline and open mind. In my case and the case of the teams I lead the following is a set of rules that we adhered to:

1: Have the Support of your Family.

2: Organize yourself and your team.

3: Define your own Investment Ability and do not Exceed it.

4: Define what is the “Right” business for you.

5: Line up financial support: Investors, Banks.

6: Keep in mind that about 90% of those that try to buy a business do not complete a deal.

7: Do not get hooked (fall in love) by a business and its products / services. Get hooked by its               profitability

8: Try to have a choice of two or three deals in the making to re-leave the pressure of compromise.

9: Set the parameters that if you can not meet you will not make the deal. Just walk away from it.

10: Do not close the deal before completion of “Your Business Action Plan” that you intend to

implement after closing.

 

11: Be at the purchased business in person immediately after closing and talk to the employees about yourself and your interest in the company

Footnotes

1 Meeks, Fleming, and Nancy Rulenier, “Am I going to mind sweeping the floors?”, Forbes, Vol. 152,  pp.142-146

2 April or May, 1995 Inc. Magazine or Fortune Magazine.

3 E. R. Biggadike, Corporate Diversification: Entry, Strategy and Performance (Cambridge, Mass: Division of Research, Harvard Business School, 1983).

4 E. Mansfield, “How Economists See R&D, ” Harvard Business Review (November-December, 1981) pp.98-106.

5 Adapted from Daniel J. Levinson, et al The Seasons of a Man’s Life, (New York: Alfred A. Knopf, 1978, and Jeffrey Timmons, New Venture Creation, Burr Ridge, Illinois: Irwin, 1994)

6 From Robert Hisrich and Michael Peters, Entrepreneurship: Starting, Developing and Managing a New Enterprise, 3rd edition, (Chicago: Irwin, 1995) p.44.

7 Chandler, Gaylen N. and Jansen, Erik, “The Founder’s Self-Assessed Competence and Venture Performance,” Journal of Business Venturing, Vol. 7, May, 1992, pp. 223-236Figure 2.1: Age and characteristics bearing on new venture start-ups

Figure 2.1

Characteristic              20s                   30s                   40s                   50s

1. Relevant business                        Low                      Moderate to high               Higher          Highest

experience

2. Management skills        Low to moderate                             Moderate to high                        High

and know-how

3. Entrepreneurial goals   Varies widely      Focused high       High                              High

and commitment

4. Drive and energy          Highest                 High                      Moderate                     Lowest

5. Risk taking                     Highest                 Moderate to high               Moderate                     Lowest

6. Credibility                      Lowest                 Moderate                            High              High

7. Network                          Lowest                 Moderate                            High              Highest

8. Access to financial

resources             Lowest                 Low to moderate               Moderate                    Highest

______________________

Adapted from Daniel J. Levinson, et al The Seasons of a Man’s Life, (New York: Alfred A. Knopf, 1978, and Jeffrey Timmons, New Venture Creation, Burr Ridge, Illinois: Irwin, 1994)


Main Reference:
“How to Acquire the Right Business”

John Psarouthakis & Lorraine Uhlaner

Published by Xlibris, 2009

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