5 Reasons You’ll Never Buy a Small Business

Buying your first business is a major accomplishment.

Unfortunately, most aspiring Searchers never make it happen.

They get pumped on the idea by the echo chamber of social media and business podcasts, but fail to move a deal across the finish line.

After speaking with more than 100 of you interested in ETA—Entrepreneurship Through Acquisition—those of you who are stuck in your search are making the same mistakes.

So today, I’ll share the common traps (and hopefully motivate a few of you to change things up!).

Let’s go:

Mistake #1: Overweighting “Off-Market”

The average Wealth² reader earns more than $200,000 per year.

If you are reading this newsletter, odds are you’re financial secure.

So what don’t you have?

Happiness.

…jk 🙂

What you don’t have is spare time.

Let me be clear:

Conducting an off-market search for deal #1 is a waste of your time.

Let the brokers do the exceptionally hard work of convincing an owner to sell a good business.

More importantly, let them spend the months it takes to educate that owner on what their business is worth.

Instead, focus on curating deal flow.

Create a streamlined process to efficiently filter through brokered deals.

You can even use services like Lando (affiliate link) or Kumo to help.

Also, spend time meeting brokers face-to-face (virtually, of course).

A pre-existing relationship can go a long way, especially if you find yourself in a competitive process down the road.

Mistake #2: Fixating on Pricing

Remember:

If you acquire a business for 4x its annual cash flow, use no debt, and keep the business flat, you would generate a 25% year 1 cash-on-cash return.

In other words, you spend $1 million to buy a business that generates $250,000 of cash.

That is exceptional.

Borrow 50% of the purchase price (from the bank or the seller) and that cash return moves to 40%.

Grow the profits just 10% and the cash-on-cash explodes.

It’s simple math.

So don’t overcomplicate it.

You want to find a good (low-risk) business where small changes have the potential to make a big impact.

Changes like:

• increasing prices

• modernizing brand assets

• spending $ on digital marketing

• scaling capacity through international talent

The easy stuff.

If you find a good opportunity, don’t lose it because you won’t pay above 3.9x.

Too many searchers are penny wise, pound foolish.

Mistake #3: Being Afraid to Shoot

You need to be comfortable hearing “no”.

If you submit an offer with a thoughtful explanation for how you arrived at your valuation, you will not offend the broker.

No matter how low the valuation is.

You may offend the seller, but who cares?

You’ll never see them again if you don’t buy their business.

The key is to be efficient with your time.

Here’s my process:

Step 1: When I see an interesting business come through my inbox, I sign an NDA and spend ~10 minutes scanning the investment memo.

I focus on:

• Seller’s motive for selling - is it believable?

• Business model - does it fit my criteria?

• Revenues - are they sufficiently diversified and stable?

Step 2: Assuming the business passes this screen, I’ll call the broker.

Step 3: If that call goes well, I’ll ask for a 30 minute meeting with the seller.

Step 4: If I’m still interested, I’ll submit a written Indication of Interest “IOI” via email.

This includes:

• A broad offer price (eg. $1.2-$1.6 million)

• A rough consideration mix (eg. 60% cash at close, 30% seller note, 10% earn-out)

• An ability to share a comprehensive and specific Letter of Intent “LOI” within 2 business days once the commercial terms are agreed upon.

Step 5: If the seller is interested, usually there will be one more quick call to chat through specifics before submitting the longer LOI.

I find this approach to be the most efficient way to spend my time.

It balances building a connection with the seller, but not wasting time if price expectations are too far off.

Mistake #4: Narrowing Scope

Many searchers attempt to narrow their search to a very specific industry and/or geography.

While it can make sense down the road (after you’ve acquired a business and want to scale it), in the beginning, I believe that approach is quite restrictive.

Instead, I’d suggest focusing on specific business attributes.

For example, I look for “overlooked” businesses with predictable revenues and strong free cash flow generation.

“Overlooked” is a broad characterization for a niche business, often led by a retiring founder, that could become a bigger business with the right investments.

This framework led to acquiring a donation management platform for non-profits and a sign & mailbox installation company.

Two businesses that, on the surface, could not be more different.

Cast a wider net and you’ll have more success with your search.

Mistake #5: Lacking Confidence

Unfortunately, many of us lack the self-confidence needed to become successful entrepreneurs.

Acquiring a small business is not for the faint of heart.

It requires a healthy relationship with risk.

But if you understand how to mitigate those risks, and believe in yourself, you can create an exceptional outcome for you and your family.

So here’s my encouragement:

• Quit entertaining self-doubt.

• Quit listening to podcasts.

• Quit scrolling Twitter.

And go make things happen.

Until week,

Danny

Personal Update:

My business partner and I are preparing to raise outside capital to accelerate our playbook and take advantage of a generational wealth transfer.

Over the next 20 years, we plan to buy and own over 50 companies (with no plans to sell).

If you:

• Admire the success of companies like Berkshire Hathaway, Constellation Software, Permanent Equity and Enduring Ventures 

• Love essential, but “unsexy” (and often niche) businesses

• Have at least $50,000 of patient capital to invest

Then complete this 1 minute survey and get in touch:

I’ve enjoyed meeting many of you who have already completed this survey. We remain on track to share the full investor presentation in the next couple weeks.