BY: Jeffrey D. Jones, ASA, CBA, CBI
During the past 35 years, my business brokerage firm has represented over 1,800 clients and customers in the sale and acquisition of small to midsize businesses. My appraisal firm has represented another 1,200 clients involved in lawsuits between buyers and sellers or partners/shareholders after a business acquisition. The majority of these transactions were successful with over 75% of the acquisitions still being in business after five years or longer. In the transactions that did not succeed, most fell apart within the first year following the acquisition. This article is not about cases where the buyer knowingly purchased a failing business and was not able to successfully turn the business around or changed the concept, or buyer fraud was intended, but rather this article will focus on those transactions where the business was profitable prior to the sale, but failed shortly thereafter. The following is a review of 12 factors that commonly lead to business failure, and are in no particular order.
- Poor price and deal structure
There are many transactions that take place between sellers and buyers without the involvement of business brokers, such as sellers who sell to an employee or relative. Without professional help, these types of buyers often agree to a price and terms that almost guarantee failure. In many cases the sellers set the price based on his/her own needs and then agree to finance the purchase with a low down payment and a short term note payout. This results in a high monthly payment that the buyer cannot pay when business is slow or cash was needed to handle unexpected repairs. The seller then begins the foreclosure process, and the buyer who has very little investment in the business steals what he can and departs. Seller financing is often used to finance a business acquisition, especially when the business records are insufficient to meet a third party lender’s requirements. The key to seller financing is for the seller to get a significant down payment, say 25% to 40%, and then a payout that the business can afford to pay. Typically, it takes five years with current interest rates being 6% to get monthly note payments low enough wherein the profitability of the business can afford to pay the buyer a reasonable salary and the note payments.
- Refuse to develop a relationship with the customers.
A business only exists because of the customers. When you take over the business, the customers do not care that you are overwhelmed by the workload or that you do not really understand their question. What they care about is that you call them back within a short time. They need to vent and obtain some satisfaction for their complaint. However, you do not like confrontation or unhappy people. Therefore, you do not talk to them. Within a short time, they will be gone. In addition, with them goes your opportunity for success. Make two things a priority: 1. Go see (or otherwise have a meaningful contact with) every customer within 30 days of purchasing the business and 2. Return every phone call in 24 hours or less. If necessary, make sure your assistant or secretary makes the return call. Be certain that your new customers know you are thinking about them. This is vital and is one of the main reasons these new business owners fail. They do not understand that and operating business is essentially a people-to-people enterprise. If they fail to develop the relationship with the customer, the business will fail.
3. Replace key employees.
Frequently this action recurs. The new owner takes over and within a few weeks has a falling out with one or two key employees. He/She just paid a staggering sum for the business and did not expect the employees to be insubordinate. Nevertheless, the new owner forgets that the experience is new for the employees as well. So rather than work through all the newness, it seems more fitting to replace the insubordinate employee with a hand picked confederate of your own. In one case we worked on, within 2 months the new owner replaced the chef with over 6 years of experience, and the entire wait staff. Without realizing it, he had replaced every person that all of the customers and vendors had grown to think of as the “business.” Many of the customers who know the staff by name and no long felt comfortable coming to the restaurant with mostly new employees. As a result, sales dropped by 50% from prior levels. Within 5 months, the business declared bankruptcy.
A business acquisition can be a great way to get into a business or expand an existing business. Avoid the above factors that can lead to failure and enjoy the benefits of being an entrepreneur of a profitable business.
Jeff is President of Certified Appraisers, Inc. and Advanced Business Brokers, Inc. 10500 Northwest Frwy., Suite 200, Houston, TX 77092, 713-680-3290, firstname.lastname@example.org