CEO Anonymous With Purdeep Sangha
8 Mistakes That People Do When Buying A Business
December 20, 2021
As a continuation of 2 episodes ago, some people may not consider the mistakes that often occur when buying a business. Here we will peel it off thoroughly. Listen to this episode's podcast to find out more.
Well, welcome back to another episode of business brothers podcast. We're not going to do the corny intro like we usually do because it's always a miss, but my name is Purdeep Sangha and

Harjeet Sangha. We always got to find a way to mess it up. Don't worry.

It's all good. It's all good. So the last few episodes that we've been chatting about hardship have been about business acquisitions. That's a big one. That's a big, that's a big, sexy topic out there. People like to do it. And today we're going to talk about some of the things that can go wrong when it comes to buying a business eight mistakes that people can make when buying a business. What are your thoughts?

I mean, I think eight's probably a good start employment. I've probably seen a few more pointers that we can add to the list, but no, I'm excited for this conversation. I mean, we're really going to unravel some of the key points you should be looking at when you're at the stage of transaction.

Yeah. I think it's important. So let's just throw it into schema. We're not here to deter you from buying a business. That's not our point here. We just want you to be aware of some of the things, the common things that we've seen through our experiences of things that go wrong. Because sometimes when things go wrong, it's okay. You can go get through it and you can still make the deal work. And sometimes when things go wrong, stuff hits the fan and people can get financially hurt and it can actually shut you down. So we want to make sure that you're successful longterm, you're thriving. So let's get right into it. One of the things that I see, it's a simple one and that's why people do or should do business valuations, but paying too much. I think the stats out there right now are, but 80% of transactions are where businesses have our people have paid or organizations have paid too much for the business.

Yeah. And, and kind of on that point, pretty, I mean, I think they kind of lie on that comes up for an acquisition as good. Well, how much should you pay for Goodwill? Right? When you pay more than a fair market value for assets it's attributed to Goodwill. And one thing that, you know, buyers need to be aware of is that sometimes their bankers or their banking institution will not finance Goodwill actually seen this this summer with, with a, a client we were working with that they actually negotiated at the highest range outside their bankers comfort zone for plan finance and Goodwill. So it kind of delayed the purchase price because they had to bring in another fund answer to, to, to make the acquisition. So don't get yourself into that problem. You want to have good conversations with your professionals before you sign a letter of intent, make sure you do the due diligence. I know I've been harping on the due diligence. I kind of sound like that guy banging the drum there, but be very, very careful. I mean, sometimes when you pay a little too much, you might be able to work it through, through the cashflow that you have from your existing business, or you unlock some other synergies, but you need to make sure you're able to finance it. You don't want to be caught with not having the ability to finance it.

So when you say Goodwill, you know, this is, let's say that's a typical accounting term or a due diligence term. What exactly is included in Goodwill for the average person who doesn't understand what that means?

Yeah. Simply put, it's just the purchase price minus the tangible asset back. And you know, essentially what is the fair market value of the assets today or at the date of acquisition? So that is what we call a Goodwill. And from that perspective, I mean, it's, it's quite normal to see it when you have acquisitions. That's how it comes about on the, on the balance sheet. But you want to be very careful of how much annual earnings you need to pay back Goodwill. I mean, if you, if it's going to take 10 plus years to pay back Goodwill from your annual EBITDA or, you know, annual earnings after tax, I mean, I would caution. You certainly want to caution you. So every sector industry kind of has a multiple that we would look at. And sometimes you pay a little bit more because there's, there's a higher growth trend or you're unlocking synergies, but you want to be careful that if that Goodwill purchase is starting to look like an outlier, chances are you're paying too much.

So what is included, you know, you talked about the difference, okay. So you've got tangible assets that you can actually put a value to and then everything else is considered Goodwill. So one of those things is brand right. Brand value because that's a tough one to put a sticker on in terms of this is what it's worth, but that is for example, you take a look at, I believe Coca-Cola is a top the fifth top brand right now. How do we know that it's a massive brown? We know that it's huge and that has a significant amount of Goodwill involved in it because Coke is a huge brand, but how do you really put a tangible value on it for a Coke? Everybody knows about it, but for let's just say the normal business putting value on, on the brand can be difficult. And that's where the hesitation comes in for banks or whoever is financing, private investors, because it is difficult to put a value on Goodwill.

And I think that's, that's the simple one there. And that's why we get to the second point, which is really around due diligence and hearts. You've talked about this, but it's not necessarily just the due diligence, right? It's the surprises that come about if you don't do the due diligence because yeah. And I see this because people are savvy. When it comes to business, you might be a seasoned business person that acquires businesses as a, and you might've been doing it for decades, but there's always that surprise that you don't know about that can shut things down. And that's what due diligence does. It's it's the times where you don't or aren't diligent, the things you, you get caught with the surprises and that's what due diligence does is it helps you, it doesn't eliminate it completely, but your chances of finding something that you should be aware of significantly go up when you do the proper due diligence.

Yeah. And to kind of expand on that point, I'm pretty, but I mean, even if you do all your due diligence and you look at all your checkmarks and listening, everything, there's still going to be some surprises and hopefully they're not large ones and you can live with them. I mean, I think we all have a very uncomfortable relationship with bad surprises, but when, if there are good surprises, certainly they're welcome. But you know, some of the common ones that we would see in our industry is inadequate working capital, right? So you would pick that up by having, you know, good record keeping and reviewing that of the business and make sure that their audited statements, I mean, you just don't want to go with internal documents. I mean, you want to use that with a level of risk, but if you have a little bit more assurance, you know, it's been audited and you've had several eyes review it. I mean, those are some ways that you can kind of catch an adequate working capital. And in liabilities, you want to make sure that there are no environmental claims or pen and litigations from, you know, customers or internal employees, just make sure that anything that you can catch with all your due diligence you do, you make every attempt to. And those are just some common things that we've come across in, in practice.

And that's why having the right team is born and having the right legal advice. Having the right tax advice is important because people can get stuck with a big tax bill if they don't do the proper tax due diligence are structured appropriately. So those are all parts of the deal that are important. One that sticks out for me. Another one big one is not being prepared. I think a lot of people just kind of go in thinking that buying a business or merging into a business is going to be simple, but there's a lot that goes on when it comes to buying a business that could be taking on or within U S with the new business could be, Hey, look, you've got to convert their systems over so that they match your own systems. Maybe you have to deal with employee contracts because here's a simple one is if you're dealing with a union and, or you're buying a union shop or you're buying a non-union shop and your current business is the vice versa.

For example, you have to make sure that either a you're you're prepared to be unionized or, or the conversations around that these are all things that you need to be prepared for when buying a business. So I would highly recommend that you have some kind of a merger team or advisor to help with the integration part because that's important. Being prepared for an acquisition can definitely improve your chances of, again, we talked about this in previous episodes, buying a business is all about capturing value. There's no point in buying something. If you don't capture the value and making sure that you do the acquisition effectively increases your chances of capturing that value.

Yeah, it was very well said. I mean, I think you've covered a lot of the points there, you know, w we may think that the acquisition should occur seamlessly and you can kind of integrate, but that's not always the case.

Yeah. And that's, and that, that really takes me to another thing, which is okay, not putting enough resources behind it because, and I've seen this too. I'm used to in the, in the past, coming from the banking world, that when we used to do mergers or acquisitions, if I remember the very first one that we tackled, we had very minimal resources on it. Maybe just a couple of people. And that's when we had the, oh, crap when we went through it, because it was, it was huge at that time, the executive table, we didn't think it was going to be that big. We just thought, Hey look. And I think that

First one was just a simple asset purchase arch. I think we were just purchasing assets. We weren't purchasing anything else. And that in itself became a huge, huge project. So when the next one came, we said, okay, we've got to double up on the resources. And then as we slowly acquired more and more, we had this entire team. And we knew at that time that if we were going to acquire another business, guess what, it's going to take a lot of resources. And it's going to take away from the projects that we have ongoing right now. So we better be prepared to say, what is the opportunity cost of doing this? Yeah. I mean, your, your team has to be well equipped. I mean, as much as I know about finance and, and business valuations, I don't pretend to be an expert in tax. So you have to have a bare minimum of, you know, Avengers on your team, for sure, you know, round them out with good bankers, lawyers, accountants, and valuators, but you know, who can also be added to that team is if you're looking to acquire, you know, another business and you're growing at a rapid rate, which I think is a great surprise, a you know, a great opportunity.

You also have to look at in terms of what happens when you outgrow the space that you're currently in, and you don't want to lose any potential business because you're kind of confined within your real estate. So you may need to talk to a commercial real estate broker and look at properties that you can grow into. So there's, there's many different individuals I can think of, of that into the team, but don't think you can be an expert on all the different items. I mean, you, you want to specialize in what, you know, the best and focus on that and just make sure that you have good members that can speak another professional language.

Yeah. And, and I would recommend on that note, when you're talking about a team for acquiring a business, you have the professionals that help you pre acquisition. But then I would also consider, depending on the size of the business that you're acquiring and your budget bringing in a project manager that is seasoned in acquisitions or mergers, because that can make your life a lot easier and extra save you a lot of money in the end. And I, I wouldn't bring them in after you make the purchase. I would bring in men before you actually sign and close the deal, because they can make you aware of certain things that, that you need to be open to when it comes to signing the deal and then have them prepped and ready so that when the closing does happen and you're ready to turn over or get the keys that that person is ready to go and has a team that is sufficient to be able to do the merger acquisition effectively. And,

Oh, sorry, go ahead. Oh, I was going to say, you know, what, as much as we, we all want to, you know, think we're good negotiators or whatnot. Sometimes you will see business owners who know their craft very well and know their competition very well, but they're not good at negotiating. So you may want to bring in someone from a training perspective to really bring you up to speed and help you develop some of those skills. So when you're in the boardroom and you're negotiating that you can actually make a competitive bid. I mean, you could find a great acquisition, but if you overpay for it and you don't have the negotiation skills to really lock in that intrinsic value, I mean, you're losing potential value there. So we all like to think that we're great at negotiation, but I, I don't want us to, to miss that point, because that is a very, very highly skilled portion of your team that you need, because you can do as much valuation and due diligence as you want. But if you have a really skilled negotiator, I mean, you can add an unlock, some potential value there as well.

And put that one on the list, have a skilled negotiator by her side. It's important because we all have this conception that, or perception that entrepreneurs by nature are dealmakers and negotiators. And that's not necessarily true because I know entrepreneurs who are good at a specific craft. They're not great at making deals. They're good at a specific craft or they're good at managing people. Very, I would say very few of the entrepreneurs that I've come across are actually real good negotiators and deal makers. And that is a skill that can be developed. I can tell you for myself, I was never really good at making deals. I shaved shied away from it because I wasn't about the money aspect that actually made me uncomfortable. It made me uncomfortable and negotiate, and I had to learn over the years to be able to negotiate and negotiate effectively. So it is a skill you can develop it if you want to, but if you want to stay away from it, bring in an expert.

Yeah. And I think you hit it right, right. On the head of the nail. They were pretty, I mean, I think a lot of people are uncomfortable with it. And I think for some, some individuals who think they are really good at it may not be good at it, but, you know, ultimately it comes down to understanding why the other party is pertaining to the transaction. If you can understand their why, and you can unlock their interest and rather being focused on their demands, look at their interests. I mean, you may be able to look at the negotiation or the transaction differently.

Yeah. And, and so what else do you see hearts in terms of some of the mistakes that are made?

I mean, I think we've kind of already talked about not devoting enough resources for the acquisition. So we're, we'll, we'll shut that one off, but I mean, not communicating effectively there's times where your staff and maybe the, the staff that is part of the acquisition, they may not pertain well to the transaction. In fact, they may think that the culture is going to change or that there's going to be immediate downsize. And to be a little bit leaner, there's a certain avenue and level of communication that you need after the acquisition to retain top talent and make sure that you can kind of hit, you know, hit the stride seamlessly as possible, but you can't communicate earlier because you might have that NDA or letter of intent and have to keep things pretty pretty tight-knit to your chest. So it's a very tricky one. In fact, maybe, maybe if you could share some of your kind of expertise on that.

Yeah. I think from my personal experience, what I've seen is very rarely has the financial aspect been the downfall of a failed acquisition. It's always been the people's side. And I think that's something that we need to keep in mind is people make businesses and people break businesses. So we have to understand that the first thing someone thinks about when there's an acquisition or there's a merger, is what does this mean for me? What does this mean for my role, the salary that I'm making, am I going to make more? Am I going to make less, am I going to get fired? Am I going to get promoted? Is someone going to take my place? Is someone going to take the place of one of my colleagues what's going to happen here? Is there going to be a downsizing? These are all things that are natural for a human being to think about.

And we have to put ourselves in their shoes and we have to say, okay, how do we address these challenges first? Because if you can address those challenges early on, get people on side, that acquisition is going to go a lot more smoothly. And you're more likely again, to capture the value to actually get the essence of that transaction out. So communication is important. Do it effectively, make sure there's no surprises, always address that question. What does it mean for me? Think about that for every person in that division or department or whatever it is, they are thinking that if you can proactively address that you're going to put them at ease and get them on your side.

Yeah. Very valid point. It kinda brings back some memories. When I used to work in the, the lumber and plywood industry and kind of looking back at that time, we were just, I'd say probably a year or two before the greater financial crisis, but you could kind of see the writing on the wall with a company. You know, I won't mention names, but you would kind of see how the shift in culture was happening at quite a rapid pace and the anticipation that the market was going to slow down. And that there'd be less demand for housing building infrastructure material. And instead of shying away from the communication, the company actively had engagements with, with us and the staff and just said, listen for us to survive. And for you just to be gainfully employed, we got to change the way we do things. And that's just got to start with being leaner.

So what we were used to doing with maybe two or three individuals for jobs, I mean, we were kind of slashed in half and those other individuals were, you know, doing other work items or procedures across the middle. So essentially you were working harder, which wasn't a bad thing because the way the company communicated was no, we have two possible choices. We could go bankrupt or we could work harder and still have you employed. And that was part of the acquisition communication that they had with us. So I, I would say myself as an employee, yes. It changed the work environment. But I kind of looked at from the perspective that management gave, it was, you know, we can look at this as a, as a bad evil, or we can look at as an opportunity to stay in the business. And there will become a time when business recovers and we'll will grow through it. Had they not done the communication? I think there probably would have been some, some pretty bad engagements in conversations. Yeah.

Yeah. That's that's, I would say that's an interesting one because as I look back and I, I go through the series of acquisitions that I've experienced. It's interesting because I think humans by nature shy away, someone that is buying a business, doesn't truly feel like firing anybody either. Right? If they pick up a business and they know that they have to cut the staff or the FTE, because that's, what's going to make the deal work. It's uncomfortable for the person that's actually doing the firing. And sometimes I've seen people shy away from that. And what ends up happening is that they keep people employed that shouldn't be employed. So let's be honest there's times where you have to keep people on board. Yes. Right. To keep the culture going. And then there's times where you have to make a decision and say, okay, this is not a good business decision to keep these people in the organization.

I've experienced that where one of the organizations we took over, they I'm going to say they had dead weight, that people that were just not performing, but because of the environment, because of the state of the business, they were able to get by. And I think that's ultimately why the business was acquired in the first place. But when they saw the performance that we were expecting of them, why was it? It was a sticker shock for them. Some of them couldn't deal with it. Some of them didn't want to, and the decision had to be made that those people had to be let go of. And again, that's an uncomfortable one, but you have to think long-term for the business. What does the business need? Sometimes it does need people to be moving on to their own next stage or next step, because that's, that's, what's going to keep the business going healthy and strong. And one of the other things I think harsh, I see often too, is sometimes people will play a blind eye to things like it just doesn't exist, or they're hoping that the problem goes away. And I don't know if you've experienced that.

Have you, I mean, elaborate a little bit further. Give me, give me some context.

Well, I think sometimes people will say, Hey look, okay, maybe that person's a problem employee, or maybe we have a failed system here. Maybe it will fix itself. Or we bought this business. Guess what? Everything's just going to work out. I've heard that a lot of times everything's just going to work out.

Yeah. I mean, I kind of see where you're going with this and you know, if I'm going to give you another example, it's kind of the old classic story of having a Ferrari with no engine. I mean, with a lot of digital technology advances that we're seeing out there. I mean, I do think there's a lot of opportunity to acquire other smaller companies that are through, you know, have record growth transitions, or, you know, growing at a rapid pace. But if you're not effectively incorporating that into your daily operation and the practice of your, you know, your talented staff, I mean, it's a Ferrari with no engine and in today's world, you know, there's so much extreme pressures from coming from you at multiple angles. And we're always looking for operational efficiency and whether it's AI or looking at a cloud or looking at other ways that we can streamline the business. One area that I've seen is that you acquire a technology company, but you're not actually integrated into your daily practices. So certainly, I mean, that's one frustration that I've seen is that you just, you know, you want to get leaner. You, you want more time at the end of the day, so you can meet more client face and, and, and obviously provide more solutions to your client base. But if you're not integrating the technology properly, I mean, it's, it's just a failed acquisition.

Yeah. And acquisitions, there's a discipline behind it. And discipline actually leads to progress. This is something that is important. It's one of the practices that I always preach all the time is if you're disciplined, you're going to make progress. That's ultimately what's going to happen. I was just talking to a gentleman a little while ago. And, and one of the core disciplines that I was getting him to implement in his business is a dashboard. Because with the dashboard, you could see exactly where you are every single day and a lot of entrepreneurs. And I'm surprised because we think dashboards are for, for, you know, big organizations, multimillion dollar organizations, and, you know, the average everyday person doesn't need a dash. Everybody needs a dashboard. It doesn't matter. And I'm surprised that even businesses that are making 30, 40, $50 million a year, how some of them don't have dashboards.

Yeah. You make a great point. I mean, I met with a banker yesterday and then his point was exactly that, that some businesses, as large as what you mentioned, $50 million in sales actually don't even have a dedicated person to their finances. I mean, there's no dedicated CFO. I mean, they may have an accountant that works outside the organization and in a big four or another, you know, another medium size firm, but they don't have someone designated to do KPIs and have dashboards and actually put together, what is our benchmark? Are we growing? Are we not growing? Know where can we improve things? And that, to me surprises me. I mean, we have dashboards for our farm. I mean, people may laugh, but yes, you, as a farmer need to know what your, what yield you're getting of your crops. And looking at that on a annual basis to see, you know, where, where are we achieving our goal and where are we missing our goal?

You know, what things can we do differently? And yes, there's going to be fluctuations with the weather that we can't control. The certainly I think to, to set a very proper dashboard and KPI system and measurement is, is very key. I mean, when you hire a personal trainer, I think one of the very first things you do is you, you jump on a scale, you need to know where you're starting from, and we're not just talking about your weight and kilos or pounds. We're talking about what is your body mass index? What is your fat to muscle ratio? You gotta go a little bit deeper.

Yeah. That's important. I think on that note, just to close it off here, one of the last things that you should have in place for an acquisition is a dashboard is some key KPIs to say. And not just when you close, because the deal truly starts when you get the keys, right? Because again, you have to capture that value. It may take you a year. It could even take you five years to fully integrate that business into yours and actually get the value out of that business that you're looking for. You might even take 10 years, depending on how much you paid for the business. So it's important for you to create a dashboard for that acquisition, especially if you want to acquire more businesses down the road. And when we did this arch, when we did the dashboard, here's what we saw that the acquisitions actually weren't worth it. It was a scary thought. We actually took a look at it and said, okay, these acquisitions were just not worth it because we could have grown faster and better and more effectively, organically with less headaches than actually buying these businesses.

And, and going back to that earlier point with list, some of these, you know, medium, medium sized enterprises, some of them don't know what their internal rate of return is. I mean, they may, to your point have a higher return on assets from their existing business and have higher organic growth just from where they are today versus the acquisition itself. So if you're acquiring a company that's only going to grow, let's just say 8%, but you're already organically growing much higher than that. I mean, you probably want to keep your assets and your resources internally so they can grow at a faster rate. But that's a very key point. I mean, having that due diligence process as we, you know, we keep pounding the payment on that is very, very key. I mean,

Yeah, exactly. So everything that we talked about here today, isn't to overwhelm you, it's actually give you some tools to make your acquisitions more effective. Having a dashboard, bringing in a project manager, doing the due diligence is going to save you time. It's going to save you money and guess what? It's going to save you a lot of headaches, a lot of sleepless nights. So rest assured that having the right people on your team is actually going to make your chances of being successful longterm higher. And that's ultimately what we're here to share with you so hard. I don't know if you have anything to add to this.

I do actually my ass for our listeners out there. Thank you for your comments and, and dropping the likes. I mean, we accept all comments, whether they're good or bad, we want to grow from this experience. And we want to hear from you. So if you have a topic of that

You want us to cover, or you actually want to be part of the show, we would love to hear from you. Yeah. And I want to thank you for joining us on this podcast. We really did not expect for it to take off this fast with this many listeners. We haven't actively even promoted it. So for those of you who are listening to this, so I want to thank you. I want to thank you for sharing this. And if you could please pass this on to other people within your community, that you would see get value from this. Because our job here is to help people and help people get value out of their businesses. Because we know that when you're successful in business, you're going to be more likely to be successful in life. And that's our ultimate purpose. Perfect. Okay. So with that, you know what I want to wish you the very best and we'll see you next time. I find everybody take care.