What to Consider When Buying a Company (Part 1)
Acquiring and selling businesses is one way to live a rich and happy life, but how do you know which companies to buy?
In today’s episode, Roland Frasier walks us through some important things to know when buying a business. This is part one in a series where he’ll be sharing some of his extensive knowledge and acquisition experience.
Listen in as he talks about the first two questions you need to answer before you buy.
How Am I Going to Define My Acquisition Criteria?
That’s question #1. If you don’t know what kind of business you want to buy, it’s easy to get overwhelmed. You’re like a kid in a candy store. You’ll save yourself a lot of headaches by establishing criteria first. Roland uses a matrix for this. It can be as simple as a whiteboard or a piece of paper with four quadrants:
- What you enjoy
- What you have experience in
- What skills you have
- What connections you have
Quadrant #1: Make a list of things you actually like to do. Being an entrepreneur is hard. It’s more motivating to go forward and deal with problems if you’re actually passionate about it. Take an inventory of your interests.
Quadrant #2: What do you have experience in? Brainstorm all your prior experience and things you’ve actually done in the past. Write down all of it, even if it doesn’t seem relevant. You might see connections later.
Quadrant #3: What do you have knowledge, training, skills in? This is similar to #2, but this time you’re writing down specific skills you have.
Quadrant #4: What are your connections? What networking resources do you have access to? What things are you a member of? What business contacts do you have? List all of them; don’t leave anyone out.
These four things will help you determine what kind of business you want to buy. You’re looking for common threads among things you’re passionate about, have experience in, are skilled at, and have connections for. What kind of business makes the most sense when taking all four of those things into consideration?
How Do I Select a Target Type?
This is the second big question to ask yourself. How do I select a target type of business? The type of company you’re looking to acquire can fall into several categories:
- A company that no longer exists
- A company that exists but isn’t profitable
- A company that’s breaking even/profitable
Roland recommends focusing on that last category, unless you have specific skills in turnaround. Not everyone is cut out to acquire failing businesses and turn them around. It’s hard. There are plenty of profitable companies to acquire. In the break even/profitable category, if he doesn’t see things that could make it profitable in 30 days, he’ll pass.
How do you decide how profitable a company needs to be before you acquire it? Roland doesn’t care about sales. He cares about profits. There are two types of profit. The first is SDE (seller discretionary earnings). That’s how profitable an owner-operated company is. Then there’s EBITDA (earnings before interest, taxes, depreciation, and amortization) for a company that’s professionally-managed.
You might want a company with an SDE or EBITDA of a certain amount. What do you want that amount to be? First, ask: how much do I want to pay myself for doing this deal on a monthly business? Let’s say $10k/month. That’s his new target type—a company that’s profitable and making at least $10k/month.
In addition to that, ask: what am I going to do with this company? Let it go as is, or do you actually see growth potential and there will be a little bit of investment to help it grow, either to sell or to make more money to pay yourself more?
And finally, ask: how much money do I want to budget to spend on increasing growth? Let’s say you want to spend $10k/month on growth. So you need a profit of $20k/month total. You need to find a company with an SDE or EBITDA of $240k/year.
That’s how Roland selects the kind of company he wants to go after. He asks which businesses fit his four criteria and have a profitability of $240k/year or more.
Stay tuned for Part 2!
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