42 Steps to Acquiring a Small Business

42 steps

“42” is a famous number. In Hitchhiker’s Guide to the Galaxy, it is the meaning of life. It was also the number worn by trailblazing baseball star Jackie Robinson. “42” should be especially important to members of the SMB searcher community as well because buying a business takes 42 steps. If that sounds lengthy, frustrating, or intimidating, that’s because this process is difficult. While most searchers won’t go through every step on our list, everyone will make a large number of decisions and hire numerous team members before they successfully acquire a company. 

Acquiring a Small Business without an MBA

Private Market Labs organizes these steps so that you don’t need to take an “entrepreneurship through acquisition” course at a top MBA program to acquire a small business. We break down the acquisition process into five distinct phases, outlining the decisions a searcher will make at each step in their acquisition journey. We will elaborate on each phase separately in future posts. Once you’re ready to get started, sign up for an account and check out our Broker Directory and Service Provider Marketplace.

This piece outlines the choices each searcher needs to make throughout the process. For more details about the ETA industry, its history, and why a person might want to pursue this path, check out the following foundational books:

Phase 1: Getting Started

The beginning of a searcher’s journey when acquiring a small business requires a series of challenging decisions. In the earliest days of their search, an entrepreneur needs to determine the search strategy that fits their goals, network, and financial situation.

  1. Decide whether they want to search at all. Risk-averse entrepreneurs should consider why they value acquiring a small business over a corporate role with a steadier paycheck. 
  1. Decide whether they want to operate a business as a CEO or play more of an investor role, owning multiple small businesses operated by others. Entrepreneurs that like making deals but dislike managing companies could consider becoming a business broker.
  1. For those that want to operate a business – decide between different search fund models. Traditional search funds take money from investors, buy bigger companies, and hold less equity than self-funded search funds, which primarily finance a single acquisition using debt and seller-financing.
  1. For those that want to invest, but not operate: do they have the funds to do this on their own? If not, what is their thesis and how can they convince investors to back their venture? Building a portfolio of SMBs may be difficult for an entrepreneur early on. Instead, they can partner with established investors or start by operating a single business.
  1. Similarly, entrepreneurs interested in business brokerage may benefit from joining an existing firm or becoming a franchisee of a large national brokerage before branching out on their own. 
  1. Entrepreneurs should think about their personal thesis and competitive advantage. “Why them? Is the timing right? Why this particular cross section of industry, location, and company size?”
  1. Once a searcher decides on a search strategy, capital structure, industry, and location, they can start having conversations with lenders. While this may seem early in the process to talk to a lender, lenders want to be involved as soon as possible. Obtaining a letter of support from a lender can make building relationships with the sellers and brokers easier. 
  1. Traditional searchers, holding companies, and independent sponsors need to start engaging with investors. Buyers, investors, and lenders need to align on target industries, transaction sizes, locations, and capital structure.  
  1. Finalizing an agreement with investors requires a formal legal document. Searchers that are not comfortable managing this on their own may want to consult a lawyer. 

Phase 2: Finding a Business to Buy

For everyone other than the luckiest searchers, identifying a business to buy is the most time-consuming part of running a search fund. The most successful entrepreneurs build a search strategy based on the amount of time they have and their search criteria.

  1. Decide on a search strategy. This includes connecting with business owners that are working with brokers and actively looking to sell. Searchers will also perform a proprietary search, reaching out to businesses that meet their criteria but haven’t indicated their interest in selling. Each of these strategies has strengths and weaknesses. In general, companies represented by brokers will be better-prepared to sell. Brokers help sellers put together detailed information about for buyers and prepare sellers for the emotional burden of parting with their business. This can lead to faster closings and an easier negotiation process. The advantage of going with a proprietary search is the ability to look at a substantially larger number of companies, including exact matches to a searcher’s target criteria. However, outreach to businesses that are not on the market can result in transactions that are tougher to close. Sellers in this position are less-motivated to sell and may demand higher prices.
  1. Searchers that want to work with brokers should use resources like the Private Market Labs Broker Directory to build connections with the right brokers. 
  1. Brokered deals often appear on listings sites like BizBuySell. However, those deals are often the ones that were most difficult for a broker to sell through internal buyer lists. This means that listings sites are helpful but should only represent one source of brokered deal flow. Buyers should also engage brokers directly to try and access deals before they arrive on listings sites. Do this by being prepared, transparent, and willing to share information about financing sources. 
  1. Proprietary searchers can hone their outreach through subscriptions to data companies or publicly-available datasets from a local library. 
  1. Once a target business has been engaged, the first step is to sign an NDA. NDAs for brokered deals often include language protecting the broker’s interests in the deal. Buyers should carefully read each NDA and consult a lawyer if they are unsure about any particular provisions.
  1. After signing the NDA, buyers receive their first financial disclosures from a target business. This will often take the form of a Confidential Information Memorandum (CIM), a document that includes summary financial and business operations information. Some confident buyers will analyze these documents on their own to save money. However, investing in consultants or business analysts up front can save thousands in due diligence costs down the line. 
  1. After reviewing the CIM, buyers will ask follow up questions if the business continues to look interesting. This includes a conversation with the seller. Successful buyers sometimes disagree on whether to ask detailed questions at this stage, or to wait until a Letter of Intent (LOI) is signed.
  1. Buyers will choose whether to move forward with an opportunity or pursue a different option. Buyers and sellers will negotiate an LOI, which should clearly outline valuation expectations and the conditions under which a valuation could change. The LOI will often provide the buyer with a period of exclusivity to do diligence into the business prior to purchase.
  1. The LOI will also outline the buyer-seller relationship after closing, including seller earnouts and any seller financing expected for the deal. It’s important to communicate well with the seller at this point of the process. 

Phase 3: Due Diligence

Due diligence can be painful for both parties. Buyers may find new information that can make acquiring the business more difficult. Sellers may need to account for decisions they’ve made in the past that could make a business less attractive, lowering the price at the time of sale. Because due diligence can be lengthy and expensive, making prudent investments in a deal team is important for every buyer. 

Depending on the deal size, the buyer’s budget, and the type of deal, buyers need to make decisions about hiring for each of the following items. Typically, a buyer will hire experts in at least some of these categories:

  1. There will be a massive number of documents shared back and forth. Prudent buyers will invest in deal room software that can help with version control and document management. 
  1. Every search involves financial due diligence. Buyers need to understand a company’s balance sheet, working capital, and key revenue and expense metrics. Depending on the deal, buyers can hire an accountant, financial analyst, or auditor to take a look at a business’ books.
  1. On all but the smallest deals, buyers conduct a separate and in-depth quality of earnings analysis to understand the sustainability of financial results going forward.
  1. Real estate due diligence is important for any deal with real estate involved, particularly if real estate is a large portion of the deal price. Hiring an expert that understands how to value real estate and is familiar with the local market can support buyer negotiations. 
  1. Other asset inspections and valuations depend on the nature of the deal. For example, manufacturing deals include complex machinery that must be evaluated for condition and quality. Buyers looking at deals with high-priced leases can bring their lawyers into an asset or real estate inspection to help them understand lease break conditions and lessee obligations. 
  1. Insurance due diligence helps buyers understand existing coverage as well as additional insurable and non-insurable risks associated with a business.
  1. Tax accountants support a buyer’s efforts to understand the tax implications of their purchase and financially manage any taxes they can expect as they take over a business.
  1. Tax legal advisory is slightly different from number 25 above. In this case, buyers may need legal support to understand the legal implications of existing tax compliance issues or liens. 
  1. Buyers will want to understand any personnel challenges that await them in the new business, particularly if prior ownership’s HR management has created any latent risks. Hiring an HR expert to support this piece of the diligence process can be helpful. 
  1. Legal issues facing a small business can be diverse and costly. Make sure that an experienced M&A attorney is on the deal team. Bringing in a lawyer that understands the industry in question often yields additional dividends. There is a delicate balance between a lawyer that is too conservative and bogs down the process, and a lawyer who is not conservative enough in protecting their client’s interests. Speaking to multiple attorneys and making sure legal support has M&A experience can ensure that a buyer has the support they need. 
  1. Diligence on sales and customers can help a buyer avoid pain down the road. Look for customer concentration and the presence of expiring contracts.
  1. Industry-specific consultants can add value, particularly in evaluating a highly-technical business.

Phase 4: Closing

Closing involves final negotiations based on information found during due diligence. Parties will discuss the management of funds and transfer of business ownership. 

  1. Drafting transaction documents will require the support of a local attorney. For buyers that have been using local attorneys for other deal steps, this part is simple. However, out-of-state buyers may struggle to find a local attorney if they’ve employed counsel in their home area for other parts of the deal.
  1. Buyers must get approval of the final deal structure from their investors.
  1. Buyers will contact lenders to obtain final approval for their specific deal. For both this piece and step 32 above, regular communication with key stakeholders will make sure the deal closes. Buyers using an SBA loan should be prepared to work with sellers through a large amount of paperwork. SBA loans also require a personal guarantee from the buyer.
  1. In the event of a disagreement on the final price, buyers and sellers can obtain an independent business valuation to support negotiations.
  1. Finalizing the purchase involves working with an escrow office and managing large numbers of legal documents. 

Step 5: Post-close Transition and First 100 Days

After a long process, successful buyers step into the exciting and high-pressure world of business ownership. Buyers will face new responsibilities whether they are serving as the CEO of the new business or managing an executive as a multi-acquisition owner. At this stage, entrepreneurs must manage transitions on multiple fronts. They will make important decisions about who to hire, how fast to move, and how to start enacting their vision for the newly-acquired business.

  1. Acquisition entrepreneurs often must make changes to financial management early in their tenure. Possible changes include modernizing financial accounting, shifting a company’s basis of accounting, and identifying new KPIs. New owners will need the services of financial analysts, accountants, and fractional CFOs to support their business’ financial plans.
  1. Ownership transitions are challenging when it comes to personnel decisions. Owners will assess the capacity of current staff, identify areas to change, and hire new employees.
  1. With personnel and operating changes come challenges to a company’s culture. The new owner needs to be the culture-setter in their organization. Even strong leaders benefit from the support of a cultural transition consultant, a CEO coach, and/or a change management expert.
  1. A separate but similar responsibility involves strategic planning. Founders frequently embark on a “listening tour” to learn more about the business from current employees. To increase employee buy-in, work collaboratively and listen for feedback when implementing new ideas. 
  1. Longstanding businesses, especially those founded in the pre-internet age, often have deficiencies when it comes to the deployment of technology. This includes CRM systems, project management tools, and supply chain management products. New owners will need to assess the company’s technical capacity, evaluate numerous tools, and implement new systems. While leveraging technology to improve efficiency and scale a company’s operations can be a key piece of a buyer’s growth thesis, this strategy can also be challenging in practice, especially if existing employees are resistant to change. 
  1. Business owners also need to assess the strength of a company’s brand, including its logo, online presence, and website. This involves a separate set of technology and design investments.
  1. Several years down the line, after growing their small business, entrepreneurs may consider selling their investment. Successful business owners can make substantial returns. This starts the process over again. To sell, entrepreneurs will consider listing the business themselves, hiring a business broker, or directly contacting candidates for a strategic acquisition.

Again, if this looks like a challenging and involved process, that’s because it is. However, if there’s one take away from this article, it’s this: entrepreneurs that are able to connect with the right experts at each step will be put into a position to succeed. Private Market Labs is here to be that connector, so entrepreneurs rely less on personal relationships and more on finding the right team member at the right time.