Aspiring buyers of small businesses have search costs to consider beyond just the purchase price. Sourcing, legal fees, and even living expenses during the search significantly add to the overall price tag for your acquisition. While each deal is unique, when it comes to its associated various financial considerations, there are some common expenses that most people will incur during the course of a search. This article will highlight the most frequently-encountered costs, supporting you in developing a more informed financial strategy.
Navigating SMB Acquisition Search Costs
A thorough understanding of all potential expenses is crucial for developing a strategy for efficient resource management during your search. Here are areas where costs may arise:
Sourcing
Building a strong pipeline of potential deals is an essential component of every search process. It is also a place where costs can vary substantially, from both a financial and time perspective. Depending on your sourcing strategy, costs can range from $0 to a few thousand dollars per month. The lowest cost options consist of online marketplaces and broker websites, though this strategy will typically take a substantial amount of time, since the buyer will have to manage the sorting and deal identification process on their own. This is also the case for off-market proprietary deals, where a buyer sorts through large datasets to find existing businesses that fit their deal criteria and inquire about the owners’ willingness to sell. This strategy can be more expensive than the marketplace strategy due to the cost of data.
Some buyers will hire buy-side support to help navigate data and sorting challenges. Buy-side brokers typically charge fees that range between 5-10% of the deal size, while consultants may charge either an hourly rate or a flat fee.
Some searchers follow Jason Vogt’s advice, hiring virtual assistants or globally-remote employees to aid in proprietary outreach. While this can streamline your search process, the cost of both the employees and the data can add up to a substantial sum.
Private Market Labs is using technology to reimagine the deal sourcing process affordably and at scale. Our place in the market is to help buyers quickly identify deals that fit their investment criteria from across the industry through precise matching. This is designed to reduce the time to acquisition, while also reducing costs relative to other customized options.
Besides online platforms, you might also have to invest in market research. Purchasing industry reports, subscribing to business intelligence platforms, or engaging in specialized data analysis can quickly add up. The quality of the data acquired directly impacts your search success.
Legal
Acquiring a small business can be a legally complex transaction, with multiple steps that often require the help of an expert. Hiring a lawyer who is experienced in SMB M&A can prove invaluable throughout this process.
From the start, a lawyer’s skill is key in crafting the LOI, where you will outline the basic terms of your proposed deal. As you delve into due diligence, your legal costs are likely to escalate. This phase demands a careful examination of the target business’s finances, operations, and compliance, with your lawyer sifting through contracts, employment agreements, and lease documents.
As the acquisition progresses towards closure, legal counsel ensures your agreement is equitable, legally sound, and protective of your buyer’s rights. Your agreement will detail such fundamental things as the final sale terms, purchase price, payment terms, and parties’ rights and responsibilities.
Legal costs can range from a few thousand to tens of thousands of dollars, contingent on the deal’s complexity, the required time, and your lawyer’s rates.
Our key advice here is to:
- engage a lawyer who is familiar with small business M&A – inexperienced lawyers can kill deals;
- budget for at least $30,000 of legal costs for a self-funded search.
Due Diligence
The due diligence phase is a critical stage in your acquisition journey. It involves a deep dive into every aspect of the business you’re considering, highlighting any potential issues that might impact the company’s value or feasibility. Due diligence can represent a significant expense, often second only to the purchase price itself.
Different types of due diligence each carry their own costs, in order to achieve a thorough exploration of all legal factors related to the business – from the company’s structure to contract reviews and regulatory compliance checks.
Accounting and tax due diligence involve a detailed analysis of the company’s financial health. Expert accountants will scrutinize financial statements, examine tax records, and validate financial projections using Quality of Earnings (QoE) evaluations.
Another potential cost, industry consulting, entails hiring industry experts to gain insights into the business’s market position, competitors, and industry trends. These experts’ insights can be invaluable when assessing the company’s long-term prospects.
The cost of due diligence is highly variable, influenced by the size and complexity of the company and the depth of the investigation required. Costs can range from under $30,000 in cases with limited complexity or where the buyer has a skillset that allows them to perform some diligence functions on their own (not recommended since a second professional set of eyes can really help) to over $100,000 in particularly complex cases. An anecdote shared by Roman Beylin highlights how these costs can vary greatly, even for transactions under a million dollars.
Post-Close
Securing a business purchase is an achievement, yet it’s not the endpoint of your financial commitment. The post-close phase ushers in additional expenses necessary for a seamless transition and efficient operation under new ownership. While these search costs can be sizable, they should be viewed as investments in the future success of your business (and in this case, they can be paid from the cash flow of your new, profitable acquisition, which helps reduce the hit to your personal finances).
Post-close expenses may involve hiring consultants with specialized knowledge in various business aspects. They can offer strategies for optimizing operations, overcoming challenges, and enhancing profits, which can be especially helpful if you’re new to the industry or lack specific expertise.
You may also need to bring in new employees. If the previous owner was integral to daily operations, their departure might create a void that necessitates hiring more staff or promoting existing team members. If expansion or diversification is in the cards, additional workforce might be necessary.
Contractors might be needed for particular tasks or projects, like IT professionals for system upgrades or builders for physical alterations to the business premises. Upgrading or purchasing equipment and software can be another cost. Depending on the business’s condition at acquisition, new machinery, technology, or software systems might be necessary for improved efficiency.
Living Expenses
When acquiring a business, the cost of living is often an overlooked but significant expense. If you’re dedicating yourself to the search full-time, it’s important to consider the financial implications. Your living expenses should be a crucial part of assessing the overall costs associated with buying a small business.
These expenses not only impact your budget but also influence the timeline and pressure of your search. The need for personal income can create urgency and potentially lead to rushed decisions or compromises. Entrepreneur Derek Turner highlights the tangible financial pressure a full-time business search can place on personal finances, as well as the iterative stress of having multiple deals die in the due diligence phase.
For searchers without savings or financial support from a spouse, pursuing a strategy that allows you to continue making money while searching is important, whether that’s searching part-time, or drawing living expenses from investors.
How your strategy impacts search costs
Your approach to seeking a business can significantly influence the total costs involved. Different approaches can either alleviate or increase the financial implications of your search. Let’s explore two common search strategies and their effects on costs.
Traditional search
In a traditional search, prospective buyers partner with investors or a group of investors to fund the search process and eventual acquisition. While this path involves giving up a portion of the equity in the target business, it offers financial advantages. Searchers often receive a salary to cover their living expenses, reducing immediate financial risk and SMB M&A search costs.
The arrangement allows searchers to dedicate their full time and attention to the search process, providing them with the financial runway to make a well-informed investment decision.
However, giving up equity means sharing future profits with investors. It’s important to carefully consider the implications of this and how comfortable you are with sharing control and profits.
This approach is favored by those who prefer the security of a steady income stream and the backing of experienced investors, who can also provide valuable mentorship, industry connections, and advice. It offers stability, reducing financial uncertainties during the search process and allowing searchers to focus on finding the right business to acquire.
Self-funded search
Choosing a self-funded search path is a different experience compared to a traditional search. This approach provides autonomy and full ownership of the acquired business but requires a significant personal financial commitment, including small business due diligence expenses.
A self-funded search can be more time-consuming as it typically does not include institutional support from experienced experts and self-funded searchers need to ensure they can cover living expenses through other means. It requires financial preparedness as you fund all search costs, such as sourcing potential businesses, legal fees, and due diligence expenses. This process can be lengthy and costly, necessitating careful planning to manage the cost to buy a business.
Despite the challenges, the self-funded strategy offers long-term benefits. Retaining the entire future profits generated by the business and having full control over decisions is appealing to those with a clear vision for their venture.
In summary, a self-funded search suits individuals with the financial means, a high risk tolerance (or longer time horizon to search while working), and a strong desire for control and ownership. However, it requires meticulous planning, patience, and resourcefulness to navigate successfully.
In Conclusion
Acquiring a small business involves more than just the purchase price. Understanding the various costs associated with buying a business is essential for effective financial planning and decision-making. Consider the different search strategies available, as each strategy comes with its own financial implications and trade-offs, so it’s important to evaluate your preferences and resources.
Ultimately, balancing expert guidance and personal expertise is key to managing costs and achieving a successful business acquisition. By understanding the cost variations and developing a well-informed search strategy, you can navigate the journey of buying a business with confidence and financial prudence.