Building a Business You Can Sell for Top Dollar

J:
Let’s welcome David Barnett to the show. How are you doing today, David?

David:
Oh, I’m doing great. Thanks for inviting me along.

Carol:
Thank you so much for being here today. We know that you have so many great tips since you are the expert on buying and selling businesses. And this is a topic that will resonate so well with our listeners. So thanks for being here and we cannot wait to dig in.

J:
Absolutely. And like Carol said, you are an expert on buying and selling businesses, but I imagine you weren’t born an expert on the topic, you didn’t come out of the womb as an expert on buying and selling businesses. So take us back a little bit. What’s your backstory? Tell us a little bit about your entrepreneurial journey, where you came from, how you started down this path of getting into businesses and entrepreneurship.

David:
Yeah, sure. I’ve always been interested in business. I was one of those kids who always had the childhood businesses on the go. Growing up in Canada, that meant shoveling my neighbors’ snow, of course the driveway, the walkways, etc. Then I started mowing lawns and delivering newspapers and starting all those kinds of childhood businesses, and I was always interested in business. And so it led me to go off to business school to earn a business degree, and I thought that would make me into a business man. But into about the third year, I realized that what they were trying to do is turn me into what I refer to as a Fortune 500 bureaucrat, some middle manager inside a big organization.

David:
And that really wasn’t where my heart was, I was interested in everyday businesses that you see when you’re driving your car through your city, all the different businesses that people own that they’re trying to run, they’re trying to provide for their family and they’re trying to make their customers happy so they keep coming back. And so it was when I was finished business school that I actually got what I call my real small business education. I got a job as a sales rep for a Yellow Pages publisher. And so my job was to go out and meet with the owners and managers of small and medium sized businesses, learn how they ran their business, how they made money, and figure out what customers they wanted to meet.

David:
And so I was helping them design their ads in the Yellow Pages. And this was the ’90s, so the Yellow Pages was a really relevant media for local businesses at that time. If you were to type plumber into Google in those days, you would get a plumber in California no matter where in the world you were because they hadn’t figured out how to do local searching or any of the stuff that we rely on Google for now. Back in those days, if you came home and you had a water leak in your pipes, you grabbed that phone book because you needed to find a plumber that could be at your home in 10 minutes.

David:
And so I got to meet all these people and learn from them. And I spent about seven years in that career and eventually started to understand that the phone book was never going to be what it was forever, that the online presence and searching for things on your phone in a mobile sense was going to change that business. So I decided to leave and I started a business with a friend, and it worked really well, but after a while I realized it wasn’t for me and we decided to move on from that. And we got the crazy idea that we could sell the business, and we did. And that was the first time I was ever involved in the sale of a business.

David:
I had no idea what I was doing and I’m very fortunate that I did business with a really stand up and honorable guy because the deal came together just the way it was opposed to, we got all the money we were supposed to and everything worked out. I left that experience and started another new business brokering commercial debt for small businesses. So I was getting bank loans, doing what are called factoring facilities, which is when you sell your accounts receivable to a third party to get some money today. I was also doing capital and operating leases for equipment, things like that. And so I was meeting people who had businesses that wanted to grow them and I was helping them get the money, especially after they’d been told no by a banker.

David:
And it was during this time that I started to meet people who were looking for money to buy a fully functioning operating business. And what I saw really was surprising to me because what I ran into were a lot of people getting involved with intermediaries, no idea what they were doing. So I saw deals that were put together poorly, I saw deals for businesses that had receivables and payables and inventory being put together, for example, on a real estate contract, which didn’t address any of those kinds of things. I saw people lose deposits because the way that the deal had been proposed didn’t reflect what they understood was happening, and because it wasn’t structured properly, someone’s deposit got lost.

David:
So I saw a lot of terrible things happening and I realized there’s a real need in my city for someone who knows how to do this well. And I had been exposed to business brokerage a little bit earlier in my life, and then what happened of course, was the financial crisis happened. And so in my brokering business, half the companies I was using as a source of capital went under and my whole deal pipeline dried up. I had no place to bring some of these B and C tier blending opportunities. And so I said, “You know what? Now’s the time for me to make this pivot for myself.”

David:
And I joined up with a big international franchise brand and business brokerage, and the reason why I chose them is they created an opportunity for me to learn. There’s a certification program that’s been out there since the 1970s. I spent two and a half years going through that program while I was working under someone else’s wing and became the first person in my city to ever be certified as a business broker, a designation that had been around since the ’70s, and so it just goes to show that there are some really underserved markets out there when it comes to real professional business brokerage.

David:
I ran my own office for three years and in those three years I sold 36 companies for other people and it was very exciting and it was absolutely awful as a business to be in because the cash flow profile of a business brokerage office is like a crazy roller coaster. And if you’ve ever heard a real estate agent, for example, complain about going through dry spells, they’ve got nothing on business brokers because it would typically take me one to two years to convince someone that I was the guy to sell their business. Once I had secured the listing, it could take me up to three years to sell the business and that’s when I got paid. And so it can be insane.

J:
That’s awesome. So I think most of our audience has a decent idea of what a business broker does. I mean, a lot of our audience are real estate investors and they’re familiar with real estate brokers who essentially they represent the buyer and/or the seller and they put together the transaction. But maybe you can tell us in a little bit more detail in the business world, what does a business broker do? What does a business broker not to? And maybe even related to how it works in the real estate world. How is a business broker different than a real estate broker?

David:
Sure. And you know what’s interesting is that the world of business brokerage I think has evolved from the understanding of what happens in real estate, particularly in North America. So the idea is that you are a person in the middle who brings together the buyer and the seller. Here’s where it’s different though, when a business owner meets me and say they want my help to sell their business, as a business broker, the very first thing I have to do is an evaluation to figure out what the business is worth. And it’s not like looking up a series of comparable listings in a local market because I don’t want to compare my local dry cleaner with other businesses in the neighborhood that may be in different industries. I want to compare the dry cleaner with other dry cleaners that right sold because each industry has its own risk profile.

David:
And so I would collect an engagement fee from that person, and I would do an evaluation and show them what I thought the business would sell for and suggest an asking price for them. If they wanted way more money, in the beginning I still took it but after a while I learned that if they wanted way more than what it was worth, that I was just wasting my time. So I would then list the business for sale. And here’s another fundamental difference between real estate in the world of business, if anyone found out the business was for sale, the business could be ruined. And so the marketplace for businesses is a secret one. So there are some big business for sale websites out there, and if you go looking, what you will find is listings that say things like this, “Family friendly franchise restaurant in the greater Atlanta area with revenues of $1.5 million and cashflow of 170,000.”

David:
So all we really know is that it’s somewhere near Atlanta, it’s a franchised restaurant where families are welcome, and we have an idea of the cashflow and the revenue. And so to learn anything more, we have to engage with that business broker and probably go through and sign nondisclosure agreements and things like this. After you’ve found a buyer and after you’ve come to terms, the business broker then often has to work with the buyer in order to secure the financing. So that can get as detailed as sitting down with a buyer and helping them write a business plan with cashflow projections and everything.

David:
When I was a business broker I used to charge 12% of business value and 7% of any real estate value, I happened to sell real estate when I was selling the business and people would initially say, “Wow, you’re really expensive. I thought it would be like a real estate agent’s fees,” but when I explained everything that a business broker does, what I’m hoping you’re picking up on is that the business broker is doing the job of the appraiser, the agent and the mortgage broker, if you want to make that analogy with real estate because really because of the secrecy, all of this stuff has to be taken care of by someone who isn’t going to spill the beans or let it become known into a wider circle that the business in fact is even for sale.

J:
So one more differentiator, I think maybe based on your description is in a real estate transaction, both the buyer and the seller are each represented by their own agent, somebody would represent their own interests. The way you’re discussing a business broker, the broker is the sole entity, not each side has their own broker. If that’s the case, who do you represent or do you represent both sides equally?

David:
It’s a great question to bring up. In a lot of jurisdictions in North America, different States and provinces, business brokers are actually covered under the same legislation as real estate agents. And this is what causes a lot of confusion because realtors hold the same license as business brokers, some them feel that they’re qualified to do the deals and it can lead to a lot of problems. So where I live, dual agency is perfectly okay as long as there’s disclosure between all the parties understanding that the broker is acting for both parties. And what I would say to both the buyer and the seller is I would say, “Look, I am going to be sharing any and all information that I have to try to get this deal done.”

David:
When you’re buying and selling a house, we’ve all got access to information. The buyers generally have access to financing in the form of mortgages and we have a pretty good idea of what’s available for sale because different real estate agents have listings out there. And so it can be more of a combative negotiation process because the buyer and seller each have their own ends. The seller is trying to get the highest price, the buyer is trying to get the lowest price, and once the deal is made, they don’t have a lot to do with each other. They’re each using their own team to get the rest of the deal done for them. When it comes to selling a business, it’s completely different.

David:
Oftentimes buyers can’t get the financing, often they can only get financing maybe for the tangibles, or they need some other kind of longterm help from the seller, a transition period for example. And so the process of buying a business is actually more collaborative. The buyer and the seller end up working together to come to some agreement that they’re both okay with. It might not be the thing that each of them wants, but they can both live with it, and then they have to work together to help get the financing in place. Usually, the seller can be as involved with the banker as the buyer is, providing information, background, etc. And then once the business is sold, the seller often has to provide mentoring and coaching support to the buyer.

David:
And the seller usually has an interest in the buyer’s success, which is a big difference from real estate because if the buyer can’t borrow the money, guess where it comes from? It’s still owed to the seller. So a lot of the times the deal will be done, but the business isn’t fully paid for. So the seller needs to make sure that his buyer is successful so the buyer can afford to make the additional payments, whatever the terms are, to finish paying for the business. And so you have to come together as a team. Now, in Florida as a point of interest, there really is an entrenched culture of business brokers having representatives on both sides of the table.

David:
So you will see that more in Florida, but that’s about the only place where we see that. Everywhere else it’s quite common for there to be one person. The question then is, well, who do you represent? And when I was a business broker, I used to say, “I’m trying to get the deal done.” And of course I have the interest of everyone at heart, but most importantly, my reputation is my interest because in any community, if you do something that’s going to really hurt somebody else, your days in business brokerage are numbered because people will find out. And it’s a team effort, so in addition to the business broker, the buyer and seller both have CPAs and attorneys, and usually some other kinds of experts too, maybe business coaches, technical experts if there’s a lot of machinery involved, maybe there’s real estate involved, so they’re going to have real estate appraisers.

David:
And those other teammates usually are not working for both parties, they are only working for one side or the other and the buyer and seller needs to rely on those people’s advice as well.

Carol:
Excellent. Thank you. I really appreciate you drawing those, the correlations and the comparisons in the… a lot of our audience is familiar with real estate brokers and that of business brokers. There’s one other little nitpicky thing I’m just curious about from a whole a brokerage standpoint. You are mentioning of course, how it’s a secret business. That we can’t know that they’re for sale or these whole businesses might fall apart. So I’m curious, on the broker side of it, you’re saying there is no public MLS, is there like some kind of background MLS or something that brokers are aware of a place that business brokers can go to solicit these businesses or see what might be out there?

David:
So for example, in the example of Florida, the business brokers there are quite organized with this system, but everywhere else, not really. It depends. So sometimes business brokers will be a part of a real estate organization and a lot of the times they won’t put their businesses on any kind of MLS because the MLS system is designed for real estate, and so they won’t allow you to list something without an address, for example. And so what ends up happening is that a lot of the listings for businesses that are for sale are exclusive to the brokers that’s listed them. And they’ll use these big public websites, things like BizBuySell, BusinessesForSale.com.

David:
There are several of them and anyone can pay a fee and put a business for sale up on those websites, and that’s how generally buyers find them unless they go looking for ones that aren’t for sale, which is a different strategy altogether

J:
That’s interesting. And Carol and I are both entrepreneurs and real estate investors and we’re actually licensed in multiple States as a real estate agents and brokers. And I did note that when we moved down to Florida about eight months ago and we both passed our Florida real estate agent/broker exams, there were a whole lot more questions on the Florida exam about business brokerages or about being a business broker than I’ve seen on any other state. It was very clear that in many cases in Florida, real estate brokers are business brokers. So I did think that was very interesting.

David:
Well, and the fact that the market is secret allows for something that doesn’t happen in real estate, it allows for people that are completely outside of the system to actually be acting as brokers too, because it’s very rare that anyone would ever discover them, point them out or that any state regulatory agency might even care. So we give you an example, when I was a business broker and I had my office open here I had a local competitor who wasn’t licensed as a real estate broker and I was. Look, I had to spend money every year on the licensing and on the insurances, and I had to go spend two days every year going to… nothing to do with businesses and these guys didn’t have to do it.

David:
And when I complained about them, the government agency basically said, “Well, we don’t really enforce in that way.” And I said, “Great, where do I hand in my license? Why am I putting up with this?” But I mean, that’s just, what? Sour grapes? Don’t worry about that.

J:
So don’t worry about that there are several online marketplaces for businesses where people who want to buy or sell their business can go without a broker, so BizBuySell, BusinessesForSale.com. If, let’s say somebody wanted to sell their business there or they wanted to buy a business there, is there still a role for the broker in that transaction? Can they say, “I want to buy this business, but I’m uncomfortable doing it myself I want to be represented. I want to bring in an intermediary who can help me either buy or sell.” Does that ever happen or is it basically if you go to one of those sites, it’s just, you’re on your own?

David:
Well, it’s interesting because this is how I help buyers today. When I got out of business brokerage at the end of 2011 and left the industry entirely and I got drawn back in because people kept calling you up asking for help. And I kept telling them, “I don’t do this anymore. I don’t do this anymore.” Finally, one day this guy named Bob called me, who I had met when my office was open. I had met him as a buyer, and he said, “Dave, I found a business and I want to buy it, and I’ve spoken to my accountant, I’ve spoken to my lawyer. Both of them are telling me what I need to get out of the deal, but neither seems to be able to help me get through this or understand some of the things that I’m finding in the deal.”

David:
And I said, “Look, I can help you, but I’m not a broker anymore, so I’d have to charge you like some kind of consultant.” He just said, “Great, what’s your rate?” I didn’t know what to say, so I just threw out a number, and he said, “Sure, let’s work together.” And so the buyer, they may not necessarily need an agent in an intermediary or agency role. As real estate brokers, you guys understand when you’ve earned agency relationship with someone, you represent them. That may not be necessary, the person can represent themselves to the seller, they can talk with the seller, but there’s certainly room for people to be helping them.

David:
And quite often when I’m working with one of my buyers, they don’t necessarily want the seller to know that they’re working with me because if the seller were to Google my name and find out that I’ve written books on the topic and I’ve got hundreds of YouTube videos, they might freak out and feel that they need to go and get someone on their side of the table who can help them out just as much. So it’s about building the team to help you analyze and look at it. And there is definitely a role for people who want to go and find a business that’s already for sale, and oftentimes what that will look like is the buyer will contact several brokers, several business brokers, and talk to each of them about the listings that they have.

David:
That’s really not as arduous a task as it might seem because for every probably 200 realtors, there might be one business broker. So it’s a much smaller field of people in any given area.

J:
That’s great. Okay. This was a fantastic introduction to how the world of business brokering works. And from here, we could probably talk for the next two hours about if I want to buy a business, what I do and how I handle that. We can talk for the next two hours about if I want to sell a business, what I do, how I handle that. Instead of trying to do everything, I want to focus now a little bit more on the selling side. So let’s say I’m an entrepreneur, and Carol and I have our own small businesses and we do, and I know plenty of our listeners out there either have a small business, are looking to start a small business, will at some point have a small business.

J:
And let’s say we’re thinking two, three, five, 10 years down the road and we know that our likely exit strategy, potentially are our exit strategy, I should say, is we were going to want to sell that business. Now, we probably don’t want to wait three or five or 10 years to start getting our business ready for sale, we want to do things upfront so that our business is going to be saleable, it’s going to be attractive, we can get the most money for it. As small business owners who are starting or growing a business right now, what are some of the things we should be thinking about so that when we get to that point where we might want to sell, our businesses prepared for it?

David:
Yeah, sure. Well, first of all, let me give you this one big huge warning, businesses sell for a lot less than you think, number one. And the top reasons… And because they sell for less than you think, people don’t often want to sell them, it’s usually worth more to an entrepreneur to hold a profitable, successful, cash-flowing business than to sell it. So why do they sell it? Top five reasons, burnout and fatigue, divorce, poor health, the need to relocate and retirement. And if you’ve been counting, four of those five are not planned. So 80% there; need to sell, they weren’t planning for it. And so that’s why this question is so critical because if you own a small business, you need to be thinking about it like an asset that may have to go on the block at any time.

David:
And won’t necessarily have… four out of the five things happens. And so the value of a small business comes from one thing, the cashflow, the true, honest, normalized cash flow. So what do I mean by that? Well, you can have a business and you can be managing that business and you’ll be working in it 50 hours a week and you can be taking home 30 grand a year because that’s what the business can afford. But if you did that job for another company, they would probably pay you 55,000 a year for that job. So when a buyer looks at your business statements, and one of the things they’re going to do is they’re going to take out whatever number it is you’re paying yourself to be the manager and they’re going to put it in a fair market wage for what it’s actually worth to do the job as the manager, and you will find in that example that the business actually is not profitable at all.

J:
So, just to give an example there, let’s say I have a business that I’m paying myself $30,000 a year, fair market value for somebody to run the business, let’s say a general manager or a manager is $70,000 a year. So I’m underpaying myself by $40,000 and let’s say at the end of the year, that business turns a net income of $40,000. Well, actually because I’m underpaying myself by $40,000 to manage the business, we have to subtract that out and the business is now worth zero.

David:
So it’s not worth zero, it’s just producing zero. So zero profit over and above what your labor’s actually worth. This is important because if you run your own business and you’re earning about the same amount of money you would doing that job for somebody else., if you worked for me for example, then I don’t say that’s a business, what I call that is owning a job because you basically are your own boss and you earn the same amount of money you would working someplace else. A job is sellable. There are people out there who want to buy a job because they have some impediment to the labor market and they’re not able to get a job like that, they’re willing to pay for it. But if we dial down a little bit, if you are actually subsidizing the business with free labor, there’s something else that… a different word we have for that.

David:
If you put your labor into something to make it work, that’s called a hobby. And so hobbies are very difficult to sell because you have to find someone who’s going to pay money to be willing to then work for free part of the time and that’s really difficult. On the other end of the scale, if you can pay yourself the fair market wage for what your job is worth and then there’s other money over and above that’s a real business because when a buyer goes to look at a business, they’re actually wearing two different hats. Almost every small, medium sized business out there is managed by its owner. That’s pretty much how it is unless you get into certain restaurants, convenience stores, etc, where you can start to have chains of these things and whatnot.

David:
So as the business buyer, I’m looking at businesses and I’m thinking in two different mindsets. One mindset is the investor, “If I put some money down and I acquire this business, what sort of rate of return will I get on my investment?” But the second mindset is that of a job seeker, “Am I going to be interested in doing this work? Will it be fulfilling? Is it going to be curious and engaging for me to do this every day?” And this is one of the big drivers. And it’s one of the reasons why it’s important for the business market to be secret. You can have a really successful profitable flower shop and as a business broker, I could have an engineer come into my office looking to buy a business. He’s not going to buy the flower shop, it’s not within his wheelhouse of interest or desire to own the flower shop, even though it’s a profitable business.

David:
And so you’ve got to make a match on these two different levels. So that’s what it’s about. It’s, it’s got to fit the person and it’s got to make sense from an investment point of view, and the business actually has to be profitable. So the value of the business comes from the cashflow, that’s the first thing. The second thing that’s going to happen is the buyer’s going to look at that cash flow and they’re going to say, “What is the likelihood of this cashflow continuing under my stewardship?” So now we’re not just looking at what the money is that’s been being earned, we’re looking at, “Do I have the ability to take it over?” So now we’re starting to look at the skills match. Again, this is the job seeker thing, “Do I have the skills to take over what the seller is doing in his daily job and how organized and systematized is this business?”

David:
There’s an example I love to use is a past client of mine, he had a roofing business and in the summertime he would have three different crews of guys replacing shingles on houses and stuff like this. And he had been in roofing for 30 years and he wanted to sell and he had a choice, he could either find someone 20 years younger that had 10 years of experience, who knew how to measure, estimate and how long it should take to install the roof. Or he could build the tools, the spreadsheet estimate, how do we measure the roof? How do we calculate the valleys, how do we calculate the extra labor that’s going to go in depending on the shape of the roof and all that kind of stuff.

David:
And if we build that spreadsheet, now we can teach anyone how to quote the roof job. Then if we build the operations manual and we build tools for the guys on site to make sure that they do everything they’re supposed to do, now we can take somebody who’s never been on a roof and we can show them that we have the tools to teach them how to run the roofing business. What ends up happening is more potential buyers are going to believe that they can run the business, and so it’s going to increase the marketplace for the business, there’s going to be more potential customers who want it, that could have an impact on the price but the biggest impact is in [crosstalk 00:29:35].

Carol:
Great. Thank you for that. So I would like to follow up on that a little bit more. It sounds like in the roofing example for example, you are saying that building that tool so that anybody could come in and take over that estimating process was crucial. It sounds like building out an operations manual, why can I get that word out right now? Was critical in helping the sale of that business in a timely and efficient manner. What are some other things we as business owners should be building some tactible, tactile… Oh my gosh, I can’t talk today. Some tactical, tangible things that we can deliver so that when it is time to sell our business, it can be moved along

David:
Well, here’s the thing that I want to carry on with the operations manual and the tools, is we tend to think about this stuff because we’re thinking, “Let’s make the business more salable.” But what we’re really doing is we’re figuring out how the business can also function without us personally being there. And here’s where that can be really important. People have accidents, people get into car accidents, people get ill, people have sudden family crises that force them to have to go travel for a month at a time to go visit family members that are ill, for example. If these things are in place, you can get other people to do them. And if they’re not in place, what’s going to happen to your business?

David:
So it all gets back to that idea that the reasons we sell are often not chosen, they’re not planned for. And the preparation we make to get ready to sell actually prepares us against many other eventual possibilities. It’s just good business planning. If everything in the business is tied up in the owner’s head, you really get a challenge sometimes with buyers because they say, “You know, I’m not you, I don’t know everything that you know. How am I going to be certain that it’s all going to be transferred over. And unless you can demonstrate that it can be transferred over, you have to basically look for a younger clone of yourself.

J:
I love this. I often talk about the fact that business and real estate are highly related. And I know a lot of our audience are real estate investors who are also doubling as business owners, they do both things and it’s interesting how, once again, we see the relationship here. You talked about the five reasons that people sell their businesses; burnout, divorce, health relocation and retirement. And these are, at least four of those are the big reasons that people sell their houses, they get divorced or they have health issues or they have to relocate or they retire somewhere.

J:
Same thing in businesses. If you want to find a great opportunity to buy a business, maybe an under-priced business or a great a win-win for both you and the seller, these are things to look for. So I thought that was just tremendously interesting. And then the other thing is, you mentioned often doing things to your business to make it more saleable to grow your potential base of buyers.

J:
We do the same thing in, in the real estate world. A lot of times, we’ll take a piece of real estate that’s tremendously distressed, maybe it has foundation issues, maybe it needs a new roof. And a lot of even investors don’t want to buy it, and we can go in and we can fix that really big distressing thing, maybe we fix the roof or we fix the foundation and then suddenly it’s not so scary for another investor to come in and say, “Hey, this is now something that I’m comfortable taking over.” So just that analogy again to the real estate world where we treat our businesses in a lot of ways is same way we treat our real estate to make it sellable, to create the largest potential buyer pool and the highest price.

J:
Again, it’s very analogous, so that’s fantastic. I really appreciate those tips. Now, along with all the things we can do to make our business more saleable, I assume there are certain mistakes that a lot of us as sellers make. What are some of the mistakes that you see sellers make when they’re trying to sell their business that either hurt their ability to sell or hurt the value at which they can sell?

David:
Yeah, there are a bunch of them, here are some of the biggest ones. Number one has got to be that you don’t keep proper records. So I’ll give you an example. When a buyer goes to look at your business, they’re going to want to see what’s going on in your business. And I’ve seen, for example, and I’m not talking about financial statements from an accountant, but your own internal business record keeping system where people will have eight different revenue lines, so maybe they sell different products and they have different services in their business, and they’re keeping them separate because they want to know which services and products are bringing in what amount of money.

David:
And then they’ll have a cost of goods sold line and they’ll have one cost of goods sold. So they can’t actually separate out where their costs are in relation to their revenue. And so then the question will come up, are you sure you’re making money on all those different eight lines of business that you do? And they really don’t know.

J:
Yeah, they can figure out their business margins, they can’t figure out their product margins.

David:
Right. They can’t figure out their gross margins before all the expenses. And then they’ll have things like the overhead labor and the direct line labor, if they’re in a service business will be mixed together on one line. Things like this. And again, if you sort this stuff out, it’s going to make it easier for a buyer, but it’s also going to make it easier for you as an entrepreneur to know what’s going on in your business. So you can recognize that there’s some kind of problem. Another big concern is that people will often do things in a small business in order to manage their tax burden, and big air quotes around that.

David:
Big companies have huge armies of CPAs that figure out how they can pay less in taxes, small business people don’t have that. So what they do is they take their teenage daughter and they give her a company cell phone because it’s cheaper for the business to pay for the daughter’s cell phone than it is to take money out of the business, pay income tax on it, and then use after tax dollars to get a cell phone for the daughter. Right? And so technically that thing is not allowed. You’re avoiding taxes. Now, things like the daughter’s cell phone, I mean, that’s pretty easy. It’s easy to show a buyer that the cell phone bill does not really have any kind of thing to do with operating the business. And we’ll usually address that when we normalize the financial statements with something called an add back.

David:
So it’s a discretionary expense the owner did and we’re adding it back because it’s really a roundabout way that the owner’s taking profit out of the business. Those things are simple. You know what’s difficult? When you do cash business and you don’t record the sale because now what you’re trying to tell a buyer is that the top line revenue’s not real, that really it should be higher. And the problem is that you may be able to convince the buyer that the business is really better than what your financial statements and the tax returns show, but the chances that the buyer in turn will be able to go and convince his banker of those things, next to none.

David:
And so people will sometimes get lured into doing things in their business, believing that they’re saving money in the immediate term on things like income taxes, and they may be right and they’re taking certain risks that maybe they’re comfortable with, but the problem will come when it comes time to sell. Now, all of a sudden, buyers who may even be interested can’t get financing. The business can still be sold, guess who’s going to finance it? And that’s the flip side. Whenever sellers say, “Oh my God, I don’t want to finance 80% of the sale of my business.” I’ll say, “Well, think about all the money you saved in taxes.” It’s a double-edged sword, you take from one side, you give on the other?

Carol:
Sure. Go ahead J.

J:
No, please go ahead.

Carol:
I was just going to say, speaking of tax returns and these double-edged swords and all that, from a buyer standpoint, I’m thinking about flipping it over the buyer side now instead of just talking about the selling, when the tax returns just simply don’t agree with the financial statement, how do we as a buyer know what to believe? Like how do we even go about figuring out what the real deal is?

David:
Well, that’s a great thing because in actual fact, you can’t really know for sure, which means the deal has to be structured in such a way that risk is managed. So I’ll give you an example. I once sold a pizzeria and this was the circumstance, the tax returns said they were doing a certain level of business and the seller claimed they were doing more. And so the buyer made him an offer saying, “Okay, here’s the deal, I’ll buy your business, I’ll pay you a price that we both agree on based on the performance you claim is there.” Now, he made the seller carry a note worth almost half of the purchase price and there was a matrix included in that note, which showed that in the first six months after sale, if the sales were not what he claimed, certain amounts are going to be deducted off that note.

David:
So the seller was made to put a warranty on the business proving that this is really what’s going on and if it is not the case, then you get to buy the business for far less. And so in that deal, I asked the buyer, I said, “Look, if it turns out he’s lying and none of these sales are there, then you will end up paying this for the business. Are you okay with that?” And he said, “Yeah.” He said, “I couldn’t build that pizzeria for that amount of money. So even if he’s lying, I’m still okay.” And that’s what you have to do. And so from that seller’s point of view, they handed the business over to someone else. And do you think they had an interest in making sure that the guy was successful? Right.

David:
So that’s seller was there, he was available, he was ready to coach, he was ready to consult. And any of the big customers that business had, the regular repeat customers, that seller was more than happy to keep talking to those people up, telling them how great the new owner was because he needed those sales to be registered in order to get the full purchase price for the business.

J:
That’s great. And that brings up another question that I had. We know, and again probably a lot of analogies to real estate, certainly there are plenty of businesses that are bought for cash. And then there are businesses that are bought for, we talk about seller financing where the seller actually holds back a portion or they hold a note for a portion and then they’re, I assume they pay monthly or whatever that is. But what are some other common terms? If I’m a seller, what are some other common terms that a buyer may ask for to sell the business? Or if I’m a buyer, what are some terms I could be asking for to alleviate the financial burden on me up front?

David:
Well, it’s interesting because how much money a buyer needs is one of the big topics of discussion I have whenever I’m working with a seller. Because you could have a business where there’s a business and then eventually they own the real estate and then they have some other things which may or may not really contribute to the business, but they’re worth money, and the sellers will typically want to sell it all in one shot. And I’ll explain to them that if we need to find a buyer who has a down payment on the business, and the down payment for the building, and is able to put up extra money for the surplus inventory that’s been accumulated, etc, then we’re looking for someone with a lot of money. And there are buyers out there but very few of them have a lot of money, most of them have a little bit of money.

David:
So how can we reformat this deal to make it attractive and within the reach of people with a little bit of money because then we of course widen the field of buyers. Anything you can do to make more buyers available means that the length of time on market can be shortened. So that seller, for example, could liquidate surplus inventory in advance of a sale. They could remove the surplus inventory from the sale, they could liquidate it in another market. I gave give you an example of that. They could withhold the surplus inventory and liquidate it by selling it to the buyer after the deal’s done.

David:
So as the new owner requires it, he can then start releasing it and sell it to the new owner at that time. We could separate the business from the real estate so the seller could become the buyer’s landlord and now the buyer doesn’t have to have a down payment on the building, they just have to buy the business. There’s many different ways to slice and dice this stuff and it’s always the same goal, how do we find a way so that it can become more affordable? Here’s what’s amazing, here’s what’s absolutely amazing is that if you go into any car dealership and you and you ask those people, “How are you going to sell more cars?” The very first thing they’re going to think about is the fact that customers don’t have $40,000 in their bank accounts.

David:
And so the car dealer goes and he meets the bankers and he meets the leasing companies and he gets all the paperwork and he brings it into his office so that if you want the $40,000 car, he says, “Look, just sign here. Fill in this form. I’ll get you the money.” The car dealer is keenly aware that the problem people have in buying a car is getting the money. But when it comes to selling businesses, most sellers, their first instinct is, “How can I get the most money possible?” And they don’t put two thoughts into how the buyer is going to put the deal together. And maybe that’s because they’re influenced by the world of real estate because in real estate, of course the buyer just goes and they talk to the mortgage lender or what have you.

David:
Financing isn’t the same problem in real estate as it is in business.

Carol:
That’s great. I love all these analogies and I really love that car dealership example. And you’re right, I’m like, “What the heck? Why isn’t it thought of in the same manner,” and it is just fascinating that that’s the way it is. So I just wanted to know for myself, for other listeners before we go into the four more, how do we go about fighting a business broker and especially if we’re looking to buy or sell a specific type of business, do different brokers specialize in different types and how does that all work?

David:
It depends on the market that you’re in. So in some bigger centers you will have specialists, and there are bigger specialists. There are specialists in specific industries that work in large areas or across the country or even in several different countries. In fact, I met someone in the UK the other day who… several different countries. And so some of them will be specialized by the type of business. What is more common though in North America in particular, is to have a geographically-based business broker. So they’re working in a certain city or a certain state, or several counties for example, and they’re representing any business that comes along within that area.

David:
So if you want to find a business broker, you just type into Google business broker in the name of your community or state or your county, for example, or metro area, and you’re going to find people and you’re going to find a couple of different kinds. There are business brokers that are organized into big franchise or a couple of big names, big names like Murphy Transworld or Sunbelt, you’re going to find those offices all over the country. And then there are independent people who have their own office and they operate under different names. What is important though is that you figure out if you’re going to sell a business, you have to make sure that you’re going to be working with a qualified business broker who really knows what they’re doing.

David:
If you’re buying a business, you will eventually find out if the person you’re dealing with is qualified or not because I always say that the biggest job of any business brokers to set expectations in the minds of the buyer and seller. So I’ll give you an example about the seller financing. And I’m based in Canada, and so the financing for businesses is even more difficult here than it is in the States because in the States you guys have the SBA programs. So when I met with a business seller, I would tell them in the very first meeting that they would be required to finance part of the sale of their business. And if they didn’t like that, I really didn’t want to spend any more time with them because I knew that even though they didn’t want to do that, it just wasn’t possible.

David:
But even in the States right now, under the current SBA 7(a) rules, the SBA will look at up to 90% financing, but the seller may still have to hold paper on those deals. Sometimes a very modest amount, a little 5% stake. In my mind, that’s not enough. I always tell people that whenever you introduce 90% leverage into anything, you create a big opportunity for people to get in over their heads. And so in my opinion, SBA financing helps people sell businesses, not necessarily helps them buy them. So I imagine as a real estate people, you guys get that analogy pretty well.

J:
Yes, we certainly do. And over leverage is obviously one of the biggest risks in the real estate business. And I think that’s again, another great analogy for our real estate investing listeners out there that when thinking about buying and selling businesses, leverage has the same double-edged sword, it has the benefits, but it also has tremendous risks.

David:
Well, actually I’d like to expand on that a little bit, because in business, businesses are asymmetrical systems. So think about this, if I have a business with $1 million in sales and I have a profit of $100,000 so my costs are fixed. If I have a 10% reduction in sales, what could my profit reduction be?

J:
Say that again?

David:
So, if I have $1 million in sales and I have a profit of $100,000 yeah, and most of my costs are fixed, if my sales drop by 10%, my profit could drop by 100%.

J:
Yes, absolutely.

David:
It could go to zero. And so tiny changes in the top line can cause huge changes in the bottom line. And that’s why sometimes in real estate people will say, “I want a debt service coverage ratio of a certain amount,” maybe they go for 1.15 or 1.25 depending on their market and the type of real estate. But when it comes to business, we want debt service coverage ratios of like two times because we really have to have some extra fat to cover off something unexpected. And the things that are unexpected truly can be unexpected. Like when the city decides to replace the sewer on the street in front of your restaurant and it takes five weeks. That’s got nothing to do with your customers, your employees, your recipes, your advertising.

David:
None of that’s going to matter when people can’t get to your restaurant, and can’t park on the street. And these are the kinds of things that I’ve met people over and over and over again. These are the kinds of things that either kill or almost kill a really great business, and they’re very difficult to plan for.

J:
That’s great. I love this. Okay. I could talk for another hour. I’d love to talk about the buyer side. Maybe we’ll have you back and talk about the buyer’s side another time.

David:
Sure.

J:
But we’re getting a little long here. So I want to jump into the final segment of our show that we call the Four More. And that’s where we ask you the same four questions that we ask all of our guests and then we give you an opportunity to tell our listeners more about you and how they can connect with you. Sound good?

David:
Sure. Mm-hmm (affirmative).

J:
Perfect. I’ll take the first question. Is that okay, Carol?

Carol:
Absolutely.

J:
Okay. So David, what was your first or your worst job and what lessons did you learn from it?

David:
My first job was as a Dickie Dee ice cream boy, which is one of those tricycle bicycle carts with a big ice cream freezer on it.

Carol:
Oh, that sounds fun.

David:
It was a lot of fun. I got a great tan, I was 14 years old and I learned to make change, and I just thought that was great. And I also lost weight, it kept me in shape pedaling that bike. Yeah. It probably helped to cement my desire to be in business.

Carol:
Heck yeah. I can see how.

David:
Most of the ice creams were less than a dollar, but we had these fancy ones for a $1.75. I developed a whole pitch because I remember one of the most called the Richard Dees, and I said, “You know, it’s made with select dark chocolate and inside you’re going to find a creamy vanilla center with a wisp of maple syrup.”

Carol:
And this is at age 14, you’re like doing the whole upsell.

David:
Now, 30 years, I still know the pitch.

Carol:
You do. Inside and out, you’re very convincing. I would totally be buy in the buck 75 treat right there for sure.

David:
Probably $5 now.

Carol:
At least. At least. Okay. My question, the second one of our Four More is, what is that defining moment when you realized you had an entrepreneurial itch?

David:
Oh, geez. It was, it was actually after the Dickie Dee job when I worked for a vegetable market. It was a produce and vegetable market, and I got to drive home one day with the head cashier and would stop at the bank and make the deposit into the night box. And I had spent three and a half hours there after school, and I don’t know what I was earning, probably like six or $7 an hour back in those days. So I worked for three hours and I had my $21 of earnings and she’d deposit like $8,000 in the bank. And I thought I’m on the wrong side of this. I’m on the wrong side of this.

Carol:
You figured that out really quickly.

David:
I’ve got to do something. Yeah.

J:
Awesome. Okay. Question number three. I’m a big book fan and so I always like to hear what the best book on the topic we’ve discussed is. And I know you’ve written several books, so please don’t be shy. If you have the best book on the topic here, recommend one of your own.

David:
Well, if somebody out there has a business they want to sell, they should read my book, How To Sell My Own Business. The first half of the book is actually how to pick a business broker and how to know if you should rather go with a broker instead of doing it yourself. But as far as the stuff we’ve been talking about getting your business organized, it’s without a doubt, It’s the Michael Gerber book, E-Myth Revisited It’s a foundational, something everyone should read.

Carol:
Excellent. Thank you. And then our fourth and final question, which I rather enjoy is what is something that you have splurged on in your professional or personal life somewhere along the way that was totally worth it.

David:
Oh, it’s just buying business class plane tickets. I’m 6’3″, so it’s worth it in so many ways. I can’t measure how much it’s worth. Yeah, fly business class. You meet great people, you make business contacts, and you don’t get cramped up with your knees, jammed into the person in front of you.

Carol:
Win, win, win all the way around.

David:
Yeah.

J:
Awesome. Okay. So that takes us into the more part of the Four More, and that’s where our listeners can find out more about you. Tell us, don’t hesitate to tell us about your books, tell us how they can get in contact with you if they’re looking to find out more about your services or anything else you want to tell us about, and what’s the best way to connect with you?

David:
Sure. The best place to go is to my blog site, DavidCBarnett.com. From there, there’s all kinds of other websites I have specifically for buying or selling or what have you. But what about online courses and information about my books and links to YouTube videos, there’s probably 400 videos now on the channel. Almost all of them come from questions from people about buying, selling and managing small and medium-sized businesses. And if you’re interested in business deals, join the email list. I send out an email almost every day where I just talk about stuff that comes across my desk and different thoughts and ideas that I have about doing these deals.

David:
And most importantly, getting your head around risk. You know, entrepreneurs are very optimistic people and don’t often truly understand the risks of what they’re getting into. And a lot of the times, especially if you have some money, you can create problems for yourself because it’s easy to buy stuff, it’s easy to invest money. What is a real challenge is figuring out how to do these things without it. But that’s how you build a truly resilient business that has a high return on owner’s equity, is by figuring out how you can make money without necessarily investing a lot of your own.

J:
I absolutely love that. David, this has been fantastic. All the stuff you just mentioned, we’ll make sure it’s in our show notes. So go to our show notes for anybody that wants more information or links to all those things. David, again, this has been absolutely fantastic. Your expertise and knowledge has been invaluable to us, and I’m positive our listeners as well. And like I said, we may ask you to come back at some point and talk about it from the buyer’s side as well because I have a whole lot more questions that we didn’t have time to get to.

David:
I would love to. It’s a lot of fun. I love doing these interviews.

Carol:
Awesome.

J:
Fantastic.

Carol:
Thank you so much. I learned so much and you’re awesome. Thank you.

J:
Thanks, Dave.

David:
All right. Bye-bye.