Last week, we explored whether or not the hot new trend of buying “boring” businesses is a good way to generate passive income. TL:DR: There’s nothing passive about laundromats. (ICYMI, you can check out the full article here).
So when does it make sense to buy a business?
First off, I’ll say that despite my takedown of the boring business hype last week, I am still a massive proponent of acquisition in general. But, as with most things business, it’s complicated and nuanced.
What makes me qualified to even speak on this subject? I’ve done two full-blown acquisitions in the last three years, one of which was a resounding success, and one that resulted in spectacular failure. I’ve also invested as a minority partner in two dozen other companies over the past decade and let’s just say I have a lot of scars to show for it (as well as a few wins.)
I used to love learning the hard way, but I’m trying to quit.
My first mistake was the belief that because I was good at running my own business, that meant I would be good at analyzing and investing in other businesses.
That turned out to be a costly mistake (to the tune of several million dollars). With hindsight being 20/20, while it would be nice to have that money back, the experience that I gained was priceless.
Even though I’ve made plenty of mistakes, I try to never make the same mistake twice. I applied my learnings from the first acquisition to the second, and it paid off.
So without further ado, here are my lessons learned for buying (or investing) in any business:
Stay in Your Lane
This may sound obvious, but over the years, I invested in everything from automotive restoration to medical supply to hospitality. The reality is I had zero specific knowledge in any of these industries, and as such, had no business investing in them.
When I bought my e-commerce business, I only knew enough about e-commerce to be dangerous. My wife runs a digital marketing agency and has scaled dozens of e-comm clients, so I figured that with her marketing skills and my operational experience running other businesses, that we would be able to add value and increase revenue quickly.
My wife held up her end of the bargain on the marketing side. However, I underestimated the complexity of the areas that were new to me, namely manufacturing, shipping, and inventory management.
I spent the first year learning the intricacies of these new skills, but it was a year I didn’t have with a business that was losing money.
This leads me to my next lesson…
Only buy a healthy business
The allure of buying a distressed business for pennies on the dollar may seem like an easy way to make massive returns on your investment, but turnarounds are often a siren’s song.
Attempting a turnaround is not for the faint of heart and should be done by experts only, ideally by those with previous turnaround experience.
I learned a powerful lesson: distressed companies are distressed for a reason. It’s easy to blame poor management, but more often than not, the problems are due to poor fundamentals.
The company that I bought sold American-made products, so its costs were much higher than those of offshore competitors. It turns out it’s hard to out-sell bad margins. Even after coming in and cleaning house by reducing employees, cutting costs and streamlining operations, we simply couldn’t acquire customers profitably, meaning that we had to rely on lifetime value to turn a profit. For a company burning cash, we didn’t have the luxury of time on our side.
Leverage can be your greatest ally or worst enemy
One of the allures of acquisition is the favorable terms available via SBA loans. With 10% down and 10-year terms, SBA loans can be a powerful form of leverage.
But when things don’t go as planned, debt service can become an ever-tightening noose around the neck of a struggling business.
Worse still, SBA loans require a personal guaranty, so there is more at stake than the business itself. Combining a turnaround with a bank loan turned out to be a death blow for my e-comm misadventure.
All of this could have been avoided had a followed this next rule:
Have a process for due diligence, including strict go/no-go criteria
During the due diligence process, I kept finding more and more hidden bodies. While none of the individual pieces were a deal breaker, I liken what happened to the frog boiling in water. If you drop a frog into a boiling pot, he will leap out. But if you turn the heat up slowly, the frog won’t notice and will boil alive.
Bad news rarely gets better, and by the time I had the full picture of the business’s state, I had already taken over operations and was racing toward closing. I fell prey to the sunk cost fallacy.
Now, you may wonder how I could get into such a quagmire. What did I even see in this business in the first place?
When I first went under LOI, my cash flow projections showed that if I cut expenses, reduced debt, recapitalized, and stabilized operations, the business would be cash-flowing at $70k/month. But every new challenge that arose meant a reduction in profits, and the deal got worse and worse. If I had set strict criteria for what I was willing to accept from the outset, I would have been forced to walk away as the deal worsened.
Now, let’s take a look at the second acquisition and how I applied these lessons learned to create a better outcome.
The second acquisition was another digital marketing agency, one that offered similar services to my wife’s current company. We had a long-standing friendship with the seller, and we knew that his skills would be complementary to our own, meaning that 1+2 would be greater than 3.
Having been burned in the not-so-distant past, we structured the deal to protect the downside at all costs, removing as much risk as possible. Rather than using debt to finance the acquisition, we structured the deal as a merger, with the seller’s equity in the newco tied to revenue and client retention. This meant that if clients left after the acquisition, we would not be worse off, and incentives would be aligned.
We also went in with with eyes wide open to the hard work required to integrate two cultures. We knew that we would have to rebuild and strengthen processes and invest heavily in systems that would support a much larger agency. We estimated that it would take at least six months of relentless hard work to see the light at the end of tunnel.
So, to recap, this business was squarely in our lane. We didn’t use debt and protected our downside by only paying for accretive revenue. We knew the owner well and knew he would be a massive asset to our leadership team. Finally, during due diligence, we set strict criteria for the deal structure, including having hard conversations about how we would unwind if it didn’t go according to plan.
It took every bit of six months, and as predicted, it was damn hard work. There were plenty of sleepless nights and gut-wrenching decisions.
But it paid off.
I am intensely proud of my wife and her new partner for their relentless dedication and growth as leaders. Six months later, we have already grown revenue by 50% from the time of acquisition. Operations are humming, the team is stronger than ever, and the company is in a powerful position to continue to scale rapidly.
This is the power of an acquisition done right.
But the biggest lesson learned? Even with 10 years of experience and domain specific expertise, it was still hard.
My conclusion from last week remains the same: when it comes to acquisition, the person (or people) who do the work make the money.
Acquiring a business can be an extremely lucrative endeavor. But you have to be ready to roll up your sleeves and do the work.
To the builders doing the damn work,
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