Leap of faith

Entrepreneur, Feb, 1998 by Dennis Rodkin

Everything seemed to be sailing along smoothly in the summer and fall of 1996, when Norman Savage was negotiating to buy a small mortgage company in Ft. Wayne, Indiana.

Having owned nursing homes and restaurants over the past three decades and, most recently, a firm that brokered distressed mortgages, Savage was no newcomer to buying and selling businesses. This latest deal, to purchase North American Equity Corp., seemed just right. The seller had provided three years of audited financial statements, all of them pointing toward a bright future. The company was exactly the next step Savage wanted, a jump from distressed mortgages to conventional home financing. And a sharp, well-chosen staff was already in place. It looked as if Savage could just step in and glide along with North American Equity as it continued on its way.

Not quite. In the first few weeks after closing the sale on November 13, Savage was hit with a string of problems. The seller had given some employees 20 percent pay increases after the deal was made - effectively buying for himself the credit for being a generous boss and leaving the cost of that generosity tO Savage to pay. One key employee was mulling over a job offer from a competing company. A printer stopped working, and in getting it repaired, Savage learned that one of the office computers had needed to be replaced for some time. Some of North American Equity's business licenses were about to expire, and the necessary documents to renew them weren't easy to locate. On top of all that, several important clients let Savage know they needed to meet with him right away to determine whether he'd be giving them the same kind of service they had been getting from the company under the previous owner.

Even after those rocky first few months, Savage still calls the purchase "one of my best moves." Although unexpected, the problems were all ones he was able to wrestle to the ground. "It was extra work I hadn't counted on," he says, "but nothing I couldn't do." Savage's experience was not catastrophic, but its stressfulness is typical of the business buyer's experience. No matter how wide open your eyes are during the shopping and negotiating periods, you're still in for some surprises once the deal is done.

That's why "wiggle room" should be built into every business buyer's plans, says Bill Yegge, a Moody, Maine, owner of five businesses and author of A Basic Guide for Buying and Selling a Company (John Wiley & Sons). Whether it's financial wiggle room - a little bit of capital set aside for unexpected expenses like a new computer - or managerial wiggle room - the chance to meet with key employees privately before closing the deal - it heightens the buyer's confidence that obstacles can be overcome and goals achieved. Entrepreneurial businesses are notoriously risky; planned wiggle room is a strategic way to minimize the risk.

"It's not exactly an arm's-length deal when a small business is being sold," says Yegge. "Because of the closely held, private nature of most small businesses, the buyer just can't know all there is to know until after the sale." Because pitfalls and delays are inevitable, planning for them should be automatic.

* RISK MANAGEMENT

For some business buyers, the decision to buy an established business instead of starting a new one is the first step they make toward giving themselves wiggle room. In 1996, when Texan Michael Garrety was downsized out of the oil industry, he felt his time to run a small business had finally come. But he wasn't interested in risking everything he'd built during his 20-year career. "Everybody says it takes three to five years to build a new business from scratch, and during that time, there's a fair amount of uncertainty," Garrety says. "I'm a middle-aged guy; I'd rather buy an existing business and take that same five-year period to pay a note back, knowing I've got cash flow from the first day." Garrety bought San Jacinto Staple & Supply, a Houston-based commercial distributor of packaging and shipping supplies, in September 1996.

Caution is especially important when planning your debt load, Yegge advises. While it's tempting to buy the biggest business your financing will allow, that tactic doesn't leave much of a safety net if the business doesn't do as well as expected. "What if the seller inadvertently takes 20 percent of the sales with him because the customers loved him? What if Wal-Mart decides to build down the street?" Yegge asks. "The safe [move] is to buy less than you can afford, even though the real psychology of all of us is that we always buy more because of enthusiasm."

While there's no broadly applicable way to calculate precisely how much money to keep off the table for emergency use, Yegge advises buyers to use the tools of leverage to their advantage, thereby reducing their own cash investment. Finance as much of the sale as possible using the assets that come with the company. Whenever possible, he says, "get a list of the target company's assets, take it to your banker and ask what you can borrow on each of the components individually."