Book: HBR Guide to buying a SMB

This guide presents the acquisition of a small business as a compelling alternative to traditional corporate careers or the high-risk path of start-up ventures. It provides a structured approach to the entire process, from self-assessment and identifying prospects to negotiation, financing, and closing the deal, emphasizing the potential for significant financial and personal rewards.

Key Ideas and Facts:

1. Entrepreneurship Through Acquisition (ETA) as a Viable Path:

• Buying a small business offers "significant financial rewards—as well as personal and professional fulfillment."
• It allows individuals to "be your own boss, fashion a company environment that meets your own needs, and profit directly from your success."
• The barrier to entry is often internal: "It’s making the decision to do it.” - Tony Bautista, an entrepreneur through acquisition.

2. The Opportunity Landscape:

• There is a substantial market of smaller firms in the US, estimated between 130,000 to 240,000 companies with revenues in the $5-25 million range. Including businesses with revenues under $5 million, the number exceeds 1.4 million. (Note 1)
• This presents a wide array of potential acquisition targets.

3. Key Stages of the Acquisition Process:

• Self-Assessment: Determining if entrepreneurship through acquisition is the right path, considering skills, lifestyle, and financial goals.
• Sourcing Prospects: Finding small businesses for sale through brokers or direct outreach.
• Evaluating Businesses: Assessing the financial health and long-term profitability of potential targets.
• Raising Capital: Securing debt financing from banks and equity investments from individuals.
• Negotiating the Deal: Reaching an agreement with the seller on price and terms.
• Due Diligence: Conducting thorough investigations to confirm the business's viability.
• Completing the Acquisition: Finalizing the transaction and taking ownership.

4. Identifying the Right Business:

• Focus on "dull" businesses with "enduring profitability" rather than high-growth or trendy sectors.
• Look for businesses with:
• Strong reputation.
• Lack of significant competitors.
• Services that are a small but essential part of customers' costs.
• Integration with their customers, leading to recurring, loyal relationships.
• Financial metrics like high EBITDA margins and low customer churn rates are indicators of enduring profitability. "We suggest looking for businesses with churn rates of 25% or less."

5. The Importance of the Seller's Commitment:

• Assessing the owner's genuine willingness to sell is a crucial "deeper filter."
• Factors to consider include their motivations, post-sale plans, and professionalism. "If the owner cannot seem to interact professionally with you at this early stage, the likelihood of a smooth transition after an eventual sale is far less."
• Be wary of owners with unrealistic price expectations or a lack of clear exit plans.

6. Financing the Acquisition:

• Buyers typically use a combination of debt (bank loans, seller financing) and equity from investors.
• Senior loans from banks often cover one-third to one-half of the acquisition cost.
• The SBA 7(a) Loan Program is highlighted as an "excellent vehicle for obtaining a loan for your acquisition" if you qualify.
• Equity investors play a vital role, and many individuals in your community can be potential sources.

7. Making an Offer and Deal Terms:

• Thorough financial modeling, including EBITDA analysis and free cash flow projections, is essential to determine a fair offer price.
• Consider various offer price strategies.
• Deal terms beyond price, such as financing structure, timing, and the seller's post-sale involvement, are critical.
• The acquisition can take the form of buying the company's stock or its assets, with asset purchases generally being more favorable to the buyer.

8. Due Diligence - Uncovering Potential Issues:

• Confirmatory due diligence is a critical stage involving detailed examination of financial records, legal contracts, and operational aspects.
• "Quality of earnings" analysis helps verify the accuracy of reported earnings.
• Legal due diligence assesses contracts, intellectual property, and potential liabilities.

9. The Letter of Intent (LOI):

• The LOI outlines the non-binding preliminary agreement and certain binding terms like exclusivity and confidentiality.
• It is a crucial step before significant time and resources are invested in due diligence.

10. Closing and Transition:

• The closing involves the final transfer of ownership.
• A smooth transition requires careful planning and cooperation from the seller.

11. Personal Suitability for ETA:

• The authors encourage readers to ask, "Do I want to do what an entrepreneur does?" rather than just "Do I want to be an entrepreneur?"
• Qualities like leadership, decision-making skills, and resilience are important for success.

Quotes Highlighting Key Concepts:

• "Purchasing a small company offers significant financial rewards—as well as personal and professional fulfillment."
• "You can buy high-quality small businesses for a price that allows you and your investors to earn an excellent return on your investment."
• "Our best data on the number of smaller firms in this size range suggest that there are 130,000 to 240,000 such companies..."
• "We think that entrepreneurship through acquisition is an extraordinary professional opportunity..."
• "...a 'dull' business might be the best investment..."
• "As you look for a company to buy, you will identify and compare literally hundreds of prospects at different times."
• "...you don’t need to use all your own money to fund your search or to buy your own business..."
• "If your investor is an expert in an industry that you are targeting, use the terminology of that business. If the investor isn’t familiar with the business, brandishing buzzwords will signal to them that they are getting involved in something they don’t fully understand..."
• "Is the prospect enduringly profitable?" (as a key deeper filter)
• "We suggest looking for businesses with churn rates of 25% or less."
• "...assessing the commitment to sell is an iterative process."
• "...the purchase price multiple paid has rarely exceeded 6x, most commonly has been 4x–5x and on (a few) occasions has been below 4x." - Jim Goodman, describing valuations of smaller firms.
• "Most buyers use senior loans—that is, loans that stand first in line to be paid—to cover between one-third and one-half of the cost of their acquisition."
• "Before you pursue other loans, contact a local bank that advertises itself as participating in the SBA 7(a) Loan Program to determine if you qualify. ... These are 10-year cash-flow loans with no promises to the lender other than paying the required interest and amortization payments. They are also relatively inexpensive."
• "Generally, buying assets is more favorable to you as a buyer..."
• "...this letter sets forth the non-binding preliminary indication of interest..." (referring to the IOI).
• "The purpose of this letter (the “Letter”) is to set forth certain nonbinding understandings and certain binding agreements..." (referring to the LOI).
• "Do I want to do what an entrepreneur does?"

Authors' Background:

• Richard S. Ruback: Willard Prescott Smith Professor of Corporate Finance at Harvard Business School.
• Royce Yudkoff: Professor of Management Practice at Harvard Business School and co-founder of ABRY Partners, a private equity firm.
• Both teach a popular course on the entrepreneurial acquisition of smaller firms at HBS.

This guide serves as a comprehensive roadmap for individuals considering acquiring and running a small business, emphasizing a strategic and informed approach to maximize their chances of success.

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