Business Finance – Lessons Learned from Buying a Business With Partners

Today, we are going to continue where the last article left off. We are going to go over the lessons learned from my experience buying a business with partners. I will list them out with short descriptions. There is no particular order to the list. Any names mentioned other than my own have been changed to protect the innocent…

Lessons Learned

Partners (The Team) – Our team consisted of four partners. Bob and Carl are the majority investors and took out an SBA loan to acquire the business. John and I are minority partners and not party to the SBA loan. Because Carl, John, and I all have full-time jobs and at the time Bob did not, the plan was that Bob would learn and operate the business until we could afford to put someone else running the business, leaving Bob to pursue his personal interests. See my last article for how that all turned out.

Recommendations:

Be transparent about individual drivers. Becoming your own boss and becoming wealthy eventually become competing interests for an entrepreneur.

Professional respect is critical. Tolerance is listening to every idea quietly. Professional respect is availability, transparency, punctuality, and preparedness.

Autonomy must be earned, never assumed in a partnership.

Bad habits are hard to break in others.

Operating Agreement/Bylaws – Depending on whether you have a Limited Liability Company (LLC) or a Corporation (Co), you should have either an operating agreement or bylaws to govern how the business will be run. In our case, since we had a corporation, we had bylaws. We deliberated on what to include in these bylaws to ensure smooth operations, but did not go far enough. They did not spell out the duties of each partner & role, because we thought that all of us being adults, we would do what was needed to be successful. What we realized was that we each viewed the word through a very personalized lens and what seems obvious to one, (or two, or even three), is not obvious to everyone and if the fourth person feels strongly enough about it, they just will not go along unless forced to. And even then, although begrudgingly agreeing in discussion, they will still fight and obstruct the wishes and decisions of the group. If we had, as a group, decided on the duties for each role and assigned responsibilities for each role to each member of the group, then documented it in the bylaws, it would have made things a lot clearer.

Recommendations:

The operating agreement or bylaws should also include a defined exit strategy that everyone has agreed to and is committed to following. It should have defined triggers that initiate the exit strategy. These triggers should be something that the partners can easily monitor and measure against.

It should also be spelled out how to handle decisions and requests. In our case, decisions initially required unanimous board approval. We amended the bylaws later to only require a two-thirds majority due to the one partner asking for a solution to a problem, but not liking the board recommendations, then never implementing the solutions.

Due Diligence – Nowhere near enough due diligence was done on this business or partners. We did not understand enough about how either operated. The revenue the company was making included the previous owner doing work on weekend “off-book” to get jobs out & keep expenses down. It also relied heavily on promotion via owner visits with distributors and their personal relationship. We had no relationships.

Additionally, having a partner who tells the group he agrees with the intention of not taking any profits for three years, but assigns himself a $100,000 per year salary and in the first week of operation directly violates the ground rules we set up for operating the business. We, (the other three partners), realized that the fourth partner had pursued the investment deal to set himself up with a kingdom where he was king. #AvoidDat

Recommendations:

Know how the business operates prior to purchase.

Calculate how much revenue you need to make to break even.

Have a budget that takes into account ALL costs to operate.

Unless you are laundering money for drug cartels, whatever starting capital you have isn’t enough.

That much isn’t enough, either.

Planning to grow? Triple the previous statement.

Financials – While we started out with modest working capital, we had no understanding of our run rate, break-even point, or runway length. In other words, we did not know how much it cost us to operate, how much we needed to make to break even, or how long we could operate with the amount of working capital we had. We eventually figured those things out, but not until it was too late. Also, another point to make, as referenced in a previous article, you have to pay attention to Cash Flow to stay on top of your business finances. We utilized the accrual method of accounting, but did not regularly look at the cash flow reports. Because of this, we would account for interest paid on our loan from the Income Statement (P & L), but did not account for principle repayment in any of our break-even or forecasting exercises until almost two years into the business.

Recommendations:

The person managing the business needs to have a fundamental understanding of basic accounting and business / financial principals. This is a KEY point and will lead to many headaches if not followed.

Know your costs to operate, to the penny! AND, make sure you include labor!

Cash is King! When you run out of working capital, that is pretty much the end of the business.

Gross margins should be higher than thirty percent. If not, this will lead to a death spiral for the company.

Sales – The business we purchased operates, (soon to be preterite or past-tense?), conducted sales via a convoluted structure. The products are sold via distributors to building supply centers for builders. So if an end user wants to use our product, they get their builder to point them to their preferred building supply store, where they can look at brochures or in some instances, floor models to decide on what they would like. They then request a quote. That request comes to our operation, is processed, and returned to the building supply store salesperson. That salesperson has limited information on the product nor incentive to sell it.

From our end, we pay a commission to a sales agent to promote our products to the distributors, who in turn make them available in building supply stores. This is too far removed from the end buyers and in my opinion, not an effective spend.

Recommendations:

Agencies DO NOT replace effective sales people! Agencies represent a large portfolio of products and do not focus on pushing your product(s) 24/7.

It doesn’t matter what your product is if you and your team cannot sell the product(s). No sales = No revenue = No profit = bankrupt company.

It does not matter how much you cut costs or control spending if you and your team cannot sell the product(s). (See equation above)

Operations / Efficiency – Prior to closing the deal on the business, since Bob was going ot be operating it, we requested that Bob create a budget and document processes for what the business would need to run. He never gave us a budget, nor processes, even after being in the business for a couple of years. His initial excuse was that he had to be working IN the business to understand how the business operated (for processes) and that we, as the board, should be giving him a budget that he could spend. These were two more missed #RedFlags in our journey that should have told us to run, not walk, to the nearest exit. As of today, there are still no documented processes. We kind of have an idea what our budget is through reviewing financials, but we don’t trust the numbers because they are constantly being adjusted. So, we only have an idea, and nothing from Bob. Ultimately, there are still a lot of inefficiencies in the way the business is being run.

Recommendations:

Inefficiency is expensive and cripples or kills a company. From the start, focus on efficiency of process, capital, communication, and decision-making.

Be deliberate and realistic about growth rate. In projections and practice. Year over year revenue and product volume increases have to be realistic and managed to avoid unmet expectations and quality issues. It’s nice to have targets, but remember that you need sales to support targets (see Sales section below). And it is much easier to have a customer wait for quality than to apologize for a sparkly piece of crap.

Product Management – This business has about eight main products with practically infinite levels of customization, not counting special-order material types. Every order is a custom order with many options to choose from. There are forty-five different options to choose from when requesting a quote. This leads to decision fatigue and indecision in customers. Ultimately, our quote/win ratio was very low. We suspect that most customers that requested a quote had already decided on something else by the time they received the quote back. Additionally, “Bob” was continuously wanting to add new products to the portfolio because they were the latest hot thing selling.

Recommendations:

Have IP, a unique desirable product, or both. If you have neither, shoot it in the head, kill the deal, pull the plug, or whatever euphemism you want to think in. Unless your goal is to be your own boss, then feel free to limp along for eternity (or until your cash runs out).

Keep or reduce your product line to your top sellers. Based on the Pareto Principle, roughly 80% of your business should come from your top 20% of sales. (Just a note, it will not be exact. This is a rough guideline) So, find out what products make up the majority of your revenue if you already have a large portfolio of products and focus on selling those products. If you only have a few products, keep this idea in mind before adding new products. Which leads to the next one…

Before adding a new product to the portfolio, always write up a business case and do sales/cost impact projections. In fact, this should also be done for any request or change to a product or portfolio.

Product customization is less important that total customer buying experience. If you make it easy for your customer to buy your product, you will have more sales.

22-Nov-2019

As of right now, the business is still operating. I do not know how much longer that will be the case. It continues to limp along, hanging by a thread.

Stay tuned for further updates…

And, as always, let me know what you think in the comments. Ask questions, tell your story.

If you like my posts, please share them with others and subscribe to this blog.