In this episode, Stacy sits down with savvy business expert and author, David Barnett. The two discuss David’s wealth of knowledge regarding buying and selling businesses, and he even provides insight suggesting why you should keep your business selling dreams a secret.

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Stacy: 00:00
Welcome to Marketing Mistakes and How to Avoid Them. I’m Stacy Jones, the founder of influencer marketing and branded content agency Hollywood Branded. This podcast provides brand marketers a learning platform for top experts to share their insights and knowledge on topics which make a direct impact on your business today. While it is impossible to be well-versed on every topic and strategy that can improve bottom line results, my goal is to help you avoid making costly mistakes of time, energy, or money whether you are doing a DIY approach or hiring an expert to help. Let’s begin today’s discussion.Speaker 2:00:31
Welcome to Marketing Mistakes and How to Avoid Them. Here is your host, Stacy Jones.Stacy: 00:35
Welcome to Marketing Mistakes and How to Avoid Them. I’m Stacy Jones. I’m so happy to be here with you all today. I want to give a very warm welcome to David Barnett who helps people buy and sell business. David has been working with small and medium-sized businesses for over 20 years and has written seven books about buying and selling businesses, franchises, and local investing with titles like 12 Things to Do Before You Consider Selling Your Business, How to Sell My Own Business, and 21 Stupid Things People Do When Trying to Buy a Business. He also has a YouTube channel with over 400 videos.Today, we’re going to talk about the process of buying and selling, and what you need to set yourself up for success years before you’re even considering making that transaction happen. We’ll learn what has worked from David’s experience, what maybe could be avoided, and where people are missing the mark. David, welcome.David: 01:20
Hey, Stacy. Thanks for having me on the show.Stacy: 01:22
Super happy to have you here, and I am thrilled to be learning today about how you actually set yourself up for success when you want to actually sell your business or buy someone else’s. Can you start off by sharing with us a little bit more about your background and what got you to where you are today to make yourself such an expert?David: 01:43
Yeah, sure. I’ve always been interesting in business, so I’ve been in a lot of different businesses from childhood into my 20’s, and after university, I got into a business and ultimately ended up in a sales career working in the advertising world. Do you remember the Yellow Pages?Stacy: 01:59
I do.David: 02:01
Back in the ’90s, I joined up with the Yellow Pages back when it was still really relevant media because in those days, if you typed “plumber” into Google, you would get a plumber in California no matter where in the world you live, so they haven’t gotten the local search down yet, and in those days, if you came home and there was water on your floor, like you had to open that book to find some guy who would drive to your house right at that moment. Right?I started to meet owners and managers of these small Main Street businesses when I was working with the Yellow Pages, and eventually, I did realize that the internet was going to kill that book and the future was bleak for me working in that field, so I decided to pursue my dream of owning my own business again because I’d always had those childhood businesses. After university, I had a business, so I got back into it.That very first business was a junk-removal business. I ran it with a partner, and I got tired of it quite quick, and I sold it, and it was the first time I ever sold a business, and then I got into business financing. When I got into the world of business financing, I was brokering commercial debt, factoring facilities, commercial loans, and leases for business owners. I kept meeting people who were trying to get financing to buy a business, and what struck me as very awful is that they were trying to buy businesses, but the people they were working with didn’t seem to know what they were doing.Around that time, the great recession came along, and so my business, brokering and finance, became very difficult because a lot of these funding organizations were having problem selling their paper on Wall Street, and so the pipeline of money slowed down, and I realized I had to make a change for my own career, and that’s when I got into business brokerage because I saw that demand in my hometown.

I joined up with a big international brand because they created a path for me to get the proper training, and I became certified, and I was the only person in my province. I live here on the East Coast of Canada. I was the first person in New Brunswick to become certified as a business broker, and so I started operating as a business broker, helping people to buy and sell businesses. Over a three-year period, I sold 36 businesses for other people, and it was exciting for a person like me who likes to solve problems and try to get two different people who have different ideas and desires to fit somehow together.

Stacy: 02:01
Right.

David: 04:26
It was exciting, and it was really cool. It was also a nightmare from the point of view of cash flow, and it’s a terrible business because it can take years to convince a business owner to list the business for sale with you, and then it can take years to sell it, and so under that model, it’s traditionally a commission-based model, so one of the first businesses I listed for sale when I started off was a fried chicken franchise, and the last business I sold before I finally threw up my hands and quit was that friend chicken franchise three and a half years later.

I left the industry thinking it was crazy, and I started working with a bank actually, and I had to cover a large territory. I’d be driving in my car, and my phone would ring. It would be people who got my name, and they would say, “David, I’m trying to buy this business,” or, “David, I want to sell my business, and people tell me you’re the guy to talk to.”

At first, I would just say, “No, I don’t do that anymore,” and then I realized this demand I saw before was still there, but there was a different way to do it, and so I got back into helping people buy and sell businesses first as a side hustle, and then later, when the bank wanted to rationalize its sales department, I raised my hand because I said, “You know what? I’ve already got something here on the side, and I can build it into a real business,” and so I started helping people buy and sell businesses again, but this time, I do it as a consultant.

I don’t represent people anymore. I don’t act as an agent. What I do is I hold people’s hand through the process, and I do things for them that they can’t do on their own. I liken my relationship with clients to be more like the relationship people have with CPAs and attorneys. You go to them because you need their help. They do something for you. They give you a bill. You pay them, and off you go.

Right now, people pay me… People who own a business, they’ll pay me to evaluate the business, prepare the documentation to present to buyers. They’ll pay me to run their advertising program, and they’ll pay me to coach them through it, and I charge them for each of those things as I go along the process. At the end, when they sell, there’s no commission, so it’s a different way of helping people achieve the same end, and it allows me to work with people from all over the place, and that things like my books and YouTube channel bring me clients, buyers, and sellers from all over the world really.

Stacy: 06:45
Yeah. That’s great, and you’ve established yourself as an expert obviously because you are an expert in this space now, so that is very valuable, and it’s a lot nicer not having to hunt and kill your dinner in order to get your paycheck.

David: 06:59
Yeah. There’s a lot of problems with that business model that I was living through. I had to look professional. I had a nice office, and I had a receptionist, and I had associates and all the bills that came with that. You have to do a certain amount of business just to cover that before you actually get to take your paycheck.

Stacy: 07:22
Welcome to agency owner life because that’s the life I lead. Yes. Okay, so I know there are so many questions that people have when it comes to getting your business ready to be sold, and also, from conversations I’ve had with other agency owners, other businesses, clients who I’ve had, people tend to put the value of their business as something that’s not quite realistic always, so how do you price a business? How do you set yourself up for success? I bet this is a very long response because there’s a lot of things you need to do.

David: 08:04
No, no. It’s very short.

Stacy: 08:04
Oh.

David: 08:07
Here is the whole thing in a nutshell. The price someone will pay for your business is a function of the cash flow that the business provides and the riskiness that the buyer perceives. Okay?

Stacy: 08:19
Mm-hmm (affirmative).

David: 08:20
Then, they’re going to modify that by the number two big thing, and that is the belief, the likelihood of how likely it’s going to be that they can carry on that cash flow under their stewardship.

Stacy: 08:32
Okay.

David: 08:33
Here’s where the problem comes in when you talk about things like an agency business in the world of marketing, advertising, design, anything creative and anything professional. Your engineers, your accountants, your bookkeepers, your lawyers. The buyer is going to be fearful that the reason you have the earnings you do is because people want to do business with you.

Stacy: 08:51
Yeah.

David: 08:52
Right? One of the things that you have to think about is, “Are these customers coming to do business with me, or are they coming to do business with the firm?” If you think about the barber on the corner and then the convenience store across the street from them, everybody in the neighborhood knows that if they want a Coca-Cola late at night, they can go to that convenience store. Hardly anyone in town probably knows who the owner is. Right? They see the same faces in there all the time, but it doesn’t really matter. They’re going to the store because they know it’s open and they get a bottle of pop, right?

Stacy: 09:25
Yeah.

David: 09:25
The barber across the street though has a much more personal relationship with the clientele, so the more bad haircuts he gets… he gives to people, the worse that relationship is going to be. Right?

Stacy: 09:25
Mm-hmm (affirmative).

David: 09:38
If he gives really great haircuts, the more people are going to be willing to wait, for example, to have their turn in his chair, and so that’s the example of the business where… what we call the good will, the willingness of the public to do, and then there’s an accounting term called good will too, but the good will of the business and how it’s perceived in the marketplace, is it tied to the business, or is it tied to the person?

If the buyer of your business believes it’s tied to you, what will end up happening is either you are going to tie yourself into that transaction. Meaning, the buyer is going to buy the agency and you for a period of time so that that good will can transfer, or they’re not going to believe that they can actually buy your business, and what they’re going to start to do is look at what you’ve built in terms of less attractive things like they’re going to say, “You haven’t really built a business. What you have is a client list. You have a bunch of people that do business with you, and I’m willing to buy that, but I’m only willing to pay you a function of the number… based on the number of those clients that are willing to come over to me.”

I’ll give you an example of that with an accountant. There’s an accounting firm that I was working with, and they were very interested in doing small business accounting, but like many accountants, when they first open their doors, they have to take all the business they can get, so they have this long list of people that went there every year for their personal tax returns, and the accountant didn’t like to do them, but needed the revenue, and so when her small business practice got big enough, she said, “I want to get rid of these personal tax returns,” and so she found another new accountant, and she made a deal.

Basically, what ended up happening is they said, “Look, here’s the list of customers. We’re going to mail them all a letter, and I’m going to tell them that you’re now handling my personal tax return practice, and I want a percentage of everything you bill those people for the next three years.” Right? Which is very different from an accountant saying, “I’ll buy your personal tax return business for X number of dollars.” Right?

Stacy: 11:43
Right.

David: 11:44
The buyer very much bought a client list not knowing and fearful of the fact that some of those people may not come to him, and at the end of the day, he was happy with the deal because he only had to pay for the customers that actually did come to him.

Stacy: 12:00
Much safer for the buyer in that situation, but less money potentially for the seller.

David: 12:06
Yeah. Well, in less of a windfall kind of environment.

Stacy: 12:10
Mm-hmm (affirmative). Yeah.

David: 12:12
When people think of selling a business, they think of having all this money come through the door. The reality is very few small business owners… When I say small business, I’m talking about what I call Main Street businesses, so anything with earnings under half a million dollars. Most of those businesses, they don’t sell so someone can cash out. These internet guys with the online businesses, they build these businesses if they’re really lucky, and fortunate, and smart, and they’re worth a ton of money, and those guys cash out, and they secure generational wealth for themselves in one big transaction.

Small business owners don’t do that because the valuations don’t lend themselves to that. Most of the time, small businesses can sell for anywhere between just a little over one times the owner’s discretionary cash flow, which is the profit plus the owner’s salary that it takes. One time up to maybe three times, and so when sellers learn that, when they say, “Wow, if I stick around for the next two and a half years, I’ll have the same money,” they’re not excited about selling, and so that’s usually not why they do it. They do it typically because they can’t run the business anymore.

Stacy: 13:29
Right.

David: 13:29
The top reasons why people sell a business, number one, is burnout and fatigue followed by divorce, poor health, and need to relocate, and retirement. These are all the same reasons why people sell a house or sell their sports car they love. A pressing personal concern forces them to need to sell the business so they can move on to something else, and when those things happen, then we have to act fast because if the person is not interested and not able to run the business the way they have been, then that drop in passion and drive is going to start affecting the business, and if they ask way too much like you opened up the conversation where they ask a price that’s way to high, what happens is they chase off what I call the qualified or a reasonable buyer.

A reasonable buyer is someone with industry experience who has money saved up. They have good credit. They’ve got access to bank financing, and they’ve been doing research, and they know what businesses like yours are going to sell for, and if they see you asking twice as much, they just think, “Oh, this person is nuts,” and so the reasonable buyer doesn’t step forward. What you get instead are the people who don’t know anything or don’t know any better, and they’ll come and talk with you, and they’ll take up your time, and they’ll waste your time. They’ll negotiate.

They may even make an offer and agree to something, and then they’ll go to a bank, and the banker will laugh at them, right, and say, “Ah, this deal is crazy. We can’t do this,” and so I’ve seen people price a business the way you would price a nice home or artwork. Usually, they price it high, thinking I can just bring down the price layer, and what ends up happening is a year goes by or two, and they keep wasting time with these people, and the passion, the drive, the dedication to the business starts to decline. Sales start to go down. Profits start to go down, and pretty soon, the good will, the thing that is valuable in the business starts to erode, and then soon, there isn’t much left to sell. Right?

This is why it’s so key to put the right price on it in the beginning because once you make that decision, “I don’t want to run this business anymore. I’ve had it,” or, “I can’t,” or, “My doctor says I’ve had it,” then it’s got to go quickly and you want to meet that reasonable buyer, and the way you attract them is by sending a signal that says, “I’m not foolish. I’m not crazy,” and that’s by putting the right price on it.

Stacy: 15:53
Okay, and so I know we’re talking about service industries, agencies, the accountants and the like. What if you flip that and we look at tangible product companies where it is less about the individual and more about the established brand?

David: 16:11
Yeah, that’s what makes it easier. If you’re a manufacturer of widgets and they get sold through distributors, the person at the end of the road who… in the store, a retail store who buys that widget, they’re not as connected to who the owner of that business is. We’ve seen examples of businesses where they’ve created that figure head character, and what’s interesting is sometimes, the business will be sold and they’ll want to keep that figure head. Think of Burt’s Bees.

Stacy: 16:41
Mm-hmm (affirmative).

David: 16:42
Right? That was eventually bought by a large multinational company, but they still wanted Burt around.

Stacy: 16:42
Right.

David: 16:47
Right? They want to bring him out for special events and things like that, and so there can be that marketing tie into who the owner is, but if you went and had to buy parts for your car, chances are you don’t know who owns the company that made the part. As long as your mechanic says it’s a good part, you’re okay with it. Right?

Stacy: 17:09
Yeah.

David: 17:09
That in a lot of ways is easier, and those kinds of companies do tend to sell for higher multiples because it’s much clearer that the brand good will belongs to the company, not the owner.

Stacy: 17:23
Okay, so your advice would be for companies that do have that individual brand ambassador that’s typically the CEO, owner, some sort of stake, along those lines is to potentially pull back from that if they want to sell and mellow it out so that there is more of a clean line of seeing that there is a strong team in place or strong more so brand in place?

David: 17:49
Yeah. I’ll use a great example because my girlfriend is going through this problem right now and she owns a travel agency.

Stacy: 17:55
Yeah.

David: 17:56
She has a team. She’s got 20 people on her team, and she started by herself. Right? A lot of the long-time clients who keep coming back to the travel agency, they know her and they want to do business with her. What she’s had to undertake is a deliberate strategy to retire from the position of travel agent to spend her time being travel agency owner. Right? What that looks like in her example is that when people email her or Facebook Messenger her at 11:00 at night is she replies to them and she says, “Look. Thank you for reaching out. I’d love to help you. Unfortunately, I’m really tied up. I can get back to you in three or four days, or someone from my team can get back to you tomorrow morning.”

Stacy: 18:41
Right.

David: 18:41
Right? What she’s able to do is she’s able to start transferring some of that good will from herself to the brand and the name of the company. She just can’t manage it all, running the business and being a travel agent, and no… After 20 years, you don’t want to be doing that.

Stacy: 19:01
No. The goal is actually to not be working in your business at that point, but to be working on, and then growing it, and looking for ways to continue growing, and helping other people make money, and you make money.

David: 19:11
Yeah, exactly. Yeah.

Stacy: 19:13
Yeah. Okay, and so what are other mistakes that people make along the lines of thinking that their businesses are more valuable or trying to position them in such a way that they’re not?

David: 19:26
One of the things that people get very confused on is they’ll start to bring a homeowner mentality into their business. A homeowner mentality is, “I’d rather pay a mortgage than pay a rent because I want to own the home eventually rather than give money away to the landlord.” That kind of thing. I see a lot of businesses who will do things like they’ll buy the building that they’re in, and what ends up happening is that once that building is paid off and they have no mortgage, they then believe that their business is so much more profitable because they’re not paying out that money for rent or for a mortgage. In reality, buyers are not interested in the profitability of your business. The cash flow is important. What they want to see is how much profit are they going to make versus the amount of money they have to put in.

Stacy: 20:14
Which is the HEI. You’re talking about what is the HEI there before actual operations? Are you saying the net at the end of the day?

David: 20:23
I’m talking about the return on the equity.

Stacy: 20:25
Okay.

David: 20:27
If I put in a certain amount of cash to buy your business and then borrow some from the bank, how much money do I make on my money that I put in?

Stacy: 20:33
Right.

David: 20:34
What will happen is business owners will take this debt-averse attitude, and they’ll pay off debts. They’ll pay off loans. They’ll end up with a ton of equity in their business, and the turn on equity will get quite low. In the worst case scenario, you end up with what I call a zombie business. I’ll give you a quick example.

Stacy: 20:54
Mm-hmm (affirmative).

David: 20:55
I met with a business owner who had a laundromat or sorry, a dry cleaning business, and he worked there full-time, and he had some other employees. Every year, he went to his accountant, Denise. His accountant said, “You’re doing really well this year. You earned 60 grand or 70 grand,” et cetera, and so he decided he wanted to sell the business, and I looked at the financial statement, the P&L, and I said, “Where’s your rent?” He said, “Well, I own the building. I inherited this business from my dad.” I said, “Oh.” I said, “Well, if you rented out this building to somebody else, what would they be paying you in rent?” He said, “Oh, about 30 grand.”

I said, “Great, so $30,000 of your $70,000 profit actually belongs to the building because you’ve got two different activities mixed into one business here. You’ve got a real estate investment and you have an operating company, and if you any real estate appraiser comes along and he evaluates the building, he’s going to look at the market rate of rate, and he’s going to appraise the building based on what it should be earning. So, if I own the building and you were paying me the 30 grand, it means your dry cleaner only earns 40.”

Now, how many people want to spend money to buy a business for the privilege of working full-time to earn 40 grand a year? That’s when you realize the business really doesn’t have any value, and one of the problems is that business owners, they’ll look at their financial statement, which is correct. They’re prepared correctly, but they’re prepared with a view of understanding what happened in the business so that you can pay your taxes properly. Very rarely does anyone ever sit down and look at their financial statement and say, “What is the actual market value of the assets I have within this business? What is the actual value of my equity, and what is the return on that equity?”

Those are the questions that people over at Walmart are asking themselves every day or the other big companies that you can think of. They’re trying to think, “How can we earn more money with less of our own capital?” That’s something that’s often lost with business owners, small business owners, and they’ll end up with emulation of equipment, machinery, inventory, real estate, and the cash flow that is running in their business wouldn’t support somebody buying all that stuff throwing money for it.

Stacy: 23:15
You think that’s because they’re just under-financed in general so that they are just keeping, and nickeling, and diming everything so that it stays as low as possible within the business versus trying to find those additional cash flows, or investors, or ways to grow the business?

David: 23:33
I think what ends up happening is people don’t like the idea of being in debt. They don’t like the idea of owing money to the bank, and so they do what they can to pay off the bank, and then once those debts are gone or paid down, then they feel more relaxed, and then they stop pursuing the business with the same vigor that they did when they were younger. When you get into a business, and you have a lot of debt, and you have to make your bank payments, you do everything you can to push, push, push to get that extra sale. When the dogs stop nipping at your heels, well, then you can relax. It’s when the effort and everything tunes down. The performance may look good because you might look like you’re making profits on paper, but if your return on equity is going down, then your business’s value as well could be.

Stacy: 24:25
Okay, so anything else that service industry should know or be advised of of ways that they could try to make themselves a little bit stronger?

David: 24:35
Yeah. The thing that I most often see people not doing is just being consistent with things like price increases. I know some restaurant tours who religiously every year try to work in a 2% to 3% price increase just to always make sure that they’re maintaining those margins or protecting themselves because your suppliers are. Right? Everybody who’s taking money out of your business, they’re doing that. They’re trying to protect margins.

Prices are going up, and if you don’t consistently do it, what ends up happening is you start to lose pace against inflation, and then the clientele… If you’ve been charging $1.50 for a coffee for the last five years, now try to move it to $1.95. Right? You have to keep pushing, pushing, pushing just like everybody else is pushing you. You got to protect that margin. Otherwise, you end up working for less, and that’s not going to help that cash flow. The cash flow is what gives the business value. Someone believing that they can carry on that cash flow once they’ve taken over, that’s what makes someone decide they’re going to buy your business.

Stacy: 25:49
Okay, and you get to the point where you’re like, “Okay. I’m ready to sell. I’m going out. This is what I’m going to plan on doing.” What do you do? How do you find someone who’s going to be interested in your business?

David: 26:02
Yeah. The first thing you have to do is not tell anybody because if people find out that your business is for sale, you can end up destroying it.

Stacy: 26:10
Okay.

David: 26:10
Every stakeholder group you can think of has a problem with you selling your business. Your employees are worried that the next owner won’t be as competent or maybe you’re saying you’re selling because really, you’re in some kind of trouble. Most people get their business education from the mainstream media, and the last time you heard a business went up for sale from the front page of the newspaper is because the business was in trouble.

Stacy: 26:34
Yeah.

David: 26:35
Right? People will make that assumption. They’ll go, “Oh, there’s something wrong,” and a lot of employees really need their paycheck. The vast majority of people out there live paycheck to paycheck, and if they think that there’s some kind of hazard to that paycheck continuing, they’ll start looking, and they’ll either worry that the business is failing, or they’ll worry that the new owner won’t like them, or they’ll worry that the new owner has a brother-in-law that needs a job, and he’s going to give their job to the brother-in-law. Right? The big problem, of course, is that in any business, your best employees always have opportunity because your competitors know them.

Stacy: 26:35
Right.

David: 27:11
Right? Your competitors know who your good employees are, and so they can go and find jobs. If they start bailing, of course, then it creates a problem for you in maintaining your service to customers. Suppliers, bankers, customers, anyone who finds out the business is for sale, it can be damaging to those relationships, so the first thing you have to do is you have to put a proper price on it. You have to work with someone who understands how to do it properly to give you a realistic price and show you why the price they’ve determined is what someone will realistically pay. Then, you have to prepare your package, which is every bit of information a buyer might possibly want to know about your business because the worst thing that can happen is you get an interested buyer, and then you make them wait six months while your accountant finishes something.

Stacy: 27:58
Right.

David: 27:58
Right? You need to create momentum in the process, and so you have to be ready for everything that they’re going to want. We call that the package. Then, you go advertising or you strategically reach out to people or use a broker. For example, if you’re going to go with a business broker, they’ll help you with the evaluation and the packaging, and then you start talking with potential buyers, and you use nondisclosure agreements, and you confidentially talk with them. When you find the right buyer, then you have to work with them to help them make the deal, and this is where a lot of people have trouble, and so they approach this as though we’re like selling a house or selling a car. They think, “I’m the seller. You’re the buyer. Bring me the money, and you can have the thing.”

The biggest problem in selling a business is for the buyer to get financing, especially if you’re talking about a service-based business or an agency business where there’s not a lot of tangible goods or inventory. Things like that. The bank is not going to be very pleased with that because there isn’t any collateral. Right? The buyer is going to have to figure out, “How am I going to pay you?” More often than not, that means that the seller is going to end up financing part of the transaction, and it’s amazing how many people have been in business for a very long time don’t understand that when businesses are sold, sellers often don’t get all the money at closing. They walk away with a note, and they have to get paid over time.

It’s interesting because if you go down the golf course and someone says, “I just sold my business for a million dollars,” everyone says, “Whoa, congratulations.” Nobody ever says, “Oh, yeah? What were the terms of sale? How much did you get on closing? Do you have to hold paper? Over how many years?” Nobody asks those questions.

Stacy: 29:38
Right.

David: 29:38
That’s very often what ends up happening. Right here near me, I have a friend of mine that I know who sold a family business. They’ve been in business for over 20 years. They sold to a multi-billion-dollar corporation who still made them finance 35% of the deal.

Stacy: 29:57
Wow.

David: 29:59
Right? They probably could have written a check, but they didn’t.

Stacy: 30:03
Because it lowered their risk.

David: 30:05
It lowered their risk, and it also… The other thing is that they need to maximize the return on their own money, so taking their own money and giving it to someone to buy a business is not a good use of their money. They want to borrow by the business. It’s the same with if you need a house. If you had $25,000 or $50,000 in the bank and you needed a place to live, what most people would do is they’d use that money as a down payment, and they’d borrow the rest from the bank to buy a house, but you could take the 25 or 50 grand to buy an old trailer home. Most people don’t do that. Most people want to leverage for something bigger, and so if you’re trying to sell a business for half a million dollars, the buyers don’t have that money. The buyers you’re going to meet are people that have 50 to a hundred grand. The people with half a million dollars are trying to buy the $3 and $4 million businesses.

Stacy: 30:57
Right.

David: 30:57
They’re trying to leverage bigger, and so if the buyers can’t get the money from the bank because there’s not enough collateral or whatnot, then you’re going to have to be the bank, and that’s a big surprise for a lot of business owners.

Stacy: 31:09
What does that usually mean for them? If they’re going to be carrying a note, what typically are the terms to get payment on them? How long are they going to be carrying a note? How does that actually work?

David: 31:22
It’s a great question. It all depends on the negotiation. Sometimes, it even depends on the other lender, so if there is a bank involved, that bank will often dictate terms to the buyer and seller. They’ll say, “Look. We’ll finance this deal, but this is what it’s going to look like.” I’ve had people come along where the seller has agreed to finance 20%, well, let’s say, and the buyer has 25% of the money, but the balance of the money is coming from the bank. The bank says, “Yeah, we’ll make this loan,” but the seller is going to have to wait for five years with interest-only payments before you start paying down the principal on this note. That’s one example. Okay?

In other cases, it could simply be that the seller has to carry a note over 3, 5, 7, 10 years, and they can start getting their principal payment right away. In other cases, it can be based on ratios on the balance sheet, so the seller can start collecting his money, but if certain balance sheet ratios in the business weaken, the bank manager can dictate that the seller no longer gets payments until the ratio improves.

See, the seller financing, it does a lot of different things. Number one, it protects buyers from risk because it’s usually subject to offset in the case of a material misrepresentation. Buyers are worried they’re being lied to, right? If I have the seller financing a part of the deal and if I find out later that they lied to me about something, then I can offset my damages against that note. It makes me more confident as a buyer to move forward on the deal.

Stacy: 32:59
Sure.

David: 33:00
It’s also a way for the bank to offset part of the risk because the bank will always become ahead of the seller in the security list. Right? In the ranking or order of liens, and so if a buyer comes into a business, and after a couple years, they start to falter, then the bank knows that the only person who would likely ever want to come in and take over that business is the seller, so the bank will call the seller and say, “Look. If we have to foreclose, you’re going to get nothing. Why don’t you foreclose? We’ll let you sign your name on the note here at the bank and you can basically take the business back from what’s owed?”

There’s all kinds of things that can happen, and I always say, “Compare it to a car dealer.” A car dealer knows that most people don’t have $40,000 in the bank, and so what do they do to sell those cars? When you go and meet with them, they’ve already got the paperwork from the leasing company and the bank, and everything all set up.

Stacy: 33:54
Yeah.

David: 33:54
They’re ready to help the buyer with that problem. When you’re selling a business, it’s the same thing. The buyer is not going to have all the money, so how are you going to help them buy your business? I’ve seen a lot of deals go sideways because the sellers have this attitude like, “Show me the money. I’ve got a great business. You got to pay me.” In reality, they should be trying to find the best, most qualified candidate to buy, the person they believe is going to be successful because that’s going to be their best opportunity of getting all the money paid off, and then the seller is going to have to have work with that buyer to help them get the financing.

I just helped a client in Wisconsin, and they were selling a bakery that have been in the family for a long time, and I was coaching the seller, and when the buyer came along, the buyer made the offer, and I said, “Look. This is what you may have to do.” In the end of the day, they were able to get SPA financing, but when the buyer went to the bank, the seller was with them in the banker’s office saying, “I’m here for you. What do you need about my business? What information do you need? What can I do to make this process work for the bank? What can I provide for the buyer?” Really, it’s a collaborative effort, and that’s what the seller financing also does is it aligns the interests of the buyer and the seller. If I bought your business and just paid cash, you would have no interest in helping me down the road because you could walk away with your money.

Stacy: 35:24
Yeah.

David: 35:25
If I bought your business, Stacy, and still owed you 30% or 40% of the money after closing day, and then I had a problem or a question about a long-time customer, I could call you up and say, “Look, Stacy. Can I talk with you for a few minutes with this customer? I’m having some issues with them.” You have an interest in helping me because you want me to be successful because you want your money.

Stacy: 35:45
Sure. Right.

David: 35:46
Right? It’s a way of entrenching or codifying this relationship sort of mentorship, partnership kind of thing that goes on, and in the 36 deals that I did here locally while I have my business brokerage office open, in every case but one, the buyer and seller ended up becoming friends through the deal, and so after the transition period was done, after the training had been delivered, after everything in the contract was said and done, they’re still talking to each other.

Stacy: 36:20
That’s great because you’re really… I mean, if you’re a bit of an entrepreneur, you’ve created a business, you’re really selling your baby and you want someone who’s taking it who’s going to take care of it.

David:
36:34
Not only are you selling a baby, you’re selling something that’s ethereal. It’s not tangible.

Stacy: 36:39
Yeah.

David: 36:40
When I describe a business, sometimes people will say, “Well, my business is my auto repair shop,” and I’ll say, “No, that’s a building,” and people will say, “Well, my business is my portfolio design.” I’ll say, “No, those are pictures.” Right? Really, what a business is, is a system where people and capital in someplace, either online or in the real world, work together to create a cash flow, and so the buyer is buying that system, that methodology, that repeatable way of doing things, and you can’t put your hands on that.

It’s a very intangible thing, and sometimes, we use tangible tools, but it’s a system, and so it’s very difficult for someone to repossess it. That’s why the banks don’t like to lend against a business unless there’s a government program backing it up. As long as the taxpayer is on the hook, they’ll make the loan, but if not, they say, “Well, what collateral is there?” Right? “What machines, inventory, et cetera could we take if you don’t make the payment?” It’s because they’re very aware of just how fragile a system can be. You put the wrong person in customer service for a couple of weeks and they start to alienate your clients, they can ruin a business really quick.

Stacy: 37:58
That’s why franchises are often preferred by people buying businesses because they’re looking at something that has been able to be duplicated by others and that there is a guarantee almost that there’s a safety net.

David: 38:13
Well, I’ve got a lot of opinions about franchises. In fact, I wrote a book called Franchise Warnings.

Stacy: 38:20
Yes.

David: 38:20
I think that what you said about systems and things is accurate.

Stacy: 38:24
Right.

David: 38:25
When you buy a franchise, you should be getting an operating system and be taught a way of doing business. Opening a new franchise is just like opening any other new business. You’ve got to take customers from someplace is.

Stacy: 38:36
Right.

David: 38:39
The guarantee of success that franchisors like to talk about like how much more successful it is to open a franchise than a new business from scratch, I throw a lot of salt on that argument in my book. I’ll just give you a quick, a couple quick tip… hints as to why I say that. In order to open a business from scratch, you need like $100. Right? You got to register a domain name, maybe get some business cards and a phone, and you can be in business. Right?

If you’re going to compare the cost of spending $100, or $200, or $500, or a million dollars on a franchise versus that kind of startup, it’s very easy to say that the franchises have a much better rate of success because the people who are starting them have much greater financial resources.

Stacy: 39:26
Mm-hmm (affirmative).

David: 39:28
Right? The person who invest $100 to try to become a window washer, if they find a better job, their business is going to close. Right? Right?

Stacy: 39:35
Right.

David: 39:37
lly to finance losses where a lot of the from-scratch startups can’t, and so it skews the statistics. The other thing that I have seen many times with franchises is that they’ll talk about how many of their businesses are still open for five years, and the most common commercial property is a five-year lease.

I have seen financial statements for a lot of franchises where they’re marginal breaking even or losing a bit of money, but the buyer or the franchisee had to personally guarantee the lease on the rented location, so it actually made financial sense for that person to keep a losing business open rather than risk getting sued by a landlord, and so when they reach the end of their five-year term, then they give their notice, they close up, and they move out.

The real question for franchisors is, “How many locations are open after six years with their original owner?” That last part is really key because sometimes people will spend hundreds and thousands of dollars. There’s another example of this right here in my own town. Someone opened a franchise food place had to go $400,000 building the store. After a year and a half, they just couldn’t make it. They ended up losing the location. They didn’t pay the royalties. The franchisor took over the location, made it a corporate store briefly, then sold it to someone else for less than a hundred grand.

That second owner has a much different financial position than the first one did. They don’t have the debt, so their cash flow situation is much better, and they may be successful. Only time will tell, so the question is, how many are open after six years with the original owners? You start to see a very different picture of what’s going on with the franchise.

If somebody wants a business and they want to be told what to do, and let’s face it, a lot of people work well within systems and rules, then I often say to those people, “Look out a franchise. Don’t open a new one. Look at one that’s for sale,” because then you can actually see what the performance of that unit is and you can look at what you’re buying, and you can say, “Look. I’m going to invest x amount of dollars, and this is the cash flow I’m going to acquire, and I’m going to get the benefits of the systems, and the brand, and the trademark, et cetera.”

Stacy: 42:09
No, that makes absolute sense.

David: 42:11
Yeah.

Stacy: 42:11
Okay. You are right, so listeners, before we even started this, he said that this could take 12 hours or more in order to dive in deep to everything. I’m like, “Oh well, we’ll have about an hour or a little less,” but it really will, looks like, take over 12 hours, but this has been extremely valuable. Before I ask you for some last thoughts and a little bit more advice, how can people learn more about you, and where can they find out more information about your seven books and having you come on as that mentor, coach, consultant?

David: 42:45
Yeah, sure. The best place to reach me online is at my blog site. It’s davidcbarnett.com, and on the blog site, you got access to hundreds of posts, which have videos embedded in them, and there’s direct links to YouTube, my YouTube channel and different playlists that I put together. From that page too, you can sign up for my email list, and I send out emails almost every day, but you can choose which topics you’re interested in, so if you like… If you want to know about buying, or selling, or better management techniques, or financing, you can just check off what topics interest you, and then you’ll get to learn more over the course of time.

Stacy: 43:20
That is awesome, and so as some parting words of advice to those who are still firmly in… have their business. Maybe they’re not quite ready to sell it. Maybe they’re just trying to think about it a little bit because 10, 15 years can pass very quickly in a blink of an eye. What would you tell someone as the most important thing to start doing right now?

David: 43:43
Just start to think about what might happen if you weren’t there tomorrow because when you sell a business, that’s what’s going to happen. You won’t be there on a certain day, and so how is that new person going to be able to manage things or take care of things? Start documenting your systems. Start writing down your workflows, how you do things. Even professionals that are highly skilled in a creative talented area, they still have a process.

Stacy: 44:12
Right.

David: 44:12
Right? When you’re working with someone on marketing, maybe number one, you examine what they’re doing, and then number two, you confirm what their desired goals are, and then number three, you figure out what the budget might be. There’s a process even though it might be in your head. Start to document that stuff so that you’ll be able to hand it over to someone, you’ll be able to teach someone, and more importantly, this is one of the big things. The reason why, and we talked about franchises, but the reason why McDonald’s sells a lot of Big Macs is when you’re on the road in a strange town, and you’re in a rush, and you don’t know what food is going to taste like at different places, you can be comforted by the fact that you already know what a Big Mac is going to taste like because you’ve had them before and they’re all the same. Maybe the Big Mac isn’t the best hamburger in the world, but you’re going to get what you expect. Right?

Stacy: 45:04
Yeah. It’s consistent.

David: 45:06
It’s consistent. By documenting your systems and processes, and getting things written down, what you’re going to be able to do then is be able to adapt or present those and have your team members use them. It actually becomes a selling tool to get your customers off of you personally and on to your team because you can start to say like, “Yes, we’ve been working together for years, and our documented process is an 87-step process that we take every client through on every project. Sally, and Peter, and John, and Felipe, they all have the same process that we all use together, and we all talk about our clients at our regular meetings at the different goal points through that process. Even though you’re going to be talking with Sally instead of me, you’re still going to end up with the same result.” That’s what’s going to allow you to start to divest yourself is when you get those systems in place.

Stacy: 46:02
Yeah, that makes absolute sense, and I think all of us probably could use a little more systems and processes.

David: 46:08
Yeah. That’s awesome, Stacy. Thanks for having me on the show today.

Stacy: 46:12
I really enjoyed it, and I think our listeners will have as well, so thank you for your time, David, and for everyone listening, this is Marketing Mistakes and How to Avoid Them, and I’ll speak with you quite shortly.

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