CHAPTER 7

Managing Your Search Effectively: An Overview

As you begin your search, you’ll need to juggle two closely related tasks. First, there is sourcing—finding small companies that are acquisition prospects. While you are looking for just one good acquisition target, you’ll need to source at least hundreds—yes, hundreds—of prospects that are available before you find one that is right for you. Second, there is filtering: You’ll need to learn enough about these prospects to eliminate the companies that will not be good acquisitions for you. To search efficiently, you must be ruthless and quickly reject weaker prospects so that you can spend time learning enough about interesting acquisition opportunities to make an offer.

Sourcing

Whether you choose to source through brokers or go directly to owners, you will need to build a system that generates a steady stream of prospects throughout the time you are searching. It will take a month or two for you to build momentum, and after that, sourcing will be a largely repetitive task through which you’ll discover, on average, two new prospects every day.

As your search progresses, keep refining your sourcing efforts to more efficiently find the deals that are the most interesting to you. You might, for example, discover that certain brokers specialize in particular industries or geographical locations that intrigue you, or you might focus on a specific industry that you believe has particularly attractive prospects.

As you search, don’t get so excited about a particularly attractive prospect that you devote all your time to it and stop sourcing new prospects. Most exciting prospects eventually become far less exciting: Perhaps you discover that the historical results are much weaker than originally represented, or perhaps the prospect has lost several large customers, or perhaps you and the seller cannot negotiate agreeable terms of the sale. Whatever the reason, sometimes it takes months to eliminate a prospect. If you stop sourcing, you’ll have to restart sourcing. The restart will take a month or two, needlessly delaying the successful conclusion of your search. It is much better to maintain your sourcing momentum and add new prospects every day up to the day that you finally close on the small company you acquire.

Filtering Prospects

Efficiently filtering the new prospects you source is one of the most important tasks in the search process. Most of the business you source will have to be rejected quickly for you to have sufficient time and resources to learn more about those that seem to hold greater promise. Filtering is an iterative process. There are initial filters that you can apply quickly and with very little information; for example, you can eliminate a prospect for its unattractive location or industry almost immediately. When the prospect survives the initial filters, you’ll then apply deeper filters that require a bit more information about the business and bit more time to form a judgment about the business or its seller. Eventually, either the prospect will be eliminated on the basis of readily available information in the filtering process or you will decide the prospect is worthy of more scrutiny. This next step—preliminary due diligence—is covered in part IV of this book, “Making an Offer.”

Initial filters

Your initial filters should be based on simple information about the prospect—information such as a basic description of the business, its size, and its location. For prospects sourced through brokers, this information will be readily available in teasers, one-page summaries of businesses up for sale. Teasers offer the first information you’ll learn about the prospect, and this information is often sufficient to eliminate the business from consideration. For directly sourced prospects, some of the information for the initial filters will be available from business directories and other public listings—indeed, you may glean enough information from these sources to eliminate a prospect before even attempting to contact the owner. For the businesses you do contact, you’ll apply the initial filters using the information you receive during your first call with the owner. Whether you are applying your initial filters through a teaser or the information you glean from the first call with a directly sourced prospect, it is usually a very quick process. For companies that you can eliminate because of a feature like location, the filtering might take less than a minute. Other filters will take more time, but in general, you should conclude within an hour or two whether a prospect satisfies your initial filters.

Your initial filters are reasons to quickly eliminate prospects. In the last chapter, we described some features of the business we think you should search for. Use the initial filters to apply those characteristics to quickly reject the prospects that don’t measure up. Some aspects of firms, like enduring profitability, will not be readily apparent and so won’t be first on your list to investigate. But others, like the overall profitability of the prospect, are easy to determine. Your initial filters should answer these simple questions:

  Is the prospect consistently profitable?

  Is it an established business instead of a start-up or turnaround?

  Is it in the right size range?

  Is it located in a place you are willing to live?

  Do you have the skills to manage it?

  Does it fit your lifestyle?

If you can answer yes to these initial questions and the prospect also survives any additional filters you choose to apply, it is time to apply deeper filters.

Deeper filters

Here are the two most important questions that you want to answer when applying your deeper filters:

  Is the prospect enduringly profitable?

  Is the owner serious about selling the business?

While it’s too early in the process to expect definitive answers to either of these questions, you are trying to make a quick preliminary assessment, which will require a closer reading of the materials or a conversation with the broker or owner and some judgment on your part. Brokers can provide more information about the prospect either in a phone call, an email, or a confidential information memorandum (a more detailed written description of the prospect). For prospects directly sourced, information is more difficult to obtain. You can request financial statements from the seller and then talk with him or her to learn more about the business. With any of these methods—information from brokers, financial statements, direct communication with owners—you are not trying to learn everything you can about the prospect; instead, you want to learn just enough to eliminate it.

The first deep filter to apply to a prospect is an assessment of its enduring profitability. An essential characteristic of a smaller company with enduring profitability is that it has customers that regularly buy from it again and again. But because you do not yet have access to historical customer lists at this stage of filtering, you need to infer what you can about recurring customers from the information that you do have. Try to figure out why customers buy from this company instead of its competition and why they don’t use the presence of competition to drive down the company’s profit margins. In chapter 10, “Enduringly Profitable Small Businesses,” we will identify specific business characteristics associated with recurring customers and, in turn, with smaller companies that have enduring profitability. Chapter 11, “Using Financial Information to Gauge Enduring Profitability,” provides some quantitative filters you can apply to also get a sense of a company’s enduring profitability.

The second deeper filter we recommend is that you evaluate the owner’s willingness to sell. As we mentioned earlier, for most owners, this will be their first experience selling a business. As they make this journey, they will learn a lot. They will learn how much their business is worth. They will learn the risks and requirements of normal deal terms. They will reflect on what their lives will be like after the business is sold. For all these reasons and more, it is not uncommon for a business owner to change his or her mind about selling, even after considerable effort has been expended by both buyer and seller. The sellers aren’t being deceitful; they are learning as they go. But if you’ve spent several months working with a seller and learning about the business, you have paid a heavy price for their education if the deal doesn’t go through. So, we recommend making an early judgment about an owner’s commitment to sell and only pursuing the prospects whose owners are serious about selling. In chapter 12, “Filtering for the Owner’s Commitment to Sell,” we offer some guidance on how to make this assessment.

Next Steps

The initial and deeper filters help you eliminate prospects that will not be good acquisitions for you. If you use these filters efficiently, most of your time will be devoted to learning more about the companies that survived these filters. As you study these companies, you’re likely to come up with more questions about each business than you have answers. Keep track of those queries—if a prospect still seems interesting after you’ve spent a day doing research and applying the initial and deeper filters, those questions will form the basis of the next step in the process, preliminary due diligence. We’ll cover that in chapter 13, “Preliminary Due Diligence,” but first we’ll describe the sourcing and filtering processes in more detail.