CHAPTER 9

Sourcing Directly

In May 2012, Ari Medoff completed his acquisition of Nurse Care of North Carolina, a home health-care agency located in Durham, North Carolina. He found Nurse Care after eight months of sourcing prospects by directly contacting business owners. Ari explained why he chose to reach out to sellers directly as part of his sourcing strategy: “We did some outreach to brokers. But by directly approaching owners, I was able to see opportunities before they were widely shopped. I also avoided the competition of a broker-run auction.” Also, he wanted to live in the Southeast, where he had been raised, and in a smaller city, where he could raise his family and become a member of the community: “I grew up in a tight-knit family of six children in Greensboro, North Carolina, where my dad was a doctor at Duke Hospital and my mother a stay-at-home mom.” Direct sourcing would allow Ari to incorporate his strong geographic preference into his search.

Searchers who focus on direct sourcing often say they get better pricing and find better companies. They also form a stronger personal relationship with a seller. Good relationships are particularly important in the small-company marketplace because sellers usually have no experience selling companies and are often surprised by standard deal terms. A broker can help mediate a transaction, but in their absence, a friendly, trusting relationship with the seller supports the give-and-take that gets deals done.

There are two early, essential steps when you are sourcing prospects directly. These steps are not required when you source through brokers. First, direct sourcing requires that you find owners who are interested in selling their businesses, while with a brokered search, the fact that the owners have retained a broker is at least some evidence of their commitment. Second, direct sourcing requires you to collect, on your own, enough information about the prospects so that you can reject some of them. In a brokered search, on the other hand, that information is contained in the teaser and confidential information memorandum (CIM).

Finding Interested Sellers

Direct sourcing requires that you communicate with thou sands—yes, thousands—of companies’ owners to find those who are interested in selling their businesses. This task becomes a numbers game because it is very difficult to learn much about a small, private company and its owner without talking with them, but very few—usually 5% to 10%—are interested and willing to have that initial conversation. With the willing owners, however, your outreach will be warmly welcomed. These become your prospects. Of course, most of these contacts will not pass your initial and deeper filters, but remember, you are only looking to buy one company.

With a direct approach, you use business directories and online databases to identify the thousands of businesses you’ll need to contact to identify just a few interested parties. Once you have selected the prospective businesses, use some combination of emails, direct mail, and phone calls to reach out to them. Email has a practical advantage over trying to cold-call business owners by telephone, even though the latter might at first seem like a more personal approach: Business owners tend to have receptionists or voicemail as gatekeepers on their telephone; your email, on the other hand, is likely to reach “owner eyeballs.”

However you approach it, direct sourcing is an intense and time-consuming process. Searchers who direct-source usually use unpaid interns who are assigned tasks of assembling mailing lists and sending out emails or letters to business owners. These interns are typically recent college graduates who are looking for business experience to burnish their résumés. They spend from three months to one year working full time on an acquisition search—the searchers we have spoken to report that interns are not hard to find. Because interns require management and coaching, it is best to employ full-time and not part-time interns or, at a minimum, interns who can commit a meaningful number of hours each week.

Your message to owners

With a direct-sourcing approach, you need to balance reaching a large number of prospects with generic messages on the one hand and crafting personalized messages that generate a higher response rate on the other. Ari Medoff took a hybrid approach that allowed him to do both.

First, he and his interns created a large email list with 20,000 names of smaller firms located in the areas he wanted to live in. They assembled the list from a variety of sources, including internet listings, business directories, local chambers of commerce lists, and so on. He emailed thousands of owners of these firms, introducing himself and describing his objective very generally. Ari’s typical email read like this:

Over the several months of this generic but far-reaching campaign, Ari saw a response rate as low as 0.5%—similar to the average response to direct mail.

At the same time that he was sending this generic message, Ari also created a set of much more personalized emails. Because each message required more time and effort, he didn’t send out as many; however, the response rates were better. Here is an example of one of his more customized communications:

Like Ari, once you have assembled your list of prospects, you will need to determine the right combination of personal messages and mass mailings to reach out to owners. You could randomize how your messages are assigned, but you might more reasonably target the more personalized messages to prospects that seem more appealing, for example, in light of their location or industry.

Filtering Prospects

Once a business owner signals interest in selling, you need to learn enough about the prospect to decide if it is interesting to you. You’ll follow the same filtering process as with a brokered search, but you need to find your own information to evaluate the prospect; without a broker, there is no broker-prepared teaser or CIM. Most searchers schedule a telephone call with the prospective seller as the first step in assembling the information that will be the basis of their filtering.

The first call

The easiest way to begin to gather the information you’ll need to filter prospects is to speak with the owner. While there’s an enormous amount that you need to learn about the business, the owner is unlikely to give you much information at this point, and you can only focus on so many things at once. Owners are especially sensitive about sharing any detailed information about financials. Therefore, with this first call to the owner, focus on three goals.

First, as with a brokered search, you need to establish your credibility as a buyer. You need to quickly make the owner feel that you are someone to whom they could imagine selling their business. You should leave the person with an impression of your management skills, humility, willingness to learn, and energy—and access to capital. For Ari, his geographic focus helped: “I found that owners all took me more seriously when they learned I was from the local area.”

Second, you need to assess the owner’s interest level in selling the company. The risk of an uncommitted seller is far more acute than it was with a brokered approach—you are now, after all, dealing with owners who may have never thought about selling, not ones who hired brokers to sell their businesses. Gently probe the owner’s interest in selling. Although an assessment of the owner’s commitment is one of your deeper filters for prospects sourced through brokers, there is a much higher likelihood of an uncommitted seller among directly sourced prospects. Consequently, getting information early about the owner’s reasons for selling is especially helpful. Selling is a big decision for business owners, and real sellers are usually able to specifically describe their motivation. We’ll provide guidance on elucidating and examining these reasons in chapter 12, “Filtering for the Owner’s Commitment to Sell.” Although you also want to learn early on if the owner has a realistic valuation for the business, this first conversation is too early to accomplish that. Before you can discuss value, you will need to obtain the company’s financials and determine the annual cash flow it generates.

Third, you want to begin to gather information to apply your initial filters. For example, make sure that the business is in the size range that works for you. If it is too small—profits below $500,000—it probably isn’t worth your time. If it is too big—profits above $3.0 million—you’ll probably be unable to acquire it for a reasonable price and the acquisition will require more fund-raising and associated complexity than we recommend for a first-time buyer. Of course, prospects are not going to reveal their company’s profits to a stranger, but you can get around this by asking some general, high-level questions about the business: How long has the company been in business? Why do customers select it? What are the competitors like? How many employees does the company have? From the owner’s answers, you can extrapolate whether the company is likely to fall into your size range.

Armed with the information you gathered in the first call and the information about the prospect’s location and industry that you gathered before the call, you should be able to apply your initial filters. As the call ends, if it seems that the prospect passes the initial filters, be sure to keep the momentum going. “This has been a good call. I really appreciate your time, and I’m excited about your business and its potential. Why don’t we both give it some thought? May I call you next week? We’ll probably both have some questions we’ve thought of in the meantime.”

If the prospect does not pass your initial filters, try to use the conversation to generate additional leads. Small-business owners know other small-business owners and may well know other businesses that might be good prospects.

A warning: You will find prospects who seem interested in discussing a sale, and in the very first call, invite you to visit them as a next step. It’s tempting to accept; it can feel like you’ve just gotten a sharp tug on your fishing line. But it’s much too soon to visit unless the owner happens to be a short drive across town. You will exhaust your time and resources if you visit every owner who expresses interest in meeting you; just because the owner is interested in selling doesn’t mean the company is an attractive acquisition. You need be confident that the prospect meets your initial and deeper filters before you get on a plane.

Next Steps

As you continue to work with a prospect, move toward signing a nondisclosure agreement; then the owner can send you some historical financials. This may take a while because owners will be reluctant to share confidential information. But having those financials in hand, together with your conversations with the owner, is like having a CIM; you’ll be able to apply your deeper filters to see if the company is enduringly profitable or if there is a reason to say no. You can learn about the company’s profitability, stability, growth, and thus its value to you. As you go, you’ll generate more questions to ask the seller, such as the reasons behind any year-to-year changes in revenue, expenses, and profits. You’ll use that information to assess whether the company is enduringly profitable—which we’ll discuss in the following two chapters.