The Tricky Business of Selling Small Businesses

Introduction:

This week, special guest David Barnett, who started helping owners buy and sell businesses in 2008, offers some guidance on an often-misunderstood sales process. Early on, David was a business broker. “I sold over three dozen companies for other people,” he tells us, “and it was very interesting and exciting. It was also a terrible business.” So he changed business models but has continued to do pretty much the same work. As a result, he’s amassed a lot of first-hand knowledge, much of which he shares in our conversation, including: why many owners fail to think of their business as an asset, why sellers shouldn’t be too quick to reject earnouts, why buyers should consider making multiple offers for the same business, how buyers can protect against the post-purchase loss of important customers, why businesses are selling for less than they were a couple of years ago, why there may be a smarter way to buy a business than by scouring business-for-sale websites, and why there really isn’t a true market for buying and selling small businesses.

— Loren Feldman

Guests:

David Barnett, who is based in New Brunswick, Canada, and helps people around the world buy and sell businesses.

Producer:

Jess Thoubboron is founder of Blank Word.

Full Episode Transcript:

Loren Feldman:
Welcome, David Barnett, our special guest today. It’s great to have you here. I’ve really been looking forward to this conversation for a lot of reasons, but especially because you’re a consultant who helps people buy and sell businesses. And my sense is that, as important as those activities are, the buying—and maybe especially the selling—of businesses, I think, are not nearly as well-understood by business owners as perhaps they should be. And for some understandable reasons, but it’s still an interesting dynamic. Do you agree with that?

David Barnett:
Yeah, I do, and it aligns perfectly with my experience. I’ve been involved in this for a long time. I was a business broker back at the end of 2008 for three and a half years before I left that and eventually ended up doing the same kind of work as a consultant. But I would probably suggest that about 90 percent of business owners are not really thinking about their business as though it were any kind of asset. The person who owns the roofing company, for example, who has several crews, and they go out and replace shingles on people’s homes, a lot of the people who run that kind of business consider themselves roofers. They don’t consider themselves business owners.

And I think it’s when people consider themselves to be a business owner, they start to think of this thing like a thing they own that creates a cash flow. And I think that it’s probably 10 percent or so of business owners who probably have that sort of attitude. And that’s the attitude, I think, that is required in order for somebody to start to proactively think about the future and what their plan is going to be, as far as an exit—and worrying about things that they could do in the business to actually make it better or more valuable or easier to sell.

Loren Feldman:
You know, it’s not like anything you just said is a deep, dark secret. This conversation has been ongoing for a long time. Do you have any theory as to why it hasn’t sunk in more deeply?

David Barnett:
Yeah, I think it’s perfectly rational that, for most people, it has not. And let me justify why I’m saying that. The first thing we need to understand is that businesses sell for relatively low valuations. We typically talk about businesses being sold as a multiple of cash flow to the owner. And so, right now in the stock market, there are several high-flying stocks that we hear about all the time that are selling for many dozens or hundreds of times their annual cash flow. But, traditionally, stock market public companies would sell for, I don’t know, 15 to 20 times earnings.

And small businesses, small privately owned businesses, will sell for sometimes less than two times earnings, up to two and a half, three-ish. So a really great, well-run, successful small business that’s owner-operated, if the owner does everything right and exits and achieves all these things we’re talking about, they basically are going to be able to walk away by pulling forward just a few years of earnings into their pocket. And so if a business is really small, if it’s not that profitable, if it’s kind of marginal—there’s all kinds of reasons why somebody rationally might not put the effort into making those preparations. Because they may realize, in their own introspective way, that those preparations and the work may not really pay off for very much. Does that make sense?

Loren Feldman:
It does. It makes perfect sense. The biggest challenge I’ve seen for owners looking to sell is that they have not figured out how to remove themselves from the day-to-day of their business. Is that what you see as well?

David Barnett:
Well, it depends on what you think your challenge is going to be. So if your challenge is selling your business quickly, or if your challenge is selling it for the highest price, those are two different challenges. And to sell a business more quickly, you need a bigger pool of buyers. And in order to get a bigger pool of buyers, you need to be able to show the greatest number of people that they, too, can run the business.

To use the roofing company example, if you can show a guy who works at the post office that you have systems for marketing and systems for quoting and systems for organizing the schedule and the payroll and systems for ordering the product and how you get it all delivered to the right house on the right day with the crew showing up, the person who works at the post office is gonna be more convinced that they can run the business too. But if you don’t have any of that stuff, your business may still be sellable, but it’s probably only going to be sellable to some person who works in the roofing trade and they already have some insight into what it is that they’re going to have to do every day when they own your business.

And so, when we try to get the highest price, price is usually a function of the cash flow. So if you can make your cash flow from your business as high as possible, that’s going to justify a higher price. The buyer is always going to ask themselves the next question, and the second question is always: Great, now that I understand this cash flow exists, what is the likelihood of it continuing under my stewardship?

So the systems and things may be important in that question, but what’s really important in that question is: Who are people really doing business with? Are they doing business with this company, with the brand name? Or are they doing business with the owner who people know, like, and trust? And if it’s the owner, if the owner is front and center—and we’ve all seen these local businesses where the owner is in the advertising, and you go to the business, and the owner is helping customers and shaking hands and stuff—now that owner is going to be creating a harder time for them to transition the business to somebody else, because the buyer is going to be worried that once that seller is gone, that the people won’t want to come and do business with them.

Loren Feldman:
Do you have a checklist that you use if someone comes to you looking for help selling their business? I’m guessing you have a series of questions that you ask to understand what’s going on in that business. Could you walk us through that a little bit?

David Barnett:
Yeah, so when we start helping a business owner with the whole process, the very first thing we do is an evaluation of the business. And we have a system that we use that has this big questionnaire, and they’re general questions, and there’s over 100 questions, and we go through it. We actually try to cull it a little bit before we send it over, to remove the questions we know just won’t be applicable. But we try to get our heads around all the different areas. So there’s operational stuff. There’s marketing stuff. There’s customer concentration. There’s employee concentration issues, labor market issues, all kinds of factors that we look at.

And at the end of the day, the value comes from the cash flow, but we’re able to then modify—there’s a tool we have which allows us to subjectively modify the output of our analysis, so we grade it. Now, the output is a polar graph, actually, and you kind of see the area change as you score things above or below average. And it helps to quantify what those different sort of qualitative factors might imply. And sometimes we actually have to deal with things that are such a big problem that we deal with them in the actual deal-making itself.

So if you had a business, for example, where the top five clients were old, like 50 percent of your revenue, you could expect as a seller that there will be some kind of tie between the ultimate amount of money you get paid for the business and the retention of those top five clients. And that tie-in could last for several years. Because at the end of the day, what a buyer is buying when they buy your business is, they’re buying its cash flow. They need a cash flow, usually, to replace the job they’re leaving. Or maybe they’re already in the industry, and they want to grow strategically by buying your business, and they’re acquiring the cash flow. And the cash flow is required to service the debt they’ve taken on, likely, to buy the business.

And so, to have that cash flowing, they need all those customer relationships. And if some of that falls apart shortly after the takeover, then they won’t be able to service the debt with the reduced cash flow. And so a lot of the time, sellers have an issue with this. They say, “I found those customers. I nurtured those customers. What happens if I hand this business over to you, and you don’t take care of those customers and you lose them? I don’t want to be held responsible for what you’re going to do once you own the business.” But the reality is every part of business ownership is risky. And people face risks in the startup, they face risks in the operation, and there are also risks in the sale. And when you tie sellers and buyers together with these kinds of features in the transactions, what you actually end up doing is, you end up creating these temporary partnerships where both the buyer and the seller are in alignment of their needs and goals.

So if the seller needs the buyer to be successful in order to get all of their money, that helps the buyer have the confidence that they should actually do the deal, because they can see that the seller is willing to expose themselves to certain risks. And that shows the buyer that the seller— who understands the market, the business, and can appreciate who the buyer might be—has confidence in that person and the business and the marke. So the two of them then move forward.

And I’ve seen many instances where we have these big customer-concentration issues, and the seller ends up being somewhat responsible for those continuing for several years. And that means that the seller always makes themselves available to coach and consult with the buyer, to talk about that customer relationship, sometimes even to show up on the golf course two years after the sale, when the buyer is taking that customer out for a round of golf, and the seller shows up just to help cement that handover, to make sure that the cash flow continues and that, ultimately, the buyer gets what they paid for.

One of the things, Loren, that I often talk about when I’m asked to do an interview is that business owners spend an awful lot of time thinking about their customers: what they want, what they need, what they’ll pay for, what features they might enjoy in the product or service, etc. And then something weird happens when people start to think about selling their business. They suddenly become very self-centered. They think about only themselves and the money they’re going to get.

And the reality is that when you sell a business, you’re still in the business of selling something, and your customer is the buyer. And business owners need to think about that buyer and what the buyer needs. And what the buyer needs is, they need a cash flow that’s going to allow them to take home a salary to support their family. They need to be able to pay their taxes. They need to be able to service their debts. They have to be able to replace machinery as it wears out and breaks down. And I just find it very surprising how few business sellers ever sit down and look at their business and say, “If I was the buyer, what would my situation likely be? How much would I be borrowing? What would my payment be?” And just kind of walk through it from the buyer’s point of view to see what exactly they’re asking someone else to do.

Loren Feldman:
There’s a lot there. One of the things that strikes me is, I know it’s very common conventional wisdom that sellers are told to try to get as much of their payout as they can on the day the deal is closed, and not to rely on the performance of the business going forward for the rest of their payout, because you don’t know how well this person you’re selling to is going to run the business. It’s kind of coming at it from the opposite direction that you just described, and I’m curious what you think about that advice.

David Barnett:
It’s interesting. I just recorded a video that’s going to come out in the next couple of weeks on this, but the value of a business—it’s like a machine with two knobs, and there’s a price knob and there’s a terms knob. And if you adjust one knob in one direction, the other knob automatically goes in the other. They’re linked together with some kind of weird belt inside the machine.

And so if you want the highest possible price, then what you’re doing is, you’re stretching everything to the point where everything’s got to function just perfectly for that buyer afterwards. And it’s really hard to gamble on everything working out just right. And so a buyer will then see that they’re getting into a riskier scenario, and they’re going to want to try to offset part of that risk. And the easiest way to do that is to get more seller financing or some kind of earn-out provision.

If you want all cash on closing, the simplest way to achieve that is to get a lower price. And then it’s easier for somebody to stomach the risk of what might happen in the future, because they’re gonna have a lower debt obligation, etc. I’ve just seen these negotiations go back and forth. And when I’m working with buyers, for example, one of the things that I’ll often suggest to many buyers is that they make more than one offer at the same time. So what happens in that scenario? Well, the buyer gets three different offers with three different prices and three different sets of terms, because it is worth money to a buyer for a seller to solve part of their problem.

Let’s take the conversation to the car lot. Okay, so you’re at the car dealership, and you want to buy a $50,000 car, and the car dealer knows that most people do not have $50,000 in a bank account, right? So what the car dealer does is they go out and they make relationships with leasing companies and finance companies and banks so that there’s somebody there at the dealership who’s already got all of those problems solved so that they can then say to you, “Hey, you don’t need to have $50,000. We can help you get a loan.” And that helps them sell more cars.

So when you’re selling a business, the issue is that it is sometimes difficult for buyers to get the money they need to buy a business. And so by being willing to be part of that financing solution—like the car dealers, getting those banking relationships lined up—if you say, “I know it’s going to be hard for you to pay this really high price, so I’m going to help you. I’m going to invest money by lending you money to buy my business,” then you’re going to make it easier for the buyer to do the deal.

And by extension, if you understand going in that you are likely going to do this kind of deal, what it’s going to do then is number one, you can attract a greater number of buyers, which is going to give you more options as to who you’re going to sell the business to. And you can make sure you pick the right buyer who’s got the qualities, skills, and experience that you think are going to set them up for success, and ultimately, who’s willing to pay a higher price because of your help.

Loren Feldman:
I was also intrigued by what you said about client retention. Obviously, we’ve all heard of sales that involve an earnout, but it sounds like you were suggesting a specific kind of earnout, where the the future payments to the seller aren’t just dependent on the general success of the business, but tied specifically to whether the business is able to retain clients. I’ve never heard of that. Is that a common practice?

David Barnett:
It’s not very common, but many of my clients have ended up doing this. One thing to understand is that you can get as creative as you want to be in any of these business deals if there’s no bank involved. If there is a bank involved, then you might have another set of rules kind of applied onto the deal. So for example, if someone’s buying a business and they’re using an SBA loan, the SBA does not like these earnouts. They want the business sale to have a definitive price written down, like, “This is the price of the business.”

I’ve had deals before where there has not been one seller financing note, but there’s been six. So the buyer puts some money in, they borrow some money from a bank, and they give that money to the seller as well. And then there were six different seller financing notes, and each one of them was tied to a specific customer. And so the buyer was paying those loans, but the rules of those notes said that if the sales to the specific customer fell below a certain threshold, that the note payment in that month would be forgiven. So in that particular case, it’s almost like an earnout in reverse, where there is a specific price. This is what’s being paid for the business. But if, for some reason, one of those customers fails to continue buying, then the seller ends up losing a little bit of their sale price, the amount that was tied to that client.

And that’s just one example of how you can do this. Ultimately, like I said, we’re talking about a case where you could have five customers or six customers with half the revenue of the company. It would be significant in most small businesses if they lost one of those big five clients in that kind of scenario. The entire profitability of the business could evaporate.

Loren Feldman:
That’s all really interesting. You obviously have a tremendous amount of experience doing this. Let’s take a step back. How did you get into this?

David Barnett:
Oh, so, I was just one of those kids that’s always been interested in business. And walking into every business, as a kid, I always thought about how they could do things better, or what they could do to make the experience better, and eventually got into sales. My real education, though, I went to business school because I thought I would become a business person there. But you know, that’s not what they teach. They teach you how to be a middle manager in a big company. My real education came when I got out of university, and I went to become an advertising sales rep with my local Yellow Pages publisher, because I literally spent all my days meeting—

Loren Feldman:
[Laughter] You may have to tell some of our listeners what the Yellow Pages are.

David Barnett:
Well, the Yellow Pages was a printed version of Google before Google, right? And so, everyone had a telephone that was tied to the wall, and under the phone was this big book, and the front half of the book was everybody’s name and address—you know, it wouldn’t pass any kind of privacy laws we have today. And the back half of the book was yellow, and it was by classification. So, the accountants were in the front, and then the plumbers would be under P, and the tow trucks would be under T. And you would go in, and there would be advertisements there. And so it was my job to visit all these businesses and talk with the owners and managers and ask them what kind of customers they were looking for, and figure out how they made money, and how they could take advantage of additional phone calls coming from the Yellow Pages.

Loren Feldman:
That would have been great training for a business journalist, too.

David Barnett:
Well, it would have, because I learned so much about these different businesses. And for some of them, more customers meant putting a bigger ad in the local book. Or maybe there were a lot of ads, so maybe the right move would be to put color in their ads, so their ads would stand out. And for other customers, who were dealing more regionally, the solution was to put ads into many different books in other cities around us. And so I got to learn about what they were looking for, how they made money. Eventually, though, things changed. Google did come around. We got smartphones with the Internet. And so I left to start my own business, and eventually sold that and got into brokering commercial debt.

And this is where I first started to meet people who were looking to get money to expand their business. So I was helping with lease arrangements. I was doing factoring facilities, which is when you sell your accounts receivable to try to raise money. I was also helping people getting business loans and things like this. And the Great Recession came, and so a lot of my sources of capital kind of dried up. And I also met several people who were trying to get money to buy entire businesses in that time, and that was my first exposure to this whole idea that you could buy and sell a business. And so I decided, “You know what? I’m going to get into this.”

Because I saw some pretty awful things, Loren. I saw people trying to intermediate these deals between buyers and sellers who didn’t really know what they were doing. You know, people like real estate agents trying to sell a business, and the contract wouldn’t contemplate anything to do with inventory or operating capital. Or, there was one case where some people bought a motel and restaurant, and just before the sale, the sellers went and sold thousands of dollars’ worth of gift cards to their restaurant at a discounted price, and they pocketed all that cash. And the buyer shows up, and all of a sudden, all these people want to use these gift cards. And then he realized, “Oh my goodness, I’ve been screwed.” And he went and got a lawyer, and then the lawyer got me involved, and was like, “Can you comment on this?” And I said, “Yeah, this was a person who didn’t have any understanding of what they were doing, trying to broker this transaction.”

And so I ended up joining a big international franchise chain so that I could get access to training through an association of business brokers, and I did that for three and a half years. I was a business broker. I sold over three dozen companies for other people, and it was very interesting and exciting. It was also a terrible business. You can talk with a business owner for over a year about selling their business, and then when they decide to sell, you can get them to sign an agreement with you, and then it can sometimes take six or eight months for them to deliver all the paperwork you’re looking for because they’re busy running their business.

They’re not that organized. Their accountant still has to do something or another from last fiscal year. You know how it goes. And then, when you finally get everything you need, you package it together, and you start to confidentially advertise the business. And it can take you another year or more to find the buyer. And once you find the buyer, then you have to help the buyer. So the buyers got to put together a business plan and a cash-flow forecast. You have to bring them to a lender. You have to help them arrange their debt. There’s so many moving parts.

And so you can get down to the 11th hour on one of these deals after having invested two years in the transaction, and then things can fall apart for reasons entirely outside of your control. I had deals fall apart for franchise businesses where the franchisor was just a total jerk to the buyer and totally turned them off from the opportunity. I had situations where banks issued funding letters and then later rescinded them. I had businesses that operated within licensed industries where a government agency had to issue a license to the buyer and didn’t. All kinds of things that can’t really be foreseen. But when you’re putting these deals together entirely for a commission, you need it to close in order to get paid and bring home the bacon, as it were.

Loren Feldman:
That’s so fascinating to me, because I’ve always heard a version of that story that comes from the perspective of the business owners who say, “You know, the problem for us is there are lots of brokers who want to help big businesses do deals; there aren’t that many qualified people who are looking to broker deals with businesses the size of mine.” And I think you just explained why that is.

David Barnett:
Absolutely, and most business brokers are charging 10 or 12 percent commission. When I was a broker, I was charging 12 percent of business value and 6 percent of real estate value if the business owned real estate when it was being transferred. And those end up being pretty big commission checks when you sell a business that goes for $800,000 or a million dollars. When you’re talking about a business that could be worth a couple hundred thousand, then obviously you are talking about a much lower check. But it seems like a lot of money to that business owner.

The first business I listed for sale was a fried chicken franchise, and I sold it three times. The first two times didn’t work out at the 11th hour. And the last time I sold it was December of 2011, so I had that listing for over three years. I worked on that file, and at the end, the seller said to me, “Wow, must feel good getting that big commission check.” And I remember I said to the guy, “Look, the person that works at your front counter that asks people if they want fries with their chicken has earned more money since I met you than I have.” [Laughter]

Loren Feldman:
Was that literally true?

David Barnett:
It was literally true. And ultimately, that was the frustration that beset me, was this roller coaster cash flow in my personal life. And I thought, “I’ve got to get out of this.” So I left the industry and then became a banker, Loren. And I worked with much larger businesses in my banking career. But my phone just kept ringing, people who were working on these transactions. They were looking for help and guidance. And I would say to people, “I can help you, but I’m not in that business anymore. I guess I could charge you a consulting fee. I’ll charge you $100 an hour or something.” And people just said, “Oh, great. Can I meet you Saturday?”

And I realized slowly that the stuff I used to do in the hope of someone one day paying me a commission, that people wanted that help. And they were willing to pay for it. And eventually, the bank reorganized, and I was able to get a package when my position was eliminated. So I used that opportunity to build the business that I have today, that I have had now for almost 10 years. And I wrote a couple books, I started the YouTube channel, and got myself out there more. And today, I work with people all over the world who are buying and selling. We help buyers analyze deals and give them an idea of what reasonable offers might be. We work with sellers and help them do an evaluation, then we do the packaging, and we help them advertise, just like a broker would.

But the difference is—I learned from my first time around—now we act as consultants, and we have sort of a menu of services and a roadmap. And we just charge people for the things we do along this path. And ultimately, what it means for the business sellers is a much lower bill than if they sold through a broker. However, it’s not contingent. So I’m issuing invoices to people every week, and so it’s changed the sort of cash flow character of my business, and it’s allowed me to give that better level of service and provide for the people you’re talking about—those smaller businesses that can’t seem to get the attention of a good, qualified broker where they are. It’s sort of another alternative model.

Loren Feldman:
So you’re essentially doing the same thing. You’re just charging for it differently. In other words, your clients don’t have to also hire a broker along with you as a consultant. Correct?

David Barnett:
No, that’s right. And the other big difference would be agency capacity. So a business broker is an agent. They have an agency role, and it’s important to understand under law, because they represent the business owner. And so we never take on that agency capacity. So what we do is, we provide the services and coach the business owner and help them along the way without standing out in front and kind of being their face and representing them for the other parties.

Loren Feldman:
You said you help businesses all over the world. How is that possible? I assume that the game is played differently everywhere—and I should point out, you’re based in Canada. I assume there are some differences between Canada and the U.S., let alone around the world. Tell me about that.

David Barnett:
Sure, back when I learned my business brokerage practice, when I learned how to be an intermediary, all the training that I took was based in the U.S.—the United States being the leader in this kind of stuff around the world. It generally follows a couple of basic rules. You know, the negotiation for businesses is between people, the sort of rate of return, or what a buyer needs to get out of the deal, numerically works out to be kind of the same sort of solution no matter where you are in the world.

There’s a very big difference when it comes to the financing, and that’s probably the only exception. The United States has the SBA, and so the SBA program allows for a higher degree of financing on something like a business acquisition. Everywhere else in the world, people are more limited in how much they can borrow to do a deal, and that just means the terms end up being different. So in another country, like in Canada, sellers have to carry more paper, as they say. They have to finance more of the deal, just because the buyers can’t get their hands on the money.

Loren Feldman:
Canada doesn’t have the equivalent of an SBA?

David Barnett:
It has different programs. So, for example, there is a government guaranteed program, but it’s tied to financing the value of assets. So the more tangible assets in the business, the more someone can borrow, whereas the SBA looks at the value of the business almost like you’d value a house. You know, if the business is worth a certain amount of money, that’s what they’re going to base their lending on. And that’s what’s unique about the SBA, is that they kind of bundle together the goodwill and the tangibles into one lump, as it were, whereas in other places, they look more specifically at the collateral inside the business.

But I want to further comment, because you made the comment that sellers are told, “Get as much money up front as you can.” And that has a lot to do with what the terms of the deal are. So if somebody is borrowing from the SBA to buy a business, and the seller is being asked to finance part of the deal, people in the U.S. understand that the SBA will finance up to, say, 80 or 90 percent of the deal, depending on certain conditions. And so the sellers know that the buyers have access to greater leverage. The sellers also know that if the buyer defaults on that SBA loan, that they’re going to have very little in the way of rights to be able to get recourse and try to recoup the money that they’re owed.

So that advice can make sense, if that is the scenario. If there’s no SBA deal, if there’s no SBA loan involved, if the buyer is using more conventional financing, or mixed with their own money, as far as a down payment, it can be a very different kind of scenario. And the seller’s position, as far as their security against the assets of the business, and the position they are with respect to a bank, for example, can be very different. A seller can have a lot more options if that buyer who’s using conventional financing were to default on their loan.

Loren Feldman:
So there’s an awful lot of uncertainty, at least in the U.S., but I suspect in Canada as well, involving the business outlook for small businesses in particular. What are you seeing? What’s the market look like to you?

David Barnett:
It’s a great question, because businesses—small businesses—are unique, and a lot of small businesses need a certain kind of buyer with a certain background and skills. And so I used to believe that there was such a thing as a market for small businesses. And now what I’ve come to understand is that very few small businesses have a market.

If you define a market as being a place where there are buyers and sellers and many objects being bought and sold, you can say that there’s a market for three-bedroom homes in Columbus, Ohio, and there’s a market for four-door used cars in New York City. But within the world of small businesses, you might be able to say there’s a market for gas stations or convenience stores. But when you get out of those general kinds of categories, each one starts to become very unique. You can have a really great, profitable flower shop and a whole bunch of engineers trying to buy a business. And none of them will buy the flower shop because it doesn’t fit within their area of expertise, understanding, and ability to improve the business. And so, what I’ve seen over the course of time is just that—

Loren Feldman:
Let me stop you there, because if private equity is interested in flower shops, then there’s a market.

David Barnett:
Yeah, but private equity isn’t going to go buy a corner flower shop. They’re only going to buy what they call a platform business, and then they might go acquire some bolt-ons. We’ll see how successful they are in the long run. We’re in the middle of a really big experiment that started with the zero interest rate policies a few years ago. A lot of these private equity people never dipped their toe into the world of small business. They were driven here looking for a yield by the fact that they couldn’t make any more money on the stock market or through bonds.

I remember, when I started out, you would never hear of a private equity company coming in and chasing after some of these small deals. And then, probably five or six years ago, I started to have clients who started to compete with them on businesses with cash flows under a million dollars, which I’d never seen before. And now you’re hearing about some of these private equity groups going after businesses that have cash flows of half a million dollars.

Loren Feldman:
Usually to roll them together, correct?

David Barnett:
Well, they’re trying to roll them together, but usually they’ve made a promise to their investors that they’re going to get the money back out to them in five or seven or 10 years. And so the reason why I say we’re in this experiment is that we’re kind of just now coming to the point where some of these people now have to exit. Now they have to demonstrate that their plan actually worked, and that they were able to achieve the efficiencies and everything that they had gone looking for. And we’ll see if it can work out or not.

Loren Feldman:
Do you have a standard piece of advice that you give to a seller who’s considering selling to a private equity firm?

David Barnett:
Well, if somebody got big bank rolls of cheap capital, and they’re willing to pay you more than you think you can get from someone else, and you just want to cash out, and you don’t really care about how your business is going to be run after you’re gone, then go for the money. A lot of sellers, though, do have some kind of concept of business legacy or desire to see their business carry on in some way that is congruent with the way they operated it. And one of the bits of advice that I say to people is, “Look, if you want someone to be able to afford to live up to a legacy, it means that they’ve got to have the cash flow to be able to afford to do the things that you thought were important.”

And so that often means that that legacy-carrying-on buyer who’s going to come in and operate the business in the same fashion that the seller has, they’ve got to have meat on the bone after the deal. And often, that buyer won’t be able to pay as much as the private equity firm. But the private equity firm, if they’re going to pay top dollar, or even more than, quote-unquote, the business is worth, then they have to have some kind of plan to either grow or cut expenses. And that means change. We don’t know exactly what the change is.

I know people here in my own community that work for small businesses that have been bought up by private equity companies. And the changes don’t take long to start happening. And it usually means prices go up. It usually means that they try to keep wages as low as possible, that they try to make the schedule as thin and lean as possible. They maximize all the different things that they can, as far as technology and everything, to try to squeeze as much as they can out of it. And what the private equity group is trying to do is, they’re trying to show the next owner of their portfolio that not only is there a greater cash flow, but there’s a growth pattern to the cash flow. And as long as they can keep that growth pattern going, their hope is that they’re going to be able to exit at a higher value themselves to whoever the next buyer is going to be. So that’s what’s going to happen to the business if it’s sold to private equity.

Loren Feldman:
Sorry, I threw you off track. I had asked you what you saw in the current market, and you were explaining why there really isn’t a market for small businesses, but I interrupted you. Can you finish that thought?

David Barnett:
Yeah, so whether the macro conditions are positive or negative, most small businesses tend to trade within the same range of value, because it really has more to do with the buyers and what they need to get out of it and what they think they’re going to do with the business. And there was a brief period of time there, back in ‘21-‘22, where people were paying a higher price for small businesses, and it was driven entirely by the very, very low interest rates that we had. And now that interest rates have come back to normal, people are not able to pay as much.

We’re still seeing some sellers that want to get those really high ‘21-‘22 prices, and the way that they’re achieving it, Loren, is by being willing to hold a higher degree of seller financing at a discounted rate. So I’ve seen plenty of deals where sellers are carrying 30 percent of the transaction at 5-percent interest, because that’s what they have to do in order for the buyer to be able to afford the price that they’re asking for. And so anyone who understands the time value of money will realize that they’re really just kind of selling at a discount. It just looks different. They’re discounting the interest rate instead of discounting the price.

Loren Feldman:
What does that mean for you and your consulting business?

David Barnett:
It doesn’t really mean a whole lot. I mean, we get a pretty consistent, steady flow. As the number of people who hear about us and meet us online grows, the number of inquiries grow. But I wouldn’t say that we’re seeing any kind of change in our business with respect to what’s happening in the macro economy. It’s really just, as we grow, we meet more clients. There have been a lot of conversations in the last couple of weeks about the threats from President Trump, about tariffs, from both sides of the border. There are a lot of American companies that are reliant upon stuff that comes from abroad. There’s lots of Canadian companies that export to the U.S.

Loren Feldman:
Auto companies, where the car goes back and forth multiple times.

David Barnett:
It’s funny that you mention the auto companies. You’ve got to imagine those people have a powerful lobby group, don’t you? Like, there are some pretty big vested interests who would be opposed to this kind of thing. So I would be very surprised if it really happens. I think that he’s got a track record of saying outrageous things in order to try to set a peg for negotiating. And if his goal is to get the attention of people in Canada and Mexico, with respect to border control, I think he succeeded. I can tell you, on this side anyway, there’s all kinds of news about changes in investment and in wayward ways that the border is going to be managed and things like this. And I think that’s positive. If it really came to pass, I just think it would be absolutely catastrophic.

Loren Feldman:
Our time is running short. There are a couple of things I want to try to run through quickly. You wrote a book about the choice between starting or buying a business. Can you give us a hint? Do you believe that one is better than the other?

David Barnett:
No, I believe that there’s two different paths to ownership: You either start or you buy. And in the book, the main thesis is simply that you cannot lose track of the other path. So we talked about business values and the prices people are willing to pay for small businesses. I get a lot of deals where people will take a hot sector—for example, HVAC companies are very exciting right now. There’s a lot of talk about them in the world of buying and selling businesses with this idea that it’s a business that won’t be taken over by Amazon or can’t be delivered from China and all these other factors that make it great.

And so people are paying a higher and higher price for these things, and you have to stop and ask yourself: This business I’m looking at buying, could I actually build it and finance a couple of years of startup losses for far less than what they’re looking for as an acquisition price? And sometimes the answer is yes. And so one of the things that I do with my buyers when we’re looking at a particular business is we will take a step back and say, “What if you tried to build the same thing? And what if you had to finance losses for a couple of years while you built it up and hit that breakeven point? What would that look like?” If it’s a third of what the seller wants for their business, you really have to stop and consider whether it makes sense to do that deal.

Loren Feldman:
How close do you think you can come to estimating what it would actually cost to replicate the business that you might otherwise buy?

David Barnett:
Well, I’ll just give you an example. I was talking with someone who wanted to buy a plumbing company, and we looked at the number of people on staff, and we estimated their salaries, and we looked at the number of trucks that they had, and I just added it up. I just said, “If we bought the trucks, if you hired the same number of plumbers, and you paid them for a year, and then you ran a promotion saying, ‘We do plumbing for free—just pay for the parts,’ would you build a clientele?” And that expenditure was far, far less than the asking price of the business. And I’m not suggesting somebody should do that, but it’s just a sort of out-of-left-field way of looking at something, which really can make you think in different ways.

Loren Feldman:
What do you typically hear from your clients? Do they lean one way or the other, in terms of starting or buying?

David Barnett:
I mean, most people come to me because they find me online, because they’re looking for information about buying a business. And the reason that they’re looking for information about buying a business is because they believe it’s less risky, because what they’re thinking about is customer acquisition. And the riskiest thing about starting a new business is not finding enough customers that are willing to pay the price you need to be able to make money. If you buy a business, though, you get the customers. That’s the conventional thinking.

But here’s the problem: I you overpay for that business, and you end up with a huge debt, and you have to service that debt, then it means that if you lose 5 percent of the customers, you might have trouble paying your bills and paying yourself. Well, isn’t that the same problem? It’s still market risk, but from the other point of view. Your risk now comes from erosion, and you’re in a worse situation, because if you start a business, you’re going to risk whatever capital you’re able to put into it to get started. But if you buy a business, you could have a personal guarantee on a million dollar bank loan. And so it changes the way you sleep, Loren.

Loren Feldman:
It’s pretty commonplace in the U.S. for business owners, in those kinds of situations, to take out a loan that requires them to use their home as collateral. Is that common around the world?

David Barnett:
Well, what’s more common around the world is just that they can’t get the business financing, so they end up using things like home equity as an additional source for financing the deal. So it’s not that the bank puts a lien on their house because they’re doing a business loan; it’s that the bank is only willing to do a smaller business loan, so then they end up accessing the home equity and putting that into the deal themselves.

Loren Feldman:
So if you do decide you want to buy a business, what’s the best way to find a business to buy?

David Barnett:
Well, I guess it depends on your timeline. The businesses that get advertised online on these business-for-sale websites, a lot of them are being put up by brokers. And the value proposition that a business broker brings to a seller is that they will try to create competition amongst buyers for the business. So a really great, profitable, growing, small business that is very desirable, when it hits those websites, it’s going to get a flood of inquiries. And that buyer competition is going to make the price go up, but you can do a deal relatively quickly in that kind of path.

If you’re trying to get a more reasonably-priced deal, and you already know exactly what kind of business you’re looking for, then you can also do what’s called a proprietary search, where you go out and create networks amongst business owners in that target industry that you want to go after so that they know you. The problem in the business-for-sale market is one of visibility. It’s really easy for someone who wants to buy a business to see businesses. I mean, businesses advertise. They want to be known to the public. But a business owner cannot look out over a crowd of people and identify which ones want to buy a business. There’s no visibility from that point of view, and so that’s why we have these marketplaces online and people like business brokers.

But if you want to buy a business, if you want to buy a machine shop in upstate New York with revenue between $2 and $5 million and up to 12 employees, well, all you need is Google, or if you can find a copy of the Yellow Pages. You can go find all the machine shops in upstate New York, and then you just have to find out who their owners are. And then you have to talk with those people and let them know you want to buy a machine shop. And most of them will have no interest in selling to you. But the top five reasons why small, privately controlled businesses go up for sale, Loren, are: burnout, boredom, and fatigue; divorce; poor health; the need to relocate; and retirement. And if you consider that list, you realize only one of those items is something that’s planned for. The other four are a circumstance of life.

And so you work your network. You work your list. You create your contacts. And you wait for somebody to end up in one of those situations, and then they need to sell their business. And now they already know you. And that’s how a proprietary search kind of works. It’s all about figuring out who you want to do a deal with and trying to create a relationship with that person, and hopefully go there and make a deal with them before maybe they go to a broker who’s going to bring in other buyers.

Loren Feldman:
David, I think I could talk to you all day. I have lots of other questions that I would have loved to have gotten to, but maybe we’ll do this again someday.

David Barnett:
Oh, I’d love to. It’s a lot of fun.

Loren Feldman:
My thanks to David Barnett. Thanks so much for sharing, David. I really appreciate it.