7 Questions to Ask Before Buying a Business

Earlier this year I came close to buying a mid 7-figure business with a team of 15 people.

At first, it looked like a diamond in the rough.  A business I could purchase relatively cheaply, spend a short time improving and systemizing and then step back to enjoy significantly improved profitability.

But after doing my diligence and talking with others I realized it ultimately wasn’t the right opportunity for me.  

How could I have initially been so excited about something that clearly wasn’t the right move?

Today I share the 7 questions that prevented me from making a very, very expensive mistake…

…and perhaps will help you at some point, too.  

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(With your host Andrew Youderian of eCommerceFuel.com)

Andrew: Welcome to the eCommerceFuel podcast, the show dedicated to helping high six and seven-figure entrepreneurs build amazing online companies and incredible lives. I’m your host and fellow e-commerce entrepreneur, Andrew Youderian.

Hey, guys, it’s Andrew here and welcome to the eCommerceFuel podcast. Thanks so much for tuning in today. And today on the mic you’ve got only yours truly, flying solo. I love starting doing something today that I’d like to do on a regular basis maybe even as frequently as monthly depending on how you guys like this, and that’s just talk about…gonna do a shorter episode instead a full 30 minutes, maybe something more than 15-minute range about something I’ve been thinking a lot about or an experience that I’ve had that hopefully it’s gonna be applicable to what you’re doing as an entrepreneur and store owner.

And what I wanna talk about today is seven questions to ask yourself before buying a business. If you listen to the show regularly you know that based on a recent episode, you know, I spent the last six or seven months really trying to figure out what I wanna commit to going forward, taking a little time off. As part of that was deciding to whether or not to go full time on eCommerceFuel which I decided to do, but also during that period was deciding if I wanted to buy eCommerce business, another eCommerce business, you know, really do that.

And I looked at a number of businesses, a couple seriously, one very seriously where, you know, I went on-site, met the owner, met the team, was, you know, strongly considering making an offer. So that’s the business I wanna talk about today. I’ve had people ask me because not really a spoiler here that ultimately I did not decide to buy that. It was a difficult decision.

Almost Pulling the Purchase Trigger

It was a decision at first glance I thought was gonna be a home run purchase and, you know, people have asked me, “How did you work through that? Because there was so much there. How do you work through the process of deciding whether or not to buy business like that?” And so I wanna talk through the process I went through to ultimately come through the other side and feel really, really good about my decision.

So a little bit of context about the business. So I have been a customer of this business at some point and that’s how I got to know the owner. Just on the phone one time we were chatting and I mentioned to him that, you know, I was in the eCommerce space, he was curious. We started talking and built up a nice rapport.

And he kinda learned that I was gonna be out in his neck of the woods at some point in time and invited me to swing by and check out their operation. And so that kinda lead to, you know, planning a trip. And in the interim before I get out there, realized that the business potentially could be for sale. So that’s how the ball kinda get rolling on this. So high level details, the business was doing about, you know, kinda mid seven figures in revenue.

Margins were on the lower side, you know, probably about 30% gross margin. There’s a lotta overhead, a lotta overhead with the business and, you know, they have a team of about, you know, 10 to 15 people or so.

And, you know, at first glance I thought that there was a ton of opportunity there and here’s why. First, the team of people was phenomenal and they had a phenomenal reputation in the space. They were widely regarded as knowing their stuff, providing great customer service, and just being a trustworthy outfit. And that’s something that you can’t come and swoop in as, you know, a takeover turnaround cowboy and fix in six months.

That’s something that’s built on a long time and, you know, a long track record. And so that was very attractive. On the back end behind the curtain from a business perspective they had terrible, terrible systems. Their warehouse was very, very rudimentary. I remember, you know, they didn’t have room for everything, so I think when they opened up a lotta times they’d have to take some of the pallets out of the aisleways and put them in the alley to make a room to walk back and forth.

They didn’t have a purchasing system, they didn’t have an inventory system, they had no idea how much inventory they had. The owner had a rough idea. And I think when I asked him…the owner was incredible, really great guy, very trustworthy. He seemed, you know, obviously knew his business extremely well. But from a system standpoint they just were a little bit behind the times. I think I asked him, “How much do you have in inventory?” He said, “I’m not sure.” And I said, “What do you mean you’re not sure?” He said, “I’m not sure.” I said, “Was it…is it half? You know, is it X or is it Y?”

And he was, you know, didn’t know on a magnitude of hundreds of thousands of dollars which was in some sense shocking from an opportunity standpoint assuming he would come in and make sure you didn’t get hurt on the purchase side. That means that they’re not running optimally in terms of running minimal inventory and not even that, but a lot of their other systems in terms of, you know, placing purchase orders, dealing with vendors, things that were very ad hoc and causing a lotta problems could be streamlined with some great systems, and some great software.

So that, from a guy who likes operations and likes automation, and software seem like a huge home run. They didn’t do very much custom manufacturing, if any. So all their products were resold, where…so I saw a huge opportunity to come in, take stuff that was selling really well, have it manufactured, bring in-house and double your margin on it. And they had an incredible lifetime of their customers.

Their customers would often come and, you know, they’d come in and they would buy over and over and over again. So you can find great, you know, repeat customer lifetime value with a company that was well known for their reputation and their service. If you come in on the back end and really clean up the accounting systems and the efficiencies, and cut some costs, and increase the margins, you potentially have a home run there. So was pretty excited and I saw a lot of potential there.

What Is The Future of This Industry?

So the questions I started to ask as I dug really deep. The first one is, what is the future of the industry look like? And this was something where at first, I wasn’t too worried, but I should have been. And ultimately it was something that caused me concern. The product that they sold was for a product that…it’s not sold anymore and, you know, there’s still a lot of them out there, but they aren’t making anymore new ones. And so the need for the products that they sold related to the core product, they…there weren’t gonna be more customers coming into the market.

The ecosystem, the amount of the core products, you know, accessories for this product were limited. And at first I thought, you know, “It’s not a big deal how fast this is gonna drop off.” But the owner actually warned me about this himself, other people I chatted with warned me, and ultimately at the end of the day I decided that this is nothing, but a liability. Best case scenario, you know, you stay flatline and that’s not gonna happen. So the future of the market was not strong, there was no upside which was a concern.

What Level of Working Capital Is Needed?

So the second question was, what level of working capital is this business going to need to grow? And for this business it turns out they had a tremendous amount of inventory relative to the profitability of the business on a factor of 4x. So like let’s assume for the sake of argument that the business generates a million dollars in net income, they had $4 million in that case in inventory which is just an insane amount relative to how much money the business makes.

I haven’t seen…I’ve seen very few businesses that have that much working capital, that much capital inventory required to generate that little amount of profitability. And they turn their inventory, you know, we didn’t know how much they turn their inventory because, you know, they can have their system set up. But you can roughly tell based on their sales, they turned it probably at least three maybe four times a year.

But just their margins were so small that…and they had so much overhead that, you know, it was…that’s kinda how it penciled out. So that scared me and some of the things I wanted to do to decrease the overhead, to improve the margins, I thought I could make a big bite into that. But I was starting in really, really deep level on the hole. Needed a tremendous amount of working capital, and that’s scary.

How Were The Gross Margins and Could They Be Improved?

Number three, how were the gross margins and how hard would they be to improve? So the margins were not awful. They were lower than what I would have assumed for a company that stocks all their products, but they weren’t atrocious. They were on the low side though of, you know, what I was expecting. But I figured, “Hey, you know what, this is probably a big opportunity. I can come in here and look at their top 10 to 20 selling products that probably make up 80% of the revenue, have been made in-house, have them manufactured, double or even triple the margin there and I can bring up the gross margin substantially.”

That was what I was hoping, but when I really dug into the process behind doing that, what I realized was there wasn’t that 80/20 relationship that I was expecting with the top products. It was more like a…their top 20% of their products made up 32% of their revenue. So it was an outsized amount, but not nearly the amount I was planning on. And bottom line what that means is I could go through and manufacture those top 20 products and it would boost the margin, but not very much.

To boost my margin really to double that, I’d have to go out and probably manufacture half if not more, you know, if 75% depending on the, you know, the distribution of the product sold, I’d have to manufacture a tremendous amount of the catalog and they had an enormous catalog. So I quickly realized that trying to manufacture that many products was gonna be a nightmare. That was a big concern.

Can I Personally Add To This Business?

Question number four, am I uniquely qualified to add value to this business? So originally I thought it was and, you know, my skills are in marketing, systems, and software automation, community building, and eCommerce. And so looking at there’s three, you know, really three big areas where I was gonna have to come in and hopefully add value. On the operational side and the automation side, yes, I think I coulda strongly added a lotta value there.

On the manufacturing side, no, I don’t have a lotta experience on the manufacturing side, very little. And I think that woulda been important to get the business to where I needed to be. And also on the team leadership side, you know, the biggest team I’ve ever managed has been about, you know, three, four people in-house with let’s say, you know, seven or eight contractors. That’s very different than having 15 people in-house.

And, you know, obviously I could have done it, but it wasn’t something where I think I…there woulda been a steep learning curve there. So sitting down and being honest, I could add value in some areas, but, you know, definitely only one out of the three.

Question number five I asked was, am I ready to spend the next three to five years focused on this? And coming into this opportunity I kinda had this very utopian idealistic plan of coming in, hitting the ground, spending 12 to 18 months really turning this thing around, increasing the profitability by 3x, and letting it run on its own. And, you know, going back to wherever I wanted to be, whatever I wanted to do, and kinda just letting it be a passive asset, maybe with some strong management in place.

And talking with the owner, talking with some other people I quickly realized that when I was honest about it and you apply the factor of how long things actually take in the real world versus how long you plan on them taking, I think this would have absolutely minimum been a three-year project, full-time, much more likely a four to five-year project. And I wasn’t willing to commit to that, I wasn’t ready to commit to that, or at least that scared me a lot more.

It was a much harder thing for me to wrap my head around. So that was something that was a little bit sobering as I was, you know, getting much closer to seriously thinking about making an offer.

Is This A Good Lifestyle Fit?

Number six, is this opportunity a good cultural and lifestyle fit? And for me this wasn’t something, again, I really thought about until I was, you know, the rubber hit the road and I was considering writing an offer. I was gonna have to uproot my family for a couple years when I’ve got two young kids. Was gonna have to move to a place where I didn’t have community and that was, you know, significantly more expensive than where I live now.

And also I was gonna have to take on a team of 15 people, potentially have to layoff a lotta those people, have a team leftover that was dealing with the fallout of a layoff. Because I think with the systems that we put into place, there was gonna be a decent amount of, it sounds brutal, but part of the plan would’ve had to be to cut the overhead, cut the staff, and automate some of that things…some of those things. All of that sounded terrible to me.

Nate gave a great talk at the last ECF Live talking about how this is something that he did not fully consider when he made the move from his home in California out to I believe Atlanta, the Atlanta area to buy and run a business and how it was something he wishes he would’ve thought more about, and he didn’t realize the impact of that. If you’re a community member we’ll go ahead and link up to his keynote which is available in the forums. Great talk if you didn’t attend the Live events, and that kinda came back and stuck with me.

What Do Smarter People Think?

And then finally, last question to ask was, what do smarter, more experienced people think? You know, I sat down and had lengthy discussions with at least three people who either had experience in the space, people who were…had experience buying businesses or had seen a lotta businesses and then worked in the investment space and the property equity space before. And those were immensely helpful, you know?

A number of these issues that I just talked about came directly as results of those conversations, or they took things where I didn’t think they were issues that were on my radar, but I wasn’t worried about them and made me really think through them more seriously as potential, you know, deal breakers. So that was tremendously helpful. Kinda goes without saying, talk to smart people, get a second set of eyes, or third or fourth or fifth in my case on the deal, but was tremendously helpful.

So, for me I obviously ended up passing that deal, but couple of things I learned from the whole experience. One, if you have a super capital intensive business, that is brutal. It’s brutal from your side because you’ve gotta go ahead and cough up all the capital and it’s not capital that you can use, it’s just capital that’s stuck in the business. And the second thing is it kills the multiple on the business.

If you ever try to go sell that business, you can sell it, but you won’t get most likely the going multiple for it, and if the offer I was gonna make and any offer I think would’ve been accepted by this owner would’ve been far below like your standard 3 to 4x multiple for business just because there was so much money needed to run this business. So that was one thing that I thought was interesting that really kinda hit home.

Another thing was it’s always a good idea either in terms of just meeting interesting people or having kinda serendipitous opportunities come your way to get to know the owners of businesses either in your area or that you have purchased from in the past that you think are interesting. You know, I had a great relationship just kinda even now, like the guy who owns it now, I still…we’re on very good friendly terms.

And I’ve offered to help him in the future, you know, when he does sell the business and if there’s any way I can add value there. But you never know, like, introduce yourself to businesses that you come in contact with and there’s some cool opportunities, if nothing else a great friendship that can come out of that.

The Right Decision Isn’t Always Obvious

Another thing I learned is the right decision isn’t always obvious. Lotta times it can really take a lot of time in terms of bringing a lot of the data together and kinda just letting it sit and marinate for awhile in a crock pot. And a lotta times you gotta really dig deep into this stuff, do your diligence to be able to either get into a deal and feel great about it or walk away with no regrets. You know, I’m here months later, zero regrets about passing on that deal. I am, you know, 99% sure it was the right thing to do.

But had I not spent the three to four weeks really doing a deep dive, I don’t know if I would’ve felt that way and I could’ve had that what if, did I pass on one of the best opportunities I’ve ever seen?

Large SKU Businesses Are Tough

And then finally, the last thing I learned is large sku businesses are brutal to run. I mean, I think about this guy’s catalog, he had thousands…I don’t know about thousands, but probably thousands, I think yeah, he did. I’m visually walking through their warehouse, there were thousands of products in there, thousands of products in his catalog, and that is just a tough business for a couple different reasons.

I mean, the capital constraints are one, but, you know, you gotta have…you gotta stock so many more things even if they don’t sell very well, you got more…either on one side you’ve got more dealers you have to purchase from, or you have more products you have to deal with the manufacturing on. Just, it’s just tough, especially for, you know, kinda who I am, a smaller entrepreneur in that, you know, seven figure business range, or at least aspiring now since I sold my other businesses.

Large sku businesses are hard, they’re tricky and starting one from scratch, you know, that was on my list of attributes, looking for a business with fewer products. But man, looking at one in person just really drove home the difficulties and problems that, you know, having a lotta skews brings in.

So, that was my experience thinking through, and it was a really fun exercise. And, you know, hopefully you got some…a few nuggets or a few things out of my experience in the way I thought through this process. But yeah, glad that I did it and also glad that I, you know, made decision that I did as well. So anyway, if you’d like these kinda this solo episodes, hopefully I haven’t totally put you to sleep with my voice nonstop for, you know, 15-ish, 20 minutes here, let me know.

Share Your Thoughts!

Comment on, maybe hit “Reply” to the e-mail that you’ll get about this or comment on the blog post over at ecommercefuel.com/podcast. I would love to hear your thoughts. If you guys like ’em I’ll keep doing ’em in the future. Thanks for listening.

Want to connect with and learn from other proven eCommerce entrepreneurs? Join us in the eCommerceFuel private community. It’s our tight-knit vetted group for store owners with at least a quarter million dollars in annual sales. You can learn more and apply for membership at ecommercefuel.com. Thanks so much for listening and I’m looking forward to seeing you again next time.

 

What Was Mentioned

 

Photo: Flickr/jdj150

Post tagged in: Buying & Selling Stores, Podcast

2 Comments

  1. Thanks for this interesting content Andrew.
    Not buying a business alone self. There many question to ask before buying anything products or service. People want to know the reason why of buying it. Does’t worth it? Can I get the value, etc.
    Before people made a buying decision there are hundreds of question in the mind

  2. Great article, really appreciate the insight into the process. Never been through buying a company myself, but I am often asked to weigh in on the total health of an eCommerce company.

    I really like to find out customers acquired and customers churned in a year instead of looking at total growth.

    Churned customers – this tells you what you have to acquire every year or you’re going to shrink. It also gives you an idea at how much repeat business you can rely on vs. needing to acquire.

    Acquired customers – the raw number of acquired customers tells you what you have to do to stay on their growth trajectory (or beat it). It also demonstrates what kind of predictable new sources of customers they have set up and what kind of opportunity/threats might exist.

    Just my 2 cents, but I think its so often overlooked in favor of just looking at growth which blends the two and loses a lot of this insight. All this is assuming the company you’re looking at can produce that kind of data!

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