How To Actually Bid For A Business

Earlier this year, I opened my email to see what the broker had replied to my question about how much the seller of a particular business would be willing to sell it for.

“We are currently soliciting bids from a few different buyers and expect to receive final bids by the end of the week. To maintain the integrity of the process, we aren’t sharing what other bids are.”

Ok then.

It drives me insane when brokers act like this.

There’s two reasons they do it, and maintaining the integrity of the process isn’t either one.

The real reasons are because:

a.) They’ve not had any bids but want to make you think they have

b.) They think they’ll get higher bids if they do this.

What they don’t realize is how many buyers get put off by this bullshit.

Tell us what price the seller has in mind, and if we’re comfortable and agree with it, we’ll bid that price.

If another bidder comes in higher, tell us and we’ll decide if we want to increase our bid.

It’s really simple.

Better brokers will say something like “What did you have in mind?” and you tell them, and they say “That’s not really competitive, you’ll need to increase it to X if you want a chance”.

We can decide whether we believe them or not, but at least we know what we’re working with.

When a broker is coy like the first example, it leads you to the age old conundrum:

“If we offer too much in our initial bid, we might have to pay more than we wanted to” so we don’t do that.

but on the other hand…”If we offer too little, we might miss out”.

What’s even worse, many brokers will just come back and say “Your bid didn’t win, sorry”, when we would’ve been willing to come back with a higher amount if we’d been told we needed to.

It’s ludicrous, and it causes issues for sellers too, because ultimately someone will come in with a high offer to drive competitors away, and then during the exclusivity period they’ll find reasons to renegotiate the price lower.

Don’t believe me? See my story about when I sold HPD.

So, with all this in mind..how do you actually go about creating an offer to buy someone’s business?

The objective of any offer you are making to buy a business is threefold:

1.) Offer high enough for the seller to accept

2.) Beat out any potential competition

3.) Offer low enough to be comfortable with the price

But there are nuances.

You can’t come in too low initially, or you might just lose the deal right away.

You also don’t necessarily need to have the highest bid in order to win a deal either.

The art is submitting the “best” offer while capturing all 3 objectives.

So. How do we go about this?

Let’s assume you’ve completed enough due diligence to be able to make an offer.

Sidenote: You usually have to make an offer before you can complete every piece of due diligence, which means your initial offer might not be the final price you pay, but you should at least be honest in the price you intend to pay.

If you have to lower it later as new information comes to light, then that’s ok.

Coming up with the price in the first place is the challenge, but you’re not starting completely from scratch:

1.) Unless you’re working off-market, a broker will have listed an asking price 90% of the time (so why on earth do they not tell you whether your bid is competitive?)

2.) If you’re doing things right, you’re not bidding for the first ever business you’ve analysed. As such, you should have a rough idea what market rates are for this type of business, or at least a general range.

3.) You should also be aware of what else you can buy for the same amount of money, which helps you figure out whether something is good value or not. This is very much an imperfect science though, as no two businesses are equal.

The difficulty is not from having no idea what the fair price is, but more:

1.) Figuring out where you sit in the order of preference if there are multiple bidders,

2.) If you want to bid below an asking price, how low can you go and still have a seller accept (and how low can you go without insulting them to the point of blowing up the deal).

3.) Understanding how to structure your offer. For example, if you’re paying less up front, you might be willing to pay more overall.

4.) Ultimately, making sure you aren’t paying more than a business is worth (again, very much an imperfect science).

I also usually try to work with a seller to come to a fair price. I’m not trying to “win” a negotiation by lowballing them or convincing them to sell for less.

I once worked with a buyer who’s offer was based around what the seller’s ROI would be if they sold for X price, rather than what the actual value of the business was.

Kind of like “Come on, sell it to me for half what it’s worth, you’re going to get paid a lot anyway!”

^^ That’s not how it works.

Psychologically, a seller’s biggest fear is selling their business too cheap, just like yours might be overpaying. This is the same kind of dichotomy you might get when buying/selling a used car.

If I think a seller is being unreasonable with their asking price, I’ll explain why, or I’ll walk away (well…I’ll close my laptop in dismay at least). If I think they’re more or less accurate and it’s a price we can pay, then we can move the conversation forward.

At the end of the day, most sellers are doing this for the first time too, and have a lot of fear around accepting an offer. It could be anything from “Is this the right price? To “What would people think if I sold it for such a low multiple?”

They’re also thinking things like “Can I get more if I run the business for 6 more months before I sell it?”, while being nervous “What if I hold it for 6 more months and it declines?” - note: You probably don’t want to buy a business with that kind of risk, but sellers will have that fear either way.

Part of what makes a successful acquisition is not just the price you pay, it’s how well you work with the seller and their team to understand the business, the nuances of the operations, and pain points of the customers, and the narrative that drives sales.

If you jeopardise some of those things by nickel and diming a founder aggressively from the start, you’re going to have a bad time later on.

I’m in danger of overcomplicating things in this post, so let’s get back to the point.

We need to figure out these two things:

1.) The price

2.) The structure

So far I’ve spent the first 1,000 words talking about the price, and the 3 objectives you have with setting it.

Now let’s talk about the various structures you can use. By structure I mean, do you pay all cash, or is there a seller note or earnout?

If you want to get really financial wiz-esque, you’ll start to think about things like the time value of money, internal rate of return, and leverage.

These are all important, but you also need to think about risk. Should you use an earnout, and why?

Let’s Jump In

Seller Notes

A seller note is where you don’t pay all the cash up front, and instead pay some of it over time. This could be in equal installments or it could be one large balloon payment sometime in the future (usually 1 or 2 years, but sometimes longer). It could also be a combination of both.

A seller note can be very useful if you don’t have enough cash to pay for the full business yet, but you’ll still need to come up with the rest of the money somehow, as the cashflows of the business are not usually sufficient to pay for the final payment…unless you’re able to significantly increase them.

Seller notes also come with interest payments in most cases, and many times a seller will ask for a higher total price if you’re using a note, so it’s not cut and dry that you want to use a note.

That said, due to the time value of money and the way return on equity and IRR are calculated, you generally get higher return on your money, increased liquidity, and more cash available for investments if you delay the payments.

That was a pretty mansplainy couple of paragraphs and I hope it was valuable. To summarize though, the benefits of a seller note are:

1.) You can justify a higher total price for a business, which is often enough to win the deal.

2.) You get a better IRR and you have more cash available for other investments (such as investing in growth or buying a second business)

3.) You can buy a larger business.

Earnouts

An earnout is where some of the payment is dependent upon the performance of the business post-acquiistion. The earnout could be based on the first year after you buy it, or a different length period.

It’s used in two ways. One is to protect your downside in case you think there is risk of a decline. The other is to justify paying a higher price. In many negotiations, a seller wants more money for their business because it is due to grow significantly based on work they’ve already done.

Maybe they want a higher price as a result, or maybe they want to sell later once they’ve hit the growth and will earn more money. In your case, you might be happy to pay them for that growth, but not until it’s happened…and thus, an earnout is born and delivered by the M+A stork.

The point is, an earnout is not just a tool to protect a buyer, but also a method for compensating a seller in a fair way.

If you’re into seeing my face, I talked about Good and Bad earnouts on my Youtube channel last week, you can view that video here.

Rolling Over Equity

You can also offer a seller an equity rollover, which is a fancy private equity term for saying, let them keep some of the upside. Maybe you buy 90% of the business and let them keep 10%.

This is useful if you want a seller to hang around for a long time post exit, but is not essential.

If you want them to just stay for a year or a certain transition period, you can work that into the purchase price via an earnout or a holdback.

How Different Structures Affect The Total Consideration

Another thing to note is if you aren’t paying all cash up front, you might want to offer more total price. If a buyer is offered “$1M all up front” or “$700k now and $300k in a year”, what do you think they’ll take?

On the other hand, “$1M now or $700k now $500k in a year” suddenly sounds interesting to the seller.

It also works the other way. Let’s say you want to pay $1M but the seller wants to be paid $1.2M. You can say “Sure, but in that case I’m only paying half up front”.

There’s never a perfect way to do it and every deal and negotiation is different. What I’m trying to do here is show you how various different elements of a deal structure come into play with one another.

If there’s one lesson to take away from it all, it’s that the purpose of the negotiation is not to get the best deal or beat your adversary. Instead, it’s to use the various tools available to get the best structure for everyone. You do that, and you’ll win more.

Ok, we’ve covered a lot, and I feel like there’s still deeper we could go, but I want to give you something actionable to end this week’s newsletter, so here it is.

Let’s do a hypothetical analysis.

There’s a business you like. You’ve done your due diligence and are more or less happy that it’s going to be a good acquisition. The business made $200k in the trailing twelve months, and is trending flat. You’re anticipating it will make you around $200k in the next year, and you don’t need to increase expenses.

In your mind, it’s probably worth around $800k. You’d love to get it for $600k and you know the seller really wants $1M (but knows deep down it is not worth that).

You also know there are other buyers circling, some of them are more cashed up than you.

How do you bid?

Well, the first thing you want to do is try to find out from the broker what it’s going to take to land the deal. This isn’t always easy, as some of them are coy (see the start of this article), and they’re also trying to be fair to all bidders.

Plus…they’re representing the seller and are incentivized to get the most money possible…though they also want to make sure the deal actually closes.

Let’s say the broker tells you the seller really wants $1M but will probably take $900k.

Woof, that’s still more than you think the business is worth, but does give you some anchor to work with.

You dig deeper, and the broker tells you that there are a few other parties involved, and one of them has made a full cash offer around that $900k range.

Dammit.

Of course the broker could be lying, so you’ll need to use your judgement.

Always helps to try to build a relationship with brokers so you can gauge their integrity, and often you’ll know right away if you believe them or not.

Anyway, back to the problem at hand.

You have a few options.

The first one is to simply walk away. Congrats to the seller, they’ve got a great offer. If it falls through, tell them to give you a call, otherwise, you wish them the best.

But that would be the lamest conclusion to this article ever.

So let’s get creative.

Option two is to fomo into the deal and offer $950k all-in. Fuck it right? YOLO.

That’s not the option I’d like you to take…but I’d love you to come play cards at my place some time.

The next option is to figure out how much you can actually afford. If you have $900k cash great, you can decide if you like this business enough to pay a higher multiple for it.

But what if you only have $800k, is there a way to win the deal?

Well…maybe.

Here are some things I’d be thinking about here:

1.) Can I just buy 90% of the business for $800k? This values it roughly the same as the other buyer (if they’re even real), allows you to deploy less cash, and has a couple of added bonuses.

The first is the seller may prefer this offer, since they can keep some upside.

The second is that it’s a better deal for you, since you can probably require them to perform some tasks for the business (or at least not disappear into the sunset) in exchange for that 10% equity.

It’s also more tax optimised for the seller, but not by a huge amount.

2.) Can I offer them less up front but more upside? For example, the earnout structure we talked about earlier. $700k up front and $300k extra if the business grows over the next 12 months?

This one is riskier for the seller as they have to believe their business will grow, and you are the one to grow it.

Many sellers would just take $900k guaranteed vs $700k with $300k upside, but not all sellers. Some of them genuinely believe their business is growing and are willing to take the higher option (especially if you structure it more like $800k + $400k for example).

3.) Finally, I’d be asking if I could do something like $700k up front, with an additional $200k paid at the end of the year, plus some interest. This could work because the seller only has to wait 12 months for the extra payout, it’s guaranteed as it’s a note not an earnout, and it’s better for you since you get to keep more of your own cash to invest in the business or elsewhere.

Plus it may help you win the deal in the first place.

Now, in an ideal world, you’re the largest or only bidder, in which case I’d recommend simply giving them this offer:

1.) You can have $600k now and $200k in a year, or $700k now.

But the trick is knowing how to be creative when you aren’t the one with the largest pot or willing to pay the most.

There’s one final thing I haven’t touched upon yet. I glossed over it and you may have wondered….how did we come to the conclusion the $200k profit business is worth $800k in the first place?

What if $1M is a solid deal too? In many cases it could be. No one business is alike, so using average multiples doesn’t always work. Your 3x business could be a much worse acquisition than my 5x one, and so on.

And that’s another lesson we need to cover. A lesson that unfortunately warrants its own article (I guess I know what I’m covering next).

But for the purposes of this piece, I did want to keep it simple and use fairly arbitrary valuations to discuss how to form a bid. Adding in valuation models would complicate it further.

That said, you DO need to consider different valuations. In the example above, we’re talking about a presumably stable business that is going to give you flat year-on-year profits. What if it was growing 10% year over year? What if it was growing faster? You’d probably be willing to pay a higher multiple. What if it was shrinking? What if it had recurring revenues?

See what I mean? A whole other article..

For now though, just know what there’s two real sides to the coin. One is figuring out what the thing is worth, another is figuring out how to bid.

Most people focus more on the valuation than the bid, and rightly so, which is why I wanted to dive into the other side of the coin first.

If I could close this article with one summary sentence, it’s this:

Bidding for a business is more art than science, and takes practice and experience to be able to do well. It’s not essential to be a master in order to buy a business, but it will improve your success. Don’t let a broker or your peers tell you how to bid, but seek guidance along the way.

Ultimately you’ll be surprised at what kind of bid will be accepted. The key is making it work for all parties, not just yourself.