Episode 28: The Boutique: The Fine Line Between Risk Taking And Carelessness
One of the keys to selling your business is to reduce investor risk and eliminate the risk for the buyer. In this episode, Greg Alexander and Sean Magennis discuss how owners can increase the attractiveness of their firms and the mistakes they must avoid when reducing investor risk.
Why Do Owners Struggle to Reduce Investor Risk When Selling a Business?
Sean Magennis [00:00:15] Welcome to the Boutique with Capital 54, a podcast for owners of professional services firms. This show aims to help you grow, scale, and sell your firm at the right time for the right price and on the right terms.
I’m Sean Magennis, CEO of Capital 54 and your host. In this episode, I will make the case that one of the keys to selling a business is to eliminate the risk for the buyer. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s chief investment officer. Greg has helped many boutique business owners increase the attractiveness of their firms by reducing investor risk. Greg, good to see you.
Greg Alexander [00:01:05] Thanks, Sean. This will be a controversial episode.
Sean Magennis [00:01:09] I love it.
Greg Alexander [00:01:10] Some of our listeners are running firms that carry a lot of investment risk, and I bet some of them don’t even know it. I might inadvertently call some babies ugly today.
Sean Magennis [00:01:20] Well, the good news is we do not have a live studio audience, so you will not hear the boos. On a serious note, tell us why some boutique owners have blind spots in this area when selling a business.
Greg Alexander [00:01:36] Firm owners think like operators; they do not think like investors. Therefore, they approach a deal with all the reasons it works. Whereby, the investor approaches a deal with all the reasons it will not work. For investors, their number one goal is to not lose money. A return is expected for sure. But the rate of return is considered only after the threat of capital loss is calculated.
Sean Magennis [00:02:05] Greg, you’re correct on this one. Our listeners are owners of firms, but they are also entrepreneurs and founders, and as a breed, we’re an optimistic bunch. We have to be. I can see how this glass is half full mentality can be a hindrance when trying to develop a business exit strategy and selling a business.
Example: How Not to Exit Your Business
Greg Alexander [00:02:26] Yeah. Let me share a story to bring this to life. So a few years ago, a media buying firm put itself up for sale. For those unfamiliar with a media buying firm, these firms buy advertising space for media companies and sell it to advertising agencies. The advertising agency uses the space to place ads for its clients.
This firm’s specialty was newspapers. This was pre-Internet. A roll-up of media rep firms was happening. A few large firms are buying up all the boutiques. This owner was getting a lot of interest. Yet, he blew it. He had a golden opportunity to exit immediately for a very high price, and he royally screwed it up.
Greg Alexander [00:03:13] Sadly, he eventually had to file bankruptcy because, as you know, the newspaper advertising business got crushed by the Internet. What was the fatal mistake made by this owner? He was unable to complete due diligence quickly.
His financials were a mess. His personal life was wrapped up in them. He was unreasonable with his add-backs . His family members were on the payroll and didn’t do any work. His salary was not reflective of the true cost of the position. He took family vacations and charged them as business expenses. I mean, this guy was a real cowboy. All of this could have been worked out. However, a land grab was underway.
Greg Alexander [00:04:02] Speed was of critical concern. The firms, particularly the big firms, looked at his books and concluded it was simply too much work. And it would take too much time to figure out this mess. So they bought this guy’s competitor instead. His competitors were running tight ships and could close quickly. This was a tragic story.
Sean Magennis [00:04:28] Geez, what a shame. So the moral of the story is to run a tight ship. Greg, what advice would you have for our listeners to help them avoid this type of tragic outcome when selling a business?
How to Reduce Investor Risk: Mistakes Professional Services Firms Should Avoid
Greg Alexander [00:04:41] The big lesson here is that there’s a fine line between taking risks and being careless. Entrepreneurs are risk-takers , and therefore they build great boutiques, but this cannot go too far. If it does, once in a lifetime, wealth creation opportunities can pass you by.
Sean Magennis [00:05:03] Greg, give our listeners some examples of how they might be taking it too far. What mistakes should they avoid?
Greg Alexander [00:05:10] Gosh, there are so many. For example, don’t cheat on your taxes. Investors and potential acquirers hate cheaters. Don’t be careless with the law. You know, if you push the limits here and get caught. Lawsuits will get filed against you. These get found during diligence. That can kill a deal as fast as you can say sorry.
And heaven forbid if you were in the crosshairs of government regulators, you know, then you’re in real trouble. You’re not going to be able to sell. So stay far away from regulators. So those are just a few obvious mistakes to avoid when selling a business.
Sean Magennis [00:05:45] Those are great examples, Greg, and extremely good reminders.
Sean Magennis [00:05:53] And now a word from our sponsor. Collective 54 is a membership organization for owners of professional services firms. Members join to work with their industry peers to grow, scale and someday sell their firms at the right time for the right price and on the right terms. Let us meet one of the collective 54 members.
Brenna Garratt [00:06:18] Hello, my name is Brenna Garratt. I own Sustena Group of Business-to-business brand development firm. Most of our clients are mid-sized B2B companies with investor or private equity backing.
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We solve these challenges by developing a strategic foundation, the brand infrastructure, and go-to-market brand activation programs to help our clients articulate their business and brand. If you’re interested in learning more, please visit sustenagroup.com or connect with me at [email protected]. And lastly, a nod to Collective 54. The organization has been absolutely invaluable to me.
Sean Magennis [00:07:10] If you are trying to grow, scale, or sell your firm and feel you would benefit from being a part of a mastermind community of peers, visit Collective54.com.
Questions to Ask When Reducing Investor Risk and Selling a Business
Sean Magennis [00:07:29] So, this will take us to the end of this episode. And as is customary, we end each show with a tool. This allows a listener to apply the lessons to his or her firm. Our preferred tool to use is a checklist. And our checklist-style is a yes-no questionnaire.
We aim to keep it simple by asking only ten yes-no questions. If you answer yes to eight or more of these questions, you have successfully de-risked your deal. If you answer no too many times, you are too risky for investors. So, let’s begin.
Greg Alexander [00:08:05] Number one, do you have five years of audited financials?
Greg Alexander [00:08:10] Yeah. I mean, such an easy thing to do.
Sean Magennis [00:08:12] Exactly.
Greg Alexander [00:08:13] Pay somebody; they can do it. It’s beneficial not only when selling a business , but it also is beneficial as an operator because it gets you thinking about your business as an investor would.
Sean Magennis [00:08:22] Great example. Number two, do you have five years of tax returns? Number three, are you operating according to industry-standard accounting principles? Number four, do you have a few, if any, add-backs?
Greg Alexander [00:08:39] I mean, don’t be a cowboy.
Sean Magennis [00:08:40] Exactly. Number five, is your personal financial life clearly separated from your business financials? Number six, have you ever been sued? Number seven, have you ever sued anyone? Number eight, are you clear of any outstanding legal action?
Greg Alexander [00:09:05] If you have any, settle.
Sean Magennis [00:09:07] Yep. Number nine, are you using industry-standard legal contracts with clients, employees, and suppliers? And number ten, are you compliant with your industry regulations?
Sean Magennis [00:09:24] In summary, do not give a buyer a reason to say no when selling a business. Run a tight ship. Run your boutique by the book. Operating in the gray area will make a potential buyer nervous. And any gain from doing so is just not worth it.
Sean Magennis [00:09:44] If you enjoyed the show and want to learn more, pick up a copy of Greg Alexander’s book titled “The Boutique How to Start Scale and Sell a Professional Services Firm.” I’m Sean Magennis. Thank you for listening.