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McLemore & Associates NewsletterBusiness Broker Insights
September 2012
Greetings!

I hope you enjoy this issue of Business Broker Insights.  Whether you are a business owner, banker, lawyer, CPA, financial consultant, advisor or entrepreneur, hopefully you will find these articles of interest and benefit.  Please feel free to pass this newsletter on to others that may also be interested, and let me know if you have any questions or if I may be of any service.

B. Reagan McLemore III

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   Common Mistakes Made by New Owners 

 

The 12 steps commonly used to kill a business in the first year of ownership. They are listed in no particular order:

  1.  Outsource tasks that were performed in-house by the prior owners: You buy a business and you think that hiring a professional to perform the various tasks makes some sense. Maybe the IT person on staff can be laid off and you can hire an IT firm for the same price, hopefully less. Alternatively, you want to outsource the accounting function. Our experience is that you just cannot make that decision without a significant amount of experience in running the business. You may think the IT person is the IT person. However, he might be much more and since he is on staff, his cost is fixed. Outsourcing that service likely will only raise the price of the service as you eventually will be faced with the reality that the IT guy really did more than just the IT work. In addition, the IT service will not "pitch in" on all the other projects that the IT person performed as a matter of course. So now, you are short-handed.
  2.  Refuse to develop a relationship with the customers: Here is a tip: the business only exists because of the customers. When you take over the business, the customers do not care that you are overwhelmed by the workload or that you do not really understand their question. What they care about is that you call them back within a short time. They need to vent and obtain some satisfaction for their complaint. However, you do not like confrontation or unhappy people. Therefore, you do not talk to them. Within a short time, they will be gone. In addition, with them goes your opportunity for success. Make two things a priority: 1. Go see (or otherwise have a meaningful contact with) every customer within 30 days of purchasing the business and 2. Return every phone call in 24 hours or less. If necessary, make sure your assistant or secretary makes the return call. Be certain that your new customers know you are thinking about them. This is vital and is one of the main reasons these new business owners fail. They do not understand that all business is essentially a people-to-people enterprise. If they fail to develop the relationship with the customer, the business will fail.
  3.  Replace key employees: For reasons that we just cannot comprehend this action recurs in just about every single case we work on. The new owner takes over and within a few weeks has a falling out with one or two key employees. The new owner is (justifiably) indignant. He/She just paid a staggering sum for the business and did not expect the employees to be insubordinate. Nevertheless, the new owner forgets that the experience is new for the employees as well. So rather than work through all the newness, it seems more fitting to replace the insubordinate employee with a hand picked confederate of your own. In one case we worked on, within 2 months the new owner replaced the prior owner's secretary (8 years of service), the production manager (12 years of service) and the sales manager (12 years of service). Without realizing it, he had replaced every person that all of the customers and vendors had grown to think of as the "business." Further, the secretary knew all the customers by the sound of their voice and the production manager took hunting trips with a number of the key customers each year. Now, none of the customers had a real contact with the business and within 5 months, the business declared bankruptcy. And it was no surprise to us.
  4.  Refuse training from old owner: Yet another mystery. Why would anyone buy a business and then assume from day one that they can run it without help from the new owner? Yet, one moron after another does just that. I tried a case in March 2001 where the buyer essentially asked the seller to leave the business after three days. Worse, during those three days the new owner refused to accept any training from the seller. Please, understand that the buyer should not fail to utilize all of the training that is part of the agreement. Time with the seller should be treated like gold. There is simply no excuse for not wringing all the information possible from the outgoing owner. Failure to learn all you can from the seller is a sure way to get in trouble. Worse, some buyers assume that the employees know enough. Our observation in case after case has taught us that the employees are important, but the owner is the one that built the business and the one that knows what is required day-to-day to run it. Always listen to everything the old owner says.
  5.  Absentee ownership: One broker recently told me, "There is no such thing as an absentee owner." Truer words were never spoken. In almost every case that we handle this is a problem. Without explanation, a new owner will delegate to the employees most, if not all, of the day-to-day responsibilities. Then the new owner begins to work fewer hours. This begins gradually, but within a few months the business will have gone from an owner-seller that worked 50 or 60 hours a week to an owner-buyer that works 40 hours a week, at most. Many of the cases we see involve new owners that don't even work a 30-hour week. Ultimately it is true that you cannot expect employees to have the same care and concern that you have as owner. Eventually, without a steady hand on the controls, the business will begin to falter.
  6.  Make significant operating changes in the first year: This happens very often: Old owner sells medium-grade widgets. New owner reviews the widget catalogue and realizes that the margins are much greater on high-grade widgets. Therefore, he slowly transitions to high-grade widgets. It seems to make sense because even if sales were to slow down, he would make up the lost sales in higher margin. However, the reality is that the old owner probably sold the medium-grade widgets for a reason. Maybe they were more durable or the customers had an affinity for that grade or brand widget. The truth is that the new owner is just too inexperienced to make any significant operating changes in the first year. In the words of Dwight Eisenhower and George Bush, "stay the course." The business was operated profitably using a certain paradigm. The new owner is no more qualified to make substantive changes in operation than a new salesperson or a new stock clerk. The difference is that the new owner just happens to own the business. This section is addressing changes as small as changing the price of cokes in the break room. You will be tempted to make changes, just don't do it! Don't reorganize the work force. Don't change the commission structure. Don't retool the employer's manual. Just don't do it. Wait. Observe. Learn. The prior ownership was successful for a reason. Don't make any changes for a year. You will be glad you did.
  7.  Purchase expensive and modern equipment to replace old, outdated equipment: This temptation is almost too great to pass up. You have purchased a business that manufactures widgets. These widgets are currently produced at the rate of 40 per hour on a Widget Maker 87. The Widget Maker salesman has come to you and discussed the new and improved Widget Maker 2001. It can produce 80 widgets in the same hour. It is also automated. So it should allow you to cut at least one salary out of your budget, at least in theory. But more than that, you realize it can and will produce twice as many widgets as the old WM87. The cost of the new machine can be easily amortized by using the salary of the employee you can terminate and by factoring in the greater efficiency. Since they offer lease terms you can afford it (on paper, anyway), you take the plunge. However, while the new machine is theoretically more efficient, you have failed to consider the fact that, unlike the trusty WM87, the new machine is more complex than any of your illegal alien workforce can operate. Therefore, you must hire an MIT educated engineer to run it. Or you did not realize that you only need to produce 40 widgets an hour and any more capacity than that is really just waste. But these realizations come too late and you are committed for eternity on the lease. It won't take many of these types of decisions to torpedo your chances. This mistake turns up in just about every manufacturing business that we see having problems.
  8.  Have limited operating capital: Hopefully, when you bought the business you projected its profitability under your ownership. Therefore, you should have projected cash flow and realistically looked at how you could manage the cash flow of the business. However, most of the failed business owners either do not undertake this step, or they use projections that are based on a fantasy. They do not review the numbers with the seller to determine if the projections are realistic. Rather, they charge ahead with a rosy picture of future operations. Invariably, they project growth but never question why the business will grow under their leadership while it only remained steady under the guidance of the prior ownership group. Eventually, there will be no capital to operate the business.
  9.  Allow your ego to make all the decisions, or put "your stamp" on the business: You put the deal together and you bought the business. You are now the boss. It is human nature to want to make all the decisions and to put your own brand of management in place. Don't do it. Don't demand that things be done your way solely because of your ego. You, understandably, just want to be recognized as the person in charge. However, when a decision needs to be made, you want to appear decisive. When you should be gathering all the critical employees and asking their opinion, in essence building a consensus, you are instead relying on your own judgment. After all, if they were as talented as you, they would own the business. It is the road to ruin. Whatever steps you take, make sure they are taken for all the right reasons. Under no circumstances should you decide to make a change, or for that matter make any decision, just because you are the boss.
  10.  Refuse to develop a relationship with the vendors: If you do not have vendors, then you do not have a steady supply of inventory or supplies. Without those things, you cannot stay in business. Get to know your vendors. Find out their policy on extending credit and for shipping product. Find out who the key contacts are at each major vendor. Make sure those people know who you are and how to get in touch with you if there is a problem. Do not allow the relationships with vendors to deteriorate. It is just too costly in the end.
  11.  Hire your friends and family to help run the business: Employees are very smart. Typically, they have more experience in the industry than you do. So when you hire your brother-in-law to run the warehouse, you made an enemy out of every other employee. Particularly when the newest employee-family member is hired to supervise key employees.   It has never worked. It will never work. If friends or family are hired in they must start at the bottom, like everyone else. You must be fair in your hiring. Not for legal reasons, but for morale reasons. The employees must know that you are a fair person who is not running the business as a country club for your close associates. Otherwise, they will feel their hard work is for nothing.
  12.  A failure to understand the business is really a group of interdependent "systems." You must view the business as a group of inter-related parts and "systems." Remember Murphy's law: what can go wrong, will go wrong. If you see a worker in the shop that is older and decide a lower-paid younger worker will provide a better return, consider the impact the loss of the older worker will have on the company as a whole. Who in your management used the older worker as a mentor or sounding board? Or what if that older worker is the glue that has held together the production team for twenty years? His role may seem insignificant on paper, but what effect will a termination really have? Customers that grew comfortable seeing him at each delivery may view your company as unstable if he is not there at the next delivery. All of your people, product lines, divisions and equipment are inter-related and inter-dependant. Seemingly minor changes can lead to unexpected and surprising results. Be very careful.  

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