Outside of a dog, a book is man’s best friend. Groucho Marx
Your business is doing well. So well, that you’re thinking it’s time to expand. One possibility is to slowly continue to build the business by adding customers or clients one at a time. Another possibility is to quickly add new customers or clients by acquiring a book of business from another company. This article will examine some of the issues involved in acquiring a book of business.
Finding the book
Locating the book of business may be one of the more difficult parts in acquiring a book. There are four common sources of finding a book of business to acquire:
- Business brokers
- Investment bankers
The least expensive, and perhaps the best, way to find a book of business to acquire is to find it yourself.
It’s generally advisable to engage in professional and social networking. It’s a good way to expand your knowledge and learn what others are doing. It’s also a great way to make contacts that may eventually lead to an acquisition.
Networking, however, tends to be long term. It can take years before results are achieved. And some people, no matter how hard they try, just are not very good at networking.
An alternative, then, is to turn to a business broker or finder or an investment banker.
Conducting due diligence
Once found, you’ll want to fully investigate the book of business before you agree to purchase it. This investigation—to minimize the risk that your acquisition is not what you expected—is known as due diligence.
The conduct of your due diligence should include at least the following:
- Seller’s financial and personal background
- Books and records
- Evaluation of customers or clients
The due diligence can be conducted before or after a definitive agreement is signed.
How much to pay
The amount that you will pay for the book will be negotiated by you and the seller. As a shortcut method of valuation, people often look at the price as being equal to a multiple of revenue or EBIDTA. But this is just a shortcut. The actual value of a book of business cannot be truly derived by applying a simple multiplier. Each company—and especially its mix of customers or clients—is unique. The parties need to review and break down the demographics of the customers or clients.
The key factors to evaluate are the age of the customers or clients, the services and products being purchased by the customers or clients and the location of the customers or clients.
In addition, you’ll want to consider whether the seller’s customers or clients are a ready source of additional business. Do they have children who are now or may in the future be the next generation of customers or clients? Have the customers or clients historically been a ready source of referrals?
If necessary, an outside valuation firm or accountant can be hired to place a value on the book of business.
Signing the definitive agreement
You and the seller should enter into a definitive agreement. The purpose of the agreement is threefold:
- To memorialize your actual agreement
- To create a road map for closing the deal
- To govern in case of dispute
Depending on the deal with the seller, the agreement may include certain seller covenants, including agreements by the seller that it will not solicit the clients being sold to you or will help you transition the customers or clients.
In any event the agreement will provide for the method and timing of payments that will be made to the seller.
Paying for the book
It’s customary that at least a portion of the purchase price be paid at the closing of the acquisition. The balance may be paid over a period of time in the form of fixed payments or earn-outs or a combination of both. The buyer may also issue or assign equity to the seller for part or all of the purchase price.
Fixed payments and equity are pretty straightforward, but what’s an earn-out? An earn-out is a way for the seller to be paid based on the future performance of the book of business being sold. The more the book earns for the buyer, the greater the payment to the seller. And contrariwise, the less the book earns, the less the payment to the seller. The earn-out shifts some of the risk from the buyer to the seller. It’s a real option, especially when the seller agrees to help transition the customers or clients to the buyer.
Acquiring the book of business is not the only option. There are alternatives.
One possibility is to purchase more or all of the business, not just the book of business. Are there personnel that you wish to bring on board? Are there facilities or systems that you might wish to use? If so, consider acquiring the business, not just the book.
Purchasing a business will be a lot more complicated than just purchasing a book of business. The definitive agreement will need to be longer and more comprehensive; the due diligence review will need to be more extensive. And, of course, following the acquisition, it’s a lot more difficult to integrate a business then it is a book of business.
A second possibility is to acquire the book of business indirectly, instead of making an outright purchase. The book can be acquired by accepting referrals from the “seller,” instead of purchasing it outright. The seller, as a referrer or solicitor, would sign a proper solicitation agreement with you. He would then receive a portion of the fees you receive from each of the referred clients. The fees can be a fixed amount or a percentage. They can run from one year to five years to forever.
You may be concerned that the book of business is somehow tainted, that the seller may not quite have the freedom to transfer the book to you. This can be a real issue when the seller is working for another firm; the customers or clients technically (and legally) may belong to the firm, not to the “seller” who has the real relationships with the customers or clients.
Now may be the time to expand your business by acquiring a book of business. I hope this article sheds some light on the issues involved.
Inside of a dog it’s too dark to read. Groucho Marx
— Alan N. Walter