Podcast: Micro Private Equity: The Art of Acquiring Small Businesses
Learn about the opportunities present in micro private equity. Deal structuring will be an important skill for young entrepreneurs looking to acquire businesses and those owners seeking an exit.
In this podcast, Ace Chapman, business acquisitions specialist, talks about:
- The importance of timing the market when selling a business;
- The opportunity of finding hidden value in business acquisitions;
- How young future entrepreneurs can buy a business with little or no capital;
- The fact that a business is worth zero if there are no interested buyers; and
- How properly documenting five areas of your business can help increase business value.
About the GuestOver the last decade, Ace Chapman has bought and sold 11 companies using funds raised from high net-worth individuals and institutions.
Ace leverages his experience in micro private equity, capital raising, and entrepreneurship to help investors generate above-market returns through the acquisition and sale of small businesses.
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Read the Full Transcript Here:Noah Rosenfarb: Hey, it’s Noah Rosenfarb from Freedom Exit Advisors, the author of Exit: Healthy, Wealthy and Wise, and today we’ve got Ace Chapman. For the last decade, he has bought and sold over a dozen businesses and he also helps other business buyers build deal flow, find businesses on the hidden market to due diligence, and complete valuations. Ace has a depth of knowledge that he’s looking to share with us today as well as an owner and an adviser to owners. Ace, thanks for coming on the show.
Ace Chapman: Glad to be here. Thanks for the invite.
Noah Rosenfarb: Yes. You had mentioned you acquired your first business when you were 19. Why don’t you share that story because it’s probably a unique one?
Ace Chapman: As a kid, I was an absolute nerd. I was in love with the stock market, loved business. I remember being young and there wasn’t the internet back then. This whole thing with the stock market just excited me. Every time I was at the library, I just love going and getting encyclopedias and actually reading. There is a section that I probably read a hundred times just about how the stock market worked and what it was and all that. When I was 19, I came across a website that basically was an online stock market simulator and I loved what they were doing. I loved their vision. This was at the beginning of kind of the internet boom back when we were still in dial up and using AOL. I loved what they were doing, but it felt like they definitely were not promoting it.
I started a little web development company. During the summers, I would usually start a little business whether it was lawn or whatever so I knew a little bit about marketing and all that. For them, it was definitely a soft project and somehow I managed to get the CEO of the company that owned that website on the phone and started talking to him. Unbeknownst to me, I negotiated my first leveraged buyout not because I was financially creative or anything like that. It was out of necessity. I was a college student and had no money, but I really wanted this business. I got them to do about half owner financing. I had some credit cards. I had a little bit of money and brought in a friend who wanted to invest as well. I ended up buying that first business.
Noah Rosenfarb: Walk me through the mechanics. Did you do this all on your own? Was the friend sophisticated or was this kind of age of 19 just winging it?
Ace Chapman: It was definitely age of 19 absolutely winging it and I had no idea what I was doing. We got the business. Now, the great thing was that the partner that I brought on was technically sophisticated. That’s something that I feel really valuably then. It’s finding the right partner who has a different skill set. What we brought to the table with him knowing how to do the programming and improved some of the things that were needed on the site to help to facilitate good growth and I was really curious and interested in the marketing side of that business. Together, once we bought the business, it was a fun, fun journey. I remember just kind of running through in my head, reading books, doing research and trying to come up with some creative ways to make that deal work.
Noah Rosenfarb: Did it work in the end?
Ace Chapman: Yes. We took the site down, did a complete rebuild. There was the commercial a long time ago that really simulated it, but we had sent out a lot of invites to other college students and there was a novelty. Things were a little bit easier back then because there wasn’t a ton going on a lot. We sent some invites to friends and told them about the site and all of this and we had some viral aspects where we would give them more money to play trade and process and that kind of thing if they spread the word.
The first night, we put the site online and we had built it in the database thinking, "Okay, it would be crazy if we got 500 people over the course of the school year. By the end of school, maybe, we’ll have 500 people trading on this thing." We’re sitting there and the first hour it’s 50 people and then 100 and 200. You know that whole story. Then we realized, "Wow, we’ve got some work to do."
Noah Rosenfarb: That’s great.
Ace Chapman: That was fun. The other lesson that I learned and one of the things that’s really important for I think the people in your audience is that was before the internet boomed. Then, the internet boom happened. We had seven-figure offers to sell that business and really what it took how to see it through. After the bust, the whole model changed. The advertising changed and all of that and we got probably less than a tenth of what we could have gotten during the boom. That was a huge lesson that probably you know led of me being a little trigger happy in building the career that I have now where I’m building businesses and I’m quick to sell them for a profit.
Noah Rosenfarb: Have you found that your ownership mentality has changed also where you’re focused on value as opposed to profit or are you profit-focused as well?
Ace Chapman: Yes. I think it’s a combination of both. I mean at the end of the day the more cash flow that you’re able to build, that’s what attracts buyers I found. I think a lot of people get really excited about building a lot of assets and having a tremendous amount of value there. What I like to do is have as much cash flow as possible. It makes it easier for one to get good financing because it’s getting tougher and tougher on the asset side to put together deals. Yeah obviously, it’s a combination of both and each deal stands on its own. Where I like to play is go and buying a business, building up the marketing. I’m sure you see it as well that just most businesses aren’t pushing the marketing side of their business as much as they could. I literally see it.
One of the recent businesses I bought. I walked into the business and they had a 10,000-person database of past clients and customers that have actually spent money with them. They have their email. They have their phone numbers. They have their addresses. They never emailed them. They never called. They never sent any direct marketing to try to sell those people on coming back. I literally bought that business and doubled the month-to-month revenue ended up selling it in about six months by all just targeting their past customers. There are situations out there like that. It may not be that obvious, but I like to find those hidden assets like that that you can leverage and grow the business.
Noah Rosenfarb: As you go through those twelve businesses that you’ve owned and some of which you sold, have you found those hidden opportunities in most of them?
Ace Chapman: In most of the businesses, yes. You’ve got one or two things. This is something that on the sales side it is getting a lot more competitive and so there are more opportunities. Either there’s a hidden opportunity or a hidden asset inside of that business that we can go in and leverage or there’s a situation where the seller is just motivated. Whether it’s a divorce or death in the family or illness or whatever, there’s a situation where they’re just willing to get really aggressive about the deal structure.
The other thing and this is something that I think a lot of advisors are getting a lot more savvy with is really coming up with creative deal structures that attract buyers. A lot of times, when I’m selling the business, I try to paint different pictures of different options on ways to structure deals so that the buyer will be attracted to my deal as opposed to somebody who just says, "Here are the financials. Here’s the business plan. Here are the projections." You go figure out how you can close this deal. I want to come to them with, "Hey, I was talking to this financing company. You can get some money here. Here’s one way that I would structure it if I were buying this business. Here’s how we can limit your cash up front." Coming to the table with deal structures. We look for hidden assets that we can leverage and opportunities to either get a low sales price compared to the value or creative deal structure.
Noah Rosenfarb: Are you primarily doing that in the due diligence process or are you figuring it out kind of post closing you just have a sense that there’s going to something you’ll find?
Ace Chapman: In the due diligence process.
Noah Rosenfarb: You and I had spoken that probably the sweet spot for you is million dollar companies plus or minus, what’s the typical due diligence process like in that size deal? How long does it take and what information are you getting access to?
Ace Chapman: The time can really vary. The funny thing about that story I just mentioned is in the example of that business I was very sure to close this. I was excited to get in there and kind of leverage that database. It varies anywhere if I know a deal, I know really based on some hidden asset the price is greatly undervalued, I’ll close it within a couple of weeks and not spend a ton of time on due diligence as long as I get the information that I’m interested in.
Another thing that I think just a quick thought note for a lot of business sellers is there are a lot of people that don’t value the money that's spent on getting a good valuation and having somebody sit down and think about the value that’s in the different areas of your business. In a lot of cases, the buyer can come in. On both sides, you have buyers that don’t think about valuation so they look at a price and they just automatically start negotiating and you have sellers who don’t think about a price and may price it too low. I will sometimes pay the exact sales price because they’ve undervalued the business. Does that make sense?
Noah Rosenfarb: Yes. It makes a ton of sense. I want to go back and pick up on a word that you mentioned in that first company which is a leveraged buyout. I think you need that in a 19-year-old who does a leveraged buyout because that’s a term that we mostly hear thrown around with kind of bigger deals.
I know that’s something that you promote to the people that you’re working with is the use of leverage in the acquisition of a company. Tell me what that conversation is like and perhaps direct it to either the owners or advisers on the call that have young, hungry, entrepreneurial, and spirited people that want to be in business but have no capital.
Ace Chapman: Absolutely. What I spent a lot of time doing is working with young folks. It’d be great if more people spend time doing this because it’s going to be absolutely necessary as we see over 12 million more businesses that have ever been on the market in the US’s history, coming to market because of the baby boomers retiring. It’s going to really, really flood the market. Unfortunately, nobody is cultivating and nobody is training a younger generation to come in and take over those businesses. What we’ve spent time doing is kind of working on both sides, getting businesses in the position where things are systematic and someone else besides the CEO can come in and run the business and then working with the small business buyers.
With those younger folks, there’s the preparation and then there’s the actual structure. Most people go in and most advisors when I’m brokering a deal or advising a business on selling, a lot of times you can only go to a very select group of buyers or you have buyers come in and we all know that 99% of them are not going to be able to buy the business. Either they don’t really have the financing or they don’t have the experience or they have both of those, but they don’t understand due diligence so they just won’t pull the trigger because deep down inside, you know if you don’t really know what you’re looking at and you don’t know a good deal when you see it, it’s going to be hard to put your life savings and turn that over at the closing table. We start with preparation so that they have the training. They start building business credit. They have an LOC that’s going to be looked at favorably by the banks. Not that that makes a huge difference, but it is a difference.
Noah Rosenfarb: A lot of the other guests I have had on the show and the people I speak to in the course of my professional career, they’re telling me the bank aren’t loaning any money. How are you finding capital? Aside from seller financing, are you able to get some bank financing for some of the smaller deals that you’re working on?
Ace Chapman: No. We do not deal with the banks. They’re right. That’s another huge mistake that a lot of people make. They go to one bank and that bank doesn't loan then they go to another that has an ad saying "we’re the business friendly bank" and that bank says no. Everybody goes to banks, banks, and banks. The truth is just historically banks have only done 7% of all of the lending in the commercial and business lending. It’s a very small percentage. In 2008, it went down to 1%. It still shows that there’s lending going on because the other 99% was picked up by everybody else. There are just a lot of nonbank lenders out there. We have a database of over a thousand lenders that we work with. It’s just everything.
The financial approach that we take with those leveraged buyouts is we work with a lot of different kinds of lenders. We built a database so that we can track which lenders like what kinds of deals. When we’re looking at a deal, we’re looking at a person’s financial situation, we plug it into the database and it pulls up some lenders that we can work with.
One of the biggest keys where most people do these deals especially where we play with just under $5 million or when I’m buying deals under $2 million, everybody kind of takes that bank loan or one loan approach to get the money. We just take the same approach that larger businesses take where you look at their capital structure. They’ve got some stock. They’ve got some bonds. They’ve got some straight loans or asset-based loans or AR financing or equipment financing. There are a lot of different things that are there to build a capital structure that creates a great ROI for the company. We take a similar approach.
Noah Rosenfarb: The lenders that you’re dealing with, are they involved in these micro-private equity concept that you’ve kind of created and promote?
Ace Chapman: They are involved in the sense that they’re helping to finance the deals. We had a Gold’s Gym down in Alabama where there’s a tremendous amount of equipment and those things. You know, we’re putting together a deal. They are one of the financing companies of maybe four that we deal with. We did a carwash deal where SBA has a program that’s great for those where there are eleven different carwashes that got bought. But for the most part, the biggest problem with the banks is they’re definitely going to seek some SBA-type guarantee and it’s going to cause you to tie up all your assets in liens. The house is going to be leined. The business is going to be 100% leined, all the assets in there, so we’re not able to put together different types of financing to get a really great deal for the business buyer.
Noah Rosenfarb: Most of these lenders that are interested, if they’re not somehow leining assets, the identifiable tangible assets, are there other lenders that are just interested because they like investing in entrepreneurs and if they could get a return, that’s in the high teens or mid-20s, are they up for that risk capital?
Ace Chapman: Absolutely. There are a lot of local opportunities to do to get financing for just specific programs. In that deal that I mentioned in Pennsylvania where she bought the publishing company, there was a part of that deal source who was a local loan that the state of Pennsylvania is offering for people that are bringing jobs specifically to Pittsburg. There are different types of financing out there based on the deal.
That’s why I’m definitely not being evasive by not saying like, "Oh well, there’s this company, this company, this company." Every deal is really unique and we go after every type of financing that might work we see we get access to. We see what lein they’re going to require and then we try to pick out the best type of financing and deal structures that’s going to work for that business buyer.
Noah Rosenfarb: How about on the flipside? I’ve mentioned before this micro-private equity concept that you promote. How about for people that want to have equity in a portfolio of companies but don’t want to be the operator? How are you involved in that and what’s your advice to maybe owners that think, "You know, I’d love it if I could own four or five different companies, maybe part of a carwash, maybe part of an internet publishing business. I’ll chip maybe some advice if I can but hopefully I’ll just collect some dividend checks and maybe sell it for a profit later on."?
Ace Chapman: One of the things that happen for us over the last six years as I’ve been working with clients is people had bought businesses and exactly that would happen where they see the value that the huge thing with private equity or just buying a business especially when you get under that $5 million dollar mark. It’s the multiples are just incredible. Now, you need to be able to manage the business. You got to work it. When you talk about buying a business in three years, it’s going to be completely paid off. Four years, it’s going to be free and clear. That’s a powerful investment strategy and wealth building strategy and there’s just no other asset class. When you look at real estate, you look at obviously the stock market, there’s just no other asset class where you’re buying something at that low a multiple.
Once you go above $5 million, you’re competing with private equity. Below $2 million especially, you’re doing deals max at a two multiple. We’re often finding deals at 1.0x and 1.5x. That creates a huge opportunity. We have had people that buy businesses and then they realize, "Hey, I really like this. I don’t want the headache of buying another business." That’s when we kind of start to develop this micro-private equity concept where we don’t really go out and seek investors, but most of the people that we work with are literally past clients and then they’ll talk to, build a relationship with and connect with some of our, in some cases, younger buyer clients and invest in them and their deals and not only put up money, but put up experience and time and become a mentor and really get involved on a strategic level with that business without having to deal with the day-to-day and still be able to take advantage of the benefits of buying a business.
Noah Rosenfarb: That’s a unique concept to me before you and I met, and I kind of read about that on your website. I’ve never really heard of it framed in that model. I guess it’s similar to how you describe the leveraged buyout. You know, it’s taking a concept that applies at a different scale and just scaling it down and it’s even more powerful I think when it’s scaled down than as it gets scaled up.
Ace Chapman: Yeah. It really is. That’s the interesting thing. Obviously, the great thing is private equity companies don’t want to play on my playground. Obviously, we’ve got all these other market dynamics with twelve million more businesses that are coming to market, just a lot happening in the space creating. A lot of those businesses are going to be under that radar. They’re going to be under $5 million. It’s creating an opportunity on both sides.
Noah Rosenfarb: Let’s talk a little bit about those twelve million businesses. We had Richard Jackim on the show, the author of The $10 Trillion Opportunity, and then there’s Peter Christman and the other co-author. We were talking about some of those dynamics of baby boomers leaving their company. One of the resounding responses I’ve got into that from business brokers and others that are in the same space is most of those people are never going to sell. They’re going to end up just either dying with their company or die a slow death or they’re never going to get real value. What advice do you have to those owners that fall in that lower quartile so that they can actually get value out of their company?
Ace Chapman: There are a few things. One is to be proactive. There are a few things that a lot of business sellers take for granted. The first is timing. There is your personal timing. A lot of good people think about that. A lot of advisers talk about that. That’s just what’s going on with your health, what’s going on with your personal life, do you have dreams that you want to go after and all of that. That’s great. But also, thinking about the economic timing and your business cycle timing. I learned that the economic timing early on with my small business. Those things do affect us. What’s going on with banking and lending and all those things affect us. The other huge elephant in the room of course is all the other businesses coming to market which may push you to start to think about what you’re going to do. What is your exit strategy?
Think proactive about coming up with the exit strategy and proactive in the sense that it’s not just, "Oh, I think I’m going to pass this down to my kids." Or "I think that manager may end up buying the business" but really talking and having a very specific transaction along with a specific timeline. Unfortunately, we end up getting a lot of great deals in those micro-private equity deals where somebody waits until something occurs, whether it’s tragic or just something happens in their personal life where they have to sell.
The next thing is having a package that’s going to attract a buyer. One of the things that we do when we’re selling businesses in addition to just laying out the deal structure is we have five different prospectuses. Sometimes, they’re short. They’re only three pages. We have five different decks or five different prospectuses about a single business. They cover everything. We have a product prospectus which talks about the product. We give a description of each service and each product line. We give the relative importance of the product and the inventory that they’re going to get. We give a prospectus about our customers and just how we track in and market to and deal with our customers and any contracts that we may have to. We go through the marketing and we go through the financial. We definitely put together each aspect of the business so that they are very clear about the value that they’re getting when they buy that business and the fifth on is the systems.
Noah Rosenfarb: For owners that kind of wait until the end, you know when you’re on the buy side and you see somebody that they just had grandkids in Texas and they decided they got to up and move and they’ve got that small business that’s local and they can’t take it with them, what happens to the price? Where do you see the price versus what it could have been if you’ve met with that owner six months before and just help them prepare?
Ace Chapman: Like you said, a lot of times, we go into those situations. They’re dealing with a price of zero. Everything that we give them above zero is a great price and so it does create some really great opportunities. That’s one of the other things that they’re fighting against is the fact that they’re competing with a lot, that the internet businesses are a new asset class in the space that weren’t paid attention to four years ago but people like the fact that they’re relocateable, scalable, they can come in and run the business a little more easily and they have some systems in place and all of that.
For the person that can’t transfer their business and they’re going somewhere or just is a couple that is just ready to get rid of the business, in a lot of cases, when you want to sell immediately, there aren’t a lot of buyers out there. Your a lot of times facing, just not selling it, closing it up and leaving. We have had some business deals that we just weren’t interested in. That literally happened. It was actually profitable, great business. That’s why I really stress to people this isn’t something of, "Hey, maybe if I don’t play it I’ll be able to just sell it for 20% less or 30% less." In the coming market, if you don’t have a plan and you’re not proactive literally starting today, you’re literally looking at zero.
Noah Rosenfarb: What would be three things that you would tell an owner that they should start doing today?
Ace Chapman: The first thing is to start to put these things in place. I would break it up into those five areas. I would do competitive analysis. I would do some marketing and sales analysis about your business, put together the product analysis, and go through the different areas of you business and start to document them. The thing that that does when you bring in a buyer, most of the time people treat it as like a house. You can go in a house and see the value. "Okay, I like these cabinets. I like the paint that was in this room. I love the bathroom and the Jacuzzi tub." And you can leave that and know what you’re buying. When you walk into a business and you start to talk, they give you some financials to leave and make your decision on, that’s great but that’s not what you’re buying. What you’re buying is this business system, so describe to me the business system.
You do have a lot of people that are in the market. On the buyer side, you’ve got just a lot of people that are the other side of that retirement equation, the people that have saved up for retirement, gotten hit by three or four stock market crashes and they’re in retirement and just don’t have the money to officially retire, but they do have the money to buy a business. The second thing after putting everything together would be coming up with your target market. Who is the person that you’re going after to come in and buy your business? I mean you wouldn’t go out and just spend money on advertising or spend money marketing without having a target market. It’s the same here. Unfortunately, people don’t do that. They kind of just go out blindly thinking, "Okay. Hopefully, somebody is going to come and buy this business. I just want a buyer." Having that target market, building your materials and everything to really show the retiree if that’s your target market, "This is a great business for a retiree. This is why and this is why it’s going to be a great business you can pass down to your kids." That’s a huge value because it makes that person feel like, "Wow. This is the business for me. I mean look at all these other businesses advertising to the world and this one was specifically made for me."
The last thing is to hire advisors and a build a team. Every year, nobody is going to just trust their taxes to be done by anyone. They want a strong CPA because they don’t want to get screwed when it comes to the IRS. This is an even bigger deal than that. This is a bigger deal than doing your taxes. This is the payment for all the work that you’ve done building this business. Unfortunately, a lot of sellers just don’t take it that seriously and don’t build a team around them to go after the buyers and do everything that we’ve kind of talked about on this call today.
Noah Rosenfarb: Yeah. Before we wrap up our call, Ace, what else would you say are kind of a couple of bits of advice that you like to tell either every owner or every acquirer?
Ace Chapman: Every owner, what I tell people is don’t be a lazy seller. You can put a lot of work into a business and then there are a lot of folks who just think, "Okay one day, somebody’s going to walk through those doors. They’re going to want to buy my business and I’m going to turn everything off and head out of here." I call them, people that are addicted to hopium. You can’t live in a world of hope and dreams. Your business isn’t going to work and profit on hope. You’re not going to be able to sell your business on hope.
What I tell buyers is now is the time. I mean now is the time to really gain this skill set, gain the micro-private equity or private equity skill set which I consider to be finding really great deals, negotiating those, being able to do due diligence, knowing how to do valuations, and knowing how to structure and get access to financing, raise capital, put together deal decks and all of that so that you can have a financing to go and do deals.
Noah Rosenfarb: Well, great advice. Ace, if for those of our listeners that would like to get in touch with you either to talk about buying a business, selling a business or learning more about becoming a lender in your portfolio or being part of your private equity program, how should they get to you?
Noah Rosenfarb: Terrific. Well, Ace, thanks so much for joining us today. To all our listeners once again, I want to remind you if you could rate us on iTunes, we’d appreciate it. Be sure to leave your feedback either anywhere on our website or on LinkedIn if that’s how you found us. We look forward to having you again. Thanks so much!