QUESTION: I own a small residential maintenance and repair business. I’m considering buying a one-person plumbing contractor that’s currently breaking even after the owner pays himself. The owner of the plumbing company would become my employee and run a new plumbing division.
Do you have thoughts about whether this makes sense and any pitfalls to avoid?
ANSWER: Research shows that most acquisitions do not provide a good return on investment for the acquirer. However, on the surface, this deal sounds interesting. We suggest following the five tips below.
Don’t overpay for the business.
- Our primary rule when acquiring a business is to ensure that you have a clear plan for running the business more profitably than it is currently run. In this case, the business you are considering purchasing is just breaking even. Of course, it doesn’t make sense to pay anything for a company if it isn’t going to make money for you, so breaking even isn’t acceptable.
Therefore, you must have a plan for improving profitability. The good news is that it seems you may have that opportunity.
When you combine your maintenance and repair business with the plumbing business, there should be an opportunity to reduce the overhead. For example, you can combine functions such as accounts payable, accounts receivable, scheduling, bookkeeping, etc. Since the plumbing business is currently operating at break-even, the overhead reduction would become your profit margin. If the owner of the plumbing business is currently doing all of this work himself, the consolidation would free up his time to do other work.
Further, you are probably using subcontractors to do plumbing work in your current business. You should make more on this work when your new plumbing division does it. Make sure this is the case.
These two opportunities will increase your profit. However, if you overpay, any acquisition can be a bad deal. Make sure that the projected profit increase is sufficient to provide a good return on what you pay for the business. After that, any growth in the business is gravy.
Make a good hire.
- Assess the plumber as you would any prospective employee. One thing that often causes deals like the one you are describing to go wrong is that the owner of the acquired company turns out not to be a good employee. If you wouldn’t hire the owner of the plumbing contractor other than for the fact that you are considering buying his company, the deal is much less attractive.
Ensure your employee is motivated.
- Make sure that the plumbing contractor has some skin in the game. We’d suggest paying for his business over time. You might pay in monthly installments that are more than covered by your increase in profit. Otherwise, you may run into cash flow problems.
Make the total amount you pay for the acquisition dependent on how well your new plumbing division performs. Alternatively, make the compensation you pay him for running your new plumbing division a function of how well it performs. Paying someone a lot of money for his business and giving him a fixed salary when he comes to work for you is a recipe for an employee that lacks motivation. We’ve seen it too many times.
Be clear about what you are buying.
- If you are buying the business, you’ll get all of the assets, for example, cash, accounts receivable, customer lists, physical assets like trucks and equipment, etc. You’ll also get all of the liabilities. These may include accounts payable, loans, etc. Further, you’ll get contingent liabilities. For example, if you buy a business that subsequently gets sued, your company will likely be liable. Make sure you don’t acquire an unpleasant surprise.
An alternative is to purchase just the assets of the business and have the owner dissolve the existing plumbing company. This offers more protection from contingent liabilities. Either way, make sure you know what you are getting. You don’t want to think you own a truck and plumbing tools and then have your new employee claim that these items are his personal property and weren’t a part of the deal. Yet, we’ve seen this happen.
Get a non-compete.
- Insist that the owner of the business you are buying sign a non-compete agreement as part of the deal. You should also include a non-poach clause as part of the agreement. The intent is to keep the seller from taking your employees or your customers should he leave. Check with an attorney to make sure that the non-compete protects you and is enforceable. You don’t want to buy a business and find out six months later that you are in competition with the former owner.
More acquisitions fail than succeed. Follow the tips above to improve your probability of success. Finally, if you are inexperienced in such matters, we’d suggest that you seek competent advice from experts.
Doug and Polly White have a large ownership stake in Gather, a company that designs, builds and operates collaborative workspaces. Polly’s focus is on human resources, people management and human systems. Doug’s areas of expertise are business strategy, operations and finance.