Exploring the Untapped Potential of Buying Small Businesses with Baton CEO, Chat

Speaker 1: 0:10

Welcome to the Funded Podcast, where we dive into the details of how businesses really start, grow and operate. We'll hear from experts that guide us on our small business decisions in finance, marketing, managing people and everything in between. I'm your host, stephanie, the CEO of Funded, where we're on a mission to redefine how the smallest businesses understand and access capital, and today I'm chatting with Chat, the co-founder and CEO of Baton, on buying an existing business. Baton is Zillow for small business. Let's dive in First. Welcome, and the first thing on my mind is like the most basic is like who should buy a business?

Speaker 2: 0:49

Yeah, that's a great question. Thanks for having me here. I think anyone can buy a small business. I think the biggest issue is most people don't realize that it's a good opportunity for them and something that they can do, versus starting a business from scratch, working in a larger company or working for someone else. And I think a lot of what we spend time on is really education to give people a good sense of what are the steps to buy a business.

Speaker 1: 1:14

Cool. So anyone should consider buying an existing business. And before we kind of dive into buying a business, why might this be a better route than starting a business from scratch?

Speaker 2: 1:25

Yeah, I think a lot of it is because a business that's going has already essentially addressed a couple of key things right. They either have a bunch of customers that love them, they have carved out a location or a geographic concern right, if they're a contractor or whatever it is, or a landscaper, and I think at the end of the day, you want to reduce uncertainty in any new venture and an existing business has done that, especially if they've been around for 15, 20, 30 years. You want to almost be the honorable successor for that business right and how you can take it to the next level.

Speaker 1: 2:00

That's such a good response, sue, and I just love this topic. I'm so excited to have you on the show today because when I started my first business out of college, I didn't even consider buying an existing one and I think, like a lot of people, I just assumed I couldn't afford it. I know so much more now that, like, actually, because it's an established business, I might actually be able to afford it more than being able to afford starting one, and that some of these businesses are like SBA pre-approved, which means they're lendable, and not to mention like the cash flow right, like as a first time entrepreneur. A lot of people don't think about the fact that, like, if you buy an existing business, you literally can know if it's going to be profitable in its very first month, which sounds a lot less stressful than like I might go start something. So big fan of buying an existing business over starting one. If someone is interested in buying a business, what is the first step they should take?

Speaker 2: 2:53

Yeah, I think at the end of the day, it's what do you want to buy? It sounds like a very simple answer, but it actually matters a lot. I think you've done this as you've started businesses. It has to be something you're passionate about. It has to be something that you're going to wake up every morning and want to be in it on the good days and the bad days. So I actually think that's an important piece. Some of it is that the industry and the type of business, location constraints, but at the end of the day, it's really something that you want to do. I always tell people when they're doing tech startups is this something you want to do for the next 10 years? And I think buying an established business is the same thing. What is going to get you excited about it? And then, once you really hone in on that and look at different businesses kind of research them I think then you can start to go into some of the next steps, of what part of the financing paths can I should I line up investors for this, how big of a business do I feel comfortable buying, et cetera.

Speaker 1: 3:47

Awesome. That's so interesting. One thing I never thought of when I bought a business way back when is I kind of felt like when I hear that you have to be excited about it and passionate about it, I always thought like, oh, it has to align with almost my hobbies. But what I realized is also being passionate about the business could have little to do with the business and more to do with do you like managing people, do you like leading, do you like making decisions? And it's like well, if all those things are true, a bigger, more established business might be more interesting to you than a company with like three people where you're likely going to be doing the work of the business. So it's like are you a baker that wants to actually be in the kitchen? Buy something really small. Have you been a baker your whole life and you're a great manager? As a result, maybe buy something bigger. So when it comes to financing the purchase of an existing business, I'm also curious about first steps and options. The first thing on my mind wondering is we said you're the Zillow, a small business. Is it the same Like can I go get pre-approved or what do I do?

Speaker 2: 4:52

Yeah, that's a great question. I think there are a lot of parallels, but one of the unique pieces with getting pre-approved is a lot of SBA lenders are actually interested in knowing the exact business that you want to purchase. So a plumber buying a plumbing business is different than a tech salesperson buying a plumbing business. Not to say that both couldn't get approved. But the lender actually looks at that differently. So I think part of it is ensuring that you have your financial house in order, so when you're ready you can move quickly. You can get the equivalent of pre-approved sometimes and you should establish a relationship with a lender so they can start to do some of the work and you look like a more serious buyer. But really, at the end of the day, right, there's a ton of financing options. If they're the SBA 7A loan, you can line up investors, you can roll over a 401k, you can do a bunch of different things. But the more that you understand about it, the more that when you identify a company that you want to buy, you're really able to move quickly. But it's not required to get pre-approved because most lenders, honestly, they'll give you a letter saying, hey, we would want to work with them once they identify a business, but it's not the equivalent I would say, as a Wells Fargo or think of. America pre-approval.

Speaker 1: 6:09

Yeah, and so I think what you're saying too, is that the pre-approval happens more on the business side than the individual. It is important to care about your personal finances I've emphasized this before in the show Like your personal credit, while personal is, in fact, an extension to your business lendability, because that's all they have to sometimes go off of, Is it true? I remember a brand I was looking at a long time ago and what it promoted was like this business has been pre-approved for an SBA loan. So, on the business side, can they get pre-approved to essentially sell their business?

Speaker 2: 6:44

Yeah. So we actually do this at the time because a business can get pre-approved and because essentially what the lender is looking at is last few years of cash. They're essentially looking at the durability, if you will, of the revenue going forward so they can do a pre-approval. It is contingent on a buyer coming in but it tends to be more conservative than if it's a fast-growing business. You don't necessarily get credit for all that growth because the lender is going to look at maybe that was a good year and it's going to go back to how it was two years ago or three years ago. But you can get it pre-approved and we in our valuation actually do a first pass on how much do we think this business could get approved for an SBA loan and then for the ones that we represent and list to sale, we actually go through the effort of getting them pre-approved. So we work with a strategic lender and send them all the information so that it's ready to go Again, to try to speed up the process so that we've done as much pre-work as possible.

Speaker 1: 7:43

Awesome, and you mentioned some other ways to purchase a business in there. You mentioned SBA investors. Let's start with the SBA. It sounds like this might be the most common path for an existing business.

Speaker 2: 7:57

Yeah, I think. And back to your personal credit, there's a personal guarantee on an SBA 7A loan, but the terms again like an FHA loan for a mortgage. It's a federal program because the federal government wants to incentivize small business creation and growth, and so relatively really good interest rates, a long-term 10 years, so you can be very clear on how much the debt payment will be. And you're back to your point earlier, using the cash flow from the business to help pay for the financing. And so most people will generally go to an SBA loan, provided the business is able to be funded by the SBA and everything else works, because it's, I would say, the best option. All else being equal, whether it's 70, 80% of the purchase price, you can get up to 95% in some cases, so it just depends, but a lot of people I would say like 80% on an SBA loan, 10% on a down payment and 10% that seller financing, which has a dual interest where the seller stays involved in the business, but also which is good on both sides. Right, the seller is invested in making sure the transition is good and is also getting a little bit of upside if you can continue to grow the business.

Speaker 1: 9:14

Okay, and so some other options you mentioned. I remembered them. Let's go to investors. So you know, we always think of investors in the venture world, but there's like this whole rising this entrepreneur through acquisition or search funds or just random people you meet that are willing to invest in it. So can you tell us a little bit more about financing the purchase of a small business through investors?

Speaker 2: 9:37

Yeah, so similarly, let's call it a million dollar business or it's a five million dollar business. You can go get an SVA loan and do that.

Speaker 1: 9:45

As they get more expensive.

Speaker 2: 9:47

The SVA will cap out at a certain level and so what some people will do is the lineup a bunch of investors. So again they bunch of friends that are doctors or lawyers and are looking for a different investment vehicle versus the stock market. You basically agree that they will be let's say, five of them that are going to give you a million dollars and a bunch of different outcomes that you can pay interest on it. Allow, an SVA loan could be similar to venture, kind of upside on top, once the business is throwing off cash and they're getting in an annuity. But essentially you're lining up those investors as a alternative to the SVA, which is the federal government giving you a loan. In this case it's investors giving you a loan and there's pros and cons to each right. The federal government it's like kind of pulling teeth sometimes and there's a lot of paperwork, but it's more structured and more well known Investors. Sometimes the terms can be a bit different based on what those investors want to do. But, as you pointed out, with entrepreneurship through acquisition, I think more and more people are in the space and there's more and more standardization there, but those are generally, I would say, used for the larger businesses. If you're buying a bakery, as you were mentioning earlier, and it's a $400,000 bakery, most investors aren't going to be interested in that. That's generally a good use for an SVA loan or some of these, like rubs, 401k or rollovers, where you're taking money from one investment and moving it into another because it's a smaller scale.

Speaker 1: 11:12

Yeah, and I've heard entrepreneurs through acquisition investors or search funds sometimes refer to as mini private equity. So for people that are listening right now, those are going to be like businesses call them like even $7 million and up, but probably less than 30 million Somewhere in there is going to be a good fit for that and you would take on investors because you essentially can't get just a loan for that much. The one that's most interesting that I know it's so little about but it's super fascinating to me is your 401k. Like, when people have said this in the past, I literally thought they were like taking the hit and cashing in their 401k and I'm like, oh my God, what are you doing? That is not the case. This is me being not informed, so tell us about this 401k option.

Speaker 2: 11:58

Yeah, that's essentially a rollover option. So, as many people know, you have a 401k at a company you leave. You can either move it into an IRA at any Schwab or wherever you bank, et cetera, or invest. But one option is this is now known as Rob's rollover business and there's another one in startup plan which is kind of this QSBS thing. So if there's qualified small business stock and you get the proceeds from that, you kind of have this clock where in six months you can roll it over to a small business that you acquire and you get to carry over the timing because there's this sort of five year clock and so the 401k is at a high level very similar. But essentially, if you're gonna use that investment into a small business, it's a way to put it there, versus putting it into your IRA, which would be the other option. You can keep it in your instead of being a 401k that gets contributed at your old company. It has to go somewhere. You could sit in that again a Schwab account if Schwab's administering your companies 401k, but you have the ability to shift that over into a small business and so that's. It's an interesting option for some folks where they want to do that.

Speaker 1: 13:09

And so just to clarify too, that is like without penalty. So people doing this they aren't getting hit or anything, it's just something to explore.

Speaker 2: 13:19

Yeah, it's like a tax loophole that allows you to disperse it. It's one of the unique places you can put it, other than an IRA, where you're not taking that early withdrawal penalty and so that was obviously a few others, but I am not a tax person, so that's fine.

Speaker 1: 13:34

And so, okay, sam, I'm a aspiring small business owner. I probably looking for a business on the side of my day job, and this is actually my understanding. The most overwhelming time consuming part is finding a business to buy. So where do people find businesses for sale?

Speaker 2: 13:55

Yeah, and I think it goes back to my earlier answer, like figuring out what you want to buy and what's interesting. In some ways that's time consuming because you're probably researching a bunch of different industries and verticals and what seems interesting, what throws off cash, that you're interested in, what are the multiples, etc. Once you get to that point, then actually I think you can search on sites like Bizbuysale, which is kind of a Craigslist. Obviously, you can come to Patan Awful Craigslist. Yeah, sorry, we don't want to talk about it, but it's awful, in my opinion, yeah, but it is where things are. They're broker sites, but again, at the end of the day, if you understand what you're interested in, purchasing, the sites that do a much better job and rose-colored glasses. But I think we do a good job of enabling buyers to express what they're interested in and then we reach out to them when we find results or they can look at our results in our deal room of active listings and decide for themselves and actually go through. And I think, ultimately, the other piece is not only is it an interesting business and industry, but what is something you bring to the table? That's, in a way, a thesis. Like you think you can bring them into the digital age because they don't have a website, you could lean into that Digitization or their operations might be a little bit of a mess. They've never had an issue getting new sales, but they're like my back office is kind of a mess and but you're amazing at that, or vice versa, you're an amazing salesperson and like they have all the equipment and kind of the process and know how. I think it's those kind of matches right when you can come in and, like I said before, be that honorable successor, because you're able to take over the business and then take it from where it is cash flow that's coming out of the business and use that cash to invest and help it grow to the next level.

Speaker 1: 15:42

Interesting. So I find a business on one of these sites. I go through the diligent process what happens if the existing business I'm looking at has debt and like how does that factor in?

Speaker 2: 15:56

Yeah, there's two main, really only, types of sales that happen. It's either an asset sale or an equity sale. In terms of this question, one of the big differences is in an asset sale the debt does not transfer. So if you're buying a business for me and I have a $100,000 line of credit or a loan, I am responsible for paying that off before all the other assets go to you. If you bought the business for me as an equity sale, then you are taking over that. You also get other stuff with it. So that's a bit of a trade off and kind of depends on the type of business. There's some again tax benefits, pros and cons on the two. But, essentially, if there is debt, I think, depending on the unique situation, the buyer will either want to assume that because there's something they want to do going forward and it's worth it to do an equity sale, or it's going to be free and clear because it's an asset sale and you're essentially buying kind of the physical and intellectual property assets of that business, but any of the debt does not move forward.

Speaker 1: 17:02

Yeah, so interesting. I think about that because as a small business owner, we carry debt. It's part of the business model, of what we're in, and so a factor you have to think about in selling is that the price to sell has to be large enough to one pay off all of our debt plus have whatever left over, which isn't impossible. But I can see in this kind of changing interest rate environment where interest rates are starting to be really high and I know the debt on my business is the interest rates are pretty low how someone might come in and strategically want to do equity over asset just to be able to get access to capital out of lower interest rate or maybe something like that, yeah, okay, and I think those are good analogy right these days with real estate again, because if the same thing of if someone had a 2.5% 30 year fixed mortgage on their house, a lot of people are like, hey, can I keep that?

Speaker 2: 17:56

And how do we do it? Just rent that from you, yeah. Because, so it's sort of the same thing, like you exactly to your point. Yeah, Right Like, is that the option? And that's why you want the debt, because the debt is at a term that actually makes sense for the business. So then it's an equity transaction.

Speaker 1: 18:11

Yeah, so interesting when I'm evaluating businesses as a potential small business owner. What are, like, the key metrics to look for? Like, if there was a handful that you should know about every business you look at, what would you say those are?

Speaker 2: 18:25

Yeah, I mean, at the end of the day it's the cash flow. It's how much cash does the business generate? I don't know if there's one key metric, because businesses can be different, but like the amount down the cash that they throw off. And what I like to say is the more important thing is how consistent is that cash flow and how durable is that cash flow? So, consistency meaning is it going to stay consistent over time? Is it going to stay consistent across the different parts of the business? Like maybe there's two business, three business lines. Are all of those consistent Is only one and the others kind of go up and down. Do they come from certain parts of the team or the business, right? So you just have to understand what's going to stay different or what's going to stay the same. What's going to be different? And then I think, durability. It's like looking forward into the future once I take this business over. How durable is this? Are they locked in on contracts? Do you have to renegotiate those contracts? Is it snow removal and lawn like mowing lawns? It's like you could make the case that over time, in certain parts of the country, snow removal becomes less and less of a thing over time? Who knows right? And is that a durable business? Does that have to change, whereas lawns will probably grow? So some of those things and what's recurring, and how much money is coming from the same customer base. And then I think, the other piece is when you look at that cash flow, what are the opportunities to grow it by top what I call above the line stuff, so you can get more customers and grow the pie? Do the digital thing build the website which allows you to get in front of other customers or below the line, where the margin improvement? And can you see a path where those two things could change? So X amount of cash flow turns into 1.2X the first year, 1.3X the next year. Those are the kinds of things that you want to dig in. But if you have the financials. You should be able to see it from there.

Speaker 1: 20:17

Yeah, I really like kind of knowing the industry and what the numbers mean. In that industry I know, like in services, which is a massive majority of small businesses, there's always the question of can you retain customers? Like a marketing agency, for example, it's usually right in the agreement with the clients if they can essentially use it as an out at the business sales or is transferred, so you can actually look those up and find those out and start to understand that model better. One number that I came across I was surprised by to look at, especially for a new small business owner that's willing to kind of grid it out for a while, is the amount of money the owner is taking out overall, because for a well-established business, through both salary and distributions, that number could be quite large, like way larger than you need at the beginning. And if you're willing to kind of use that difference to pay off the loan, you can kind of maintain or even decrease your monthly expenses.

Speaker 2: 21:19

Yeah, and that's why we talk about it as cash flow, because those are ad-bacs that we do in our valuation. So again, maybe we see distributions, we see an owner salary of 200K or 300K. Right at that point they're sort of extracting a chunk. You can say, actually I can use 50K of that for the SBA loan, I can use 150K of that for a general manager to help me in the business and get the operations right, and so I'm still taking a minimal salary but I'm in the investment phase of really helping this business scale and grow and so you can kind of do that math. But we try to get to an apples to apples comparison of the cash flow that comes out of the business so that you can look at one service business versus another and actually see that one's throwing off 200K in cash flow and one's throwing off 300K in cash flow. You're not having to dig in to be like actually it's 200K in cash flow, but the owner is actually paying. Yeah, it's apples to apples in our valuation and in all our sales.

Speaker 1: 22:15

Oh cool, that's awesome. Yeah, that's super interesting and you bring up a good point. Is with that extra money, like, are you willing to do the job or do you need to hire a manager? I know for me I'm almost getting too old or something. It's like I'm at a point in my career where I'm not open to buying a business where I'm going to have to be the manager of it. So if that owner I'm buying from is the manager, I feel the board want to going forward.

Speaker 2: 22:41

No, and I think we talked to a lot of owners right. We're like this is a win-win. If you can get yourself out of the day to day, you can actually go on vacation and you can have dinner with your family and a buyer will be more interested in this business because it is something where, if they want to be day to day in the business, they certainly can. But they don't have to. So it gives them optionality and kind of to your point, like there is a GM that you would ensure that you retain in the sales because they're a key employee, all that kind of stuff. So that's generally a win-win, which is also like the better your financials are, the better it is for a buyer, but honestly, the better it is to manage your business on a day-to-day basis, those kind of things A lot of it just is win-win which is great, yeah, cool.

Speaker 1: 23:24

How long does it normally take to go through this process, from the time someone not that they start thinking about buying a business, but they start taking action? What are we looking at here?

Speaker 2: 23:36

Yeah, it's great. I mean, it's probably the million dollar question of do you need a year, do you need six months? I think generally people say six months. Maybe it's six to nine months. I do think part one thing that we're trying to do a lot of at Baton is shrink that process down and also have a chunk of that process be hopefully while you're still in your existing job, because we're helping you identify businesses, we're helping you do some of the curation early, and it's really only once you get close to the bottom of the process and the end of the process that you are thinking about okay, now I'm going to leave, now I'm going to look at stuff, because a lot of the time it's probably a chunk of time to figure out what kind of business. There's a bit of a lot of waiting because you have to find the right business and only takes one. But again, I think home sales are another good analogy right now, because there's not a lot of homes for sale because people are sitting on amazing mortgages and whatever, and so how long will it take you to move from someplace to another place and find that home? It's a bit of an open question, but whenever we kind of think about it that once you've identified a business, you can actually move very quickly and have an offer on that business within weeks, and then it's generally a month or two to close once you have an accepted offer and the largest variable is on that search phase.

Speaker 1: 24:58

Interesting you brought up such a good point on. I'll keep like pushing into this one buying a business versus starting one is if you're buying a business, you can do this on the side while keeping your day job. You're not like quitting your job to see what you might do and have that pressure. You could be like quitting your job like right before you go into managing business, which really debrits the process and, for a lot of us, takes away a tremendous amount of stress that nobody really likes caring Well, okay, so to wrap up, I would love we've talked about Baton a little bit throughout the show and different questions, but just for our listeners I would love to hear, like what does Baton do to help aspiring business owners? What does that process look like specifically on the buying side? So someone looking to buy a business?

Speaker 2: 25:48

Yeah, I think I use analogies a lot, but I think we talked about Craigslist before. It has a lot of inventory but there's not a lot of trust and transparency. There is the data right are these real bicycles that are for sale, or a room for rent or whatever it is? And I think we want to be that trusted, transparent source where a buyer can come in and know that every listing that's on Baton has been vetted, whether it's an active listing, whether it's been sold, et cetera, and we really think of ourselves as the one place that you can get verified and trusted data and so, as a buyer, that's super important because any buyer that's listening to this, if they've been on a biz by sell, they're constantly reaching out. They may or may not get hurt, may not hear back, they may or may not get an NDA. Then they see the data and it doesn't match up what they thought Like. For us, people go all the way through. They can see the actual name of the business on our site, click through to the data room, do the evaluation and then schedule a call to move down the process. We had one of the businesses on our platform get listed on a Tuesday. We had an accepted LOI from a bunch of buyers by end of day Friday and now we're in the diligence process and closing Right, and so there's this ability to really bring serious buyers with serious sellers and cut out kind of a lot of the wasted effort that happens in the current ecosystem today.

Speaker 1: 27:18

Awesome, so needed, and thank you so much for being here today. We've learned so much For all of you listening. Thank you for listening to the funded podcast. We hope you found this episode informative and helpful on your business journey, and don't forget to subscribe to our podcast and follow us on social for more great content. If you're looking for funding to grow your business, buy a business. That's what we do on our site at getfundedcom, and otherwise we will hear from you all next time.