Sam Penny (00:27)
Ladies and gents, welcome to another built to buy session. This is one of the most critical sessions in the entire buying process. It's identifying and pricing risk in a business purchase. Now, the built to buy series, it's for people who want to buy business investors, and people who just want to
increase their portfolio. My name is Sam Penny. I'm coach for the brave and I work with investors and acquirers and entrepreneurs who want to make smarter decisions when buying a business and also to avoid the kinds of mistakes that cost you the time the money the energy long after the deal is signed. So this session is more than just doing due diligence.
It's about knowing what to look for and what it actually means and how to also price that risk into your offer so that you walk away entirely when the maths doesn't stack up. Because let's be honest, the truth is most buyers either miss the risk or they don't know how to factor it into the deal. Today, we're going to fix that. You're going to walk away with a clear framework for how to spot red flags.
understanding the three types of risk that every buyer must evaluate and how to turn what you find into leverage, how to negotiate better terms and protect your downside.
So here we are built to buy identifying the risks and pricing the risks into a business purchase. So what is this really about? And it's pretty simple. If you don't find the risk, you're going to end up paying for it. Every business you look at, no matter
how polished the pitch is, how clean the numbers are, or how charming the seller is. They all come with risk and your job as a buyer, it's not just to evaluate the upside. It's to understand the downside and to either reduce it, price it in, or even walk away if it's too high. Too many buyers, and I see this all the time, they get swept up in the excitement of the deal and they skip the steps. They ignore the warning signs.
Or they just assume that everything will work itself out after settlement. And I'll tell you what, it won't. What you don't catch during due diligence becomes your problem the moment you sign. So this session, it's about helping you develop really a sharper lens to go beyond surface level checks and to start thinking like a professional buyer. Now, what you're going to learn today is what kinds of risks do you need to look for?
how to identify and recognize them early, and how to build them into your negotiation so that you're never paying full price for the business that comes with red flags. This is how real investors protect themselves. And I want to make sure that you do too. All right, if this is your first session, welcome. If you've joined a previous Built To Buy webinar, it's great to have you back.
I'm Sam Penny and I work with business owners and buyers. who want to make smarter, safer acquisitions and avoid the traps that catch out most of the first time or even emotional buyers. You see, I've been on both sides of the deal table. I've been a founder, been an acquirer and also an advisor. And I've just seen how quickly a promising deal can go wrong.
If you don't look beneath the surface, my focus is in helping buyers ask the right questions, help you interpret the answers and structure deals that are built to protect your capital and give them a strong runway. Once they take over, I've worked with buyers acquiring everything from small service firms to modern million dollar companies. And I've seen this over and over in this time.
The quality of your questions determines the quality of your deal. So today it's about sharpening those questions. So you don't just buy a business, you're going to buy a future that really works for you. Now, before we get into the context of today, I just quickly want to share with you a resource that really expands on everything that we're talking about in these sessions. It's called the Built to Sell, Built to Buy podcast. And if you're
actively thinking about acquiring a business or preparing for one. It's really a powerful way to keep learning between these webinars. Each week, I speak with people who've bought businesses, they've sold them or advised on some of the deals. And we break down what actually happens behind the scenes. What we talk about are the deals that went well and why, the ones that fell apart and why, what was missed, how buyers found leverage, what red flags.
only showed up post acquisition and how to evaluate risk more accurately, even when the business looks polished. You see, it's a mix of strategy, probably cautionary tales and real world examples that you're just not going to get from textbooks. So if you want to keep building your buyer IQ, the podcast is great way to do it. You're going to find it on everywhere where you get to your podcast. It's on Spotify. It's on Apple podcasts.
And each episode aligns directly with the kinds of insights that we're covering today. All right. So let me give you a quick roadmap of what we're going to cover in this session so that you know exactly where we're going and what you're to walk away with today. It's all about risk and specifically how to spot it, how to interpret it and price it into your offer when you buy in a business. Because the truth is most buyers either overlook risk completely or they
notice it, but they just don't know how to quantify it. And that leads to either overpaying or walking into a deal that you're really not truly prepared to manage. So here's what we're going to cover today. We're going to cover the three types of risks that most buyers miss. So not all risk is obvious. We're going to break it down into operational, financial and transfer risks and explain what each looks like in practice.
We're going to see how to spot red flags early. So what to look for in the numbers, in the team, the systems, but also the seller's behavior and how to price risk into your offer. This is a part that most buyers skip. So we'll cover how to adjust the deal terms to reflect what you uncover.
We'll also have a real case study. So I'll walk you through a real world example of how a deal looked on paper, look great on paper until we started asking some of the right questions. I'll also give you some tools to help you stay sharp. So things like checklists, frameworks, some simple techniques that you can use to spot risk before it becomes a problem. And by the end of today, you'll be thinking like a much more sophisticated buyer.
someone who can separate a good business from a risky one. So here's the mindset shift I want to anchor today's session. Risk is your responsibility.
Okay. Risk is your responsibility as the buyer. It's your job to find it, understand it and price it. lot of first time buyers, they assume that if something's wrong with the business, the seller has to disclose it. Yeah. Like buying a used car with a roadworthy certificate, but that's not how business acquisitions work. You are the filter. You're the investigator. And if you miss something, it becomes your problem. The moment the deal's done.
And here's where I see buyers go wrong. Firstly, they treat due diligence like a verification process, just like ticking off documents, confirming numbers, and assuming that if everything matches, they're good to go. But great buyers know better. Due diligence is not just verification, it's interpretation. You're not just asking, is this number accurate? You're asking, what does this number mean?
What's hiding behind it? What happens to this figure? If the owner steps away, is this strength real or just momentum tied to one person or one client? Remember your job is to stress test the story. need to dig under the surface and to make sure the deal you're buying is as solid as it seems, or to discount it if it's not.
And look, let's be honest, no business is perfect. Every deal has risk, but if you don't find it, you're going to pay for it in time, in money, or in regret. Now, let's talk about how to actually organize and think about risk, because not all risk is created equal. In every deal, you need to assess risk across three distinct categories. If you only focus on one, say the numbers,
and you ignore the risk, you're really flying blind. So let's break it down. First one is operational risk. So this is about how the business runs, who does what, how things get done and whether the business is built on systems or held together by really the owner's personal hustle. if the business can't run smoothly without the current owner, that's a real operational risk. If knowledge is undocumented,
If roles are unclear or if key people hold all the power, that's risk. And the second part is financial risk. So even if the numbers look great, your job is to question them. Are they consistent? Are they inflated by ad backs that don't make sense? Are there seasonal drops not disclosed in any summary? You see, you're not looking.
for red flags and cashflow debt levels, margin erosion or over-reliance on short-term spikes. Now the third part, the third risk category is the transfer risk. And this is the risk that comes from the transition itself. So will the team stay? Will the client churn increase when the owner leaves? Does the seller have a solid plan to hand things over or really are you walking into chaos?
And here's point. If you miss these three, you're not evaluating the business you're really guessing. And when you guess in business buying, you're going to pay.
So let's dig deep into the first one.
Sam Penny (11:45)
This is about how the business actually runs day to day because here's the reality. A business that looks profitable on paper might fall apart the minute an owner walks out the door. See it all the time. And that collapse won't show up in your P &L. It shows up in the gaps, in the team, the processes, the invisible decisions that the current owner makes every day that no one else ever sees.
So here's some things to look for. First up is key person dependency. So is there one person, and it's usually the owner, who makes everything work. If they're doing the sales, if they're approving the spending, if they're managing the ops and they're holding all the relationships, then they are the business. And if they leave, you're left with a shell. The second operational risk is that there's no systems or SOPs.
So you need to ask to see documented processes. If it's all verbal or, ⁓ we just know how to do it, that's not a business. That's tribal knowledge. And without systems, you're going to inherit confusion and inconsistency. Now, the third part is that the owner is the glue. If the owner is doing the hiring, the handling, the top clients managing the marketing, closing the deals, they're way too central. That means
post acquisition, you have to fill that gap or rebuild the entire operational structure. And the last operational risk when you buy in a business.
is they're going to be a culture collapse on exit. And this one's pretty subtle. If the team is held together by loyalty to the founder and not by visions or systems or leadership, they might walk when the founder does. And that means you buy in a team that you may not be able to keep. Look, your goal here is to really depersonalize the business. You want a machine, you don't want a personality, you want a business where roles are clear.
Responsibilities are shared and systems are followed with or without the founder. So you need to ask questions like, well, who runs the show when you're away? How is onboarding handled? What would break if you disappeared for 30 days? If you find that those questions are pretty vague or defensive and the answers to those, you're really staring at operational risk.
We'll talk in a moment about really how to talk and how to price that risk into the deal. But for now, let's just flag it. We want to spot it and we want to name it. Now let's shift gears a little bit. Let's talk about financial risk. The area most buyers spend most of the time on obviously, but I'll tell you what, they often still get it wrong because his thing, just because the numbers exist doesn't mean they're accurate, stable or trustworthy. see financial risk.
isn't about checking that the P &L adds up. It's about understanding what's behind the numbers, what they mean in context, and whether they reflect a healthy and sustainable business. So let's go through each of the key red flags in the financial risk. The first part is flaky P &L. So if the profit statements, if they look inconsistent, if they're
poorly categorized or if they're missing key line items, that's a real risk. You want to see at least three years of clean financials. And ideally with trends that you can follow, you want to watch for random spikes for things like declining margins or even line items that just have no explanation.
The second part is what I like to call ad-back gymnastics. And this is a big one. Many sellers will, they normalize the EBITDA by adding back one-off expenses or owner wages, vehicle costs, those kinds of things. Some of that's totally valid, but when you get a long list of ad-backs, especially vague ones like marketing or miscellaneous, you really need to ask and dig a lot deeper. And here's what you need to ask.
Would I really not incur this expense? Is this truly non-recurring or are they just trying to inflate the earnings? Now the third financial risk is overstated revenues. So is the revenue tied to real cash or is it inflated with things like accounts receivable, ⁓ project-based billing, or even things like future contracts that haven't closed yet?
Also check whether large customers are on short term deals that create really fragility in the top line.
And the last financial risk is cashflow issues, masked by growth. So sometimes businesses, they might look great because they're growing quickly, but that growth is hiding deeper cashflow issues. So you might see increased sales, but also increasing debt. might see supplier pressure or poor working capital management. Growth without cashflow is a red flag.
And it's certainly not a green light. And as a buyer, your job is to interrogate the financial story. Not to be paranoid, but to be precise. Because once you own the business, the numbers are no longer theory. They're your reality. So you need to ask to see these. You need the monthly P &Ls and not just the annual summaries. You need to see a normalization schedules with explanations.
You need to see the age receivables and the payables report. And are there any major variances between the years and why? And if the seller can't explain it clearly or even seems really evasive, that's when you need to proceed with caution. So the final category, and often the most overlooked, is transfer risk.
This isn't about how the business runs or what the numbers say. This is about what happens the moment the owner changes hands. Because here's the hard truth. A business can look profitable, can look systemized and stable and still fall apart during the transition if it's not fully prepared. And your job as a buyer is to ask this, what will happen in the first 90 days after I take it over?
Who's staying? Who might leave? What knowledge walks out the door with the owner? So here are some major red flags to look for. Firstly, that there's no clear handover. If the seller doesn't have a documented plan for training you, for handing over the key responsibilities, or even supporting the transition, that's a risk. You shouldn't have to figure it all out yourself post settlement.
The second transfer risk is a weak transition plan. So will they stay on in any capacity and for how long? What will they actually do? And so a vague, well, I'll help out for a few weeks. That's not a plan. You want a structured and written onboarding process. The third transfer risk is customer or staff attrition. So
Are there key clients or employees who are loyal to the founder personally? And if they leave when the owner does, revenue and capability could collapse. So ask yourself, who holds the client relationships? Who's trained as backup? Have customers been informed about the potential transition? I've seen so many deals that have gone through and then staff leave.
and then clients leave and you're left with an absolute shell. And it's really sad for the new buyer. Now the fourth transfer risk.
is that knowledge is not documented. So things like core processes, contacts, vendor details, if they live in the head of the founder, that's dangerous. So what happens if they walk away and you're left guessing? You want everything from onboarding checklist to passwords documented to everything handed over cleanly. And here's the mindset shift that I want you to make.
Don't just evaluate the business, evaluate the handover and ask yourself this, if I own this tomorrow, could I run it confidently? Would I need months to stabilize it or could I step in with support? And if the answer is unclear, that's a transfer risk. And like the other risks that we've just covered, this one can...
Absolutely be priced into your offer, which we're going to cover next. All right. Let me walk you through a real example. So on the surface, this business, it looked like, to be honest, a textbook acquisition had $1.2 million in revenue, 360 grand in profit. EBITDA had five staff, great brand presence, some loyal customers.
The seller claimed it was systemized and that he really wasn't required in the day to day. So the asking price of $1.26 million represented a three and a half time multiple. And to be honest, at first glance, this looked like a clean, straightforward deal. But once we started digging into the operational details, the financials and the transition plan, the story changed. And here's what we found.
So on the operational risk front, we found that the owner was still central to the business. They were personally running the marketing, the managing, the major clients. And when we dug into it, there weren't any SOPs, standard operating procedures. None of the systems were documented to hand over. And the team really relied on verbal direction. And the second thing was the financial risk. So...
The P &L included several really aggressive ad backs, which included some staff bonuses. There were vehicle costs, the marketing extras that were likely to disappear, but the cash flow was stretched. They were pushing payments to suppliers just to maintain a positive working capital. And the third part was the transfer risk. And there really was no
real handover plan. The seller, honestly, in this case, wanted a two week exit. Two staff members were really close personal friends and they weren't sure if they'd stick around and the client handover was not even discussed. The deal looks stable, but this one was a real fragile deal. So let me show you how we structured it. So once we recognize that of all these
risks and they became clear. We started to renegotiate this deal and we really wanted to reflect the reality, not the marketing of how they presented it to us. So here's what we did. We reduced the multiple from three and a half to 2.6. So this brought the valuation down from 1.26 million to 936,000.
And of that, only 750,000 was paid upfront. The remaining 186,000, we turned into a structured deal as pretty much a 12 month earn out. It was tied to clients and staff retention milestones. So we required the seller to stay on for a full three month transition period. And we gave him clear deliverables. We needed documented SOPs. We needed client introductions.
And we also needed the team leadership handover. We also added clawback protection. So if major clients left part of the, your earn out would be forfeited. And this is really the power of identifying risk. gives you leverage and it protects your capital. It lets you pay the right pie, the right price for the business that you're actually getting, not the one that's been sold to you on a glossy summary and a little marketing pamphlet.
Most buyers, they honestly wouldn't spot these issues and they would have paid full price. So this is what really separates professional acquirers from emotional ones.
So let's talk about how you actually respond to risk once you've found it, because risk isn't just something to be aware of. It's something you can leverage. You don't have to walk away from a risky deal, but you do have to price the risk in. And here's how smart buyers do that. The first step is to reduce the multiple. If the business has operational weakness, if it's very owner dependent, or it's got fragile systems,
you're not going to pay a premium multiple. Even a drop from three and a half to 2.7, as we saw just before, can mean saving hundreds of thousands of dollars.
Second part of how to price risk into your deal is to stage the deal. So you can use tools like earn outs, like holdbacks or callbacks to link part of the payment to performance. If revenue or key staff don't stick, the seller doesn't get paid. It's pretty simple. The third thing is that you can tie the price to performance. So if the seller claims clients will stay or growth will continue,
high part of the purchase price to these outcomes. Let them prove it, not just promise it.
And the fourth part is to require a transition period. So don't settle for just vague support, set clear expectations, 60 to 90 days of structured involvement with very specific deliverables like training, client handover, SOP creation. Fifth, you need to negotiate the risk into the agreement. So.
Everything you've uncovered, from concentration risk to system gaps, these should all be reflected in your term sheet.
Remember, this is not just your gut feel. And here's the key takeaway from this.
The price is just a number until you attach terms to it. The smartest buyers, they use structure to turn risk and turn risky businesses into fair protected deals. You're not trying to punish the seller. You're simply balancing the risk across both parties. And if the business performs, they get their money. If it doesn't, you're not left holding the bag. Remember, the money's
better in your pocket than theirs. All right. I'm to simplify things a little because I know that there's a lot that have already gone through and this is really going to simplify it. You don't need to be a forensic accountant. You don't need to be a dealer lawyer to identify and price the risk properly. You just need the right tools and the discipline to use them. So here are the four tools that I recommend every buyer have in their kit.
The first one is a due diligence checklist, and this is your first filter. So it's a comprehensive list of what to ask for, what to review, and what must be in writing. You need things from financials to contracts to staffings to systems. This ensures you don't miss anything. And I've created one based on the checklist I use with all my private clients. And if you want it, you can grab it.
at Sampenny.com, just search it on my website. Second one is red flag sheet. This is your real time gut check as you assess the business. So as you go through the data and the conversations, note anything that feels off and then categorize it by risk level. So minor concern, yeah, it's negotiable. Or is it a deal breaker? This keeps emotion out of the process and it helps you communicate issues clearly.
to advisors and also co-investors. The third part is a risk scorecard. And this is where you quantify what you've seen. I want you to score each risk area, operations, financial, and the transition on a simple scale. The lower the score, the more protection you'll need in your offer.
And truly it's a fast way to translate gut instinct into a structured decision making. And the fourth part is a business readiness report. ⁓ That's if the seller hasn't already done it. If you're buying from someone who's used my system to prepare the business for sale, ask for their readiness report. It'll really show you where they've done the work and where the gaps still are. So if they haven't done one, that also tells you something too.
Now these tools really take the guesswork out of buying. They give you repeatable processes and they protect you from relying too much on the seller's story or even on your own enthusiasm. And remember a business that feels like a good fit still needs to be proven. And these tools, they help you do that. They're clear, they're consistent and you do it confidently. They're all available on my website, sampenny.com. Easy.
Okay. So where do buyers go wrong? Let's be honest. Most buyers buying most businesses by mistakes. They're not made in the negotiation. They're made before the contracts even signed.
It's during due diligence. It's in the assumptions and the mindset. So here are the four of the biggest traps I see buyers fall into over and over. So the first part, it's trusting the seller too much.
I want you to look because some sellers, they're great people, but your job isn't to become friends. It's to test the story they're telling. So that means verifying absolutely everything independently. If they say, ⁓ my team runs the business without me, ask for proof. If they say revenue will hold after I leave, show me the contracts.
Show me the retention data and the transition fine. Trust is fine, but verify every claim. Now the second where most buyers go wrong is rushing the due diligence. You see excitement in these deals. It really kills your discipline. And I've seen buyers do a lot due diligence in a week because they wanted to close fast. Then two months later,
The cracks appear, staff leave, seller disappears. So take your time. The longer you take to buy it right, the faster you recover your investment. And the third place where I see buyers going wrong is they get really emotionally attached. Don't fall in love with the business. Fall in love with the deal, the structure, the cashflow.
the margin or the safety.
emotion blinds your red flags. You start justifying weaknesses instead of pricing them in. stay always objective. Now the fourth place where buyers go wrong is equating good profit with low risk. And this is a big one. You see, a business can be highly profitable, but also highly fragile at the same time. If
one person holds the relationships or perhaps the revenue it's tied to maybe two big clients or that even the systems are non-existent, profit doesn't protect you. You're still exposed. So I want you to ask what could cause this profit to vanish after I take over? And that's how you stay safe. And the bottom line, smart buying is less about optimism and more about discipline.
And these traps are all avoidable, but only if you're willing to slow down, do the work and think like an investor, not a consumer.
All right, let's bring everything together. If you want to make a smarter acquisition, if you want to avoid overpaying or inheriting a mess, it comes down to doing five things really well. Okay. The first thing.
Know the three risk categories. We've already covered them. Operational, financial and transfer risks. Every business you assess has some level of exposure on each. Your job is to find it, to understand it and to respond to it. The second thing is don't trust smooth numbers. Clean P &Ls don't always mean low risk. So ask about the cashflow, the client concentration, the ad backs.
and what happens to profit when the owner exits
And third, always link risk to price. Don't absorb risk for free. Lower the multiple, use earn outs, tie payments to performance, and require seller involvement where you need it. The fourth part is to use the tools, don't use instinct. So things like checklists, red flag sheets, scorecards.
I need you to build discipline into your process so you don't get swept up in the excitement of the deal. And fifth, and I love this saying, if it's not in writing, it doesn't exist. Verbal promises don't hold contracts, handover plans, SOPs, everything needs to be documented and assume nothing and document everything.
And when you approach buying a business with this kind of mindset, you're going to protect your your capital. You're going to buy with confidence. And to be quite frank, you're going to avoid the regret that most buyers feel six months in.
All right. If you're looking at a business or even if you're just thinking about buying one and you want to avoid the costly mistakes, I want to offer you something pretty simple. Let's just take 30 minutes to get together and let's just review the deal. What we'll go through is what you've been told by the seller, what red flags I'd be looking for, what questions you still need to ask and how it's structured the offer to protect you.
Now this isn't a sales call. It's a strategy session. It's focused 100 % on helping you buy smarter because here's the thing. Buying the right business at the right price with the right protections changes your financial future. But buying the wrong business, it can really set you back years. And unfortunately, most of the damage happens before even the deal is done by not asking the right questions.
or absorbing risks that could have been avoided. And if that's something you want help with, you can book a call with me to do it anytime. Just jump onto my website. just go to sampenny.com forward slash strategy. Book in a 30 minute chat with me. It's free. And let's gut check.
the deal before you sign anything.
I've got a huge amount of resources on my website, sampenny.com. lot of due diligence checklists, a lot of red flag checklists, also use the business valuation report to get a multiple based on a lot of these risks that we've just spoken through today.
huge amount of data and information on there. it's fantastic place to go to start. Also, if you go back and have a look at some of the past webinars, so I've looked at things, for example, how to spot a business that's owner independent. Last week, was a due diligence deep dive. So being able to look beyond the numbers, and today was all about
being able to price risk into the deal. If we go back past some of the past webinars and podcasts, remember, jump onto my podcast, Built to Sell, Built to Buy, it's on Apple podcasts and Spotify and everywhere else. You'll have all the information about how to do a due diligence deep dive. Those things are vital, but you need the tools. And that's why I've created
such a deep resource on my website, because I see too often business investors and people wanting to buy a business make stupid mistakes that could quite easily be avoided. And that's why I've created all of these things because look, you've made the money. You now need to invest the money. And if I can help you avoid making costly mistakes,
Absolutely fantastic. And it's on the flip side as well with a lot of, the business owners that I work with, I'm trying to increase their valuation through increasing their multiple. And when we increase their multiple, remember the multiple is a risk factor. And so if we can increase their multiple, it also means that we're reducing your risk as a business by.
And it's absolutely fantastic.
All right, well, look, before we wrap up, I wanted to share with you what's coming up in the next built by series. The next webinar, this is a great one. What the system say, how to read the business behind the SOPs.
So this is all about the operational intelligence and knowing how to interpret the inner workings of the business through the system. what you'll learn is what a well-documented system really says about the owner, the culture and the risk, how to spot the SOPs and what's actually being used that drive real outcomes and how to use those insights to negotiate stronger and more confident deals.
So look, if you want to become a sharper operator and you want to be a smarter acquirer, lock that one in. I'll see you there. Thanks for joining me. I'm Sam Penny, and I hope today gave you the tools to buy smarter and negotiate with confidence. I'll see you in the next session. Until then, stay sharp and be brave.