What’s it all about?
From the buyer’s perspective, it’s about tacking on some extra customers. From the industry’s perspective it’s about cleaning house.
If only a fraction of those house cleaning companies which failed last year could have been folded into an existing company, then we might begin to make some meaningful progress towards a more reasonable level of consolidation. Instead, many of them ended with the owner gifting the most valuable accounts to a few good employees. In this way each failed enterprise perpetuates the cycle: one or two of the employees will ultimately decide to parlay her few accounts into a viable scaled maid service enterprise, beginning another cycle of fragmentation and failed enterprises.
In Denver, we are continuously negotiating with one or two companies for the purchase of their accounts. Each transaction requires the passing of time, and has a low probability of success. But no failed transaction requires much effort. We initiate the process each year by sending happy letters to all our local competitors inviting them to sell us their accounts. Most of them toss the letters in a huff, but a few of them stash them in a drawer where they remain until one receives a certain job offer, or suffers her own final straw. When that day comes she pulls the letter from the drawer and makes the call: “I received your letter several months ago stating your interest in purchasing my company. Can you tell me more about your offer?” We get a nibble . . . and so it begins.
Baiting the Hook
I hope it’s not too obvious, but I kind of enjoy writing our annual letter to competitors. It’s great to congratulate them all on their great success in launching their new enterprises or making it through another year. Our letter introduces our company and invites each of them to contact us to chat about the weather or compare notes on local market conditions. But most importantly, the letter includes a paragraph which offers to buy their company, should this be their year. The gist of the invitation is included in our website at:
Sell us your House Cleaning Company.
We identify each year’s crop by perusing the yellow pages. We try to send the letters out as soon as we receive the book so we reach them at the earliest possible moment, before the early birds manage to fail. Even if we miss them, the early birds are not much loss; we’re really after the tired and haggard. They are the ones that have lasted a couple years, and have sufficient accounts worth buying.
Identifying the Target
What kind of company are we talking about here? That’s a very important question. There are two kinds of acquisition candidates:
- Going concern
- Distressed enterprise
It’s important to distinguish between the two types of candidates, because the price, deal structure, and process for buying them are markedly different.
Going Concerns are most often sold by business brokers based on prices which reflect a multiple of cash flow to owners. The purchase of a Going Concern allows a well-capitalized entrepreneur to enter the house cleaning market with the lowest degree of risk. Buying such a business allows an inexperienced operator to benefit from systems which are already in place. Most importantly it includes a schedule of recurring assignments balanced with a trained and experienced tribe of cleaners. These represent a means for such an investor to avoid the painful and costly start-up period associated with creating an enterprise from scratch. [For those who think that it is cheaper to start a company from scratch rather than buy one, I advise: keep a scrapbook. Make entries daily during the startup phase. Read it five years from now. Then jot me a note about whether you still disagree.]
Distressed Enterprises, on the other hand, are the sort of failed businesses with which a business broker will refuse to be associated. And a new entrant may find it more difficult to transform a distressed Enterprise into a Going Concern than did the previous owner (who by definition found it impossible). So generally, there isn’t a lot of competition to buy such companies outside the few successful local Market Leaders. For Market Leaders, purchasing Distressed Enterprises represents a means of subsidizing their otherwise healthy growth rates. And to the extent they can buy profitable accounts for the right price, the accounts will make the buyer more profitable, and therefore, more valuable over time.
So for Market Leaders, Distressed Enterprises are the target. Most Distressed Enterprises initiate the first contact masquerading as Going Concerns. Don’t bother trying to dissuade them of their disguise; only time can do that. If they are truly distressed, time is on your side, so keep smiling and let it do its work. We generally expect each transaction to take a year. So treat every acquisition candidate who contacts you as though they are a Distressed Enterprise. Afterall, who would flog their company to a competitor if they were in a position to hire a business broker?
The Importance of Being Cool
If you’re going to buy distressed house cleaning companies, it’s important to be cool. Being cool requires that you take an opportunist’s approach to each prospective deal. An acquirer can always shorten the negotiating period and significantly increase the probability of closing a transaction, but doing so will always spoil the deal. And no deal is better than a bad deal. So, progress at the seller’s pace. Accept the low probability of completing each transaction. Be patient. Be opportunistic. Be cool.
When we get the first nibble, we are friendly, complimentary, and sympathetic. We are collegial and kind. We are generous in spirit, though never in any offer. Most of all, we are informative about everything–everything except price. Our objective during the introductory call is to impress the candidate that we are nice guys and will apply our best efforts in giving them a fair deal. We are not in a hurry—we’re pleased to answer their questions by phone at any time and will be pleased to engage in discussions whenever the time is right for the candidate. Over the phone, we lay out the details of the process.
With respect to price, we coyly explain that the price will depend on the quality of accounts, and that we can discuss that once both parties reach the conclusion that other important conditions warrant initiating negotiations. We want to sound professional, keen and interested, but we end each such conversation by asking the candidate to think about it and call us back anytime we can help, for questions, or if they ever wish to meet.
Under no circumstances would we ever offer or agree to phone them, for any reason. When it comes to buying companies, necessity is expensive. Remember, time is on your side. Always take the call, but never make the call. Jiggle the line, but don’t try to snag the fish.
Arranging the First Meeting
Usually by the second or third phone call, the acquisition candidate has either given up or buried the hook deep in his own lip. You know the acquisition candidate is ready to meet when he accepts your request for information. Until he’s ready to provide the information, phone calls should suffice. Again, for the format of the “Confidential Statement of Recurring Cleans,” see our website at: Sell us your House Cleaning Company.
Offer to trade (and indeed insist on trading) confidentiality agreements. We have drafted our own. It’s a one-pager sort of check in the box type agreement. You can draft your own based on a “Do it Yourself Contracts” book, or if you’re feeling flush and enjoy the company of lawyers, then you can have one drafted for you. The agreements will include non-solicitation clauses relating to customers and employees. The point of the agreements is to assure genuinely interested acquisition candidates that you’re a good guy and chase everyone else away. Let’s face it, during the first meeting, you’re not going to be telling your competitor any confidential information or introducing him to your employees anyway.
In terms of venue, under no circumstances for the first meeting do I ever accept to meet at any location other than our office, because mostly, competitors simply don’t show up for the meeting. And if they don’t show at my office, I have no problem keeping myself occupied in lieu of the meeting. By the time they are ten minutes late, I’ve already forgotten that they stood me up. But when I’m waiting at Starbucks, it’s a different story. There, I resort to reading the Style section of the newspaper, run up a big coffee bill, then leave with a really annoying feeling. It’s nearly impossible to reach a win-win situation when you start out by losing, so for me there is no recovering from such a situation.
The First Meeting
Get ready for the first meeting by preparing the confidentiality agreements in advance. Present them as soon as you have offered your guest a soft drink. The objective of the first meeting has to be a continuation of the phone call—you’re going to convince the acquisition candidate that he is going to get the best deal out there for his accounts, and enjoy working with you to boot.
Aside from that, you have to determine early on in the meeting whether the acquisition candidate has anything worth buying. Until you make this determination, don’t say anything negative; just keep uttering noncommittal positive sounds. You’ll determine this primarily by evaluating the Confidential Statement of Recurring Cleans.
Throughout the meeting, keep saying that everything being discussed is subject to due diligence. Once you’ve determined that the acquisition candidate might have accounts worth buying, then explain your methodology for determining a price, and describe the payment schedule, and the broad terms of the deal. I generally decide the number of months on which the price will be determined on the spot (see next section); if you feel uncomfortable with this, then you can just give them a range.
During the first meeting, you should make a lot of positive sounds about the importance of retaining the seller’s best cleaners. In fact, you’re probably kind of hoping to take on some quality employees through this transaction, because doing so can enhance your probability of retaining more of those clients you choose to retain. This notwithstanding, you’re going to evaluate the new employees in the same way you evaluate all employees: you’re going to keep and reward the good ones, and cull the poor performers. The only question will relate to the mediocre ones, and the decision for those will largely come down to your economics and immediate requirements. Mostly, we try to keep as many as we can reasonably justify. With respect to compensation, legacy issues may have to be accommodated. Generally, we expect to eliminate differences in compensation over several months. If someone appears to be massively over-paid, we give them a pay cut immediately and suffer any consequences.
There are going to be questions about assets. Basically, sellers are going to wish to keep some and sell some, so adverse selection becomes an important factor. Mostly, you should expect that anything lemon flavored will be sold to you and anything candied flavored will be kept by the seller. If you wanted to buy a used Toyota, you could jolly down to the Toyota dealer and buy one yourself. If you wanted to buy a used Sanitaire, you could visit eBay. So asset purchases in connection with the purchase of accounts are, at best, a necessary evil. We manage this issue during the initial meeting by always stating that we have no problem buying any assets which are business related based on prices which reflect their market value, and that we can negotiate a price for those separately once we have reached an agreement about the more important issues.
Finally, you end the first meeting the same way you ended the first phone call, with pleasantries and an invitation for the acquisition candidate to phone you back once he has had a chance to think about your “offer.” In terms of when I phone them back if I haven’t heard from them, I use never as my guideline. So again, be cool.
Evaluating the Confidential Statement of Recurring Cleans
Can your cleaners earn acceptable margins by cleaning his customers’ houses to your standards? This is critical, because you can’t entirely correct a big mistake in evaluating the quality of his accounts through the pricing or structuring of the deal. Mostly it has to come down to comparing his average clean prices to your own. Without checking the houses or working with his cleaners, you have to assume that: 1) his clients will quit if you raise prices; 2) his cleaners are doing a crap job; 3) his margins are low. It might sound like a harsh collection of assumptions, but you have to consider, how did his company come to be so distressed?
What you are looking for is nicely priced jobs which can be added to your own schedule for a profit. In the short term, it’s likely that you’re going to depend on his cleaners to continue cleaning the assignments, but once you’ve had the accounts for several visits, you’re going to have to fold his schedule into your own. So, make the determination about the value of his accounts on the basis of your cleaners cleaning them according to your schedule.
Structuring the Deal
When you buy the accounts, you must have a way of: 1) sorting clients, by keeping profitable accounts and offloading losers; and 2) transferring the transition risk back to the seller. You do these two things by structuring the transaction in a way that accomplishes these objectives. So, without actually showing you our standard Purchase and Sale Agreement, I’ll explain the primary provisions of it.
During negotiations, we always say that we are flexible, because being flexible sounds darn nice. In fact, when it comes to structuring the transaction, the only thing we are truly flexible about is in which font the agreement will be written. For us, in terms of structure, the primary provisions of the purchase and sale agreement pretty much represent a take it or leave it proposition.
The primary provisions state that we are going to pay the seller 75% of the actual cash received from customers for a specified number of months, generally number of months, generally two to four months, depending on the quality of the accounts. This time range determines our deal price. The payments will be made on a one-week lag, except that the last month will be paid on a five week lag. The agreement further states that the seller shall reimburse us for any accounts which defect to the seller or any past or existing employees.
This structure provides the opportunity for us to clean all houses the first time and then immediately evaluate the profitability of each assignment. If the price is too low, we increase it immediately, thereby forcing the customer to accept a higher price for the second clean. More often, the customer will choose to quit, in which case we haven’t paid much for the bum account. In this way, we transfer most of the risk of mispriced cleaning assignments back to the seller. With respect to the final delayed payments, the delay allows us to insure that the accounts actually transfer to us. This is very important, because some wise-guy employee might just love to exploit any weaknesses he might perceive by offing with the clients during the transition. By withholding the final month’s payments for an extra month, we can mitigate this risk to us, and transfer it back to the seller. This is reasonable, because it’s been our experience that the seller is in a better position to influence the behavior of his employees during the transition.
The Purchase and Sale contract also must include a load of other provisions such as restrictions on the seller with respect to non-compete and non-solicitation, remedies for nonpayment by Purchaser, etc. We used to kind of buy and sell companies for a living, so we’ve kind of developed agreements for such things throughout our careers. Our standard purchase and sale agreement is five pages long. For sure, a lawyer would hate it–too short for their liking by at least half. If you haven’t figured it out by now, we don’t depend on lawyers much. Despite that, I’m obliged to advise: you should consult a lawyer to draft the purchase and sale agreement.
Executing the Deal
As with every phase of the process, we let the seller set the pace of signing the purchase and sale agreement. Until a deal is signed, we’re pretty relaxed. Once the deal is signed though, we invoke a flurry of activity.
First, we prepare a joint letter to customers and another to employees, announcing the deal. The letter is signed by both parties. Then we combine schedules, bending over backwards to avoid disrupting assignment dates. We always include one of our Team Leaders on each assignment.
Once we begin servicing the new customers we evaluate them daily. I personally speak with the Team Leader at the end of each day about each assignment and make an immediate decision about whether to reprice. Generally, if they are in the ball-park, we don’t. So, we generally would not have price adjustments less than 20%.
We usually expect to take it in the chops for upgrading the quality of cleaning. We accept this as part of the cost of doing the deal, and ignore it in terms of how long it will take to clean the houses in the long-term. The overall condition of the homes is also considered in evaluating the quality of new employees we just inherited.
Further on this point, each day I speak with the Team Leader about the new employees. If they report deficiencies, I instigate counseling sessions immediately to correct the problem and establish a standard for improving performance.
It’s easier to buy new companies when you have a previous seller around as a reference, so we do our best to maintain an excellent relationship with the seller throughout the process. Most importantly, we pay them precisely as agreed.
Measuring Success
We’ve experienced an interesting phenomenon in buying companies: newly purchased customers seem to give more referrals than our existing customers. So when we have purchased accounts in the past, we have always seemed to generate new customers just by doing the deal. I think to a large extent this is because the transaction gets customers’ attention. Right after the announcement letter, they start paying attention to every little service detail. Mostly, their previous service was probably deficient, so when we do a better job, they notice. Then they dash off and tell their friends about their good fortune—their cleaning company was sold to a better-managed company. Then their friends call us up and we win a new referral for free. In the past, this has had the effect of almost doubling the accounts purchased, with as high as a one to one referral ratio in the first three months.
When we look back on the three companies we have purchased to date, we’re really pleased with one, pretty happy with one, and really sorry we did one. With respect to the really sorry one, we made some mistakes, and made adjustments to our methodology accordingly. Had we structured according to our existing standard Purchase and Sale agreement, then we would have done a lot better. One of the employees offed with a significant part of the company during the transition. We chased her down, and eventually pounded her in court, but it was a long, painful and expensive process. We ultimately prevailed in court, but were only awarded our costs. Luckily, we were able to offset the purchase price for much of the loss. So while it was devastating to the employee, it was also turned out to be a loss for everyone else. It’s pretty difficult to call the transaction a win. But it made us smarter, and the next deal was our best one yet.
Presently we are in low intensity discussions with two prospects. I’m not really sure where we are on those deals, you know, because I don’t really phone them to ask . . .
For those of you who are ready to take the concept for a spin, good luck. Let me know how it goes: clude@denverconcierge.com.