Why Smart People Buy Bad Businesses

Speaker A: Have you ever wondered why smart people can sometimes do really dumb deals in the world of business? Well, there's a guy named Solomon Ash. He did some experiments and it can help us understand why smart people do dumb deals. Stay tuned.

Speaker B: I'm David C. Barnett and you're tuned in to Small Business and Deal making, the podcast, YouTube channel and blog where I talk about buying, selling, financing and managing small and medium sized businesses while controlling risk. So if you're looking to take control of your future through buying a business one day, or if you already own a business and you're looking to grow

Speaker A: or exit, you've come to the right place.

Speaker B: I talk about interesting things, I talk to interesting people, and I answer your questions every week right here. So be sure to hit like and be sure to hit subscribe and let's get to it.

Speaker C: Are you thinking of growing your business

Speaker A: or beginning a journey into entrepreneurship?

Speaker C: Take a shortcut to success by buying an existing and profitable business the right way. Visit businessbuyeradvantage.com and learn more about my online training group, coaching and consulting services

Speaker A: designed to help you win. All right, when I talk about smart people doing dumb deals, I'm not talking about careless people and I'm not talking about people who didn't know better. I'm talking about intelligent, successful, hard working people who look at, at a business, see the warning signs, feel the discomfort in their gut, and then they still move forward. Okay, So I, and believe me, I've seen this happen. Uh, and I've unfortunately met some of these people after they've done this when they go looking for help. I made a video about it just, uh, a few weeks ago about someone who lost half a million dollars in one of these deals. Um, why does this happen? Well, I think part of the answer can come from one of the most famous psychology experiments ever conducted, the Solomon Asch conformity experiments. So in the 1950s, this psychologist named Solomon Asch brought people into a room and showed them a very simple test. Okay, There was one line on one card and then three lines on another card. And the participant had to say which comparison line matched the original line. Now, I'm going to show you an image of that. I'll describe it for people that are listening. So, uh, literally on one card there's a line. On the next card there's three lines. A, B and C. And it is absolutely obvious that the matching line is, is line C. Right. The A is too short, B is too long, C is the one that matches. Okay, so this is not complicated. Right. It's not complicated math. It's not a business valuation. It's not a tax return or cash flow forecast or any of the complex stuff that people get into when they're looking at analyzing a business. Right? This is just people looking at lines. Here was the trick. Okay? So they did this test with a room full of people, and people verbally gave their answer as to which line they thought matched the one on the first card. But. Da, da, da, da, uh, most of the people in the room were actors, okay? And they were instructed to give the wrong answer out, uh, loud. So the real participant would be sitting there seeing the correct answer with their own eyes, but then hearing everyone else in the room confidently choose the wrong line. And this is the remarkable thing. Many of the participants conformed to the incorrect answer when they heard that that was the consensus of the group. Right? They gave the wrong answer just like everyone else in the group. Not because the line was unclear and not because they were unintelligent, but because the pressure of the group caused them to doubt what they could plainly see with their own eyes. Now what, what does this have to do with buying a business? In fact, there's a lot, it has got a lot to do with buying a business, because buying a business can become one big Solomon Ash experiment. Buyer looks at a business and thinks the price seems high, or the cash flow doesn't really support the debt, or the seller add backs are aggressive, or the business depends too much on the owner, or the equipment looks tired, or the lease situation makes me nervous. I'm not sure if the employees will stay. I don't fully understand why the seller is leaving. Right? But then what are the inputs that come back to that buyer? Right? The broker says, we've had a lot of interest in this listing. The seller says the business has huge potential and another buyer is supposedly looking at it, ready to make an offer soon. Right? And then there's this lender who issues a pre approval letter who is willing to finance the deal. Right? And the spouse, your spouse seems excited, right. About this deal. And, and then you bring things to your accountant and your accountant will say something like, well, if the numbers are accurate, it could work. And now you've already spent money on investigation and due diligence, and maybe you've already imagined yourself as the new owner. And suddenly this is where the buyer in our story starts to feel the pressure. And it's not necessarily pressure from one evil person trying to be manipulative. It's often far more subtle than that. It's like the pressure of the room, the pressure of the market, the pressure of scarcity, the pressure of wanting to be seen as serious, right? The pressure to not want to be seen as someone who's scared. It's the pressure of thinking m. If everyone else seems interested, maybe I'm the one who doesn't understand. And that's the Solomon Asch problem. In the business buying market, the buyer's not just analyzing the business, he's also analyzing himself. When you're going through this process, um, in relation to the crowd, and that's where the danger is. Because the crowd, all these other people, they might not know anything, right? But they're expressing opinions nonetheless. We all know there's people everywhere who don't really know anything who express opinions. We hear this all day long. And now that we have social media and anyone can put their opinion out there, we know that there's a lot of nonsense being spewed from people who don't know anything, but they're. They still have an opinion, right? So the crowd of people in your circle, they may be responding to the same sales pitch that the broker's giving you, but they are responding in a more positive way. The crowd might be full of inexperienced buyers, or the crowd might be excited because they want to believe, they want this to be the deal that works out for you, that, uh, is going to make you a business owner. The crowd might be influenced by cheap financing or easily available financing. We talk a lot about business acquisition financing here on this channel, but all kinds of people get into trouble buying a business because they've got access to other kinds of cheap financing, like a big HELOC on their house or a big, um, a, uh, policy loan option on a big whole life insurance policy, right? Like they've got access to this money without potentially gatekeepers like business loan officers who are going to analyze the deal to make sure that it makes sense. People hear all these online success stories. They buy books about people who successfully buy businesses. They get themselves all excited, right? There's the broker marketing. There's the online fantasy of, of finally escaping their job, right? People get excited sometimes about the stuff I put online, even though I try to make a big point of letting people know just how risky business is, right? And how dangerous this can be. So here's the really important part is all those other people in the crowd, they don't have to live with the consequences of the decision, right? The broker doesn't have to make the loan payments. The seller doesn't have to Operate the business after closing, it's now your job. The, the other buyers that you might be talking to don't have to deal with the broken equipment, the departing employees, the customer concentration problem, or the sales decline you do. If you buy the business, you're the one that has to live inside the deal. And this is why I always tell business buyers that finding a business is not the whole game. In fact, finding the business could be the easiest part. The harder part is keeping your judgment intact once everyone around you starts telling you that the opportunity is obvious. Because once you're in the deal process, there are all kinds of conformity pressures, right? There's social proof because people are saying, oh, there's other buyers. And we know there are other buyers for every deal out there. I talked about that last week. There's urgency, right? You need to move quickly. I told you that last week too. Like, if you find a good deal, you got to act on it. There's, there's the sunk cost, right? You've already spent money on lawyers, accountants and travel. So people then don't want to think that they've lost that money. In reality, it's already been spent, right? There's the identity pressure, right? You told everyone that you were going to buy a business. If you've been telling everyone that you're going to buy a business, you should sign up for my email list over@DavidCBarnettList.com because one of the free gifts is a recording that addresses this exact problem that you've got to listen to if you've been telling everyone that you're going to buy a business. Um, there's the optimism pressure, right? Just imagine what you could do with it, right? The whole look forward to a beautiful blue sky. There's the expert pressure, right? The bank is looking at it, so it must be financeable. There's the scarcity pressure. Good businesses are hard to find. Now, some of the things that I just mentioned there, some of those pressures could absolutely be true, right? Good businesses are hard to find. There could be other buyers. The seller may have built something of value and the bank indeed may be interested. But. But none of those things, whether they're true or not, replaces your own analysis. None of that means the business is worth the asking price. None of that means the cash flow will support your family, the debt service fund the working capital, replace equipment and survive a bad year. The business buyer's job is not to agree with other people. The business buyer's job is to see clearly when the room is excited and that is very hard to do alone sometimes when. Right, so, so this is one of the big reasons why in my business Buyer Advantage program, I created the implementation group where people get together and they discuss these kinds of things because it's for people who are serious about buying a business, but they don't. Buyers don't just need information, they need a process. They need a way to slow down, test assumptions and have conversations and be able to share or ask uncomfortable questions amongst people who understand. Before the bank owns their house and the seller has their money right before, before the trigger is pulled, you need to be able to bounce your ideas and your concerns off people who are trying to develop their own judgment in the same way. Right. A good buying process should help you say, show me the real cash flow, which add backs are legit. What does this business look like without the seller? What happens if sales drop 10 or 15%? Can this business pay me a market wage? Can I service the debt? Can it afford reinvestment? What am I missing? Am I buying a business or am I buying a job with debt? So these kinds of skeptical questions, this is the opposite of conformity. It's independent judgment. And independent judgment is one of the most valuable skills a business buyer can develop. The irony is that the smartest buyers are not the ones who pretend to be fearless. The smartest buyers are the ones who are willing to be skeptical. They're willing to walk away at, ah, any point in this journey. I've made many videos about this topic. How the only true leverage a buyer has is a willingness to walk away. Right. A strong skeptical buyer is willing to look foolish in front of a broker because they don't let their pride get in the way of avoiding a bad deal. They're willing to disappoint a seller. Like I've done so many bias, um, business, um, buyer insight analyses where I've analyzed a business for someone, sat down with them, walked through the numbers, showed them how there's just no way for it to work. And do you know what the response has been to some of these, from some of these people who've paid me to basically help them avoid just a disastrous situation. Many, uh, of them will say, I don't know how I'm going to tell the seller. We get along so well. I'm like, you're worried about disappointing the seller. And they are, they're worried about disappointing the seller because they feel some kind of social obligation because they've come into the scenario as a buyer. The seller wants to sell, they get along with each other, they become friendly. And now the buyer has a sense of obligation to carry through with the deal. And I have to, I have to like, like I wish they weren't standing in front of me because I'd grab them by the shoulders and shake them, right? This is not your job. It's not your job, Right? So as a successful buyer, you have to be willing to disappoint the seller. You have to be willing to disappoint your spouse. Right? You have to be willing to go home and say, I know, listen, I know we got excited, but it's, this one isn't going to work. And then go down and up that roller coaster again. You have to be willing to say, the numbers do not support the story. That is strength. It's discipline. That's how you avoid buying a bad business. So if you're trying to buy a business, here's what you have to ask yourself. Am I making an independent decision or am I conforming to the excitement around the deal? Am I seeing the numbers clearly or am I letting the pressure of the room change what I know to be true? Because Solomon Ash showed us something really important. People can be talked out of what they see with their own eyes. And in the business buying market, that can be extremely expensive for you. So before you chase the next deal, get educated. You know where I'm heading with this, right? Learn how to analyze a business properly. Learn how to understand cash flow, debt, service, seller dependence, working capital equipment, leases, and risk. Most importantly, surround yourself with people who will not simply cheer you into a transaction. There's a business buyer education program out there, and I, uh, kid you not, this is what they do. They organize their students into mastermind groups where it's all people who are newbies who've never done a deal before. And then they coach each other on how to do a deal. Think about that. That doesn't make any sense. Right? So you want to surround yourself with people who aren't just going to cheer you into a transaction. Um, so what you do is join Business Buyer Advantage. There's the online training, and then there's the implementation group, which I chair every meeting of. But we've got people in there who've done deals before and they're still in there because they're working on their next deal. So they're experienced. And we teach you how to maintain judgment. Right. Buying a successful business can be a wonderful path. Totally. It's a path to freedom, wealth, control over your own life. But only if you buy the right Business at the right price with your eyes wide open. Open. Don't let the crowd talk you into a bad deal. Learn how to see clearly before you buy. So, you know, head over to businessbuyeradvantage.com if you haven't already. It explains the entire program there. And, uh, coming up in September in Palm Springs, we've actually got a mastermind event. If you're thinking you might want to go to that one. There's more information at business buyer advantage.com but you should do the online training before you do that because you want to get the most out of the live session. If, uh, if you're going to come and join me, live with that, I'll say thank you very much and we'll see you next time. Keep your wits about you, uh, and remember, everyone around you can absolutely be wrong, especially when they don't have anything on the line and you do. So you have to keep your wits about you. You have to remain skeptical and pragmatic at all times. You know, in the natural world, humans, we're not the strongest, we're not the fastest, we don't have the sharpest claws, we have the biggest brains. And that means you need to think. That's our only advantage. And the quickest way someone's going to dupe you out of what you've got is by convincing you to not use your brain. With that, I'll say, see you later. Talk to you next time. Cheers. Awesome. I hope you enjoyed today's video.

Speaker C: Before you go, I'd like to invite you to come visit my blog site over@davidcbarnett.com it's full of information, links and details about my products and services. While there, join my email list. That's where I share practical ideas about buying, selling, financing and managing small and medium sized businesses. I make complicated business topics simple, useful and grounded in the real world.

Speaker A: M Also, if you're going to be

Speaker C: a successful entrepreneur, you need to know your numbers. Check out my newly updated cash flow forecasting and business plan writing program online@bizplanschool.com this program teaches entrepreneurs how to build a financial forecast and business plan from the ground up. Designed for people starting or buying a business or planning a major expansion. The goal is not just to create

Speaker A: a document for a lender or investor.

Speaker C: The real goal is to understand whether the business or the deal actually makes sense. Learn more and enroll@bizplanschool.com.