AMA Insights Summary

Eric Hsu, founder and managing attorney at Clear Focus Law, recently joined our community for a masterclass in strategic SMB acquisitions. Eric's firm specializes in buy-side M&A, where he's developed deep insights into what makes deals successful over the long term. Beyond his legal practice, Eric runs the "Freedom Through Acquisition" newsletter, demonstrating his commitment to educating the next generation of business owners.

Key Due Diligence Red Flags: Looking Beyond Surface Financials

Eric highlighted two critical risk areas that often get overlooked in initial deal evaluation but can significantly impact long-term success:

1. Employee Misclassification Risk: The temptation to classify workers as 1099 contractors rather than employees is pervasive among small businesses, creating what Eric calls a "ticking time bomb" of liability. This is particularly acute in states like California, where regulatory scrutiny is intense. Beyond the immediate financial risk, misclassification often signals deeper operational issues that need addressing post-acquisition. Eric advises making workforce structure analysis a pre-LOI priority.

2. Sales Tax Compliance: In our increasingly interconnected economy, businesses often sell across state lines without fully understanding their tax obligations. Each state has unique sales tax thresholds, creating a complex compliance web that buyers inherit. Eric emphasizes engaging specialized tax diligence professionals early, as remediation costs can significantly impact deal economics.

Deal Structuring: The Art of Alignment

The discussion revealed how sophisticated deal structures can solve complex problems when approached thoughtfully:

• F-reorganizations have emerged as a powerful tool for license transfers, though they come with costs ($10,000+) and timing implications. Eric recommends explicitly addressing these costs in the LOI, demonstrating how technical details often have strategic importance.

• Recent SBA guidance now permits equity rollovers, creating new possibilities for keeping sellers engaged while maintaining necessary licenses. This flexibility allows for more creative deal structures that align incentives.

• For multi-location acquisitions, Eric highlighted how SBA lending can accommodate blended amortization periods when real estate is involved. This often overlooked detail can significantly improve deal economics.

LOI Best Practices: Building Foundations for Success

Eric emphasized that comprehensive LOIs, while requiring more upfront work, ultimately save time and increase deal success rates. Critical elements include:

• Working capital requirements

• Pre-closing accounts receivable treatment

• Work-in-progress handling

• Warranty responsibilities

• Asset vs. stock deal structure considerations

• Detailed seller note terms

• Retention bonus structures for key managers

Particularly noteworthy was the discussion of retention bonuses split between buyer and seller, a structure that creates powerful alignment of interests. As community member Kinza K. noted from experience with a multi-location operation, getting these details right early is crucial for smooth transitions.

Current Market Dynamics: Opportunities in Complexity

Eric shared several observations that paint a picture of a market rich with opportunity for prepared buyers:

• Multiples remain steady at 2-3x SDE, occasionally reaching 4x for exceptional businesses

• Mid-single-digit million deals are seeing increased PE competition, especially in home services trades, yet individual searchers maintain key advantages

• Seller preference for individual buyers over institutional capital remains strong, creating opportunities for relationship-driven deal-making

• Proprietary deals through cold outreach continue to yield results, suggesting many good businesses aren't actively marketed

The Human Element: Building Trust and Value

Throughout the discussion, a common theme emerged: successful deals require more than just financial engineering. Community member Mike O. highlighted Eric's attention to detail and reasonable fee structure, illustrating how professional advisors can add value beyond technical expertise.

Future Challenges and Opportunities

The session concluded with a thoughtful discussion about scalability challenges in the lower middle market. While various platforms attempt to streamline the process, Eric noted that seller inexperience and lack of advisors often necessitate experienced counsel. This challenge presents an opportunity for innovation in how deals are structured and executed.

The complexity of these issues underscores why successful acquisitions require more than just capital – they demand a deep understanding of both technical details and human factors. As we navigate an unprecedented wave of business transitions, this holistic approach to deal-making becomes increasingly valuable.

For those interested in continuing to learn from Eric's insights, he can be followed on Twitter/X at @lawyer4SMBs, where he regularly shares knowledge about the art and science of successful acquisitions.

EBIT Community

Our community of hundreds of searchers comes together daily to share real experiences and help each other succeed. You can see it in action from our recent AMA with Eric Hsu of Clear Focus Law, where searchers traded practical insights on everything from deal structuring to valuation multiples, while community members like Kinza and Mike jumped in with their own experiences and lessons learned. These kinds of candid, valuable conversations happen naturally in our WhatsApp group - just experienced buyers helping others navigate their search journey. If you're actively looking to buy a business and want to connect with others doing the same, click here to join our free community.