Martinka Consulting's Getting the Deal Done Podcast
Martinka Consulting's Getting the Deal Done Podcast
John & Jon (Stoddard) Discuss Business Buyers, Sellers, Bad Deals, Good Deals, and More
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Jon Stoddard is the Host of "Top M&A Entrepreneur's Podcast" and joins me for a fascinating discussion on business buying, search funds, make-believe deals, and a lot more. He is also the author of, How to Buy a Million Dollar Business.
You can connect with Jon at jon.stoddard2016@gmail.com or (520) 488-6704. See his podcasts at https://www.youtube.com/c/JonStoddard.
John Martinka
Jessica Martinka
Contact us via either website or give us a call and be sure to check out our blog pages with new posts weekly.
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This is John Martinka, and welcome to the Getting the Deal Done podcast. And my special guest today, very special guest, is John Stodder. Welcome, John.
SPEAKER_01Hi, thanks for having me.
SPEAKER_00Let's start out with tell us a little bit about your background, how you got into the MA world, and what you're doing now.
SPEAKER_01Yeah, so uh last couple years I started a uh business of teaching other people how to buy a business. It's basically courses offered through dealflowsystem.net. And it's how to buy a business. Uh it's a course, like lots of modules. And then I also have a course on how to raise capital for uh to buy a business because a lot of people don't have that big equity injection. Um, and I have some other courses that have to do with deal review, understanding the financial report cards or the language of business, which is accounting. Uh, because I find a lot of the people that try to buy a business don't really understand the financial report cards, which is the income statements, the balance sheet, the cash flow statements, and what they mean. And what the kind of story it tells about the ability of the business. So uh I have in the past, I started a company called Turbosquid a long time ago. We raised capitals from uh some venture capitalists and Intel. That was many, many years later sold to Shutterstock in California. Uh, and then I worked for some software companies, and then I left and started. Uh, I bought a company, which I six months later had to shut down because I made a couple of mistakes there. I bought a Turnaround, which is an e-commerce company. I built that up and I sold that on Empire Flippers, and it sold within 72 hours. And then I helped uh another company acquire some companies, and I still own a percentage of that company. So, and now fast forward, I'm helping people buy businesses.
SPEAKER_00So, how did you segue to writing all these courses? What drove you to take that path, putting courses out there?
SPEAKER_01Yeah, uh part of it had to do with, you know, there was a guy out there on LinkedIn called Justin Welsh, and Justin Welsh was using LinkedIn and selling courses for 150 bucks and making a lot of money by just posting on LinkedIn and then referring to his courses. So wait a minute. And I go, hey, I've already got 19,000 followers, 3,500 friends. Why not make some money on what's in between my head here and write a course and help people out?
SPEAKER_00Okay. And where are your courses available?
SPEAKER_01Uh they're on dealflowsystem.net.
SPEAKER_00Okay. Is that the only place?
SPEAKER_01Yeah, that's the only place. It goes right to it's a Kajabi platform. You can purchase the courses. Uh, you know, there's payment plans, all kinds of stuff. And there's a couple levels you can get into, which is just courses or coaching or group coaching.
SPEAKER_00Yeah, so let's talk about that. You uh yeah, you someone buys the course, and uh you you and I were talking about uh offline, the chances are it's gonna go up on the shelf. Uh I used to say the same thing about business plans that people go through this great exercise with the fancy software and it becomes a shelf plan. So yeah, so then you you've expanded into doing some coaching on that. Get people, get them motivated.
SPEAKER_01Yeah.
SPEAKER_00Okay, yeah.
SPEAKER_01So the group coaching starts out with every Monday for about two hours, we have this group call, and we just talk about deal flow, deal review, and raising capital. So I focus on those three areas because I that's where I find most of the problem people have problems because they we we got to focus on deal flow, which is taking massive action, finding deal flow that could start with on-market deals because on market, I like on-market deals because two thresholds have been made. One is that the seller has decided to sell, you know, they've made, you know, sign a contract with the broker to say, hey, I'm selling the company and I'm moving on to the second stage of my life. And two, if they list it with a broker who's been around for a while, the broker understands that, hey, look, the only way this is going to sell is with a reasonable valuation. So there's two thresholds have been met that they want to sell, they're moving on to the next stage, and two, they've got a reasonable valuation. So I say focus on on-market deals first, you know, start getting some reps in, get your NDAs out there, get your sims, take a look at it. If it's a business you want to do, it looks like it's good financials, get the financial report cards to sent to you, and then evaluate the business. That's deal flow. And you really need to be looking at a lot of those, getting a lot of reps in to understand the process.
SPEAKER_00Yes, you do. It's rare. I mean, I've had a couple clients where you know they found something in the first month and closed in four or five months, and but that is the exception to the norm.
SPEAKER_01Yeah, that's the except I've got a couple of students to whose we've looked at, I think it was the fourth business he went into a deep dive. And I say, look, all these other businesses you're looking at, like he's got a big tax bill from PPP that that govern California is going to come after him. Say, no, you got to move on, you got to cut it. Let's go find a really clean business. Found a security company doing really good cash flow. The guy's run it for 20 years, it's clean. Uh, the UCC shows clean, everything's good about it. And the ballot, the books are balanced. Like, this is what you want to spend your energy on right here. Start, go for it. Make an offer, go raise the money, find an SBA lender, and let's go get it.
SPEAKER_00Yeah, yeah, you got to be patient for the right one. Um, like you what you're just talking about, mature 20 years, profitable, and I'm assuming fairly priced.
SPEAKER_01Yeah, it was fairly priced. I mean, it was in right around the three-ish, but it was really profitable for a security company, the guy that just ran with you know, his ability to clean keep his books clean, they were balanced every year. Plus, you know, you you just look at it, it goes like this guy's did a great job of turning his assets to cash flow. He understood what makes the bell ring. I go, this is what you want to spend your energy on. Everything else, every other story where you got your reps in, like, you know what not to go after now.
SPEAKER_00Okay, so you know, you've just described a big mistake that a lot of buyers make is that is they find the shiny object and they try to make make it, they find the unshiny object and try to make it shiny. The ones you couple you just talked about. Um, what are the other mistakes you you see these buyers making?
SPEAKER_01Just a lot recently of these buyers going in and signing an LOI before they have their cap stack filled out. A lot of them are will sign a deal and say, hey, I'll do this. Here's all I split up the pie, and but they don't have all their money ready to go. Now that could be money they brought themselves, but most of the times there's this big gap of an equity injection of 300,000 to 700,000 that they don't have to make up that gap for the equity injection. And they go, okay, I need to go raise it, and I need to go raise that money in three months because the LOIs expires in three months. Like, yeah, that is gonna be a difficult ask.
SPEAKER_00Yeah, so what you're describing is someone going in there pretty skinny on their own money and putting off the raising of capital till it's too late.
SPEAKER_01Yeah, yeah, a lot of the I don't know where it's coming from, but a lot of the business buyers think that if I build it, they will come, or if I sign the LOI, they will throw money at me. No, I mean, raising capital to for that equity injection, that gap from outside investors takes an expertise level and time that you know it's not usually doesn't fit into the the 90 days unless you've done it before. You know, I've seen a lot of guys that were a private equity or you know, they were doing startups before or something, and they know how to raise capital for investors, they know how to put a package together, they know how to create a campaign, and they know how to go get investors and close them within 90 days.
SPEAKER_00Yeah, I I'm thinking of on Search Funder, I saw one a number of months ago, and someone wrote, Hey, I just signed an LOI on an HVAC business now. Uh what do I do to raise money?
SPEAKER_01Yeah, it's like they're raising money from outside investors is kind of a difficult scenario today. Uh, and I'll just explain this is because what you're seeing is a lot of search vendors are self-funded searchers, you know, and they're doing it all 100% themselves, no outside money from uh a private equity firm or no outside money raise investing so you can do search by yourself. So a lot of these guys that they reach out today, these investors are bringing their terms from private equity and venture capital into the game. Meaning, you know, hey, I I need to raise $500,000, and then they'll go to an investor, and an investor will ask for you know their liquidation preferences, participating preferred, a coupon, a 1.5 to 2x step up, and they're looking for a 20 to 30 IRR. And that's difficult to deliver, especially if you're trying to buy an HVAC company that for the last 20 years has only grown by five to ten percent a year for the last 20 years.
SPEAKER_00So the search fund model has been around now for a good uh 20 years. I remember when I first heard about it, uh, a client said, Hey, I'm going a different direction. I I created a search fund, and it was like, what's that? And uh now it's everywhere. Although I did see a headline somewhere recently, and it said, Do um do search funders actually make any money? Meaning who gets all the who gets the reap the rewards? And it was not the searcher, it was the it was it was the investors. Yeah, comments on that?
SPEAKER_01Yeah, I I interviewed a guy, he was a searcher for a search fund, and and uh he was had the right buckets checked, which which was I'm in Harvard MBA, and but he had no experience, and so I had him on my podcast, which is the top MA. I had you on as a guest, but I said, I'm trying to understand something. Oh, like why would a search fund help you buy a multi-million dollar company and put you into the CE role when you have zero experience running a business or managing people? Why would you do why would they do that? And he said, because they buy these enduringly profitable essential products businesses that are growing five to ten percent a year where a monkey could run them. And say, Well, you have I guess okay, I I can see that. So you don't have any problem being a W-2 employee for five years, and at the end of five years, you get 25% of the business. You you like that, or was the mandate for you to grow it and sell it if that was the the cards that you were playing? Fortunately for him, he was able to see some opportunities in the business, and he grew it probably five to seven X in a short period of time, and they were able to sell to a uh to a uh another buyer, which they all made money, they turned in five years, and the you know, the search fund was happy, and the searcher was happy. So I think that's a I don't know if that's an extreme case or isolated case, but you know, that whole model of our Arbury Proper, what is it? Arbury Partners from Royce Rudicroff, uh Harvard Business Review, where he, you know, they set up a search fund, they had money, but they couldn't find they couldn't find a lot of businesses. Deal flow was too tough to find a lot of good deals. So they said, hey, let's outsource this to ambitious recent Harvard MBAs and let them do the legwork.
SPEAKER_00Yeah, before there were search funds were and and before they were really popular, I should say, I would have people come to me and say, Well, I got this VC or PE firm, and they says, Well, if I find a business, they'll fund it, then I can run it. Then it's like, yeah, is that what you really want? You really want to be an employee at 20%? Yeah, usually it was no, I'm going into this so I can be the guy in or go in control. Um John, what you just talked about is uh you know, remember on when I was on your podcast, I said people need to know how buyers need to be some degree know how to manage and lead people, processes, money, and enthusiasm. And yes, you yeah, for most of the people, the ones I work with, and I'm sure the ones that are hiring you to coach them, um, they don't want to be the monkey. They're looking for the one where they can truly add value and they have the skills to do it.
SPEAKER_01Yeah, yeah. I don't I don't have any uh I don't have any negative to say about the search money. It doesn't work for me or for my students. I I only work with self-funded searchers, yeah.
unknownYeah.
SPEAKER_00No, I understand. I think there's two there's many different models. Uh and when they when they teach people that they can go out and do this, and here's the funding, uh, it's a lot different when someone has built up their own equity and has a lot of their own skin in the game. They're really vested to making that company work.
SPEAKER_01Yeah, yeah. These those are those are different people. Uh, you know, these are people that were probably W-2s before and don't want to work for anybody else anymore. Yeah, and they want a little more control about the decisions they make in an organization, organization, and they they want the ability to you know change and have kind of like their their uh financial lifestyle, what they want that to be better, and it's amazing what you can do buying a business with the SBA today is you know, you can buy cash flow a lot higher than you were doing with the SBA, yeah.
SPEAKER_00So speaking of SBA loans or loans in general, what are you seeing with interest rates? I mean, you go back uh two years, and interest rates are SBA loan interest rates are double what they were.
SPEAKER_01Yeah, that's crazy, isn't it? Just in two years, yeah.
SPEAKER_00And actually, they're probably the interest the prime rate is back to what it was historically for a long time. Um, we just got very spoiled.
SPEAKER_01Yeah, cheap, cheap money, uh, a lot of people to come in and buy businesses, lots of activity. But now I think what I'm seeing is you know, 11.25% plus three to five percent closing cost can put a lot of stress on the cash flow. Um, I'm seeing smaller loans, maybe not the 90%, but maybe the 50 to 70 to 80 percent.
SPEAKER_00Yeah, I'm seeing more seller financing because they can they can leverage a lower interest rate the seller will take, and the seller can get their price. Um, I just there was uh something on Search Front and just yesterday. I I don't know how well it has been received, but someone is complaining about the interest rates, and you know, buyers are offering lower prices because they're paying more in interest, and said that doesn't make sense. A business is worth what it's worth. And I wrote, well, maybe these people who are so tight because of the interest rate should look at a smaller deal where they have a higher percentage of equity and they won't be paying as much in interest. Yeah, but everyone wants seems to want the most they can get their debt up to their eyeballs.
SPEAKER_01Yeah, yeah, that's like you know, you gotta run a debt stress test on the cash flow, right? But I've seen brokers just in the last couple of weeks having a conversation with some of my students, they they realize, like, oh yeah, it's 11.25 percent, probably going up, mortgage rates are going up, possibly go up a little bit more. And yeah, we understand. They voluntarily offer more seller financing. What I'm seeing, what I'm hearing from the brokers representing sellers.
SPEAKER_00Yeah, we've got some we've got a client on the sell side, and I think if I'd have to look at the deal, I think it's 40-45 percent seller financing.
SPEAKER_01Wow, yeah, that's good. Yeah, what's the interest rate on six six? Yeah, and I I don't I I just saw some post on Twitter about some hurdle rates on that. You know, six percent, you're kind of losing your money. It's better to have it in other places than at six percent. I'm seeing eight percent and probably like closer to nine percent.
SPEAKER_00Yeah, well, this I I've got another one where it it was at eight. We actually talked them down from eight because uh on the buy side, uh the buyer had offered six, they accepted it, then want to raise it, then they wanted to raise it. But yeah, you know, the the seller's got to balance that with it will they offer less money? It may not make sense from a theoretical position point of view that you know you're you get less because of interest rates are high, but theoretical doesn't always uh apply to the real world.
SPEAKER_01Yeah, I think I still it's a seller's market still.
SPEAKER_00It always is a seller's market, it will never be a buyer's market for good businesses.
SPEAKER_01That's right.
SPEAKER_00It's a buyer's market for for the junk.
SPEAKER_01Yeah, and there's look, and there's nothing wrong with that. I bought a distressed business turned around. I don't recommend it to anybody that doesn't understand how to buy a distressed business because you know there's a lot of sacrifices you can make, some of them are financially, you will spend more money to fixing it, and you're gonna put a lot of stress on your home life with your wife and marriage, guaranteed. That's my story.
SPEAKER_00Yeah, so we get over the you know the searching and finding and all that. What what tips? What what have people done that they shouldn't have done uh as they analyze a company and put an offer together and all of that?
SPEAKER_01Yeah, this comes back to deal review. I uh I'm not an accountant, but I worked an Intuit for five years, so I've seen a lot of financial report cards, which is the cash flow statement, balance sheet, the income statement. And you really should bone up on this the language of business, which is accounting. Warren Buffett says this like, I can see a bad deal in five minutes or less because I understand the language of business, accounting. And I tell everybody my students come in, or anybody that comes in in my group coaching on the Monday, and they send me this income state, and I go, Yeah, looks great. You know that number there? That's a theory, it has nothing to do with what's cash in their account or how well they're turning uh their assets into cash flow. And I go, what do you mean? I go, well, let's go over to the balance sheet in the equity section. There's gonna be a Net income. That's more representative of what the business is doing than what the income statement is doing. Now, if those two numbers do not match, I can tell you immediately the books are not balanced. And now you have to do more forensic audit of your uh of your uh accounting systems.
unknownYeah.
SPEAKER_00John, I think based on this, and and when I was on your podcast, we could do a whole podcast on the importance of the balance sheet as non-accountants.
SPEAKER_01Non-accountants. Like I, you know, I go from the start at the top, like, oh, what's the cash and account? I have seen some businesses doing $3 million with less than $10,000 in the cash account. I go, say no to this one. Go, why? Well, look, there's no cash in the account. Either he's take there's a number of reasons. Like he's take that seller's taking a ton of cash out of the business immediately paying bills, or he just he's juggling all these bills, you know, to figure out what's going on. There's not enough cash in this business. He's not very good at turning assets to cash flow.
SPEAKER_00Yeah.
SPEAKER_01And then you go down and you look at the accounts receivable. Is it up or down? You look at the accounts payable, like what do they owe? And you have to look at two balance sheets to get some context. Like, what did they do last year? If it's always, I tell all my students, like 12 months apart, same exact date. So we can see some context. You know, you can only tell what to do in the future about what happened in the past in the rear view mirror. And we look at everything, we look at all their liabilities. We looked at a durable medical equipment supplier, I think it was in North Carolina, and we looked at the liabilities and I go, okay, why do they have these debts from a whole bunch of people, investors? So they get they had to keep borrowing money to pay their bills to get the cash flow that looked great on the income statement.
SPEAKER_00Yeah.
SPEAKER_01So they were just chasing their tail, and just never gonna go anywhere. I say we that's a no immediately.
SPEAKER_00Or when you see about three or four years of balance sheets and at the year end, and inventory is the same on every one of them.
SPEAKER_01Yeah.
SPEAKER_00And what are you doing? Yeah. Yeah. What they're doing is writing everything off. Uh you don't know what's good, you know, they have no idea what's good inventory, what isn't.
SPEAKER_01Yeah, I just chances are they're gonna come and see one of my students is an ADC all, you know, he does and he's trying to buy this business, and it was in Maine or something, and it was a farm equipment business, and it looked great. Owner owned it for 40 years. So that's to me, that's kind of a good story to start, right? It's a family-owned, you know, they've been paid living their life for a long year, long time. But I go, uh, this balance sheet's got a lot of assets, and uh, he's trying to sell you these parts here, like five million dollars worth. And I go, look, this is probably assets accumulated over the 40 years, and they're worth nothing. So if you're gonna be buying this business, it's gonna be an asset purchase agreement, and that is not included. Because you're not gonna get any money on those parts.
SPEAKER_00You had a boat dealer deal a number of years ago, and it was the same thing. The you know, the yeah, they had parts, and guys says, Well, yeah, I can someone who has a 25-year-old outboard, I'll I'll probably have the part for them. Well, when do they come in once every 25 years, right? You gotta watch that uh inventory.
SPEAKER_01I gotta have more time than that, right? Yeah, you can go find that uh you know on rare parts, rareboatparts.com if you want to do that.
SPEAKER_00Yep. So when you get into uh when you get into the uh negotiation, the deal structures. What do you see your uh what do you see these buyers wanting to do? Is it typic is it typically I got a little money or investors SBA loan? That's it. We offer cash as possible.
SPEAKER_01Most of the time that's it. And I go, I think the really the bad habit is you see these buyers, they they they uh you know uh pay want to pay too much to get the deal done, they'll pay too much. Like, hey, I'll give you it's an HVHC company, it should be around a three multiple, but then they want to offer five to get the LOI sign and then make up the difference somehow. Doesn't work. Mathematics don't work. I always I tell people like this is look, this is you gotta get most of this business, is gonna be bought with a debt, and these lenders are not dumb, they're gonna go through underwriting. So this underwriting are guardrails for you on the highway, right? You're you can only give the sellers X amount of dollars because the lender is only gonna lend you this amount based upon the valuation because that's all the cash flow can support.
SPEAKER_00Yeah, that's right. Yeah, so is it financial, right? I'm big on pushing debt coverage ratio, and you know, I I there are lenders that'll go way too low on a debt coverage ratio, they just want to make the low. You need you want a good bank that will insist on a at least a 1.5 to 1 debt coverage ratio. Smaller the business, the higher it goes. And you know, you you can't just say, well, I'm gonna grow it because you don't know when you're gonna grow it. And it takes cash to grow it, which is why you need that.
SPEAKER_01Yeah, there's a lot of you you have to come into this business like you're not gonna get any new clients the next year. You may make mistakes and you'll see a drop. You may lose clients because you took over it and told everybody. A lot of bad things could happen in the first year that you need to have very conservative financial principles in place.
SPEAKER_00Yeah, and that's why bank a good bank, good banker will run a stress test if if earnings go down 20%.
SPEAKER_01Yeah, that's right. I mean, I got a death stress test that goes down 50% because oh, it just happened two years ago. I could destroy a lot of businesses. Yeah, yeah.
SPEAKER_00No, on the flip side, I've seen so many owners they sell, the buyer comes in, and the employees are so glad the owner's gone and the seller's gone, and the buyer's a breath of fresh air. And yeah, things pick up. Because a lot of these a lot of these sellers or founders, you know, it's it's their baby and they run it like a dictator.
SPEAKER_01Yeah. Yeah, that's that's uh that's a very subjective type of uh area because you know, if somebody's running their business for 20 years, they they have their culture, right? And sometimes they're not doing things nefariously to be evil like an evil dictator. They just created these habits in the business where they also hire, they bring their culture and they also hire in their image. So if you're coming in, I mean, I there's extreme examples. Like I had a student who was trying to buy this therapy center, and I said uh he was a male, and I go, uh, yeah, I'm not sure you want to buy this. And he goes, Why? Well, I said, Did you check the Facebook page? This is therapy for female after having babies for sexual therapy. Like, your culture is not gonna work, they're not gonna listen to you, right? None of the instructors are gonna listen to you, so they're that's an extreme example, but they all have their culture, and he goes, Can you change that? I mean, who's that? I also bring an example of you know, culture. Like, who's the coach from uh Deion Sanders? Right, he came into Colorado, Colorado Buffaloes, and his culture is completely different. It's the NFL, he's done stuff. He let go a lot of the players immediately and then brought in his own players.
SPEAKER_00Yeah, well, his first meeting he told us told the team, most of you won't be here next year.
SPEAKER_01Yeah, that's right. Yeah. Like, could could you do that to a small business without you know, you can't do that with a small business. You're gonna have to sit there for a year and figure out who the players that can be that want to be here and want to do a little bit more and want to take part in the future success. Yeah, sometimes you don't you can't, I mean, you you can't really do these, you know, free interviews and figure out, oh, I okay, he's gonna he's gonna take this uh test, and it looks like he wants to be part owner of the business. I'm happy to help him. If we can create this comp plan that increases his output, you know, but then you can't do that immediately. You have to like get in there and figure out what makes the bell ring.
SPEAKER_00Yeah, you know, John, I had a couple years ago or so, I had a client's two guys, and they bought both former both business owners bought another one, and they knew something was up with the with the culture. Um, we we kept talking during due diligence about the the employees were paid so little, and they came in and almost immediately put in a a different comp plan with bonuses. This was a uh uh pretty much an online-based distributor, and employees were customer service, and they put in a better comp plan, bonus plan, etc. etc. Uh, grew grew to a very healthy business 50% in the first nine months.
SPEAKER_01Yeah, that's great. I like you know, Charlie Munger says that uh show me the comp plan, I'll I'll show you the outcome.
SPEAKER_00Yeah, yeah.
SPEAKER_01I like that. I you know, I'll tell you a story. There's one of the interviews we had with this manufacturer, CNC manufacturer in California, and one of the first calls we had, we kind of were talking, dancing around his style, and he mentioned um Andrew Carnegie's uh business partner, Fricht, like I follow Fricked, which is who ruled his production plant with an iron fist. I mean, he had these people working 14-15 hours. So we went back and looked at, hey, we asked what are the salaries of the people that are in there, and some of them were $15 who had been there, $15 an hour, who had been there over 10 years in California, in San Diego. And I go, everybody here is underpaid immediately. Can we fix that? You know, possibility if they like working here because it's a cool factor or whatever, but everybody's underpaid. So what happens next year when we boost everybody's salary so they can actually live in California, San Diego here?
SPEAKER_00Yeah, I I saw one of those a few years ago in Portland, Oregon, and uh you know, it was everyone was underpaid, except in this case, the the turnover, the churn of employees was really high. Yeah, was high, and the guy just complained about the about the employees.
SPEAKER_01Well, when you pay him what he was paying them, yeah, they're all somewhere else tomorrow. The weird thing about this business, like the churn was low, like that there's no employee turnover, but it was you know, you're I don't know who wrote this in it in a book, and I go, you know, but I like the advice, it's like uh that show a long time ago, Colombo. You're yeah, you're you're just asking these silly questions. Oh, just one more question. Oh, just one more question, right? You're trying to put all these pieces, the puzzle together so you can mitigate the risks or at least understand them going into the next thing if you're taking the baton. Uh just trying to figure out, you know, red flag. Hey, he mentions Frit, who ruled with an iron fist, his manufacturing plan to his employees are underpaid. Like, what would we do he have to do? Is that fixable? Yeah, it's fixable. You know, you could come in with the new comp plan, help people out, churn is low, get a factor, but you know, that affects profitability if I pay everybody that line item and the expenses was pretty high. If I boosted it up to 15-20, that's another effect on cash flow, which means is it still financiable?
SPEAKER_00And a new buyer coming or a buyer coming in, the new owner is most of the time a trigger for employees to think they're gonna get a raise.
SPEAKER_01Yeah, agreed.
SPEAKER_00Hopefully, if they've seen that before, yeah, yeah, and of course, then there's the sellers who uh I've I've seen a sellers, not not all the time, but I've seen enough cases that it's it's not uncommon. They see I'm selling the business and you're gonna get a raise when the buyer comes in.
SPEAKER_01They've obviously experienced that before at some other point, or somebody told them like, hey man, that's a good thing for you, possibly.
SPEAKER_00So, John, what are you uh what are you seeing in the market these days as far as deal flow with your people you're working with?
SPEAKER_01Uh well um I I immediately tell people they gotta bump up their deal flow. They need to be looking at five, ten deals a week. It's just like the nature of the business of you know, if you reach out to a broker, whatever it is, the hundred top sites. Um you sign this SIM, you know, ask request the SIM, you sign the NDA, you get the SIM. Sometimes that process happens fast, sometimes it happens in two weeks, sometimes it never, you never see the SIM, even though you requested it. So you have to fill your calendar with people and you know, businesses, brokers that really you know deliver the sim, so you could say no fast to get on to the next one.
SPEAKER_00Yeah, you know, and at the size you've been talking about, not the private equity where there's three, five, ten million dollars of EBITDA, where you know, you get an NDA, you send them the SIM right away, where these low individual buyers, a good intermediary is going to want to talk to them before they send them the SIM.
SPEAKER_01Yeah.
SPEAKER_00Because there's you know, so many unserious people out there.
SPEAKER_01Yeah, I I think that those are easy to tell on the phone. Most of the time, I have a business partner, like for instance yesterday. We were looking at this, he's a former pilot, or it's a pilot today. We were looking at this cargo business, and it did 12 million in uh 2022, but it's down like it's it's probably only gonna do five to six million in 2023. So it's not a business, you know. We can ask all the great questions as possible, but is it gonna be a financial business at this point? Probably not, right? Or maybe the lender says, Hey, I do like that business, I've done these businesses before, and they'll just take out 2021, that big number, and then average them, which was you know, it looked over the last three to five years, it looked about five to six million. So, you know, the 12 million was an anomaly. We need to take that out.
SPEAKER_00Yeah, it doesn't, you know, it doesn't work to go the other way. Yeah, I told uh doesn't work. I told an owner's yeah um yesterday, I wrote them an email and said you need to wait till the end of the year, and your 2023 needs to be at least as good as 2021 because it's yeah, based on 2022, you're probably better off liquidating the assets. Nobody ignores the down year to average out around the really good year.
SPEAKER_01Yeah, and it's like there's no we're not buying it by the last year's numbers, so there's no lender gonna do that. Lenders are conservative, you know what they're gonna do. Like that's in and out.
SPEAKER_00They're a sanity check for the all buyers, but mainly the individual buyer. Yeah, this isn't private equity where if they really want the deal and they say, Okay, I'll write a check for two million more. You know, the individual buyer's not gonna do that. Heck, you're just talking about 20 minutes ago, all the ones that don't have any money to put in. Yeah, investors are pretty savvy too.
SPEAKER_01And it really comes down as like, you know, time is our our most uh precious resource, like you have limited time. Like, do we spend any more time thinking about this cargo plane business? Because it's probably the chances of it being financeable, not at 12 million dollars, you know, maybe at six million dollars. You can run it by a couple of underwriters and see what they say, but you gotta move on fast from that to find if you really want to find a business and buy a business, you gotta say no fast.
SPEAKER_00Yeah, yeah, and that helps the seller too.
SPEAKER_01Yeah, it helps the seller too, like just calling back and go say, sorry, we're not interested. Yeah, it's just not something we could do.
SPEAKER_00And I like it when bankers will say, We'll be as fast a no as anyone if we don't want it.
SPEAKER_01Yeah, that's what I like too. I've heard that, and I like that, yeah.
SPEAKER_00Yeah, go back about uh five years, and uh Bank of America, my client, owned a business, we're buying another one. He used Bank of America, got almost to the finish line, and they said, Yeah, we're not gonna do it. And no, I'd sooner have the quick no. Yeah, he got it done with I got him, I got him the bank, I got him a bank and uh got it done in record time to keep he was buying a division of a European company, so there were some time issues. Quick no.
SPEAKER_01Yeah, I I'll I'll tell you uh experience I had. Uh we were placing a uh we wanted to buy this business. It it was a uh portfolio of uh courses, programming courses. Now, this is not really outside my Bailey Wick because I used I I've got an engineering degree from NAU and spent 20 years in software. So we were trying to buy these software courses from Udemy, and it was the guy had already sold a million of these things and he was doing 2 million top line, and he had 80, 90 profit margin. So, like that was going into his bank because there was no cost of acquisition. Udemy was responsible for 100% of it. And we I looked at a lot of banks. I looked at Live Oak Bank, I looked at byline bank, and everybody was you know resistant. Nobody would come to the table uh and say they didn't, they just didn't want to give me a term sheet because the problem was the money was going to be sent to the UK if they we bought it. Now, many don't have a problem with that today, but six, seven years ago when I was trying this, they had a problem with sending the money to UK. I had to bring, I felt like I had to bring more SBA lenders to the wedding as my wedding date than normal, you know, most people do, because you know, one SBA lender goes, like, you know, they say, Oh, I don't like it, we're gonna send it to the UK. The other less the SBA lender goes, Well, Jesus, I don't really believe these profit margins, or this is I usually lend on HVAC businesses, this is a little risky for us, I'm out, right? The when I finally got a term sheet from an SBA lender is when I told them, hey, I found an outside investor, he wants to do the whole thing. The fear of missing out, said, Okay, we'll do it. I had a term sheet within about 72 hours because it went after I told him that. I wasn't bluffing, I did have an investor, it just they didn't move until they had the FOMO. Yeah, so human nature, same thing everywhere around. Even in lenders.
SPEAKER_00So, John, give uh give the listeners some tips on what should people be doing? What should be they not be doing when looking to buy a you know small, medium, lower, middle market business?
SPEAKER_01Yeah. So you're looking for a business that's enduringly profitable. And something that's been profitable year in, year out, say 10 years or older. A business that it's simple to understand, not complex, that you don't know anything about, and that you think you're gonna run from above the business and have kind of general manager. Some a business that's got clean books, financial report cards, their balance books year in, year out. They probably are audited by CPA. You could see the tax returns, and the tax returns will be signed by a CPA. You'll you'll notice that they have a process in place, like a process to get customers, you know, where they put a dollar in, they get three dollars out. That's in place. They have good people in the place that have been there for a while, not a big transition, uh, you know, uh, of losing people every year, year in, year out. That's that tells you there's a culture problem. So those are the big things, but you got to get the reps in to be able to find them, get the lot of sims to be able to see them.
SPEAKER_00Okay. And how do uh how do these buyers uh avoid buyer fever?
SPEAKER_01Uh well, what do you mean by buyer fever? What's uh what's a reference?
SPEAKER_00I've gotta have it.
SPEAKER_01Yeah.
SPEAKER_00I've been searching for so long, I've gotta have something.
SPEAKER_01I I I had an experience with when I was raising capital a long time ago for some startups I was working on. And the worst thing you could do is fall in love with an investor. It creates like the Buddhists say, attachment creates suffering. Don't fall in love with any deal, don't fall in love with any investor, just keep it at arm's length until you know that business is signed over and the asset purchase, then you can like you can find it, but keep it at arm's length. Don't create these sand castles in the sky about hey, I'm gonna do this with the business, I'm gonna do that with the business, but I'm gonna do that with the business. That it creates attachment, which creates suffering.
SPEAKER_00You know, I got some uh good advice from an old broker number many years ago was said, tell buyers almost like a private equity firm, look at it that you're gonna own it for five to ten years. If you fall in love and want to be married to it for 30, great, but don't look at it has to be the perfect business for the rest of your life.
SPEAKER_01Yeah, yeah, that's a that's one of the questions. Uh, one of my students is looking at a uh port-a-potty business in you know, I'm somewhere in the Midwest, and it is incredibly profitable, incredibly. I mean, it's he just rents these port-a-pods, yeah. He's making two million top line, one million bottom line. There's no expenses, maybe some fluid, you know, the uh cleaning solution to clean these things and the trucks to move them, but there's no cost of acquisition, marketing expenses all because he's the only player in a 200-mile radius. Really profitable. I go, but do you want to do this business? Like clean out other people's ships and talk about it, you know, at a party. Hey, what do you do? Uh porta putties, porta jobs, whatever. You gotta ask yourself that question.
SPEAKER_00Yeah. Yeah, well, I I like it when buyers say I want, you know, I want something boring and you know, not flashy, and that's you just described a boring, not flashy business.
SPEAKER_01Yeah. But the problem, the problem is if you when you become disinterested, it will start showing in the business.
SPEAKER_00That's right.
SPEAKER_01And the type of people you hire, and you know, whether you're picking up trash at your location, whether you're having your location cleaned, or whatever it is, like are like managing the books. Hey, yeah, it's okay. When the day when you say, no, it's okay, let it go. I'll get it tomorrow.
SPEAKER_00So, John, we got about eight or eight or nine more minutes. I know you got a commitment. Um, talk about your philosophy on when you see all these adbacks. And the, you know, the net income on the PLs and tax returns is 400,000, but they make it look like it's 800,000.
SPEAKER_01I just I just got a question on adbacks today on Facebook. Somebody said, are attorney's fees and accountants' adbacks? I said, uh, will you be using them next year? Uh yes. So they're not an adback, right? Unless it's a one-time event for the sale of a business or something. You know, that's kind of a different situation. But adbacks, you gotta really adbacks come from wanting a higher multiple and more money on the sale of the business. So you have to take all these adbacks with skepticism. Is it a legitimate ad bac? Is the expense going to be there next year? I mean, the same business I was talking about earlier, the CNC Manufacturing Company, they had a salary in there for the CEO as an advent. And I like, okay, is this thing gonna run itself? No. Yes, that expense is gonna be there next year. So those are like verifiable, even down to like complicated ones like depreciation, amortization. Like a lot of people throw that in, but it's not really cash into the business, right? It's just a nice deduction, tax deduction. Warren Buffett, Charlie Munger, they hate that note.
SPEAKER_00Oh, yeah. I I actually uh tell clients I give them a uh a word doc with a bunch of quotes from uh searching Warren Buffett and EBITDA. And yeah, he you know, his his best one that I remember was uh people who believe in the term EBITDA think capital expenditures are funded by the tooth fairy.
SPEAKER_01Yeah, it's you'll see those a lot in the heavy asset businesses and go, hey man, look at that depreciation. It's gonna, you know, it boost the STE by that. Like, okay, does that change my cash position any?
SPEAKER_00No, because you're pay because they're paying the they're paying the uh payments every month to the bank for that depreciation write-off.
SPEAKER_01That's right, that's right. It doesn't change your, you know, you're not gonna get any more cash in your bank account because of the depreciation. Yeah, yeah. It's a nice uh tax deduction for the tax returns, but uh it doesn't. So yeah, adbacks, really high level of skepticism.
SPEAKER_00Yeah, and then the the blending of the personal and business checkbooks is and and it you know, they get in the and they can't stop.
SPEAKER_01Yeah, that's a that's a tough one because you know, if you own a business for 20 years, 10 years, whatever, you know, you could use it as your personal bank account. Hey, you can just get in there and a all right, I I got this truck, this you know, three-quarter ton truck, and I I use it most of the time, but I'll you know drive it back and forth to work, but I can also vacation with it or phones, cell phones, or whatever, all kinds of stuff.
SPEAKER_00No, cell phones are needed these days, just like medical insurance. But uh yeah, yeah, yeah. It's uh you know, I I'll just give you a story, John, real quick. I asked, I got referred to some owners, and I asked, uh, well, uh, you profitable? Well, we don't show any profit, but the business paid for our airplane and it paid for our beach house. And okay.
SPEAKER_01That I mean yeah, and that I have to tell you, in those conversations, you understand when you start asking these questions, you and your as a buyer, you understand, you know, my I'm gonna place a bet on this, they're not gonna be a motivated seller when I start asking these questions. Because what happens is they have the business paying for all the accoutrements that surround their life. And when they sell and see this number, and I go, Well, geez, that's only gonna pay my bills for two years. I can't, I'm not a I'm not selling. Yeah, I have seen that a lot.
SPEAKER_00Yeah, yeah, I've seen that uh over the years. In this case, the husband, at least he said, uh, I get it, that we we got to show income if we want to get paid for the business. We'll see what they're doing. It was to say about a year ago, and uh I'll check in with them and see how they're doing on it, but it's a tough one to get over.
SPEAKER_01Yeah, yeah, absolutely. Yeah, I I've seen there was a uh kid out of Dubai had some one of my students who was trying to buy this e-commerce business. It's like skinny pants, he's doing seven million dollars, but he was taking out a lot of million, it was really profitable. He was taking a lot of money out. I go, we looked at the balance sheet, and he was paying for a lot of these cars, this big apartment. I go, I said, David, he's not my guess is he's 34 and he's gonna take this back off the market because somebody's gonna whisper in his ear and he goes, Look, this is throwing off a ton of cash and it's paying for all your stuff. There's no way you're gonna make this money again. Sure enough, just a month later, he goes, I he's decided not to sell. Yeah, you can tell.
SPEAKER_00Yeah, what you want is the owner that's been doing it for long enough. They they've got some, maybe them or their spouse has some mild, they or their spouse have some mild health issues, or worse. Yeah, not that we look for that, but you know, they're worried about the future. Um doctor has said don't, it's time to get out. The spouse has said, you know, we need to be going to see our grand grandkids around the country more often, and you're always working. Yeah, that is the ideal situation, but it's not always the it those aren't all that common. Uh usually it's hey, it's I it it's to me, it's always it's the owner who you know is saying it's time. I'm burned out. I've been doing it long enough. I don't want to grow, I don't want more risk of growing. Uh that's what a buyer should be looking for.
SPEAKER_01Yeah, yeah. Yeah, and you gotta be able to ask the right questions to be able to determine that, right?
SPEAKER_00Yeah.
SPEAKER_01And get a relationship with the seller.
SPEAKER_00Yeah.
unknownYeah.
SPEAKER_00Well, relationship. I mean, when I you remember when I was on yours, I said relationship is besides motivation, like you just talked about with the young guy, uh, relationship is key in these size deals. You gotta have a relationship with the but with the seller, with the banker, and even the broker. Because if the broker doesn't like you, they're not gonna let you meet the owner.
SPEAKER_01Yeah, yeah, yeah. And this is why you got to take massive action, have a lot of deal flow, because I guarantee you, whoever you are, you're going to not you're gonna have friction with somebody. Yeah, you know, one broker you see a great deal, but he doesn't like you because you graduated from uh Ohio State. Whatever it is, I don't know what it is, but it's gonna be friction somewhere.
SPEAKER_00Yeah. Well, John, thank you. I know we filled up uh just about our hour. Tell tell the uh viewers and listeners how they can get a hold of you.
SPEAKER_01Yeah, definitely. You can find me on LinkedIn or uh John Studdard, or you can find me at uh my business at dealflowsystem.net or my podcast, top MA Entrepreneurs on YouTube.
SPEAKER_00Okay, so is it DealFlow System or Systems Plural? System, just uh singular, singular dot net, dealflow system.net. Okay. Well, I appreciate this. It was a good discussion. The time just flew by on my end, and uh I think here's a lot of valuable tips you gave people who are going to be listening to this.
SPEAKER_01Yeah, John, thanks for having me on. I appreciate it.
SPEAKER_00All right, all right, all the best, John.
SPEAKER_01All right, take care.