PE Sales Challenges: Woes and Wins When Buying or Selling

Private Equity firms are acquiring. Many business owners are woo'd by PE money and look to sell to the highest bidder. But what is it doing to the industries that the investors are active in?

Many challenges face PE and sellers alike. So knowing the endgame for each side is important if you want to make an informed decision. It's also not all it's cracked up to be.

We look at the PE industry from our observations and experience. How will this impact you if you are looking for a buyer? Listen in to learn more!

Please like, share, and subscribe.

[00:00:10.22] - Alice

Hello. Welcome to Books in the Biz, a podcast that looks at both the financial and operational sides of success. Please welcome our hosts, Dan Paulson and Richard Veltre. Dan is the CEO of Envision Development International, and he works with leaders to increase sales and profits through great cultures with solid operations. Rich is CEO of the Veltri Group and a financial strategist working with companies to manage their money more effectively. Now on to the podcast.

[00:00:43.21] - Dan Paulson

Good morning and welcome to Books at the Biz. Rich, how are you doing today?

[00:00:48.14] - Rich Veltre

I'm good, Dan. How are you?

[00:00:50.07] - Dan Paulson

I am doing wonderfully. If it was any better, I would be you. How's that?

[00:00:57.01] - Rich Veltre

I don't know about that one.

[00:00:58.16] - Dan Paulson

You don't know about that Well, hey. Today, we're going to talk about buying and selling businesses, more specifically with private equity. And let me just pull up the article that prompted our illustrious discussion before we got started here. So this popped up on X, formerly known as Twitter. It's like Prince, the artist formerly known as Prince. Anyway, this gentleman, Rod Sterling, Robert Sterling, was pointing out some interesting facts about private equity as it's an industry you're familiar with, Rich. I can speak to some other ones like dentistry and manufacturing and other financial companies. But I thought this was interesting and thought you might have some insights to kick us off here. So it sounds like PE is starting to buy up a lot of accounting firms.

[00:01:56.23] - Rich Veltre

They are definitely attempting it. It's been It's been prevalent for... I don't quite know when it started. It was recent that it started to become something that people had an interest in. I think accounting has always had a pretty healthy profit margin. And so it's always been attractive. But people had to figure out how to get around certain rules, particularly just anything to do with a license, any industry that has to do with a specific license. How does a non-licensee become an owner of a company that's traditionally full of licensees? So It became one of those things that I think they figured it out when they started to figure out how to buy doctors' practices, or physicians' practices, dentists' practices. Those are traditionally licensed as well. So once people got creative and those actually worked, then it became, well, why can't we do that somewhere else?

[00:03:07.08] - Dan Paulson

Now, I find some states actually have different requirements for that. For example, I believe in Wisconsin, and I only know this because working with the dentists, I don't believe you have to be... It's either Wisconsin or Minnesota, one of the two. You don't have to be a dentist to actually own a dental practice.

[00:03:26.17] - Rich Veltre

Okay. Other states are completely different than that.

[00:03:29.29] - Dan Paulson

Yes. And I know there are states that that is an absolute requirement. So then usually what happens is they throw a dentist on their board or somehow put them in some leadership role for that particular practice. And that's How they work around it there. How do they do it with the accounting firms?

[00:03:48.12] - Rich Veltre

I think it's pretty much the same thing. So essentially what I see happening or what I've seen happening in the physician dental structure There's usually two companies as opposed to one. So you can leave the clinical work to a company that's owned by licensed professionals, but you farm out the administrative portion of it to the other company. And that company is owned by the outside professionals who can understand how to build up workflows and processes that are along the back office. So it can become a nice balance between having the clinical people actually doing what they're good at and then having the business people or the back office people doing what they're good at. And as long as they get along, then you're good to go. You've got a a combined practice that grows and grows as a cohesive unit. If If you're looking at an accounting firm, you have the same problem because there is one thing the accountants can do that no one else can do. And that's it. So if the firm that you're looking at is an audit firm and they are actually preparing audited financial statements, the likelihood is there can't be owners in there that are not familiar with that process.

[00:05:28.25] - Rich Veltre

And there's not going to be in there that are not subject to continuing education requirements, et cetera. Now, again, state by state. Every state could be slightly different. It could require that more than 50 % of the ownership have licensed professionals that own more than 50 %. That might be the way that certain states get past it. Other states still have the same rule like the doctors do, that they say, No, can't own any of it. Has to be split. And then you have an outside entity that somehow finds a way to make it whole, to make the money flow the way it's supposed to flow. And these numbers have gotten bigger and bigger. The bigger firms have found a way to do it, probably because they're the ones who have the money to be able to investigate and hire the legal protection and the legal support to be able to put the structure together.

[00:06:31.16] - Dan Paulson

Yeah, and we're seeing a lot of private equity. I mean, private equity has always been around, but it seems like within the last five years, maybe 10 years, you see a lot of private equity coming in and just gobbling up businesses left and right. And I know this from a friend that works in the cheesemaking industry. Well, turns out a lot of cheese factories are getting gobbled up by private equity. Dentists, as we've talked about, accounting is related to this article here Even real estate businesses, realtors, I see a lot of them. Actually, one of the biggest ones is actually our buddy over in Nebraska owns a bunch of them.

[00:07:15.08] - Rich Veltre

Who's that? Omaha?

[00:07:17.23] - Dan Paulson

Omaha, yeah. That guy. Oracle?

[00:07:19.04] - Rich Veltre

I forget what the Oracle owns. He owns one of them. I know that. He's got a big stake in one of them, but I can't remember which one it is.

[00:07:28.18] - Dan Paulson

He's got a stake in a number of There's a pretty large local one here in a my state that he purchased a while ago. I know there's a very large one up in the Twin Cities in Missouri that's owned by his company. And, yeah, I mean, I think he's just gone around and scooped a bunch of them up. Funeral industries, funerals. That's another one that's had a great deal of private equity. But what we want to talk about today is the good, the bad, and the ugly of that, because I think for as much as private equity swooping in and gobbling up all these businesses, it's not come without its own bumps and bruises along the way for both the people who are selling, and also the people who are buying.

[00:08:16.03] - Rich Veltre

Yeah, I think you have to look back at the model and you will wind up doing a little bit of the puppy dog. You know what? Why? And I think that my big concern with it is, it sounds like it's a fabulous succession plan. It sounds like it's fabulous that this could be something great for the industry, because if these firms come in, really, they're only interested in the big ones, right? They're interested in the higher level middle market practices and not so much your mom and pop local accountant. The amount of work they're going to wind up doing to do that investment They would much rather go and buy something that gives them some skin in the game, some meat, where if you go get a small practice, you're just going to wind up being forced to have to go buy another practice. And the other problem, I think, is that on the smaller level, accounting practices generally require a lot of time of the owner. The owner of a smaller accounting practice is usually an operator at the same time as they are the So there's not a very big definition of the difference between the two hats that they might be wearing.

[00:09:37.08] - Rich Veltre

It could be a matter of minutes. Five minutes, he's working on being an owner, and five minutes later, he's back to reviewing a tax return or a financial report or something else. So there's not a lot of differentiation there. So how do you bring somebody in who throws a lot of money in and says, okay, I'm going to be just the owner. Yeah. Well, and operator.

[00:09:59.09] - Dan Paulson

And what you tend to see, especially in, well, I've seen it in the medical field plus in accounting, is the smaller company that sells out to the larger one, typically they're no longer the owner, they're now an employee. But their roles don't really change all that much from what I've seen. You might speak to this more on the accounting side, but from what I've observed on the dental side is pretty much they're still doing all the same things they were doing before with the exception of now they don't really have controlling ownership in their own business. Typically, they're given some equity as part of the deal. But, does an accountant feel comfortable in their own company stepping back to be just a tax accountant, for example, or are they expected to do more in that case?

[00:10:50.26] - Rich Veltre

But I think that comes down to the same comment that if you're in a bigger firm, you are probably used to not being in charge anyway Because there's always somebody who's in charge. So the bigger the firm, the more infrastructure that's been built up, the more of a number of levels. I worked for Pricewaterhouse long time ago. And even if you made partner, there were other partners that were over you. There was a chief partner for the whole United States. And then there was another partner that was in another country that was working that country. And then there was the chairman or whatever that was the global partner. But as a person who was just servicing my clients, if I made partner there, who would I be answering to? The partner at the next level, the guy who's ahead of me. So I always had a boss. But I think on the smaller side, if you're looking at somebody like myself in the practice that I'm running, I don't have anybody to answer to. And if I feel like going sitting in the in the backyard tomorrow, I can do it. No one's going to to stop me.

[00:12:00.25] - Rich Veltre

But these are the things that I have to think about when I think about the private equity coming in and wanting to put in money. I mean, they're serious. They're going to be in the backyard. They're going to be like, that's just us. And you're just going to report to us tomorrow when the month is over. You're going to report how you did. And you'll be responsible to report to us, and we'll come up with new plans, and then we'll push them down on you and say, this is what we have to do. It's just natural that that's the way that operation will work. But I think my bigger somewhat concern of the whole thing is that accounting has... And the article is great at explaining why they think that there's a difference. And I agree with what they were saying, that when you look at the accounting industry as a whole, especially in the United States, there are four major players who deal with a lot of the SEC work And then if you look at the ranking between number four and number five, which is usually somewhat speculative because these are private companies.

[00:13:09.07] - Rich Veltre

So where the detail comes from or where the numbers come from, usually it's somewhat of a guesswork. But the top four are way above the revenues of number five. They just don't necessarily match. And the top four are doing some acquisitions, but usually it's strategic acquisitions. They're trying to get something in that they know they have a hole, they're not able to provide a certain service that some of their clients need. So they go and they find an expert and they buy the expert. And then now all of a sudden they have that service that they can offer. Private equity is not there. That's not where the private equity firm is. I think one of them may have an arm that's also private equity-based or the models-based, but it's not normal. So where do the firms expect to go? If I'm coming in as PE and I buy number five, I'm not suddenly going to get ranked with the top four. How am I going to get there? Would I have to buy everybody else up in order to become that level of servicer. But then who do I sell to? Private equity's model was always that we're going to buy something, and we're going to perfect it, and we're going to make it something bigger, and we're going to do that in three to five years.

[00:14:33.17] - Rich Veltre

So are you saying that you're going to buy the number five accounting firm, and you're going to perfect it, and you're going to beat the other guys, and you're going to sell it to who?

[00:14:42.20] - Dan Paulson

Yeah, to the other guys, more than likely.

[00:14:45.06] - Rich Veltre

You're going to sell it to the other guys? You're going to break up number five to become one, two, three, and four a little bit bigger than they were before? I don't see that exit strategy. I see somewhere along the line, you might see some make transactions happen with some of the middle markets that you make them bigger, and maybe they move up to become number five. But I don't know where you go from there. I feel like there's a wall.

[00:15:14.00] - Dan Paulson

Yeah, it's always a question of what private equity really wants to accomplish, because I agree with you. If what they're buying is that middle market and there is no clear gain that they're going to get to compete with the top ones in accounting, you got to wonder what's the end game for that? Because like you said, typically it's hold it for five years and try to get what an eight to 10 multiple is usually what they're trying for. I mean, They have investors. They're trying to make sure their investors are making more than market rate. So I'd say a five multiple of what they put in is probably the bare minimum. So they're trying to grow that business five times over in five years in value. We look at it from the DSO side, dental service organizations, where they're gobbling up all these little private practice dentists and putting them in one conglomerate. And it's the same thing. You take the very systematize simple, or not simple, but the similar processes, you combine that into one that operates at the administrative level. And then the idea is the dentists just practices dentistry. Well, then the push down is, well, you need to see more So now a dentist that's probably in his 50s or 60s that's thinking about retiring but can't leave for a couple of years because of his agreement now has to figure out how instead of seeing maybe 6-8 patients a day, he's seeing 10, 12, 14 in some cases where it's pretty significant difference.

[00:16:48.09] - Dan Paulson

I think that's probably what some of the biggest challenges most people don't realize when they sell the private equity. There's very few situations I've seen where the owner has been allowed to walk from day one. Usually, they build in a transition phase period where that previous owner is now there for a year, sometimes two years before they're allowed to get out, basically, and get all of their equity out. I'm not sure how that's working and say something like accounting, but that seems to be a pretty consistent model across the board is you'll get so much catch up front that you'll get the structured buy out. Oh, and by the way, you're going to be now our employee as we work on a transition to eventually place you. So from the seller side, I think you really have to look at that and say, is that a structure you want? Also understand that how your company is going to change over the next several months while you're there watching them make those changes can be rather painful as well, because let's face it, they're going to do things to optimize that business way more than you initially thought you could.

[00:17:56.29] - Dan Paulson

And if you're willing to accept that, I guess that's fine. But most people, again, the business is their baby now to see somebody saying, well, the baby is going to run on a treadmill now and we're going to cut it lean, so no more carbs for you. It's going to be low fat, high protein lean diets, and you're going to have to cut out the snacks and everything. I don't know many companies or business owners that are going to appreciate that unless they're completely detached from their business. They can turn it off and say, well, it's just a thing. It was making me money. I'm fine handing it off. And maybe more in the tech sector, they're fine with that. But most of the companies I've seen are not looking at the sale of their business that way.

[00:18:42.22] - Rich Veltre

Yeah, I think the other thing is The thing that keeps eating at me a little bit, okay, and equally between all these licensed professionals that are all suddenly enamored with the private equity money. One of the exit strategies, while it doesn't happen for everybody. One of the exit strategies was always IPO. You always had the opportunity that if you could build it up big enough, then you could go IPO, and you could sell to a whole lot of individual investors who come in or institutional investors who come in, and that's how private equity exits. But in these professions, there's no market there for these professions to go IPO. So you've taken one of your exit strategies completely off the table, or at least that's the way I'm looking at it.

[00:19:32.26] - Dan Paulson

Oh, I agree with you. I haven't seen any of these private equity guys talk about anything about IPO.

[00:19:38.07] - Rich Veltre

No, because we have the same licensing ownership problem. Can it be where they're going to go in? Are they going to go up against the legal challenge of having that administrative side of the entity suddenly is going to be where the where the IPO happens? Maybe that is possible. Maybe I'm not one who really has gone down that IPO side. But if you have very strong people, like I said, I haven't seen it yet. Maybe because somewhere along the line, you have to get something that's big enough to warrant the cost of the IPO. Because it's an ongoing cost. It's not, oh, well, once we make IPO, that big thing of, hey, we throw the celebration and it's all over. No, No. The next day, you're under regulation of the SEC. And you're going to have to be audited by one of the big firms and keep going. Just your whole life changes a little bit with that. So it has to be big enough. It has to be robust enough that the SEC cost is not over burdensome.

[00:20:51.28] - Dan Paulson

Well, but do you think that's really the route that they're trying to go? Because one of the first things you said, and you said it specifically about accounting firms, is county firms pretty much have a very good profit margin. They make good cash. And I guess looking at from a PE side of things, if I can gobble up a bunch of these and I can take 30 to 50 % of their administrative costs, I can consolidate that into a very systemized approach to everything from customer service to follow up to billing to receivables, whatnot. And then we just leave the the accountants to do their thing, very similar to what I see in the medical side of things, where dentists practice, they tend to have a pretty good profit margin. They're pretty healthy. And there's guaranteed work. Here's the other thing. I have yet to see an accountant officially go out of business. They'll typically sell off to somebody else. But even if they go away, there's more than enough people to backfill the demand that's there. And we've talked in the past about how there's now fewer and fewer accountants. Well, it's the same thing in the medical field.

[00:21:59.22] - Dan Paulson

There's fewer and fewer dentists, which is also part of the consolidation. But to me, part of what I think these PEs are looking at is we have a really profitable industry that if we can consolidate that industry and find 20 % savings on the operations side due to overhead costs that we can, again, fewer people at the handling everything from insurance to receivables or whatnot, we could just sit back and let this thing run, and we're all going to do well from it. I'm wondering if that is itself not really an exit strategy, but the strategy that they're trying to implement is just get this thing where it pretty much runs mostly by itself, put a few people in charge, and then they just sit there and collect on the profits.

[00:22:47.25] - Rich Veltre

To me, that's just, I mean, it's a little bit of a struggle, because then, are you a private equity firm? The model of the private equity firm we started out with was three to five years, and then exit with a big gain.

[00:23:04.28] - Dan Paulson

But as we said, who do you sell to? Whether it's medical, whether it's accounting, whether it's- Yeah, which is why they've always been focused on, can we get it to either sell it to the next level big firm, or go IPO, or...

[00:23:19.16] - Rich Veltre

I don't know if there's a plan C. Plan A or plan B would have been IPO, or sell off to the next bigger guy. But the model doesn't sound like PE. It starts to sound like, well, this is just a new investor holding company. So maybe that becomes where the new next bigger guy are family offices, or maybe there's something else that's the next piece that we're going to do here. But I don't know how that works with your ROI calculation if you did your initial decision on how to make your investment. If you did based on a private equity model, and now you're saying, well, we'll just hold it. I have to imagine that changes their ROI pretty significantly. You're absolutely right. If it's just kicking off cash, and I have a dividend that I can give to my investors every year and they're happy, who's to say that's not a good thing? But my concern is, does the market dilute enough, or does it become a little bit more where you don't have that upside sale ability. And then where you're dealing with things that are more on value-driven financial statements, and all of a sudden, your value is not going up anymore because there's no new market.

[00:24:43.29] - Rich Veltre

There's no bigger market for you to sell to.

[00:24:46.15] - Dan Paulson

Well, and I think that's, again, I'll speak from the dental side because that's where I've spent a fair amount of time. And what I know is that's where they're running into the problems is they have dentists that have practiced for 20, 30, 40 years. They want to sell their practices, but they have younger dentists that are coming into this that either don't have any interest in buying a practice or don't have the resources to. If you're looking at a dental practice that's five million dollars, that could sell, depending upon how it's run anywhere between five to eight million dollars. There aren't a lot of 20, 30 something year old dentists that have that cash. They can throw down on that. And again, you got the the owner of the practice who's looking at going, well, once I'm done, I'm done. I'm not practicing dentistry anymore. I don't want to do this. I want to go off and have my fun and retire and do my thing that way. And I'm almost wondering from the accounting side if that's not all that different. There's not enough younger accounting people coming in, the younger CPAs that A, have the money to buy the practice out it was valued at now, or B, have the interest anymore, because that whole work-life balance thing that's changed with these younger generations that don't look at it as, I'm going to spend 80 to 90 hours of my time working on this.

[00:26:07.04] - Dan Paulson

I want to clock in. I want to clock out, go home, be done.

[00:26:12.04] - Rich Veltre

Yeah, and I know that the industry has already been talking about that now for many years, that they've already shot themselves in the foot a little bit about making it, where in order to get a CPA license, you have to have five years schooling as opposed to four years of schooling. A lot of people will try to argue that that's not the reason. Well, if that's not the reason, then the other reason is you haven't made the profession look as wonderful as you should. Because if it's that profitable and people don't want to go into it, you didn't sell it very well. You didn't explain the... You didn't sell the industry very well. So at that point, is it worth getting the CPA? Because at that point, does that help you to have the knowledge base, to be the trusted advisor, to be the guy that can bring in those cash flows? Why wouldn't you want to go down that road?

[00:27:14.20] - Dan Paulson

Yeah. Exactly.

[00:27:16.04] - Rich Veltre

And so there's something else that might be happening here. I hope that private equity has looked at it and said, well, we have a way to get around that. I don't know what it is, but if they have a way to get around it, then I might be making the wrong argument here. But my gut says that I don't think there's a magic pill here. There's just not enough people going to school at this point for accounting. And therefore, you have to address that part. That's something you really do have to address. And otherwise, you have to start figuring out, can you turn this into a technology experience as well, where you can adjust how the profession works, maintain the profit margin, and maybe you don't need all those extra people.

[00:28:08.18] - Dan Paulson

Exactly.

[00:28:09.14] - Rich Veltre

It can work.

[00:28:11.09] - Dan Paulson

It's going to have to be something there. And I think that also ties into what we talk about often, which is how are you going to fill that talent gap? From the PE side, they tend to look more towards people that they can put in either an interim basis or maybe a fractional basis. So are we going to see more people that are in their near retirement years, take it, whether it's accounting, dentistry, any other medical thing or these other industries that we talked about where they'll be actually stepping into more of a fractional role at the PE level. And the same, I would say, when you're looking at it from the sell side, where you're a company going, okay, I'm doing everything. How do I structure myself I can get out from under this and maximize my value and maybe find a different alternative than the PE route to get things moving. I think that's going to be a challenge that they're going to have to look at as well, because let's face it, there's just not enough high level talent out there. I mean, I just say a quick look, there's a lot of operations jobs open.

[00:29:23.09] - Dan Paulson

I'm sure if you look at the financial side, there's a lot of finance jobs open where it's just people lacking the experience to fill those positions.

[00:29:31.08] - Rich Veltre

Yeah, I was talking to a friend of mine yesterday, Monday. I think it was Monday. And he's in the recruiting space. And he recruits for higher level accounting type people, finance type people. And he said, there's jobs, but he can't put any people in it. They just don't fit. He tried to say that they can fit. And then he asked three questions, and boom, he knows that they don't fit the job. So there's definitely a talent gap. I think private equity surely should be adopting or finding a way to adopt the fractional moves. Because I think getting people in there who have that knowledge base, whether you're going to use it to train the next level and bring them up to be able to do the job themselves on a full-time basis once this thing grows to where they want it to grow, I think adopting the fractional movement makes complete sense to me.

[00:30:40.25] - Dan Paulson

Yeah, definitely. Well, there's a what we have going on here, you and the finance, and me and everything else. So it's going to be interesting to see how this works out. I guess my view on this is I question the PE model. I think there's opportunities there, but it almost seems like they get so driven by the numbers that they look past all the other stuff that's important, the customer service and what their clients are expecting to how to keep their employees happy because they're busy trying to maximize profits over costs. It's going to be interesting to see how this shakes out as it currently is structured.

[00:31:28.19] - Rich Veltre

I definitely agree with that.

[00:31:29.27] - Dan Paulson

So if these guys ever decided that they needed help, what's the best way they could contact us, Rich?

[00:31:37.05] - Rich Veltre

Send me an email, rich@xcxo.net.

[00:31:40.22] - Dan Paulson

And you can get a hold of me at dan@xcxo.net. And be sure to check out xcxo.net, because if you have fractional needs, we would love to assist you with that. Also, you should like share and subscribe. If you're watching the video, you can see us on YouTube or visit us at booksnbiz.com. That is B-O-O-K-S the letter n biz. Com. And Rich, that's been fun this week. We got a new guest next week, but we will talk to you then, if not sooner.

[00:32:10.02] - Rich Veltre

All right. Sounds great.

[00:32:11.10] - Dan Paulson

All right. Take care.

[00:32:12.26] - Rich Veltre

All right. Take care.

[00:32:14.05] - Dan Paulson

All right, Bob, take it away.

[00:32:15.10] - Bob

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