Unprepared Makes You Undervalued

Success in business is offering a better produce or service than a competitor. The same applies when you look at succession. You need to be more attractive than another company to maximize your value.

Being prepared for the next move is critical. Today we will share some Books & The Biz experiences that show what happens when you fail to prepare your company for succession. This is especially important if you are counting on the business sale to fund your retirement.

[00:00:00.00] - 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 Veltre Group and a financial strategist working with companies to manage their money more effectively. Now on to the podcast.

[00:00:44.11] - Dan Paulson

Welcome back to another episode of Books in the Biz. Rich, how are you doing this week?

[00:00:49.21] - Rich Veltre

I'm doing great, and I have my coju, so I'm good to go.

[00:00:53.01] - Dan Paulson

There you go. He's got his caffeine. Wonderful. And as of the recording of this, you are also getting through that letter half of tax time. So I'm sure you are breathing a sigh of sigh of relief there as well.

[00:01:08.09] - Rich Veltre

Absolutely. Absolutely.

[00:01:10.29] - Dan Paulson

The joys of accounting. Other good news at the time of this recording is we're seeing a slight drop in interest rate. So we dropped a quarter of a point, didn't we?

[00:01:21.29] - Rich Veltre

Yes, we did. They announced it yesterday. And the indicators are that that is one of more to come, but we can only do that. We hope that next month they do it again or whatever they plan to do. But indicator was it's time to bring them back down. Yeah.

[00:01:44.17] - Dan Paulson

So We'll get a little bit closer to hopefully making stuff more affordable, but we'll actually see if that happens or not. So we were talking earlier before this recording about what's going on, especially when it comes to succession planning. And I think we both got some stories to tell about, here's what happens when you say, I'm going to sell this thing tomorrow, and you don't do any prep work to get the company prepared to either be passed on to employees or sold on private market or PE or any of those things. And it can turn out to be a rather costly situation for you, can't it?

[00:02:26.12] - Rich Veltre

Absolutely. I was working recently with a company that was buying another company out of bankruptcy. But they were doing their due diligence. And the offer on the table was a certain dollar amount. And the first thing that they realized as they were going through it was there was a sales tax liability that was not quite quantified, wasn't filed. And it became a real back and forth conversation over how am I paying this full value and how am I covered for the fact that I might get I might have to pay that liability. And they wanted to figure that out and come up with the reason. And at the end of the day, they wound up paying, I believe, less than what they originally said they were going to pay because there was this mystery of the liability there. So that was a very recent case, within the last two weeks that it came up. And that's just one of many I mean, we had one that we were selling a big company to a private equity firm that was spending hundreds of millions of dollars to buy the firm. And sales tax, again, became the issue because somebody looked at the compliance and said, okay, everything's filed.

[00:03:51.13] - Rich Veltre

But there was a pretty quick and pretty accurate assessment of the fact that they were short on what they paid one year because it came down to Indiana, I think. Indiana taxes the capital improvements. And they had done a build out on a building, and there was a lot of personal property put in that wound up being sales taxable, and they had not paid the use tax, which use tax just means that you pay it rather than the contractor or whoever you paid would collect it and pay it. Use tax is really the same thing. It's just that if you paid it, but they didn't collect it, you still have a responsibility to submit it. So use tax was not provided, and therefore, there was a big liability that now they had to figure out how to fit that into the deal. And it changed the amount of money that the owners were going to get in the sale. So these are types of things that come up. And in our case, both of those cases, we were doing due diligence because the deal was on the table. This was something that could have been done in advance and planned for and mitigated.

[00:05:09.05] - Rich Veltre

And then it wouldn't have been something that comes up at the deal table. And everybody says, well, we're not going to pay that much money for it. So when we're talking to our sellers, we're essentially saying to them, look, be prepared. There are things out there that could show up. Maybe you want to do some advanced planning. Maybe you want to a little bit of due diligence of your own ahead of time. So you know the skeletons that are in the closet. Can you mitigate them? Can you not? Do you look like a rock star if you're going to come out and say, look, I got this. I got this thing I got to deal with, and I'm bringing it up to the table. I mean, wow, talk about being the rock star seller of a company, in that you're actually showing someone, here's a skeleton. Let's work it out right away so we don't have to impede the deal. Right. So these are some of the things that we want to bring up to people and say, look, if you're trying to sell, these are the types of things that can come up. And you're trying to sell everything where you list it on Friday and you get your money by Monday.

[00:06:17.14] - Rich Veltre

If there's skeletons there, you're not going to ever come close to that anyway. So prepare.

[00:06:26.13] - Dan Paulson

Yeah. Well, if you can turn a business that quick in a couple of days, please Let me know how you do that. It seems to be a lot more work than that. I tend to look at things from more of the operations side of things. So a lot of things that I hear or get keyed into are Okay, what internally isn't built, designed, systematized, documented, and who's doing what? Because there's actually some fairly decent-sized organizations. I'll say organizations, 40, 50 people in them, where there are still a lot of functions that have to flow through the business owner. And when the business owner says, Look, I'm done. Sell this thing tomorrow or within the next year, however long it takes, I find that once you start breaking down again, who's doing what, how much are they doing, who needs to prove, et cetera, et cetera, et cetera, there's a lot of issues that aren't documented down. So this is coming from the seller side going, I get this thing off my plate, or I want to retire, I want to collect my dollars and go. And you start talking to them about pricing, what they think their business is worth, and they'll give you a number.

[00:07:41.23] - Dan Paulson

And sometimes it's realistic. Other times, they're asking for pie in the sky numbers and aren't even sure where they got that number on their head. I think most people look at what am I selling each year? And is that revenue equate to a buy number for somebody else? Sometimes It does, sometimes it doesn't, just based on the way the multiples break down. But what I continually see is, okay, I have a salesperson, but the primary salesperson is actually the business owner or There are people that handle certain operational things, but everything has to flow through that business owner. Finance, same thing. He controls who spends the money, how they spend the money, what they spend the money on. So you have people doing tasks for the owner, but the owner having final say and direction and everything. And I find that they rarely communicate their thought process to anyone else. So nobody else really understands, well, why did you make this decision on this, but not on that? Because they're essentially doing a task. They're not paid to think on, should I ask that question or not? So then you get towards the end of the discussion when they're going to sell the business, and then they come back with a number.

[00:08:58.27] - Dan Paulson

The buyer back with a number that is significantly lower than what the seller thinks it's worth. Now, that again could be for a number of reasons. Did they do their own due diligence in coming up with an accurate number, or did they just pull a number out of the sky that they would love to get but have no reason why. But in most cases, what I find is it really boils down to the owner didn't do their homework and didn't build their systems in place so that they could walk away from the business without a hitch. We've talked about this in the past. Usually the owner leaves and they have to replace the owner with three to four other people of pretty significant salaries and benefits in order to backfill what that owner was doing. And the owner always assumes, well, you can just hire one other person. They can do the same thing I did. It never works out that way. They have a different vested interest as an owner than an employee would. So to me, that's the other side of the equation. I agree with you 100 %. There needs to be more understanding of the financials and how the financials impact the business.

[00:10:03.20] - Dan Paulson

And you also have to look at how the operations as a whole is impacted by your departure. And I don't think most business owners understand that. And they're starting to find out the hard way now, because I think you and I have talked to a couple of companies that they're like, if I could get out tomorrow, I would. And while that's a wonderful thought, A, it's going to take much longer than that. But B, are you going to get what you believe your company's worth or are you going to be offered something that is substantially discounted because the buyer sees that they have to do a bunch of work to keep this company afloat after you leave?

[00:10:45.18] - Rich Veltre

Yeah, I think there's definitely a mismatch. And I think on that particular issue, I have come to really be much more reliant on the buyer's analysis than on the seller's analysis. Because the buyer asks the key questions that the seller doesn't necessarily want to hear or get the answer to. Because you're right. If you have to hire three or four people, then you're going to decrease the amount of money you're willing to pay because you have to pay those people after you make the purchase. So that's a legitimate adjustment of what they're going to calculate into your purchase price. So I'm much more keen now after going through a dozen plus of the last deals where someone really sat down and did the workflow of, this is what the people are actually doing. We have to basically hire people to replace that. And we calculate that into our number, our adjusted EBITDA, which becomes the multiplier becomes your purchase price. So they know they're going to make less because they got to hire three more people.

[00:12:06.25] - Dan Paulson

Right. So in your opinion, which is better? Do you sell the company at a discounted rate and not Are you about fixing all the things that you're going to fix? Or is it better to put those systems in place ahead of time, hopefully to maximize the value?

[00:12:25.19] - Rich Veltre

I think there's two factors in that. Number one is your timing. Number two is your owner, your current owner. If the current owner just wants out, then maybe the conversation is, if you just want out, this is what they're going to adjust. Be prepared for that. If you accept that number, you're good to go. We don't have to do We don't have to do the adjustment. You just basically become, as I talked about before, you become the rock star seller because you're basically saying, look, I know there's a workflow problem right here. You're going to ding me for it. I've already accepted that. I'm already dinging myself for that. So I know my price is going to be lower because I'm not going to do the work before you commit. Or if you take our advice and you start early, you have the option that you can put those dollars in your pocket because you can realize that this is a problem, address the problem, change the workflows to include a couple of key people who can do the things that you want them to do, train them so they do it your way. And then that might take you two years to get somebody up to speed, to get somebody really running to the point where you don't have to be in the office all the time, because that person is doing what you already would have done.

[00:13:45.27] - Rich Veltre

So at that point, when somebody comes in and says, well, we're going to ding you because you don't have a person. Yes, I do. He's right over here. Let me introduce you. Now you're basically saying, I've already taken care of that problem. I've already taken a step back. That an adjustment is less. So very much so a piece that can be addressed ahead of time. So that's why I say it has to be timing. And is your owner willing to actually relinquish in a two-year period, three-year period, whatever it takes, it depends on what it is. So that's my thought pattern on that one.

[00:14:20.05] - Dan Paulson

Yeah. And like you said, we've been giving that advice for a while. I would also make a similar case for why you should do it early Because you stand to profit in multiple ways. One, freedom of time, because if you're training somebody else how to do what you do, that's going to take work off your plate. Now, there's a process to that. As you mentioned, a couple of years, at least, to get somebody fully tuned in to how you do things and make sure they're doing it the way you would expect. The other benefit is you're making improvements to what we'll consider as an already successful business. So you stand to benefit a couple of ways there, increased sales, increased profits. So not only have you freed up your time, you've also started generating more revenue and hopefully generating more profits on top of that, which now becomes even more attractive to a seller because it's not somebody who's just been sitting on their laurels and waiting their time out to sell their business. It's showing that there's still momentum for growth here, which I think is a huge advantage. And there are a certain group of buyers that are going to want to look for what I call turnkey businesses, which is they can just step in and take over because most of the work has already been taken care of.

[00:15:37.14] - Dan Paulson

Now, there's another group of buyers, similar to your two categories here. There's another group of buyers that will not be interested in that business because they want to buy the discount. They want to get things at pennies on the dollar because they're willing to accept that they know there's needed improvements, but they're also going to pay at a much lower rate than, say, a company that has all its ducks in a row and functions well and can operate without the owner being there. So I think those are definitely issues we need to consider when looking at that buying or selling phase, because there is a lot of work involved either way as you transition a business. The last thing, in my opinion, you want is to spend more time fighting over the nickels and dimes and hashing out these issues when they're not addressed ahead of time. From a financial side, how do you prevent those surprises? Because sometimes these surprises the owners don't even know about, correct?

[00:16:36.16] - Rich Veltre

Yeah, I think the big prevention factor is to bring someone in Shameless plug, like us.

[00:16:47.10] - Dan Paulson

Keep plugging.

[00:16:49.14] - Rich Veltre

I mean, I think when you use somebody that's not you, okay, when you're the business owner, you have a certain set of eyes, right? You are basically looking at the same business you've been looking at for a very, very long time. Coming from the accounting world, I can tell you a dozen times when we used to do things more on paper, you'd have a whole stack of numbers, and you could go through and add them up every single time and still come up with a wrong answer. And when you go back and you keep looking at it, you do it again. You don't find the misqued number because your mind is focused on the fact that you've done it over and over and over again. You just keep doing it the same way. Now, you hand it off to someone else, and they add up the numbers, and suddenly, they get the right answer. And it's because they haven't looked at it four times. They looked at it 100 % fresh with no predisposed notion of this is how it's going to go. So they can get the answer right. So translate that to due diligence on your company.

[00:17:58.20] - Rich Veltre

Let someone else come in and take a quick look at it. Even if it's not full on due diligence, what are they going to ask for? What do you think that an outside buyer is going to ask for? What do you think their advisors are going to ask for? Because they may not be doing the due diligence themselves. They may hire an accounting firm that does it. So you want somebody who thinks like that. And that person can sit there and say, this is what we see. This is a potential problem. Are you prepared for that? Should we pull these Should we have them out already? Real estate market. If you're selling your house, who's to say that you shouldn't have a home inspection done on your own about your own house?

[00:18:45.20] - Dan Paulson

Actually, that's becoming a lot more common where the realtors will even say, We should do a home inspection now. So we can lay out all the problems, decide what we're going to fix, and then decide what the pricing of the home is going to be from there.

[00:18:58.00] - Rich Veltre

Correct. So who's to say you shouldn't do that for your business.

[00:19:01.24] - Dan Paulson

Yeah. Yeah. Across the board, audit, I think, is a good way to look at it, where you've got somebody looking at all aspects of the business, not just the financial records, but actually getting into the details of the operational role as well. You're never going to be a... Well, I can't say never. You're rarely going to be a perfect situation where somebody's going to come in and say, I want it just as it is. It runs perfectly. Somebody's always going to want to negotiate with you because they believe they can do it better or there's something that they want to do differently, and they're going to try to negotiate that out of the price. It gets to be a lot tougher argument, though, when you have a well-run business that is operated without just your control. And I think it becomes a good argument for you, just like doing the home inspection ahead of approaching any seller. The seller can come in and say, Well, I don't like this or I don't like that. And you can show them the home inspection and you can say, Well, here's what we fixed already. Here's what we're choosing not to fix, and here's how we priced the building.

[00:20:05.09] - Dan Paulson

Now that's your choice to adjust it if you want or not. But to me, it's a better argument for the price that you're asking for. It's more justification. And some M&A companies will do some breakdown. Usually, again, it's more around the financial side, looking at the balance sheets, looking at the P&Ls, and from there, determining, well, what can we add back in? We've had Paul Curtis on a couple of times talking about this. So there's different things you can do there. But how many really look at the operational side? Or do the M&A guys go, well, how do you think the business works? Oh, I think it works great. Okay, shake their head and away they go. Yeah. So a third party could be very helpful to this. Here's my turn for Shameless self promotion or Shameless Blugs. We have our 20 questions review, which is pretty basic, but also at what I would call a basic rate. We have our full on, I would say business audit, where we go into much more detail and start digging into maybe those challenge areas or some of those issues that we know could be impactful to the sale of the company and to the overall operation of the business.

[00:21:23.12] - Dan Paulson

So to me, there's a couple of different options that we have. I don't know what other people have, but that might be something worth looking at if you're seriously considering selling, especially if it's a relatively short term that you're looking to make on this. To me, it's even more helpful, honestly, if you're looking at that three to five year window that we talk about, because now you have time to make those improvements more so than if you got six months to a year, because some changes you're just not going to make. So then, like you said, it's determination. If you want out now, you have to give up some money to do that. And it's It's just good to know where those issues are. They're probably going to get flagged. So you can be prepared for what the potential buyer is going to push back on.

[00:22:10.12] - Rich Veltre

Totally agree. And the other thing to think about, too, is we've talked about this in that there is a market effect on the buyers. And it's happening right now, especially in the small business arena, where interest rates were high. As of yesterday, they seem to be showing that they might come down, which would be a great thing, I think, for people who really want to make this transition. But as of right now, they're still high. And there's a lot of people out there who were looking at this as the next career, that they were going to be buying up smaller businesses, and that would be a new career for the rest of their work time. And market effects have basically told people it's expensive. And they've moved things away from being able to use the resources and borrow the money they need to buy your business. So if they're running into those market effects, that's decreasing the number of people out there to be buyers, which everything in the world is supply and demand, right? There's a lot of people trying to sell their business, a lot supply. But if the buyer number goes down, it's going to decrease the availability of money.

[00:23:36.23] - Rich Veltre

It's going to decrease the availability of buyers to buy your business unless you lower your price. So there's market effects in play here. There are a lot of businesses out there who want to make the transition, who are expected to make the transition. The silver tsunami, et cetera, is being attacked by market conditions. That that would allow newcomers to come in and buy the business from you. So keep that in mind and understand that if this is something that you're going to be going through or it's something you want to go through, start early. Not only the things we talked about today, but the market effects are another one that basically will say, can I get out on Monday if I'm leaving on Friday? It's unlikely. It's unlikely.

[00:24:27.26] - Dan Paulson

Yeah, we are definitely seeing that pattern. And if you just look at demographics, it should tell you right there that there are going to be fewer and fewer people to have an opportunity to purchase a business just based on population numbers. So you really do have to be ready for what's to come and be prepared now instead of waiting until the future and then miss that opportunity. So we highly recommend that. Rich, if they need to get a hold of us to do either our 20 questions or our full on and audit, what's the best way for them to do that?

[00:25:03.11] - Rich Veltre

Best way to reach me is by email, rich@xcxo.net.

[00:25:08.20] - Dan Paulson

And the best way for me is dan@xcxo.net. Rich, as always, wonderful discussion. And I think we hit on some key points here. So until next week. Have a good one.

[00:25:20.10] - Rich Veltre

All right, you too.

[00:25:22.22] - Bob

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