Spending Money to Make More Money

The power of Add Backs.

In our final roundtable for October, we bring Paul Curtiss back on to talk about add backs and how spending money on people and operations can actually INCREASE the money you get at sale.

We will discuss where many business leaders spend money that actually take equity away from the deal instead of maximizing dollars in the offer. Learn about why hiring executives and investing in new equipment and technology will help you now and later!

Be sure to Like, Share, and Subscribe!

[00:00:00.00] - Dan Paulson

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.

[00:00:42.08] - Dan Paulson

Welcome, everyone. We're back in Books in the biz. Rich, how are you doing today?

[00:00:47.19] - Rich Veltre

I am good, except wet. It's raining.

[00:00:51.05] - Dan Paulson

It's raining out in your area. It's dry out here, but it's cool. So I'm going to enjoy at least the sunny weather for a little while. Our guest today, our roundtable discussion, Paul Curtis, you are back again. Welcome back.

[00:01:06.28] - Paul Curtiss

I am. Thank you.

[00:01:08.10] - Dan Paulson

And moving dirt. You're here to chat with us more about some different opportunities that business owners have to maximize the value of their company. Because one of the things that we were talking about last time, which we really didn't get into on the podcast, we talked about it a little bit afterwards, was adbacks. And I think this would be an interesting discussion for all three of us to have on what are adbacks and how does spending money actually help you make more money and how to do that. So I don't know if you want to open it up, Paul, or if you would like Rich to open it up, but I'll let you guys fight over it. How's that?

[00:01:46.29] - Paul Curtiss

All right. I can open it up, Rich, just because my level of Adbacks is a little higher than I guarantee yours will be. And the reason we bring adbacks in is because we I specifically have had situations where adbacks have adversely affected the sale price with things that could simply have been addressed even six months prior to close. But if you do it for that whole last year prior to listing, it makes it a lot easier for everybody to add them back. And so some of those... And what the adbacks really do on my end are make it so that we can show a better value or the, we'll call it true value of the business.

[00:02:39.25] - Dan Paulson

Paul, you want to just give a brief definition of what an add back is. They might be able to figure it out from what we're talking about here. But why don't we just give them a breakdown of what is an add back and why it doesn't matter.

[00:02:51.20] - Paul Curtiss

Okay, to me, I'll explain what an add back is for us. And then Rich will probably be able to actually give a more...

[00:02:58.19] - Dan Paulson

Financial definition?

[00:03:01.24] - Paul Curtiss

Financial type definition, I think. And so we'll see. For us in the business world as a broker intermediary, an adback is a line item on your PnL that indicates something that is being used through the business, oftentimes for use by the owner that can co-mingle in the business. But a lot of times, if we can add that back, for instance, the owner's vehicle, that's my best example, the owner's vehicle, you're going to funnel that through the business. But at sale, if you're going to keep it, or better yet, if you're going to leave it in the business, either way, we can add the value at the time of close back into the business to increase that value of business. The other big one that I see is dispersion or distribution, depending on who it goes to, to help with the annual tax coverage or Yes, the annual tax situation. And for instance, I had an owner recently that was doing roughly $300,000 annually over the last four to five years as that dispersion. And I couldn't do anything with it because the government doesn't see it as a taxable situation or inside the business in any way, shape, or form as a asset or a deduction And so when we take those numbers, for instance, that $300,000, and we show it either as an income to the owner or put back into the business through any means, whether that is marketing or another employee who you could give the hat to that you are wearing as the business owner so that they can do that.

[00:05:07.07] - Paul Curtiss

Then we now can add that back into the business, which means we can take that $300,000 and put it on the bottom line. And for instance, with my client, they were at a four times multiple on their EBITDA or bottom line. So if you take $300,000, multiply it by four, you get 1. 2 added on to the bottom line that they get to take away at closing. So that's how I look at Adbacks on a really super high level. Rich, it'd be great if you could add a little bit to that and dig a little deeper. That's my really high end and a yellow definition, definition with example.

[00:05:48.14] - Rich Veltre

No, I did. Thank you very much. You did very good.

[00:05:52.08] - Dan Paulson

So I would step one step back and just reframe it a little bit so I can I'll throw my two cents in.

[00:06:01.14] - Rich Veltre

But we're talking about EBITDA, right? Earnings before interest, taxes, depreciation, and amortization. That's what EBITDA is. And the national, I'll say national, but it's the business standard that you use EBITDA as your starting point. And like you said, you multiply it by a certain multiple, depending on your industry, depending on other factors, economic factors that will allow you to figure out what your value is. So EBITDA is your starting point.

[00:06:33.26] - Paul Curtiss

Even on that, I want to throw two more acronyms that I see, and you can add any more to that, because if you take EBITDA, sometimes people don't really know what that is. Thank you for the definition. That's extremely helpful. But a lot of times I'll even get discretionary cash flow, like DCF as a term to... When the business is a little smaller, they will use that or they will use the net operating income, which is not really the same thing, but net is that. Right, exactly. It depends on the end of the table. Exactly. I've had to do the same thing going, we can go with net income generically, but we can't add any additional term. Those are just two things I'd love to throw out that people will sometimes use and ask me, when you say EBITDA, do you mean this? Yes, but more. Sorry, I just wanted to throw those in there while we're at that definition.

[00:07:34.29] - Rich Veltre

I think there's another one that seems to be where depending on whose preference you're dealing with, they'll also use SDE, which is seller's discretionary earnings. So they're all aimed at what's the bottom line of what I can expect to get if I'm the buyer? So what we're talking about here when we're leading towards how do we figure out what an ad back is, the valuation of the company is usually based on adjusted EBITDA. So EBITDA is what's ever in your financials. And then you're going to look at it and say, well, what's in the financials that are not repeatable? Because there's two ways that everybody looks at. And that's why you're looking at this becoming the negotiating point, right? The seller is looking at from a standpoint of if I have adjustments that are positive, then raise my EBITDA up. Like, if I was paying my sister to do something or my cousin is the person that's on the payroll. You mentioned the car. You have all these things that you're taking out that's not normalized. So a new buyer is not going to have to pay those. And the new buyer wants to know what's the number that I can expect is going to repeat once I'm the owner.

[00:08:58.29] - Paul Curtiss

Yeah, and the new buyer may not even include certain things that you as the owner, currently the seller, are using those things for, like the car. Maybe they don't want to have their personal vehicle. They definitely want it to be a company vehicle, and that company vehicle stays with the company, or their computer even is another one. Their cell phone is an additional one. Sometimes their travel plans, they go to a convention, right? So I just wanted to throw some more of examples there, too, in that moment.

[00:09:32.07] - Rich Veltre

So that's the negotiating point. That's why you're going through and saying, what are my adjustments? And you as the seller, it could be the first one to say, here's how I came up with my value, right? Because you may be the one who's actually pitched That company is worth a million and a half. Pay me a million and a half and we're all done. Well, how did you get to the million and a half when you only made a dollar fifty last year? And then, well, here's all my million five of adbacks, right? To get to my value, okay? And on the other side, the guy's looking at it saying, well, I'm not paying for that. I'm not paying for that. I'm not paying for this. And then so he says, well, I'm only at $750,000. And now the negotiating happens, right? Let's get to a number that everybody agrees on. But that's what the ad back is, right? It's basically the old owner had expenses on the books that I'm not repeating. And it's, adbacks are the easy one. What about the ones that are going the other way? Because the buyer is going to have ones where they're going to go, and I think Dan is going to love this one.

[00:10:43.16] - Rich Veltre

But when we talk about the owner does everything. And so if he leaves, I got to bring in three more people. And those salaries are now going the other way because I now, as the new owner, have to pay three people to do what you were doing by yourself.

[00:10:59.04] - Paul Curtiss

Yeah. And the other way, that's a great segue. I want to have you take over from that, Dan, but I want to mention one more thing that I've seen, too, is now there's a thing called debt coverage from the buyer that a lot of times the seller, if they've been in business long enough, owe nothing on their business. They do net 30 and pay cash every time they need whatever it is they need, whether that's a product or something that is going out the door or whatever. And so But yeah, that's a great segue. I wanted to get back to that and just say, because I had mentioned that if they're wearing too many hats, right? So, Dan, the real question is, how do you look at adbacks from an employee managerial standpoint?

[00:11:47.16] - Dan Paulson

Well, for me, I look at it. Employees are one, technologies, two, equipment is three. So I'll use dental as an example, because for a while I was working with a number of dentists, and you walk into some of these dental practices, and it's still 1970s wall paneling up. They're still doing things on paper. There's still a lot of stuff that they have the old X-ray machines where they actually still use film and had to develop that. They don't have the new digital stuff. You look at somebody who's trying to sell that practice, and there's an example of where because there weren't investments made, the value is much lower, where if they have modernized, they were now using software, they were doing everything digital. The practice looked modern, and it was attracting new patients in. You're benefiting two different ways. You're benefiting off of the investment, creating your own growth and your own profit for you. You're also benefiting because now, as somebody else looks at that business, in this case, maybe another dentist, they see it as something where they can just step in and work. They don't see it as, well, I'm going to have to pump in another half million or million dollars to get this business up to where I need it to be in order for it to continue And you're growing after that.

[00:13:01.13] - Paul Curtiss

Now, I'll take it- That's where a lot of times... Sorry. I like to try to keep the things in the point that they're at. So that's why sometimes I'm cutting in on you guys. But it's at that point, too, that limits my ability to negotiate. Like Rich was talking about, if when they start to look at how are operations happening now and how do I, as the buyer, new owner, need to make operations happen day one and this coming year, and it brings in the possibility of needing more debt coverage for working capital and improvements. So I just wanted to throw that in there right quick at that point.

[00:13:44.11] - Dan Paulson

Yeah, we were actually having this discussion with somebody yesterday about their business and the fact that you're going to... Sometimes you have to make investments in order to gain that maximum value. And that's what I continually am hearing when I talk with other prospects or clients is, part of this is my retirement. This is either going to help fund all of what I'm going to do after I'm no longer working or it's going to at least fund a good chunk of it because I've worked in this company for 10, 20, 30, 40, 50 years, sometimes scary enough, even more than that. They're still involved in the company. And you look at, again, app backs. Well, let's look at these as takeaway. So now, Mr. Business owner, and I was having this discussion at the beginning of the week with the electrical company, owner bragged about how much work he did or he and his partner did in the business. They handled everything. They did everything. They managed everything. I'm like, well, just so you know, and he's talking about selling his business in five years, just so you know, when you go to sell that business, that business is actually worth less because of your involvement, not more because of your involvement.

[00:15:00.05] - Dan Paulson

And I actually, I think I put it out today. If not, you'll see a video out on LinkedIn or other socials where I talk about how business owners need to get more lazy. And they're going to look at me weird because it's like, well, I built all this because of all my hard work. Yes, and you didn't structure the business so it could run without you. And that's where I see the big mistake made, because we always talk about freedom and money when we're talking to business owners, especially small to medium-sized companies, because typically, again, they're either family run businesses or closely held businesses. And you talk to almost every business owner. The reason they started the business is they were good at something. They were good in manufacturing or they were good electrician or plumber or whatever it might be. And they saw a way where they could make money on their own. They could keep a little bit more of that profit for themselves, and it would give them more freedom to do what they wanted to do. Well, that works in the first phase of a business building or business growth. And then you get to that point where now you're adding employees, you're adding trucks, you're adding other equipment, you're adding buildings.

[00:16:07.07] - Dan Paulson

Now all these other expenses come into play, and now this business is a bigger part of your ongoing income and lifestyle And mentally, there's a need to maintain that. Ego-wise, because we all have a bit of an ego, we want to see that business grow and succeed. We also realize we have another number of other people besides ourselves expecting that work to continue because your employees are now expecting that paycheck or expecting their benefits, whatever it might be. So the more involved that owner gets, the more control they have, the less that business operates by itself.

[00:16:46.25] - Paul Curtiss

Absolutely.

[00:16:47.11] - Dan Paulson

To me, the add back in this way is sometimes the takeaway of the responsibility of business owner and adding it back into the business with employees, with technology, with equipment.

[00:16:59.08] - Paul Curtiss

Well, and that goes to the normalization that was mentioned earlier by Rich, that person's... So again, let's just use that $300,000 number that I have a client that was wearing multiple hats and pulling out the different funds. One of the things that we had to do was normalize. And what that means is taking what they have and what is normal in the industry for that service, that function, that role, that employee title, right? So a lot of times we will notice that business owners don't have their income at the typical standard or their salary at the typical standard. They're either at 25 to 40 % under or they've bolstered it to be higher because they're wearing multiple hats. And so they can pay themselves a year because they're doing two people's jobs at $100,000 a year. Yes, great. Go hire that person for $100,000. And if you can hire them for $80, great. Then you're going to get a little bit more profit. But if you hire that person for $100,000 and you're not doing that, it makes it easier for me to negotiate to have you have a better value, especially if we're looking at real estate and all of the mechanicals, whether that's a car or the computers or anything along that line, because Because those things, if those are behind and you're wearing multiple hats, oh, man, it makes it very hard for me to negotiate the value up in any way, shape or form, because those are things, as Rich mentioned before, that they're going to have to take on as a new owner to make it so that they can run the business the way you ran it, but without losing their mind in the first month.

[00:18:56.06] - Paul Curtiss

And so that's what I see.

[00:18:58.29] - Dan Paulson

Yeah. Yeah, I agree with you on all that. It's really figuring out how, again, you get the most value out of that business. And we've talked about this before. Businesses that are going to sell are going to sell in two categories. One category is going to be, they're going to sell for parts, basically, because there isn't enough structure. There aren't any systems in place. The owner might think there are, but they're not documented. And it's not autonomous without that owner being there. That's going to sell at pennies on the dollar compared to a business that somebody else can just step into. And it's like nothing ever happened. It runs just fine, whether they're in there or not. And I know you've even mentioned this, Paul, where business owners, you'll start asking them questions. Well, could you leave your business for a day and how it run? How about a week? How about a month? What if you took off an entire quarter? And of course, the longer the term gets, the wider the face gets, because they realized that they couldn't leave it that long, or they wouldn't trust it being left that long and expect it to work properly.

[00:20:03.18] - Dan Paulson

Rich, how about you? What are some of the other things you see we're making those investments? So it's almost the reverse add back can really influence where that value is. I think you were sharing an example before we went live here, too.

[00:20:19.17] - Rich Veltre

The thing I would add, because I think in your list, you talked about the people changes. We talked about the technology changes. But I think the other thing you What you have to consider is what business are you? Is it a service business? Is it making something? Do you have inventory? There are other parts here that can go into that. And on top of that, the thing you want to understand, especially if you're the seller, right? Because really, I think in what I'm saying here, I'm talking more to the sellers anyway. The buyers know this. They know what they're looking for. They have ideas of what they're looking for. And the thing that the buyer... I'm sorry, the thing that the seller doesn't know is what the buyer is thinking. What else are they looking at? What's not in your financials that could be an issue? And I have one in my mind, which is warranty expense. If you have to That's the point. If you give somebody a warranty and it's not in your books because you just have an accountant who's just doing your tax returns or whatever and just taking your books and filing your taxes, you're not recording the fact that you potentially could have to pay somebody back on a warranty issue.

[00:21:31.24] - Rich Veltre

The other one that I remember from being in a bigger firm, there used to always be environmental issues. If you had a plant and you were doing things that was, you were actually manufacturing and using chemicals, et cetera, did you have a chemical or an environmental liability? And a buyer is going to start thinking about what business are you in? And the seller doesn't necessarily think about that. So the seller should because they're going to get surprised if the buyer comes in and says, oh, by the way, we calculated what we think the environmental or warranty liability would be, what we might have to pay after you're not an owner anymore. And these are the types of things that are outside the box. They're outside of your financials. And that's why when you're thinking about preparing to sell, start thinking about the things that you may not know, or talk to some people ourselves who could basically say to you, did you think about this? I mean, that's a pretty easy sentence for me to ask or a question to ask, that did you think about this? Can lead you to, all right, I'm prepared now, because I know they may come in with that.

[00:22:44.22] - Paul Curtiss

And that also leads to the example of valuation, like having a certified valuation done versus having, oh, I had my accountant tell me the value is in my business. I'm like, okay, did they look at just your members? Did they ask you questions like you're talking about, Rich? Because not every accountant asks those questions. And that's not a bad thing. They're probably extremely good at what they do. And sometimes people don't realize that there is different lanes that accountants run in and have specialties even inside the accounting world, just like attorneys have specialties, just like physicians have specialties. There's lanes like, yeah, you're a doctor, but I guarantee that I'm I'm not going to want to go to my general practitioner to do my heart surgery, and I'm not going to want to go to my heart surgeon if my knee hurts. Yeah, no, I'm going to go to somebody different, right? And so it's the same situation that you start to run into on the business side of things that they just don't think about, we need the employees in place that are doing what you're doing as a business owner too much in a week.

[00:24:00.26] - Paul Curtiss

If you're working 70 to 80 hours a week, that does not look good for me. That does not help me replace you. And it's awesome. Be proud of that. I think it's awesome that you're able to operate the business on your own. That means you're taking more income for yourself. But now let's make that apple shinier. Let's make that apple bigger on the vine, on the tree so that you can get when you pick it, they want to pick your apple versus the other If you've ever been to an actual apple orchid, you're looking at the tree going, well, that one's too small. I don't want that one. Oh, that one looks better. Oh, it's not the right color. Oh, that one. That's the apple I want, right? And we want them to look at you in the market when there's other companies for sale just like you in the area, maybe even in your same city or state, that they could go, oh, well, this guy, all he does is he works less than 30 hours a week. And he has people that just report to him. And man, even in his example, he talks about what he wants to do when he retires.

[00:25:05.17] - Paul Curtiss

He wants to go to his second and third home in these different places because he already spends time there. Okay, I like what that guy's doing I can take that over and barely do anything. So you got to have those questions be asked by the people who want to ask those questions. So if your accountant isn't asking you those questions, or your broker isn't asking those questions, or your financial planner isn't asking you, what are you going to do with this windfall when it comes? Do you need that money right away? Or is there a way we can take some of that windfall, massive amount of money that you don't get annually and you're getting it as a one time? Can we put it in some buckets that get taxed later so that you don't get taxed on it now because that tax is going to be smaller, because the number is going to be smaller, right? Those things. Yeah, there's just so many things that need to be asked by a number of people. Sorry, I went off on a tangent on that one.

[00:26:07.25] - Dan Paulson

Yeah. Well, let's pull it back in a little bit. We're running low on time here. So maybe something that we should each do is, What are the things that you would recommend a business owner look at before they even start thinking about selling? So Rich, what would you tell them, regardless of industry, because as you point out, different industries can have different needs, but what are the main buckets you would tell them to start looking at to figure out how they can use that as an add back or how they should start investing, spending that money in that particular category to maximize that business value?

[00:26:46.19] - Rich Veltre

I think the starting point should always be the financials. It should always be a report that you pull out of your system that says, here's what my EBITDA is. Okay? Don't worry as much about net operating income. Don't worry so much about net income, because the items to get from EBITDA to net income are not necessarily transferable to a buyer. So I would start with your EBITDA, figure that number out, track that, and then from there, take a look at the buckets that you mentioned. The people, the technology, do those first, and then get into your industry once, because they're probably, yes or no, could be the arguing point. But if you know of them, write them down. If you don't know them, that would be the point where I would say talk to a professional and just ask about, what do you think based on my industry? What else should I be thinking about here?

[00:27:44.13] - Dan Paulson

Got it. Good. Paul, how about you?

[00:27:46.04] - Paul Curtiss

Yeah, so mine would be, what am I doing each day as a business owner that is a personal activity that I am funneling through business? Or what am I doing each day that I am personally using that I am going to want to use outside of the business when I am retired that I am putting through the business? And then the other one is, how many hours each day do I do activities that are not working on the business as its growth or decision making, helping others make decisions that they could make when I'm not there, versus working in the business and doing the work that those people are trying to decide whether or not it should be worked on. Because if you're those things will indicate if you need to replace somebody When you tell people, oh, I wear so many hats in my business, what are those hats? That is the other thing you need to figure out and figure out how soon can I find somebody that I can give that hat to so I don't have to wear it anymore. Stop putting it on the hook and then taking it off the hook and putting it on your head.

[00:29:05.25] - Paul Curtiss

Put it on somebody else's head. But that comes to you. I probably answered one of your things. Sorry.

[00:29:13.08] - Dan Paulson

No, that's great advice because Yeah, they tend to... Sometimes they put that hat on somebody else's head. They don't like how it looks, and then they put it back on their own. In that time, they've also added two or three hats that they're wearing at the same time. So now you see this stack of the trucker's hats going up their head, and that It doesn't help out either. Guys, this has been a great discussion. But before you end, what was your thought?

[00:29:35.11] - Paul Curtiss

You didn't really give...

[00:29:37.10] - Dan Paulson

Oh, what was my thoughts? Well, you guys actually, in a lot of ways, answered it. So for me, the things I look at, again, how much is that owner doing versus other people doing. So back to your situation with the hats. If they say they wear many hats, that's a red flag for me. So I need them wearing one hat, and that's the hat of the business owner, focusing on business growth. Everything else is probably operationally related and should be done by somebody else. But it's not because they haven't built accountability, they don't have systems in place, they haven't taught their people, so there's no coaching or mentoring there. And that's why everything rolls back up to them. The other parts of it What things can you systematize so they don't have to worry about hiring somebody else again? So is there a new technology, new software? Is there new equipment that can be used that can minimize the amount of help you have to hire? Those things can be rather big capital expenditures, but at the same point with that stuff in place, that can really save you a lot of time, a lot of money.

[00:30:37.24] - Dan Paulson

And that new owner has got to look at that the business is set up for future growth, and I'm not going to have to make that investment on top of buying the company itself. So I guess those are the things I see from an operations side that I tend to look at is how do you, how do you, again, get that owner out of day to day operations so that way, when the company does go to sell, the company could stand on its own without that owner being constantly involved. And I think that's critical. Guys, been a good conversation. Paul, thanks for joining us again. And anyone listening, if you got other ideas on things for us to talk about, please let us know. But in the meantime, guys, we're going to take it away and thank you all again.

[00:31:19.13] - Paul Curtiss

All right. Thanks much. Have a good one. See you guys later.

[00:31:22.22] - Bob

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