EP18 - Interview with ESOP business valuation expert - Will Rodriguez - Tampa, FL

Welcome back. Thanks for tuning in. I'm the ESOP guy and let's continue on this journey to an ESOP. Now, if you're just tuning in, this podcast is for those people that are thinking they might want to transition their business to an ESOP, and that might be for a growth strategy, a succession strategy, or maybe even an exit plan for the owner. If you are interested in the podcast, there are other episodes available. So if you go to journey to an ESOP.com, you can find all of the available podcasts, but today, I am excited to have the privilege of interviewing Tampa-based business valuation expert, Will Rodriguez with Vision Point Capital Inc. Will has been practicing for over 20 years. Early on in his career where he worked for national and regional CPA firms, he did a lot of work with valuations and consulting engagements for business owners and really started working, you know, his experience level. And with 14 years of experience on ESOPs, he started his own practice. Um, which is a company called Vision Point Capital in 2015. This, uh, firm basically covers the nation with um, ESOP clients. They perform annual valuations as well as ongoing ESOP transaction work. Well, thanks for joining us today. Phil, thanks for having me on and definitely appreciate the introduction and in the invite to discuss, you know, something that's very near and dear to my heart as we worked with many clients over the years and definitely enjoyed the the opportunity in exploring an ESOP transition that's part of their overall exit strategy. And that's, and that's one really nice thing with uh Will and I, we both agree we're, we're both passionate about ESOPs and what they do, not only for the business owner and the transition process of selling their business, but also for the employees themselves. So we also do both do evaluation works. So we're both valuators and on kind of different sides of the transaction. And so I wanted to start with really where, where you're working towards supporting the, the trustee. What is your process will in going through that process or that part of what you, the role you play? Sure, so yes, if I'm performing the evaluation for the ESOP transaction, then as you mentioned, the trustee, that that is my client. So even if I'm referred by another CPA such as yourself or you know other advisors, truly any and all work that I'm doing as part of the process is for the trustee. I'm acting as the independent financial advisor and, you know, essentially my evaluation will be used to support to help the trustee support negotiation during the transaction. The majority of the rest of the evaluation process is similar for ESOP versus non-ESOP transaction. So again, we would, you know, do all the basic things such as information gathering, do our preliminary financial analysis, then, you know, usually we'll be able to prepare for our site visit management interview. that we will conduct on site, you know, as appropriate and available, we'll be looking for, you know, benchmarking industry research guidelines, whether that's public companies that we can benchmark or, you know, private transactions of companies that sold recently in the company's industry. Um, and again, we're going to finalize our financial analysis, um, you know, using any and all appropriate methods. And then, you know, at the end, we're going to prepare a draft valuation, a report and send to the trustee. So and then the trustee and his or her team will have a chance to review, you know, the draft valuation report. And from that point, you know, they'll be able to ask questions, you know, request more information, you know, be able to truly understand because my job is to You know, educate the trustee on, you know, my findings and, you know, the conclusions and where they're in a position that they, you know, agree or maybe they feel one method is more appropriate, the more comfortable one method. So again, it, you know, the trustee does have a range of value that when considering, you know, in the offer negotiation. Um, and then of course when we get to the, you know, making any of those necessary changes from the trustee feedback, we'll prepare the final evaluation report and then of course, we continue to assist throughout the rest of the transaction process. And if needed, depending on the size, depending if it's the controlling interest or not, we may or may not be asked to prepare a fairness opinion for the transaction. Very interesting. Yeah. I think too that the, this thing to stress is the role the trustee plays on the buy side is a critical role. And, you know, he or she is really relying on the evaluation firm to provide a good overview, but they're the ones that make the decision at the end of the day in terms of what that Uh, purchase price is going to be. So the role, the role you play there is very important. And, and I would also add to what you said too, because it, it, it's so important from a fiduciary standpoint to have the independence of a transaction. And so, you know, if I look at the different roles that we play is my role is to really educate the client before they get into the, the, uh, the actual transaction. And so that they're really unders understanding what first off valuation is. And then understanding that as a, as a seller of their stock, they have to feel comfortable with what they're, what they're selling it for. Um, but that supports this, this place of independence that Department of Labor really stresses for a transaction. Yeah, and 11 other point to note is typically, you know, you get a hang up is again my valuation goes to the trustee and it doesn't get shared with the other side. So again, the company that's paying for it doesn't really get to see it. So that's, you know, sometimes that's an education process, but just to kind of keep that line in the sand that again, I'm working for the trustee, it's an arm's length negotiation between the trustee and the selling shareholders. So again, you would be on the seller shareholder side and I would be on the buyer side, which is the e of the trustee. That's a great point. Well, and, and I don't want to labor it too, but, but I, I've had clients say, you know, well, do we ever get to see it and, and they never do get to see the evaluation, um, at least the initial one that you do and. So, so moving on, um, and I, I have to talk about this only because it's, you know, so pertinent to what's happening in the economy, um, and what we're seeing in the marketplace with COVID-19, and I really have two twofold question. First, you know, companies that were in the process of converting their business to an ESOP. So nobody expected COVID to be like it is in certainly in February of this year. Um, things changed quickly. And the second part of the question is, with existing ESOP companies working through the crisis and how, how are both of those, uh, dealing with this, uh, you know, not just the economic downturn, but I think in general, what, what are you seeing in, in your clients and transactions? Yeah, definitely this COVID-19 um pandemic has really hit the, the pause button, I would say on most current deals. And not that it killed them completely, but again on the few deals I had kind of in the pipeline, you know, it's kind of, well, let's wait and see to the mid half of the year and see if things pick up because again the the biggest item obviously affected is the valuation. So again, to remember that valuation is always forward looking. So if we're, we're looking in December at December 31st, 2020 to be You know, guns, guns are blazing, go ahead, a lot of growth potential and so valuations were, were, you know, reached an all-time high, um, whereas now, you know, come. Come mid March, you know, later, even a little bit earlier, right, the world has changed. So again, the outlook has changed and of course we see that in the equity markets, but that risk has been priced in that change in the status quo. So again, that would obviously lead to change in, you know, the ESO valuations that we are doing um because again they're all tied up back to the fundamental investments and cash flow that we're projecting. But, you know, hopefully, again, hopefully we'll, this will be a short-term recovery, um, but I, I think it really depends on the The company industry, some will be faster turnaround than others, and again, whether or not it it may take a little longer for them to get back to, you know, the valuation levels that they were prior to this, this pandemic. Now for companies that already uses, right, they're having to navigate um the the challenges and really look into their crystal ball a little more, uh, so again, a lot of them have layoffs or at least reduced hours to employees. And you know, fortunately, we've had some stimulus on recent rounds of stimulus that's really provided some much needed working capital, but still, how long, how long will this, you know, kind of short term or will it be kind of the new norm be in place to, to determine whether, you know, to bring all their employees back or, you know, again, if their their suppliers go out of business or, you know, the customers go out of business, the significant impact that can have on, you know, on the evaluation of the company. And as you think about kind of what, what triggers right valuation, you know, and the employee statements, you know, at that point in time, so if we're doing a December 31st valuation, now, you know, we, we have to lay off one third of the workforce. Now we've just kind of accelerated that repurchase obligation that's kind of, you know, comes with, with the ESOP you have to kind of be prepared for. So again, it's just You know, a lot of factors, a lot of moving parts to consider, and again, just trying to be on the phone, be, you know, uh, in touch with, with the clients, and navigate this, this, um, time period with them. Yeah, I think that's, that's great advice because it's, it's definitely something that a lot of, I mean, I've been around for 30 years and then nobody's seen anything like this. We've seen economic recessions, but it's to see this much shutdown that quickly. My, my thing I would add to what you said is really to looking at the industry-specific um effects. So some industries have been really affected more than other industries. And what, what I'd also say is that, you know, looking at, like you said, the forward-looking concept of evaluation, which comes back to your forecast. That, you know, it's really difficult, you know, in a, in a normal market to, to have a forecast where like, all right, that's, you know, we feel really super good about it. But now when we're, you know, well, when you're faced with forecast, a new forecast that you just got, how do you get comfortable with that in the process of supporting a trustee and, and it may say transaction that's still going on? Yeah, definitely, whose crystal ball is better, right? The, you know, the essence is truly comes back to do we have an established history, a pattern that we can track that would be, you know, kind of key, for example, you know, some companies just don't prepare forecasts, they just don't have. Have the depth of management, have the insight into their business, and that's, you know, usually problematic versus, you know, some companies, they give me pretty strong detailed projections every year and, you know, again we check every year. So how do we compare it to what you project to last year? Well, we're pretty close or maybe they were conservative and we, you know, we exceed expectations. So depending on the client, you know, I'll, I'll say trust more but rely more on the projections, um, depending on the client and their, their track record of, of meeting those projections. And of course, as best we can, you know, to, to look to the industry, to look to, you know, everything that the best information we have available to really see, you know, get comfortable with, you know, how long, you know, what um what's the overall impact this will have, you know, not only short term but long term, so. Great. Yeah, I think that's, that's gonna be a, a, a point we're gonna come back to as well. But in looking at the business evaluations that you do, you have, you, can you address the significance of the different dates? So the evaluation date versus the report date versus the transaction date and also really the concept of known or knowable standards within the business valuation. Yeah, so this is Um, gotten more, uh more headline headlines these days than it ever has before. So we'll just, we'll just keep it, you know, simple and simple example for now. So of course, the evaluation date is the date of the evaluation that the underlying assets, i.e. the ESOP stock is being valued, and as an appraiser, I can, I can account for everything as of that time that is known or knowable, and we'll get a little more into that here in a little bit. Of course, the report date is just like it sounds the date that the report is completed and submitted to the client, the trustee, or whoever, and then the transaction date again is just like it sounds, is the date of the actual transaction. So in a simple example, let's say we know shareholders of ABC Company wanted to do a 30% sell a stock to its newly formed ESOP. As the appraiser, I got the 2019 financials by February 15th. We worked very aggressively to finish our valuation by March 31st that we presented the trustee. The trustee then uses that valuation to negotiate with the shareholders, and agreement is reached by April 30, 2020. And then, you know, attorneys have to do their thing. They get involved and get all the documents ready for a closing set for May 31st. So now we, now we have this 5 month lag between the valuation date, which is December 31st, and the transaction date May 31st. And in a typical situation, the trustee, you know, would generally requires maybe not a full valuation update, but a dropdown letter to satisfy, you know, to make sure the value is still within the, you know, IRS or Department of Labors who required adequate consideration guidelines. So as an appraiser, I would, you know, get additional information from the companies such as Interim Financials. I'll be looking at, you know, kind of year to date. Are they on track with the projections that we used in the original report? I'll have additional management interviews to make sure there's no significant changes to the company or industry between the two time periods, and then generally you would issue the the dropdown letter, assuming the same valuation as As you had December 31st valuation. So in the past 20 years, this would have been the the typical process is there for, you know, I come up with three points in time, which would be the dot-com bubble in 2001, the Great Recession of 2008, and then of course, most recently this COVID-19 pandemic. So this is where, you know, the known or knowable standard comes into play as of December 31st, this pandemic. Um, wasn't, you know, technically known or knowable, you know, to the US economy. It didn't really happen until, you know, like I said say late February, early March. So, again, if I finish my my evaluation report by March 31st. You know, and come May 31st, right, there's no way we could look at the marketplace and say nothing has significantly changed when the world has changed. I mean, things are just went on shutdown unprecedented. So this is where you would, you would have to most likely do an interim evaluation, say in May 31st. 2020 evaluation um to be able to include the impact that the COVID-19 pandemic has and, you know, the trustee be able to negotiate at a true fair market value or adequate consideration that's required. Yeah, so that's, so you kind of walk that you walk through that really, I think very clearly and it. And it does present some issues and I, and I think for, from my experience too, whether we have these great economic changes or not, there's still always this lag that's created between the date of when you do your evaluation date at 12:31-19. Um, and just so, so one thing that I do with clients on our cell side is we build at the very front end, we're building a evaluation model that educates the client on the particulars. and so assuming the, you know, something changed with the forecast and we are producing different interim results. We're automatically updating that with the client, so they can see the effect on that. And I think the, the better the client understands the, the, the, I guess the elements or how valuation put together, the better they can understand what you're coming back with, even though they can't see what you have, they're really seeing it really through the negotiations from the trustee. Um, but I find that really helps because it's confusing and I, and I think too in our industry, Um, the valuation sometimes is handled on the front end differently, and I sometimes it's, hey, your, your multiple is say 3 times or 4 times, and they kind of know what that means, but they really don't know why. And I think really having a model to support the, the conversations that you have with the trustee and then well, really the negotiations helps to update these changes that are that can happen even in a, even in a normal marketplace where some dip down. Yeah, and it could go the other way too again, maybe there was a significant contract that was won between the the date of the valuation and, you know, current, so you know if they've just been awarded a $10 million contract that again that evaluation most likely go up if we, if you did an interim evaluation, so that'd be something, you know, on a positive trend why you would want to do an interim evaluation, but again it's, it definitely is, it's facts and circumstances and again given the company's. Um, you know, where they're at, and again, like I said, I know the, the triple B loan, the stimulus has really given some clients, you know, that needed working capital to be able to say, OK, at least we can, we can breathe for now. We got a couple of months and then hopefully things will turn around and we'll be able to come out the other side with as minimal impact as as possible. So, so we kind of talked a little bit about the interim evaluations and again, this is, this podcast is probably more for people that aren't yet in an ESOP, but at the same time, you're, you're kind of saying that you would do those interim evaluations to support the lag period with an economic downturn. So, so somebody could get a evaluation and you're gonna have to do another one maybe prior to a transaction date. Is that kind of what you're saying? Depending if things have significantly changed, you know, the assumptions used in the original evaluation and you don't want to do that fees, there's fees involved to update any evaluation at a point in time. Everything has to be updated as of that point in time. So, um, as much as possible we try to avoid that, but when it's necessary, we have to do it. So, on the interim evaluation side, can you just kind of walk through what you feel like the key issues are with that specifically? Yeah, so for example, if we're, you know, looking at in evaluations, you know, right now, again, as I mentioned before, kind of what's, what's the crystal ball, um, and I wouldn't even say we would. You know, we wouldn't just say, here's what it's going to be. Like who really can know that. What I'd say it's probably best is we would perform some type of scenario analysis where we're going to say, OK, if things rebound in 6 months, here's what you know, business will most likely look at versus if it takes, you know, 1 year, here's another scenario and And if it takes 2 years, here's here's, you know, that scenario, what evaluation impact that would have. So yeah, trying to again, really say we, we get these projections right all the time. But again, it's it's what's best reasonably known and, you know, again, portable as of that that evaluation date. Great. Yeah, I think that's good. So we're, um, I'm, I'm gonna kind of wrap up with one last question and, and one of the things I want, I was thinking of, cause we, we wanna talk about deal structure a little bit more specifically with like warrants and SARS, but let's say that for another time. Um, but just kind of in general, I think if, you know, again, we're not in a, forget the, the, the, the issue that we have with COVID, just thinking about a normal market. What are some pitfalls that you see, um, or problem areas that you see going into a deal that would make someone hesitate or think, uh, think twice about an ESOP? For sure, well, and this doesn't necessarily just apply to ESOPs, but you know, really, you know, small companies, you'll hear, you know, small companies are small values, and typically that's for a reason. A lot of times smaller companies, the quality of financial information is lacking. Um again, not just, oh well, my CPA prepares my tax returns versus do you at least get compiled financials versus a stepped up, you know, reviewed financials versus audited financials. So when When as an appraiser when I see audited financials or you know even reviewed or satisfactory still. You know, it gives me a lot more comfort in relying on those numbers versus again just somebody's tax returns that may or may not, you know, truly reflect the operations of the business because generally a tax return is there to, you know, minimize the payment of taxes. So is it truly reflective? And then when you get into, you know, all the ad backs, the adjustments with owners, you know, perks, and if there's significant amounts of those running through, then, you know, it's really, you know, gives you gives you caution to As you're working through the numbers, lack of management debt, again, this could be a function again, if you're small, you really can't hire that C-suite of executives that you, you know, really want. But, you know, for those companies that have a strong organization chart, you know, where the, the CEO, you know, where the own primary owners, the CEO, CFO, and the admin. You know, those are, those are problematic. And um again, maybe they just haven't invested, but you know, during the years to save on save some cash, but, you know, it may end up costing them on the back end because, again, a good executive will, you know, be worth their weight in gold, and it'll help with the transition and the value of the business on the back end they're going to bring skill sets that Um, the, the owner and, you know, kind of the entrepreneur may be good in one area, but again, they can't be great in all the areas. So, you know, that's what where I see, you know, a lot of uh You know, with smaller businesses and not just EOs or, you know, specifically, um, so again, that those are all the risks when it comes to, you know, valuation that we account for and account for the upside, we account for the the growth, the cash flow expectation, product services, all of that, but we also have to look at balance that with the risk of the business and you know, that's where we do the deep dive and um in our analysis. Yeah, and I think um all of those are gonna be important and, and, you know, really for, for those that are listening is really get into those much deeper at the front end before you even get to the trustee stage. And I think that's a really essential part and, you know, we'll mention several things. I've seen issues as well with. Um, customer concentration and, and where there's risks that you as a buy as an owner of a business, don't really look at, because you're, you're so used to making money at it. But when you start looking at it from a buyer's perspective, um, they're not thinking the same things you're thinking only because they haven't lived the life that you've lived and they're not there really for the same, um. You know, the same initial goal. Their, their goal is to protect the uh the ESOP, protect the employees, um, make sure that they bought it at a fair market value. And so there really are two things and I, and I think educating a business owner is, you know, really important at the front end to understand. You might not see this as a business risk, but it is to, uh, to the trustee and to the evaluator that's going to come into it. Agree, definitely agree. Yeah, customer concentration is probably number one we see with smaller businesses, they just, um, not that you don't want that, that customer, you just want to build around it or minimize the risk as much as you can through some contractual relationships, uh, agreements or, or, or the like. Yeah, and I think that really does, like when you identify that with a client early on in the process that I go through, you're able to build this like almost a strategic plan, a business plan around mitigating risk, you know, at the front end. And I think when you've done that, and then you create a forecast, and then you kind of pull it all together and say, you know, this is our business plan. We identified some weak areas, we're addressing them here. We've actually addressed the cost of the business plan in the forecast. I think that flow works well because the forecast tells the story of the business plan. And um and it might not always be to mitigate risk. I mean, sometimes I um obviously a business owner wants, a business wants to capitalize on an opportunity, but certainly there's areas there that you can work into your plan and make sure you're, you know, you're, as a business owner, um, educating your advisors and, you know, how that should flow, and I think that's the value of this, of this episode of podcast is really understand how like Will's looking at it and where, what is going, what he's gonna be presented with before you even get there. I think that's really important. Yeah, so if you definitely, you know, business owners listening, if you, if you have a couple of years before you say I would implement, just go ahead and start, start with a strategic plan or preparing projections for the next year. Maybe it's something you've never done, but it'll be a good, good exercise, plus, you know, come come next year we get to the end and see how you did and, you know, come down the road when the ESO trustee and the evaluation is looking at your projections. And you know we can have a track record, as I mentioned before. Hey, I've hit my projections throughout the last 4 years, you know, here they were, and here's the same underlying assumptions that go into these projections and why they're not overzealous or out of out of bounds kind of in looking at the evaluation today. I think that's awesome advice. Well, we are out of time, unfortunately, and there's other things to talk about, but I really want to say thank you, Will, for your time today and your insight from an evaluation perspective and of course, your experience with ESOP valuations. Thanks so much for having me. I really enjoyed it. Look forward to uh Great. So if you're interested, check out uh Will's company at visionpoint Capital.com. And as we close out, I just want to remind you, um, if you like what you hear, please subscribe to the podcast, share it with a friend, it's a resource for, for anybody that's thinking about going through an ESOP, and have a great day. We look forward to our next episode. Thank you.