John Bly - Cracking the Code to M&A Growth

Welcome to the Exit Coach Radio show, the show for baby boomer business owners who are looking for cutting edge information as they plan their 3 to 10 year business succession and exit. Every week we interview top professional advisors for their best tips, strategies, and precautions so you can be well planned and don't miss our 1 minute exit. Coach tip of the day on exit coachradio.com. And now here's your host, the exit coach Bill Black. Thanks so much for joining us. Welcome to the show. I'm very excited to announce our next guest because, you know, someday you're gonna sell your business or you're gonna transfer, you're gonna transition it, you're gonna need to turn it into cash in some way, shape, or form. And my next guest is John Bly, who's joining us from LBA Haynes Strand PLLC in Matthews, North Carolina, and we're going to talk about cracking the code to mergers and acquisition growth. So John, welcome to the show and thanks so much for joining us today. Bill, thanks, Bill. I appreciate it. Good to, uh, good to be on the call and uh look forward to sharing here. Great. Well, you know, John, tell us a little bit about before we get started, tell us a little bit about LBA Hays Strand PLLC and uh and, and a little bit about your background. Give us a little background. Sure. We are uh about a 70 person CPA firm, regional firm here in North Carolina offices just out of Charlotte, uh, also in Greensboro and just north of Winston Salem. We focus on the entrepreneurial space, uh, small businesses, 1 to $30 million dollar entrepreneurs. And my background is really around the passion for growing entrepreneurs, businesses, not just in the tax advice, but also in the strategy and the operations. A lot of small businesses can't afford to have a board of directors can't afford to have all the C-suite type executives on their team, and so a lot of times they rely on outside sources like CPA firms or their attorneys or consultants, and so we try to be part of that. Great, so it it is a team effort to grow a business. Do you find that other members of business owners um team um like to work together? is there a struggle there between advisers say attorneys and financial advisors and CPAs, or do you, uh, do you find that they work well together as a team? That's sort of a, that's sort of a loaded question. The, uh, you know, it depends on the individuals, I guess, starting with, but, but I find that if you're proactive and you're trying to do the best from the client and you're having a discussion, so for instance, I met with a banker today and discussed a client, and we'd rather have those discussions and then make sure we're on the same page before we talk with the client because maybe we disagree on a specific subject or we disagree on the strategy on how to get there and so it's better to have that and then go with a unified, you know, decision to the client as to as to which way to go. If you, you know, put us all in a room and we all have to, we all have to share our opinions, you know, sometimes we might disagree, which is OK, uh, from disagreement many times and conflict comes some of the best, uh, ultimate outcomes and decisions. So, you know, I think they can get along as long as consultants sometimes have to put their egos aside and say what's best for the client. And sometimes they feel like they know what's best, but if they have to, if they have to be good listeners, they have to be able to listen to the other advisors and say, you know, I hadn't thought of that or I didn't know that about this type of business or I didn't know that you as a banker were going to look for that specific, uh, number or ratio and so as long as you're working together you end up coming out with the best result for the client. Thank you for that input you know, I, I know that in my experience a lot of times the advisers are kind of at odds with each other and, and if they can get in the same room and really uh focus on the client, a lot of great planning can be done. And I think that's so vitally important. Let's talk about small businesses and how they are valued. You know, there's, there's several ways that businesses can be valued, but how do you find that most small businesses um are valued these days? Sure, what's funny is that the term in the newspapers and, you know, on CNN and everywhere else is about uh earnings before interest, taxes, depreciation and amortization. But in the small business world that's just not that relevant. What's much more relevant is the term cash flow. And the difference being even does for larger companies, I would say roughly 2 million plus of earnings of profit to further define that. Cash flow, however, is used for smaller businesses because there are lots of things that a small business owner does inside their company that won't necessarily be done by the next owner. For instance, maybe they pay their life insurance policies through the company. Well, I doubt that the buyer of that next company is going to put life insurance, uh, for the seller on their books. I mean they're not going to do that. I mean lots of things like that, whether that's a vehicle inside the company name, whether that's their large 401k. Deduction that they're using, whether that's the, you know, having some of their kids on payroll because their kids are working summers there all of those sorts of things define cash flow so it's not just the profit you can't just look at net income as the starting point for a small business you have to take net income and then say what are all the things that are gonna go away the day this person no longer owns the company and they sell it to somebody else and that really gives you the the definition for cash flow. It's a great point, and the flip side of that is most owners forget that the company was paying for their cell phone, their car, their entertainment expenses, their, their, maybe their baseball or football, you know, a lot of expenses that that we ask business owners, well, what are you going to need to live on? and they give you their, their take home number and you go, wait a minute, what about all these things that are going to come back to you as a personal expense? Do you find that that happens a lot? Absolutely, you know, and, and it definitely is very relevant. uh, we had a, a client sell the other day and it's the exact scenario where we, we were showing all of the types of things they were putting through the company, you know, that were legitimate business expenses. They were, uh, a single person who, who, uh, is not married and doesn't have any kids, but they, they play a lot of client golf. They're in the entertainment business, they're out all the time. They have Panthers season tickets. They go to Bobcats games. I mean, all of those sorts of things now. are no longer, you know, deductible. I mean they're, they're all against their salary personally and so it's a big difference. You're exactly right. Well, and the good news about that is if they're selling their business to an outside buyer, great, we'll recast financials and put those expenses back in as profits and then hopefully get a multiple on that on the flip side, you know, either you're going to stop doing that stuff personally and, and. You know, realize the gain from the sale of the business or or it's going to be tough on your, on you personally to adjust your lifestyle. What, what, what kind of discussions do you have with business owners when you're talking about those types of issues? Yeah, one of the things we try to point out, especially if somebody's 2-3 years away from selling or even in the, or even in the time frame, you know, if they're 6 months away from selling is we try to say think about all the things you're doing inside the company that aren't going to go away and let's try and document them now before you go to actually sell the company because the the more buttoned down those things are, the more easy they are to present to a potential buyer in the future. It makes it so much easier. It's like, OK, here's profit. It was $100,000 last year, but here's $10,000 we spent on Panthers tickets, and here's the $5000 life insurance policy, and here's the support and you know, you can create a little basic Excel type document that shows the tie out of profit down to cash flow and the fact that you've done that proactively ahead of time and you've put it together and you've documented it for them makes their life so much easier as a buyer. It just makes the transaction smoother. It makes it a Less questions. I mean, many times that you've probably seen this many times over your career. What happens is deal fatigue. I mean people ask more and more questions and they keep digging and they keep digging and they find something else and the more transparent you can be up front and the more documented it all is, it just makes the transaction a lot easier. And, and that includes normalizing owner compensation too, right? for I mean exchanging what an owner might be paying themselves for maybe some a manager position they might find on salary.com or some other type of a website that shows what what normal salaries might be. Absolutely whether that salary is too high or too low, it's absolutely correct. You definitely want to normalize that and say what is the if you had to replace yourself, that's the way we define it, you know, exactly what you're describing going on salary.com. If you had to replace yourself in a company that's doing X in revenue, whether that's 2 million or 1 million or 4 million, you know, what does that mean if you're going to have to replace yourself on a day to day basis and what are you going to have to pay that person? So cleaning all this stuff up early makes sense from a number of situations. It, it shows that you run an above board business and it also shows that there's more profits in the company. The downside is you might have to pay some more taxes along the way if you show more profits, and a lot of business owners hate that idea, right? It's true, it's true that you say that. I, I do some speaking, and one of the things I say all the time is that some small businesses, I know, uh, don't always report all their income. Sometimes they shortchange the cash drawer or something like that, and I always tell people, you know, if you, if you shortchange the cash drawer, $10,000 and so let's just say it's $10,000 a year, that $10,000 you would have paid 30 or $4000 worth of tax on, but somebody would have paid you cause that $10,000 you didn't put into revenue. It's all profit. You recorded all the expenses, so that $10,000 is additional revenue and additional profit, and somebody might pay you $2000 to $50,000 you know, 2 to 5 times that for that extra profit. So you're going to shortchange the government 30 or $4000 so that you don't get, you know, 20 to $50 in the future. It just, it doesn't make any sense. I mean you really have to clean that stuff up and and be fully transparent and so yes, it means a little extra tax, but the multiple of that is so much higher. The tax is only 30 or 40% and the multiple might be. You know, 200 to 500%, so it, it makes a lot of sense to clean it up and be above board. Yeah, and I think the big point here is that there's a lot of things that make sense when you're 10 years from selling your business that don't make any sense when you're 3 to 5 years from selling your business, right? Yeah, and you know the, the issue that a lot of entrepreneurs have and a lot of small business owners have. Is that unfortunately most of them wake up, at least in my experience, most of them wake up less than a year and a half from when they want to sell, and, and the problem is they don't, if they're, if they're not planning ahead and doing these things the whole time they end up deciding they're going to sell on January 2nd because, you know, their, their wife had a a a heart attack or or something significant happened over Christmas or they realized they They missed, you know, one of their grandchildren's births or whatever and and then they decide they're going to sell and they decide they're going to go to market then and so you don't really have the time to clean this up if they haven't been doing it proactively all along. So what you're saying is, and I agree with this, is more businesses are sold based on unplanned events that are sold based on planned events. That's a that's been my experience, yeah, that's been my experience. I mean it. Yeah, I just had, I'll tell you a personal experience. I, I have a good friend of mine who's a business owner was working out a week and a half ago, had a heart attack and died and left behind a mess of a business that we're working on right now. And you can imagine, you know, that there was no plan. A plan on expanding the business at the time, not on, not on preparing it for sale. So you can imagine the mess we're dealing with right now. It's really hits home. So it's important to be planned for those unplanned type of events, and that's great advice for all of our listeners out there. Tell us more about that, yeah, go ahead. I'm sorry. I was gonna say I think, I think that's exactly right. I think those unplann events tend to happen way more often than people think, and You have to, you have to almost build every single company like you're gonna sell it in a year or two. I mean, you always have to be thinking that way like what if somebody made me an offer today? What, you know, what kind of holes would they shoot in the plan? Absolutely right, absolutely right, you gotta look at it like a buyer would look at it and then you ask yourself, would I buy this business based on this, based on the way it looks right now, or am I just running it to for my lifestyle and and pushing things under the rug and and not worrying about things. So what's the current M&A environment like for for small and mid-size businesses these days? Currently I would say it's as hot as it's been in 7 years. Uh, if, if there are lots of sellers, but there's also still a decent amount of buyers that I believe and at least in my experience in my opinion, that's going to change in maybe 5 years. There'll be maybe a lot of sellers but not a lot of buyers as the boomers exit the market. And you know, I think the, the prior person you had on the, on the show, you know, I mean they were talking about the, the boomer generation, and as that generation ages out of being entrepreneurs and they have their exits, there's going to be less buyers and so that's going to happen to evolve over time. But right now it's really hot. I mean the multiples are higher than they were in the last 567 years and I would say some of that's come back starting starting a little bit in 12 but then really ramped up in 13 and 14 was a good year for it and 15 at least in in the Carolina's has been very hot. I mean, we're working on 5 or 6 transactions right now where companies are buying or selling on both sides of it we're, we're helping out and the multiples are higher. The companies are stronger, they cleaned up their balance sheets coming out of 2008, 209, and 2010, you know, global, global debacle that happened and they're, they've cleaned them up and they're and they're strong now and they're ready to to go to the market in a good way to sell. And there's a lot of idle cash out there that's just sitting there doing nothing, so a lot of people want to deploy that cash into something that'll make some money for them. Uh, what are some of the sources of buyers that you're seeing? Are they individuals? are they private equity groups, or is it all of the above? What's the mix? Yeah, it's a great point. What your last point is a great one in that there is a lot of capital. I would say that the mix is a bunch of different things, which is, which is rare, I think, in this environment. What's happened is that the private equity groups, the hedge funds, the, the high, the the Uber net worth individual that has a lot of personal wealth, all of those folks have decided that they got to deploy this capital and they're not going to just do it in the S&P 500, they're going to deploy it in in businesses and what they've found. At least in my experience is that they're not there, there aren't as many as what the mid-cap companies, you know, those $50 to $500 million dollar companies that that the private equity groups used to love and chase. There aren't as many of those. They've done a lot of roll ups on those over the years, but there are a lot of companies under $30 million in revenue and a lot in the small business sector, so they're really coming downstream in a major way. Um, sometimes they're coming in as the buyer, sometimes they're coming in as the as the person who's going to recapitalize the company. Uh, they're gonna, they're gonna put a strategic investor in place as the CEO or you know, whatever it might be, they're going to ride the growth out because what they found is that there's a lot of growth opportunity in companies under 2030 million, you know, and the smaller businesses you get, the less human capital expertise they have. And so if you can pile on a, a private equity group with their, with all of their human capital resources and all their, you know, MBA degrees and every all their experience. You might be able to grow the company 20%, 30%, 40% a year for a bunch of years and and as such, get a really good return on investment. The the opposite side of that is the Small Business Administration and banks have come back to the market very, very competitively in the last 18 to 24 months. Interest rates are, you know, at historic lows and have been for a long time and. I think there's been a lot of government push here over the last, I would say 30 to 90 days, and they're, we're hearing lots of stuff about the Fed, you know, maybe changing monetary policy and and increasing the rates, you know, before the end of 20 2015. So now's also a great time to, to buy a business from a buyer's perspective because the the rates are really, really, really low and you can get great terms and banks are really aggressive because they've mostly cleaned up their own balance sheets, uh, on the bank side they've gotten rid of some of that bad debt. They've gotten rid of all that commercial and and residential real estate that wasn't good for them, and they're ready to come back and do pure blocking and tackling operating companies. That's great, great tips and advice. Now tell us, uh, if you're looking at um at 3 clients and you're looking at it as a buyer, what are some of the things that would would attract you? Forget about the industry for right now let's talk about the, the operations and management and processes and systems and you know the the ease of of uh transferability of a business. What are some of the things that would make you choose one business over another these days if you were a buyer? Sure. Number one is, um, strong cash flow, uh, that's obviously the, the top priority for a buyer is, you know, strong cash flow, consistent cash flow, not just this up and down cycle, you know, make money one year, lose money the next, not that sort of cycle. The, the second is a recurring revenue stream. This has become a constant theme amongst buyers over the last, I would say 10 years. It's more than I've ever seen it. They're, they're constantly looking for, I don't want to have to resell my product every single time to the same people, but getting them in some sort of contract base where they might sign a 2 or 3 year contract or if it's a software company doing it as software as a service rather than selling the software at one time and getting like a licensing fee up front. Um, those two things and then third is management team that you know that lots of small businesses run because the entrepreneur is such a powerful driving force. And what you really want as a buyer is you want that entrepreneur and that driving force to really be secondary. You want the management team to be running it, and you want them to be really key and you want them to be the people who are able to make decisions and strategically thinking about the growth of the company. If it's all in the owner's hands. And really they're the one driving decisions without some key decision makers with them. Then when you buy them out and they go away. That's the driver. Now you're stuck having to, you know, do it yourself or or get up to speed as quick as you can because the management team's not strong. So those three are by far the top 3 things that when I see buyers that they're looking for if you're comparing 3 different businesses. And and we you validated what we hear over and over again. So um thank you for that information. Now let me ask you a question. You're looking at those 3 factors give a weighting to each of those 3 factors that equal that adds up to 100%. Strong cash strong cash flow recurring revenue stream and management team. Yeah, I would say 50% cash flow. 25% uh recurring revenue and 25% management team. OK great great so it's important to make sure that your cash so someone's looking at your business, uh, they're they're looking for a lack of gamesmanship in the P&L, right? They're looking for a clean uh clean run operation pretty much. That's right, and, and strong. It's got to be consistent and strong. It can't be, you know, I, I, I, I was at a lunch meeting today with, uh, with this banker I was talking about, and one of the clients we were talking about was a, a, a joint client that bought a company, uh, 18 months ago, and the company came out of the recession really strong, making a lot of money, but in the, in the recession got absolutely hammered, as bad as any business I've seen. And we were talking about how the, the seller who was not a client of either of ours, the seller, really didn't get as much value as they could have. They were so tired by the time they came out of the recession. They, they had their really two good years and they sold their business. If they had had that same numbers for 2 more years, it's just the same numbers, not even any more growth than that, they probably could have sold the company for 2 to 3 times what they ended up selling it for. So consistent cash flow. They had had 3 bad years. Through the downturn in only two good years and so you know having consistent cash flow throughout the term and put that in in difference to I have a client who has grown it's a landscaping company and they've grown more than 10% each of the last 15 years top line and bottom line, even through the downturn. And that right there shows a lot of value. Makes them very attractive. John, I'm getting the high sign from my producer that it's time for us to move on to our next guest, but I've really enjoyed getting to know you and and hearing some of your extremely valuable tips. How do our listeners get in touch with you if they want to find out more about your firm and get in touch with you? Sure, that's great. Uh, they can go to. www.lbbahs.com or they can email me at johnbly By@lbbahs.com. Also, uh, cracking the code my book is available on our website as well or on Amazon.com. Well, I appreciate you helping us crack the code today to M&A Growth. You really did a great job and those were very valuable tips. I took a lot of notes myself just and unfortunately we're out of time, but I really want to get you back on the show again and get deeper on this topic because I think you have a lot to offer and some, some excellent, clearly defined tips for our listeners. So thanks very much for joining us today. Thanks, Bill. Look forward to being back on someday. We're gonna take a short break and we'll be right back after this. So please stay tuned. Just thinking about what will happen to your business if you're gone keep you awake at night? Will you get the price you need from your business to carry you through retirement? The BEI Network of Exit Planning Professions is the world's leading advisor network with the power to help business owners transition out of business on their own timeline and terms. Ask your most trusted advisor to create a BEI plan for you, or visit us at exitplanning.com. That's exitplanning.com. 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