John ”Murph” Murphy - What To Do Before The Buyer Calls (D1618)

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. Minute exit coach tip of the day on exit coachradio.com. And now here's your host, the exit coach, Bill Black. Welcome and thanks for listening. This segment of the show is brought to you by JK Murphy advisors and features, um, their namesake John Murphy. John, welcome back to the pleasure to see you again. Yeah, it's awesome to be here. You last time and it was, it was a lot of fun so I wanted you to come back and we're gonna get into a specific topic. Tell us a little bit about your firm before we get into that. Uh, we've been around 10 years, 10 years next month, June 1st, I can't believe it. And, uh, I was a former investment banker and I worked with a lot of companies here in Orange County and also in LA County, and I didn't see a lot of planning going on in the middle market. So, um, and worse, most of the companies that we worked with were competing against companies that were doing planning. And particularly what I didn't see is trying to capture the opportunity the business has, what's the, what's how to define and see what the opportunity is, and compare that to the risk preference and objectives the owners have. And what I oftentimes found it was out of sync. That maybe they were growing too fast for the risk preferences or they weren't more often they had their foot on the brake because they didn't want to grow as fast because they didn't want to take that much risk and yet the business sort of needed it, so to speak, you know what I mean? They needed that kind of investment or it needed that kind of, uh, forward action that the owners were are not willing to take because their risk profile had changed, most notably because they get older and they, they don't want to take as much risk, which is certainly. Understandable. So I didn't see anybody doing that and decided to jump in and God, God believe it was 10 years ago. So does a, does a lot of the conversation start from, well, we got to figure out what you need to get out of this thing to start with and figure out if, you know, where we are on that, on that continuum today, uh, you know, because that gives us a goal to shoot for and that tells us what our strategies are gonna be. Yes, and that's not only economically, but nonconomically. It's what kind of money do I need to fund my lifestyle, what kind of lifestyle do I have? And there's great wealth managers in the world who can help run models that help you do that. But there's also the psychic side. What do I get out of this position, the power, the prestige, the um the kind of power base for a community, and the other things that I do in a community, for example, and Sometimes it's just not time to let those go. So it's, it's both economic and non-economic I find. Well, family businesses are tough because of that because dad doesn't want to let go of the power, but he, he doesn't want to do as much and son wants the power and, and, uh, it's tough in those situations. And you know what I find in that is the, the, the. Answer that says, OK, we'll let son run it, but dad's livelihood still depends on it cause he hasn't sold his stock and it's still, that generally doesn't work out. That, that's tough because as long as the, the, uh, the older generation's livelihood depends on it, they're gonna keep hanging around. They're gonna be around the hoop cause they're, unless they get, unless it's a, a great sit a really fantastic situation where the son or daughter or whoever takes off with it, but usually it's tougher when they keep having their livelihood tied up in the business. I always find a good litmus test is that does dad let the son drive the nice family car? Because if he doesn't let him drive that car, there's chances are he's not gonna let him drive the business and drive dad's retirement. So, let's move on, John. Um, that reminds me of the old George Carlin, the good scissors. Your mom always had the good scissors, the good family car, and the not so good family car. I like that. Let's move on. One of the topics we were talking about before was All the calls that these business owners are getting that are promising so much, you know, a phone call, it's so we can sell your business for X amount of money, or we can sell it quickly, or the market's great. And, and you just talked to a, to a group about this very topic. So what was your experience? What, what was the talk about and what was it like? Um, well, there's so much capital out in the market today. Uh, private equity, strategic buyers with cash on their balance sheet, all their forms of lenders that many of them go direct now, and they've created calling programs and outreach programs to try to reach private business owners on their own, and not wait for auctions or um calls from investment bankers who act as intermediators. And because the shortages, good management teams and good growth stories, the shortage is not capital right now. So the, the question then is, so as you're an owner of a business and you keep getting these calls, not only from intermediaries as you described, which we want to sell your business, but others that want to invest in your business, we wanna buy your business, we wanna go direct, we've identified your business. The first thing to do is to kind of think about what kind of a call it is. Many of these private equity groups, um, hire people out of college and they literally sit in kind of a room and dial for dollars. That's probably not as interesting cause it's just the name on a database. But recently a client of mine got a 2.5 page written letter. How many written letters are there today, right? Um, and on top of it, very well thought out. Analysis of why this owner's business would fit with this private equity company that they already have. That's a common technique where they buy a business called a platform and then they add acquisitions to it and grow it and sell it down the road. And, and in the meantime, the difference is that perhaps it's a business that an owner didn't want to make those acquisitions, didn't want to risk the capital again getting back to the thing we talked earlier about the risk preference, and, uh, the private equity world is, is geared around taking that risk. So, uh, this was a 2.5 page letter. They knew a lot about the business, they've known a lot about the industry, and it was something that my client really wanted to understand better, so they wanted to take it, take the next step and kind of have a conversation. And I'm always telling people, generally speaking, having conversations is good. You learn about your business, you learn about how people think about your business, you learn about the industry, you learn about how other people are viewing the industry. It's not great to be for sale all the time, which is kind of the far extended, uh, uh, continuum of that because then people don't tend to take it seriously. But you can certainly have conversations about, uh, where the business is going and industry without getting into details and revealing a lot. So, um, last night we gave a talk in San Diego to a number of executives in the aerospace and dispense industry about this topic because everybody's been getting barraged in the last, I'd say the last 4 or 5 years, especially the world of capital is being very aggressive in pursuing companies directly. So the first question is, do you want to have a conversation? And I would say yes, generally you do, uh, particularly if it's a, it's a it's a more well thought out inquiry rather than kind of this the dialing for dollars one. And then the question is, so what if you want to continue the conversation, if you want to take it to the next level and start revealing information, you need to be ready to do that. And that's kind of where we talked the last time where we focused our business on is how one aspect of our business is how do you get ready to have a conversation like that? How do you get your business ready for sale? And probably the three most important areas to think about, uh, kind of the, the cheat, there's a lot of issues that we, that we get involved with that we are gonna talk about today, but the 3 most important ones, I think are we think are, uh, uh, people, the management team, the growth story, what are you, what are you really selling, what's the business opportunity the company has, and the finances, having your credibility in the finance area. So the first one is the management team. How good, you know, I, I, um, I asked the question last night, you know, how many people have a great management team? And a number of them raise your hand and I said rhetorically, so how do you know if they're great? Um, you, you think they're great, but ultimately, if you ever have a conversation with a buyer, you go through any kind of a process for a capital raise, people are gonna judge your management team. And, um, David and I like to say that, that, um, there's a part of the process that when you sell your business called the management presentation, which is about halfway through, where you're really starting to open up the kimono and talk a lot about your business in very granular detail. And we, uh, we, uh, when we look at managers we say who's gonna add value in that room who can, who can impress the people on the other side of the table and we take that as a proxy for impressing potential sales, you know, and, uh, sales contracts and protecting, uh, assessing or impressing particular, uh, suppliers or other big, uh, constituencies that a company has or being able to hire people. How can they tell the gross story. Enough that somebody says, I wanna join that company. I wanna work for you. So, um, that's how we, when we look at management teams and interview management teams, that's what we're thinking about is how impressive are they gonna be in the room later on if they ever get into a process. Now what's the risk of someone, uh, opening up that conversation and saying, here's our great management team, and, and then the, the potential buyer saying, let's go after, right, some of those key people, that person's a star, which they didn't know before they had this conversation. So is it, is there a prerequisite for the owner to have thought this through and locked in those key employees in some way, shape, or form? Well, there's two things. One is we advise our clients to to lock down their key managers. Some buyers don't like that because they want to be able to pick and choose, but usually having your good team already, what we call a leave behind team, buyers want them is the best way to go. And usually you don't enter into a more detailed conversation unless you sign an agreement called an NDA that has, you can't solicit our people for a particular period of time. OK, so in the steps along the way for preparing for these calls and how to respond to some of these, there's some prerequisites that you need to be thinking about. Don't just, don't just tell everybody who your great people are and what a wonderful person they are because you might lose them. By the way, they are wonderful because everybody, you know, these kind of meetings, everybody talks great. Nobody talks absolutely. No, they don't get down to the nitty gritty till later on. But the other thing that we always usually advise is if you like one conversation, you like the, the, the where it's going, you're always best to have more than one. And in that case, we usually recommend hiring an investment banker to proceed with the process. But kind of jumping back to where you're just getting yourself ready to be able to get into that any of those things, management team, making sure you got a great management team and they're under contract. And that they have a, they, they know what the vision is and they hopefully were part of what the vision is and where the story is and they know what their role is in getting there. That's really important because um they say real estates, location, location, location. I think a lot of what we do in, in the private business world is management, management, management. And the way they, they look at management and the way they judge management, how they invest capex, how they, with the hiring decisions they make, how many people stayed, how many people left, those are the kind of things that you look at and, and little things and trying to judge management teams. And then in case of David and I as well, we say to ourselves, are they gonna add value when we if we ever get to uh put them in a room with buyers and they're gonna add value to the story. The second thing is the story itself, and we talked a little bit about this last time, where people kind of plant a lot of seeds and don't focus as much, but there's also a couple of words that revolve around for us as scalable and sustainable. Scalable is being able to grow a business, um. We've got a healthcare services IT business and whether their software system has a million clients or 1000 clients, the system doesn't know, it just handles it. So that's a pretty scalable business. A lot of internet businesses are, and generally speaking, they, they can command a higher premium in the world. The others sustainable, can it be. Can it happen over and over and over again that leads to how much financing you might be able to raise, the more sustainable it is, the more financing you generally can raise, the more comfortable people are lending money. Those are all good, good things to have in grow stories as part of, you know, where we're driving the business, and the other is visibility on earnings to the extent you can have a business model that creates visibility on earnings and be able to predict with pretty decent certainty where you're gonna be 1 month from now, 6 months from now, a year and a half from now. That adds more value to the equation as well. So naturally businesses that are subscription based services like cable TV, for example, you can pretty much tell what your revenues are gonna be. You know what the minimum are they you may grow it from there, but you know what the minimum are. So that's just one example of companies that have great, um, great growth stories. Oh, those are 3 great tips to get ready for that buyer who calls. We're gonna take a short break. I'm talking with John Murphy from JK Murphy Advisors. We'll be right back after this message. You're listening to Exit Coachradio.com, the show for age 50 plus business owners. We're interviewing over 250 professional advisors for their tips, ideas, and precautions so you can be well planned. We upload new 20 minute interviews and 1 minute highlights every day at exitcoachradio.com. Come listen for a minute. Do your advisors think like a buyer at JK Murphy Advisors, we use a think like a buyer, not an owner perspective, to help private businesses of all sizes identify challenges, overcome obstacles, and achieve the objective of increasing the market value of their company regardless of whether they choose to sell, raise capital to grow, or focus on growing their business without a transaction in mind. For information, contact Merck at 213-705-0391. That's 213-705-0391. Welcome back, friends. Just a reminder that we have interviewed dozens of advisors on a wide variety of topics, and you'll find all of their interviews and highlights online at exitcoachradio.com or on iTunes at iTunes. Exitcoachradio.com. And I'm talking with John Murphy from JK Murphy Advisors and, uh, before the break, we have some great tips about some of the things you need to get ready to, to be able to present your business if you like the call that you're getting. And let's talk a little bit more about that third one because I think we, we started to touch on that one, but the financial side of things. Well, any good any investment bank or a business broker will tell you if the numbers aren't good, it's tough for them. So if it's tough for them, it's tough for the company. And what do we mean by tough? I mean that the numbers don't add up the historical numbers. There's issues about revenue recognition. There's not been an outside independent opinion, whether it's an audit or some other test, uh, the accountants do to just independently verify the numbers. That's really hard. Um, it comes down to trust to trust, right? I mean, that, that's, you know, there's a term called shoebox accounting that has grown up that where businesses have all the receipts of cash, all the receipts in one shoebox and all the rece expense receipts in another shoebox, and that's kind of tough to make sense of. Sometimes buyers like that because it allows them a wide latitude. You to be able to negotiate the price down because they know they, they honestly don't know what they're getting or they think they may not know and they want to use that as a price reduction. So the more you can have your ducks in a row, the more you can have outsiders independently verify the numbers, the more you can have a great finance staff inside. And when we were talking last night at the dinner, uh, one of the questions, uh, one of the owners of the business asked was, you know, he described his situation and he said, Am I too young to have a CFO or should I have a CFO in the business? And the answer we gave is, we're big believers in spending and finance. Now, that kind of goes against the grain of most private business owners because finance is in a revenue generating area. But credibility is important, not only if you ever want to enter a process and hire a banker or respond to a call and sell the business and raise capital, but having good information to manage your business on, or having even better information to manage your business on on a day to day basis. We, we admit we're biased, but we believe that money spent in finance is well worth it's well worth it. And so having good finance people, having a good finance system that creates good numbers on a regular basis, whether it's got uh a benchmarking and or it has uh dashboards, um, all that helps because it gets better information to manage the business and if you ever want to go in. To a conversation, not only is the historical numbers in good shape, but the projections which many companies don't have, and part of what we do is help them put together projections to kind of capture the business opportunity. They need to make sense as well. How many years of verified financials do buyers want to see? At least 3 to 5, sometimes depending upon if it's cyclical, the more back, maybe back to the last cycle. If it's not cyclical, perhaps not as many, but I'd say 3 to 5 is what they want to see, which goes back to why we say you ought to start thinking about this exit planning process 3 to 5 years in advance because you're gonna have to start. You know, getting your, one of the interesting thing that's that's developed in that world that the accounting world is, is very aware of is there's a thing called the quality of earnings, a QOE, which a lot of buyers use to verify, um, IBITA, which is the cash flow measure that most businesses are traded off of. So they take the existing accounting information and really scrub. The EBA and the ad backs and we talked a little bit about that last time where private companies run expenses through their, their company that if they die to sell the business, you can add it back to get try to get a true measure of operating cash flow things like excess owners' comp, maybe a car, you know, more extreme examples are the gardener and the pool guy at the house and things like that, um. So this QOE has really become popular. We're searching for investment bankers for 3 of our clients right now, and all of them are talking QOE pretty, pretty, uh, much more so than than even 2 or 4 years ago in my opinion. So it's a, it's the accountants of the world have all seen this, and many of the accounting firms offer QOEs now as well in addition to the more uh audit and traditional audit work that they that they have always provided. So they're saying they don't want to. They don't want to have to do the ad back, so we don't want to do that Mickey Mouse stuff. We want quality earnings. We want, we want this quality of earnings, and what happens is because the buyers require it now some we're, we're asking our sellers to think about doing it in advance so we can identify any issues that anybody might have a problem with. And it's not that they will accept it 100%, it's that we'll have a better chance of getting everything that we want if we already show people that we've already had somebody come in and do a QOE. So that just goes to the what that goes to is is even more credibility on the finances, making sure the numbers are in row. So we talked about the three areas that you need to be able to have a good story, a good solid story to tell the people that call and your people, your growth, and your financials. Now, let's talk about the quality of the calls that you're getting. We talked about that a little bit at the beginning, but sometimes it's that boiler room call that that may or may not be anything. Uh, sometimes it's a 2.5 page letter that they, you can tell that they, they've done their homework to start with. How do you What, what advice would you give people as they get these calls to, to kind of filter through the ones that they may want to and, and how do you treat these types of calls? Well, the boiler room calls to me are just probably not worth much because they're probably a young kid out of college that has no positional authority in the firm and is just dialing for dollars, hoping to get something and probably working on a contingency basis. They must get some somewhere, pardon me, they must have. Some, yeah, they must because they keep, they keep doing it, right? There's somebody who's having a bad day that took that call and said, oh, I wish I'd never done this. I'll give it away. Uh, I, I'm, I'm a believer in having a conversation and knowing what people are interested in your, in your business and just, you know, it can't hurt you to have conversations. But, when somebody calls you and says, I, I'm interested in buying your business, John, what, what should you be asking back of those callers? Uh, the, the, that's a good question. The answer is, so why are you interested? Is you own, do you own, in the case of a private project, do you own a portfolio company that wants to make acquisitions? Do you not own a portfolio? You're just dialing for dollars? The dialing for dollars stuff I wouldn't be so interested on the 2.5 page letter I was impressed by, and um, it was well thought out. It was well researched. They knew a lot about this business and they knew a lot about how it would fit with the existing business that they had. In fact, actually, there were two of them. One was they hadn't, they hadn't had the grown, uh, bought the business yet, the platform, but they'd identified an industry executive. A lot of times private Groups will say we want to be in this industry. They identify an ex-executive of a company and they'll try to build a company around that person and that's what this was. They wanted to use my client as the platform for and here's the guy we bought which my client knew he knew him because everybody in this industry knows everybody, which is common in a lot of industries. And he said this is a smart guy. I understand what they're trying to do. I'd like to have a conversation with. Then we had another one which was they already had an existing um platform in the industry and they had a quite a long lengthy letter of why that made sense. Those are more interesting to me because they're more well there's more substance to it, so there's more and they're smarter about your industry and your space and what how you might fit in that space. So it's probably interesting to learn what they're what they're thinking and and why they're interested. So the most important thing is why they're interested. And what does it mean for me and what, what are the pluses and minus and not that I would tell them the pluses and minus, but ga gauging as the owner, what, what are they telling me and what are the pluses and minuses for my business? Are they gonna go get somebody else? So I'm gonna be competing against a deep pocketed capital source in my. That could be a plus, that could be a minus. Um, are they not gonna this is just a one-off deal and they really want me that could be positive for me because they might pay a higher price. It just kind of depends on the circumstances. But having said all that, if you do have conversations and you are interested in pursuing a conversation. You should probably have more than one conversation. We've got one client right now that's pursuing the conversation that we, um, told them not to hire a banker, which was against our general rule because the price was basically an infinite multiple of cash flow, and it was an internet multiple for a service business which you don't find very often already off the bat, but everything else we're big believers in the process that a banker or a broker can provide as part of the work that they do. Murf, you're a great source of information for our listeners. I really appreciate you coming on. We're gonna have you back and talk about more of this stuff. Can, where can people come to find out more about, about this topic and to talk with you about it. Thank you for doing that. Uh, thank you for the comment. I love talking to you. You, you asked great questions, and we, uh, I enjoyed that obviously these topics are, you know, something I feel passionate about. Uh, JK Murphy advisors.com is our website and uh 213-705-0391 is the phone number and thank you for having us. Great source of information, a lot of, lot of, uh, tools on their website. So go check them out. We really appreciate you coming on the show. See you again soon and, uh, we'll be right back after this message, so please stay tuned. You're listening to Exit Coachradio.com, the information station for age 50+ business owners, where we're interviewing over 250 top advisors for their best tips, ideas, and precautions so you can be well planned. We upload new one minute tips every day. Exitcoachradio.com. Come listen for a minute. Thank you for listening to Exit Coach Radio.