Jeff: We appreciate having you. Jennifer, the idea of crowd funding, it seems that we really started to hear more about crowd funding from the very beginning at about the time of the financial collapse in 2008. It seems like maybe this was an idea that may have been born slightly ahead of that, but that started to really gain some traction as an option for companies to find a way to finance at least part or maybe even in some cases all of their business when maybe the traditional means of funding their business may have dried up a little bit after that financial collapse that we saw in 2008. Is that correct or has crowdfunding been around for a lot longer than maybe we give it credit for?
Jennifer: I think that's mostly correct but there is a bit of a history to understand in terms of how we got to today's notion of crowd funding. And I think if you look back just a little past 2008, maybe several years before that, with sort of the advent of the Internet being a constant source of communication between companies and the crowd, or between causes and the crowd and they're being sort of this 24-hour news cycle. It became quite popular to raise money online for various humanitarian causes. So the Red Cross and other international relief organizations turned to the Internet as a means to reach people to make donations for crisis-oriented events. That sort of merged forward with this notion that individuals could raise money, that companies could raise money for their projects, that people who wanted to make films could raise money, people who have medical problems could raise money. Websites like Kickstarter and IndieGoGo were founded on the notion that if humanitarian companies could do this why can't individuals. And organized companies do this for the sake of reaching people that have an interest or passion in connecting with those people and getting funds from those people.
IndieGoGo and Kickstarter were set in place really before the recession, but they were an outgrowth of this notion that the Internet was this perfect way to reach people with news and information and have them become involved monetarily with these causes, or with these crises, or what became products, films, and other passion products of individuals and companies. The history here is that the Internet provided a terrific interface for people who needed money, with people who are willing to give money if they could form a connection around the cause, or the passion, or the common interest. That's sort of the long history of how we get to the JOBS Act.
But to your point, certainly the recession brought a lot of typical and customary sources of capital to a halt. Banks stopped lending. Most venture capital fund and private equity funds rolled up shop for a while and weren’t making traditional investments, certainly not at the pace in prior years. There are a lot of failures in technology and other industries. So investors started to hold on to their pocketbooks in a way that we hadn't seen in a long time. At the same time the Internet was out there and companies were raising money. Companies that were producing movies, creating new consumer products, launching restaurants, and also individuals who wanted to forstore foreclosure, or raise money for medical purposes, etc. People were turning to the Internet to raise money and have people participate in their project. However, it was not legal then and it just recently became legal to have these people take the form of investments to make actual equity investments in the company. Until recently IndieGoGo and Kickstarter, I'm picking on them because they're the most popular and widely used platforms were able to take pledge-based donations or pledges or donations.
The history here is that the Internet provided a terrific interface for people who needed money, with people who are willing to give money if they could form a connection around the cause, or the passion, or the common interest.
Jeff: In other words pledge is really from anyone. We're not talking institutional investors here but we're talking about the guy or lady next door, right?
Jennifer: That's right. And that's sort of the beauty and the magic of crowdfunding is that someone who wants to raise money for a movie, or a new consumer product, or open a new restaurant can find some way to appeal to someone who maybe can only donate $10, or $5, or $75, or $100. But over the course of hundreds of donations like that companies can raise substantial amounts of money. But yes, it's true. There was no particular disclosure requirements. People were giving money for the sake of helping companies and for getting back some kind of perk. So these perk-based campaigns for example, if you're raising money to produce a movie, if you pledge $10 maybe you get a hat. If you pledge $50 you get a t-shirt. If you pledge $100 you can come to the movie set. If you pledge $1000 you get a copy of the script signed by all the actors. They were ways to create incentives for people to make pledges. And this was all fine in terms of the securities laws because no one was actually investing, no one was anticipating sharing in the profits of the venture. And conversely the companies didn't have to make any particular representations, and have any particular compliance requirements. The bottom line was the company had to try in good faith to accomplish what they promised the pledgers they were trying to accomplish. Make a movie, produce a product, open a restaurant, and so forth.
Jeff: Let's broaden the base here. Crowdfunding as a source for funds for privately held businesses. You were getting ready to, before I kind of walked on you just a little bit there, Jennifer, for clarification. You were getting ready to talk about some changes that have come about for the purpose of equity investing now as opposed to just kind of a one-off contribution to a company for the purpose of helping it grow or get up off the ground. Things have changed a little bit, is that correct?
Jennifer: Oh yeah, they've changed radically and substantially I would say. The history as I said is sort of humanitarian relief, and then companies and individuals who wanted to get money from the crowd for projects, or new companies, etc. And this was sort of during the recession. And then a movement started amongst people who were hosting the websites, amongst the individuals in the crowd who said, "If we can give money for the purpose of getting a t-shirt or some other gift, why can't we invest money and actually participate in the profits?” Meanwhile, in 2012 the JOBS Act is adopted. The JOBS Act provides many changes to the securities laws. But most importantly it opens up the access point between companies that want to raise money, and people in the crowd who are willing to invest money and take a risk, but who want to participate in the profits. And this is known as equity or securities based crowdfunding.
And so the first generation of that under the JOBS Act was changing a very, very old rule that the FTC and Congress have laid down decades ago that if you're going to have a private offering, if you're going to offer securities privately, if you're a private company and you're going to work with small groups of investors, that offering in fact had to be private and you could not have any public advertising or what's known as general solicitation. So in very traditional venture capital financing, the sort of closed loop capital environments, investors knew emerging companies, emerging companies knew where to go to meet investors, etc. But there were a lot of entrepreneurs who couldn't penetrate that environment. And as we said, in 2008, 2009, 2010, those environments were shut down anyway. The FCC said, "If raising money privately, having existing relationships with investors is not working, we need to open up the capital markets we need to be responsive to what Congress has asked us to do under the JOBS Act." Under the JOBS Act this really sort of ancient rule about no general solicitation, no public advertising, you can only take money from people you already know, that was eliminated. And that was known as the elimination of the ban on general solicitation.
What does that mean? That means that you can go beyond people you know in your direct circles. You can go beyond the traditional sources of capital, and you can open up your offering to the general public by means of advertising by email, on the Internet, and so forth. However, that first stage, that first step of the JOBS Act, which was huge frankly for the securities regulatory commissions at the state level and also obviously for the FCC, you could go to the crowd and you could offer your investment and your company but you could still only take money from high net worth individuals or credited investors. All these years when you were doing private offerings with French capital firms and high net worth individuals, and everybody was sort of in that club of ready investors, they were all credited. And if you were a private company and you had a relationship with an investor and the investor was accredited you could take their funds. And the investor could tell you on their own, they could self-certify as being accredited. There was this ecosystem of companies who could find high net worth individuals who were accredited. The accredited investors could say, "Yes, we're accredited." And the transaction could move forward. Because of the JOBS Act, and because the FCC reacted to the JOBS Act, you could advertise on the Internet. As I said, the ban on general solicitation was gone but you could still only take money from accredited investors. The trick here and what the FCC did was they said, "Okay, you can advertise to the public. You can find accredited investors, but the way you determine whether or not they're accredited is going to be more challenging, it's going to be more difficult.”
If it's private you can self-certify as accredited. If you find investors over the Internet and you want to verify that they're accredited there has to be some third-party substantiation or documentation. People have to submit tax returns or investment statements, or their lawyer, or their accountant or somebody has to write a letter verifying that they're accredited investors. What are credited investors? They're people with over a million dollars of net worth, or they're people with substantially high annual incomes of either $200,000 if they're independent or $300,000 if they're married. Congress said, "Go to the crowd and find these people. Find the accredited investors. The FCC said you can do that but we're going to make it a little harder for you to verify that they are in fact accredited." That was the first part of the JOBS Act. It created a new exemption under Section 506-C Regulation D which is a mouthful. But basically the first stage was to allow companies to reach the crowd but only to reach investors who are otherwise qualified to invest in private companies. That was sort of the first wave of it.
The second wave which just recently was implemented by the FCC is under Title 3 of the JOBS Act which allows companies to go to the crowd, and so to your point, to allow anyone, sophisticated or unsophisticated, wealthy or not wealthy, to invest in private companies. This is a general equity crowdfunding rule. There are some limits but basically it has proverbially opened the floodgates for everybody in the crowd to become an investor in private companies, and for private companies to reach virtually everyone they can via public means to appeal to these people to become equity investors, stakeholders, profit holders in their company. We can talk more about what those regulations entail, but you can see it's been sort of a steady march forward and there have been incremental changes. But given where we were and given where we are now it's quite substantial, the changes.
If you're going to offer securities privately, if you're a private company and you're going to work with small groups of investors, that offering in fact had to be private and you could not have any public advertising or what's known as general solicitation.
Jeff: But from where you sit as an attorney, and really as someone who, I'm sure you're an investor as well and probably have a 401K set-up there through the firm that you're with. But as someone who works a lot with business owners is this a good thing, do you think?
Jennifer: I think it depends on which side of the table you're on. I think the regulations and the FCC mandate to protect investors is really where the regulations were geared to. There's a lot of wording in the adopting release. There's been a lot of wording in legislative history and so forth to protect investors. People in the crowd are going to be seeing these company offerings, is there going to be fraud, and are they going to be taken advantage of, and how do we protect investors? That is the FCC's focus and that is more or less their mandate and understood. But your question is really I think in some ways the more interesting question.
If I represent the company or companies out there trying to raise money, of course they want funds, of course they need capital, of course they have to have money to survive, operate, and grow. However, they really have to ask themselves, and I tell my entrepreneur clients this, "Do you want to have in your company hundreds of shareholders who have never invested in a private company, who don't know what to expect, who could be nervous and demand liquidity at a time when you can't offer it, and who have ultimately voting rights in your company, and who also have quite a buffet of statutory and contractual rights to hold you accountable for what happens inside of your company?" That by itself is not a bad thing, shareholders should have rights. But think about having hundreds of strangers, people you don't know, don't know what their qualifications are, don't know what their level of sophistication is, potentially involved in your company, potentially having to manage them to a process, etc.
I think for entrepreneurs there's a real question of, first of all, could you raise the money. And second of all do you want to have all of these shareholders to manage. Even having a company where the shareholders are sophisticated, or venture capital, or angel investors, or people that have a background of investing in startup companies. It's tough to negotiate and keep your shareholders happy. It's just the reality of being an entrepreneur. I think it's that much more risky when you're dealing with investors you've never met, you have no relationship with, and you don't know what their level of sophistication is. You have to be willing to live in a new environment where you're bringing with you through your corporate life lots and lots of stakeholders who may or may not be a good fit for your company or for the ups and downs that your company is going to experience. A few of the things we don't know, we don't know with very many examples, there might be a few but very many, what happens to companies that are crowdfunded and have 300 or 400 shareholders. Maybe they've raised $750,000 or maybe they've raised a full million that they're permitted to raise under the rules. Will sophisticated, institutional investors invest in a company that already has hundreds of shareholders? Investors are smart, they're savvy, they want to make money, they're looking for exceptional opportunities, but their risk tolerance only goes so far.
And it's very risky to invest in a company where there are hundreds of other shareholders that you don't know, can't control, don't know what they're going to react to, don't know how they're going to behave. So it's another layer of risk for institutional investors as to whether or not they're going to want to co-invest with the crowd. And that's just an unknown right now so unknown if it's going to work. There are some commentators out there saying, "It's going to go the other way. Investors are going to put in the first half a million and then that's going to give the crowd confidence to go in and put a million on top of that. In other words as long as someone with sophistication, knowledge, and experience has invested why wouldn't I?" The thought there is that companies might be able to leverage early rounds of capital through angel investors and other sophisticated investors, and then go out to the crowd to raise money on top of that.
There are a lot of unknowns there. I think it creates some risks which can probably be managed but nonetheless risks new to entrepreneurs and growing companies. When you invite into your capitalization table potentially hundreds of investors who frankly have never done this before. There are some unknowns there.
Jeff: Interesting point, very risky indeed. There are risks with anything that is new and different, and crowdfunding has been around now for a few years and is gaining traction, and it's gaining investors quite honestly from coast to coast. My name is Jeff Allen and we're going to talk more about this idea of crowdfunding. Is this something that you could benefit from with respect to your business and raising capital? We're going to continue our discussion with Jennifer Post from Raines Feldman LLP when Deal Talk continues in a moment.
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Jeff: Welcome back to Deal Talk where we are becoming the Internet's go-to resource to help business owners understand what it takes to sell their company successfully. You can find a wealth of resources along with all Deal Talk episodes and their transcripts simply by visiting morganandwestfield.com. I'm Jeff Allen with my guest Jennifer Post, partner at the law firm Raines Feldman LLP in Los Angeles talking about crowdfunding as a source of funds for your business.
And it doesn't really matter what stage you are in, in terms of business ownership or how old your company is for that matter, how long you've been in business, crowdfunding is something that is relatively new, it's relatively different to consider. But let's say for example that you've got somebody out there, they've already got a Small Business Administration loan. They're working to pay that off. They've been in business for five, ten years and they're looking for a means to raise capital for any variety of needs. Maybe it's to buy additional equipment, supplies, to expand their business, maybe to open up a new shop someplace. Is crowdfunding really something that they should seriously look into, do you think?
Jennifer: I think crowdfunding potentially can work for a lot of different kinds of companies, but I don't know that it's a solution for all companies. I think companies that are likely to succeed in crowdfunding are companies that have some sort of wide appeal to their product or service, sort of a "sexy industry", some sort of brand new technology, something all consumers can relate to. Perhaps it's a film or creative production that has popular talent associated with it, something that appeals to a lot of people in a broad range of cities, lifestyles, etc. in the country. Companies that have some sort of sex appeal to them if you will are probably going to do well in the crowd.
Other types of companies that are going to do well in the crowd I think are companies that are regionally based. For example I'm in Los Angeles. I like restaurants. I'm not going to invest in a company that's starting a new restaurant chain in New York because it's not in my backyard. But I will be motivated to work with companies, or take a stake in companies that are in my neighborhood, in my region, or in my city. I think companies that are looking to build a brand, or don't have a presence or a connection with the local community I think will also do well. And companies that can find a way to use crowdfunding to find the pockets of investors who will understand them I think will also do well. Posting a crowdfunding campaign and expecting to reach millions and millions of people, and hoping that someone out there understands your business may not be the most strategic way to crowdfund. But if you can find specialized crowdfunding portals, or access, or avenues where people can help you develop and cultivate an audience of people who understand your industry, or understand your technology, or understand your brand then you're more likely to find people who will actually invest. If you're a machinery company and you're involved in aviation, all the better for you if you can find a crowdfunding platform that seems to attract people who have worked in industry, people who have worked in manufacturing, people who have worked in the aviation industry.
I think we're going to see a development probably by necessity of crowdfunding portals and intermediaries, consultants, and advisers who will help these portals and these companies cultivate sort of, if you will, the equivalent of a direct marketing campaign to investors who will appreciate the company, their status, their industry, etc. Otherwise we're falling back to who's interesting, who's sexy, who's got wide appeal, or conversely who's in my neighborhood, who's in my community, who's in my state that I'm interested in supporting?
You have to be willing to live in a new environment where you're bringing with you through your corporate life lots and lots of stakeholders who may or may not be a good fit for your company or for the ups and downs that your company is going to experience.
Jeff: What do we not know yet about crowdfunding that you may have a concern about in terms of risks potentially, not just risks to a company for embarking, going down that road. Whether or not you've got a sexy product or not it really depends and it's kind of in the eyes of the beholder. Really, what is there that you are concerned about as an attorney from a legal standpoint that we just don't know yet enough about crowdfunding and its safety as far as a resource for companies that want to go that way?
Jennifer: We've discussed in the first half it’s not only risk for the companies in developing large populations of shareholders that can be a burden from an administrative point of view, it can be a burden from the point of view executing on transactions. And also there's some exposure there frankly to shareholders who don't feel that there's enough liquidity. Or frankly if there's no success, people I think don't really expect to lose money. I just think that that's going to be a new reality for a lot of investors. On the other side of the table for the investors I think there will be a lot of disappointment. I think there will be a lot of complaints filed with the FCC and also with state regulatory commissions, people who feel in hindsight that they didn't get a good deal, that they lost money unnecessarily, or there must have been a problem with the company or the management that wasn't disclosed.
On the investor side I think there's going to be some amount of frustration. What happens with that frustration I think is the big risk. There's been a lot of discussion by commentators and others as to whether or not this is going to be a breeding ground for class action lawsuits. Hundreds and thousands, maybe millions of investors coming together to sue the websites that host these offerings, or the companies that offer securities. There certainly is always a risk of fraud. But I think the biggest risk in the market right now, unfortunately, is that there is this legal track developing for offering securities. The securities offerings to the crowd needs to be conducted on registered Internet sites, or they're known as intermediaries or funding portals. These are websites that register with the FCC, will be regulated by the FCC, are mandated to provide certain types of information to the crowd. However, the Internet's a big place. Lots of people get email, lots of people get spam, lots of people get solicitations from all sorts of websites. I think there could be, at least for some period of time, an unregulated crowdfunding market that could develop. So investors could be fooled in other words into investing in companies that are not offering securities through these regulated crowdfunding portals. That is certainly a risk. It's really hard to know if that's going to happen, but I think that risk is out there because there's a lot of misinformation, misunderstanding, and lack of clarity around how someone in the crowd can invest in a small company. The regulations are still developing. I think that that will be a continuing risk.
The other risk I see for investors, and this happens even in well-funded, well capitalized companies, is that investors want liquidity. If you're a company with a few hundred shareholders, shareholders want to sell their stock. We live in a world where people buy things and then they're not useful anymore and they want to sell them. So people will want to sell their stock to their friends and family. They may just want to get rid of it. People frankly move, they die, they become incapacitated. What happens among the ranks of shareholders in terms of how they want to handle their stock as property is a risk we don't have any answers to. Will there be a secondary market where people start trading in these crowdfunded companies even though they're either not supposed to or the regulations restrict that? Again, another unknown, it's a risk for the shareholders and it's also a risk for the companies.
A lot of unknowns really about how the rules are going to be implemented. Whether they'll be sort of a shadow market. Even if people successfully invest in crowdfunded companies what are they going to do with that stock and how long are they going to be willing to hold on to it before they start taking action which are contrary to the regulations.
Jeff: Because we're running out of time I'd like to go ahead and just break now and tell you that we might have a need to have you back on the program for a follow-up edition of our show just to once again explain maybe even in greater detail some of the key concepts here that we talked about today. And provide us with the an update as news comes down about any changes, further changes in the law and regulations, and legislation concerning crowdfunding. We hope that you'll do that at some point in the future.
Jennifer: Sure, I'd be happy to. These are very complicated regulations. Things are changing rapidly. There's a lot of material to talk about.
That is certainly a risk. It's really hard to know if that's going to happen, but I think that risk is out there because there's a lot of misinformation, misunderstanding, and lack of clarity around how someone in the crowd can invest in a small company.
Jeff: I'd like to find out too also Jennifer how people can get in touch with you if they have any questions about this subject that we're talking about today or if they want to talk to you too about any number of other business related matters concerning their companies, how can they reach you?
Jennifer: I'm a partner at Raines Feldman. We have offices in Beverly Hills and also Orange County. Our website is www.raineslaw.com. There's always the telephone. I'm at 310-440-4100. I'm happy to speak with people about their questions and comments on this or other topics that are important to them.
Jeff: Jennifer Post, again, I thank you so much for participating with us today on Deal Talk and we look forward to having you back on again.
Jennifer: Great, thanks so much for having me.
Jeff: Business law attorney Jennifer Post, partner at Raines Feldman LLP has been my guest today. We hope you enjoyed the discussion.
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Gabrielle: Thank you so much for having me. I'm looking forward to our conversation.
Jeff: Thank you Gabrielle. Tell us a little bit first of all about what a chartered global management accountant is and does.
Gabrielle: The CGMA is a designation by the AICPA, and essentially it says that we're qualified to help with managerial type of accounting. And a lot of that is basically your day-to-day accounting and how you handle and manage your business. That's basically it.
Jeff: The one thing that really impressed me about visiting your website, and we won’t talk long about this because I want people to be able to go and visit at their leisure when they have some time to do so, Gabrielle. But the one thing that I noticed is that you have a unique, small team approach to the services that you provide. You're not just a CPA. We've talked about that, chartered global management accountant. Really, you are providing if you will some consultative services to people who come to you that kind of go above and beyond what a typical CPA might do. Am I getting that wrong?
Gabrielle: No, you're absolutely right. Basically what we're looking to do is be that consultant, that ear that most small business owners need. They got into business. They did not go into accounting. And so they're needing that extra support to help their business grow and scale up. And so what we do is provide the whole accounting back office to help them do that, and then take them through the compliance and the tax filings and all those other things, and help them dodge a lot of killer things that will take businesses down. We take by the hand, partner with them, and help them grow their business and scale it in the way that they would like to do it. It's all centered around their goals and what they want to accomplish in their life.
We take by the hand, partner with them, and help them grow their business and scale it in the way that they would like to do it. It's all centered around their goals and what they want to accomplish in their life.
Jeff: Very important stuff. Let's start to zero in on some of this stuff a little bit, businesses, financial future. You really do try to make an effort in addressing this on your website and how important it is for business owners to understand their business' financial health. Let me ask you, Gabrielle, from your experience, do you think that most business owners actually have a pretty good idea of the financial health of their companies, or is it difficult to see the truth through some of the numbers in our ledgers, and our P&L statements and what they're telling us?
Gabrielle: Yeah, sure. I think a lot of companies really don't know where they're at financially. I was doing a Periscope and it was interesting because they were having a conversation about their financial health and where they're measuring their numbers, are they keeping track of things. I had several people actually reach out and say, "I really don't know where I'm at." That is a big problem in small businesses and that's the thing. That's the reason why you have accounting, and that's why you have financials. It's not just for the end of the year tax season, it's for planning, testing, and seeing if what you're actually doing is profitable or not. And so we break down those numbers, break down those processes, and help business owners really decide if the value that they're bringing to their customer is actually profitable or not.
Jeff: How true is this statement that many business owners tend to overestimate the value of their companies because they don't have a clear understanding or grasp of the accounting procedures, or what the numbers may not in fact be telling them?
Gabrielle: Right. I think that's true. A lot of times there's an emotional attachment to your company. And you know all the blood, sweat, and tears you had to go through in order to create that company. And so they don't take into consideration what their true value would be when they do go to sell. And so they get before a CPA or an expert in valuation and they get bad news because they aren't measuring the right things. And so if you're looking to eventually sell you should be looking at those and measuring those as you grow your company to really see what you're going to be selling in the future.
I had several people actually reach out and say, "I really don't know where I'm at." That is a big problem in small businesses and that's the thing.
Jeff: Let's figure out then what a business owner has to do or where they should start in the assessment process to start to kind of drill down to see where their issues lie and what needs to be fixed in order to lift that value up to a level that they think their business probably should be.
Gabrielle: The very first thing that most people interested in buying are looking for a profitable business. Depending upon their goals and what they're trying to accomplish, that's usually the first thing that they start to look at, is it profitable, and is this a good idea. Of course usually the numbers do not lie. And so once you look at profit and determine that this is indeed profitable then you go and you start to drill down into the figures as far as the cost of the product to make it, basically the cost of doing business. You start to drill down further and further. You would jump to the balance sheet, make sure that the assets that are on-hand are going to be continuing to produce at the level that they're expected to, and are they fully depreciated, are they 10-year assets that only have a year left maybe, are they going to have to reinvest into this business to keep it going at the speed that it currently is. And you also need to look at your customer lists and things like that to see if there's true value in that customer list and to see if you can grow other lines of services to those same customers. There's a lot of different things to evaluate when you're looking at the value of this company. That's just a few. Profit and loss, balance sheet, look at your assets, and customer list I would say are probably the top three.
Jeff: You're listening to Deal Talk, my name is Jeff Allen with my guest Gabrielle Luoma. She's a CPA and owner of GMLCPA LLC in Tucson, Arizona. Gabrielle, when you go in and you've been contacted by a business owner and they ask you, "Gabrielle, I'd really interested in having you come in and take a look. Something's not quite right but at the end of the day I'm really just interested in maybe having you do the sanity check for me." What oftentimes do you find through your investigations and going through the books and talking with these business owners do you find is a common weakness that most business owners seem to share, maybe they're not aware of, where you can see that might be contributing to significant losses in those companies?
Gabrielle: I think a lot of times what business owners do is they truly don't understand how to pay themselves. And so there's a lot of co-mingling of funds. That's probably the number one thing that I see in small businesses, and we're talking small, below a million dollars. You probably see a ton of closely owned companies that are co-mingling funds. It's hard to actually see what their profitability is.
There's a lot of different things to evaluate when you're looking at the value of this company. That's just a few. Profit and loss, balance sheet, look at your assets, and customer list I would say are probably the top three.
Jeff: Let me ask you something, when you say co-mingling of funds, is this out of necessity? They feel like they have to take and blend these funds in order to maybe finance the expense of having to pay for equipment, or machinery, or parts, or supplies, or whatever their business might be. Or are you talking about co-mingling in other areas?
Gabrielle: I would say it's in both areas. Lots of times a business owner will have their own personal funds instead of actually loaning the money to the company, they just go buy the asset. Of course you can go back and properly account for that but rarely do they. So you go to their balance sheet and there's a bunch of assets that are missing and haven't been recorded because of an off balance sheet transaction that took place. Then you also have those situations where they're not really sure how to pay themselves. Should they give themselves a pay check, should they be taking draws? And it depends on the type of entity of course but it's a big problem legally if things go south in one way or another. Co-mingling of funds, buying your personal groceries, whatever it might be that would also throw off your financials and not give you very good readings as far as the profitability of the company.
Jeff: Are those easy fixes for you to go in and you sit down with them, and you talk things over, and you say, "No, this is what you're going to do starting next Monday"?
Gabrielle: Yeah, absolutely. We can go through the whole financial statement, income statement pretty much sitting down for an hour and can identify things fairly quickly and say, "This is not what you should be doing. This is not going to help you. This is how you should pay yourself" - things like that in order to really get them on track. It's a really simple fix but it's not when you are in trouble.
Jeff: Let me ask you this, is it sometimes uncomfortable for the client to see this because maybe they do understand it, they do know exactly what it is that they're doing, but they don't know that it's wrong. Or is it uncomfortable for them because they're thinking, "This is not something we can sustain. If I make this change I'm not sure that we're going to be able to make it. I'm not sure that we're going to be able to sustain the change.”
Gabrielle: Sure. I think there's a lot of fear that's around the financial statements and numbers in particular. I find that a lot that because they don't understand it there's a fear around it. And quite honestly it's just changing how you see your financial world. It's really not anything different from what they're normally doing. They just happen to be co-mingling the funds in their business. It's all showing up in their business where it shouldn't be. A lot of times they feel like they've gotten their hand slapped as well. "Oh yeah, I know I shouldn't have done that", all those other things. Now, you bring in a CPA, you bring in somebody to help you be more accountable. You say you want to be successful so bring in somebody that will help you stay accountable and do the right things. And that's what we really do with our business owners is, "This is what you said you wanted so let's make sure that we're going to help you meet those goals.”
I think there's a lot of fear that's around the financial statements and numbers in particular. I find that a lot that because they don't understand it there's a fear around it.
Jeff: Better to have Gabby slap your hands than the IRS slap your face, or punch in your gut, or whatever it needs to be.
Jeff: Very good points, and I think very important indeed. How does this new understanding, this awakening, that business owners might have one day when they talk to you, or they talk to their CPA, or someone who's kind of involved in a more forensic kind of way, how does this impact one's exit strategy? Because I think a lot of, certainly our listeners to Deal Talk, they've got plans on leaving their business at some point and maybe they've gotten an early start on making those arrangements. Really, if they had to do it in a pinch this is probably not a good time for them to leave. Does this cost people oftentimes to have to change those exit plans that they have so that they can get things right?
Gabrielle: Sure. I think that you have to start looking out, depending on your goals, when you're trying to actually exit your company you have to first make sure your financials are in place. That is usually when people start to realize, "At some point I'm going to have to sell my company and I don't want to be doing this forever. I think maybe in five years, or two years, or whatever." That's when they start seeking out professional help a lot of times. And so certainly plans might have go change due to just the way that they've been handling their business for the past, it could be 20 years. You have to really go back, make some changes, and put together a plan B.
I think that you have to start looking out, depending on your goals, when you're trying to actually exit your company you have to first make sure your financials are in place.
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Jeff: Welcome back to Deal Talk, I'm Jeff Allen with my guest Gabrielle Luoma, owner of the GMLCPA LLC in Tucson, Arizona. She herself is a CPA and a chartered global management accountant, and we thank her so much for joining us today. It's been fun so far. Now we're going to switch gears just a little bit, Gabrielle. There are so many things that we could talk to you about and may have to actually have a second show to fit all of these things in and we'll do that in another time. But I'd like to start the second half.
We're going to talk a little bit about selling a business. I was just kind of wondering, how does one really know, to start the second half, the right time to sell his or her company? Is there a right time, is there a perfect time? We've always been told, for example when we get married that there's never a perfect time to start your family or to have that first child. But with regard to your business a lot of people sometimes confuse their business with their children, and for some people that's exactly what it is, it's their child. How do you know when it's the right time to let go?
Gabrielle: I think it's different for everybody. I don't know that I can make a blanket statement, but I think you have to really look at your goals and what you want to accomplish in your life. A lot of times what happens is the business becomes your life as you mentioned. It becomes your child. It's your baby and you cultivated it up from a little seedling. And so there's a lot of emotional attachment to it and sometimes the best course of action is talking to a professional, because they can actually help you break away from the emotional side of it to this needs to be a business transaction. From there the best thing would be to look at what you're trying to accomplish. If you're 60 years old and you would like to be fully retired by 65 then what do you need to do in order to make sure that that happens? If you're an entrepreneur, let's say you just started a company of great ideas, and you think that you would like to get it ready to be actually sold in a year or two. Then you would put together ideas and ways that you would go about doing that. The best time would obviously be when the company's performing its best. That's a really hard time to let it go actually, but that's probably when it's the most attractive. And rarely do people actually give up their companies when that happens, unless you're an entrepreneur and you just spin off ideas like crazy. I would say that decision is a case-by-case basis but usually it's when you're on top.
Jeff: How many of the people that you work with, Gabrielle, can you say the timing was really, really good where they had their exit strategy in place and they said yes. Maybe they've re-worked it a bit. "Okay, I'm going to retire in five years and sell my company." And then five years come up and things were right on top, everything was great, business was booming, and they were able to take and make, bank, the transaction of their business, and everything worked out really well.
Gabrielle: I've been involved in several. One was actually a solar company, and it was right before solar really started to take off and all these credits were being given out by the federal government. And so that was a great opportunity for them to sell, and move on, and fully retire. And I think that what they were doing that along on the way was actually cultivating relationships, getting ready for that situation so that when it was time, it was time. And so they were actually able to go out fairly on top. I've also seen other companies who have developed and developed and developed, and they had a small company that, let's say it's an $80,000 a year company. It wasn't a big company but it was their lifestyle company that they actually raised their family on. They got to the point where they were ready to retire and another company was able to come in and just buy them out straight up with a cash deal. And so for them that was successful, that's what they were looking for. It doesn't happen all the time but I would say 50/50. If you're planning and you have relationships, and you've been doing some networking and kind of trying to keep your ears and eyes open then I think you have more chance of a very successful deal at the time you're ready.
And so there's a lot of emotional attachment to it and sometimes the best course of action is talking to a professional,
Jeff: Let's say I'm thinking about selling my business or exiting my business at some point but I'd like to know what the options are that are available to me when the time comes. Can you talk to us a little bit about some of those options that are available out there?
Gabrielle: The first option and the one that most people just think about is somebody just coming in and buying them right out. They come up with an agreement and then they just settle. Usually that requires you to have some sort of ongoing relationship so that you can keep that company going. Rarely do I see you completely get out of that company right away. But that does happen. So there's cash deals. And then there's opportunities for a key employee or you want to bring on a partner. It could be one of those two different combinations. So a key employee who really would love to take over the company, they've grown up through the company and they're ready to buy you out. That's a great opportunity so you should always be looking around to see if somebody in your company is interested and capable of taking over when you go to your next situation, whatever that is. And then of course taking on a partner, somebody who is already in the business, who already understands what's going on in the industry could come in, become a partner, while you phase out and then they eventually buy you out in stages. Those are a few of the different ways I've seen companies be bought out.
Jeff: You touched on the $80,000 a year company as an example, and that's actually kind of a way to maybe frame this next question. If I've got a business and maybe it's not necessarily making money hand over fist, but let's say it's maybe on the smaller side of that. How am I going to know how easy it is for the prospective buyer to actually buy my company? Is there a way that I'm going to know for sure whether or not my company qualifies for bank finance, for example?
Gabrielle: I think that getting a banker involved really early on for the buyer will be really, really important. In that situation you might have a company who's much, much larger just be able to go in and do a full stock sale. So that may be an option too. But if somebody's coming in and wanting to finance, there's a couple of different ways of doing that. You could do a partial finance, you could go to the bank and say, "I want this much of a loan." Usually what they're going to say is, "I want you to put up 20 percent, 30 percent, 40 percent, 50 percent to go towards that purchase." You may have a seller financed where you're going to have to carry the loan for that large company and I've seen a deal like that. It was a few years ago but I did see someone who carried the loan for quite some time. And it was a large loan and it worked out great for them. You just really need to make sure that you have a good banker involved and then they're looking at all the different avenues to help finance any of the buyers that are coming along.
So a key employee who really would love to take over the company, they've grown up through the company and they're ready to buy you out.
Jeff: And looking out for your best interest too. After all, if it is your banker in fact they're going to be doing that. Typically what happens, do you get paid in one lump sum or do you take payments over time after the deal has been consummated?
Gabrielle: Yeah. So if you're doing a seller financed situation then you would get a lump sum. And sometimes it's on the back end too so you'll do a small lump sum in the front just like a down payment then payments for however long the duration of the loan would be, and then a big lump sum at the end. So that that new business owner can create some credit and get some traction underneath them, and then they can go to a bank in three-five years and ask for a loan to pay off that lump sum. That's kind of the reasoning behind doing something like that.
Jeff: Gabrielle, it looks like we're almost nearly coming to a full stop here on this show. You look up and there's the clock, and time flies when you have a good time. And that's exactly what we've done. I hope that you've enjoyed yourself. Real quickly though, what I wanted to find out. I know that there are a number of people listening and they probably like to get in touch with you. They've got some questions and maybe even for the purpose of potentially working with you at some point, how can they reach you?
Gabrielle: My website at gmlcpa.com is a great place to start. You can contact me through firstname.lastname@example.org, or call our number at 520-572-1248 and just ask for Gabby and we'll get you all set up.
And sometimes it's on the back end too so you'll do a small lump sum in the front just like a down payment then payments for however long the duration of the loan would be, and then a big lump sum at the end.
Jeff: Fantastic. Gabrielle, it has been a real pleasure. It's been a very informative session today and I hope that we can have you back on again on Deal Talk real soon.
Gabrielle: Yeah, that would be my pleasure. I would love that.
Jeff: Gabrielle Luoma, CPA and chartered global management accountant has been my guest today and we thank her so much for joining us.
If you're a professional who normally consults with small business owners, a serial entrepreneur perhaps who owns multiple successful businesses, or a small business owner who has sold a business and you'd like to share your experience with our listeners we'd like to hear from you about joining us as a possible future guest on Deal Talk. Simply give us a call at 888-693-7834.
Deal Talk is presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. If you're thinking about selling a business or buying one call Morgan & Westfield at 888-693-7834 or visit morganandestfield.com. I sure have enjoyed having you as our listeners today and hope that you'll tune in again soon. My name is Jeff Allen, thanks again for listening to Deal Talk, we'll talk to you again.
Jeff: Welcome to Deal Talk brought to you by Morgan & Westfield, I'm Jeff Allen. If you're looking to sell your company now or at some point in the future it's our mission to provide information and advice from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.
Private equity firms equate to big business both in their own industry in investment banking, and of course in those businesses they invest in. Now more than ever even the smallest of small businesses are benefiting from private equity investment. Your business could be one of them. To fill us in on the subject of using private equity to fund private business I'm joined on the Morgan & Westfield guest line by Mr. Phil Brennan, managing partner of Go Capital. He's made his career out of investing in business across a broad spectrum of industries generating less than $50 million in revenue. Phil Brennan welcome to Deal Talk sir, it's good to have you.
Phil: It's great to be here. Thanks for having me.
Jeff: Phil, I was wondering, so much has changed in over really the last 25-30 years and so many people have kind of jumped on the business ownership bandwagon during that time. And really sometimes when you're trying to run your business, despite all of the media that's available to you, despite the Internet and being able to look at the Wall Street Journal at a moment's notice, and watch CNBC, and do all these other things that a lot of folks are interested in the news do, many folks are simply trying to run their business and they're caught up in the day-to-day. And they may not necessarily know about all of the resources that are available to them. And what I thought we’d do today on the program, Phil, is talk a little bit about private equity but we're going to kind of attack this from, first I think kind of an elementary perspective. And what I thought I'd like to do first of all is just kind of get a ground floor explanation from you, the difference between for example, a private equity investor, venture capital investor, and an angel investor. Most of us are already familiar with the terms but could you just kind of set the record straight, the difference between those three.
Phil: Sure. I can give it a try. I'm not a venture capitalist or an angel investor so I should throw that out there first as a disclaimer, but I'm happy to give it a go. I think private equity, when you hear that term it's really a reference to a group of investors who look to invest in companies that have established track records. So the types of companies they invest in have typically been around for a while, they’ve proven a model of earning revenue and typically also profitability. And they've reached a stage in their life cycle where they’re ready to take on new capital and a new partner. And that could be triggered from a bunch of different reasons. It can be for growth, it can be because the owner wants to take some "chips" off the table in the form of a liquidity event. But the general theme is that these companies, they're not new, they're not ideas, they're real businesses with teams, with revenue, with profits, and with customers. If you contrast that with a venture capital firm, venture investing, a lot of that tends to revolve around the idea of investing in an idea. Or maybe it's more than just an idea, it's actually a concept that's been developed into a business plan and there's a team but the business tends to be either in its nascent stages - perhaps it's generating some revenue but not profitability. And it's just earlier in its life cycle. And so what you're looking for in a partner is different. You're usually not looking for a partner that's there to create the liquidity event for the management team. Usually you're looking for money to grow. And so the whole process of evaluating those companies, valuing them, and investing in them is quite different from when you hear the words private equity investor, what they look for and how they invest. And angel investors are similar in a lot of respects to venture capitalists. When I hear the phrase angel I actually think of even a less institutionalized, less formalized process for investing in very small companies or ideas. And so it's probably more similar to venture investing than it is private equity, but even at an earlier and often smaller stage.
When I hear the phrase angel I actually think of even a less institutionalized, less formalized process for investing in very small companies or ideas.
Jeff: Are there some companies out there, Phil, that will actually take and perform two of those functions as a private investor, private equity investor, and venture capital investor? It seems to me that there are probably some big firms out there that might engage in both or have maybe different departments that engage in both.
Phil: There are. There's a handful of names that you read in the Wall Street Journal that at this point have developed teams and built business around investing in just about every type of investment class, asset class if you will. So those firms are out there. And there's plenty of hybrids that their model is to invest in both mature companies and early stage companies. I would say they're more of the exception than the norm though. I think most investors try to be good at one thing, stick to their knitting. And then from a branding perspective it's easier to articulate to the market who you are when you really have a clear, single focus. And so if you were to take a poll of the broad world of private investing groups, most tend to stick to one form of investing versus multiple.
Jeff: You should probably say too that you've got a depth of experience that goes back to working for one of the larger firms. JP Morgan is a matter of fact is one that you come from and so you have a lot to be able to contribute in the discussion and to talk to us about those types of experiences that you've had in working for those larger types of firms. What do you believe though makes one PE firm, private equity firm, more suitable than others for businesses that are looking to raise capital?
Phil: That's a very good question. I think it depends on what you're looking for as a business owner and as a seller. There are so many options out there in terms of the investor groups that you can partner with. You have to be really clear about what you're looking for. Are you looking for just money, or are you looking for an investor that offers more than money: operational expertise, strategic insights, relationships? Because certain investment groups, they will be very clear that we're money people. We make a lot of investments in different businesses and our time is spread fairly thin across all those investments. And really what we're here to provide is money for you and then sit on a board of directors and try to be counsel when we can. But that's about it. There are other investing groups that I think my firm Go Capital fits into more of this bucket that say, "No, we're not only going to be a capital provider but we want to roll up our sleeves and try to help you in the areas you need help." And so I think it's a question that the business owner has to ask themselves, is what am I really looking for here in a transaction? Am I looking for just money? Am I looking to exit completely or just get capital to grow, but I want the investor to stay out of the day-to-day, or could I use the help in whatever capacity I need the help? In which case maybe you're looking for that investor that offers that too.
There are so many options out there in terms of the investor groups that you can partner with. You have to be really clear about what you're looking for.
Jeff: Let's go ahead and let's kind of just camp out for just a moment right here on this point, Phil. When you're talking about helping out you're talking about contributing and being able to make suggestions in order to help a company perform at a higher level. Does that mean taking controlling interest of a company through your investment?
Phil: It doesn't have to. You can be a minority investor in a company but also play a more hands-on role. There are ways to structure those types of transactions, so it doesn't have to. But I would say the majority of investors out there, and also frankly the majority of sellers, are usually looking for a deal where the investor takes a majority position in the company. And often a company in that investment can need the kind of operational strategic assistance that I've described. But again, I hate saying there's a hard and fast rule because in the modern era of private equity investing there aren’t those rules that maybe at one time existed. There are just so many different models out there that you'll see minority investors who also roll up their sleeves.
Jeff: Phil Brennan is a managing partner of Go Capital and my name is Jeff Allen. You're listening to Deal Talk brought to you by Morgan & Westfield talking about private equity today. How does the process work? Are you scouting the businesses you want to have in your portfolio actively every day, the first thing you do when you get to the office in the morning, or do you also have business owners approach you saying, "Hey, I think we deserve a look. If you're not familiar with us we'd like to talk to you a little bit about what we do and see what you think."
Phil: I would love for that to happen but that rarely happens to be perfectly honest with you. So the short answer is we're doing a lot of the outreach. And that really comes in two forms. One is we work through a broad network of business brokers, investment bankers, and other, for lack of a better term, intermediaries who typically represent business owners and help them navigate the process of selling their company or selling an interest in their company. And so we've developed over the last 15 years a network of over 10,000 of these intermediaries, I refer to them as, spread across the country and we're regularly either emailing them or having direct conversations with them over the phone or in person about their current clients and whether those clients would be a fit for us. Then the other thing we're doing every day is reaching out to business owners directly, and that is done the old fashioned way. It's looking up their information online, it's attending trade shows, it's trying to attend as many events as you can where you get in front of business owners in sectors that are of interest to you, and it's developing a relationship, it's developing a bond where they view you as a strong candidate for an investor and then you get to know their business better and decide it's a place you want to put your firm's money. So those are really the two ways we find, source, and execute deals. Unfortunately, we don't get a lot of business owners talking to us directly but we would love that, we would encourage that.
There are just so many different models out there that you'll see minority investors who also roll up their sleeves.
Jeff: Let's talk a little bit about those types of businesses that you look at, that Go Capital looks at. The businesses and industries that are kind of in your sweet spot, that are attractive to you.
Phil: Well, we look at across a lot of different industry verticals so it's not an easy question to answer if you're just talking about industry. I would say it's easier to describe the size of the company we look for and then the situation. The size is typically a company that makes between a million dollars of revenue all the way up to 50 million in revenue annually. And earnings or even EBITDA which is a common phrase used in the industry which stands for Earnings Before Interest Taxes Depreciation and Amortization. And really it's a metric that people in our profession use to describe cash flow. We look for businesses that have cash flow or EBITDA between $500,000 and about $3 million a year. And so if a business meets that size criterion, we're going to be interested. Then the second criterion we look at is what is the situation. Is the business owner looking for a capital partner because they want to retire off into the sunset and just go do something else with their life, that is a very common theme because there are so many baby boomer business owners, that's a mouthful, reaching the point where they're ready to retire now but they just don't have a very good transition plan in place. And so we're there to help them in those situations. They've reached the point where they're ready to do a transaction. We would come in, provide capital, and actually roll up our sleeves and play some kind of role building out their teams so that they can retire and go off into the sunset and do whatever else that's next in their life. And so the whole retirement being a catalyst for a transaction is very much a situation that we're interested in. Another situation that we're interested in is we're a company that's growing. We've grown a lot more than we ever thought we would grow, and we need a capital partner to help us navigate all this growth. We're just in a little bit over our heads. We need help determining things like building out bigger teams, systems, all the kind of things that happen to companies as they grow from very small businesses to mid-size businesses. So as companies reach that stage and they’re almost crying out for help, we love getting involved in those situations.
My answer isn't a direct one. It's more driven by situation and also size than it is industry. But the truth of the matter is those are the most important things to us. It's a separate question but I could talk to you about some sectors that we think are hotter right now versus others. But we never lead with that as criterion because the other two criterion I mentioned are even more important.
Jeff: Involving a private equity firm to help fund your business to help raise capital to get involved, that's what we're talking about with my guest Phil Brennan, managing partner of Go Capital. I'm Jeff Allen and we'll be back on Deal Talk after this.
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Jeff: Welcome back to Deal Talk, I'm Jeff Allen with my guest Phil Brennan, managing partner of Go Capital in Chicago. We're talking about the subject of private equity and getting those outside your company involved in your organization. If you're looking to raise capital, if you're looking to take the next step, and that might include bringing on investors, then Phil Brennan has a lot of experience in that in his professional background. Phil, we so very much appreciate your participation today in Deal Talk. We're glad to have you. As we continue our conversation I'm kind of wondering how a business owner out there can make his or her company a lot more attractive to an investor. Maybe it's not something that they necessarily trying to do. This could be a company that quite honestly has seen some success, maybe it's one that you've missed and maybe they're trying to somehow maybe raise their own value or try to kind of get your attention. How do they go about doing that and maybe you can just kind of give us some tips.
Phil: Sure. I think putting myself in my own shoes the first thing we look for when we look at a potential investment is can they grow? I think a business that's in an industry that's just going to have a hard time growing makes for a tougher investment. So I think from an owner’s perspective it's being able to articulate what the growth path for the future investment partner would look like, and also a blueprint for how that growth would be achieved. I think to the extent you can really lay that out, really think hard about it than lay it out so that you can have a meaningful conversation with the potential investor about it you're going to be more likely to strike a deal because you're just going to get their excitement level, their enthusiasm, and their belief in your business up relative to where it was before. Beyond growth, I think it's having a strong history, so a track record of strong business performance. Things like lack of customer concentration or concentration around one specific product or supplier. I think bridging beyond those things and demonstrating some diversification is always a really good thing. But then beyond the stability of the business and its growth potential, some of the softer things. Don't take them for granted because they're just as important. And by that I mean a management team that's not only competent but can grow and evolve with the next investment group. I've seen enough businesses that generate a lot of profit and they've got a good track record of growth. But when you really need the team you're struck by how spread thin everybody is, and the lack of bench strength that there is to really support the business as it goes to the next level. A business owner needs to think about that and be willing to make the investments in people that they believe can grow and evolve as the company grows and evolves. That's a really important thing and I understand it's extremely difficult to do. But building that strong management bench strength is very important from the investor's perspective because these are the people that they're going to be partnering with for the future. And then culture is the last thing I would say too. It's amazing how much of culture can be driven by a business owner, often the founder or the entrepreneur of the business. And having a strong culture, one that they can be proud of but then also one that translates in terms of the investor's fit into that culture is really important. If you're a hard-edged, hard-nosed investor and you're looking at a business that doesn't have that same hard edge to it, you can't necessarily put that on paper what that means as far as future implications for the business. But I think having some alignment around some of the cultural aspects of business, whether it's how employees are treated or customers are treated, it actually is important. It's quite important, and maybe just as important as all the other things I mentioned. It's not one thing. I think it starts with growth but it's cultural fit and it's management, and it's stability as well.
I think a business that's in an industry that's just going to have a hard time growing makes for a tougher investment. So I think from an owner’s perspective it's being able to articulate what the growth path for the future investment partner would look like,
Jeff: So intangibles are given a lot of weight and really you're looking for companies that do business the same way that you do business. You're looking for standards that kind of equal one another, and I think that's really for both sides. And I'm glad that you pointed that out, Phil. When you have two sides that are coming together, or that have an interest in doing business with one another. You've got the business over here and then you've got the private equity firm over here. There is going to be I think a point where you'll decide, "Okay, we want to look more deeply at this as a real possibility here” and then you start to move forward with a process that we're very familiar with here on Deal Talk. We talk about this often and that's due diligence. How critical is it not only for the business owner but also too for your company to go through that process of due diligence, to make sure that you're making the right move and that this is also too the right move that the business needs to make as well?
Phil: Well, it's extremely important, and I understand from the business owner's perspective it can be a pain, it can be like pulling teeth because it takes a lot of time and energy away from the myriad things you have going on every day. But I would say it's important to the investor and it's also important to you, the business owner. And the main reason is it just helps both sides work through issues ahead of time that they're going to have to encounter down the road anyway. And so why not bubble them up before you close the deal so that both sides, A, have the best set of information they can possibly have about working together. And, B, you can actually start tackling those issues and seeing how each side thinks and how they work before you sign on the dotted line and move forward with the deal. It's just always better in a deal of this magnitude and importance to a business owner to really understand how their partner thinks, how they're going to respond to certain issues, and likewise for the investor it's great to know all those things for the business owner too. So it is painstaking but just keep in mind that every time you send along a document or answer a diligence request you're not only helping the investor get smarter about your business but you're creating that opportunity for each of you to work together through an issue and understand how one another thinks. And you're just one step closer to kind of hitting the ground running once you've closed. If you wait to do all these stuff til after due diligence you're going to have some speed bumps and you're not going to know each other as well as you should. It's just better to front load a lot of this, and get to know each other and get to know the business as well as you possibly can. So the short answer is: it's extremely important. And I think if you're a business owner it may not always feel this way but it's helping you out in the long run too.
Jeff: Phil, this is being redundant perhaps. I'm asking you to give us an answer that you've already discussed, I'm sure of it. But maybe you can just fill us in again the data that you scrutinize most heavily when it comes to looking at the documentation, the books of these companies during your part of the due diligence process.
Phil: Well, it depends on the deal. If I had to generalize I would probably say the financial information. And the reason for that is in the size of deals that I look at, the $50 million revenue company and smaller, there's just a lot of different ways companies prepare their financials, or don't prepare their financials. And getting them to a place where everyone is speaking the same language sometimes just takes more work. And by that I mean the typical business owner, maybe they're running their financials on QuickBooks and maybe they're on cash basis accounting. That's a very common theme we see amongst business owners. And the language of private equity and the language of businesses that are that next size range up is more of the gap generally agreed upon accounting principles language. And so there's a little bit of sometimes an education that goes on. But ultimately it's all good. And the reason is getting your financials in a place where the business owner can understand them extremely well usually means that you, the business owner, learn some things about your business that you didn't know before. And so that's probably the area that's most heavily scrutinized. But I think, again, in the long term it's value for both sides. You're going to also look at the makeup of your customers, that's probably the second most scrutinized thing. And often what you'll see investors do is actually reach out to your top customers and make phone calls towards the very end of a diligence process. Really, to kind of check the box on understanding who these customers are, validate that in fact the relationship does exist, but also just get a sense for how customers are talking about your business, and again that's important because as you think about growth you're thinking about, "What did we learn from the customers? What areas are we not meeting their needs that we could? Or what are some services that we aren't currently providing that we could in the future?" And so again, those customer calls very similar to the financial due diligence piece, I think business owners end up learning something through that process too. So hopefully it makes both sides better once they’ve closed the deal.
I think business owners end up learning something through that process too. So hopefully it makes both sides better once they’ve closed the deal.
Jeff: Let me do a sanity check Phil as we're kind of starting to wind down just a little on this edition of Deal Talk. Hypothetical, I'm running a business and business has been stagnant. In fact I'm falling behind and I'm just not bringing in the revenue that I had. Will private equity firms be interested in my business and will they be interested, are they ever interested, in businesses that some people might call distressed?
Phil: Sure. There's an entire group of private equity investors that focus on distressed companies. And so all is not lost if you find yourself in that position and there can be lots of reasons why you could be in that position. I think not unlike the private equity investors who don't focus on distressed companies, the key is going to be, again, laying out a blueprint for why are you in the spot that you are and what needs to happen in order for you to get out of it. And being as forthright, honest and open minded about that, it just encourages good dialogue and it makes the investor more comfortable with the opportunity. Because a lot of this, it really is psychological and it's getting an investment group comfortable in the opportunity that they understand it and confident in you. So even if a company is distressed, that the investor is comfortable, they grasp the opportunity and what needs to happen to turn things around, and confident in you then it might be your deal that they say, “This has a lot of potential because we believe in the team and its ability to turn things around and grow.” So the short answer is yes, they're out there. I'm not particularly one who focuses on that asset class but there are a bunch of investors for those situations that are great opportunities.
Jeff: Phil, I consider that actually kind of a positive way to end our discussion today. I appreciate your time. No doubt we've got some people in our Deal Talk listening audience who are kind of making some notes and also they've written your name down. And they may have an interest in contacting you, and I know that you talked about why you'd love to have business owners contact you who might be interested in having a conversation. How can they reach you, Phil, or your business partner? I understand that you've got a couple of different offices not only in Chicago but also too one in New York, is that right?
Phil: Yeah, that's right. Sure, there's more than one way. You can email us and you can also go to our website first to learn more about us. Our website is www.gocapllc.com. My email is email@example.com. And you can also reach me on my direct phone number which is 224-234-0779. And the website also contains the contact information for my business partner Chris Duggan who is based in New York as well. Yeah, we'd love to hear from anybody interested even if you're not sure whether you want to transact now or sometime down the road. We love just meeting business owners and learning more about their company and what they plan to do in the future. They’re fun phone calls and we're happy to provide more detail about the private equity world too. So regardless of your interest level or seriousness about a transaction we welcome all phone calls.
And so all is not lost if you find yourself in that position and there can be lots of reasons why you could be in that position.
Jeff: Great conversation and great value too. There's a tremendous value in networking and you never do know where those initial network contacts may end up. Phil Brennan, we're out of time. Thank you so much for joining us today on Deal Talk.
Phil: Thanks Jeff, I appreciate it. It was fun.
Jeff: Phil Brennan, managing partner at Go Capital has been my guest.
If you're a professional who normally consults with small business owners, a serial entrepreneur who owns multiple successful businesses, or a small business owner who has sold a business and you'd like to share your experience with our listeners, we'd like to hear from you about joining us as a possible future guest on Deal Talk. Simply give us a call at 888-693-7834. Deal Talk is presented as always by Morgan & Westfield, a nationwide leader in business sales and appraisals. If you're thinking about selling a business or buying one, call Morgan & Westfield today at 888-693-7834 or visit morganandestfield.com. For Deal Talk I'm Jeff Allen, thanks so much for listening. We'll talk to you again soon.
Fraud is a difficult subject to discuss without stirring negative emotions to some degree and creating a sense of heightened urgency and concern. I know. Fraud in its many forms result in the loss of millions of dollars for business owners each year. How do you know if you and your business have been victims? Well, it's not always easy to tell. But today we're joined by someone who knows what to look for and he'll share some of his insights. His name is Bob Bates. He's Chief Financial Officer at HP Accounting Services and also CFO of two other companies, PIQ and Velocity Data in the Bay Area. Bob Bates, welcome to Deal Talk sir, it's good to have you.
Bob: Thanks Jeff.
Jeff: You wear a lot of hats, Bob, and you've been around in sitting as controller and CFO of a number of different companies. You have a long history of being there on the front lines where the money comes in, where the money goes out, and kind of watching every penny for these companies that you've been with. How bad is fraud as far as far as a concern in American business today? Is this something that's getting worse? Are we seeing improvements in it? Just from your perspective?
Bob: Sure. Let me just preface it to say that I do deal with a lot of acquisitions and I’m a CTA and I'm also certified in forensic accounting and valuations. And so I've kind of come at this from different perspectives. But as far as like for example the American Association of Fraud Examiners, they do a lot of studies on how much fraud is out there and it's really a lot more common than people would think and until they’re actually a victim of it they just think of this as a bad word and it's something that isn't affecting them, and they feel this false sense of security. And so it's really important to be aware of what potential types of fraud that there are and warning signs, and have a plan in place really just like for anything else. Like if there was a bad weather and/or something that affects your location you have a plan in place contingency to get things back on the right track.
Jeff: How can fraud impact a business in terms of ... Are we talking about can it have top line impacts? How does it impact earnings and valuation? What have you found?
Bob: Really because we're kind of in the context of acquisitions. But even for somebody that's not looking to sell their business right now they need to be aware of potential fraud. And so I think that there's two categories of fraud that we should look at it in this context. One is obviously a seller can defraud a potentially buyer. There can be a potential fraud in that regard. But let's not go into that too much, let's think of the fraud that the company or the owners are a victim of. And you can break that down really into kind of where did that come from? Did that come from internally from an employee or did it come from some kind of an external perpetrator? And so there's so many fraud schemes out there that it's really important to be aware of what's come of them are and, like I said, to look for the warning signs. So I worked on two major – major for me, they’re six figures - and major for the company, two major fraud cases in the last five or so years. And so the first one was a situation where there was a bookkeeper who was basically paying some of her bills through the company. And that situation, they weren't even looking to sell, but you can imagine that that obviously skewed the earnings. And so the company was profitable enough that it wasn't as noticeable as it should have been. There was auditors in there, there were other consultants and finally I was the third set of eyes really to get in there and I was the one that discovered this. And so once you really add that again all of those expenses that weren't expenses of the business you all of a sudden have a company that was even more profitable. But on the same respects you have a bad connotation. When people looking at it, they don't want it to get out in the press. Or if they're selling it, it conveys a message to a potential buyer that the controls aren't strong. And so it's really important to consider the effects on valuation.
One is obviously a seller can defraud a potentially buyer
Jeff: Boy Bates, he is the Chief Financial Officer at HP Accounting Services, if you're just listening over someone's shoulder right now. And we're talking about fraud today and just how big of a problem it is in business today, and how it can impact your earnings valuation, and really just cause a whole lot of problems for you, particularly if you have an exit strategy in place and designs to sell your company at some point down the line. Bob, getting kind of back on track I recently learned of a small company here in my neighborhood that lost $70,000 because of fraud. Depending on how big your business is, $70,000 can almost be the kind of hit that you could take that could close up your company, I mean if it's a small mom and pop kind of operation. You mentioned an example where it was someone kind of paying their bills using company funds. I would imagine that that had got to be among one of the most common examples or illustrations of fraud that is out there today. We've heard of people going shopping and spending money on lavish gifts for friends and stuff. But I'm just kind of wondering, is internal fraud a bigger issue today than being defrauded by say a business alliance that you have or a business partner, or some kind of a deal maker that you do business with outside the company?
Bob: I think that the frauds perpetrated from the inside are historically more common. You have things, kind of warning sign. You look at a bookkeeper in a smaller company and you have to ask whether they have the means, the opportunity, and the motive to perpetrate a fraud. But it's interesting, and I think it's important that people be aware of the external frauds because the second fraud case that I was involved with, it was just this year and it's people that I work with. Basically what happened is that there's these crime rings out there and one of them is for example if you're the CEO and I'm the CFO of a company, and you normally tell me what wires to send out. What these groups do is they'll spoof your email and they'll send me an email that says, "Please send us $25,000 today" and it gives the wire instructions. That's an electronic cybercrime. And I think it's because of the cyber nature of it that's why it’s newer in the last 10 years or so. And the particular instance that I was involved with and got involved with the investigation and worked with the FBI on and so forth was a purchase order fraud. And so what this group did was they pretended that they were the government. They sent emails with military extensions and we even talked to them. Some of the people that I worked with talked to them on the phone before the orders were placed. So they placed hundreds of thousands of dollars of orders for computers and they actually used military addresses to have them shipped to. So everything ... but that point sounds okay, right? So you're making a profit and doing a bunch of business, this is ... maybe even a customer that you've dealt with before. Well, lo and behold a month later there's no payments coming in and things start to unravel and then all of a sudden the FBI showed up. What they did is that these people would work with FedEx to have the packages picked up from FedEx or have ... where they had some contact in the military or they knew enough about the military to redirect things from a regular loading dock at one base in Seattle and ship it across the country to a barbershop in Virginia, on a military base still. And so it's really amazing how brazen some of of these people are. It's really difficult to try to set-up controls for all of these things. But if you keep a good eye on all of your vendor lists and your customer lists, and look for any warning signs. If it's a government order people probably aren't going to be in a rush because the government isn't necessarily in a rush to do things, they go about things with procedures and so it's really just a matter of kind of having a sense of what's going on in your business.
Jeff: The idea of fraud, it's very clandestine. Some of these plans are so well thought out, they're so detailed. And every consideration is made it seems that there's kind a backup plan if things don't go well for the people who are committing the fraud. And the fact that it involved the military addresses and things like that. Anyone in their right mind just kind of doing their everyday job wouldn't question people like that, they wouldn't think of it. It doesn't sound like something that would be of a big concern. You have on your website hpaccounting.com, Bob, you've got some ideas for some things that one can do, a business owner can do to kind of ward off the possibility of fraud, or certainly reduce the risk a little bit. We'll just take a few of these items and we'll go kind one by one on these. And the first one I think you have here is probably the most important and that is communicate to employees. Everybody thinks that they've got a great team set up, but everybody's busy doing their jobs and they're not always looking for things that aren't quite right or on the look-out for those types of things. Just kind of talk a little bit about the importance of the employees in getting everybody on the same page there.
Bob: I think that really setting the tone through communication from management to employees is important so that employees are respected but at the same time they're made aware that there's controls there, whether the company is audited or whether there's the CEO or COO, somebody in a senior position is reviewing the work. They're reviewing things randomly, they're reviewing things thoroughly, and whether it's opening the mail before the accounting people open it, or it's looking at who are the check signers, comparing signatures on checks. There's so many things that can be done, and I think it's important for employees to take regular vacations so that if there's been some kind of a scheme set up that all of a sudden there’s an inconsistency and it will unravel. All those things are important.
I think that the frauds perpetrated from the inside are historically more common. You have things, kind of warning sign.
Jeff: Controlling the mail room, Bob.
Bob: Yeah, I think that's really the center of where a lot of things start. If you've got an employee that's set up fake vendors, they're going to try to go around the normal channels. And so you can only do that to a certain extent because, obviously, the true vendors are going to send their invoices, sometimes by email now. But the historical way is through mail room and so that's really one of the most important areas of the company from a control standpoint.
Jeff: This next one too, we're going to take a break in a minute, Bob, but I want to get to one more here. Review bank statements before your bookkeeper. Tell us a little about that.
Bob: Yeah, that's most of the company’s financial happenings really. So you don't want the opportunity, and obviously it seems far-fetched in some situations but you’ve got bookkeepers out there who will actually make alterations to the bank statements. So this is why auditors during an audit will request the bank statements directly from the bank. It's really the source of the information, where did it come from? Is it direct or did it go through multiple channels where it can be altered, and that's the risk.
I think that's really the center of where a lot of things start. If you've got an employee that's set up fake vendors, they're going to try to go around the normal channels.
Jeff: Very important right there, Bob, and we're going to kind of just leave it right here for the moment as we get ready to take a break. We're talking about fraud and we're talking about warning signs, we're talking about how you can try to eliminate some of the issues before they become a problem and then contribute to all kinds of issues including reduced earnings. And worst of all really reduced valuation of your company. Because if you've been working very hard at building success for your company, for your employees, and you've got a plan to leave your company at some point, sell it off, and then all of a sudden you get down to the end of the line, you find out that you've been ripped off and for whatever reason you haven't been paying attention, you could come to a point where everything you worked so hard for could be in the toilet. My name is Jeff Allen and we're going to be back with expert Bob Bates. He's chief financial officer of HP Accounting Services, also CFO of two other companies, PIQ and Velocity Data in the Bay Area and a lot of experience in this area. And we're going to continue our conversation when Deal Talk resumes in just a moment.
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Jeff: Welcome back to Deal Talk. I'm Jeff Allen with my guest Bob Bates. We're talking about fraud. We're talking about how you can work to prevent it, and what you should do once you've discovered it. And I think that's kind of a good place to jump off here for the second half of the program. Bob, it's not always easy we've heard for people to understand the severity of the situation that they may be involved in particularly if they're just getting this idea that things aren't quite right, that money is somehow walking out the door. I guess the question here is: if one suspects that his or her company is the victim of fraud, what should they do? Is there a call that they need to make to a professional in that area first before they do anything else?
Bob: Yeah, I think they want to try to gather as much information as they can without attracting attention. Because if you've got somebody who's perpetrating a fraud from within then you want to be able to contain them. And so you don't want them to run off. Because the first fraud case that I've mentioned there was this situation. What happened was the CEOs eventually contacted the police. They worked with us. We were acting as financial consultants, CPAs, advisors, and then there were lawyers involved. And so one of the first steps legally after it was confirmed that this person did perpetrate a fraud was to put a lien on their house. So in addition to going to insurance and doing all these other things they want to try to be made whole. And so you have to consult with people that have gone through this before. You also don't want to spend all of your time on it. One of the owners was actually really kind of hit hard by this. He felt kind of dumbfounded and he probably felt embarrassed, with all these people looking at his company and he didn't realize this was going on. And so you want to try to get some help.
Because if you've got somebody who's perpetrating a fraud from within then you want to be able to contain them. And so you don't want them to run off.
Jeff: There's obviously a due diligence process that is involved. Is that due diligence that one would do obviously using some professional assistance, probably maybe of a forensic accountant? And I know that Bob, you've got some experience in that area. The due diligence process, is it much different from the kind of due diligence that one would do when they are preparing to sell their company?
Bob: It becomes more detailed, but I think at the beginning when I first went into that situation I was really scanning through all the detailed transactions. But the problem with getting summary reporting and just your basic financial statements which is something that a buyer would ask from a seller is that they don't really tell the whole story. And so you really got to have an accountant in there to go through the general ledger. It's great to even have an audit done before you buy the business. On the other hand, when you're looking at a fraud examination you're starting from that point. But that's where you go down a different path because you bring in people that deal with fraud examinations, you use special software perhaps. The larger the fraud, you have to go through investigative techniques. You may be interviewing suspect or other employees, and those types of things a lot of times are best done by a professional. So they start out the same way but they definitely branch off into two different directions.
Jeff: Bob Bates, by the way, if you're just listening over someone's shoulder we talked about this at the front. He's got a lot of experience as the controller and CFO of several companies. He's currently CFO of three companies right now as it stands at least. That's what his LinkedIn profile says. He told me his website was in need of a little updating and so we know that he probably has a lot more experience in maybe what that shows. But he's talking from really the perspective of someone who's had a chance to really kind of be in once again on the front end of the checks and balances so to speak, the financial operations of the companies he's been contracted to help and those he's worked with. So he knows what to look for. He understands the warning signs, and he knows what business owners are up against. And really when it's your business you need to kind of step out a little bit. You talked about possibly embarrassment and all the other emotions that come with this discovery, Bob. And we find out yet thousands of victims every year, business owners, some of it more serious than others. Fraud really is something that has been around forever and will continue. It's just a matter of being a lot more diligent and understanding the comings and goings of the money in your business. I wanted to touch on just a few before we continue our conversation in detail on a few of the fraud checklist items that you have on your website, and we'll touch on just maybe two or three more. And it goes back to maintaining current and accurate accounting records and why that is so important. But if you could just kind of maybe repeat maybe some of the things you've talked about so far here and why it's so important to keep such accurate tight records, that would really be helpful.
Bob: It's important to keep the books current. That's a red flag to a buyer, to even a CEO. We've looked at people that I work with and I looked at hundreds of acquisition opportunities in the last decade. We've actually gotten fairly close on 25 of those and we've purchased a dozen. And I would say that having the books and records current or auditable is probably the most important thing that we've looked outside of is it the right business to buy and will it further our goals. And one of the reasons for us is that we deal in the public company environment a lot and so in that situation it's going to be audited anyway. It's easier to get it audited before you buy the business or simultaneous with even if you have to pay for it. It's just the cost of the transaction. Once you've got those audited statements you have a lot more confidence. If you're doing some type of adept purchase then the lender's going to require that anyway. And so it's probably up there at the top three things that is really part of the due diligence process.
And so you really got to have an accountant in there to go through the general ledger. It's great to even have an audit done before you buy the business.
Jeff: Another one, monitoring your approved vendor list is also one of these items that you have on your fraud checklist as well.
Bob: Yeah. So that's where in that first fraud case what happened there was that when I was scanning through all the detailed transactions I noticed that there were just too many checks cut to the bookkeeper and sometimes in a small company, it can be done out of convenience because perhaps there's not a credit card in that person's name and they used their own money and then they get reimbursed. But it really gotten out of control. And in some frauds people will go and set up fake companies. So they're issuing checks to Mick Cafe or something and there is no Mick Cafe. So they've created a company with that name. They've actually gone and set up a bank account and that's how they're taking the money. So the CEO or whoever's in charge is going to know that that's not a vendor that their company has ever dealt with or should be dealing with. And so that's the red flag.
Jeff: I think maybe a way that we can end this discussion today, Bob, on this particular segment is just kind of gaining an understanding of if you cannot get your arms around the fraud situation at your place of business, if you choose not to for whatever reason. Maybe you don't think it's a big deal. Maybe it's just a few thousand dollars from what you can see. But actually the problem may be much more grave than that. Tell me, if fraud is not uncovered and dealt with in a company and eliminated it can kill an M&A deal, can it?
Bob: Sure. It’s a red flag and reduces the confidence of the buyer. And it can kill the company even if it's not being sold. Obviously from a financial standpoint the company that I was dealing with that had this fraud with the government situation with the fake POs, now they've had to go to all of their vendors and ask for extended terms. Because they were already maxed out with their bank facilities. And so it really creates a huge mess.
It’s a red flag and reduces the confidence of the buyer. And it can kill the company even if it's not being sold.
Jeff: Bob Bates, you have some outstanding credentials. You have a tremendous depth of experience and some knowledge that I think would really be important to share with our listeners. If they've got questions and they would like to talk to you about their own particular situation and perhaps even talk to you about coming in as a consultant to help them eliminate some of the issues that they're having. And it doesn't have to be fraud related issues. You're a CPA, CVA, so you can provide some assistance where valuation is concerned, any questions like that, how can they reach you?
Bob: Sure. My website is hpaccounting.com and my phone number is 415-264-0984. And my email is firstname.lastname@example.org.
Jeff: Bob, we do appreciate once again you joining us today on Deal Talk and sharing your wisdom with our listeners and I hope that it gives them some things to think about when it comes to understanding just how important fraud is around the country in businesses today and that they just cannot be too careful with those numbers. Thank you again for joining us.
Bob: Thanks, Jeff. I enjoyed it.
Jeff: That's Mr. Bob Bates. He's Chief Financial Officer of HP Accounting Services, and also CFO of two other companies. He's based in the San Francisco Bay Area.
If you are a professional who normally consults with small business owners, a serial entrepreneur who owns multiple successful businesses, or a small business owner who has sold the business and you would like to share your experience with our listeners, we'd like to hear from you about joining us as a possible future guest here on Deal Talk. Simply give us a call at 888-693-7834. And by the way, that number I gave you is also the number to call for information on business sales and appraisals from our proud sponsor Morgan & Westfield. Deal Talk brought to you each and every occasion by Morgan & Westfield, the number again, 888-693-7834 if you're thinking about selling a business or buying one. You could also visit by the way morganandwestfield.com. For Deal Talk my name is Jeff Allen, looking forward to talking to you again soon. Thanks for listening.
Trisch: Well, first and foremost, most people’s businesses are almost like children to them, in the respect that they created the business, they raised it, and they brought it up. And by the point that they reach out to me, this is their fully-grown child, in terms of a good analogy. And they’re looking to basically set it free to the world, and it’s very sensitive process. It’s a very technical process, but it’s also a very sensitive psychological process, in which a good appraiser has a number of different attributes that aren’t necessarily found or known about by just reading a bio. Maybe just being referred to somebody, which is why I always suggest that whomever I’m working with, or if I can sense in any which way that they might be uncertain about either the monetary involvement to get their business evaluated, or the fact that there’s so much information that I need to delve through, that they meet with a couple of different people.
So they can really get an idea as to the comfort level that they have with the chemistry of that individual and themselves, and also find out about their technical knowledge and the background that they have in terms of how they’ve applied their expertise in the past. So there are a number of CPAs, accountants and so forth out there that have the smarts undeniably to do it. But it’s a matter of finding the complete package to take care of their child, of the client’s child, going back to the analogy, and preparing it to be set free, and to get the most money for the hard work that the business owner has put in terms of growing the business. So it’s extremely important to find all of these different characteristics in a good fit. And you will be working with them, the client will be working with me on average, anywhere, well, it depends on the specific case, but anywhere from a minimum of two months to upwards of a year. So you really have to have somebody that’s smart and somebody that you have good chemistry with, it’s extremely a sensitive process.
Most people’s businesses are almost like children to them, in the respect that they created the business, they raised it, and they brought it up.
Jeff: Trisch, let me ask you a question, are there certain strings in particular, or key attributes, as you talked about just a moment ago, that really stand out? For example, if someone were to come to you and maybe they had questions about your background or your qualifications, are there a couple of leading qualities that you would lead with to explain to them how you are best qualified or suited to help them as an appraiser? Something that I, as a business owner, would really, really be interested in knowing about you?
Trisch: Well, I think besides my background or another expert’s background, in terms of the work that they’ve done in the past, to be able to show that they actually have the work experience, it’s also important to find an expert that has experience within the certain specific service and niche sector that you’re looking for expertise on. So for example, there are many generalists out there. I have a couple of different areas, like medical, facility services; there are a number that I specialize in. And I’m a certified business valuation analyst and financial forensic expert. And so it’s important to find not simply an accountant, but someone that has the specific training to do a business valuation, to do the financial forensic work that you need to have done within the sector that you work within.
Jeff: That’s really important to know because I think sometimes we’re led to believe that appraisers just like any other type of business, you might be able to just simply go to an online resource, pick an appraiser and they’re going to be suitable, provided they have the background and the qualifications to help you up. But it really does, I think, bear some careful consideration that one needs to look for someone who has a fair amount of experience really treating those businesses that are key in your particular industry, or sector as you put it, to help you out rather than just go and find someone around the corner who’s been in the appraisal business for a long time and has extensive experience valuing businesses regardless of their industry. You want to pick someone who has experience who specializes in your particular industry or sector. So I think that’s very, very important news. Now, is there a resource online or a tool that someone can use if they are just embarking on their research right now to look for an appraiser that you might recommend, or what are some ways that they could approach their search? Where should they go? What kind of resources should they consult?
Trisch: Well, I am a member of the National Association of Certified Evaluators and Analysts and I’m one of the state chapter presidents, so I’m very biased towards NAPFA, which is the acronym for the association I’m certified through. But, there are a number of associations, or a handful, I should say - AICPA, NAPFA, ISBA. And on all of these different association websites, there are directories. If I was thinking of myself as someone that was seeking my service, I wouldn’t feel necessarily comfortable just blindly reaching out to someone on one of the association websites, not because they wouldn’t be qualified, but just because I would want to have a referral or maybe do a little bit more research beyond through their website, looking at various articles that they’ve written that show their expertise, that might give examples of testimony that they have given, or different cases that they have worked on and have that peer-based different resources to reach out to. So I think that where you could start, would be through one of the association websites and begin your search. You want to find a site, originally, that has plenty of business valuation analysts to be found.
I wouldn’t feel necessarily comfortable just blindly reaching out to someone on one of the association websites, not because they wouldn’t be qualified, but just because I would want to have potentially a referral, or maybe do a little bit more research beyond through their website.
Jeff: She’s Trisch Garthoeffner, Founder and President of Anchor Business Valuations and Financial Services LLC. And I’m Jeff Allen, you’re listening to Deal Talk, brought to you by Morgan & Westfield. And Trisch, again, we appreciate you taking time out of your schedule today to chat with us about these important ideas, and about the thought to considering the idea of finding a suitable appraiser, and the best appraiser possible to help people with the valuation and appraisal of their businesses. Now, I’d like to shift gears just a little bit and talk about reasons for getting an appraisal; maybe not just an appraisal for the purpose of preparing for the sale of the business, but maybe there are some other really important reasons for gaining an appraisal. Can we talk about some of those? What are some of the reasons that a business owner would come to you, Trisch? Maybe they’re not selling their business right away, certainly, or they’re not looking to do so even in the shorter or medium-term, but what are some other reasons that people might come to you?
Trisch: Sure. I actually served in a public company business valuation sector for a long time, and in the public company in which I worked. We did business valuations for underwriting, and in terms of the analogy for the private company sector, it would be for SBA loans. So business valuations are needed if a private company is seeking an SBA loan. Typically, a bank works together with the business owner to refer them into somebody or the business owner, I always suggest, find somebody on their own so they can be assured that it’s a non-biased opinion.
But actually, when I started my own business, I had found a need in this area for a state and gifting valuation. So whenever a gift of a portion or an asset is done for tax purposes, the IRS suggests or doesn’t suggest it. It demands that a valuation is put into place. And there are guidelines that are put forth by the IRS that are provided by business valuation analysts such as myself. So for gifting, I do a number in this area and then matrimonial is an area in which there’s a high demand. A lot of times, I get pulled into a case in which there is a dispute as to the value of the business, and an outside expert needs to be brought in to assign a value to that business. And very rarely does that business ever go through a transaction…it’s in order to put a value on it, to divide that asset.
Jeff: So, Trisch, I have, let’s say I’ve got that appraisal in hand, and I’ve had it prepared by your office, and I’m using this for tax-related purposes for the IRS and so forth, can I use that same valuation, the same business appraisal for the other purposes that you talked about, such as divorce proceedings and any other thing that we can think that might require a business appraisal?
Trisch: No, there are very strict guidelines in terms of the scope of the use of the business valuation. And they are all specified not only in my engagement letter, but also in the report itself. And the reason behind that, it’s not because I’m being greedy and I don’t want them to be able to use the valuation as much as they can, it’s because for each different scenario and situation in which a valuation is needed, there are different pieces of the puzzle that must be considered. So for example, in the matrimonial situation or different case law, there’s different approaches; there’s different standards. There are different standards, I should say, in different case law that are considered versus, say, for a gifting valuation or for shareholder oppression valuation; and this is where we get into more of the nuts and bolts of the valuation itself. But just as an overall answer to that question, it’s definitively no. And I have had pushback from clients before, specifically on a matrimonial side, because they pay a certain amount to have the valuation done. And then they say, “Oh, the business is worth X amount. Maybe I will consider a sale.” And then they want to start easing that valuation to shy about the business. And I have to go back in point to my engagement letter and say, “That just cannot be done.” So the answer is no, it works that way.
Jeff: Okay. No, that’s okay, and it’s really important too that we clear that up, because that almost fits into that one-size-fits-all category or purpose of the valuation, which in this case we’re learning, is not something that we want to consider. You’re going to have to make your intentions for the use of your valuation or your business appraisal very, very clear to the person who’s doing the work for you. If you’re the business owner, you need to make sure that you know exactly why you’re having it done, and make sure that that is clear upfront, so that if you do in fact want to have it done for a consideration for either tax purposes, to sell your business, for the matrimonial issues we just talked about, divorce settlement and so forth, we need to make sure that that’s absolutely clear then, according to Trisch. Trisch, I want to branch off now and go to a different area of our conversation where we’re going to talk about the types of entities and types of businesses that are out there, incorporations, is there a difference there in terms of the impact or the way that those entities can affect the value of a business? Let’s talk about, and we use the word “entities,” C Corp, S Corp, LLC, are there differences and do they have a noticeable impact on the value of a business and the way that it’s treated?
Trisch: It definitely can; for S Corporations, they flow through an LLC, and so there are tax advantages, they’re avoiding that double taxation, because they’re taxed at one level which is a.k.a., the flow through aspect of it. This is a topic that is heavily discussed in the business valuation world, and it can get really technical, and there are varying opinions and this is where, when people ask me about what I do for a living, I think this is one of the areas in which it’s very clear that it’s not a black and white deal. And so my approach is always to look at S Corporations, look at the tax advantages that you have of that flow through corporation, compared to as if it was a C Corporation, and then I incorporate that more than not into the valuation. Sometimes I don’t, in terms of the particulars, but I always consider it.
My approach is always to look at S Corporations, look at the tax advantages that you have of that flow through corporation, compared to as if it was a C Corporation, and then I incorporate that more than not into the valuation.
Jeff: So I would imagine then, if what you’re saying is correct, having multiple entities complicates the process even more, I would imagine. Is that right?
Trisch: It can, for sure. When it becomes complicated, I have given an example once before when I was asked this question and it was when I had started out on my own early on, and I had work, the gentleman wants before that the valuation for him to sell his business. And then, he came back and wanted the valuation to gift portions of two of his businesses to his son. And when I actually delved into the particulars of the two entities, I saw housed within those entities that one was basically a holding company. So there were a multitude of entities housed/umbrella-ed within the one other entity that I had valued. When I delved into it, I thought, “Oh, wow, this isn’t just two. This is actually going to be a lot more to value than what I had initially thought. So it can be real. If you don’t ask the particulars upfront, and a good business valuation analyst or one that’s been doing this for a long time knows all the ins and outs, and knows the questions to ask, and I always do a pre-screening of the engagement before I accept it, and to give a chance not only to see if there’s chemistry there, but also to find out what exactly I’ll be valuing, and see if I have time to do it, because if it’s a valuation of a holding company with 75 contracts housed within the one holding company, then that’s going to take considerable amount longer than just one retail store.
Jeff: You’re listening to Deal Talk brought to you by Morgan & Westfield; my name is Jeff Allen. My guest today is Trisch Garthoeffner; she’s Founder and President of Anchor Business Valuations and Financial Services, LLC. Now, let’s say, for example, Trisch, that I own a small business and I’ve got a couple of partners in that business. I would imagine that this is going to take some careful handling because down the line, we always try to expect the best and then we’ll want to prepare for the worst, and that involves possibly some court proceedings down the line if we want to go ahead and sell our business off, or if there are arguments or a split between ownership for whatever reason, there is some animosity there. So, multiple owners involved in a company, tell us how that is treated if that also is a rather complicated process, and if that necessitates really being a little more mindful as far as a the business owner is concerned, and the need to maybe have your business appraised in the very early stages of its existence when you have multiple ownership.
Trisch: Basically, what I suggest for business owners to do, right in the very beginning, when they are establishing the entity, when they know that they will have partners, is to give a business valuation at the point in which the operating agreement, the buy-sell agreement, all the necessary paperwork, is being established with the business being established within itself. And then for the buy-sell agreement, you typically have a calculation formula of some type in there, in which the value of the business and the percentage allocation holding of the business to each of the shareholders, there’s a specific instruction in terms of how that entity portion will be valued.
Frequently, I find that small business owners want to cut corners, they want to save money, and so they don’t necessarily get a valuation in place in the beginning. And that’s not a great idea, because as you mentioned, and many times, you can’t predict the future. And unfortunately, in a lot of different situations, there can be an issue when it comes time for one of the shareholders to sell their fraction of the business, and there’s animosity and then there’s conflict and confusion as to what the actual percentage in ownership is of the business. So I always suggest to the business owners right in the very beginning, and it doesn’t have to be every year that you get a business valuation, but you want to have some idea as to how the percentage allocation of the shareholder’s holding within the business is going to be valued when that shareholder decides to leave and/or sell the portion of his business.
Unfortunately, in a lot of different situations, there can be an issue when it comes time for one of the shareholders to sell their fraction of the business, and there’s animosity and then there’s conflict and confusion as to what the actual percentage in ownership is of the business.
Jeff: Obviously, Trisch, a lot to be mindful of there, when you’ve got different folks involved in the leadership and the management of an organization. And so you really want to be prepared for every eventuality, and be as clear-cut as possible. So let’s go ahead and let’s talk about some other things with respect to equipment and capital, with respect to your business, equipment, machinery; are those things separately appraised, or will that be included in my overall appraisal? How does that work?
Trisch: It really depends on the business. So most businesses that I value are going to concern businesses; which means that the business is not at the point, t’s still generating earnings and is profitable, and the asset value is considered more so as an evaluation. So if you’re a business that’s at the point to where it’s not profitable, and you’re going to liquidate your business, then appraisals are needed for the hard assets. I always consider all three approaches in a business valuation/summary evaluation, and an asset approach is one of the three approaches. I will look at any appraisals that the business owner happens to have, or look at very minimum, hopefully have the balance sheet and be able to look at the assets broken apart and the tax basis of those assets. But unless it’s a liquidation event, for most valuation work that I do, I don’t have to get outside appraisals. If I’m doing a family limited partnership valuation in that situation, I frequently have to get, I have to bring in an outside appraiser, and one that specializes potentially in real estate or in equipment, as you mentioned. And that’s a different type of valuation, than, say, a valuation for a divorce or a valuation for merger & acquisition purposes, and then which case those are more prevalent to look at and obtain, outside appraisals for assets, but in average, I’d say no.
Jeff: Let’s say for example, Trisch, and we’re running a little bit down toward the end of our program today; you’re at a cocktail party, a mixer, a networking event of some kind; it doesn’t really matter what kind of event it is, but you are approached by someone who knows what you do, and maybe they’ve had a chance to meet you a little bit, they’re interested in selling their business, but they’re not sure quite what to do as far as first steps; what are some tips, some guidance that you could provide here, general types of things that people need to be mindful of as they’re trying to get their head around the idea that they need to have their business appraised, even if maybe they don’t plan on selling their business right now or even five or ten years from now, maybe it’s long-term, but they need to have their business appraised and they know that; what are some things that you can leave us with as far as takeaways go?
Trisch: Well, I see this a lot and I work with a lot of small business owners; unfortunately, frequently, you get approached by small business owners and people that I know in the community, through different positions that I’ve had that I’ve met through the years, and when they go to sell, they have a business that is profitable, and I know that it’s profitable because of the communications that I’ve had with the business owner, but the tax returns might not necessarily be showing the profitability. And this happens a lot, and I always want the business owners to come to me, at least a minimum of five years, before the time that they consider a sale, so that we can really look at all of the potential discretionary expenses that might be run through the business, that might affect profitability, to look at the way in which the accounts are set up and make sure that all of the expenses are operational in nature.
With business owners, which I’ve been doing several actually right now, happens to be that I give them a quick and dirty valuation of their business. So I might not necessarily have to do a summary valuation, I could do a calculation valuation, in which case we really come through the numbers, and I always put myself in the business owner’s situation of saying, let’s just say hypothetically you have someone interested in your business, they’ve put an interest or a letter of intent on the table and they say, “I would like to buy,” or an indication of interest, “So I would like to buy your business for X amount.” Are you going to feel comfortable with them going through due diligence in your office, and looking through basically all of the information that acquirers look through to verify that the numbers you’re telling them on the financial statements, whether or not they do in fact match up with the tax returns are backed up? And a lot of times, business owners aren’t prepared for that type of invasive due diligence process. And that happens with every acquisition. Business owners need to be really aware that they need to get a true, accurate valuation of their business early on so that they can prepare their business for the sale that will go through at some point or another.
Jeff: As a business owner, someone like myself who owns his own small business, the one thing that, I guess I don’t really think too much about when I get up in the morning is, in addition to all the things that I have to do and the clients that I have to work with and satisfy and take care of and fill their orders, the one thing I don’t think about is down the line, is thinking about the day that will come that I might be interested in selling my business, and that it in turn or at the end of the day, the sale of the business is just as important perhaps as the day-to-day operation and generating cash flow and revenue to simply pay my bills and to survive, there’s actually an opportunity, I think, that business owners need to consider that when they’re ready to sell, they have potentially an outstanding pay day that comes along at the end of the line to help them in the retirement years. And so if they’re preparing for that eventuality as they go along, and they’re keeping good, accurate strong records, and they’re doing all the work ahead of time in preparation for that day, it makes your job that much easier. And not only that, but it could help the sales process go more smoothly too at the end.
Trisch: Exponentially, it’s unfortunate because business owners do get caught up in the day-to-day operations of a business, I’m to blame for the same going on. But the bottom line is what happens is I am approached by business owners. I go in and I try to help them. And it’s at the point where they’re at their wit’s end. They’re exhausted, they’re tired, they’ve been working for how many every years, they want to retire, and unfortunately, at that point, it’s too late for us to turn everything around and get everything in a smooth working order for a potential acquirer to come in and have a nice payday. Unfortunately, business owners don’t think about that enough ahead of time, and it’s frustrating for all the parties involved, and it’s not exceedingly expensive to get a business valuation, to get that preparation in place. And you mentioned it, it could potentially make you a lot more money versus not doing that. So it’s extremely important to plan for the sale of your business a minimum of five years in advance.
I always want the business owners to come to me, at least a minimum of five years, before the time that they consider a sale, so that we can really look at all of the potential discretionary expenses that might be run through the business, that might affect profitability, to look at the way in which the accounts are set up and make sure that all of the expenses are operational in nature.
Jeff: Trisch, if there is anyone listening right now that may think, “You know, this lady, I need to talk to Trisch, and I’ve got some questions for her.” How can they reach you?
Trisch: The best way to reach me, I think, is through my phone, through my office, it’s (312) 632-9144, or by e-mail, which is Trisch, “T-R-I-S-C-H” @anchor, “A-N-C-H-O-R-B-V-F-S”.com (email@example.com). I have my cellphone on me pretty much 24/7, and I love to talk to my clients and help them out. I don’t charge for initial consultations, and I don’t nickel-and-dime people. I really love what I do for a living, and then I love it when I can get a good result for each and every one of my clients, and that’s what I strive to do every day.
Jeff: And anchorBVFS.com is the website in case you want to go and learn more about Trisch before you call, or just get an understanding of Trisch’s capabilities or skillsets, and what she’s been doing, and the clients she’s been working with. Trisch, I want to thank you so much for this conversation. I’ve really enjoyed it and it’s been valuable, I think, for our listeners, and we hope that we can have you back on again sometime soon.
Trisch: Thanks a lot, Jeff, I appreciate it.
Jeff: Thanks again to Trisch Garthoeffner, Founder and President of Anchor Business Valuations and Financial Services, LLC, for joining us today. And that brings another edition of our program to a close.
Deal Talk is presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. If you’d like more information about buying or selling a business, call Morgan & Westfield at (888) 693-7834, or visit MorganandWestfield.com. Until next time, I’m Jeff Allen; I’ll talk to you again.
Jeff: Well, thank you, Sir. I hope that I can call you, “Marcus?” Let’s start by talking about reality versus what we want reality to be. And you’ve been in business, from what I understand, Marcus, for about 15 years. Is that correct?
Marcus: Yes, that’s correct.
Jeff: Some business owners, and probably so many, may have, what they believe is a fairly good idea of the value of their business. After all, they’ve owned their businesses, operated them, and have run them for some time. They’ve been profitable and they’ve done it for maybe 25-30 years, whatever the case may be, maybe 10 years, whatever. But often times, what they believe it may be worth, and what a professional appraiser such as you, says its worth, may be very, very different; vastly different, in fact. Have you found this to be the case?
Marcus: Yes, indeed. We’ve had with most of our cases, we’ve actually witnessed the fact that when we have our clients come in to have the valuation performed of their business, there’s actually a value gap between what they perceive the value of their business to be, and the current reality; and that’s because in most cases, they don’t really understand what are their key value drivers of their business. That’s the main reason. And that is because they have a perception of value that it’s mostly sentimental and passion-related.
So, when we really get down to the numbers, there are different aspects of the business, for instance: growth, profitability, cash flows, that they are not able to really understand and make the right decisions on the day-to-day basis, to really increase that enterprise value. So it happens to us that in most of the cases, this perception is really minimized when you’re able to conduct the business valuation, engage in the analysis of really getting to know the numbers of the business, what is helping your enterprise value increase, what are the risks that your business faces, and how to minimize those risks to really make sure that at the end of the day, your investment value is as high as possible.
We’ve actually witnessed the fact that when we have our clients come in to have the valuation performed of their business, there’s actually a value gap between what they perceive the value of their business to be, and the current reality; and that’s because in most cases, they don’t really understand what are their key value drivers of their business.
Jeff: Marcus, what do you say, how do you help those people that work through that process? There may be some disappointment certainly in the beginning after they’ve had a chance to look at your numbers that you come back with, and this applies to everybody. There’s so many people in your industry who are working with businesses that do the very best that they can to get these companies the value that they really want to get; but how do you address this with the business owner? I would imagine that sometimes, it’s got to be, there are some emotions involved, is that correct?
Marcus: That’s correct, Jeff. Actually, the way we engage our clients is really understanding their vision. Where do they want to be five years from now, three years from now, and that depends on each case. So, it’s really important, first of all, understanding the current situation of our clients, what’s the state of the business, what are the main opportunities and challenges as well, because we often see different case scenarios. We don’t only work for valuation in the United States, we work for valuations internationally. And of course, each business is different. So we really, first of all, want to make sure that we understand what’s the current situation of our client and where is he headed, where would he like to be three – five years down the road. After that, we really work a strategic plan where business valuation is a really important part of that strategic plan.
We really want to make sure that the client is able to see his enterprise value meet his desired number, in a way, three to five years from now, so really break down the business into what are the main value drivers, and understand, and go through with the client to really make sure that he understands what it is at the end of the day that I’m doing that really is helping me increase my enterprise value. And what are the current, and either financial, operational, or legal risk that I’m facing with the business now, and work those through to make sure that we’re able to minimize risk. We are able to mitigate those risks with enough time; another thing is that we see clients come in either because they have a potential offer from a potential buyer, and they really need to get this done very quickly. So it’s really important to get the business valuation done with enough time, and really understand what the client needs and current situation based on that. We work a plan out where business valuation is an integral part of that business.
Jeff: So making sure that you work with a professional valuation company, an appraiser such as yourself, Marcus, or another that you might trust or that you’ve been told about. Part of, from what you’re saying, of getting the value for your business that you would like to have three years from now, five years from now, ten years from now, whatever your plan is, is to make sure that it’s revisited by a professional appraiser, that you follow a course of action, a game plan to get you where you want to be. Is that correct?
Marcus: That’s correct, Jeff. One of the things, and this is really important, a valuation is a dynamic process. It’s not a static process. It’s very dynamic. And what I mean by that is that actually, when we’ve had a valuation engagement from the past, there’s not been a single valuation where the client, where we’ve reached the ceiling, let’s put it that way, so there’s probably, 15% - 20% potential of getting your enterprise value increased. So we work with a client and define a very specific path as to how to meet those goals in the future, and preferably, what are the three core areas where that’s the low-hanging fruit where we can work together with the client, making sure that we’re both on the same page, understanding what are the value drivers of the business, and hopefully by revisiting on an annual basis, by revisiting that valuation analysis, time by time, we’re able to increase that enterprise value at the end of the day.
We work a plan out where business valuation is an integral part of that business.
Jeff: We’re talking with Marcus A. Sullivan. He is with Sullivan Consulting Incorporated in Puerto Rico. He has 15 years of experience in the consulting field, and as an appraiser, Marcus, just a few moments ago, you touched on the concept of the value drivers in a business. From one company to the next, is there, or are there the top three, or the top five main value drivers from business to business that you can talk just a little bit about so we can kind of have a real, clear view of what these key areas are that we really need to be mindful of?
Marcus: Sure. So really, there are, based on our experience, of course, there are key value drivers that we think could help any business in any industry as of now. So one of the very important areas that we like to address with our clients is making sure that there’s growth. So really, having growth in the business, it’s very attractive and really increases your enterprise value. Another aspect critical to valuations is profitability. So you want to make sure that you’re not only growing, but you’re growing profitable. So that’s really important. At the end of the day, having healthy cash flows, is really key to making sure that the enterprise value and that valuation perception that the client has in his mind, well, with those healthy cash flows, stable and predictable cash flows, which can really help your valuation increase.
Other than what I just mentioned, it’s really important to have recurring revenues. So at the end of the day, an investor, someone, a potential buyer that’s willing or coming, or stepping into the business, he wants to see recurring revenues. He wants to see a business model that’s well-diversified. So at the end of the day, you don’t have customer concentration in one key area. And something really, really important, Jeff, is having solid management. At the end of the day, it’s not investing in a specific project, you’re investing in people. So you want to see a solid team that’s behind that business that doesn’t depend on any specific person, rather it has a well-put-in-place management team that has the experience, the knowledge and the commitment to continue with that business into the future.
Jeff: Okay. So we’ll go ahead and we’ll reset those, or touch on them again. Growth profitability, cash flow, recurring revenue, and having a solid team in place are the five key value drivers that from business-to-business, from your experience you’ve seen, can have a true impact on helping a business owner get the premium value that he is looking for from his business. It’s all part of that plan that we talked about earlier, stretching out, looking at your business from a bird’s eye view over three years, five years, ten years, and whatever that time horizon might be, leading up to the day when you might decide to go ahead and sell your business. So I’m just talking in general here. So, Marcus, let’s talk about the things that make businesses, that separate them, from your perspective as an expert on business valuation, what are some of the areas that best define the unique differences from one business to another?
Marcus: Okay. Well, you have businesses that are very scalable, that’s really important. Again, touching with the key value drivers, a question that you asked me before, having a business that is able to grow, in other words, is able to scale up, it’s something very important because most investors or potential buyers will be willing to look into a business that has potential economies of scale and economies of scope. So that’s really important at the end of the day. Again, the people behind the business is what makes a difference, because you want to make sure that you have the right management put in place to make sure that they can implement that business model, revenue model at the end of the day, and differentiate itself from the rest of the players. Also, it’s really important that you have a unique and differentiating product or service that can give you branding, and that can differentiate from your competitors locally or regionally. So those are really important factors that factor into the business valuation analysis. And based on our experience, it has helped differentiate one player from the rest.
Having growth in the business, it’s very attractive and really increases your enterprise value.
Jeff: You had mentioned a little bit ago that you provide valuation for those companies that do business internationally, not just in the United States. So let’s talk a little bit about that and how that is treated a little differently with manufacturing facilities, particularly of interest here, your company manufacture. Your home base is the US, but you’ve got manufacturing operations overseas. There must be a lot more involved in that process, I would imagine, conducting these kinds of appraisals. Tell us a little bit about the process there. And what kind of time is required and what are some of the differences between these types of valuations, the complexities that are involved in terms of providing proper appraisals for those types of operations?
Marcus: So, each valuation is a different project. Each valuation is a unique process where we really sit down with our client, understand their vision, understand their goals, and get into the numbers. When you add the international factor into this equation, it’s really much more complicated in that, because then you start to see other factors that could really, from a qualitative perspective, could change that valuation. And I’m talking about sovereign risk, if you have the manufacturing facility that’s doing business in a country where it’s pretty unpredictable, unstable, things are not as safe to do business as in the United States. So those things could really change the value of the business. When we do a business valuation internationally, first of all, we want to make sure that those are aligned with the GAAP principle accounting, so you want to really compare apples to apples. After that, we sit down and normalize all the financial statements. So we want to make sure that we are really concentrating on the business with operating assets and we really want to understand the operating income statement.
Having done business valuations internationally, you have a different set of challenges, not only from a legal perspective and from a financial perspective, but more importantly, doing business internationally, you have another set of challenges that you’re really not integrating into the equation of doing business valuations in the United States. For instance, the currency exchanges, those are very important as well. Usually, when we do a business valuation, and if we consider these kinds of cash flows, we don’t take into account currency fluctuations because we’re doing it in a dollar-based economy. Now, if we’re doing a valuation of a manufacturing company that’s has 100% of their revenues tied to euros, then things are pretty different, and so it gets much more complicated than that. So you really need to make sure that you not only understand the main factors of a business valuation engagement in the United States, but you’re also conscious about the different challenges such as currency fluctuations that you may have when you’re doing business abroad.
Jeff: Marcus, I know that you have pretty much a full service team there, Sullivan Consulting, but is there the need that you’ve ever had or could have in the future that you’d have to go out and contract the services of a third party, perhaps in the other country where there is that outsourced location set up in order to complete the valuation process?
Marcus: Yes, right. Exactly. So, for instance, I’ve had to hire IP attorneys when we’re evaluating the business. And there is a huge percentage of that enterprise value tied to the intellectual property. Then, I want to make sure that I bring in an expert, an IP expert to make sure that we address those issues early in the process. Also, when we’re going to do a business valuation in the country and we’re not familiar with the legal aspects, and analyzing all of the legal documentation that’s included in the business valuation engagement, we also bring in experts that can really add value in the process and make sure we really see the whole picture. And so, that’s the thing that we’ve done in the past. Although we have a pretty solid team locally, when we do business internationally, we bring people that we’ve either been referred to or done business in the past, and they can add value to the process.
Having done business valuations internationally, you have a different set of challenges, not only from a legal perspective and from a financial perspective, but more importantly, doing business internationally, you have another set of challenges that you’re really not integrating into the equation of doing business valuations in the United States.
Jeff: Marcus Sullivan is the Founder and Managing Partner of Sullivan Consulting Incorporated based in Puerto Rico, and they do business with companies all around the world, and of course, in the United States. You’re listening to Deal Talk. My name is Jeff Allen. Marcus, let’s take this just a step further. We’re going to go the other way though rather than talk about businesses with brick-and-mortar setups, other countries, maybe they’re based in the United States and they have satellite facilities or manufacturing plants in other countries. Let’s talk about online businesses, those companies that are strictly online, maybe they sell physical goods or services, maybe they provide strictly downloadable digital information for sale only. Have you had any experience with appraisals, these types of companies, and is the need for an appraisal just as important as for a brick-and-mortar type of business?
Marcus: Great question, Jeff, actually, we’ve done business with online-based companies. I would say that an appraiser, is needed for every business, no matter what industry or country they’re doing business in. It’s really important to understand again what the key value drivers are. If it’s online, you have a different set of challenges that the traditional business would have. So it’s really important to understand where is that revenue coming from? Is the business model stable? Is the customer pretty much diversified? What are the set of challenges that that company may be facing financially, operationally, legally? So no matter what kind of industry you’re in, you still need the business valuation or still, or I would recommend it pretty much. Like we said before, this is a dynamic process. It’s not unique in defense that you do what you want, and that’s it. So it’s really recommended that either if it’s online, you need to have a different set of views. You really need to reverse that engagement and understand what is it that affected the business two years, three years, maybe 18 months down the road. What are my current challenges? What are my current competitors? What’s the industry’s set of strengths and weaknesses. And other than that, make sure that you’re on the right path to increase that enterprise value.
Jeff: You know, Marcus, I just had a thought, just spontaneously came up, and I’m thinking to myself there are probably people in business, maybe they have – they work out of their home, maybe they go downtown and they’ve got a small office space that they rent, and they’ve been in business for some time. But there may be those who just feel like their business is going to die with them when they go, or that there might be someone in their family to take over when they’re finished and they’re ready to retire. But maybe also that if they believe that their business is going to die with them, and that’s what I think many people who have home-based businesses think, that they don’t really consider that their business has a value, and that in fact, it is something that they could sell and get something out of it. Have you ever found in the past, just talking to people, maybe a casual conversation at the café or something like that, that there are situations where people may not ever have considered that their business could be appraised for a certain marketable value that could provide them with a return that they may have ever considered?
Marcus: Indeed, Jeff, I’ve seen people come up to me and say, “Look, why would I conduct a business valuation? This is a lifestyle business. I really don’t want anything out of this, because I know that it has to have, definitely have any value.” So this is something that we’ve addressed in the past. We’ve had a case where we have this guy, he was working out of his home. He had very valuable clients. I couldn’t say that he saw that he had a solid management team, because that wasn’t the case. But he had a revenue model that was attractive. It makes sense, and although it was very small, his business was recurring. He made a lot of money. His margins were very healthy. And he had a business set up in such a way that his clients were able to constantly renew his contracts because he was adding value and he didn’t understand and he didn’t see this reflected in a way that maybe some other people could have done it in the past in terms of, “Look, I have something valuable. I know that I could scale this up. I know that I could bring management from outside and pump the business.”
So really, it’s really important that when you run into people that have a lifestyle business, sometimes you have key value drivers within that business that probably the owner doesn’t realize. And what’s important, again, doing the business valuation with these people is really asking: what’s the differentiating factor? What’s the unique factor that your business has and try to see if we could scale it up, let’s see if we could bring some people from outside, bring management, maybe bring an investor that could be an active partner of the business and really take your business to the next level. That could add value to the business, making sure that you continue with that path and making sure that in the case of this gentleman, that the clients continue and remain with the business and the main areas of the business, there’s business continuity.
We really work a strategic plan where business valuation is a really important part of that strategic plan.
Jeff: Wow, that’s fascinating. So right there, what you just illustrated is that, in fact, your business can be a means to an end, where the end is. Not only have you been able to provide for your family or make money and have the lifestyle that you enjoy now while you operate the businesses. And some businesses require a lot more work than others. But at the same time, even if you’ve never really considered it, and you’ve simply used your business to pay the bills and you’ve done with it all that you could do, at the end of the day, you may have something in fact that is marketable, that does have value, and very positive value indeed, that you could benefit from at the end of the line, fascinating discussion, fascinating question, and something that people, I think, probably more people should really give a lot more thought to the markets. And I appreciate that.
We’re running a little short on time, and this discussion has gone very, very quickly. It’s hard to believe that we’re almost done for this particular segment of Deal Talk. Let me ask you just what are some of the important parting words of advice or guidance you’d like listeners to take away from our conversation today when it comes to maximizing the value of their business, getting all that they should out of their business when working with a professional appraiser?
Marcus: Well, that’s a great question, Jeff. My takeaway advice to listeners would be to really sit down with a valuation expert and no matter what time we have in mind, what time frame do we have in mind, really sit down with a valuation expert, walk through the business, walk through the main value drivers, and really seek a long-term plan. Again, this is dynamic, so you may have the business valuation done today, and you may not be 100% happy about it. But the good thing about when you do things with enough time is that you can work out a plan, a financial plan, where it could – so you can work with an evaluation expert hand in hand, and you could set up a plan so that you can increase the enterprise value.
Let’s say that someone comes in, and he could be interested in increasing the enterprise value. And he has 18 months from now, so we could identify what are these – the low-hanging fruit so that we can work out this plan and really make sure that the enterprise value is up. When we work with a client and we have enough time, we’re able to adjust and monitor how the work is done and how it is progressing. What are the things that he’s continued to work on? How can we minimize weaknesses? And again, making sure that we go hand in hand throughout the process with the client. At the end of the day, he may see his enterprise value go up 15%, 20%, 30%. We don’t know, it depends, but at the end of the day, having enough time, having the right plan, and having the right expert right next to you, it could help you reach your goals.
A valuation is a dynamic process. It’s not a static process. So you may have the business valuation done today, and you may not be 100% happy about it.
Jeff: Marcus, if someone has any questions and they’d like to go ahead and get in touch with you, how can they do that?
Marcus: Sure, Jeff, thanks for asking. They can either call me, my direct number is (787) 708-6800, or my e-mail is “M” as in Marcus Sullivan, “S-U-L-L-I-V-A-N” @sullivanconsultingpr.com. That’s “S-U-L-L-I-V-A-N C-O-N-S-U-L-T-I-N-G P-R”.com. I will be glad to answer any questions that anyone has.
Jeff: And that, by the way too, Sullivan Consulting PR is the home address for your website which is bilingual too, is it not?
Marcus: That’s correct, Jeff.
Jeff: Okay. Very, very good. Well, Marcus A. Sullivan, thank you so much for joining us on Deal Talk; I really enjoyed it and we’re going to have to have you back on again in the future.
Marcus: Pleasure, Jeff. Glad to be here with you. Thanks for inviting me.
Jeff: That’s Marcus A. Sullivan, CVA, Founder, and Managing Director at Sullivan Consulting Incorporated, and we want to thank him again for joining us today on Deal Talk presented by Morgan & Westfield, a nationwide leader in business sales and appraisals.
If you’d like more information about buying or selling a business, call Morgan & Westfield at (888) 693-7834 or visit MorganandWestfield.com. Until next time, my name is Jeff Allen. We’ll talk to you again.
Jeff: To begin, in your experience, why are most buy-sell agreements flawed? Why are these things bombs? How do those flaws typically manifest themselves? What happens when those flaws become apparent?
Michael: I think buy-sell agreements are flawed for two reasons.
Number one, buy-sell agreements - if they are written at all, are typically written when the shareholders or members of the company are not really in the mood to write one. In other words, they have just created this alliance to start a new company or they are entering into a partnership together and it is human nature to not necessarily dwell upon what happens if things don't work out. Not a lot of attention is paid to the buy-sell writing. In my experience, it's even unusual just to find any buy-sell written at all. Therefore, when their written you kind of want to check off the box and move on. You don't want to think about it in too great, excruciating detail.
The second reason is I think that clients are often asking too much of attorneys to write the buy-sells for them. In other words, attorneys that write contracts are trained to write down what the client wants to accomplish and give some advice in terms of protecting clients from liability and making sure their rights are protected but, they're not necessarily trained in the mechanics of live businesses or subject interests with any business have value and so, they might pull a template or they've got language from other agreements that their law partners have used. But it's really not their area of expertise to work through the economics of a shareholder separation in tremendous detail so therefore, the buy-sell agreement often falls to the cracks and has gaping holes in it.
In my experience, it's even unusual just to find any buy-sell written at all.
Jeff: It's almost ironic, really, because they're interested obviously in protecting the rights of their clients but they may not in fact know anything about the regulations and laws concerning business and business sales which is really unusual. So, how many buy-sell agreements out of, let's say a stack of a hundred, are actually worth the result and do in fact protect the seller of the business?
Michael: I'm feeling very optimistic today so, perhaps, a third?
Jeff: A third?
Jeff: So, is it fair to say that maybe only a third of those have been put together with the help of a business appraisal in valuation service such as the type that, perhaps, you're familiar with and that you work with?
Michael: I don't know of many buy-sells that are put together with the help of a valuation adviser at all.
Jeff: Then, let's go ahead and let's talk about what happens when these things are flawed. Are there certain areas of buy-sell agreements, of course once again calling upon your experience that you have seen, were there are certain key areas that time and time again, no matter how many of these you happen to take a look at, that you see these mistakes come up over and over again?
Michael: The most common flaw that I see in buy-sell agreements is when the agreement is written such that the buy-sell price is going to be set by a predetermined price or a predetermined formula. The problems with that approach are the following:
Let's say that you have two owners of a restaurant and there's a buy-sell provision that suggest that one owner buy the other out in event of the buy-sell's triggered in the place $500,000 or one owner will buy the other out in event of a trigger for 1/3 times annual revenue plus inventory, for example. Even if that price and that formula are appropriate the day the buy-sell is written, and it's probably not, but let's say for the moment that it is, over time that price or formula is going to lead to a price that is going to differ, probably substantially, from what the market would actually bear. Certainly different from so-called fair value. And what that leads to is a scenario under which one of those partners is going to find it very much to their advantage, then, to gain the system. If they realize, for example, that that restaurant is now worth $2,000,000, however that in the event of a buy-sell trigger, they can buy their partner out for $500,000. If they can manipulate the buy-sell or the conditions of the partnership in such a way that the buy-sell will be triggered then, one of the owners will be able to buy the other out on the cheap. And so, that can very quickly set the partners at each other's throats because the buy-sell is providing an economic incentive for one of them to gain a financial advantage upon the other.
Jeff: Let's camp out here on this for a second. Using that example that you're talking about, you said it's a very common example, how can you essentially set this up to manage that risk better in the buy-sell agreement from the very beginning and prevent that sort of thing from happening?
Michael: The way to manage that is to have the price of the business set by way of an independent appraisal at the time that the buy-sell is to be triggered.
Michael: If that price is going to be set by an independent third party, we may want to talk about what independent means, because that can be a contentious thing in itself, but that price is set by an independent third party then, theoretically, there should be no advantage to either party or any shareholder that gain the system because if that appraisal process is executed properly then, the outcome is something bound to be a fair value. So, you're only going . . . you're not going to pay any more or receive any less than what that interest would receive on the open market.
Jeff: And by independent third party, I think you're talking about someone who is completely objective to either side and not someone who you happen to know who knows somebody else from some connection that you made at the annual Chamber of Commerce mixer down the street but rather someone who's completely objective who can provide objectivity on both parts.
Michael: Right. Now, it may be somebody that you know. Maybe appraisers and I think most do carry themselves in a way that is objective but particularly in the case of a buy-sell perception, very much equals reality.
Buy-sells are so contentious, first and foremost, because the value in that business probably represents most, if and, potentially all of the net worth of the individuals that are in the business so, the stakes or financial perspective are actually as high as they possibly can be. Even the slightest perception that the outcome may be skewed in favor of one shareholder or another leads to the collapse of the process.
What I advocate, and this is not my idea it's found in Chris Marshall's book on formulating buy-sell agreements, but I think it's a terrific idea, is that the appraiser should actually be selected jointly by the individuals in the buy-sell beforehand. So, when you sit down to that buy-sell and you determine the mechanism by which the company is going to be valued, let's say you're going to select an appraiser, then put into a list right now five appraisal firms which you're going to solicit bids at the time of the trigger and then maybe you say you're just going to automatically select the lowest bid, or you're going to select the bid that files in the median, and the firms that respond to the RFB and that firm is going to perform the appraisal. And therefore, because that process has been set well in advance and there's a mechanism that can't be manipulated or at least not easily, that gives the best chance for all parties deeming the result to be credible and reliable and, therefore, minimizes the chance that people are going to be calling their litigation attorneys as soon as the member comes out.
Even the slightest perception that the outcome may be skewed in favor of one shareholder or another leads to the collapse of the process.
Jeff: That man right there is Michael Blake. He's the Director of Business Valuation Services at H, A & W, LLP in Atlanta, Georgia and you're hearing him on the Morgan & Westfield podcast. My name is Jeff Allen. We're talking about buy-sell agreements that will keep you away from the courts.
From the very elementary level, Michael, we're talking about buy-sell agreements among two or more shareholders in a company here and I'd like to pause for a second to talk about why it's important to have a buy-sell agreement early in the going? And I believe that I saw in something that you wrote, and this is probably well-known amongst people who've been in business for a long time and who've owned businesses and sold them, but I saw something that you wrote, and it said: as soon as you know you have more than one shareholder, it becomes very critical that you have that buy-sell agreement . . . doesn't it?
Michael: Obviously, if you only have one shareholder, there's nobody to buy or sell so, it doesn't matter. But the second that there's the possibility that that pie is going to have more than one piece to it, there needs to be an agreement in terms of how that pie's going to be split or how that pie, frankly, is going to be put back together in the event that one of the party is not going to be participating in the company anymore. The longer you wait, the harder it is because the more entrenched people get, the more people don't want to focus on it, and frankly, the more people, then, will disagree about the value and the valuation process of the business. It's a classic example. An ounce of prevention is worth about 18 pounds of cure.
Jeff: Well, no doubt about that. So, the buy-sell agreement is critical. It's something that you carry with you in your “back pocket.” You file away and put it away and maybe don’t look at it for a while, but you need to have that done in advance up front as quickly as possible, after you know you will have someone else who may have an ownership interest in the business from a shareholder's perspective. So, two or more shareholders . . . certainly that's when you need to really start to put your plans together for that buy-sell agreement ASAP.
Michael, how are issues involving buy-sell agreements handled in court, if they ever get to court and they often do as you pointed out, how are they handled once they get there?
Michael: Well, in terms of how court handles, I’m approaching this from a layman’s perspective, I'm not an attorney, so I don’t want this to be interpreted into any legal advice, but generally, the court is going to rely on the agreement and whether the agreement benefits one party or not or whether it reflects economic reality that courts really don't care. The question is, then, whether or not that agreement is enforceable. The trouble that often arises is that the buy-sell trigger and pricing processes themselves are so badly written that the contract itself is un-enforceable. In certain cases, including in Georgia, that can lead to the judge taking extraordinary step to simply dissolving the company because the buy-sell simply can't be feasibly executed.
The trouble that often arises is that the buy-sell trigger and pricing processes themselves are so badly written that the contract itself is un-enforceable.
Jeff: Now, have you seen that often? Have you seen that happen?
Michael: I've not seen a court dissolve a company because the courts really don't want to do that but I have seen the buy-sells get mired in a litigation process because you literally have to have trials within a trial to resolve what the buy-sell agreement actually says. For example, I was involved in a buy-sell agreement where the buy-sell called for dueling appraiser method, in other words, one shareholder got their appraiser, the other appraiser got their appraiser and then by some mechanism, their appraisers were supposed to agree. If they didn't agree, right out of the chute, and we didn't agree. And one of the key areas in which we didn't agree was that the buy-sell agreement called for the valuation to be performed into the standard of fair market value. And fair market value, as a term of our own, has a specific meaning and has a meaning according to Revenue Ruling 59-60 for tax purposes. Fair market value does not have any meaning necessarily in Georgia law. The standard of value that's applied for shareholder descent and dissolution cases is a standard called fair value. So, in this particular case, the sellers were arguing that even though the agreement sent fair market value which calls for consideration of discounts for lack of market ability and minority interests, they argue that the contract should be in effect be voided by Georgia law because Georgia law suggest in those cases fair market applies. Even though they wrote fair market value, they didn't mean fair market value. Whereas, the other side, and I won’t articulate which side I happened to be on, but the other side said, "Well, this contract says fair market value. You signed it. It was duly executed. It was notarized so, you follow the law. If you didn't know what you were signing, that's not our problem and that's not the court's problem". And so, that very issue wound up going to arbitration before you could even get the trial back on track.
Jeff: Wow, so . . .
Michael: Knowing how much time and fees that ran up so, for the appraisers and attorneys, it was great. For the clients, it was an absolute catastrophe.
Jeff: A complete nightmare, really. Yes, it just sounds unbelievable…well, with that all being said now, I know that there are probably dozens more horror stories that you can tell us, Michael. We want to try to avoid those. So, how can I reduce the risk, as a business owner, of ending up in court over my buy-sell agreement? Let's talk about some of the things that we can really do starting with…first thing's first. What should we do?
Michael: So, the key is to make the buy-sell agreement as detailed as possible and to write it as if you're writing an engagement for a business appraiser. We talked a little bit about selecting…the selection process for your appraiser. Put up five appraisal firms in there and have some automated mechanism by which you select one of those five. And I would add to that that the appraiser must agree to not do business with any of the parties for a minimum period of two years after the appraisal so that…I think that helps ensure independence.
For example, if I were an appraiser and I work performing the buy-sell agreement, I might have an incentive to make sure that the buyer, in other words the remainder of the company, were made happy by my value because I'd like to do business with them afterwards especially as an accounting firm. I could sell them tax services, audit services, whatever if they were grateful for the assistance I gave them for helping them resolve that issue. If I'm the other party in that transaction, I wouldn't feel very good about that. I wouldn't feel very good about all of sudden becoming the company's accounting services provider and I would certainly question whether or not the appraiser had acted in a truly independent way. I think that's perfectly understandable. So, I often write into my own engagement letter for resolving buy-sells as we recuse ourselves from doing business with you or party for a number of years just that each party is comfortable that this is a one-and-done-kind of exercise and there's no implicit promise or prospect of some kind of back-end reward after the fact.
And then after that, I think I would go down the line to write it just like a valuation engagement letter. So, a valuation engagement letter, if you look up in the Uniform Standards of Professional Appraisal Practice or other valuation standards, will specify what will be the effect of date of the valuation? What standard of value is going to be applied? Is the premise of value going to be a going concern or liquidation preference? Is the level of value going to be equity value or enterprise value?
In defining those parameters then, you leave very little leeway for argument because you're using terms of ours…and then it's very easy for the appraiser to just go down and let's say, "yes, okay, we understand what value means and we have all the parties have agreed to it. You know what the effect of date is going to be and so forth" and that level of specificity is going to lead to a lot fewer surprises.
In my experience, what lands people in court is when one party is surprised. People can handle getting bad news but when they get bad news that's out of the blue that is totally different from what they're expecting, again, the first instinct is to run to a lawyer and to assume that you've been defrauded somehow.
In my experience, what lands people in court is when one party is surprised.
Jeff: You have down here, Michael, a list that I'm looking right in front of me here. The need to select not one, not two, not three but five appraisal firms in advance. Select them in advance. Why do we need five that we need to go to later on in order to solicit bids?
Michael: There's nothing magical about the number "5" with the exception that with an odd number, if you choose to have a mechanism where the median bid is selected then you have a midpoint that you can select from as opposed to even number where you wouldn't have that ability, but a larger number I think is better than a lesser number because if the business partnership lasts a long time, let's say last 25-30 years, some of those appraisal firms may go out of business or they may be acquired or people retire. One or two of them may actually merge. You'll never know a generation is a long time. We'd like to make sure that by the time that the buy-sell is actually triggered, that at least some of those appraisal firms are still around to actually execute.
Jeff: You talk about, nevertheless, the need for real experience in this area. That's really credible, isn't it?
Michael: I think it really depends on what you want from the buy-sell appraisal provider. I think a lot of clients right now, not just in the buy-sell arena, but in valuation generally, believe that having industry expertise, having performed those kinds of appraisals before have a significant bearing on how credible that appraisal conclusion's going to be. And we're seeing the field becoming more specialized. We're seeing a number of firms, for example, specialized in healthcare and doctor's practices. We're specializing much more in software technology companies and professional services firms. Others are very good at food service. Clients, I think, gain a little bit more comfort that that judgment is going to be just, if you will, if the appraiser goes in with a lot of knowledge about the industry and a good instinct about how businesses are actually fought and solved in the world of that industry as opposed to more academic exercise.
Jeff: One thing that I understand may be important when it comes to buy-sell agreements is you're putting in maybe discounts or premiums based on the reason for shareholder exit. Tell us a little bit about that and why those are important.
Michael: Yes. So, one of the things that makes buy-sells very contentious is one shareholder can feel the buy-sell execution is disproportionately benefiting another even in the case of an appraisal. For example, I was once brought in to perform an appraisal in a buy-sell context where one of the shareholders had been sentenced to jail. The shareholders really wanted to get him out but they didn't want to pay him a lot because he was unable to be in the company because of his own darn fault. He committed crimes. He was sentenced to a long prison term. And it really grated the shareholders than to pay him based on his full 25 percent value of the company. But the reality is that was a buy-sell because there was nothing into the buy-sell that indicate any kind of punitive measures for being bought out because of the maleficence of that particular individual. Then, they just had to live with the higher price. In that case, the bad guy kind of wanted it.
It doesn't have to be as extreme an example as that. You could be a shareholder that causes the company to be sued. You could be shareholder that does something dumb and accept bad press for the company. You could be a shareholder that fails to report to work on a daily basis. That happens quite a bit. In that case, I think a lot of shareholders would like to have the flexibility to make the other shareholders financially accountable. And again…because the second people feel that a buy-sell is being gained to somebody's advantage, the faith in the process declines rapidly. Again, that's when the likelihood of going to a litigation scenario escalates sharply.
Jeff: You're listening to the Morgan & Westfield podcast today talking about buy-sell agreements that will keep you out of the courts. My guest is Michael Blake, Director of Business Valuation Services at H, A and W LLP in Atlanta, Georgia. My name is Jeff Allen.
We really have just a couple more minutes left in the program today, Michael. Fill us in on any other important things that really we need to remember when it comes to putting together buy-sell agreements that work that keep us out of litigation. What are some other things that we need here as we get ready to round out today's program?
Michael: One area we didn't cover is what should the buy-sell appraisal product look like? Even though, I guess I sound a little self-serving, but I'm actually a big fan of the buy-sell work product taking the form of the long form, appraiser report as it is called, or a detailed report as it's called under SSVS 1. Because again, the more information that's provided that leads the reader from point A to point B in terms of information providing methodologies applied and the conclusion's reached, the more likely it is that the reader's going find the result credible, that that report is going to be accepted if not loved and that will escape a nasty business divorce.
The other element that doesn't get covered enough is discussing how the buy-sell agreement will actually be financed. The buy-sell agreement doesn't matter a whole lot if there's no mechanism that provides some sort of assurance that the money will be there to actually execute the purchase of someone's shares so, there should be some thought and verbiage on the contract given …will there be a sinking fund to establish or will there be some kind of insurance fund or insurance policy taken out or would the buyout be financed by a seller note, say over a five or seven-year period at some rate of interest? There are things of that nature that many attorneys know how to do very well because they write those kinds of terms in a garden variety M&A deal. But that part must not be overlooked. If you can afford to execute the buy-sell then, it's really not going to do your hold out of it.
The buy-sell agreement doesn't matter a whole lot if there's no mechanism that provides some sort of assurance that the money will be there to actually execute the purchase of someone's shares
Jeff: Michael, we have just seconds really before we have to end this time and we want to have you back on so we can continue this discussion and talk about some other things that you're involved with to or that can help out with.
What if people have questions? They would like to talk to you about something that they've heard on this particular podcast and they have questions about their buy-sell agreements or maybe they've got other questions about business valuations and what they need to look for, questions that they need to ask, who should they contact? How can they get in touch with you?
Michael: I'm not hard to find because I'm all over the internet but good old-fashioned email still works so, firstname.lastname@example.org and you can follow my Twitter handle @unblakeable --- spells just like it sounds. My personal website as well, I talk about things like this --- unblakeable.com.
Jeff: There you go. Michael Blake. He's the Director of Business Valuation Services at H, A and W LLP in Atlanta. Thank you so much for joining us, Michael. We appreciate it.
Michael: Thanks, Jeff.
Jeff: You've been listening to the Morgan & Westfield podcast presented by Morgan & Westfield, a nationwide leader in business sales and appraisals.
If you'd like more information about buying or selling a business, call Morgan & Westfield at 888-693-7834. Or of course, you can visit morganandwestfield.com. Until next time! My name is Jeff Allen. I'll see you again.
Jeff: Welcome to the Morgan & Westfield podcast. My name is Jeff Allen. It's nice to have you back and listening today. This is the place where people who are interested in buying and selling businesses come for information because we want to make sure that we're doing our job by helping to prepare you to make the right decisions, the right choices when it comes to either buying or selling a business. In order to help us do that, we try to make sure that we have some of the best, most highly recognized and highly prized guest experts on our program.
Today, of course, is no exception. I'm joined by Peter Agrapides. He is the founder of Filotimo Capital Consultants based in Sandy, Utah. Mr. Agrapides has extensive experience in preparing valuations for gift/estate and income taxation and reporting. He has deep knowledge of current valuation-related case law and extensive knowledge of judicial case law as it relates to the valuation industry. He produces a regular column, the Case Law Corner, for the Valuation Examiner which is a national professional development journal published bi-monthly by the National Association of Certified Valuation Analysts.
Peter Agrapides, thanks so much for taking time out of your schedule to join us today.
Peter: Thank you for having me, Jeff. I appreciate the invite.
Jeff: Well, you’re welcome. As always, Peter, we hope that this will be the start of a long dialogue that we'll have with you over a series of shows because there's so much here to talk about and only a short space of time to cover what we really want to cover. Today we're talking about appraisals and valuations from a seller's viewpoint. We're going to go ahead and start off with a leading question for first timers. There might be a number of folks listening to the program who don't have a lot of experience but they've given some thought to selling their business or at least looking into it, maybe kind of getting an education.
What would you say, for example, that a company or an individual has approached me - maybe they could be someone on my network group, they could be someone at the grocery store - and they say, "You know, I know what you do. You guys over there have something that interests me. I'd like to buy your business". Now, from my standpoint, should I plan on having my business appraised?
Peter: Well, I think that's always a good idea. I mean, if somebody comes to you and offers you however much money it is for your business, you need something to benchmark against to know that [if it's] a fair deal, a bad deal, if you could get more, if you could do something to increase the value of the business. A business appraisal would also be able to help you with the transaction in all aspects to make sure that the transaction is structured correctly, to minimize tax exposure, to minimize liabilities and risks further on down the road. But, I think - just from the standpoint of benchmarking the transaction, looking at it to make sure that the number is correct - it's good to have an independent third party appraise or come in and actually value the business. That's one thing with having a credentialed valuation analyst. We're compensated for our time. We're not compensated based off on how low or how high or whatever the number may be. So, yes, I do believe it's a good idea.
In one respect, it may not be something that you need to do. You receive several offers to purchase the business and they're all structured similarly and they're all around the same value, then you may have that benchmark. You may have that comfort level that you don't need to go out and pay for a separate business appraisal.
...if somebody comes to you and offers you however much money it is for your business, you need something to benchmark against to know that [if it's] a fair deal, a bad deal, if you could get more, if you could do something to increase the value of the business.
Jeff: That's interesting. It was going to be a follow-up question. [It] was how many instances are you familiar with or have you dealt with where a business owner did not feel the need to go out and have his business appraised and you answered that question right there. Is it common, Peter, in your business, in your industry from where you sit, to see that many instances where a small business or medium-sized business is actually not appraised prior to going to sale?
Peter: You know it’s probably 50-50.
Jeff: Is that right?
Peter: Yes. Sometimes, you'll see…you know if the owner really tends to be dialed into their professional associations to the M&A trends that are going on within their industry, a lot of times they have a pretty good idea of what multiples the company will sell for. Maybe, they have worked with a valuation analyst or with their CPA a little bit to do some value building in their company. Some simply don't want to pay for the appraisal. But I would say it's about 50-50. I mean, when I'm valuing a business, I do rely somewhat on that owner. At least it's a due diligence question that I ask them if, "Are you aware of any transactions within the industry? Any roll ups within the industry, anything like that?" And you'd be surprised [at] how many owners that are more sophisticated or pretty dialed in, and they have a pretty good idea of at least a reasonable value range for where their company would be priced.
Jeff: So it pays to really look around, be aware of your competition? Be aware of the guys across the street and the folks across the country and have an understanding of . . . at least the basic understanding so you'll know the questions to ask if you decide to work with an appraiser or not --- if you decide to do your own due diligence as far as that goes. Now, is there any difference, Peter, between a valuation and an appraisal or are they essentially just two different words for the same thing?
Peter: In technical terms, there's a difference. In layman's terms, as they're used within the industry or within the advisory community - with the CPAs, attorneys and stuff like that - they're the same thing.
In technical terms, an appraisal is usually the term for determining the worth of a tangible asset. Okay? So Real property, machinery and equipment, vehicle, home, anything like that that's tangible --- it's an appraisal. Anything that's intangible to the value of your business --- the goodwill, the trade name, the website name . . . any other type of intangible asset where intellectual property, we term it a valuation. In a valuation report, you'll see I'm very clear with how I use those two terms because sometimes, in my valuation, maybe there are tangible assets that need to be appraised and I make that distinction within the report. Don't expect that from me if you run in to me on the street. I'll probably use the two terms interchangeably as well anybody else.
Jeff: Okay. Then that's a great jumping off place, then, to ask you. You talked about the difference, the intangible versus the tangible values, so, you're talking about intangible intellectual property - include[ing] websites and things like that - in the intangibles, is that correct?
Peter: That's correct.
Jeff: Why would I not, as a business owner, want to include everything? Because if I'm selling everything - lock, stock and barrel - maybe I want to retire. Maybe I don't have an heir in my family or sons or daughters to take over my business. I just want to be free of it. Why would I not want to include everything in my appraisal?
Peter: Generally, you would. You would want to include everything that is associated with that business. You're not going to sell the business and say, "Hey, I'm going to keep the website" . . .
Peter: Or "I'm going to keep the trade name", okay? The only times that you would not keep everything that you have in your business is just, let's say you have non-operating assets. So, a lot of times, you'll see a company that maybe has real property. They've got a condo somewhere or a fishing lodge or they've got a boat or something like that that's included into the business. It needs to be appraised separately and we term it a non-operating asset because the business can continue the function even if that asset is pulled out the business. So, the company would sell and those non-operating assets would be retained or held by the owner. So the owner wouldn't receive any compensation from the buyer when they sell the business. They would just sell the business and retain the non-operating assets.
The only times that you would not keep everything that you have in your business is just, let's say you have non-operating assets.
Jeff: Okay. Now if business broker offered me a free valuation, why then should I pay for an appraisal? Now, keeping in mind we discussed the difference between a valuation and an appraisal, but should I be content with that free valuation or should I really pony up the extra money and have a full appraisal done?
Peter: Knowing how a lot of the brokers pricing opinions are done, a lot of those are just done looking at multiples . . .
Jeff: Got it.
Peter: Looking at a multiple of revenue in particular industries, looking at the multiple of revenue in the particular industries which is a relevant marker for value, but I think having a professional appraisal done, again, is wise because we're going to get in there, and we're going to really take a look under the hood. We're going to look at what's the true cash flow of the business. You know as every business owner knows you have two things that you're balancing. You want to maximize your cash flow, somebody is obviously buying your business. You want to minimize that for income tax purposes . . .
Peter: We would go in and, what we call, normalize the cash flow to get the true economic income of that business. That may not be done in a broker's pricing opinion.
Jeff: So . . . you're . . . so . . .
Peter: And again . . .
Peter: Go ahead . . .
Jeff: No. It's just that . . . my question was that, I understand through your response that . . . by paying for that appraisal - which really gets into the nitty-gritty and into the details - I could really probably gain greater value from the sale of my business based on the information contained in that appraisal. I could be losing, leaving money on the table, without that, correct?
Peter: Sure. Sure.
Knowing how a lot of the brokers pricing opinions are done, a lot of those are just done looking at multiples.
Peter: And there could be motivation from the brokers . . . if the broker wants to sell the business quickly and maybe offer it at a lower price or something like that.
Peter: Optimally, somebody should come to an appraiser two, three, four years before they're ready to sell the business so we can take a look at it, see what it's worth, and then maybe also give them a little bit of consulting advice as to how they can maybe increase the value of that business and having that discussion also with the business broker. Because they're going to have the real market intelligence for our businesses in this industry --- selling them, are they not selling, is it a buyer's or is it a seller's market. So, it's really a team approach when somebody is taking to selling that business. It's a complex asset and it's a real team approach to get everybody involved and everybody around the table start planning years in advance.
Jeff: Very good. You're listening to the Morgan & Westfield podcast series and my guest today is Peter Agrapides, MBA, CVA founder of Filotimo Capital Consultants in Sandy, Utah. He is an expert in the area of business appraisals. My name is Jeff Allen. I sure do thank you very much for tuning in.
Peter, let's say a venture capitalist has valued a business using a discounted cash flow approach. And that same business had a business appraiser value their business. And the appraiser came up with the value that is 50% less than that returned by the venture capitalist in that study. Did someone make a mistake? I mean, how does that business owner know which one is accurate?
Peter: First off, it pays to know what each of the valuations was done for. If the venture capitalist did it for business sale and let's say, the business appraiser had done that for shareholder dispute or another litigation matter, maybe a divorce or something like that, it's not an indicative that somebody made a mistake, okay?
Peter: We have what are called standards of value. Generally, the highest standard of value is what we call the investment value. That's where somebody's coming in to buy a business and they can . . . there's some economy of scale or something that they can exploit by combining that business with a particular resource that they have. So they're willing to pay more. They're willing to pay, let's say a dollar twenty. They're paying a premium for every dollar of cash flow in that business because they know that once they combine whatever resource they have - their business, their technology - whatever it is, they're going to get an enhanced level of return on that. Where what we're normally looking at for purposes of, let's say cash valuation - for gift tax, state tax, income tax - anything that's going to the IRS for federal income tax purposes, we're looking at fair market value. Specifically stated in Revenue Ruling 59-60, it specifically states that not to take into account any of those synergies or any of those economies of scale. So, if you have a valuation done on the exact same company on the exact same valuation date of the exact same interest, you can have widely divergent values just because of the purpose of the valuation if the standard of value is different.
The second issue that you have there is with the venture capital valuation, with their DCF--we need to know who prepared that projection. Who prepared the forecast, okay? If the venture capitalist prepared it, maybe they wanted to paint a very rosy picture to attract capitalists, they're going to do a round of financing and this is something we see all the time where maybe the management of the company has done the forecast and they've done it for capital raise or something where they want to paint a very rosy picture of the business and the forecast is just not attainable. Now, we'll work with them in . . . looking at industry information, looking at what we can find to make the projection more reasonable and generally lowering the value of the business in doing that.
... if you have a valuation done on the exact same company on the exact same valuation date of the exact same interest, you can have widely divergent values just because of the purpose of the valuation if the standard of value is different.
Jeff: Peter, are there different types of appraisals? We know there are different types of approaches, I mean, what are some questions that someone, a business owner, should ask if they've contacted an office like yours about the type of appraisals that are available and which are right for them and their particular business?
Peter: That's a great question especially in our [the] context of what we're talking about today. You definitely have different, basically, levels of engagement services, okay?
Peter: If somebody is calling, the first question you ask, "Hey, somebody wants to buy my business. I want to know if the number's reasonable. I don't want to communicate the number to you but I'll give you my financials. Can you tell what you think the business is worth?"
For something like that, we can do what's called a calculation of value. A calculation of value is where I sit down with my client and I say, "Look, here are the methods and approaches that we're going to use to value the business. We're going to go in, we're going to do all of our due diligence but I'm not going to write an eighty-five page report just to help you make a decision. It's a decision tool, okay?" Now, if that same client comes to me and says, "Look, I'm gifting away with 49% interest in my company. We need you to value the business for reporting purposes. We need to report this as a gift to the IRS. We want to get the three years' statute running where they can come back and audit for only a three-year period. Will you value the business?” The number would be the exact same. Let's say we're appraising a 45% or 49% interest. In both instances, their number would be the same. But in the second example where that report or that analysis is being used for reporting purposes . . .
Peter: …we have to issue what's called a full conclusion of value as per standards that are promulgated by the National Association of Certified Valuation Analysts or whatever accrediting body the appraiser is actually accredited through. If anything is being done for reporting purposes, it's going to be a higher level of service and a higher level of cost because we're not just coming up with the number, we're explaining everything in the report that helped us come up with that number. And there's several bullets that we have to hit in terms of different items that we include in that conclusion of value report. But for somebody who's just looking to get a number to sell a business and they just want to use this in their decision tool box and something that they can use with their advisory team, the approach that I tell them is, "Hey, let's do this. Have your attorney engage me." That way everything that we do is protected by attorney-client privilege. If it's protected by attorney-client privilege, it's not discoverable. So anything that comes up - if ever a lawsuit or if we do have to kick it up to a full conclusion of value - and maybe that number difference from our calculation of value, that calculation of value is not discoverable, we’re not chasing our tails having two different numbers running around.
If anything is being done for reporting purposes, it's going to be a higher level of service and a higher level of cost because we're not just coming up with the number, we're explaining everything in the report that helped us come up with that number.
Jeff: Peter, I know that you have quite a vast level of experience in dealing with attorneys and in working with legal teams and so, you're speaking from really a strength of experience there and depth of experience in that particular area. You touched on valuation of businesses for more than just business sale but also for tax purposes. Are there some other instances where someone might want to get a valuation on their business?
Peter: Sure. I mean, tax, like I said, is a big one --- both income tax or [and] what charitable donation purposes, transfer tax which is gift and estate. Bankruptcies. You also have asset allocation, again, for tax purposes. So, if somebody sells their business and they want to retain or report on their income tax that some of the sale was personal goodwill as opposed to enterprise goodwill, we can allocate the assets out separately. So, we go through and say, "The website's worth X. The customer list is worth Y. You know, parse out every tranche of assets. Like I mentioned before, divorce purposes, lot of different litigation purposes, shareholder disputes. We do a lot for SBA lending for business owners. Maybe they're buying a business. Just like when you buy a home, the home has to be appraised.
Peter: They go buy a business, and they do an SBA 7[A] loan. That evaluation is almost identical to the valuation that we do for tax planning, for reporting back to the banks. There are a whole myriad. We do a lot now for higher net-worth clients that are expatriating, that are basically revoking their citizenship and moving to another country. Maybe their business is already located in another country.
Peter: That type of thing.
Jeff: Peter Agrapides is the founder of Filotimo Capital Consultants in Sandy, Utah. We're talking to him about business valuations today and business appraisals. This is a Morgan Westfield podcast. My name is Jeff Allen. Thanks again for tuning in today. It's nice to have everybody here.
What about those businesses that are global in scope. Perhaps they're online businesses. They do a lot of, maybe, the retail sales. Maybe they're business to business and they do a lot of selling to companies overseas. What's the difference in that process? Should the business owner, someone whose doing . . . they could do anymore from a hundred thousand to a million dollars in sales a year. Do they also need to have their business appraised if they're going to sell that, Peter?
Peter: I would think so, I mean, especially with something like that because it's more of a niche business. Those are generally a little bit more difficult to value because they don't have a lot of comparables . . .
Peter: We're going into the public market place. There may not be a lot of public companies that we can compare. Or the company's too small. If it's a really niche business, there may not be any transactions of similar privately-held companies. So, it's really sitting down and building up our cap rate or capitalization rate which is what we use to convert the company's cash flow into a present value, the value of the business. But it's really going through, looking at country-specific risk factors, looking at various industries-specific risk factors, looking at, maybe, supplier concentration issues, customer concentration issues, regulatory issues which can constantly change and change very rapidly for a global business. I think that's equally important for that type of the business to have a professional valuation done.
Jeff: Some companies, entrepreneurs, perhaps, with the best of intentions, they set up a business and they've had some success but they just weren't able to make it work and accomplish their goals, their business goals. But that company has a lot of potential. This business, this particular industry has a lot of potential. And again, we're just kind of making something up here at the moment but I know that you've probably run into a situation, maybe not necessarily directly involved with your business, Peter, but you've probably heard of situations where maybe somebody wanted to try to get as much as possible for their business, for the sheer potential that it has despite the fact that they can't turn it around and do something with it. Can people get paid for that? I mean, is it possible to put a value on potential, when you're talking about providing valuation or appraisal of the business?
Peter: Absolutely. Absolutely. One of the purposes that I actually neglected to mention was stock-based compensation valuations or 409(a) valuations. Where we see a lot of those, they're really concentrated in the bay area --- Palo Alto, San Francisco. There are a lot of start-up early-stage development companies that have no earnings. Some of the companies don't even have revenues. They've got an idea, they've got technology but they either lack the resources or they haven't had the time yet to monetize those resources. If you look at the valuations that we do to those companies, they have significant value. That value could be, for all intents and purposes, "here today, gone tomorrow". Somebody else comes in with a better technology or they're just not able to get over the crest of the hill and actually monetize if that value's gone. For the time being, they have very high valuation. What we look at with those is we stay away a little bit from the three approaches - the income, the asset and the market approaches - and we rely more on what are people paying for the business in terms of when they do a capital raise? Is there raising money through a preferred of stock offering or a [Class A] offering? We look at the time frame. How far back was the last capital raise? How much capital was actually raised? And then we do some optional analysis to distill that value back, maybe, into a common stock value but yes, you can get paid for the potential. It's obviously a more volatile-type of valuation because if it doesn't pan out, that value's gone and they can be gone very quickly.
Jeff: Peter, I'm down to my last minute or so and as we wind things up, last thing I'd like to ask you today --- you've got Mr. and Mrs. Business Owner out there, Miss Business Owner out there. They want to sell their business there. Looking into it, what should they do? What is the first thing they need to consider doing or how do they prepare to sell that business? What are the first steps?
Peter: First steps will probably be get their CPA involved and a valuation analyst. Have somebody go through the financials. First off, make sure they're clean. Make sure there's not a lot of flaws in there in terms of non-business activity and what-not going through there paying for personal expenses . . . that type of thing. Make sure that you have quality financials, whether they’re reviewed or audited. Have those done for a few years, so, whoever's looking at those financial have some degree of confidence that at least somebody else has put their professional reputation on signing off on those financials. So that would be the very first early-stage steps as well as getting a team together to look at the entire business sale, the tax consequences, the liability consequences. Somebody, an investment banker that has a good network, a good reach that can monetize that business quickly.
First steps will probably be get their CPA involved and a valuation analyst. Have somebody go through the financials.
Jeff: Peter Agrapides, you've been a wonderful guest. We are going to have to leave it there unfortunately. We've run out of time. Hopefully you'll join us again here in the near future.
Jeff: Thank you again to Peter Agrapides for joining us today on the Morgan & Westfield podcast presented by Morgan & Westfield, a nationwide leader in business sales and appraisals.
If you'd like more information about buying or selling a business, call Morgan & Westfield at 888.693.7834 or visit morganandwestfield.com. Until next time. I'm Jeff Allen.
Jeff: Welcome to Deal Talk brought to you by Morgan & Westfield, I'm Jeff Allen. If you're looking to sell your company now or at some point in the future it's our mission to provide information and advice from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.
According to Webster's Online Dictionary the word premium can be defined as a high value or a value in excess of that normally or usually expected. You can put that in quotes. And it's interesting that the word value appears in the definition isn't it? The question is how can you get a premium value for your business? Let's talk about it with our guest. Joining us on the Morgan & Westfield guest line Angela Sadang. Director in the Financial Advisory Services Group at Marks Paneth LLP in New York City. Ms. Sadang specializes in business valuation and has more than 15 years of experience providing corporate financial consulting services and performing valuations. She serves both publicly traded and closely held companies. Angela Sadang, welcome to Deal Talk. It's great to have you on the program.
Angela: Hello everyone. Yes, the Webster definition is actually very accurate. Technically, in the valuation world a premium value can mean many different things. My own definition of it is any value that's in excess of fair market value as determined by a professional appraiser. Again, premium value can be achieved by any business by creating synergies with the potential buyer and companies targeted for acquisition. You could also decrease reliance on one supplier or one customer. Diversifying the product or service lines that the company offers rather than concentrating on one particular product or service. You can update technology, equipment, and facilities. And lastly, and this I think is what's key in developing a premium for your own business is developing good management expertise and [avoid] relying on one key executive or a group of executives. This is what we call the key man syndrome where you see businesses managed by just one key person. It could either be the owner or founder of the business. His role is very hard to fill in so he or she does everything. The key person is considered key in any number of business functions and I’ve seen most small to medium sized businesses managed by one person, and this one person drives the entire company.
Jeff: Angela, it's an interesting concept that you bring up, the key man syndrome, because I wanted to ask you, and kind of jump in there real quick, to ask you how many businesses you think out of a room of a hundred represented would have that key man syndrome and be suffering from that, and you just said most. Is that something that you think keeps many businesses down and from reaching that premium value that they would like to have their company valued at?
Angela: Yes, definitely. In my experience most small to medium sized businesses are managed by one person who is typically the owner or the founder of that business. And it's an advantage definitely because the person is very knowledgeable about the business. He founded the business. He runs the day-to-day. He's very involved in all the minutia functions of the business. But that's also a disadvantage because if you want to try to sell your business, an investor would come in and see what type of management this business has and they'll see only one person. And it's like putting your eggs in one basket. You don't want to do that. You want to pay a premium but you can't. You discount it because this person can pass away, can leave the company, can become ill and can become incapacitated and can no longer manage the business. So for businesses it's wise if they want to command a premium for their company for an eventual sale to have good, diversified management in place.
Jeff: This means forming a team. Essentially, really, when you get down to it.
Angela: Having key people in each function and a good management team in place rather than being reliant on one key person who's been running the business for the past 20-30 years.
In my experience most small to medium sized businesses are managed by one person who is typically the owner or the founder of that business. And it's an advantage definitely because the person is very knowledgeable about the business.
Jeff: Angela, let me ask you a question because we get down to when you think about it. And we know that all businesses are different, and by the way, we'll touch on that in here in a few minutes. But I have some friends and certainly acquaintances that I have had the pleasure of knowing in the past who ... For example one couple I'm thinking of run a single restaurant, it’s privately owned. It is not part of a chain and it is very successful. And they've constantly got people coming into this place at all hours, it's just fantastic to watch. It's clean, it's in a nice part of town, but these folks never leave. They never take vacations, and they've told me that they've got a tag team thing. One of them will go in and they'll run the restaurant the first part of the day. The other one will work the swing shift and close up at night, late at night, 2 am. But they feel like they cannot leave because they can't trust bring somebody on that they can trust as a number two lead to watch the business while they're away, so that they could have a date night for Pete’s sakes. But the business is very successful indeed. They make money. They live in 4,000 square foot home with a view. It's just amazing. In Southern California, to do that, you've got to have some money. My question is: how can you get out of that mindset when you're used to not only working in your business but on your business at the same time? It just seems to me that for some people that would be very difficult to overcome.
Angela: Yeah, especially if it's a family business, you want to keep it within the family and you don't want to hire outside professionals who can professionally run your restaurant business. That's understandable. They can still command a premium price for their business if they show that there's a continuous, let's just say in their menu they have unique recipes or their menus change constantly. Their service is also diversified and not just dining in but they lease space out for parties and they do catering. There you can show and demonstrate to investors that you have diversified your product line and your services. But on the other hand you can't command as high a premium if the business is just run by two key people. Unless, again, they demonstrated, "Hey, we have our sons and daughters also helping us here. They'll eventually take over the business. They have college degrees and restaurant management.” If they're able to demonstrate that there is some form of passing the baton so to speak to the next generation and there are other moving parts of a business and not just management as I said. If you constantly grow your revenues by diversifying your products and services, you can command a premium for that. Having a good brand name ... if the restaurant has a good brand name, that can command a premium as well.
Jeff: I'm wondering Angela, if you could, you know, you've talked about the importance if you can, assembling a strong management team if possible. What are some other important factors that you can point to that a business owner can improve upon or add to his company in order to improve the value of his or her business?
Angela: There are many factors that can improve the value of the business. I think of paramount importance is demonstrating that you have continuous revenue growth. And how do you achieve this? You achieve this through, as I mentioned, continually innovating in your products, in your services, investing in intangible assets as well as other assets. For instance, the restaurant we were talking about, if they use obsolete equipment that's about to die down in the next year they can improve the value of the restaurant when they eventually sell by investing in updated professional kitchen equipment. It's not just intangible assets such as the brand name and your loyal customers, but also tangible assets in the form of equipment. It could be technology, furniture, which is also part of your asset line in any business. Again, diversifying your operations as another potential source of revenue. You manage costs, keep costs down, and again, it goes back to having a good management team in place that's knowledgeable, experienced in capturing business opportunities as they come and not just satisfied and sitting down, satisfied with status quo. But having a good management who has the foresight to capture any opportunities out there that can improve revenues and continually grow revenues of the business. It's all about the bottom line. When you're investing in the business it's all about, "How can we grow this from a $6,000 business to a million dollar business? How do we get there?" And there are many ways to get there. But I think key is again as I mentioned, you just got to continually improve your product or service, innovate, invest, diversify, and find ways to keep your costs down, and again, have a good management team in place to have the foresight to capture opportunities that are somewhat or related to the business.
Have a good management team in place to have the foresight to capture opportunities that are somewhat or related to the business.
Jeff: Let's say we go down the line, Angela. We want to evaluate how these improvements we are making may be in fact improving or contributing to our company's value, and we want a good idea of what our business may now be worth. We want to take and reevaluate. Maybe it's been 12 or 13 months, or whatever the case may be since we've started to implement these changes, make these improvements, spend the money necessary to kind of make these improvements to our company. Is it necessary for me to go out as a business owner and contact valuation firms such as yours or you as a valuation consultant and get the full enchilada in terms of the comprehensive valuation report? Or is there another way that I can get a good sense of what my business may be worth without spending the tens of thousands or whatever I need to spend in order to get that comprehensive valuation?
Angela: This depends on the purpose of why you want to find out your company's worth.
Angela: The best way obviously is to hire a qualified business appraiser to provide professional advice, especially if you want to find out the value of your company for transactional purposes, or for tax reporting purposes, for small business lending you want a document for the bank for charitable distribution or a pending litigation. On the other hand, if you simply want to get a ball park idea on your company's worth just to satisfy your curiosity then sure there's many industry resources. There's Bloomberg, Yahoo! Finance, you simply go to those websites and look for trading multiples of your publicly listed competitors. Check if the ballpark figure approximates what you think the value of your company is. But at best it's really a back of the envelope calculation and sanity check on what you think the value of your company is. Rules of thumb can provide insight and again, they only can go as far as satisfying your curiosity. If you really want something that your investors can hang their hat on, it's best to find a professional appraiser to value your business.
Rules of thumb can provide insight and again, they only can go as far as satisfying your curiosity. If you really want something that your investors can hang their hat on, it's best to find a professional appraiser to value your business.
Jeff: Good advice to end our first segment of Deal Talk on, Angela, thank you so much for that. It's time to reset premium value and using appraisals to your benefit. We're talking about it with Angela Sadang CFA with Marks Paneth in New York. I'm Jeff Allen. We'll be back with more on Deal Talk in a moment.
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Jeff: Welcome back to Deal Talk, I'm Jeff Allen with my guest Angela Sadang, Director in the Financial Advisory Services Group at Marks Paneth LLP in New York City. We're talking about premium value, we're talking about valuations, we're talking about you as a business owner, what you need to do in order to bring that value of your business up and we've kind of touched on a number of different things. And right now we're going to get into some specific questions talking about certain aspects of valuation and what you might be able to do in order to get some estimates, or good ideas, or appraisals of certain business ideas that you have, and we're going to use that as a jumping off point. Talking about, Angela, entrepreneurs out there who have an idea of a business, or they have a concept, or maybe they've got a product idea, maybe they've got a prototype. Is it possible to get an appraisal on an idea or an evaluation of an idea in order to turn that into a reality and potentially sell that idea to a future business owner?
Angela: It is possible. There are many different buyers and entrepreneurial ideas start up and then entrepreneurial idea businesses with little or no revenues and operating losses are dependent upon private capital rather than public market. So that's the big difference. At the earlier stages most of these entrepreneurial idea businesses see financing as provided almost entirely by the founder or their friends and family. But as future success increases then there's need for more capital and venture capital has become a source of equity capital with of course a return on share for ownership in the firm. Many of the standard techniques used to estimate cash flows, growth rates, discount rates do not work in this kind of valuation because they yield unrealistic numbers. In addition, most young companies may either survive or may not survive. You have to consider that somewhere in the valuation. So I don't think the traditional valuation model is applicable to an entrepreneurial idea type of company. You cannot expect to yield reliable valuation indications. And I would use projections based on trends of similar companies or competitors, or users of those products, and users of the entrepreneurial idea. And then assess the risks. I would use a hybrid, or a modified, discounted cash flow model and relative valuation model with a consideration for discounting on whether the company can reach their goals from an entrepreneurial idea stage to, okay, we've got all these investments, how do, again, we get from A-Z. And you got to discount as to how they can meet their forecasts based on the numbers showing from the potential cash flows. So I would use a combination of, again, a discounted cash flow model and the relative valuation model, the traditional valuation model will not work here. So it is possible to put a value in an entrepreneurial idea. You're basically paying for the potential of a company. Most technology companies such as Facebook, LinkedIn, Uber, WhatsApp, all of those started with an idea and a potential.
Jeff: That's right.
Angela: Value indications come from a matrix of comparable companies or recent financial and development phase information. What your competitors’ market value would be and users of these ideas. That's also how you look at these companies. Who are the users and what industries are going to move along with this idea? Value indications can, again, come from different factors, you need to consider different factors such as potential market size, likelihood that it's going to survive. A startup company seldom generate any cash flows at the start but as an appraiser you come in and you help the company forecast cash flows based on what industries or what are the users of this idea, who are the users of this idea, and can we project from those, can we project cash flows?
A startup company seldom generate any cash flows at the start but as an appraiser you come in and you help the company forecast cash flows based on what industries or what are the users of this idea, who are the users of this idea, and can we project from those, can we project cash flows?
Jeff: In this day age, entrepreneurial ideas, ideas are born every single day. And so there's a tremendous intangibility that is attached to an idea until you kind of see it work and you see it being used by people, and being used effectively. And when you see that cash flow then that intangibility is no longer intangible, it's actually real, it's a real thing. And I think it's a very interesting conversation and one that we could probably expand on and actually do an entire show on this. Because there are a lot of inventors out there for example, Angela, who have that prototype. We've seen them on Shark Tank for example, who don't really know how to move forward. Because those three guys, or people, or gals on Shark Tank wouldn't give them their million dollars to start their company, it doesn't mean that there aren't people out there that are willing to invest in these really great ideas. I'd like though to talk a little bit about intellectual property because with the advent of the Internet some 25 years ago, whatever it's been now, intellectual property, there has never been a greater, I use the word premium again placed on intellectual property than it is today because the Internet we’re just saturated in information, logos, and service marks, and information coming from all angles both mobile and here on our workstations at our office and home. I would imagine that intellectual property, when it comes to valuations for a company, very, very important indeed, and very critical, and in some cases I would imagine that that logo represents a very significant amount of the value that is assigned to a company.
Angela: Yes, definitely. And you need a separate appraisal for intellectual property and intangible assets. We're not just talking about logos, trade names, and trademarks. Over the past 20 years as you mentioned it's become increasingly apparent that large mediums, small companies, they're now focusing on developing and maintaining intangible assets such as technology as we move from a bricks and mortar economy to one really driven more by technology. So what I've seen is most of the large companies are focusing on technology, licensing rights to IP, royalty agreements as to use of software and technology. On top of you have your trademarks, trade names, you have your customer relationships and customer list, you have secret recipes, or trade know-how, trade secrets. Yes, it's definitely of paramount importance that a company maintain and grow their value through better management and protection of these critical assets. And definitely, you need a separate appraisal for IP assets because more and more, this becomes bulk of the value of a company especially when they're thinking of a future sale or a future transaction for the company.
Jeff: Angela, believe it or not we've already come up short on time here on this edition of Deal Talk and it's been a real pleasure. Just really quickly though, any last words that you may have of advice or tips to help business owners get the most out of their companies in terms of improving their values, anything at all that you could go ahead and pass along?
Angela: Business appraisal, business valuation, it's not an art, it's not a science, I'm a firm believer that it's a hybrid of both. You can get paid for the potential of your company if, as I mentioned earlier, you take the right steps into continually improving your revenues, innovating and diversifying your product line and services. And decreasing your reliance on a key person or a key management team. For some of you, you take steps. The tactics that you use to make your company attractive in the market are largely the same ones that direct the company in a path to growth and prosperity, hopefully enhance a higher value for the business. And you need a professional appraiser to work with to just parse all these factors that can demand a high value for your business. And whether you continue to manage the business or eventually sell the business you need to find out if the value is improving or is deteriorating. My advice is yes, you have to work with a professional appraisal, especially if your aim is to do a transaction of whether it's merger, or acquisition, or a sale of an interest of the company in the future.
You take the right steps into continually improving your revenues, innovating and diversifying your product line and services.
Jeff: Angela, this has been a terrific conversation and I know that there are a number of people in our audience who've learned a great deal from it today. How can people reach you should they have any questions specific to their organizations and they might like to contact you about consulting with them and performing valuation on their companies?
Angela: I can be reached ... I work in our Manhattan office so I can be reached at 212-201-3012 Eastern Standard Time. And my email address is email@example.com.
Jeff: Angela, again, I really, really enjoyed this program and our conversation today, and hopefully we can have you back on the program in the near future.
Angela: Thank you, Jeff.
Jeff: Angela Sadang is the Director in the Financial Advisory Services Group at Marks Paneth LLP in New York.
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Jeff: To start with, I'd be interested in knowing, of the valuations that you and your firm perform, Michael, what percentage are transactional versus those that are non-transactional?
Michael: Well, most of the transactions are non-transactional though we do a lot of fair value accounting and purchase price allocation type work for our clients who have done acquisitions and they need an allocation of those purchase prices for financial statement reporting purposes. But most valuations we do are either for state gift tax purposes or for litigation matters.
Jeff: Okay, very good. What we're really finding out here, we’re kind of setting this up all from the beginning Michael, and thanks very much for bearing with me. I know that that question is probably somewhat elementary. But really, we're trying to kind of understand why valuations are an important part of doing business, not just for the purpose of getting a better idea of how much our business could possibly be worth at some point on the open market. But really to find out that valuations are really kind of necessary for other purposes. There are many small business owners out there, particularly those owners of smaller businesses that may be somewhere in the ball park of a million dollars annual revenue, maybe even less than that, that are concerned about the short run cost of a comprehensive valuation of their business. But I'm kind of wondering, if it could be advantageous to business owners to spend the money and use the information that valuation will uncover to his company's benefit down the line. We're talking about really valuation, taking and spending that money upfront is really something that could be of great importance later on, could it not, and in more ways than one?
Michael: Sure, absolutely. The truth is a full valuation or what we call a comprehensive business valuation really provides small business owners with a lot of information about his company. And a small business owner would want a business valuation for any number of reasons. Whether they're talking about succession planning and gifting that company down to the next generation, or he wants to set up his company for a potential sale. And a full comprehensive business valuation really delves into how the company has operated over the past, what the projections are for the future, how that company stacks up against the industry. And it would include an analysis of the industry, analysis of the economics, the economic environment that that company actually functions in, whether it's global or local. The business valuator would examine that and see how that market is doing. And so from that full valuation report the business owner could see where the weaknesses are in his company which he may not regularly see on an ongoing basis if he's just looking at financial statements. As a matter of fact he's making money and everything's fine and dandy when there's plenty of cash around. It tends to cover up a lot of errors. So a full business valuation could really help in that regard.
The truth is a full valuation or what we call a comprehensive business valuation really provides small business owners with a lot of information about his company.
Jeff: Interesting points, Michael, and we know that there are some companies out there like you said that are making money. They have cash flow and everything seems to be operating as normal or as well as could probably be expected. But sometimes as well as canbe expected is not always optimal, and particularly when you know that the business might be stagnant when the economy is thriving. A full valuation would allow a business owner and his team to be able to see where their certain weaknesses are that they could shore up. And actually, really at the end of the day and after some hard work maybe at the front end, really allow them to realize real improvements in their company's value over the long run. Is that not right?
Michael: Sure. A full valuation would really point out to the business owner where the value drivers are so he can maximize the value of his business. Most small business owners, most of them that worth is tied up in their business. So that's their retirement. So the sale of that business sometimes is really what they expect to retire on. So that's an asset you want to maximize the value. So you really need to understand what the value drivers are in the business. And a lot of business owners are very good at what they do but they don't necessarily understand what drives the value to a buyer.
Jeff: Today's expert is Michael Gould, CPA, Certified Valuation Analyst, and Director of Litigation Support and Valuation services at RotenbergMeril. You're listening to Deal Talk. My name is Jeff Allen. Full and low cost valuation options, you kind of touched on this just a little bit. When are these two options best used for the small business owner today? When would you go in and say, provide a low cost option as opposed to the full enchilada?
Michael: A business owner might be thinking of selling and maybe several years, few, five years down the road, or he may be considering gifting the business down to his heirs. And he may want to get some idea of what value of the business would be without spending a lot of money on a full comprehensive valuation or report. So we have another process that we go through and we call it a calculation engagement. And that engagement does not include a lot of the bells and whistles that a full company business valuation would entail, and therefore be less time consuming and less costly to the owner. And it essentially is what we call an agreed upon procedure. So we agree upon with the client, "This is what we're going to do. We're going to run a couple of income approaches.” We may agree to do a little market research in terms of comparable transactions or guideline companies. We will agree on a limited number of procedures we're going to go through to give us some indication of what a range of value would be for the business. And this is probably less than half the cost of a full valuation and to give that owner kind of an idea of what he's looking at.
So you really need to understand what the value drivers are in the business.
Jeff: Would you use that same kind of approach for the other non-transactional types of valuations that you do as well, Michael, or are these typically reserved for just kind of the periodic checks that an owner wants to kind of make just to make sure that he's on the right track?
Michael: That's actually an interesting question and it's kind of subject to some debate in the valuation community. We as a firm have a policy. We will not testify when it comes to a calculation engagement because in our mind and if you read our business valuation standard and reporting standards, the calculation engagement is not an opinion of value, it's a calculation or indication of value. So that we do not use calculation engagements if we're going to have to testify to an opinion as to what the value is because it's not an opinion of value. But it is used in a non-transactional litigation matters or... matters where the parties are working towards settling the matter in non-litigated areas. So they want to get some idea of what the value and if they can agree to it. We may use a calculation engagement for those purposes, and often do knowing that this is not going to trial and I do not have to testify to it, but we want to get some idea of what the value is.
Jeff: A calculation engagement is really kind of another way of saying it's a smart estimate that is close but it's not anything that you can really go ahead and hold someone to for the purpose of, like you said, testifying in court or litigation proceedings.
Michael: Right, because if you go to court you want to be able to say that you have a professional opinion as to what the value of a business is. And a calculation engagement, the procedures that are involved in a calculation engagement don't allow you to give that opinion. And under our business valuation reporting standards that we have to adhere to as credential business valuators.
The calculation engagement is not an opinion of value, it's a calculation or indication of value. So that we do not use calculation engagements if we're going to have to testify to an opinion as to what the value is because it's not an opinion of value.
Jeff: Correct. So the need to be accurate and as close as precise as you possibly can comes with more of a full-scale valuation procedure, and that's something that your company does an awful lot of. Transactional and non-transactional valuations, when do you need the latter? I'm Jeff Allen talking with Michael Gould, Director of Litigation Support and Valuation Services for RotenbergMeril. We'll be back with more on Deal Talk right after this.
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Jeff: Welcome back to Deal Talk, Jeff Allen here with my guest Michael Gould, Director of Litigation Support and Valuation Services for RotenbergMeril. And Michael Gould is a CPA, also has a designation of a CVA, Certified Valuation Analyst. Michael, we appreciate you're being on our program today. Let's talk about the main differences between transactional and non transactional valuations. We could go over in terms of time spent, any other details the way that they're calculated and the way that these things are processed, and all the information that they require. But maybe you can kind of give us some insight on that?
Michael: Well, there are some differences between a valuation for divorce purposes versus a valuation for tax purposes, or transaction for a potential sale of a business. In a divorce situation ... Let me back up a second. A lot of the information that you need to perform all of these valuations is a lot of the same information. Assuming historical information, you need projections if you can get them, etc. However, in a divorce valuation for instance, it really depends on what state you're in or what jurisdiction you're in because in certain states the premise of value will be different. In New Jersey for instance, there's been some precedent cases, the most notable being Brown vs. Brown in New Jersey where they basically say the premise of value is value to the holder, but that's the way everyone is interpreting the Brown vs. Brown case in New Jersey. That means that the values to the holder there's no valuation discounts applied in a valuation for matrimonial purposes in New Jersey. However in New York it doesn't hold that way. There are certain valuation discounts that are applied in New York valuations.
Jeff: I was going to say, if you don't mind, before we kind of go on just a second, Michael, valuation discounts, exactly what are those?
Michael: Valuation discounts would be for instance if you're valuating less than 50 percent it could be a lack of control or minority interest discount. It could be if you're valuing a closely-held business where there's a restriction on the transferability of the interest. It could be a lack of marketability or lack of liquidity discounts. It could be key man discounts, those types of things. The main ones are lack of control and lack of marketability.
Jeff: Okay, very good. I hope I didn't steer you too far off the track there when I jumped in with that question. You can continue your explanation.
Michael: Excellent. And then versus the valuation for tax purposes, you're pretty much guided by the business valuation standards and regulations that you'll find in the internal revenue code and the regulations thereof where it is a what they call fair market standard of value for tax purposes. However, as you may know right now and this is in October 2006 we expect some regulations to come down from the IRS probably early next year. The kind of thinking is which is going to address some of the restrictions probably, and some of these family limited partnerships and family LLCs which restrict transferability, or the right to withdraw. And if they come down with these regulations then what we expect to happen is that the IRS is going to say that valuing some of these entities, the valuations ignore these restrictions in their valuation. So if you have to ignore these restrictions in your valuation that's going to limit the discounts for lack of marketability for instance, in a tax valuation. Mainly we think now and those entities that hold only marketable securities. We believe that for tax purposes, the valuations of operating companies, operating businesses and rental real estate entities are probably going to escape these regulations. But quite frankly until they come out it's all speculation at this point.
So if you have to ignore these restrictions in your valuation that's going to limit the discounts for lack of marketability for instance, in a tax valuation. Mainly we think now and those entities that hold only marketable securities.
Jeff: So to take advantage of those valuation discounts you need to be able to take advantage of them before the end of 2015, is that correct?
Michael: I would say if you’ve got a family LLC in your plan, or sitting there and you want to start making gifts you should do it before these regulations come out. Most likely these regulations are not going to be retroactive, they will be prospective. So if you want to get the maximum valuation discounts allowable under the rules now you should do it now, absolutely.
Jeff: My goodness. There we go. Make sure that's food for thought and everybody listening is hopefully going to take what you say very seriously and take advantage of that. It's rather short porch. So if you're considering valuation right now and taking advantage of discounts such as what we just discussed with Michael Gould that you do so now. Let's talk now about non-transactional valuations where you are going in, let's say, and divorces come and it's unfortunate. But the fact of the matter is it happens and it's probably something you get a lot of calls maybe at your office about this type of thing, Michael. I can't pretend to know for sure but I can imagine that it is probably important for something like that to require a neutral party or a neutral business valuation in particular. Let's talk about that. What exactly that means and how you go about ensuring that you're getting a neutral business valuation for something like this, like divorce for example?
Michael: Yeah. Actually, I just gave a speech, a national conference last week about hiring a neutral financial expert as opposed to each party retaining their own and what are the main benefits to having a neutral expert. What normally happens, each party to a manner will hire their own experts. Those experts, their opinions lined up worlds apart, so then what happens? The judge, if it goes to litigation, is going to hire a third expert. Or the judge just decides he's going to split the baby which generally is not the right answer. So hiring one neutral expert that instead of ending up with three is clearly less expensive. The other main issue is a neutral expert doesn't owe any allegiance to either party. He or she is only an advocate for his own opinion. So his mindset is he wants to come to the most equitable and the most correct answer that he can. And that's a benefit to both parties. And then the other issue that happens when you end up each party with their own expert with kind of built-in biases because they feel they owe an allegiance to the people paying their fees is sometimes one of the parties hires what we'll call a hired gun. When a hired gun doesn't control the expectations of the client they end up putting totally distorted figures into the mindset of the party. And when that happens it becomes very difficult to actually settle the matter because they get into the matter, this unreasonable expert is, "We're going to get you a gazillion dollars." And when they find out that they're going to get half a gazillion dollars, you can't settle the matter. So it's always better to start out with a neutral expert.
So hiring one neutral expert that instead of ending up with three is clearly less expensive.
Jeff: The question is, how does one go about defining one as neutral and how do they actually come to the agreement that they use this particular appraiser or valuation expert as opposed to this one? How is a neutral expert chosen?
Michael: There are a few ways a neutral expert gets retained in a manner. In a mediation a lot of times we brought in a lot of very ... mediators. And a mediator in a manner who may not be a financial person, might be an attorney, might tell the employees there are complicated financial issues here and maybe valuations that need to be done. And he or she needs a financial expert. They may give the parties a couple of names that he or she knows of and work with. And say, “Here, interview them, pick one,” or they may say, "Look, this is the person I work with. This is the person I'm most familiar with, I have confidence in, and we've had good results with." That's in a mediated matter. There's another divorce process which is gaining favor these days and that's collaborative divorces. In a collaborative matter there's a team. And on a team there's usually one neutral financial expert on that team. So when you get into a collaborative divorce there is an already chosen neutral financial expert that the parties will retain. And then in a litigated matter, and this happens quite often, either the parties themselves will agree on a neutral expert to be brought in for the financial matters, or the judge can appoint a neutral financial person and very often we become court appointed. That's sort of the way it happens.
Jeff: Is there anything that is not included in the valuation when your team goes out and whether you've been appointed by the court or otherwise. You start to put this together for whether it be a dissolution, divorce, or what have you. Anything at all that isn't included or may in fact be included where you typically might not include in an appraisal, and all that you can talk to us about?
Michael: I'm not sure exactly how to answer that except to say that if we're doing a minority interest valuation for tax purposes we may or may not be hired to do a lot of forensic accounting. Whereas in a divorce situation you have to do a valuation sometimes and then close the old business. There may be some personal prerequisites that are running through the business which many not be what we'll call an ordinary necessary business expenses. So we may have to go in and determine what kind of adjustments we have to make for the historical income statements to normalize them so that we have a correct historical cash flow from which to develop a value for that business. So there may be some differences in what we do, but usually that gets defined early on in the process so they know whether how much time they're going to be spending doing that kind of work.
So we may have to go in and determine what kind of adjustments we have to make for the historical income statements to normalize them so that we have a correct historical cash flow from which to develop a value for that business.
Jeff: What is maybe an example from the work that you've done in the past of some things that you've uncovered? And obviously you're not going to mention any companies here but I mean what have you seen that you've gone through and you're going through the investigative process to put together these numbers and some stuff that you've uncovered where the books are just completely upside down or just a complete mess. Or maybe even we can talk about some common areas where you've seen some major accounting weaknesses that weren't anything that were deliberate but it caused your process of preparing your valuation it created a greater period of time, more work for you, in order to get where you wanted to be and have those final figures already for your client.
Michael: Yeah. There's not enough time in this program to give you all the war stories. But what'll happen, and it does happen more often than you would like is that you'll take a look at tax returns in a matter for a company, small business. And then you look at the books and records and they look like they're two different companies. You're trying to figure out, you can't trace the books and records for the company to what's been reported to the IRS. That becomes quite a bit of a nightmare and results in a lot of forensic work and analysis to try to figure out what's the true, which set of books are we supposed to be using. And then you get to the cash-based businesses like restaurants, salons, and whatnot that 50 percent of the income is actually being reported and we've had a recent case where we went to a restaurant and we had to make a couple of site visits, not that they knew who we were. We had some staff people going there and eat. We had to count tables, and heads. And because the income, I think they showed ... So we walked in and counted 20 employees and there were two on the books, that type of thing. So we had to totally reconstruct the operations of the business in order to develop some indication, what the value of that business was and that wasn't even for a divorce, that was a shareholder dispute.
Jeff: Oh my gosh, no kidding? What about for lawsuits, are you contacted by a client, a business owner when they know that maybe they're being sued, or there's litigation coming their way, and they need to reach out to you to come out and kind of analyze things before the proceedings?
Michael: Yeah, sometimes what will happen is there's a suspected theft for instance inside a company, and the company ends up actually going out of business. The damages could be either the amount that was stolen or the actual value of the business that was destroyed. Sometimes we'll get involved in shareholder disputes where one equity owner thinks he's the operator and another one's a passive investor, and they think the operating person is stealing from them, or was not reporting everything they should be. Often, rather than jump to a legal complaint and start the legal process running they'll come to us and say, "This is what's going on. What we want to do is without the judge getting involved. What's the value of this thing? Let's see if we can come to an agreement and want to buy out the other and move on without spending hundreds of thousands of dollars in litigation costs."
Jeff: Any final thoughts, Michael, as we're running out of time here that you have for business owners who may be in need of valuation, and it could be for any purpose. Maybe they're planning on selling their business soon. They're looking for kind of a midterm type of calculation just to make sure they're on the right track, or anything at all that you could leave with us, any key take aways from your perspective and experience?
Michael: I would say that it's always a good idea to periodically have the business appraised by a qualified business appraiser, and that's people who have experienced in the field, who have credentials, like having a CVA like ... and also an ASA, Accredited Senior Appraiser. There are number of credentials out there. It's always a good idea to have an idea. The truth is if they've got a buy-sell agreement in place, if they have partners, if they are doing some esstate planning and passing it along to their heirs they really need to know what the value of that business is. That's really something that should be done on a periodic basis.
It's always a good idea to have an idea. The truth is if they've got a buy-sell agreement in place, if they have partners, if they are doing some esstate planning and passing it along to their heirs they really need to know what the value of that business is.
Jeff: If somebody would like to get in touch with you, Michael Gould, at your office there at RotenbergMeril, how can they do that?
Michael: Well, they can certainly call me. My direct telephone line is 201-490-2077. Our New Jersey office is in Saddle Brook, south of New Jersey, and we have a Manhattan Office at 40th and Lex. You can always reach me through my direct line. My email address is firstname.lastname@example.org which is the initial of the firm.
Jeff: Very good. Michael Gould, it's been a pleasure sir. Thank you so much for giving us a slice of your time today in discussing these very important points. We are out of time. We'll have to leave it there. Michael Gould, thank you.
Michael: Thank you. Thanks for having me.
Jeff: Michael Gould, director of Director of Litigation Support and Valuation Services at RotenbergMeril.
Deal Talk has been presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. If you're thinking about selling a business or buying one you can call Morgan & Westfield at 888-693-7834 or visit morganandwestfield.com. And for more valuable information and insight from our growing list of small business experts like Michael Gould from RotenbergMeril make sure to join us again here on Deal Talk. I'm Jeff Allen, thanks again for listening. We'll talk again soon.