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Elliott Holland_Beyond 8 Figures_Strategies for Buying a Business

Strategies for Buying a Business with Elliott Holland, Guardian Due Diligence

April 26, 2023

Due diligence is about more than just the numbers! In this episode, Elliott Holland and A.J. discuss some of the key strategies for buying a business using A.J.’s recent deal that fell through as a case study. Elliott explains why the qualitative elements of a business are as important as the quantitative components, the value of having an advisor during the acquisition process, and how to decide whether a particular business is a good fit for YOU.

About Elliott Holland:
Elliott Holland, “reformed engineer”, the founder and Managing Director of Guardian Due Diligence, is an expert in small and medium-sized business acquisitions. He has over ten years of experience executing middle-market deals, and his company is filling the void of options that exist for smaller acquisitions.

Due Diligence When Buying a Business

When buying a business, due diligence is really important. It means doing a thorough investigation before making a decision. Why is it important? Well, it helps you understand the business better. You can uncover any hidden problems or risks. You can check the financial records, contracts, and legal matters. It gives you a clear picture of what you’re getting into. It’s like checking a used car before buying it.

Episode highlights:

  • If you are thinking of buying a business, create a list of (very specific) dealbreakers. These are the factors that will cause you to walk away from the deal. An example might be: “I don’t feel I can run the business from day one without the seller.” (02:33)
  • A QoE (Quality of Earnings) is traditionally just a quantitative analysis, but in small-medium business deals, the qualitative components are just as important. In this particular case, the downward trend in the numbers wouldn’t have been a dealbreaker if the foundational core of the business had been strong. (13:41)
  • Don’t underestimate the importance of having an advisor during the acquisition process. The role of an advisor is not to say whether a deal is good or bad but rather to ask you questions that will make you think about whether you feel it is something worth pursuing. (17:56)
  • Don’t believe everything you are told. Oftentimes, people attribute issues incorrectly. That is why it is so important to have good due diligence on your side. (19:17)
  • Make sure that the business you buy is a good fit for YOU. There are so many businesses out there you could buy and play some kind of role in, but you need to make sure that it is the role you really want. (25:00)
  • Just because we are currently in a tougher market doesn’t mean great deals can’t be done; it just means you may need to work a little bit harder, negotiate a bit better, and make sure you are getting updated financials! (37:42)

Elliott’s best advice for entrepreneurs:

“People know that they need a QOE. They don’t always know that they need advisory work in the process.” (28:00)

Connect with Elliott:

Resources Mentioned:

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Transcript

[00:01:22] Elliott Holland: Thanks for having me. I’m excited to be here again. This is gonna be fun.

[00:01:26] A.J. Lawrence: So Elliot’s been my advisor and provided the Q of E, the lead due diligence for this process, for this deal. And I think it would be worthwhile to kind of talk through this and kind of do a debrief so everyone in the audience can kind of hear.

[00:01:45] I’ve learned a lot and I’m still sort of trying to figure things out. Now, there may be some gaps in this podcast, both from what we don’t cover but also I may have to edit things after the fact because everything is under NDA. Now, just putting this out, I really do and I still really like the company that I am not purchasing, that I did have under LOI, just as we will discuss. Some things happened that really kind of pushed it away from making it a worthwhile deal for me to pursue.

[00:02:20] I think it is a great company and I really hope that they do some amazing things, and I do hope the seller is able to find someone who can do something amazing with it into the future. But kind of going there, I think the first thing that really I felt worthwhile was, you kind of pushing me to create not just the structure of how the deal was gonna happen and what was going to be, but you kept pushing me to not just create the long-term value, but like what my concerns were. Where my red flags were, the do not cross lines.

[00:02:59] Elliott Holland: The deal breakers, yeah.

[00:03:01] A.J. Lawrence: It was very interesting because that process really helped me rethink the deal. And when a major yellow flag came, which was a decrease in profitability in the company and tagged with a relatively multi-year continuous decrease in profitability. For me, it just brought up almost a cascading amount of other yellow flags that pushed me deeper and deeper and added to my concern of what this deal was. So, maybe kind of talk about this because I know you’ve written a lot about this and you’ve worked with a hell of a lot smarter people than me in walking through the Q of E. So let’s talk about the value of building these deal breakers into the deal.

[00:03:49] Elliott Holland: So, I provide diligence now but before this I was a self-funded searcher. And then previous to that in private equity, so I’ve been doing these processes for almost 15 years. And as a process person, I was always thinking to myself, Well these are these intense 69-day processes, how do you structure them given your working every week? Lawyers, accountants, the whole thing.

[00:04:13] And by far the best way I’ve seen is you get into the deal because you’re happy so you have a list of things you love. That’s cool. But probably the more important list is your list of deal breakers and you wanna be very specific about them. And also you want to only include the deal breakers, not unsavory stuff that you wouldn’t like but wouldn’t make you walk away from the deal.

[00:04:34] So you almost ask yourself, what would make me walk away from this deal? So you might say, Hey, look, if revenue drops more than 15% in the trailing 12 month period. If profitability is off more than 20% from what was reported in the SIM. You might say if customer or employee churn is so difficult that the semi-passive opportunity I thought I was buying turns into a very active hiring opportunity, where you gotta keep hiring folks cause they’re churning or you gotta keep selling because the clients aren’t repeating. Those are the kind of things that you write down.

[00:05:08] Or maybe, one that I push my clients to talk about is if you get in there and you don’t feel you can run the business day one without the seller. The business is too complex or too seller-reliant. So you list those deal breakers and then each week you’re working to see if they’re true. And you kinda put red, green, yellow lights on each one or however you wanna measure it. And the week where one of them hits red, where your deal breaker kind of level has been hit, you stop.

[00:05:40] First, pause and make sure that you calibrated everything correctly. But when it hits your deal breaker, you stop. Because if you’re not gonna go past that line, there’s no need to spend more of Q of E, more of legal. No reason to go visit the seller. You tripped a hot wire.

[00:05:56] A.J. Lawrence: What I really like, in looking back at it, we had a situation where your team came up with not different numbers than what the sellers team had, but had a deeper sort of resume of what was going on with some of the things. And that began a series of questions. But what was interesting is you were pushing me in also to go further into things that we had talked about in the Q of E timeline – things that we would look at later, going into specific contracts, type of execution, team members because, and this is what I felt was really good and I know this isn’t for you, but I had paid you half upfront or a portion upfront and we’re moving through the different stages of the deal that I would pay additional Q of E.

[00:06:49] We knew that once this first stage was passed, I would be bringing on a very expensive legal team, SMB law, at the end of the day was who we were gonna work with, who had an upfront cost and additional smaller Q of E insurance and blah, blah, blah, blah.

[00:07:08] If we had moved past this spot where I decided to withdraw the LOI, there would’ve been another chunk of sum costs. Now at the end of the day, as you have said, these sum costs are nothing if it keeps me from blowing up a million dollar personal guarantee or multimillion dollar personal guarantee.

[00:07:28] Elliott Holland: Right.

[00:07:28] A.J. Lawrence: But, to me was very interesting because you pushed me one, on the deal breakers. You pushed me to really go deeper on the deal breakers, the red flags, the yellow flags, than my first pass of like, oh yeah, yeah. As I always say, sometimes it’s very easy to say things.

[00:07:42] To make it worthwhile, I believe you either have to have a lot of self-discipline or the lot of self knowledge, or the pushing and the experience of someone who’s been there.

[00:07:53] Elliott Holland: Some help.

[00:07:54] A.J. Lawrence: Yeah, you’re right. That is important.

[00:07:55] Elliott Holland: It’s really hard to go from like a 6-figure earning situation to a 7-figure one and be objective. Let’s just be honest. Like just put a hundred people in the room making 6 figures and give them a 7- figure opportunity with a bunch of red flags and see how many run through them. It’s just human nature.

[00:08:13] So part of the Q of E’s purpose in these deals is to very quickly get to a more accurate view of the numbers than what might be presented by the broker in the SIM, so that guys like A.J. know what they’re actually looking at, not this marketing thing that was presented to sell a business. And what I do is, about a week into my process, we do an executive summary review that catches a lot of deal breakers.

[00:08:37] We kick the tires, look at bank statements, I won’t get into the boring stuff. But it allows us to very quickly tell a client like, Hey, A.J. the EBITDA may be plus or minus there we’re still working on it, but the customer churn is way different than we thought. And so now we spent week two, I’m doing my analysis, but A.J. is having conversations about the customers, about who are they about these things that are on his deal breaker list.

[00:09:03] And so now week two, we have a deeper conversation about, hey, this is picture strategy. And so again, like even me, I make money by finishing projects, but I’m more interested in clients doing well long term. So I’m pushing A.J., is this one that you want to pursue? I think we’re close to a couple of your deal breakers. Is this part of your strategy? You told me about your strategy for weeks and months. This isn’t gonna help you, you know?

[00:09:31] But I guess what we also have to talk about is let’s get into the emotion a bit, cuz this is actually a good time to open that up I think. So you’ve enjoyed the deal, put the LOI together, started paying some money. So you have some cost in this. And you’re uncertain because deal experts typically fall on the hold coal side of this, we’re more in the SMB part where it’s a couple of deals or maybe it’s the first one. So now it’s the uneasiness of what is the criteria to stop a deal, which is why the list of deal breakers is so important.

[00:10:03] But also emotionally, how much stuff do I have to unravel when I stop? Because you gotta stop and call your lawyers and say, Hey, no. Call your lenders and say, Hey, no. And everybody’s asking you what happened? What changed? Could you have seen it earlier? There’s all this crap that comes afterwards and you’re already emotionally drained, cause looking at sunk cost I think puts everybody in the f*cking mood. So it’s a tough thing to do. I think what we’re trying to like convey is, and he said, it is way easier said than done. In the moment, that thing is very hard to do.

[00:10:36] A.J. Lawrence: I think what was interesting from two things, because there was a changing macro-environment. And the macro environment has accelerated from conversations I had. But because you always, from the beginning, were pushing me to really align this acquisition around my long-term strategy [i.e creating a family business, this is multi-generation that I’m looking at]. It is that step from comfortable, have a couple of mid and low seven figure exits, but it’s really about that going from a relatively easies, and this is a small little violin. And I know I’m privileged, but relatively easy 6-figure decently mid to a potentially over the long term horizon, a 7-figure or more opportunity for me.

[00:11:24] Elliott Holland: Life changing. Yes.

[00:11:26] A.J. Lawrence: And you pushed me. What I noticed in this, in talking to a lot of people, it was about the numbers. It was about the numbers. It was about the numbers. You pushed very much around what do the numbers mean to the strategy? And as we saw, like I reached out to, I think in the end, I began the process with eight different lenders.

[00:11:50] Seven of them were just like, give us data dumps, give us the numbers, give us your things. You just sent us stuff and in one to two months, we’ll tell you what we think. A couple of them said maybe in a few weeks.

[00:12:02] Elliott Holland: Great.

[00:12:02] A.J. Lawrence: Lisa over at Live Oak, was very, very different. And I know, she’s got a little flack and I think her and her business partner from Live Oak need to be defended a little bit because some people are pushed back on, they’re pushing the qualitative story.

[00:12:20] Elliott Holland: Yes.

[00:12:20] A.J. Lawrence: I really found it very interesting because you were pushing me early. When my conversations with Lisa started accelerating around this deal, I realized more yellow flags and this is where the cascading effect came, when the numbers hit.

[00:12:36] Elliott Holland: Right.

[00:12:36] A.J. Lawrence: And that was just an interesting thing, and not every lender, broker, etc is this way, but I think a lot of people would’ve said yes to me up until the point Investment Committee XYZ down the road said no. And we would’ve been much further in.

[00:12:52] So you and then that canary in the coal mine of Live Oak going, uhh, wait a second. You need to tell us a little bit more. Just don’t give us numbers. What the f does this mean?

[00:13:04] Elliott Holland: What is the story?

[00:13:05] A.J. Lawrence: Yeah. What is the story? I think they even have a new format. And in the end it’s just their initials, I forgot. I’ll put it in the show notes.

[00:13:13] Elliott Holland: HLM Scorecard.

[00:13:15] A.J. Lawrence: Yeah. And everyone’s like, what does that mean? It’s like, it’s just Heather and Lisa Scorecard.

[00:13:24] Elliott Holland: Right. But here’s what’s funny. Their list looks a lot like the evaluation criteria that you and I worked together with to evaluate deals. So again, people are using these lists to help evaluate. But let me get to a point that A.J. made that I wanted to shout from the mountaintops.

[00:13:41] So the Q of E has traditionally been a quantitative numbers only analysis. What’s the EBITDA? What’s the working capital? Get this account outta my face. You know, I can go close now. In Small Medium Business deals, and I’ve been saying this for a long time, there’s a huge qualitative component that you can’t underestimate. And so, me being a deal professional, running a team of CPAs, we look at this differently. So A.J. mentioned two things that were the main yellow flags that pushed this deal out.

[00:14:12] I’m gonna try to say this quickly, but also emphatically. The numbers had some downward trend, but that by itself would not have kicked the deal out because a strong platform business with good bones would have still been a deal that was evaluated. But that in conjunction with the second piece, it showed up and looked like a kind of recurring revenue business. But when we actually looked at the customers, they were churning over too quickly for them to be recurring.

[00:14:40] So now when you think about the operations of the business, you’re not going in and dealing with customers that have been there three years and probably last another three. You’re dealing with customers that may be gone in 3, 6, 9 months. So as soon as a new owner gets in there, what they have to do is sell, sell, sell, sell, sell.

[00:14:59] That’s a qualitative, that’s a operational piece. But you put those two together, which is something that we do quite often at Guardian, and now the two together are like sizzling almost to the red because that long-term vision A.J. had of building generational wealth and building a platform business would’ve been negated because he just spent all his time selling new customers.

[00:15:22] But that’s not something typical for a Q of E to push people on because that’s typically like one of those tabs way in the back and am might not even make into the report. I’ve seen some reports out here that don’t even talk about customers. So you wanna visit the qualitative stuff, I mean, I agree with Lisa. I had conversation with her a weeks ago. Especially in a year like this, you gotta dive into like qualitatively business strategy wise, does this make sense still?

[00:15:49] A.J. Lawrence: And I think this is where a lot of people in the space, and there are a lot of voices in that no money down acquisitions or the sort of like, this is passive income. The reality is these are opportunities, but there’s high risk. There is long-term effort that is needed to kind of steer these. So it’s like, sure, you could buy yourself a job, you can listen to the Acquisitions Anonymous folks. Their podcast is great because they just make fun of anything where you’re buying yourself a job versus putting yourself in a business to grow.

[00:16:26] But then really, it is that fine tune. If so much of the early part of my effort would be in "buying myself a job", the long term strategy would be pushed out so much further that taking a step back and reevaluating the deal and basically saying, let me look for a different deal. Still even the delay, as long as I don’t completely delay, it still keeps me better aligned with my long term strategy than in chasing this deal to the death.

[00:16:58] And I want to get a little bit into your handholding, you gave me like a day or so to think about chasing the deal and fixing the deal and going in, then you’re like, okay, those are nice, but you know. You laid the boom on me pretty hard of like you’re chasing after something versus acquiring something to build something. And you know that one that was very worthwhile and I jokingly said it gave me a little more backbone than I think I was looking at earlier. And it helped me realize, okay, it’s not the deal, it’s the strategy. It’s my long-term direction. The deal itself is not the requirement. It is the right pursuit of the deal. Doing the right things for the right reason.

[00:17:44] Elliott Holland: You can’t miss the real goal. Doing the right deal is what you’re here to do. Kicking a bad deal out or a deal doesn’t fit your strategy is also what you’re here to do. Nothing else, right?

[00:17:56] So one of the things I think people struggle with is how does an advisor push a buyer, because it’s an interesting relationship. Now, A.J. and I are friends as well so there’s some trust built there. But let me just talk about how that works.

[00:18:09] I don’t say deals are good or bad, that’s not my role. But I can ask questions. And I think some of the questions I was asking A.J. is, if you’re looking at the customers, do you think you’ll have any of those customers in 12 months? And if you don’t have them, how much of your time will be spent selling customers into a new business you’re just acquiring? And does that sound like success for your next year?

[00:18:33] So sort of a heavy question, but not a directive, not a hey man, run for the hills. But sort of here’s the crux of the strategy you told me you were executing when you started this. Is this still on that path? And I think as you noodled on that question, you had I think 80% of the data to I think show what the right decision was.

[00:18:56] But I think you were able to ask sort of that extra 20% of the seller and the broker to get to a conclusive data set to make your decision. And you may wanna talk a little bit more about your mindset during that kind of day and a half, right? What was your mindset leading up to the point where you had to let people know that you weren’t gonna continue?

[00:19:16] A.J. Lawrence: Funny enough, that day and a half of from going to realizing the numbers were not what we had expected. You pushed me pretty quickly into not just the turnover claim, but the contract structure. And there was some good and bad by going dating, and that was stuff we had identified of moving into later into the Q of E.

[00:19:40] It just all of a sudden that went from being like, okay, that’s a secondary concern in the due diligence process to a more important thing. We learned a lot that kind of highlighted that drop of income. In my mind, what happened was it made more sense of why there was a drop in profit. And while it didn’t make the deal impossible, it showed an increased complexity in moving forward.

[00:20:10] Elliott Holland: Yes, I almost forgot about that. So there are moments in the QoE process where the one thing that doesn’t fit into the puzzle, when you start looking into what’s behind it, you actually get to the right answer.

[00:20:24] And that’s why it’s so important to have really good due diligence on your side. Because the light stuff, the light touch on these smaller businesses, they’re more complex than bigger businesses for a lot of reasons.

[00:20:37] A.J. Lawrence: Yeah.

[00:20:37] Elliott Holland: So yeah, numbers were coming in soft, so then what they typically throw at you is, oh, it’s cash versus accrual. They always say that, so I asked for the carfax.

[00:20:47] A.J. Lawrence: But they had so pushed on that cash level forever and ever, and then all of a sudden it was like, oh wait. Sorry, let’s not talk about the specifics of that.

[00:20:55]

[00:20:56] Elliott Holland: So then we hit the Carfax, we get the numbers and it was not that at all. I hear that all the time and 80% of the time, that’s not it folks. Please listen to me. 80% of the time, that’s not the issue. But the issue was, they lost a customer of significance and it happened in between the SIM was written and the deal was closing, or were it supposed to close it.

[00:21:17] A.J. Lawrence: Well, the deal closed, I think, later than they expected. And the revenue didn’t start for a much later point. So there were some parts that were, they had calculated it in for the past year. But accounting is a time-based thing and the reality is that had very little once you get into it, but it is the way we keep score.

[00:21:39] It had pushed something out that had made it look like there was a continuation to all of a sudden was like, oh. So future growth or future opportunities, is this part of it? Is it extended out? Does this just mean that more things are kind of drifting? Which would just mean like, oh, so instead of it being 30 days, things were more gonna be 90, which was gonna push then stuff at the end of the year.

[00:22:07] So like after the acquisition, push stuff much further down the road, which in one hand can be good because you know the work is there. But then the bad side is execution timeframe and cash flow. Because this is all about how quickly you bring the money in and how lower you pay. It’s that difference between when you pay and when you get the money.

[00:22:29] It’s like, you don’t really own a business, you have the difference between these two timeframes. That’s all this is.

[00:22:36] Elliott Holland: That’s it. And so what ended up happening too, A.J., getting the data back after that question, they gave us some information from the contract. So then you and I open up the contract again outside of the scope of QoE. It’s inside our scope because we’re trying to help you holistically evaluate the deal. We looked at the contract and it was clear to us that it had a beginning and a end. So now we’re like, how many other contracts had beginnings and end versus this everlasting or evergreen recurring thing?

[00:23:11] And that’s when I think we both saw it, the strategy that the business presented that it was delivering. And if you weren’t closely looking at the customers, you would’ve believed. And I think once we saw it in the contracts, it became easier to say, this is totally different than what A.J.’s strategy is. So like the numbers thing just highlighted the real challenge. And that’s how this goes a lot of times.

[00:23:35] A.J. Lawrence: Yeah. There is large opportunity from looking at the way the contract was open-ended. But the work and the guaranteed payments were very loaded. And not even reoffering, I always love those little extra letters there, but it changed the equation.

[00:23:56] Elliott Holland: Right.

[00:23:56] A.J. Lawrence: And what was funny was, from you pushing me and me spending 36 hours, send me some numbers on a Friday. On a Monday, I’m like, okay I need to reevaluate and need to figure this out and see what I can do to make it work. Friday we had asked for some additional data. We turned around. I was in the middle of trying to make things work in my head to then how can we ask this?

[00:24:21] After you pushed me into the contracts, I was all gungho until I got into the contracts. And literally after my four sessions of amor, since I sit here and I kind of live off of these little timers, I had a conversation with Lisa to go deeper into the thing. And like literally just started it with like, I don’t have an answer.

[00:24:42] Literally five minutes before, I was psyching myself up to sell her on the deal. And then the moment we started talking, I was just like, you know what? I don’t see this based upon the criteria that she was pushing me, the realm of considerations you had pushed me to generate. All of a sudden I was like, okay. I think this is a good business. But the problem is, to me, this wasn’t a good business for me anymore.

[00:25:09] Elliott Holland: There you go.

[00:25:10] A.J. Lawrence: I could have played a role, but it wasn’t the role I wanted. It wasn’t even a question of buying myself a job or stuff like that, cause I think that’s always a little bit of a mis memory. No matter what, you have to be in the business before you can be outside of the business.

[00:25:24] Love to kind of talk about some of those conversations that go on outside in the world, out there in the future. But in this situation, it really just, I came to that moment of I wasn’t gonna be able to make this deal work for me in my head. I could make the deal. Everyone else was pushing me like, oh, renegotiate, get less.

[00:25:43] Elliott Holland: Yeah.

[00:25:44] A.J. Lawrence: I had one guy like, just take it to them, offer him hat. You know, all this stuff. And I was like, no. Because in the end of the day, the turnaround is I’m buying a relationship for the long term with the seller, not just the business or the types of businesses I’m interested in. It’s that relationship so therefore that trust.

[00:26:06] And like I said, the seller was trustworthy. The seller was someone who I knew would work for the best interest of the company long term, no matter what their ownership stake was. But, I realized I was not going to be able to do what I really wanted to do. And that was tough.

[00:26:28] And I think this is where you and I have jokingly talked about the movement from being able to fly business and first class on your own dollar to doing the PJ or the private jet. But here’s a podcast called Beyond 8 Figures, this is all about the aspirational direction of what we do.

[00:26:46] And I love so much that you’re expanding out from the pure Quality of Earnings, the king of Quality of Earnings, when you and I met. Everyone I talked to is like look, the best two of who you’re gonna get in this space was Elliot. That’s a year ago when I started this search.

[00:27:04] But you’ve expanded it through the whole due diligence process to now, as my deal and I know you have a few other deals you’re working on, you’re acting more in that traditional investment banker directional. And I think this is really cool because in this space you have a big app. You have the coaches early, mostly on how to sell your business but not so much on the acquisition. There are the acquisition labs, of which I’m a member, the Jeremy Harbours and all that. And there are some coaches too, but on the one-on-one deal making and the deal flow process and the strategic alignment, that’s not something that’s really there.

[00:27:45] And I think this is interesting to maybe touch on as you move forward. What you’re thinking of helping strange people like myself go after that longer term larger vision?

[00:27:59] Elliott Holland: Yeah, so people know that they need a QoE, they don’t always know that they need advisory work, investment banking, like work through the process. And oftentimes, they’re not willing to pay for it up upfront cuz they’re still trying to figure out is this deal I just got under LOI really a deal I want to close? Or is it one that’s gonna cause dead deal fees? But I think once we get into the second half of the QoE process, a lot of times the buyers I’m working with are more evaluating do they still like the deal given what this analysis is telling them.

[00:28:31] And that is more an advisory role. And I think people who work with us and people who have done multiple deals with us will tell you, probably more than half of what we do is help the A.J.’s make that decision. To not spend another 50 grand and especially not spend another three years trying to dig out of a hole. To stop doing that.

[00:28:52] Or in a different environment where a renegotiation would’ve been the right solution, I can talk to you about how those renegotiations have worked in the past, given the deals that I’ve been involved with, or how to speak to a broker in a certain way, or how to even put together your list of deal breakers so you don’t spend more time on a bad deal or find the Maserati of deals and not close it quick enough.

[00:29:15] So there’s a lot of advisory stuff that kind of comes within our regular QoE. And then we have a VIP package that actually has way more stuff around keyman risk assessment, business planning, forecasting and that kind of thing.

[00:29:28] And a lot of people, after they realized this deal is financially what they thought it was, and now they’re thinking about, do I wanna put a million dollar plus personal guarantee on this deal? All of a sudden their concept is, should I spend another 10 grand changes? Because this information that they need to know now. They didn’t need to know it five weeks earlier when we started the QoE. But now 30 days from closing, you need to know that stuff.

[00:29:55] A.J. Lawrence: Yeah. It’s funny cuz in going into the process, I was so focused on the deal that to me the large impact was a lot of stuff that we never even got to, which was the sort of the financial structure and planning of where the opportunity for growth was. The understanding of the environment, the understanding of the cash flows, et cetera, deeper to maximize it. Not so much to understand it from a business point of view, but how to better utilize it.

[00:30:24] And that was so exciting to me coming in, which is the reason really early on, I was pushing to talk to you in that sort of higher level role. There’s been a couple of smaller deals that just didn’t rise to this equation, but this one really pushed that like, oh yeah. Quality of Earnings a lot of times gets knocked down to like this, oh, it’s the finances, and this, and this.

[00:30:49] But it’s not the numbers per se, it is what the numbers represent and how they align with it. And this is something that as an analytics person, I’m constantly like, look, who cares about the numbers? It’s usually just the directional concept of them anyway that matters. But even more, how does it align to some qualitative concept that’s important to the business or whatever.

[00:31:13] And this process really helped me understand that. And that was something I was not expecting. I mean, in my head I knew that. Like having run businesses, having built businesses from scratch, I know the numbers are never the numbers. It’s really more what does that mean or what does that allow me to do, good or bad? Or what does it make me do, good or bad?

[00:31:37] Elliott Holland: Right.

[00:31:37] A.J. Lawrence: This situation really brought in, because so much of the conversation is disjointed between different aspects of the process. You have the people talking about the lead generation and finding, and oh, you have to have your own thing or how you have to do this. You have people who are purely on the numbers. You have people who look at a deal just doesn’t matter what it’s all X, Y, or Z.

[00:32:01] And then you do have the qualitative, the Reg’s who are all about the qualitative. It is funny looking out there where the noise is coming. As a buyer, it’s hard to find a coherent concept of how to approach and how to move through. And that working with you has helped reduce that noise out there.

[00:32:23] Elliott Holland: For sure. And there’s a reason I call my business Guardian Due Diligence and not Guardian Quality of Earnings. There’s more to due diligence than just the numbers. And I set that up purposefully years ago, to be able to have this conversation. And the reality is Reg has his list cause he’s been doing something in a niche industry for years. I don’t wanna misquote but like three, five years. So he’s been under the hood on so many things in the niche industry. He knows it.

[00:32:51] Most of my buyers are first time buyers. You can’t hire Reg, he’s not available for hire. They’re not for hire. You know, fortunately you can hire me and we can sort of do a more holistic look on the deal. And I set the business up to be that because I know from my Wall Street private equity deal experience, my independent deal experience, it’s very tough to do these things.

[00:33:15] I have processes and systems because I did it in unorganized ways previously in my career and put structure around it as I got better and more experienced. So it’s important to have that. Maybe as a buyer you have some of that in your own toolkit. If you don’t, then you should really be looking for people who can augment. Like who can actually push you to kill a deal that you may be emotionally connected to. Who can tell the broker and the buyer that, no, it’s not a cash versus accrual thing. Try again without having to look at two weeks worth of data.

[00:33:47] There’s these things that happen. I always talk about you, you don’t wanna lose a million dollars. And I don’t wanna say that flippantly, but what I want to convey is everybody wants to buy a million dollar business that’s gonna grow to a 3 or 5 or 10 million dollar business. But the worst thing to do is to buy a million dollar business that goes to zero. Because you’d have been better off just staying on the sidelines. And so it’s very important to get that decision right. And it’s hard to do on your first try, so you wanna get the help of people who have been through it before.

[00:34:20] A.J. Lawrence: For me, it was a humbling experience because as I said initially, the excitement level, after having pursued deals, one LOI just blew up right away because the moment they shared numbers, it was like, okay, this isn’t anywhere close to anything.

[00:34:36] But other than that, I’ve been the bridesmaid on more than a few deals. Because the environment does still, as a self-funded searcher, as someone who’s utilizing SBA funds, the difficulty is still against you when you get to a certain range because private equity and micro private equity or things that look like micro private equity, we’ll just call it that, all cash deals trump any type of things. If nothing else, then the simplicity of the deal.

[00:35:07] I’ve had people like, Hey, one month of due diligence, where I know it’s not so much the timeframe of due diligence, but the lenders. And lenders are gonna take, you know, I have to pitch that as part of the sale process. Like, look, I’m beholden to the lenders and they should only take one and a half months, but they can take four.

[00:35:29] Elliott Holland: Right.

[00:35:29] A.J. Lawrence: I can only develop a relationship when it comes to that with the seller on the situation. So, working with you through this process has helped me better position myself, better understand the things I could control, the relationship, the value, the insights, and then how to go forward on that.

[00:35:49] Just moving forward, I do think the interesting part in looking at this environment, because look, two bank runs, a few other banks are getting wobbly, and I hate to say this, but almost all the major SBA players in the space are the mid to small banks.

[00:36:08] And you know, it’s one way they differentiate themselves. Yet macroly, that’s the category that’s going to be hit the most. Lending is gonna tighten up. So, the people who kind of pitched the Hey, I can get you 10 bank chumping at the bits for your deal. I think it’s gonna get a little hard.

[00:36:29] Now the good thing is strategically, this is still a space. And this is something else you pushed me to do early, is look at a deal under many different types of scenarios. Now, we were looking at business flow, but the idea of like, okay, it’s the same concept of, what happens if we lose revenue? What happens if expenses increase?

[00:36:53] It’s looking at scenarios of debt and increase if outside investors are needed, which I believe a lot of these deals are gonna go from that 80/20 or 10/20 with 10% seller note to probably situations that are gonna be more towards 50-60% SBA.

[00:37:12] Elliott Holland: Yes.

[00:37:13] A.J. Lawrence: A larger seller and a larger equity slug.

[00:37:16] Elliott Holland: Yes.

[00:37:16] A.J. Lawrence: Unless you have deep pockets, outside equity is gonna cost more. You’re gonna have to give up more. First, rights. Sellers are gonna want protection on their note, and that’s gonna be fun. And it will decrease some of the potential IRR, but the reality is it’s still a very healthy IRR opportunity if structured.

[00:37:40] Elliott Holland: Well, you know, I’ve had a lot of conversations with lenders recently because I always wanna be a good steward to my clients. And I am a 100% sure, and this is where I agree with my buddy Clint Fiore on Twitter. Some great deals are gonna get done this year, so don’t let my conversation about it being a tougher market negate some great deals are gonna get done this year.

[00:38:03] What it just means is you may have to work a little bit harder to get that great deal done. You may need to work a little bit harder at kicking that deal that last year would’ve penciled. They won’t pencil this year, and just realize there’s a new environment. You may need to negotiate a bit better.

[00:38:20] And so what that means is some of the talk tracks, some of the popular things that have been said on Twitter, some of the ways that people did business for the past three or four years, 10% seller notes, half of it on post standby. Well, who knows about negotiating the 30-year 50% seller note? That’s a new thing for a lot of folks.

[00:38:38] Who knows about going to your lender and asking, Hey look, I want to put this LOI in but I think a bigger seller note will get you guys more comfortable. Can we talk about what seller note will probably make this deal advantageous for you and your credit committee? Which is, I think, a different conversation than people are currently having which is more of, does it pencil?

[00:38:58] You may have to spend more time in that HLM scorecard. I’m looking at at least one bank has decided to show some of the criteria that they like on a qualitative basis. Those are things that are gonna help people crush it this year. I mean, I have several clients that are gonna do amazingly well in their deals, but you may need to be a bit more diligent this year.

[00:39:18] You may need to spend a little bit more time sniffing and looking under things. Just be thoughtful and get the help you need to do it right in areas that you don’t know what you’re doing.

[00:39:28] A.J. Lawrence: Yeah, and I think it leads to one, readjusting your timeline, your horizon for strategic value, but also the discipline. You and I have talked about how common it is for working capital, and examples from client, from people who talked to you but then didn’t work with you who misnegotiated working capital, and just how they ended up being six months to a year behind the eight ball because of that.

[00:39:59] In this situation where you’re already losing 10, 15% because of interest and equity requirements and all that, the discipline you need to make sure you have the right things, or moving forward that you are utilizing. A lot of people are like, oh yeah, you’re gonna do this and you’re gonna put a discipline in place.

[00:40:19] But I think the opportunities are going to remain there. But the need right for discipline goes from like, oh, it’s nice to have to like, if you don’t do this, you’re pulling this closer and closer to that red line.

[00:40:34] Elliott Holland: Certainly. And I’ll tell you one area right now where people are struggling. You’re looking at a SIM that has numbers through November of 2022 or maybe December. So it’s March-April now, and you’re gonna look at the SIM, love the numbers, and wanna start everything right away and not get interim financial. And you might not realize the revenue and profit may be down 20 or 30% in this short stub period.

[00:41:03] So now what you’re gonna want to do is, oh, well what’s the trailing 12 months? What’s the trailing 12 months? Will it pencil? And you missed the point. You’re not buying last year’s cash flow. You’re buying next year’s cash flow. If the trend in the stub period is different, then you have to evaluate that stub period almost as a new era of this business. It’s operating in a new environment.

[00:41:26] And there’s gonna be a lot of businesses operating on cash based accounting, which means the revenue coming in today may have been from business they sold a month or two months ago.

[00:41:39] And so you’re getting old revenue and you’re not gonna be able to see the stuff that’s they sold now that may not come in on a cash basis for two months. And you may be in a position where you don’t even see that a business is now heading towards what A.J. calls the red zone.

[00:41:58] And so I urge everyone to be very diligent in getting updated financials, and making sure the company’s doing as well in 2023 as it did in 2022 cuz your SIM’s probably coming from 2022.

[00:42:12] A.J. Lawrence: Yeah. It’s a scary thing. Just as much as we talked about, oh, how great deals are going to be happening, I think discipline of scoring discipline of deal process is very important. Because continuing to search, I’m looking at deals that very much I know are based on numbers that are not the truth. They are directional, but like It’s that fun of like brokers pushing things that were, oh, here’s the valuation. And then when you kind of do it, you realize they left one data in and you’re like, this is a year and a half old valuation.

[00:42:48] Elliott Holland: Exactly.

[00:42:49] A.J. Lawrence: Actually, I did recently looked at a deal. Without talking about the deal, they’ve been pushing the external valuation and anything I talk, if I’m interested, I have to kind of fit this valuation and the discussion around that. I’m like, okay. That’s yours, but whatever.

[00:43:03] But what was really cool was one, it’s a year and a half old, two, they’re like this naturally recognized valuation firm. I did some digging. It’s this one person, like I think he has a desk inside an insurance thing above a strip mall or something.

[00:43:19] I couldn’t find any other reference from this company and I dug through. And it’s not even their main job, whatever this is. And I’m just like, okay.

[00:43:28] Elliott Holland: Right.

[00:43:28] A.J. Lawrence: I think we’re gonna have better deal making because people are gonna be more reasonable on both sides. But two, there’s gonna also be that like, oh, you have to do this, that all you need is one sucker to take a deal. A little bit more noise.

[00:43:42] Elliott Holland: I’m seeing that already. No, that’s exactly it. So a lot of brokers are operating in the frothy market 2022, even though it’s 2023. And so they want you to put deposits down. They’re wanting you to use their documents to have all this crazy language in there and doesn’t have some of the language you need. And we talked about bigger seller notes, but you know these asking prices that are sometimes supported by valuations, some of you buyers may wanna say, I’m gonna put a 40% haircut on that and submit a letter of intent.

[00:44:12] People didn’t do that in 2022. There may be spaces where that’s the right thing to do. I’m not saying do it each and every time. I’m trying to push people’s thinking around the concept of, this valuation says it’s worth $3 million. And A.J. looking at it, saying that that thing’s a year and a half old. I’m looking at the financials now. I’m seeing a January and February that are down 10% relative to 2022. I’m not offering 3 million. I’ll pay 2.2. Forget the valuation, I’m not even looking at it. I didn’t open the thing.

[00:44:44] And folks are gonna have to get there. I mean, I think in tougher markets, and who knows what this market will end up being, you find out who knows what they’re doing are not in these tougher markets. Because the people who are like disciplined, who are reading up on this, who are having these conversations, who are trying to get better each and every day, are gonna get some great deals done this year.

[00:45:05] Because they already planned on being disciplined or organized, thoughtful. So that’s the push. Just stay, be diligent, be disciplined.

[00:45:17] A.J. Lawrence: Discipline. Discipline. Why can’t this just be an easy, quick thing? I mean, I would love to have something easy, but duh. That’s, I think everyone. It is really just kind of like, okay. The value that generates this space, this opportunity, is something. But it is something that needs to be constantly evaluated around.

[00:45:39] I do think the noise of the no money down and all that, doesn’t help the space. But the reality is if you do your own personal due diligence and then really understand the environment, there’s enough from high end to low end.

[00:45:59] Strategic acquisition is a wonderful growth tool. It’s just the risk associated, like anything that has a high return, you have a heightened risk. And heightened risk itself is not bad, especially for an entrepreneur as you and I. It’s like, look, that’s kind of our default setting. High risk is our medium risk.

[00:46:20] Elliott Holland: Yeah.

[00:46:22] A.J. Lawrence: But it is the consistent push to not lose. Maybe it’s not the question of not losing money, but not losing stupid money. It’s like, don’t do stupid things that knock off opportunity.

[00:46:34] Elliott Holland: Yeah. Don’t do stupid things.

[00:46:35] And I think this year, people just gonna have to be a bit better. More organized, a bit more willing to push their agenda. It’s been a seller’s market for a decade plus. This is going from coming back to the buyers baby. So I want you guys to think about that and be a bit more assertive in your offer.

[00:46:55] A.J. Lawrence: Let’s find a way, and we will push people as this comes, everyone in the audience. Obviously you can go Elliot King of QoE on Twitter, Guardian Due Diligence, they do regular deal breakdowns and a lot of really good content of pushing kind of how to think about deal. But you know what, I think some of this strategy and disciplining would be great to hear from you, and let’s find a way to make that happen, to kind of talk a little bit more holistically.

[00:47:22] Cuz we were just talking about sort of like a deal broke down and touched on different things. But I know in sort of our weekly calls with each other around the deals I’ve been looking at. And then also just how we’re running our businesses, you’ve been sketching out this longer term strategy for people like myself.

[00:47:43] That kind of we have to bring our own strategy and thought process into this. But you have structures that been building, so maybe it’d be great. Let’s find a way to make that happen, either another episode or let’s get you having your own podcast.

[00:47:56] Elliott Holland: Well, no, I think we’re moving to the Guardian broadly. I’m still figuring out the right words and how to package it in a way people can consume it. But it’s like my clients bring their strategy for generating generational wealth in real seven and eight figure opportunity. I help them facilitate that strategy. And facilitating it from a QoE diligence deal advisory perspective is really simple for me. It’s helping people like A.J. get out of deals quickly that they really shouldn’t be in. As we find new data or helping others successfully execute deals.

[00:48:35] So here soon we’ll have another page on our website. People know me for talking about war stories and I talk about deals that went sideways, or diligence that went sideways. I will soon have a page on my website dedicated to success stories. So talking about people who probably look like you, act like you, come from similar backgrounds, have executed and done great deals. Just so we can juxtapose and compare and contrast the two things.

[00:49:00] I think in terms of like some of the stuff that you were talking about, A.J., I think we should either do another podcast or like a article cause the discipline piece I think is so paramount for right now. And I think the only way to talk about that truly is to get to what you were saying. It’s discipline under stress, under emotions, with sunk cost on the table. It’s like we almost need to call it what it actually is.

[00:49:22] A.J. Lawrence: Hey, great art comes from great constraints.

[00:49:25] Look recessionary situations, not that we’re in a recession but we’re in recessionary conditions in some aspects of the economy, require deeper thought process and more work. But there’s opportunity.

[00:49:41] Elliott Holland: Yes.

[00:49:41] A.J. Lawrence: This is what we do. There is opportunity in those darn hills. So we’re gonna go after that.

[00:49:47] Elliott Holland: Oh, yes.

[00:49:47] And then also if you’re sitting on a job, I’ve told a lot of my friends that have called me recently even some of my business school classmates, like do you still think it makes sense that 12% interest, 10 and a half percent interest, whatever it is, and this environment?

[00:50:00] And I tell people all the time, you’re evaluating this opportunity of buying a business relative to the other opportunity you have if you don’t. So the risk adjusted opportunity here may still be greater than staying still. And so some of the reasons why I’m pushing on how success can happen in these markets is to help people who may be on the fence realize that pursuing business acquisition particularly, cause most of the self-funded folks are bootstrapping.

[00:50:29] A.J. Lawrence: Mm-hmm.

[00:50:29] Elliott Holland: They work in a job until the deal closes. So continuing on that path and being disciplined is a far better way to generate wealth than to say, I’m gonna give up because the interest rate went up. It’s still probably better than taking on the risk and also the lack of upside in some of people’s alternative situations.

[00:50:50] A.J. Lawrence: This is the way.

[00:50:51] Elliott Holland: This is the way.

[00:50:53] A.J. Lawrence: No, this is the way.

[00:50:55] Elliott Holland: Cool, man.

[00:50:55] A.J. Lawrence: So here, guardianduediligence.com.

[00:50:59] Elliott Holland: Yes. And then @KingofQoE on Twitter or @ElliottEHolland. I should be easy to find on Twitter. And then you should definitely join my email list by downloading anything on my website. We put out great content twice a month, nothing to blow up your inbox. And we’d love to support you in your deal acquisition process and help you be disciplined. So that’s what we’re here to do.

[00:51:21] A.J. Lawrence: Right. Thank you, Elliott. I really appreciate you coming on the show. This was fun.

[00:51:26] Elliott Holland: I love it, A.J. Thanks for having me.

[00:51:27] A.J. Lawrence: All right.

[00:51:28] Hey everyone, thank you so much for listening to how I had a very extensive education. Now, this was a worthwhile education for me in looking at my deal. And having had luck in the past with deals without realizing just the complexity of what I was getting into, this has been a very learning education.

[00:51:50] And as I said, Elliot made this so worthwhile. Yes, I would’ve loved to have closed the deal, but the reality is, it only works when it’s the right deal. So anything you can take out of this is, make sure the deal you’re going after is what’s right for you. Not because of the numbers, not because of anything else, and find the advisors who are going to tell you to push for what’s right for you.

[00:52:19] That was such a great experience realizing that Elliot had my best interest even when there was a large chunk of change. Sorry, Elliot, I have to mention that. A large chunk of change that he was not gonna get because this deal didn go through.

[00:52:34] So look, make sure you go after that. And of course, if you enjoy this conversation, we’re gonna try to have more of these. Not just about my own experiences, but about other entrepreneurs and other advisors in different aspects on this.

[00:52:49] Because I think so much of what we do as entrepreneurs is about how we can get better at the different aspects of what we do. And I love talking with entrepreneurs about their journey, but I think conversations like this with Elliot is really worthwhile. Very specific concepts that as an entrepreneur, you probably are not going to be expecting the specifics of what happened. I know I wasn’t. So having that familiarity is only gonna make your life better as you move forward.

[00:53:20] If this was worthwhile to you, please share it with someone you think will also find it worthwhile. Push someone to get subscribed. You’re good? Subscribe. No, share this with other entrepreneurs you think will learn something from this. Because the more people who can subscribe this, the more it lets me get great people like Elliot back on the show and talking about specifics of how we can improve our journey.

[00:53:43] Alright everyone, thank you.

[00:53:44] Elliott Holland: Follow Beyond 8 Figures on Twitter.

[00:53:50] A.J. Lawrence: Yay!

[00:53:51] We will have show stuff at @beyond8figures, but if you wanna hear more specifically, it’ll be @ajlawrence is my Twitter. And that’s where I’m gonna go talk more about aspects of the deals, things we’re working on and also, cocktails and growth concepts. Those are things that are very important to me, along with acquiring a company.

[00:54:15] All right everyone, thank you. I hope you have a wonderful day, and I’ll talk with you soon. Bye-bye.

[00:54:25] This episode of Beyond 8 Figures is over, but your journey as an entrepreneur continues. So if we can help you with anything, please just let us know. And if you liked this episode, please share it with someone who might learn from it. Until next time, keep growing and find the joy in your journey. This is A.J., and I’ll be talking to you soon. Bye-bye.

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