Fantasyland

I was recently talking to a business buyer about what he was looking for in a business. What he said all made sense; a B2B business, logical size range, wide geographic area, etc. 

Then he said he needed a business on which he could pay off the debt (SBA, 10-year term loan) in half the time. That’s 25% annual growth, from day one. And yes, 25% can be achieved. A recent client grew 25% the first year. But over five years? If it takes one year to figure things out, all of a sudden, it’s about a 33% growth rate. But then came the kicker:

“And I don’t want to have to make any investment in the business (to achieve the growth).”

No new (additional) equipment, vehicles, marketing, or people. All the earnings go to debt reduction. This is fantasy land. And it makes me wonder what other fantasies are out there. Some that come to mind are:

  • A business seller believing his or her business is so special traditional valuation methodologies don’t apply to their business.
  • Owners thinking it’s easy to find good salespeople.
  • Advisors (and salespeople) figuring because they know what they’re doing the phone will ring.
  • Business buyers thinking an owner with no family in the business has no good options, other than selling to them with a low down payment (actually this owner has all the options).
  • Company founders believing a bank will lend them money based on their great idea.

I’m sure you’ve seen many more fantasies. 

“We are living in a world today where lemonade is made from artificial flavors and furniture polish is made from real lemons.” Alfred E. Neuman

What is Your Real Income

I’m working with a private equity firm to find add-on HVAC, plumbing, electrical, or refrigeration companies for their plumbing construction firm in the Seattle area (so if you know of any doing at least $5 million in sales who want an investor let me know). The founder of the PE firm has a distinct term for the earnings/income of a company.

He calls it “real income.” What this means is, it’s the income after allowing for all the expenses required to run a business. This means expenses for:

  • A CEO at fair market salary.
  • A CFO type, not just a part-time bookkeeper who doesn’t know what a KPI (key performance indicator) is.
  • Anticipated capital expenditures.
  • Operating interest (a working capital line of credit).

About 15 years ago I started using the term “free cash flow,” which is pretty much the same as what’s above. I would add together profit, owner salary, depreciation, and interest and subtract fair market owner compensation, anticipated capital expenditures, and operating interest.

What I didn’t include was the CFO/controller role and compensation, even though I’ve seen hundreds of businesses with crappy financial systems and crazy financial statements. Not to mention no management reports, no metrics, KPIs, etc. It took a while, but I now understand that’s a role we need to account for when adjusting earnings.

I like the term “real income.” It conveys trust, non-fantasy, and sincerity. It’s now my go-to term.

“The trouble with having an open mind, of course, is that people will insist on trying to put things in it.” (Author) Terry Pratchett

Scams in buy-sell deals

On September 8, 2019 the Buzz column in the Seattle Times was titled, “Seattle Cider sues founder, former CEO” and dealt with a lawsuit against the founder of Seattle Cider and Two Beers Brewing initiated by Agrial, a French company that acquired them. In simple terms, the plaintiff alleged the books were cooked to increase the price.

More about the above later and it fits with a quote I saw this summer from Richard Parker, “Numbers don’t lie, sellers do.” I wrote him and told him how I had seen a case where the owners/sellers (creatively) made the numbers lie, at least temporarily. Richard’s response was something like, it’s amazing how creative people can get with this stuff.

The Seattle Cider case involves the seller supposedly doing “channel stuffing.” He allegedly had his top distributor accelerate orders, so sales looked stronger than they really were and then, post-sale, orders declined because the distributor had months and months of product. Oops, the buyer is now getting no orders and had the privilege of paying the seller an inflated amount (again, alleged).

It seems so easy, but this stuff always comes out (at some point). For example, a seller ripped a letter off a bulletin board as she gave the buyer a tour of the business. Turns out the letter was from their top (30%) customer informing them a change in strategy meant they were ending the relationship. The buyer later found out from an employee.

Or many years ago when a buyer sabotaged himself by letting the seller convince him he couldn’t talk to the customers because the industry was so tight word of the sale would somehow get out. Even though his attorney and I told him to “kill the deal,” he agreed (to not do customer research, even as a reference check). Turns out the top, 25%, customer was doing a “test kitchen” of new systems without inviting their current provider (the seller’s firm) to participate. No wonder the seller didn’t want any customer related due diligence. (By not talking to the customers a buyer risks not knowing about damaged relationships. If the customer has already stopped doing business and is still disclosed in the purchase and sale agreement as being an active customer there should be protections in the representations and warranties in the agreement, although it’s still deception and a major hassle.)

And this is not confined to the small business and lower middle market. Just look at what’s in the headlines about We (WeWork). 

When it comes to integrity and ethics, 99% of business owners have a high level (unless you count blending the personal and business checkbooks). But the other 1%…

“Don’t look back. Something might be gaining on you.” Satchel Paige

Non-compete Agreements Become Almost Worthless (in Washington State)

This is a little different than our regular memos, but I feel it’s an important subject for Washington business owners.

I recently sent past and present clients a fantastic summary of Washington State’s new non-compete law, taking effect January 1, 2020, which I received from Jeanette Adams Gorman with Socius Law Group in Seattle.

I received a lot of “thank you” and “interesting” comments but the best was, “Wow! this is distressing.” I was a bit surprised so many business owners hadn’t heard much about this.

I won’t get into the details (and I’m glad to send you Jeanette’s report) but will give you my top takeaways.

  • Non-competes will only be applicable to people earning $100,000 or more with the threshold for independent contractors is at $250,000.
  • Non-solicitation agreements and non-disclosure agreements, including sharing of trade secrets, are not affected.
  • Non-competes when the business is sold are still valid (the seller is bound by it).
  • There may have to be compensation to a terminated employee if the company wants to enforce a non-compete.

I encourage business owners to get professional advice on this, so you’re prepared for 2020. Advisors, make sure your clients are aware of this.

“An ounce of prevention is worth a pound of cure.” Benjamin Franklin

Is it Crazy for a Business Owner to Pay A Buyer to Take Over the Business?

Many business owners claim their business would take off if only someone did a few simple things. The usual suspect in “simple things” is to do more marketing. Really? If it’s so easy why isn’t the current owner doing these supposedly simple things? And why would a buyer take the chance on these “simple things” working?

An example

A friend pointed out a retail business for sale whose owner claims it’s in a great location. And it is, for walking around and (having fun) but not for what this business does, given the congestion and limited parking.

The seller states with a little marketing and the addition of multiple additional services they could substantially increase the revenue. This includes extending their hours and hiring more employees. In today’s tight labor market good employees are hard to find and it’s made to sound like it’s easy to find good people. 

Also, the business’s sales are declining, it’s breaking even, and the owner is not taking a salary. 

The seller has a five-year lease, probably with a personal guarantee, and other obligations. It may be cheaper to give someone the business or pay a “buyer” to get out of that lease, other obligations, and the associated worries and headaches.  

Even in this case the “seller” needs be able to back up “why” the business has the potential to get out of its rut. All buyers want to see a clear path to growth and know where they can add value. 

Let’s be realistic, the above is a bit extreme (also rare is hiring a buyer on a consulting contract to fix a business and then buy it via an earnout, but I’ve seen it). But in rare cases, paying to discard a business, like we pay to take junk to the dump, may be better than five more years of hard work for no pay. 

“What’s surreal to you is just somebody’s Wednesday somewhere.” (Novelist) Karen Russell

This was written by Jessica with John’s input

The Grass is Always Greener (When You Only Care About Headlines)

One thing President Trump and other politicians have in common is the bashing of large tech companies. It used to be bashing Walmart. Yes, Walmart took over a lot of small to mid-sized towns. Yes, some small businesses (perhaps many) didn’t survive. But the politicians made it seem like these small retailers were thriving businesses with very high paid employees. 

After talking to owners of and/or looking at information on thousands of businesses I can say, 

“Overall, there aren’t that many good businesses.”

There are a lot of companies providing the owner a well-paying job and nice lifestyle, but these don’t have much value. Value comes from profit over and above owner salary. There are even more businesses with overworked owners whose salary is just adequate. 

When I’m asked how businesses are valued my initial response is, “I don’t know anything about your company and in general, it’s a function of profit. The more profit, the higher the value.” So where is all of this going? To these three points:

  • If you own a thriving business (solid profits after your fair market salary) realize you have one of the ~20-25% (the top quartile). Keep it there, grow it, get yourself out of the day-to-day, and if you have a dominant customer, diversify ASAP.
  • If you’re a business buyer, realize it’s like the old “needle in a haystack,” so keep searching because it can take a long time. Not only do you have to find a business in the top quartile, the owner needs to be motivated to sell (for a fair price), and it has to match your skills.
  • If your business is barely getting by, it’s a struggle to pay bills, you can’t save any money, etc. realize it will be tough to sell. And, by all means, remove from your head thoughts like, “We’ve been in business for 15 years so there’s value to the name.” As per above, the value comes from profits.

We all think what we have is great – better than cold beer (or lemonade) on a hot summer day. But that’s not what matters. What matters is what others think including banks, buyers, appraisers, etc.

“Strive not to be a success but to be of value.” Albert Einstein

The Business Roundtable Creates a Snit Attack

The Wall Street Journal (and I’m sure others) sure had a snit attack last week after the Business Roundtable came out with their latest report saying companies shouldn’t emphasize shareholder return over taking care of employees, customers, suppliers, and community. 

Taking care of people sounds like a good subject for Labor Day week. And what the Roundtable is suggesting sure sounds like the Costco model. Fair prices, good jobs at a fair wage with benefits, very community focused, and while I can’t comment directly on suppliers, I do have a friend who sells to Costco and loves doing business with them.

The above is also what my clients strive for. A client looking at a business to buy didn’t see an expense for benefits. He commented on how he’ll have to add in that cost (versus the common adding back of expenses) because he wasn’t going to be an owner not providing benefits.

I looked at a company recently whose owner seemed to be bragging about how little he could pay his employees. He didn’t connect that with the fact he had high absenteeism and constant turnover. 

With an extremely high employment rate it pays to take care of your people, especially in our robust economy.

As an economics major, I well remember Milton Friedman, who’s the person who stated a corporation’s primary obligation is to the shareholders (and which the Roundtable is now disagreeing with). I think he was wrong then and it’s a wrong philosophy now. Take care of your people (including customers and suppliers) and they’ll take care of you.

“Success is a great deodorant. It takes away all your past smells.” Elizabeth Taylor

Financial Shenanigans Versus Incompetence

The Wall Street Journal and others recently reported about an accounting expert who had predicted the Madoff Ponzi scheme and recently went after GE for what he said are their deceptive accounting practices (of course, GE responded this person didn’t know what he was talking about). But this is not about GE but rather about accounting irregularities in general.

We have a government with annual deficits of $1 trillion and with a lot more “off the books” because there are non-budget items. On August 26, 2019 the WSJ had an article about how CEO pay is often much higher than disclosed (due to stock appreciation and clauses that escalate compensation).

And then we get to my world of small business where it’s usually not malicious but is accounting incompetence. Too many owners think their accounting department is like Cinderella – the weak little stepsister who must be tolerated at as little cost as possible. Sometimes it’s because they’d sooner “play” with their product than worry about the numbers and often it’s because they’re doing so well it becomes “management by checkbook,” as in, there’s plenty of money so who cares about cash flow, metrics, etc.

I’m working on a potential deal where the owner (and his advisors) setup five companies, two operating, one management, one for real estate, and one for equipment. They are so intertwined it will take a good CFO or forensic accountant to figure out exactly what their earnings are. And, it’s management by checkbook when the owner says, “we bought too much equipment and too many vehicles last year, so we’ll have to sell some.”

Tip to owners – one of the top three things you can do is have solid financial systems, accurate statements, good management reports, know your KPIs, and other metrics. It makes your life easier, especially as it seems we’ll have an economic correction soon, and when it’s time to sell, increases your value and attracts better buyers.

“The simple truth is that truth is hard to come by, and that once fount it may easily be lost again.” Karl Popper

What Is the American Dream? Part Two

Last month I gave my insights regarding a ProPublica article about how people over 50 won’t be the decision maker when they leave their job.  (Update, IBM is in the midst of a lawsuit for firing up to 100,000 people, targeting older workers. And there seems to be damaging testimony supporting the lawsuit’s premise.) A past American Dreams was to get a job at a large company, work there for 40-45 years, and retire with a gold watch and a pension. But no more, for most people.

I may be dating myself, but I remember in one college class a discussion about how another American Dream was to start a business and sell it to Sears. In those days, Sears was dominant and bought a lot of small businesses. However, a lot of those acquisitions were after Sears became the firm’s top (by far) customer and had the supplier “over the barrel.”

So, what is the American Dream these days? Actually, it should be “dreams” not “dream” as there are many versions. In early 2019 the New York Times had an opinion piece titled, “The American Dream is Alive and Well” with the sub-title of, “Most people in this country say that they are living it – but what they mean by the phrase might surprise you.”

The opening is, “I am pleased to report that the American Dream is alive and well for an overwhelming majority of Americans.” Here’s some interesting statistics:

  • Only 16% said to achieve the American Dream you have to be wealthy.
  • Only 45% said it means having a better quality of life than your parents.
  • And only 49% said it entails having a successful career.

Most interesting, 84% of Republicans and independents and 88% of Democrats said freedom was essential to it and less than 20% in either party believe becoming wealthy is essential. Many said it is experiences, not a lot of money, that bring happiness. With my clients, business ownership tops the list of desired experiences (and then getting out of business for their next great adventure in life).

Overall, all races, all levels of income, and all generations (from under 22 to over 70) are optimistic at an over 70% level. Also interesting is the Times published this during the Trump administration, which hates the Times.

Let’s move on to a Fast Company article titled, “We make $325,000 a year and don’t feel we have enough.” Catchy title but a bit misleading. Three case studies about people making $97,000 (Canadian), $171,000, and $325,000 show close similarities. 

The lowest income couple saves or has “leftover” funds of 12-20% (and a lot of Canadian safety net taxes), the other two have 30-40%. So, when the highest income couple says they feel they don’t have enough it’s because $125,000 is going to some form of savings or investment. Not bad. 

So, what’s my point, or points? Here are three:

  • It’s not as bad as the headlines – and things haven’t been as bad (or as good) as the headlines forever. Realize there are always pockets of people in a tough position no matter how good times are. But publicizing the positive doesn’t sell papers, get clicks, or get viewers. Then factor in social media, which magnifies everything and makes people think things are bad on a macro level. But when they discuss their own situation, i.e. the micro level, we get the results shown in the Times study.
  • We have different objectives – I’m guessing this hasn’t changed too much over the years and now it’s easier to collect information and publicize it so we have a lot more data and therefore insights. Different people strive for different things like money, power, prestige, spirituality, low stress, material goods, etc. No right or wrong and I applaud those who use our safety nets as a helping hand up to achieve their version of the American Dream.
  • Business ownership – as per above, for many, and this includes all of my clients, owning a business is the experience they want. It can include financial benefits but also provides the experiences many want. Those experiences include being successful, helping customers, providing jobs, being creative, and more. As in part one of this two-part newsletter, page one of my book Buying A Business That Makes You Rich, there are numerous reasons besides money people want to buy/own a business.

Conclusion

There is still opportunity everywhere. While it’s not for everybody, business ownership is the vehicle many want to maximize that opportunity, have the experiences they desire, and have a fulfilling life.

Stereotypes Can Be Deadly

We were having a cup of coffee and some breakfast at a great little coffee shop-bakery-café in Bozeman, MT before going on a hike. Next to us were three ladies, also dressed for a day in the outdoors. and I couldn’t help but overhear one of them say:

“People from cities really don’t understand the environment. And getting off the ship on an Alaska cruise to spend two hours in shops looking at tchotchkes isn’t getting into the environment.”

A stereotype of city people and I’ll admit many city people aren’t all that knowledgeable about the outdoors. Our fishing guide, who we use every summer, loves to tell (everybody) about the lady from New York city who asked (when seeing a minnow put on a hook), “Do fish really eat other fish?” *Realize fishing guides love to tell the same stories and jokes no matter how many times you’ve heard them, so we just pretend they’re new.*

But knowledge and caring are two different things. Most people, city or rural, don’t want chemicals dumped in their water or on their land. Most want to breathe clean air. Very few if any want their local resources, whether a lake or river in the wilderness or the Hudson river in New York, to be like a man-made lake in Novosibirsk, Russia nicknamed the “Siberian Maldives” because of its turquoise color. Unfortunately, the color is a chemical reaction from ash runoff from a power plant’s industrial dump site.**

So what stereotypes do you have? Some I hear include:

  • You can’t buy this business because you don’t have direct industry experience. (False, very false and tied to the misnomer “Nobody else can run my business because it’s so special.”)
  • I’m starting an advisory business but don’t have any references or testimonials. (Sure you do. You just did the work for another company.)
  • My business can’t grow. (Yes it can, maybe it’s you.)
  • I have to do menial tasks like payroll, HR, reviewing every bid/proposal, etc. (No, owners don’t have to do those things way below their paygrade, you have to trust others and get over being a control freak.)

So, what stereotypes are holding you back from growing, starting a new business, buying one, selling yours and moving on to your next great adventure in life, or anything else?

“Knowing what must be done does away with fear.” Rosa Parks

Stereotypes Can Be Deadly** This lake has become an Instagram phenom and even though people are warned not to go in the water they do. One man who floated on the lake (on a floatie) said, “The next morning, my legs turned slightly red and itched for two days; the water tastes a bit sour, looks like chalk.”