Ask the Right Questions; Get the Right Answers

For some interesting early summer reading here are a few things from my buy-sell world. Issues that, for the most part, can be avoided by asking the right questions. However, I can tell you from experience even if you ask the right questions you don’t always get the right answer (meaning what the client really thinks).

Question: (for all owners thinking of selling) “Have you worked with a financial professional to see if the proceeds from the sale are enough for your next great adventure in life?” A deal collapsed when the seller said because of other financial matters in his life he just can’t sell his business now. Believe me, this is not the first time I’ve experienced this, with both my clients and those on the other side of the deal. Plan before you jump.

Question: “What will you do when you sell your business?” I was working on a project involving selling the company to the management team. The owner, a client of at least three other projects, insisted he was prepared to sell. In reality, he wasn’t. He didn’t know what he would do, especially since the answer to the question was not, “Retirement.” He can’t see himself retired. Now, if the answer is retirement, my next question is, “Does your spouse want you around 24/7?”

Question: “Regarding your offer, can you show me your financing package?” A business buyer lost a deal to two other offers that were substantially higher than his offer. Then both other offers couldn’t get the financing together. My constant advise to buyers is, get financing alternatives lined up before making an offer. Another buyer got bank indications of interest before making the offer and it was powerful.

Question: “Have you hit past projections?” There’s a deal lingering because the company (actually the very optimistic seller) can’t seem to ever hit their projections. Another deal was lost recently because the seller insisted on a price based partially on earnings projections for 2019. When those projections turned out to be 25% above the actual earnings the buyer wondered if growth was possible. 

Question: “What are your anticipated capital expenditures?” A business owner is touting the firm’s EBITDA as actual earnings. Yet 25-30% of annual EBITDA is new equipment with an immediate write-off. That’s cash out the door or bank payments over time. It’s a real expense. This is a lot different than when capital expenditures are for a handful of computers and are only 3% of EBITDA. 

To summarize, ask the right questions (usually you’ll get an honest answer), realize how little projections are worth in today’s fast-moving world, get financing lined up before making an offer (on anything, business, home, commercial real estate, etc.), and realize while depreciation used to be a “non-cash” expense, these days it’s probably a real expense in the year assets were purchased.

“The solution to the mystery is always inferior to the mystery itself.” Jorge Luis Borges

Isolated Information May Equal Trouble

Some recent events have reinforced my belief that singular information can easily lead to the wrong conclusion. We see this in the news. A police officer makes a mistake, and some assume all cops are bad. A protestor (or protest hijacker) throws something, and some assume the whole group is bad.

Singular information in other parts of life can also get us off track.

I was looking at some of a client’s financial reports. Revenue and production efficiency should move together. If efficiency goes up so should revenue, and vice versa. But they didn’t; Efficiency was solid, but revenue went down. I found out the reason for this, it made sense but at the same time didn’t make sense. In other words, I now understand why it happened, but production efficiency shouldn’t be calculated the way it is/was. If all I did was look at one or the other, I’d get an incomplete picture.

The same goes for COVID cases. We are constantly barraged with the numbers of new cases. Just paying attention to the top line number can get you worried (it sure has with Washington’s governor). But if you look at the positive cases in relationship to the number of tests, you’ll see the numbers are up because testing is up. As per the Washington Department of Health’s website last week, the percentage of positive tests is (was then) at about half of what it was in April. Want to see the positive numbers go down, test less (that’s a joke).

Take this into account when you look at any business whether it’s to buy it, work there, or offer advice. It’s like peeling an onion. You peel until you get the right answer, whether it’s the one you want or the opposite. When it comes to buy-sell deals, you’re going to see a lot peeling. If sellers thought there used to be a lot of questions, they’ll now find their “onion” just got a got larger.

“Not all those who wander are lost.” J.R.R. Tolkien

All You Need to Know About COVID Era Banking

From June 4-10 Jessica and I interviewed bankers representing eight Puget Sound area banks.* This memo is a synopsis of those conversations about what’s going on in banking during the COVID crisis, with a focus on business acquisition loans.

If you want the full report, click here to get it. It’s in table format so you can easily see what each banker said on the various topics.

First, all the banks are, “Open for business” meaning they are considering making loans. What’s changed is underwriting is going to take longer and will be more thorough (my comment – underwriting wasn’t sloppy before COVID, especially compared to the years leading up to the Great Recession). COVID will be a focus of all analysis and underwriting, where the business was pre-COVID, how it was affected, what the future looks like.

Year-to-date monthly statements are extremely important. The banks recognize there are a lot of unknowns and realize we all fear the unknown to varying degrees. Projections will be scrutinized more than ever and owners and buyers who can present thoughtful projections, answer questions realistically, and not gloss over the current situation will be in a more favorable position. 

My accounting and CFO friends will like the following: the quality of the financial statements has never been more important. Some banks will look at the accounting department, ask if there’s a CFO or controller, and use that in their decision-making process. Having the owner’s sister-in-law who’s really a data-entry person but called the controller won’t cut it.

And, no surprise, there will be more sensitivity analyses and stress tests. Mentioned a few times was the figure “30%,” as in, what will the business, its cash flow, and debt coverage look like if revenue goes down 30%. As part of this, banks that previously did more conventional loans will now be looking to use the SBA 7A program (for its guarantees to the bank).

Consistently mentioned was how important relationship is (the PPP showed this) as well as how borrowers with known and quality advisors will be looked upon more favorably. It was said the source of the referral matters and if advisors are involved it’s a big plus. A few people encouraged borrowers to talk to multiple banks, find the right fit, talk holistically about how banking works, and have thoughtful questions and answers. Especially in regard to how the business is handling the COVID stress.

* Bankers who helped us

  • Banner Bank – Lynell Smith & Jacque Coyan
  • Columbia Bank – Jeff Wilcox
  • Heritage Bank – Addie Roberge
  • Key Bank – Jane Pekasky & Jennifer Ringenbach 
  • Live Oak Bank – Lisa Forrest
  • NW Bank – Gary Strand
  • Sound Credit Union – Donna Himpler
  • WA Trust Bank – Kit Gerwels

Time for Thinking

Recent weeks and months have been traumatic. In business June was the quietest for us in three months. As quiet to the first couple weeks of the virus shutdown. The disgusting murder of George Floyd on top of the virus sure has changed our lives. I’ve put a lot of thought in all that’s going on, done a lot of reading, and listening. About those disenfranchised by society and those whose businesses and lives have been ravaged by a virus and then by looting.

Bottom line: I can put up with our business being slow for a while (repeat, for a while) if it leads to the societal change we need. Because if change truly occurs it will benefit all of us in many different ways (not just economically).

For perspective, we have a son-in-law who’s a police officer. I had three or four high school friends become police officers, two very good friends; guys with whom I played rec softball and touch football. One of those friends was murdered at age 29 when he served a (rather insignificant) warrant, the recipient pulled out a gun, and put a bullet in his head. His partner would have also been murdered but the killer’s gun jammed.

At the same time, some of my best friends are Black. I’ve known people who have been “targeted” based on their race. It happens and I know because I’ve been on the periphery of it. While not nearly the same, a number of years ago we were in Scottsdale over New Year’s, I went out for an early morning walk around the resort grounds, and because it was about 40o I had on a sweatshirt with the hood up. Out of the corner of my eye I saw a security guard on a Segway, and he was following me. Once he saw I was a white, middle-aged guy he left me alone. Hmmm, if I wasn’t would he have acted different?

I’m a believer in the 80-20 rule (sometimes more, sometimes less). In my opinion:

  • 80% (or more) of police are good.
  • 80% (or more) of protesters are well meaning.
  • 80% (maybe 98%) of politicians are in it for themselves not you or me.

So we know this stuff happens and it’s not from the good 80%. When I hear the president make comments encouraging violence against peaceful protestors it nauseates me. Just as it does when criminals hijack peaceful protests in order to steal and destroy. A destroyed small business will devastate the owner (see the front page of the June 4 Wall Street Journal about looting in small, minority owned businesses), his or her family, and the employees, who may have a hard time getting another job or getting unemployment given the ineptitude of the Unemployment Department, at least in Washington. 

Unfortunately, there’s no easy solution to all of this other than to do our part and have more acceptance. On one of our Rotary projects in Antigua we were having a discussion and one of my (Seattle) friends said, “People are people. Some are fat, some skinny; some tall, some short; some smart, some not so smart, some black, some white, but people are people.” And that really sums it up.

Education is one of the foundational pieces and we can’t keep having such educational disparity. More education, less dependency on government assistance, and a better life for all as life in general and the economy are not zero-sum games. It takes all of us doing a little bit. Business is business and there are more important things in life.

“Hell is boiling over/And heaving is full/We’re chained to the world/And we all gotta pull.” Tom Waits

The gang that couldn’t fly straight

A few months ago, the Wall Street Journal had an article on Boeing’s recent problems titled, “The Gang That Couldn’t Fly Straight. It covered how Boeing got so off track. I’m not qualified to analyze Boeing’s issues and the article made it seem they made some decisions based on numbers versus the planes or the people. It reminded me of when in “The Reckoning,” David Halberstam wrote about Lee Iacocca’s outrage because the financial people, who had such power at Ford, had “so little feel for cars.”

For many years there was an incredible demand of planes. Did Boeing lose their “feel for planes?” (and for people?). It was boom times for sure as it was for many other businesses. It caught up with Boeing and it’s catching up with other businesses. As I heard on a recent webinar, “Any company can do well in a boom.”

When things are easy there’s less attention paid to the details, especially the details about what a business buyer will want. Here are some examples of businesses I’ve seen in the last month or so.

  • A proprietary product manufacturing company with an 82-year-old owner who is (still) the product designer, especially for the little tweaks each customer wants. 
  • A booming manufacturer with 90% of sales to one customer. The customer is no longer local and supposedly uses this firm because they can’t find a supplier near their current location. What happens when they do find a nearby supplier?
  • A firm reduced to a skeleton staff due to COVID, their best month over the last three showed sales at about 30% of last year, and they want to sell for a large, guaranteed price.
  • A very solid consumer business wanting to capitalize on a COVID spike in business, assuming (hoping) it’s a trend. Deeper analysis of sales shows it most likely is a spike.

Once again, it’s easy when things are booming. But business buyers want to know what happens when it’s not booming, when dependencies like the above owner and dominant customer manifest themselves, or what COVID and other risk factors do to the business. 

And speaking of COVID and how it’s affecting buy-sell deals, here’s what my friend Gregory Kovsky with IBA wrote me, “…until a business shows three months in a row substantially similar to 2019 prior to believing it has returned to its prior strength and where historical valuation models are appropriate.  Until that occurs, I believe some adjustment mechanism is warranted related to the ultimate value of a business in a transaction paid by the buyer to a seller.” For those of you not in the buy-sell industry, it means the buyer probably won’t guarantee the full price upfront, will pay a lower price, or a combination (or some other adjustment technique).

The value of a business is really what a buyer will pay for it. Too many risk factors and the price goes down. And the bottom line is, many of the risk factors present in small and mid-sized businesses can be mitigated over time. It takes awareness and effort. With COVID, we just don’t know.

“There seems to be some perverse human characteristic that likes to make easy things difficult.” Warren Buffett

Buy-sell Earnouts, Litigation, and the Changing Landscape

On May 12, 2020 GeekWire reported Seattle company Porch is being sued by Kandela, a company Porch acquired in April 2019. The basis of the lawsuit is Porch did all they could to stunt Kandela’s growth and profitability in order to avoid paying an earnout. If you’re not familiar with an earnout, it’s similar to a salesperson’s commission in that payment is based on performance.  

The Porch lawsuit alleges they (and this is from GeekWire), “have engaged in a stunning and systematic pattern of fraud designed to prevent Kandela from achieving any earnout” for hitting certain milestones, according to the complaint. They went on to say Porch withheld resources, refused to sell Kandela products (to Porch’s customers), and more. 

It’s why lawyers will joke and say the only winners with an earnout are the litigators. That said, in our pandemic world, everybody I’ve heard from believes earnouts will be more prevalent. And as much as I don’t like them, other than for special circumstances, I agree with this and have a business buyer client making an offer with a significant earnout component as the business has been hurt by the pandemic, and nobody knows how fast it will come back or at what level.

My advice to my client was: 

  • Keep it simple.
  • Make sure the seller can easily get to and see how he can get his full price.
  • Emphasize your goal to make the recovery as fast as possible (it’s in the buyer’s best interest anyway).

There are a lot of people out there who think there will be “deals” on business acquisitions. There will be on damaged companies (a deal meaning a lower price albeit for a company with less profit), there won’t be on solid companies, and earnouts will play a part in more deals than before (as will more seller financing). The objective is to have it be fair to both sides and be easy to figure out.

“Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.” Will Rogers

Not Rehiring? More Business Ownership?

Over the last four years we’ve tracked every incoming referral. We note the date, source, and type (business buyer, seller, exit planning, etc.). There’s no pattern, that’s for sure. But there’s been growth and consistency within a tight range. 

That is until mid-February of this year when, guess what, a certain virus started making headlines. Over the next 10 weeks we got a total of two referrals. Then, six in 10 days. 

My thoughts:

  • There’s pent-up demand to get going again. 
  • Maybe (former Presidential candidate) Andrew Yang is right when he says companies have been looking to shed workers (before the pandemic) and won’t be rehiring them. They’ll run leaner.
  • I wonder if managers and executives are sensing this and starting to think about controlling their career destiny via business ownership.

Speaking of business ownership, there are only three ways to get into business. You can start one, invest in a franchise, or buy an existing company. Preferably a mature, profitable, and fairly priced company (disclaimer: this is where I come in, helping people buy the right business the right way).

Buying the right business the right way means separating yourself from the bottom-feeders that have come out. I’ve talked to numerous owners in pandemic-distressed industries (and to other advisors). They tell me the bottom feeders will say things like, “We’ll get you out of your business by purchasing your customer list,” or, “We’ll buy your (tangible) assets.” No mention of what happens to the seller’s lease, equipment payments, etc. 

“There’s gold in them thar hills” (Mark Twain, The American Claimant, 1892). Unfortunately, some businesses won’t make it and this means opportunity for others. There will be openings for acquisitions (second disclaimer: I wrote a book titled, Company Growth By Acquisition Makes Dollars & Sense). And I mean fair acquisitions to bail out a bad situation, and maybe even a job for the seller. 

A crisis like we’re going through brings out the best and the worst in people. Be part of the best, not like the bottom feeders. 

“A ship in a harbor is safe, but that’s not what ships are for.” (Author) John A. Shedd

Deficits and Protection

The May 5, 2020 of the Wall Street Journal was, not unexpectedly, filled with articles on the virus. The ones standing out were the headlines on the front page discussing the massive amount of new debt and the risk workers and companies face as businesses reopen. 

I wrote a few months ago about how we’ve been running huge deficits in a booming economy instead of reducing the deficits. Now we’re looking at borrowing $4.5 trillion this fiscal year so the economy had better get super-healthy pretty darn quick.

But the above falls into the, “That was then, this is now” category. One of the best lines was from a director at the Committee for a Responsible Federal Budget (which seems to be a bi-partisan organization) who said, “When your farm is burning you don’t worry if you have enough water to make through the next three crop seasons. You put out the fire and then you worry about it later.”

So it’s all-aboard to pump up the economy. But, as I wrote in a recent Random Thoughts memo, what if the customers are too scared to come back? We’re already getting reports of customers and employees being scared to return to work in states that started opening up two weeks ago.

Which brings us to the second subject, the dispute about the government giving businesses liability protection against worker lawsuits in regard to getting COVID on-the-job. The meat packing industry (vegetarians can laugh here) is at the forefront of this. The President has ordered them to stay open, workers are scared, many can’t work as they have the virus, so it’s the proverbial “can of worms.”

The Republicans want full protection for businesses, the Democrats don’t, fearing companies will take advantage of workers, and the U.S. Chamber of Commerce is in the middle, wanting protection for firms that follow federal and state guidelines. I can see both sides. A business, especially when ordered to be open or considered essential, won’t want the risk of lawsuits. Employees have good reason to fear bosses will not prioritize their safety to meet production numbers. The Chamber’s position seems to be a good compromise.

Again, a couple interesting situations with no easily agreed to solutions.

“You may glory in a team triumphant, but you fall in love with a team in defeat.” (Sportswriter) Roger Kahn

What Will People Hoard Next?

We must be in the minority because we eat a lot of fresh fruit and vegetables. Now we’re eating more than before the virus crisis and I’m reading that farmers are not able to sell their crops because so many people are buying primarily meat and shelf stable food (cans, dried, frozen). Just look at the (low) price of strawberries over the last couple of weeks.

More proof, Costco posts a list of items they are out of and last week it included milk and eggs (they had some but what they had would be gone by early afternoon the day we were there), and fresh chicken. The produce section was overflowing. 

On April 27 the Wall Street Journal had an article titled, “Farmers Forced to Destroy Their Crops.” This after an article the week before about farmers dumping milk and eggs. It’s not that there’s not enough food, it’s what people are buying and how it’s packaged. If it’s packaged for food service distributors the packaging won’t work in the grocery stores.

On April 28 the WSJ had a headline, “Overcrowded Barns Hamper Pork Industry.” There’s a surplus of hogs as well as cows and chickens given the virus outbreak in meat packing plants. Tyson releases a notice about upcoming poultry shortages, stores can’t get their usual supply, and people hoard what is in the store.

I’m guessing they don’t teach about this in supply chain classes. Of course, they don’t teach about common sense and the lack of it is what’s fueling the fire (hoarding). So, will the produce aisles be hit hard next when there’s limited meat? We’ll have to wait and see.

“The secret to be successful with a child is to not be its parent.” Mell Lazarus

Random Thoughts Part 3 on the Virus Crisis

I get more feedback on my random thoughts memos than any four to six weeks combined, so here are some more.

Politicians look very well groomed, hair salons and barber shops are closed, I really need a haircut, so does anybody know where the governor is getting his hair cut?

“Non-essential” businesses are essential to the business owner and employees, aren’t they?

Did Joe Biden paint himself into a corner by saying he would pick a female running mate just before Andrew Cuomo became a star? 

What happens if government opens up the economy and workers are too scared to go back to their jobs? And/or the customers are too scared to go and buy?

We need a middle ground between Trump not caring if people get sick and (WA) Governor Inslee not caring about business owners and their employees.

And speaking of politicians, one of the best lines I’ve seen or heard came from a State rep in Wisconsin who said, why can we go to Walmart and buy flowers, but we can’t get flowers at the local florist?

There are almost no autoresponder replies to emails these days, other than from bankers telling us how busy they are with the paycheck protection program (and it’s true).

It’s easier to stay at home, especially on sunny days, if you’re an allergy sufferer and the pollen counts are at the top of the charts.

And speaking of allergies, what is the point of an allergy eyedrop coming in a .085 fluid ounce bottle (that’s about 1/7 of a teaspoon). The plastic must cost more than the solution.

I get a kick out of people who cross the street when they see you walking towards them. The mist we create when breathing doesn’t carry nearly that far (I’m guessing less than the six feet we’re told to be separated).

There’s a lot of well-deserved praise for health care workers, grocery store employees, and the same praise should be given to those in the supply chains that provide the products to the stores and medical facilities.

There’s a lot of creative comedy out there. A friend sent me a picture of an enraged Al Bundy with the caption, “Just to be clear, we’ve all agreed that liquor stores are “essential” and schools are not!”

There’s a huge and growing need for social/people interaction and Zoom Happy Hours are here to save the day. I think they’ll continue although not as frequently. 

Realize the officials in charge of the virus and economy in Washington State are the same genre of people who built the West Seattle bridge that is in danger of collapsing (on its own) about halfway through its expected life.

“If you make up your mind not to be happy, there’s no reason why you shouldn’t have a fairly good time.” Edith Wharton