The Virtual CPA Success Show: Episode 55
In this episode, Jamie Nau, our host and Summit CPA's Director of Accounting/Virtual CFO; Jody Grunden, our CEO and Co-founder; Greg Wallis, our Virtual CFO discusses how important it is to run your business like you are ready to sell. They discuss different scenarios, tips and things you need to consider to run your business operations smoothly.
Jamie Nau: Hello everybody, welcome to today's episode. Today is going to be on a common topic. One of the issues that we see out there with our clients, as well as in emails and questions, are about acquisitions. I think right now is a time when a lot of acquisitions are happening, and a lot of companies are either seeking out about selling or thinking about buying. And there's a lot of different reasons. But one of the things that we want to talk about today is, you know, it doesn't matter what time, you should always run your business like you're ready to sell it. And we're going to kind of talk about what that means both from a financial perspective, as well as a decision's perspective. So in order to have this conversation, we have a Jody Grunden here our owner.
Jody Grunden: Yeah. Thanks for having me, Jamie. I am really looking forward to hearing Greg's perspective. Greg's been with us for just about a year and works with several clients in this space. I don't know if he's got many clients that are in the selling part, but it'd be interesting to hear what their thoughts are leading up to that. So looking forward to hearing the conversation
Jamie Nau: Like Jody said, we also have Greg Wallis who is one of our trusted CFOs and does a great job with all of his accounts.
Greg Wallis: Thanks, Jamie, I appreciate the introduction. Looking forward to chatting with you both about this. One of the things that I talk to my clients about every month is just where are they on the valuation scale. So, it's a constant discussion and, there's a lot of activity in this space right now. And so just relaying that information to them and just making sure that, you know, if the opportunity arises they are ready to ready to move forward.
Jamie Nau: Awesome. I think the best place to start, for me when I work with clients and I work with other CFOs on this, is probably in the due diligence area. I think that anytime you go through an acquisition, you are going to have to do due diligence because the buyer wants to know what they get. So, Greg for a company, when is the best time to start due diligence? Have good books. What would you recommend?
Greg Wallis: Yeah. I think, you know, you've said it correctly, making sure that you have a clean set of books that way, you know where to start, and you're not going to have surprises. During due diligence, you know, there's usually a third party, like an investment banker that's going to be involved in that transaction. They're going to come in, they're going to scrub your books and you don't want to find out that some assets have no value, or you've got unrecorded liabilities. You know, one of the things that we try and do at Summit is make sure that we've got a good balance sheet review going all the time, or at least quarterly. So that at any point in time when those accounts are reconciled you know what's in them. And conversely, if you've got liabilities, you know exactly what those are capped at and you don't have anything that is a surprise later because the last thing you want to do is negotiate a price and then have some accountants come in from the other side, beat it up and then take down your purchase price to a level that you're not expecting.
Jody Grunden: Yeah. I think it what it comes down to is you know, the due diligence. Being prepared I guess for a sale is such a huge factor because it really dictates the multiple that the other firms are going to give you. Because again, the multiple is just simply an estimate of what the value is worth. It could be a lot of different things, but the cleaner and the less risk that the client is willing to take, or the prospect's willing to take will increase that multiple for you. So, if they know that your books are in perfect shape on the accounting side. You've got the KPIs put in place, you get your forecast dialed in, the prospect sees this and sees exactly what you're doing and knows how you're doing it, then miraculously, that multiple goes up because again, the client assumes that the risk is a lot less. So, I think that is super, super important.
Jamie Nau: I think it's being organized, right? I've seen deals fall apart because every question that gets asked the answer is, oh let me go look into that. And then it's a week later you come back with a not great answer. And so, you know, I think having stuff documented, having things close to your fingertips so when they ask, oh, in January 2017, what happened that month? You are like, oh, that was the month we had blizzards, and this is why none of our people could work because there were blizzards in our main locations. And like, you're able to answer it that quick because you have it at your fingertips. It just shows that you're a type of business that is worth acquiring and, like you said value goes up because it's like, okay, these people already know how to run this business. They already have some good decision-makers in place that can answer these questions. And the same goes for reconciliations. You know, if they give a look at your balance sheet and ask for seven reconciliation accounts and you have them ready for them the next day with explanations in there, that just shows you being organized.
Jody Grunden: Yeah, I agree because again, seeing multiple acquisitions, basically over the last 20 years, you really do see that the more that they can rely upon a trusted advisor, whether it's the in-house CFO, somebody that's actually working on your side or even a virtual CFO like ourselves, you want that person to be able to answer the questions because a lot of times financials are Greek to a lot of people so you don't want answer incorrectly, or deceivingly or anything like that.
Greg Wallis: To build on that, I think, you know, one of the key things that I've seen in the private sector is the reliability of the future forecasts. An acquirer is buying your future cash flow and you need to have a really detailed robust forecast that holds water because, you know, there's a time element to a transaction. And if you are your results don't match up to the forecast then that's where doubt comes in and purchase price reduces. I've seen more than one deal fall apart where a l client put out a rosy forecast that was sort of built on the back of a napkin. People walked away because they couldn't rely on the numbers. So, you know, having that discipline, having that ability to put that forecast in place now will serve you tremendously well long-term and will you’re your purchase price bulletproof.
Jamie Nau: Funny story about that is, I am the Director of Accounting here at Summit. So, I don't really work with a ton with the clients right now, but I do help out. And a couple of months ago, one of our clients was at a stage where they were thinking about getting acquired and the CFO was out for a week of vacation and they were at the point where they're like, okay, we want a final look at these financial statements and these forecasts. And that's exactly what I did. I kind of came in as an independent mind and said, okay, here's the story that your forecast is telling me. Your forecast is telling me that you're going to be able to grow 40% next year. How are you going to grow 40%? What's your marketing plan to do that? And I just went back and asked them like 15 questions based off what the financials were telling me. So, I think having someone do that is also really good. I think having the CFO or someone else that can take a look at your financial statements and your forecast to ask the important questions is crucial.
Jody Grunden: Yeah, Greg, you mentioned, obviously you have been a CFO for a long time, you said you went through a few on the corporate side with the seller. Without disclosing names or anything, can you kind of walk us through what your experience is on your side?
Greg Wallis: Sure. The most recent transaction that I was working on, we had hired an investment banker and sometimes it's an investment banker. Sometimes it's another. So, an investment banker is a financial advisor that's specifically focuses on acquisitions or sales side transactions. They're the advisors that coordinate that sale process. Either going out to find potential bidders, brokering your business out in the marketplace, or, you know, would be advising you if you're looking to acquire, they can go out and find targets for you as well. So, there's sort of the real estate agent in a transaction. So, they're brokering that transaction for you. And they're the ones that have the experience, with what the multiples are and help direct the due diligence process and coordinate. They really are your representative. And so sometimes you might have a business broker, you might have an investment banker. There's a number of boutique firms that certainly specialize in the digital agency space. But the process started with just getting the management team together and saying, this is what we're looking to make. We're looking to sell. The investment banker will look at the marketplace and identified a number of buyers. In the meantime, as the CFO I was putting together various financial models, projections, making sure that our historical financials were all together. Oftentimes if you get to a point when after you've been out in the market, you sort of shopped the business around for interest, then you would get into a situation where you might sign a letter of intent where somebody says, I'm really interested in buying you. Let me sign this letter of intent. That will go into an exclusivity period. The potential acquirer would then bring in their accountants, their attorneys, they would review all of the financial documents and do their financial due diligence. They will do legal due diligence. They will look at your HR policies, any legal liabilities, and lawsuits that you might've had. Just looking across the business to understand what the assets are, the liabilities, the risks of the organization. They'll meet with the management team to understand what the marketing plan is. They really just spend a lot of time just going through all aspects of your business to make sure what they're going to ultimately make an offer on is exactly what they're expecting. There are financial models. There are narratives that get prepared yo describe what your client base might be. If you've got a particular niche, if you've got a particular technology that you specialize in. So that's what you're selling, right? Is this future revenue opportunity in the marketplace? Then assuming that due diligence pans out, everything checks out, the forecasts are good. The numbers are good. The business story narrative is good. Then you'd get into an actual purchase agreement and negotiating a purchase agreement. And that's when the attorneys get really involved. And you describe exactly what are you selling.
Jamie Nau: I think they we talked a lot about the due diligence. I am curious about explaining a little bit, and especially for people listening to this podcast about the different types of acquisitions. So, I do think we should go down that road. Jody, do you think we should go down that path?
Jody Grunden: I think so. I want to kind of touch on the topic of the due diligence. What do they truly look for? I mean, on the financial side, also in legal and HR. Those are three major due diligence areas that they're going to look at. You want to make sure you that buttoned up. If you don't have your HR policy written down, now's a good time to do it. Due diligence can be very quick, or it can be a long, really horrible process. That does not necessarily depend on the buyer, but that's really on the seller.
Greg Wallis: I think to build on that, that gets into if you've got a lot of contractors, they're going to want to review all of your legal agreements, both with your clients, as well as if you've got employment agreements, if you've got a contractor agreement, if you've got any kind of an equity program, or equity sharing program with your employees. Usually if there's an event that's triggered based on the sale of a company that'll be your responsibility to take on. So, you're going to want to make sure you understand what might be in your employment agreements. They are going to look at if you've ever had any discrimination, claims, any EEOC claims. If you've had any legal issues in the past, those will be brought out and reviewed. Another one of the things that they will be looking at is, do you have a recurring annuity type work? Do you have retainers that are signed year after year? So, you know, looking and understanding your mix of types of clients that you have is really important in the overall valuation. So, just a few other thoughts that you want to consider as you go into a contemplation of sale.
Jamie Nau: Yeah. I'm going to give three scenarios here and let me know if I'm off base either of you on either of these three. So, kind of the worst-case scenario of your business is everything's up. Like all of your policies, all of your documents are in one or two- or three-people’s heads. And you may have those agreements, and everything signed, obviously at some point, those were signed, but they're on people's desktops and they're all over the place. And so when it comes time to the sale, you're going to have to do a ton of documentation. You're going to have to find all those files, organize them and do all of that. So that's probably like the worst-case scenario of where companies might be. I'd say kind of the middle case scenario would be you just don't know where any of it is. So you've taken the time to type things and write things up, but who knows where it all is? An HR policy might be six years old, and you might need to update it and things like that. But you have to kind of take the time to find the stuff and organize it. That's kind of that mid case scenario. Then the best-case scenario is you, are extremely organized. Everything's updated. This is when it was updated, and you have all this stuff documented. You have everything very organized and it's very easy to find. And then you're constantly updating those things. So those are kind of, to me when I've worked with companies, those are the three scenarios I've seen. The first one takes a ton of time to get ready for due diligence. And those are the ones that Jody mentioned that might last six to nine months. The middle one's a little shorter, but you're still not quite there yet. And then the last one is where the due diligence is so smooth, and the company that comes in will be like, wow, okay. Do you guys agree?
Jody Grunden: Absolutely. Yeah. A hundred percent. You definitely don't want to be in that first scenario. That first scenario is a killer. That’s where your stock gets devalued. Your price gets devalued because they open up the hood and then realize it's not all put together yet. Whereas when they open up the hood and look at that engine want, you want them to be pretty impressed. It’s not like you're selling an object. You're not selling a baseball bat. You're selling something that's actually generating income that you can't really see, or feel, that type of thing. And making sure that everything is really solid and put together so that they don't have any reason to devalue it is your goal.
Greg Wallis: You know, on that note, I think if you're in that first bucket where you're trying to put all this together, you're also still trying to run your business and it's the most critical time for you to maximize your business, your revenue, your client satisfaction. If you're distracted by having to put together all this documentation and answer all these questions, if you're not focused on the business and the business starts to fall apart in any way, if your billable hours start to drop, then you know, that's going to be viewed as a softness in your forecast. And again, it's so important to be prepared so that you can stay focused on the business. In fact, ramp up the business because you want your trend lines always to be going up. You don't want them to be flat-lining and you certainly don't want them to be tracking down. You don’t want to be distracted.
Jamie Nau: I know we're talking about sales here, but I think like what you said there is a great point for just running a business day to day. If all this stuff is in your head and it's not documented anywhere, you're probably not running your business to the best of your ability. I think this is something that you should think about even if you are not thinking about selling. This is something you should do running your business no matter what. So, we're getting closer to time here. I do want to just kind of hit on a topic you mentioned earlier, Greg. Can you talk about the types of acquisitions out there that people can be aware of?
Greg Wallis: Sure. The two primary acquisitions are either an asset purchase where a company would come in and buy the assets of your company. Essentially buy your AI, your AR, your customers, your relationships and take that and just begin to run your business from that point. And then you would retain any remaining liabilities of the company. And the other is a stock purchase agreement where somebody comes in and purchases the company, whole kitten caboodle basically, you know, exchanges out your capital or equity structure and replaces that with their own and just steps into your place in owning and running the business. There are benefits, there's two sides to each transaction. It just depends on the intent of the buyer. Asset purchases are a little cleaner because again they don't assume any liabilities of the organization. Stock transactions tend to be a little bit more complicated, but there are definite reasons for it.
Jody Grunden: Yeah, keeping in mind a stock sale, the new owner is going to assume those responsibilities and 9 times out of 10, unless there's something drawn into that agreement that is going to preclude that. You know and find out a year later and getting audited by the state department and find out they should have been doing sales tax for the last 10 years. And nobody understood that it wasn't a malicious thing. Now all of a sudden, this new owner has a million dollars or half a million dollars or a hundred thousand dollar in tax liability that they've got to pay that they really didn't have any part in. Those are the types of things you really got to think about when you go into the selling or buying a business. Like Greg had mentioned, both have their benefits. It's really important to look into those and really determine what the negotiation is going to be.
Jamie Nau: I also think with that too, part of the negotiations is understanding where people are going to stand afterwards, right? Like, so you want to make sure you're thinking about that as well. Especially you as an owner. Some owners are going to sell, and they'd be like, I can't wait to sell, get away and walk away and just like walk away with my money and be done with it. And some owners might be like, yeah, I want to still be part of the business. I just don't want to run the business and be the owner of the business. So maybe they can put you in a VP role. So, what is that deal going to look like? Not just you, but everybody on your team. Where are they going to come in? So, you want to get an understanding of what it's going to look like all the way down.
Greg Wallis: Jamie, that just raises another thought, you know, if and when you get to the point that you are talking about or thinking about selling. You know, one of the things that I've seen, is cost reduction, you know, and just running as lean and efficient an organization as possible. Sometimes we get so caught up in the sales and the revenue side of the business that we take our eye off some of the cost side of the business. One of the phrases we use is that revenue hides mistakes or revenue hides problems. So, if your revenue has been growing, your cash has been good. There still might be some opportunity to trim your costs. And in presenting financial models, you want to be continuing to show improvements, whether it's in gross margin or whether it's reducing operating expenses. So, you know, just continuing to always keep an eye on your utilization rates. Your metrics, your KPIs, understand where you are relative to the rest of the industry.
Jamie Nau: Cool. So, we are right on time here. I want to make sure we give both of you a chance to kind of throw some final thoughts out there. Greg, let's start with you.
Greg Wallis: Just going back to my opening comments, keep your your balance sheet really clean, and make sure that your CFO or the controller reporting to you. That's where it starts. And then making sure that you've got your documentation, whether it's employee contracts, customer contracts, HR policies, making sure that's all taken care of lined up and well organized.
Jamie Nau: Great. How about you, Jody.
Jody Grunden: Yeah, adding to that. I think it comes down to having that trusted advisor, I've said like three times during episode, ad it's never too late to get that. Maybe you've got somebody, a relative or somebody you want to sell to, or maybe you've identified employees or maybe it's completely a third party. It's never too late. I think it's important that if you're even contemplating that over the next three, four or five weeks about selling get that trusted advisor by your side, that way that you can kind of build the roadmap to get that highest value.
Jamie Nau: Great. Yeah, my final thought is something I've mentioned several times too, so a broken record here, but I think that getting organized, again, it helps you run a better business; you never know what's going to happen. No one can predict the future. I always say I love my house. I love my neighborhood, but if some millionaire knocks on the door and was like, I love your garden. I’ll pay $2 million for your house. I'd probably would be ready to move. And so, you want to be prepared for that. You want to make sure that you don't have a bunch of faucets that don't work and stuff like that. So, you want to make sure that everything's ready because you can't predict the future. You don't know what's going to happen. Someone might fall in love with your business and give you an offer that you can't refuse. Well, thanks a lot, Jody, Greg, I think this is a great conversation and hopefully our listeners enjoy it.
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