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Decision Vision Episode 21: Do I Need an Investment Banker? – An Interview with Roger Furrer, Brady Ware Capital

June 27, 2019 by John Ray

Decision Vision

Decision Vision Episode 21: Do I Need an Investment Banker? - An Interview with Roger Furrer, Brady Ware Capital

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**Roger Furrer, Director of Brady Ware Capital**

Do I Need an Investment Banker?

Do I need an investment banker to sell my company? How does the sale process work? What’s the difference between an investment banker and a business broker? Roger Furrer, Director of Brady Ware Capital, answers these questions and much more in a interview with Michael Blake, Host of “Decision Vision.”

Roger Furrer, Brady Ware & Company

Roger Furrer is a Director at Brady Ware Capital, the investment banking arm of Brady Ware & Company. Roger joined Brady Ware in 2016, and prior to that served as COO and Managing Partner at Bannockburn Global Forex, LLC. Additionally, Roger enjoyed over 30 years in the banking industry in which he held various senior management positions, including leading teams focused on middle-market companies.

Roger leverages this expertise to help family-owned businesses and management teams maximize the value of their investments. He guides business owners through the sale of their business, or assists them in securing the liquidity needed to grow their business.

For more information, contact Roger at rfurrer@bradyware.com or at 937-238-9401.

Michael Blake, Brady Ware & Company

Michael Blake is Host of the “Decision Vision” podcast series and a Director of Brady Ware & Company. Mike specializes in the valuation of intellectual property-driven firms, such as software firms, aerospace firms and professional services firms, most frequently in the capacity as a transaction advisor, helping clients obtain great outcomes from complex transaction opportunities. He is also a specialist in the appraisal of intellectual properties as stand-alone assets, such as software, trade secrets, and patents.

Mike has been a full-time business appraiser for 13 years with public accounting firms, boutique business appraisal firms, and an owner of his own firm. Prior to that, he spent 8 years in venture capital and investment banking, including transactions in the U.S., Israel, Russia, Ukraine, and Belarus.

Brady Ware & Company

Brady Ware & Company is a regional full-service accounting and advisory firm which helps businesses and entrepreneurs make visions a reality. Brady Ware services clients nationally from its offices in Alpharetta, GA; Columbus and Dayton, OH; and Richmond, IN. The firm is growth minded, committed to the regions in which they operate, and most importantly, they make significant investments in their people and service offerings to meet the changing financial needs of those they are privileged to serve. The firm is dedicated to providing results that make a difference for its clients.

Decision Vision Podcast Series

“Decision Vision” is a podcast covering topics and issues facing small business owners and connecting them with solutions from leading experts. This series is presented by Brady Ware & Company. If you are a decision maker for a small business, we’d love to hear from you. Contact us at decisionvision@bradyware.com and make sure to listen to every Thursday to the “Decision Vision” podcast. Past episodes of “Decision Vision” can be found here. “Decision Vision” is produced and broadcast by the North Fulton studio of Business RadioX®.

Visit Brady Ware & Company on social media:

LinkedIn: https://www.linkedin.com/company/brady-ware/

Facebook: https://www.facebook.com/bradywareCPAs/

Twitter: https://twitter.com/BradyWare

Instagram: https://www.instagram.com/bradywarecompany/

Show Transcript

Intro: [00:00:06] Welcome to Decision Vision, a podcast series focusing on critical business decisions. Brought to you by Brady Ware & Company. Brady Ware is a regional, full-service accounting advisory board that helps businesses and entrepreneurs make visions a reality.

Michael Blake: [00:00:24] And welcome to Decision Vision, a podcast giving you, the listener, clear vision to make great decisions. In each episode, we discuss the process of decision making on a different business topic. But rather than making recommendations because everyone’s circumstances are different, we talk to subject matter experts about how they would recommend thinking about that decision.

Michael Blake: [00:00:43] My name is Mike Blake, and I’m your host for today’s program. I’m a Director at Brady Ware & Company, a full-service accounting firm based in Dayton, Ohio, with offices in Dayton; Columbus, Ohio; Richmond, Indiana; and Alpharetta, Georgia, which is where we are recording today. Brady Ware is sponsoring this podcast. If you like this podcast, please subscribe on your favorite podcast aggregator, and please also consider leaving a review of the podcast as well.

Michael Blake: [00:01:10] Today, we’re going to talk about hiring an investment banker. And I think this is an important subject because investment banks, I think, oddly enough, have a lot of mystery around them. In many cases, particularly if you’re a small business, you may only use an investment banker once in your entire life. Maybe even hopefully once in your entire life. You do one exit, you make a boatload of money, and then you get on your yacht, or you go to your mountain villa or your Italian Sicilian hideaway, and never have to do anything again. And one of the parties that kind of makes that possible for that lucrative exit is the investment banker.

Michael Blake: [00:01:56] Now, I happen to have a lot of respect for investment bankers because early in my career, I did the investment banking thing. And let me tell you – I’ll get on my soapbox a little bit, and I have no problem with that – for all the for all the junk that investment bankers take, and you hear investment bankers brought up in Congress that they don’t pay enough taxes and whatnot, I challenge any of them to walk in the shoes of a successful investment banker for two years and see kind of how they do with that.

Michael Blake: [00:02:38] It is not a 9:00 to 5:00 job, unless your definition of 9:00 to 5:00 is 9:00 in the morning to 5:00 in the morning. It is not a Monday-through-Friday job. It is an always-on job. And I can tell you for a fact that those folks, if they’re a success at all, really earn their fees. And if you don’t kind of live that lifestyle, you just are not in the business very long. That’s just all there is to it.

Michael Blake: [00:03:06] And so, I washed out, and I took a step back, and I went into business valuation, which is, let’s say, a much more work/life balance-friendly profession. Although, sometimes, my wife will wonder about that. But I wanted to kind of get that on the table because when you hire an investment banker, it’s a very important decision. If they’re any good at all, they ain’t cheap. And they can often be the difference between an exit that makes you comfortable for a while, and maybe pays for a vacation, or some of your kids education, versus retiring, or possibly leaving or creating legacy wealth.

Michael Blake: [00:03:50] So, with that, let’s kind of introduce our guest here. I have with us Roger Furrer, who is a director at Brady Ware Capital, which is our firm’s captive mergers and acquisitions specialized business unit. And they help business owners and entrepreneurs understand, increase, and unlock the value of their businesses. Business owners, often, find that managing the complexities of transaction’s an overwhelming experience. So, they can even find it overwhelming when they have help, I can tell you that for a fact. And you need an advocate that’s going to be out there representing you aggressively in the marketplace and helping you find not just an opportunity, not just Mr. Right or Mrs. Right, Mrs. Right now, but Mr. or Mrs. Right.

Michael Blake: [00:04:37] And that’s what Brady Ware does. And they help ease those challenges and let you continue running your business successfully throughout that transaction. That part’s really important because I can tell you, having worked on a lot of transactions myself, not in the investment banking capacity but as the advisor, selling your business is so physically and emotionally consuming that it can be difficult to actually continue running your business and sort of forget. You can easily lose sight of the fact that until that money hits escrow or until money hits your bank account, you get a wire confirmation, that deal is not done. And if you are not paying attention, all of a sudden, you may be left with a less valuable business than what you started with. But we’ll get into that.

Michael Blake: [00:05:24] Roger joined Brady Ware’s mergers and acquisition team in 2016. As I said, he’s a director. He has more than 30 years of experience in banking – i.e. 15 times more than I do – where he led teams focused on middle market companies. He leverages his banking experience as middle market companies to help family-owned businesses and management teams maximize the value of their investments. Specifically, he guides business owners through the sale of their business or assist them in securing the liquidity needed to grow that business. And with that, Roger, thank you so much and welcome to the program.

Roger Furrer: [00:06:00] Thank you, Mike, I appreciate being a part of the discussion.

Michael Blake: [00:06:03] So, Roger, let’s start with some basic vocabulary because I’m not sure everybody knows what an investment banker does. I think there’s an image out there of what an investment banker is, but I think there’s a misconception. So, kind of in your own words, if you had to kind of describe your job, what is it?

Roger Furrer: [00:06:26] Well, sure. One of the things that people misconstrue about the term is when they hear investment, they think it revolves around stocks, and bonds, and that type of thing. So, that’s one thing that we’re not. So, I would say investment bankers do a multitude of things. Some have more well-rounded services than others. At Brady Ware Capital, we help companies evaluate their strategic options around how do you liquidate or transition your business and discuss possible selling options for them. But we, also, help them uncover, perhaps, opportunities to acquire other companies or merge with other companies, and analyze the returns around that. At Brady Ware Capital, too, we also help companies raise the appropriate bank debt, or subordinate it, or mezzanine debt for the situation that they’re dealing with.

Michael Blake: [00:07:30] Okay, yeah. And so, when we say investment banker, one, I mean, you’re not lending money yourself, but you may be an intermediary to the folks who are lending money. And that first job description that you put out there, really, is more of a wealth or financial advisor when you’re dealing with analyzing stocks and bonds. And the exception may be if you’re the kind of investment bank that is taking companies public, and you’re dealing with public securities but that isn’t you guys. And for the most part, that’s not going to be our listener base. So, we can probably set that definition to the side, at least, for the moment.

Michael Blake: [00:08:09] So, one thing — and I have to confess, I don’t really know the answer to this question in a very clear way. So, I’m very curious to hear your answer to this. And that is, what is the difference, if there is any, between an investment banker and a business broker? Because you hear those terms both used a lot, but I also know many investment bankers that bristle a little bit if you call them a business broker and vice versa. So, I’m curious, is the difference meaningful enough? If so, how would you characterize it?

Roger Furrer: [00:08:41] Well, first of all, Mike, I’d say that there’s a lot of overlap in the term. So, I think, when people define a broker, they think about a transaction being completed, a commercial real estate property, a residential property, a broker being someone that executes the trade of a stock or a bond. So, I would say that I am a business broker, but I would prefer to be identified as an investment banker more so that also helps bring a transaction to fruition. So, I think, in in our terms and in the markets that we deal with, I think, business brokers, generally, deal with smaller-sized companies, and typically list the business for sale, and identify an asking price for that business, much like you would with a piece of a real property.

Roger Furrer: [00:09:48] I think the difference between an investment banker, I believe, is in a higher strategic value proposition, if you will, where when we’re representing a company for sale, we go about an entire marketing process and identify who we see as the best strategic and financial buyers for that entity, so that we’re able to drive the highest and best value for that company. I hope that helps you from a differentiation perspective.

Michael Blake: [00:10:26] It does. And not the suck up to because I’m not, it’s actually the best definition I’ve actually heard. The best distinction I’ve actually heard between the two. So, for the first time, I think I can actually explain it to somebody else, which is the definition of a good understanding. So, what is the investment banker-client relationship look like if it’s a very good one? I think, when clients sign onto to pursue a strategic transaction, we use that generic term deliberately for the moment, I sometimes wonder, particularly if they’ve never been in that kind of transaction environment before, if clients really, frankly, know what it is that they’re getting into. So, maybe could you kind of shed some insight and give us some of the inside baseball in terms of what that relationship looks like on a day-to-day, in a month-to-month basis?

Roger Furrer: [00:11:28] Sure. Maybe to define an ideal relationship, I kind of start by saying the process to sell a business and to discuss the strategic options leading up to selling a business could be a 6, to 9, to 12-month process. So, with that being said, you’re going to spend a lot of time as the business owner with the investment banker that you choose to work with. So, I think it’s very important that you have a degree of chemistry with those folks, that everybody likes working with each other, and that the investment banker is able to also work effectively with the management team of the company and work with other outside advisors, such as their attorney, or accountant, et cetera that’s going to be working through this process.

Roger Furrer: [00:12:19] And the reason that is important, it’s not so much the time frame, but it’s the intensity during that time period. I might talk with my customer daily, twice a day, many times a day, depending on where we’re at in the process. So, there is a tremendous amount of interaction that you’re dealing with during the course of the process of selling that business.

Roger Furrer: [00:12:45] I think, the other thing that I would suggest that that somebody look for in an investment banker, and I’m I’m sucking up a little bit and touting some of my background, but I think somebody that has some experience, a multitude of experience in different business environments because there are technical, legal, accounting, financial, emotional, all kinds of issues that come up during the course of the process. And so, I think, dealing with somebody with a well-rounded background is also very important in the process.

Michael Blake: [00:13:27] I’ll underscore that because that’s also important in what I do. As you know, and if our listeners have listened to these other podcasts, I specialize in technology businesses and professional services firms, – i.e. businesses that have mostly intangible assets. And the process of selling/buying a business and those industries is candidly very different from, say, buying or selling an orthopedic practice, or even a manufacturing company, or a high-tech engineering situation, or the engineering professional services. But the point is all these kinds of transactions or businesses have their own little nuances that have to be figured out and anticipated, preferably, well in advance. And there’s a lot of value to having seen a lot of stuff because every deal will have a surprise or two that’s just unavoidable, but you’d like to keep those those surprises down to a minimum to a dull roar.

Roger Furrer: [00:14:39] And the ability to draw back on past experience and be able to connect the situation from one experience to another and say, “In this situation, this is how it was dealt with,” as kind of a starting point in understanding the discussion.

Michael Blake: [00:14:55] Yes. As I like to say, there needs to be some benefit, in my case, to having gray hair and two arthritic ankles. And what you get in exchange for that is a little bit of experience, and been there, done that, and got the T-shirt. So, one thing that I think a lot of folks don’t know if they haven’t worked in the investment bank yet is that there’s a difference between sell side and buy side transactions. Of course, a sell side transaction, meaning that you’re working for the seller, and a buy side transaction, meaning that you’re working for a buyer. And most investment bankers I know, and I truly don’t know if this is the case for you – I should, but I don’t – but most investment bankers have a preference to work on sell side transactions. So, I guess, my two-part question is, is that the case for you guys at Brady Ware Capital? And if so, why is that? Why is there a preference to work on the sell side?

Roger Furrer: [00:15:59] Well, it’s interesting that you bring this up, Mike. This morning, I was talking to another investment banker that we have a strategic alliance with, and we were introducing ourselves to another party, and they asked if he does buy side engagements, and he said, “No, I flat out refused them.” So-

Michael Blake: [00:16:19] Yeah, I’ve heard that.

Roger Furrer: [00:16:21] So, first of all, Brady Ware Capital’s preference is most certainly to do with sell side engagements. We do take on a limited amount of buy side engagements when the situation seems right for ourselves and the client. But the reason for the preference is — and this may seem a little bit strange at first, but with a sell side engagement, you know you have one willing party to start with. You have someone that has engaged you to go find a buyer, they’re ready to sell. When you do a buy side engagement, the buyer says that they want to grow from strategic acquisition or otherwise, but in many cases, it’s very difficult to define what it is that they’re looking for and trying to identify the right party to be a participant on the other end of the transaction.

Roger Furrer: [00:17:20] And if you’re able to find the perfect fit, and talk to, and find, and get financials, and identify the right selling party for that transaction, well, they work for sale when you call them, so you kind of flip the leverage in terms of the monetary value that was going to be exchanged. You kind of flip that leverage over to them because you reached out to them and created a situation that they weren’t ready for. So, it would be the same thing if I showed up at your doorstep and your house wasn’t for sale, but I said that I wanted to buy it because it was the perfect fit for me. And you kind of take a step back and go, “Well, it’s not that really for sale, but if you paid me 50% over market value, it might be for sale.”

Michael Blake: [00:18:13] Yeah, that’s right.

Roger Furrer: [00:18:13] And so, when that happens, right now, my buyer, who was a willing participant, says, “Well, wait a minute, I’m not going to pay that for that company.” So, it’s very difficult to find the perfect fit in a buy side engagement.

Michael Blake: [00:18:29] It’s like trying to solve one equation with two unknowns, I guess. And for the most part, at least larger companies, they won’t hire a buy side investment banker representative, and that’s why they’ll hire instead of vice president of business development, they’ll have a corporate development team if they’re large enough. And that’s kind of their job to go out there and hunt for those businesses to acquire. And that’s probably the more common model, wouldn’t you say?

Roger Furrer: [00:19:00] I would definitely agree with that, Mike.

Michael Blake: [00:19:02] Yeah. So, how do folks like you, frankly, get paid? In my practice, 90% of my fees are on a fixed basis. I don’t think the investment banking world really works that way. So, how are investment banking fee structures on a sell side engagement typically put together?

Roger Furrer: [00:19:30] Well, I wouldn’t have answered it this way, except for how you stated it with yours are 90% percent. Ours are probably 90% variable. So, for the most part, we are compensated when success happens. And back to your introduction, that’s when the wire transfer goes through. So, most investment bankers will receive a retainer at the beginning of a sale process, and they might receive another retainer or two throughout the course of the engagement at various stages in the process. But, again, most of our fees come from the transaction success actually happening. And those fees would range from roughly a few percentage points on up to maybe 7% or 8% of the sale, depending on the size of the transaction.

Michael Blake: [00:20:26] And the risk level, I would imagine as well, correct? In other words, if you think the deal is going to be easier to do, the fee might be a little bit less. Or does it matter? Maybe it doesn’t.

Roger Furrer: [00:20:40] I’ll say I’ll answer that a couple ways, Mike. One is by our very nature, and kind of the structure of our pricing is built around success, the idea is to identify projects that we would work on that we feel that we’re going to achieve success. And that’s a mutually determined between ourselves and our client. In other words, if we value the business, I’ll just use a number of 5 million, and our customer says that, “I’m not going to sell for anything less than 10,” then we probably don’t see a pathway to success with that. At that juncture, we might work with the customer more about how to achieve a valuation of $10 million at that point in time. So, if we don’t see a pathway to success, I’d say there’d be two things that we would do. One is not become engaged; or secondly, if the client wants us to continue through a process, we would probably change the pricing structure, so that it’s more fixed versus variable.

Michael Blake: [00:21:54] Got it, okay. And the way you described that just made me realize something, and it goes back to the previous question of buy side versus sell side. If your compensation is going to be a factor of or driven by the size of the deal, and you’re working on a buy side engagement, you’re kind of working against yourself, right, because you’d be trying to drive down a price, but in so doing, driving down your fees. Now, that would be a pretty hard balancing act to sustain in any event.

Roger Furrer: [00:22:26] Yeah, we’re a little bit — and our pricing structure, we like to be in neutral lockstep with our clients, so that we’re not in a situation like that where we’re not trying to drive the price down, so we drive our fee down. Correct.

Michael Blake: [00:22:44] All right.

Roger Furrer: [00:22:44] And, also, back to your buy side situation, because I described before that it’s difficult to identify and achieve success with it, and that’s the nature and structure of our compensation system is based on success, you don’t want to get into a lot of situations where you don’t see a pathway to success.

Michael Blake: [00:23:05] Yeah. That’s a good way to not be in business very long.

Roger Furrer: [00:23:09] Correct.

Michael Blake: [00:23:13] So, take us through a sales process. Let’s say somebody has been — you’re now engaged, and you’re ready to put a business on the market for sale at some point. I’m guessing there’s some preparation that goes into the process, but I don’t want to answer that question. I’ll let you answer that question. What does that process look like?

Roger Furrer: [00:23:37] Sure. Maybe before getting engaged, I’d like to take a step back and discuss the process of getting engaged. So, I mean, it sounds a little bit like a marriage here. So, what are you trying to accomplish, business owner? What are your objectives? Are you trying to transition your business to your management team? Are you trying to transition your business to relatives, cousins, daughters, sons, whatever it might be? Or are you trying to exit 100% of the business on sale to a strategic party? A financial party? Are you trying to retain some ownership and partner with somebody to take you further and help you grow your business in another direction, perhaps, geographically or from product diversification, whatever that might be? So, I think the first part in thinking about a sale process is really identifying and discussing, what are you trying to do with this? What’s the right solution for you? Because that’s going to drive the marketing process that we go through.

Michael Blake: [00:24:54] So-

Roger Furrer: [00:24:55] Is that helpful?

Michael Blake: [00:24:56] No, no, it is. I’m glad you brought us back to that point because I think it’s very important. I’m guessing the process where or the number of clients that you, or any good investment banker has, or if someone just sort of calls you up and says, “Hey, an investment bank,” “Great. I’ll send you a letter. Sign it.” Next thing you know, you’re engaged. I’ll bet that’s pretty close to zero, right?

Roger Furrer: [00:25:20] That would be less than zero, yes.

Michael Blake: [00:25:22] Yeah, right. So, you’ve had months of of conversations. This is something a lot of people don’t realize about investment banking is folks like you invest a ton of time, energy, and expertise in that pre-engagement relationship-building period where you’re trying to understand (A), business, and (B), the goals of the owners, and make sure those are something that you can realistically accomplish.

Roger Furrer: [00:25:55] That’s correct. And as part of that process, it’s also identifying a value range of that business, so that you understand what the potential outcome could be as a result of the marketing process. So, back to my example of the $5 million valuation where the business owner feels that 10 is their exit number, now, we’ve got to step back and talk about ways to get that business valuation up. So, I digress a little bit from your question on the sales process and what happens when you get engaged, but I thought that was a good backdrop.

Roger Furrer: [00:26:32] With that being said, so to directly answer your ,question through an engagement process, and we describe it as a several different steps that we go through throughout that 6 to 9-month process that we discussed before, where we literally write marketing material on the business by gathering financial data, understanding the products, the markets, the sales process, whatever it might be that are positioning the business as to why this is an outstanding investment consideration for a potential buyer to look at. So, we go through the entire marketing process and understanding the business.

Roger Furrer: [00:27:21] And then, as part of that process, we set down and identify who we see as potential buyers for this business. And how we do that is we review companies that might be direct competitors of the customer. They might have ancillary businesses associated with this particular business. They could be large suppliers to the business or have other strategic interests that could align with purchasing of a particular company that we’re representing.

Roger Furrer: [00:28:00] We also identify what we’ll call financial buyers, who, broadly speaking, would be identified as private equity groups or, perhaps, family offices that engage in private equity transactions. Private equity can be a very powerful option for people, especially who are interested in retaining some ownership and continuing on a go-forward basis. Typically, these financial buyers also have a strategic interest in an industry. So, a private equity firm that has a specialty in managing manufacturing companies probably isn’t going to be interested in a retailing business, as an example, but it’s usually something that’s tangential to the business that they’re already in. So, those are the things that we go through at the start of that process. And then, we literally do hand-to-hand combat outreach to the leadership team of these prospective buyers and send marketing material to them in an attempt to get them interested in this company.

Michael Blake: [00:29:22] Yeah. I like the way that you mentioned that hand-to-hand combat. And just as an aside, you mentioned, you bring up family offices because I think that’s a relatively new trend. When many of us think about private equity — I’m sorry, financial buyers, we go right to private equity. But as you know, I’m doing an increasing amount of work with family offices and dynastic wealth, and they’re starting to become a more important player as a financial buyer of buying operating businesses. At least, I’m seeing that. Are you seeing the same thing?

Roger Furrer: [00:30:00] We are. They, too, like others, are looking for profitable ways to deploy the capital that they have to invest, and they see this as one of the avenues that they might allocate a portion of their portfolio.

Michael Blake: [00:30:18] So, typically — just, let’s do a rain show. I don’t want to nail you down, but I still think it’s important in terms of managing expectations. When you and a client agree to work together – excuse me – how do you set expectations or what expectations you typically set in terms of how long it will take from, “We’re signing this engagement letter,” until you’re going to sell the business, and money wire transfers go through.

Roger Furrer: [00:30:52] Sure. I’ll start with the end answer, and I’ll break it down in stages for you, Mike. The end answer is probably six to eight months from the start of the process to the wire transfer clearing. We say it’s about a month doing our market preparation and marketing material. Another month to six weeks in terms of executing the marketing process, and identifying potential buyers, and outreach, and getting indications of interest from those buyers. Another six weeks or so in terms of providing additional information, hosting those companies on site for visits, and ultimately picking the right party and negotiating a letter of intent that we all agree on. So, that’s about — I’ll call that maybe four months total there. And then, it could be another three months or so to develop documentation, do the due diligence research that the buyer is going to do, and ultimately get to the closing process.

Michael Blake: [00:31:59] So, there’s a question I want to make sure that I — a conversation I want to make sure I have with you because I think this is very important for our listeners, and I’m sure that you’ve addressed it. And that is part of the compensation model is there is a retainer involved. And to be candid, I actually advise clients that hiring an investment banker that requires a retainer, I think, is a good thing, because that’s what helps keep the investment banker interested, especially when the deal isn’t particularly active as opposed to — and we know business brokers tend to be more like this, so they’ll operate without that retainer where there’s a purely a success fee out there, and you’re going to get the very definition of ADHD, and that whichever deal happens to be getting transact – I’m sorry – traction today is the one that’s going to get your attention. That means that yours is going to go to the bottom of the pile. Can you comment on that? Does that make any sense to you?

Roger Furrer: [00:33:09] Well, I would say what went through my mind, Mike, is I’ve seen investment bankers that charge a monthly retainer. I’m not a big fan of that. And in advising a client, I would advise a client against that because that just keeps the meter running and doesn’t necessarily drive one to success. The retainer fees that we have and the way that we restructure it is around hitting certain benchmarks, so that there is demonstrated progress in the work that we’re doing.

Roger Furrer: [00:33:48] Now, it doesn’t necessarily mean that we’re going to close the transaction, but, for example, having a retainer that hits when the letter of intent is signed, that shows that work was done, and progress was made, and this keeps us engaged and kind of covers our expenses, and time, and effort in working through to the closing process. So, I’m a big fan of retainers that way that are benchmark-driven. I’m not a big fan of retainers that are driven by the turn of the calendar.

Michael Blake: [00:34:21] Okay, good, good. So, have you ever run into a scenario where a prospect kind of raises the question of, “Well, my law firm says they know buyers, and my CPA firm says they know buyers, and maybe I can just let them sell my business and not have to pay the fee”? Do you ever encounter that? And if you do, how do you respond to that?

Roger Furrer: [00:34:50] We encounter it frequently. And the way that we address it is a number of ways. First of all, there’s many great accountants and attorneys that I’ve worked with through these processes, and many of them may have the capabilities to do these. I’ll call them one-off transactions from time to time, where buyer reaches out directly to the seller to get a transaction completed. That could work. I don’t advise that you should approach it that way, but that could work. I find it, I don’t know, I’ll use the term laughable, that accountants and attorneys would do outreach to identify potential buyers, and try and get them interested, and do the work that we do.

Roger Furrer: [00:35:46] So, they certainly have some skill sets that help in the process. But the other thing I’d say is that they’re rarely staffed to handle those steps to do it. I mean, we work constantly on a deal. Constantly, we might spend half a day for six months on a particular deal. I don’t see an accountant or an attorney having the ability to do that based on the other workloads that they have. So, we always hear about the realtors sale, the FSBO, the for sale by owner. I certainly don’t think that is the recommended approach.

Roger Furrer: [00:36:23] Independent of the advisors, here’s the other thing that I think is the critical piece of this. So, it’s a very specialized and, at times, sensitive process, which I’ve just articulated, but the business owner and the management team needs to focus on running the business and maintaining the value of the business. If you devote an inordinate amount of time to the selling process itself and the business suffers, guess what, you just diminish the value that you thought you were saving by not paying the investment banker fee. So, how is the expression? What’s the saying? “If you act as your own attorney, you have a fool for a client.” I think this is pretty similar to that.

Roger Furrer: [00:37:15] You’ve used the term before about trying to do this cheaply. Well, we certainly believe a thousand percent of the time that the process, and the effort, and the marketing approach that we do is way, way more offset. Our costs are way, way more offset by the value that we drive in the business. So, first of all, don’t do it yourself because your business is going to suffer. If you’re in a situation where you can spend six to nine months working on the selling process, I challenge that that just doesn’t happen in business very often that you can establish a new role for yourself and not do your current job. So, don’t do that is my huge advice with that.

Michael Blake: [00:38:11] So, the bullet point here is do not try this at home.

Roger Furrer: [00:38:13] Yeah, no.

Michael Blake: [00:38:15] And I agree with that, and I’ve seen it happen even with an investment banker involved. And I think, frankly, one of the values that you guys bring to the table is understanding how to manage your clients’ time to make sure they are still managing their business because there’s the dynamic of work that if your eyes off the ball on the business, that’s one thing. Over time, you could probably recover it. But the other part that, I think, is extremely hard to recover from is psychological. It’s that once your mind is kind of one foot out the door, and you’re thinking more about that condominium in Costa Rica than you are your business on a day-to-day basis, I think it’s very hard for you to snap yourself out of that and get back into full on business non-exit mode.

Roger Furrer: [00:39:15] I would completely concur with that. And I think one of the things that we do in the process is the coaching aspect of it about making sure that the business is still performing. Now, obviously, these situations occur where that doesn’t happen, but the idea is to make sure that people are maintained and maintained in their focus on where they should be to maintain the value of the business during this six to eight-month cycle.

Michael Blake: [00:39:49] So, we are talking to our Roger Furrer of Brady Ware Capital. And we’re talking about whether you should hire an investment bank. I’ve just got a couple more questions, and I want to let you go because I know you’ve got deals that you’re working on right now. But one question I want to make sure that we do cover is investment banks such as Brady Ware Capital are not just about buying and selling businesses, are they? There are other kind of ancillary — I don’t want to say ancillary because that sounds like they’re not important, but there are other important services that you offer to clients as well, as do other many investment banks. Could you talk about that for a minute?

Roger Furrer: [00:40:30] Yeah. I think a couple of things that we do well also. And I think having Brady Ware Capital being a part of Brady Ware, the accounting practice, gives us the unique capabilities of being able to work with what we would call transaction specialists that are able to be participants in a due diligence process and identifying issues that might arise in the financials of a target company, as an example, or preparing the seller for issues that might come up with their target company. So, I would broadly categorize that as transaction services type of work.

Roger Furrer: [00:41:14] Additionally, we also participate in what I would call corporate finance, which would be helping companies analyze potential cash flow and return on equity metrics for an investment that they’re making, an acquisition that they’re making, those types of things to make sure that they’re on the right path from a financial perspective. And finally, I believe I mentioned before, we do assist in capital raises. Most traditionally we have worked in the area of bank debt and other mezzanine debt that would assist the company with their capital structure.

Michael Blake: [00:41:58] Now, you mentioned debt. Sort of noticeably absent in that conversation then is equity. Does that mean that you’re not as aggressively pursuing transactions where you might help somebody raise equity capital?

Roger Furrer: [00:42:14] We do not do that as a routine. No, Mike. It’s almost one of those situations that I would parallel with the buy side discussion in that trying to find the right fit of equity participants with a particular equity need is maybe needle in a haystack type of approach. I would say, more typically. from an equity raise perspective would be around the potential transition of some of the ownership, maybe a minority ownership perspective, to provide liquidity to the primary owner or perhaps to engage in some expansion activity or acquisition activity. There is a fair amount of private equity groups that do specialize in taking a minority ownership position. So, when that scenario arises, that might be something that would be part of a process in an equity capital raise. But rarely do we do one-off type, if you will, for smaller dollar amounts to bring equity into a business.

Michael Blake: [00:43:34] So, if Wiley Coyote is coming to you, and he’s trying to raise venture capital for his roadrunner catching machine, that’s not a good fit.

Roger Furrer: [00:43:43] I know Wiley Coyote had some great Acme machine that I remember as a kid. We might invest in that.

Michael Blake: [00:43:50] Now, there you go.

Roger Furrer: [00:43:52] But yes, that is not one of our strong suits.

Michael Blake: [00:43:57] All right. So, Roger, this has been great. There’s other questions we could ask, but I know we’ll let you get back to it. If somebody wants to contact you and learn more about investment banking, and how investment banks can help a company from a strategic perspective, and maybe a bit more about Brady Ware Capital, how can they best find you?

Roger Furrer: [00:44:21] Well, I’ll tell you that, but before I do, I think there’s one other point that I think that we should talk about with the listeners. A lot of times, we’ve talked about a party not doing it at home yourself type of thing and doing it for sale by owner. When people get outreach from a buyer who calls them directly and thinks that they should engage in an acquisition discussion, investment bankers are very useful in that process as well in that the first thing that we do is help with the identification of what the value of that business should be. And, also, kind of go back to the starting point that we had before is, what are you trying to accomplish, business owner, around your goals and objectives with transition? So, I just thought that was worthwhile to bring up to before actioning.

Roger Furrer: [00:45:19] With that said, in answer to your question on how to get a hold of me, my email address is rfurrer@bradyware.com or anyone may reach me on my cell at area code 937-238-9401.

Michael Blake: [00:45:43] Okay, Roger, thanks very much for that. I think there’s a lot of good content for someone who’s thinking about whether or not they need to retain an investment bank. Chances are if you’re thinking about it, you’re probably doing. And Roger’s a great place to start.

Michael Blake: [00:45:58] That’s going to wrap it up for today’s program. I’d like to thank Roger Furrer so much for joining us and sharing his expertise with us. We explore a new topic each week. So, please tune in so that when you’re faced with your next business decision, you have clear vision when making it. If you enjoy this podcast, please consider leaving a review with your favorite podcast aggregator. It helps people find us, so that we can help them. Once again, this is Mike Blake. Our sponsor’s Brady Ware & Company. And this has been the Decision Vision Podcast.

Decision Vision Episode 10: Should I Have a Quality of Earnings Report Done? – An Interview with Teresa Snyder, Brady Ware & Company

April 11, 2019 by John Ray

Decision Vision

Decision Vision Episode 10: Should I Have a Quality of Earnings Report Done? – An Interview with Teresa Snyder, Brady Ware & Company

00:00 /

**Teresa Snyder, Brady Ware & Co., and Mike Blake, Host of “Decision Vision”**

Should I Have a Quality of Earnings Report Done?

What is a quality of earnings report? Why would I want one done for my business? How does a quality of earnings report help as I’m getting ready to make an acquisition or sell my company? These questions and more are answered in this episode of “Decision Vision,” as host Michael Blake, Director of Brady Ware & Company, interviews Teresa Snyder, Director of Brady Ware & Company.

Teresa Snyder, Brady Ware & Company

Teresa Snyder is a Director of Brady Ware & Company. Teresa has over twenty-five years of experience in public accounting and private industry. Her experience includes not-for-profit organizations, professional service firms, wholesalers, manufacturing and importers/exporters of various industries. Teresa has assisted her clients in a broad range of general management and financial consulting services, accounting systems design, and accounting and financial reporting issues.

In addition to providing client service, Teresa serves as the Atlanta Audit Leader for the firm. She has earned the AICPA IFRS Certificate. Prior to joining the firm, Teresa specialized in software consulting and implementation of fully integrated accounting software for various types of organizations including wholesalers and manufacturers, and importers/exporters.

Teresa is a CPA in Georgia and a member of the American Institute of Certified Public Accountants and the Georgia Society of Certified Public Accountants. Teresa has served as a coach for youth sports and is involved in a variety of not-for-profit organizations where she holds leadership positions.

Michael Blake, Brady Ware & Company

Brady Ware & Company

Decision Vision Podcast Series

Decision Vision is a podcast covering topics and issues facing small business owners and connecting them with solutions from leading experts. This series is presented by Brady Ware & Company. If you are a decision maker for a small business, we’d love to hear from you. Contact us at decisionvision@bradyware.com and make sure to listen to every Thursday to the Decision Vision podcast. Past episodes of Decision Vision can be found here. Decision Vision is produced and broadcast by Business RadioX®.

Visit Brady Ware & Company on social media:

LinkedIn: https://www.linkedin.com/company/brady-ware/

Facebook: https://www.facebook.com/bradywareCPAs/

Twitter: https://twitter.com/BradyWare

Instagram: https://www.instagram.com/bradywarecompany/

Show Transcript:

Intro: [00:00:01] Welcome to Decision Vision, a podcast series focusing on critical business decisions, brought to you by Brady Ware & Company. Brady Ware is a regional, full-service, accounting and advisory firm that helps businesses and entrepreneurs make vision a reality.

Michael Blake: [00:00:20] And welcome back to Decision Vision, a podcast giving you, the listener, clear vision to make great decisions. In each episode, we’ll discuss the process of decision making on a different topic. Rather than making recommendations because everyone’s circumstances are different, we’ll talk to subject matter experts about how they would recommend thinking about that decision.

Michael Blake: [00:00:40] Hi. This is Mike Blake. And I’m your host for today’s program. I’m a Director at Brady Ware & Company, a full-service accounting firm based in Dayton, Ohio with offices in Dayton; Columbus, Ohio; Richmond, Indiana; and in Alpharetta, Georgia, which is where we are recording today. Brady Ware is sponsoring this podcast. If you like this podcast, please subscribe on your favorite podcast aggregator, and please also consider leaving a review of the podcast as well.

Michael Blake: [00:01:04] So, today, we’re going to talk about something called quality of earnings reports. And this an important topic. We’re, right now, at a high point over the last 10 years of merger and acquisition activity, which in English means that businesses are being bought and sold all over the place, and valuations are very attractive, financing is out there. Whether you think it’s back to the good slash battle days of 2006 -2007, I’ll leave it to you to make that determination. But the fact of the matter is that buying businesses is definitely back, and it’s back in style.

Michael Blake: [00:01:42] And as it turns out, a lot of that or a lot of my practice in the business appraisal happens to be in the M&A world. And my job is to help a client figure out the appropriate price and, to a certain extent, the terms associated with the transaction. But within that process of examining a transaction, there’s this thing that we call due diligence. And due diligence, when we really get down to it, is really just trying to answer the question, is this business what the seller says the business is? It’s really all that and a bag of chips basically.

Michael Blake: [00:02:22] That due diligence process, if it’s done well, is typically very involved and a very engaged process. It sometimes takes 30 days. Usually, it takes 60 to 90 days. And I’ve seen it go as far or as long as 180 days if it’s a particularly complicated transaction. And the due diligence process will involve everything from legal due diligence, intellectual property, customer due diligence, and so forth. And to be perfectly candid, from the seller’s perspective, it’s about as comfortable as your garden variety colonoscopy. But if you want to sell your business, you want to get the right price for it, that’s what you got to do. There’s just no alternative to it.

Michael Blake: [00:03:07] Now, financial due diligence, of course, is an important part of this entire kind of investigation and, sort of, crunching the numbers. And what we’re going to learn about today is, kind of, a specialized portion of that financial due diligence that’s called quality of earnings. And what quality of earnings means at the end of the day is that not all earnings are alike. Accounting is a funny thing. Accounting is a language. And like any language, a word or a term can mean different things depending on the context, depending on the syntax of that conversation.

Michael Blake: [00:03:47] And so, quality of earnings can mean different things to different people, to different buyers. And looking at quality of earnings has become much more in vogue. I’ve seen it come much more in vogue in, say, the last 10 years where a specific exercise is done, not just to, kind of, validate the numbers that are presented, but really dig into what do those numbers mean, is the financial performance of the company sustainable, is it telling us the story of what we would like to do.

Michael Blake: [00:04:19] But, of course, with performing additional due diligence, that means extra expense, extra time, extra fees. So, the question comes up, does it make sense to perform or have a quality of earnings report done on this particular transaction?

Michael Blake: [00:04:35] And for those of you who have listened before, I am not qualified to tell you that. I’m not an accountant. I’m not a CPA. I don’t even do my own taxes. But I have somebody here today who is qualified to help us answer that question. And she is my friend and business partner, Teresa Snyder.

Michael Blake: [00:04:50] Teresa is an audit partner with with Brady Ware. She has over 25 years of experience in public accounting and private industry. Her experience includes not-for-profit organizations, professional services firms, wholesalers, manufacturing, and importers/exporters of various industries. Teresa has assisted her clients in a broad range of general management and financial consulting services, accounting systems design, and accounting and financial reporting issues.

Michael Blake: [00:05:17] In addition to providing clients service, Teresa serves as the Atlanta Audit Leader for the firm. She has earned the AICPA IFRS, which means international gap certificate. Prior to joining the firm, Teresa specialized in software consulting and implementation of fully-integrated accounting software for various types of organizations, including wholesalers, and manufacturers, and importers/exporters. Now, until I looked this up, I did not know you are that much of a tech head. You’ve been holding out on me.

Michael Blake: [00:05:44] Teresa is a CPA in Georgia and a member of the American Institute of Certified Public Accountants and the Georgia Society of Certified Public Accountants. Teresa has served as a coach for youth sports and is involved in a variety of not-for-profit organizations in which she holds leadership positions. Teresa, thank you so much for coming on the program today.

Teresa Snyder: [00:06:05] Thank you, Mike. Happy to be here.

Michael Blake: [00:06:07] So, let’s, sort of, before we get into it, I’d like to learn a little bit more and let our listeners learn a little bit more about your role at Brady Ware. When we say that you’re the Director of the Audit Leader of the Atlanta office of Brady Ware, what does that mean? What does somebody who hears that take away from it?

Teresa Snyder: [00:06:28] Well, our team provides audit and review services that help our clients in meeting their financial reporting obligations to investors and bankers. We also serve as advisors to our clients in a variety of business transactions, which include M&A transactions.

Michael Blake: [00:06:47] Okay. And one of the services that you provide out of this office is a quality of earnings analysis.

Teresa Snyder: [00:06:54] Yes, that’s correct.

Michael Blake: [00:06:55] So, somebody is buying a company, and they’re really interested, but they think that they would like to kind of do that deep dive into the financials. That’s something that you do through your practice, correct?

Teresa Snyder: [00:07:11] Yes, that’s right.

Michael Blake: [00:07:12] So, what is a quality of earnings analysis exactly? What is a client buying?

Teresa Snyder: [00:07:18] Well, it’s a detailed analysis of all the components of the company’s revenue and expenses, their operating cash flows, and their assets and liabilities. Typically, we’re going to look at a period of about 24 to 36 months of financial data, so that we can assess the accuracy of the historical data and consider the sustainability of future operations.

Michael Blake: [00:07:42] So, I’d like to hone in a little bit on the sustainability. What are the kinds of things that make operations or make earnings sustainable versus not sustainable?

Teresa Snyder: [00:07:52] Well, we’re looking for transactions such as non-recurring items. They might be non-recurring revenue. It might be a one-time revenue opportunity that a company had and is not present in the future on an ongoing basis.

Michael Blake: [00:08:09] Now, one thing, actually, I’m engaged, and I’m working on right now, I’ve got client who’s thinking about buying a company. And then, all of a sudden, their expenses went down conveniently right before the transaction is supposed to take place. And we’re kind of suspecting, but we don’t know that what’s happened is they’ve delayed their expenses to make that look good. And then, those expenses will wind up popping up after the transaction. Is that something that a quality of earnings analysis can bring to light for a client?

Teresa Snyder: [00:08:39] Yes, it should. It should be part of that analysis. So, you’re going to be looking at expenses as well and trying to determine, are there understated expenses for a variety of reasons? It could be someone postponing. It could be an unfilled position. For instance, an executive position that’s not filled for a time period, and so your expenses come in understated

Michael Blake: [00:09:01] Okay. So, if I’m a — we both know that doing a transaction is not cheap-

Teresa Snyder: [00:09:10] Right.

Michael Blake: [00:09:10] … if you want it done well, right. If you want to go into it blindly, it’s very cheap. It’s not cheap to do it well. On top of all the other fees we got going on, paying somebody like me for appraisals, tax advice, investment bankers, lawyers, everything else, when does it make sense to think about adding a quality of earnings study onto that to-do list or onto that venue?

Teresa Snyder: [00:09:36] Well, I think, the quality of earnings study, going through that process, part of it is to normalize your EBITDA. That’s your earnings before interest, taxes, depreciation, and amortization.

Michael Blake: [00:09:51] And that’s often a proxy for cash flow, right?

Teresa Snyder: [00:09:54] Correct. And so, then, once you normalize your EBITDA for the time period that you’re looking at, then you’re also going to start looking for those one-time transactions. And, generally, they’re going to be add-backs. They might involve owner transactions that wouldn’t be present in the future operation. There could be a variety of of add-backs to that number. And you’re trying to — once you normalize the EBITDA, that becomes your basis for establishing the multiple, which is your selling price. So, it’s very important. That number is critical in the sales transaction.

Michael Blake: [00:10:32] So, I want to touch upon — so, it’s not uncommon, it sounds like, that for even a seller to have a quality of earnings done on their own company, right? Almost like having a private investigator investigate yourself.

Teresa Snyder: [00:10:46] Correct. So, there can be two different approaches. Typically, the buyer is the one that’s going to commission the quality of earnings study. They’re going to use it for their own purposes to decide if what they’re looking at buying has a sustainability that they’re looking for. But a seller could also — and I have seen that, a seller might commission a quality of earnings study in preparation for going to market, or a buyer has come to them, and they want to see what it looks like, and are they being offered a fair price.

Michael Blake: [00:11:19] And I think that’s a smart thing to do because selling a business, in addition to being expensive, is hard. It’s complex. You and I both know the business owners, and they’re selling a business. It’s both an exciting and stressful time.

Teresa Snyder: [00:11:38] Yeah, exactly.

Michael Blake: [00:11:39] And the stress often comes from when a buyer starts pointing out, “Face of the baby is not as pretty as you think it is.”

Teresa Snyder: [00:11:47] Right.

Michael Blake: [00:11:48] Right? So, you’re getting very constructive, very practical criticism about the business. And that’s a lot easier to react to in a constructive way if you already know that criticism is coming, right. And maybe even, you’re in a scenario where you know that criticism is coming, but because you had that study done before the seller even finds out about it, maybe it discloses them proactively. And that can create a positive impression, create trust in the conversation. But the minute, at least, then, you’re prepared for it, right?

Teresa Snyder: [00:12:21] Yes.

Michael Blake: [00:12:21] So, you don’t you don’t react to it in a panic, right. Is that a fair way to think about it?

Teresa Snyder: [00:12:25] Yeah, I think so. And even if you back up and take even a longer-term view, and you go through this process or some version of this process, then you can react to it and act on opportunities that you might be missing or make corrections in areas that need to be corrected before you ever go into the marketplace.

Michael Blake: [00:12:46] Interesting. So, can you think of examples of those, kind of, opportunities that might surface if you do this preemptive, proactive QoE or quality of earnings? And if I understand you correctly, it sounds like you don’t necessarily have to wait until there’s a pending transaction. You may just do it as a matter of good management. Is that fair to say?

Teresa Snyder: [00:13:05] Correct.

Michael Blake: [00:13:06] Okay.

Teresa Snyder: [00:13:06] If you’re anticipating that you want to sell at some point in the future, and again you may not go through the full level of the quality of earnings analysis, you might do — there are some other engagements and agreed-upon procedures. And a lot of business owners know if they have a problem area. And so, that could be something that a business owner might enter into to help construct what are our challenges here, and perhaps what are some things that we can do to correct that.

Michael Blake: [00:13:38] Okay. So, a question I hear a lot is, what if the firm’s financial statements are already audited, right? There’s a perception, which I’m not sure is entirely right, but there’s a perception that because an audit has been done, automatically, they’re going to catch these things. And we had one of our colleagues, Randy Domigan on a few weeks ago and talked about forensic accounting. And audits don’t necessarily catch fraud, for example. Is it reasonable to assume that because there’s a gap compliance audit with a clean opinion or an unqualified opinion, is it reasonable to assume that there’s a quality of earnings report kind of baked in, or do you really need to kind of parse that out and separate that out because that’s a more separate detailed exercise?

Teresa Snyder: [00:14:32] That’s a great question. And there is absolutely added value to a quality of earnings study on top of an audit. So, an audit or even a review, which is a lower level of service, either one of those are a great tool to enter into a transaction or enter into discussions. Adding the quality of earnings study, it has a lot more key details of what’s occurring in the business. Those details are not going to be contained in the audit, and you won’t go through that process of normalizing the EBITDA and looking through what those add-back items might be that might be unique to your business but not necessarily to the industry.

Michael Blake: [00:15:20] Now, as a buyer, I might be thinking to myself, “I’m retaining attorneys, and I’m paying the 400-500 bucks an hour or more. I’m working with investment bankers, and they’re doing their thing. They’re getting their fees, and all kinds of advisors.” Aren’t they already doing this? Isn’t this already part of their normal scope?

Teresa Snyder: [00:15:45] No, they’re not. Everyone works in their specialized areas. And so, the attorneys are focused on the legal due diligence issues. The investment bankers are looking at how to market your company, and how to negotiate your selling price, and how to represent you in that particular transaction. So, the CPA is the accounting advisor as a part of that team. And putting that team together can help you successfully navigate a transaction and, hopefully, navigate — or excuse me, but, hopefully, to achieve your maximum selling price.

Teresa Snyder: [00:16:23] So, it does cost a lot of money for all of these professional services. But, again, going back to the CPA, the other part of the team is looking to them for their expertise and applying gap, which is generally accepted accounting principles. That’s what’s used in the audits and the reviews. And once you start applying gap, you’re taking that company, and you are measuring the transactions of applying consistency, and comparability, and reliability to the numbers in their financial statements.

Michael Blake: [00:16:58] Okay. Now, as we know, not every business acquisition is a financially-driven transaction. We can see this in some of the price multiples that are paid. Maybe there’s a strategic customer, or maybe there’s a piece of technology, maybe they just want to hire some of the talent. The only way they can do that is through an acquisition. In that case, does a quality of earnings report still make sense?

Teresa Snyder: [00:17:23] It possibly could from a buyer perspective. It really depends. They may want to look at the historical transactions and use that as a measure of not only the sustainability but the future predictions of what they anticipate doing with that business.

Michael Blake: [00:17:43] Okay. So, what are the most common issues you see that come up in a quality of earnings report? What is, sort of, on your checklist?

Teresa Snyder: [00:17:53] Well, the top one is inconsistency in financial reporting. And this goes back to the gap financial statements. Not all companies are preparing GAP financial statements. They don’t necessarily have to in terms of their tax compliance. So, even though their work might be going through a CPA for tax preparation, it doesn’t necessarily mean their financial statements are in accordance with gap. And so, inconsistency is a big thing. The gap part of that process is comparability and consistency of the financial statements and the reporting.

Teresa Snyder: [00:18:31] You also have, again, the non-recurring items or the understated expenses. If you’re trying to defer expenses in accordance with gap, you’re going to accrue that. The businesses is incurring those expenses. They just haven’t paid for them yet. So, again, you also identify related party relationships, and transactions, and owner items. That’s all a part of that process.

Michael Blake: [00:18:57] So, when you say inconsistencies, what’s an example of something that you might find an inconsistency and that winds up being material potentially to the transaction?

Teresa Snyder: [00:19:07] There, generally, are — cutoff is a big issue for a lot of companies, especially smaller businesses. So, the proper timing and recording of sales transactions, and the allocation of expenses, or the matching of expenses to those revenues generated, those are generally your two top areas where you’ve got cutoff and maybe not consistency and reporting.

Michael Blake: [00:19:33] Now, have about revenue? How about the way in which revenue is recognized? I see that in an area that’s near and dear to my heart, which is technology. And what about revenue recognition? Can you, sometimes, see inconsistencies there and how revenue recognition is applied?

Teresa Snyder: [00:19:50] Absolutely. Revenue recognition is different among different industries. And technology is unique to some other industries or other businesses. So, yes, you can see differences in revenue recognition. And, of course, the standards are changing for that as we speak. They’re going into effect this year for private companies. And so, that may present a challenge to some private companies for transactions over the next two years is working through the revenue recognition issues.

Michael Blake: [00:20:25] So, on, sort of, the other side of this process, you go through a quality of earnings process. Have you seen it? Have you seen instances where it’s actually kind of changed the price in terms of a deal? The deal typically starts with the letter of intent, which we both know is varying degrees of not that binding. It’s really just a place holder. Have you seen it since where the QoE basically changed the parameters of the deal?

Teresa Snyder: [00:20:56] Yes, it can. It can start reducing that multiple of the EBITDA. So, a seller who enters into a transaction, and they have their financial reporting house in order, so to speak, and they are able to substantiate all of the information that they’ve reported, they’re generally able to hold on to that initial selling price and not face the adjustments.

Michael Blake: [00:21:25] Now, another concern that I wonder if clients have, particular if a transaction is ongoing, we all know good transactions take a long time to unfold. When there are millions of dollars involved, grownups are careful making decisions around millions of dollars. And so, a concern might be, “Oh boy, we’re already doing X, Y, and Z. We’re negotiating. We’re doing the due diligence. If we inject a quality of earnings report into this discussion, am I going to drag this thing out yet more months and might just never going to sell this business?” I mean, how do you frame that conversation, or is that even a legitimate concern?

Teresa Snyder: [00:22:08] The due diligence process is lengthy. And I think you described it accurately. And it can be a painful exercise for you’re still trying to run the business, but at the same time, you’ve got to address all of the due diligence items in this transaction. And they do take a lot of time. And you’re addressing, again, your legal diligence, your tax diligence. There’s so many issues. Your customers, your HR, the culture. There are many, many aspects of it.

Teresa Snyder: [00:22:39] So, it’s all running concurrently, and you’re hitting all of these fronts at the same time as you’re going through this process. The quality of earnings study could potentially add time to it. It may depend on the complexity of your revenue and expense streams. Again, if the house, if your financial reporting is in order, if your books are current, and they’re accurate, and you’re able to quickly respond to questions, then it’s going to speed up that process. But if you’re asked a question, for instance, to produce an accounts receivable report, and, now, you’ve got to take some time to put one together because you haven’t been maintaining it, those things just keep adding time from the seller’s perspective.

Michael Blake: [00:23:32] Okay. So, one of the things I think, also, a client has to think about, and certainly in the appraisal world, it’s t’s very important because gathering data is the lifeblood of what we do. And, sometimes, I wonder if the client wonders who’s working for whom sometimes.

Teresa Snyder: [00:23:52] That is true.

Michael Blake: [00:23:54] I’ll get 50 questions from me. And, all of a sudden, they find out they have to blow a whole morning, or an afternoon, or sometimes more getting us the data. Does a quality of earnings look like that? And if I’m a client, I’m signing up for this, I’m not just signing up for the money but also the time I got to invest, how much of the client’s time or typically at what level of the organization does that time need to be spent?

Teresa Snyder: [00:24:18] I guess, the answer to that depends on the kind of team that you have in place. So, if you have an accounting and a finance team in your organization, obviously, they’re going to be able to field most of the questions when it comes to quality of earnings study. The owner potentially may need to get involved in terms of explaining some things, but it depends on the quality, and the training, and the experience of the accounting team that that you have.

Michael Blake: [00:24:46] Okay. Now, do you find that the quality of earnings makes a difference in terms of the impression on the parties in the transaction, the advisors in the transaction? Maybe you’re a seller, and you’ve already got a QoE, you’re ready to go, or maybe your buyer, and you want to buy the business, but you still have to get the thing financed. Do other parties appreciate kind of having the quality of earnings report ready to go, done, kind of part of the package, or are they a little maybe a little bit more blasé about that, and they kind of think, “Well, we’ll get to it when we get to it”?

Teresa Snyder: [00:25:21] Like many answers in our business, I think, that depends. Some buyers may not rely on a quality of earnings report that you provide to them. They may want to have their own report commissioned. Sometimes, depending on the complexity and, obviously, the dollar value of the transaction, sometimes, they will want to see national firms conduct the quality of earnings study.

Teresa Snyder: [00:25:48] So, again, it depends. They might read it and decide if they question that report or the credibility of that report. And they may decide to accept it if they’re satisfied with what they see, and it’s consistent with the information that you’re providing. So, that’s hard to say. If you’ve gone through it on your own and in advance of entering into a sales transaction, and you have to go through it a second time, it’s certainly not going to be as painful because you have the information. You know what it is and what they’re looking for.

Michael Blake: [00:26:24] So, another question that kind of comes up, and I see this in my world, sometimes, a client is reluctant to have their business appraised because, then, it can be asked for in the due diligence of the locker to say, “Well, I’m not going to provide that to you.” But on the other hand, it feels like you’re in a poker game, but you have to show the other person your cards-

Teresa Snyder: [00:26:45] Right.

Michael Blake: [00:26:45] … before the bets are in, right. So, that’s a delicate thing that I have to work around on my practice. I’m curious, does that come up on your end to where maybe somebody doesn’t want to do the buyer’s work for them and at their expense and kind of risk exposing anything in advance? Again, is that a reasonable concern to have?

Teresa Snyder: [00:27:09] I guess it could be. I think it depends on how much they know and understand their business, I guess, and, perhaps, what they think the buyer is looking for or might find. Generally, if they’re trying to hide something somewhere it’s going to come out at some level. So, that’s generally not advisable. The buyer, if a buyer commissions a report, which is what we’ve seen historically, they don’t necessarily have to share that information. Now, they may choose to, but they don’t have to share that information with the seller.

Teresa Snyder: [00:27:48] And, again, I think from the seller’s perspective, it’s their option if they want to share that with the buyer. They may want to share it in the hopes that they don’t have to go through the process again or, you know what I mean, it can be very positive information that comes out of that quality of earnings report. And so, it could be to their advantage to share it.

Michael Blake: [00:28:08] There’s certainly something to be said for getting out in front of the entire discussion.

Teresa Snyder: [00:28:14] I think so on many levels. And I think the seller, if they commissioned a quality of earnings study, no matter at what point they are in the process that they would want to share that with their investment bankers because their investment bankers are the ones that are cued up and ready to represent them and help them present their business in its best light and, also, provide advice to them throughout the process.

Michael Blake: [00:28:39] So, running out of time. We got one last question. and I’ll have to wrap it up. And I know, for you, it’s also busy season, so we do want to keep you away from it too long. The deliverable of the quality of earnings report, how is that typically used? Does it kind of automatically get sent out as part of the sales package, as a part of maybe the offering memorandum, or is it kept in the data room for part for the due diligence exercise? How have you most typically seen that used?

Teresa Snyder: [00:29:10] I think that would depend on the investment banker and probably the results of that quality of earnings study and how they might present that. They may decide to take the time, and make some corrections, make some improvements in the business operations, and then update a quality of earnings. I haven’t personally participated in that, but I could conceive of that happening.

Michael Blake: [00:29:37] Okay. So, if someone wants to contact you because we’re running out of time, but somebody who may have other questions, if somebody would like to contact you and learn more about this quality of earnings process whether the buy side or the sell side, how can they reach you?

Teresa Snyder: [00:29:51] Sure. You can find me on our website. That’s bradyware.com. My email is tsnyder@bradyware.com. And, also, my direct line is 678-350-9510.

Michael Blake: [00:30:11] All right. Well, thank you so much. That’s going to wrap it up for today’s program. I’d like to thank Teresa Snyder so much for joining us and sharing her expertise with us. We’ll be exploring a new topic each week. So, please tune is that when you’re faced with your next business decision, you have clear vision when making it. If you enjoy this podcast, please consider leaving a review with your favorite podcast aggregator. It helps people find us that we can help them. Once again, this is Mike Blake. Our sponsor’s Brady Ware & Company. And this has been the Decision Vision Podcast.