Acquisitions Anonymous - #1 for business buying, selling and operating - Analyzing Software Businesses for Sale with Steve Divitkos, experienced industry CEO - e66

Episode Date: February 8, 2022

We're joined this week by Steve Divitkos, Search Fund Investor & former CEO of Microdea.Steve has a background in private equity investing and after attending Business School he funded a Search Fund in 2012. He is originally from Canada.We examine two Saas businesses currently for sale.Thanks to our sponsors!Trout CPA is a full-service accounting firm offering M&A specific services of valuations, quality of earnings studies, and due diligence review services.The BEYOND8figures podcast (Beyond8Figures.com) - is a podcast where entrepreneurs and experts speak up on topics related to business and life in general. Each week our guest will have interviewees from different backgrounds to discuss what helped them get ahead while succeeding at entrepreneurship; we'll learn how these people achieved success by exploring personal journeys along the way (both professionally AND emotionally). So if that's interesting to you, make sure you check us out ;).-----* Do you love Acquanon and want to see our smiling faces? Subscribe to our Youtube channel.* Do you enjoy our content? Rate our show!* Follow us on twitter @acquanon Learnings about small business acquisitions and operations.-----Past guests on Acquanon include Nick Huber, Brent Beshore, Aaron Rubin, Mike Botkin, Ari Ozick, Mitchell Baldridge, Xavier Helgelsen, Mike Loftus, Steve Divitkos, Dzmitry Miranovich, Morgan Tate and more.-----Additional episodes you might enjoy:#62 Two Landscaping Businesses for Sale - Mike Loftus CEO of Connor's Landscaping#42 $900k Moving and Storage Company / $500k Rural Mini-Storage#61 Two Manufacturing Businesses for Sale - Brent Beshore - Founder and CEO at Permanent Equity#24 $5mm pool services and lifeguard staffing co / $2mm septic services business -  featuring baller @WilsonCompanies as a special guest!#45 $800k/yr cleaning business in Midland, TX / a $565k/yr window cleaning business in San Antonio, TX #48 Two Landscaping Businesses for Sale - Mike Botkin of Benchmark Group--- Support this podcast: Subscribe to weekly our Newsletter and get curated deals in your inboxAdvertise with us by clicking here Do you love Acquanon and want to see our smiling faces? Subscribe to our Youtube channel. Do you enjoy our content? Rate our show! Follow us on Twitter @acquanon Learnings about small business acquisitions and operations. For inquiries or suggestions, email us at [e-mail]

All right, welcome to another episode of Acquisitions Anonymous. We are back for our 66th episode by my count. So excited to keep doing these. This is the Internet's number one podcast about small business M&A and operations. Our format is me, Bill, and Mills. I'm Michael Gridley, get together every week or so, sometimes twice a week now that we've increased our cadence of production. And usually with a guest, we talk about two small businesses.

for sale and the discussions that come from that provide us and hopefully all the listeners, a lot of learning about both spaces and then business in general. So today we have very special guests that we're excited to welcome. Steve DeVitko is joining us. And Steve, I think you're our first Canadian guests. So we're so excited to have you. To get started, we'd love to give you a chance just to introduce yourself. Give us kind of a one-minute thumbnail sketch of who you are and how you got here. Yeah, thanks for having me, guys. So I'm the founder of a firm called Miniola as search partners. We invest in search funds, the entrepreneurs that run them and the businesses that they acquire. My background, many moons ago, started in private equity investing. And after attending

business school, I raised a search fund in 2012. Search for a business to buy in Canada, where I'm originally from Search for about a year and a half, acquired a software company from a father and son combination that I'd been running the business for 20 years prior to my arrival. So I bought that company in the first week of 2014, ran it as CEO for about seven years and then just sold the company in September 2020 to a private equity-backed strategic. After taking a full year off, which was perhaps the best part of the entire experience, I decided to raise a fund to help entrepreneurs and CEOs running small businesses because I know how hard it can be and how lonely it can be and how challenging and important

that journey is. And I feel like I'm able, both willing and able to help entrepreneurs and CEOs now that I'm on the other side of the table. So that is what brought me here today. That's awesome. So in terms of the focus of your fund, kind of what is your thesis, check size, and then where are you trying to get into backing entrepreneurs that are doing search? Yeah. So like I mentioned, we invest across the entire search fund spectrum. So that includes traditional funded search, which is what I did 10 years ago, self-funded search as well as equity gap situations.

we're investing out of our first fund, very flexible in terms of check size, could be as small as a couple hundred thousand bucks, could be as big as a couple million bucks, investing across both Canada and the United States, and generally looking for businesses that are between five to thirty million dollars in revenue and or one to five million dollars of EBITDA. Typically in owner's succession situations where you typically but not always have an owner who is later in his or her career looking to transition out of the business, and only nine percent of such businesses have formalized succession places and plans. So often search funds can be positioned as a succession plan that is just looking for the right

business to succeed in supporting those entrepreneurs, both in the search, in the acquisition, and ultimately in the operation of the business is where I feel really lucky to be able to be spending my professional time these days. That's awesome. Cool. Well, we're glad to have you here. We have two tech slash software deals today, which I think is right near Wheelhouse and also where I have some experience, so I'm interested to learn from you and try to do better there.

But before we dig into those, we have our first sponsor read of the day and our never-ending quest to break even on this podcast. So over to Mills to talk about our first sponsor. Yeah, our sponsor today is Trout CPA, and Trout CPA is a full-service accounting firm. There's one of their principals, Dan Choden, at Dan Chodin on Twitter. We've done some work with Dan. That's how I got to know him and how we got connected on them sponsoring the podcast. But Dan specifically helped us help Aquasil with the employee retention tax credit. But there's a whole treasure trove worth of information in Dan's tweets about ERTC, who is applicable, what scenarios are applicable, and he helped us navigate the kind of complicated

and convoluted web of the employee retention tax credit. There's a lot of people out there who are offering to help, help A. business get the credit in exchange for a percentage of the tax credits that you get because they're refundable credits. They get paid out as cash. And there's some kind of, I would say gray things happening, some kind of snake-oily things happening. And that's not the way Dan operates. And we were really thankful to have his advice and his guidance. So if you, basically what Dan has said is if you own a business, you should look at this and you could, you should consider it. And there's some kind of money to be had. So thanks, Dan, and thanks Trout CPA for sponsoring the podcast. Awesome. Awesome. Thanks. Bill,

you have our first deal, which is off Microacquire. Yeah, this might be our first or one of the first micro-acquire deals that we've done on the show. So I'm excited for this one because there's a lot of activity and hype around MicroRquire these days. So cool place to find SaaS deals. Let's have a cool place to find e-commerce deals, but that's a that's a sidetrack. But this is a SaaS one. And I actually I think it's pretty cool. So it's up on the screen if you're watching on YouTube, but I will read it if you're an audio-only person. This is a profitable SaaS business with $2.5 million of TTM revenue

that enables users to create, manage, and broadcast rich, engaging digital content. Our vision is to be the gold-standard broadcast platform enabling SMBs to broadcast their message in their own businesses, creating an open exchange and local business networks around the world. Now, obviously, that sounds like a whole bunch of gobbly gook. We did a little bit of Googling. And to give you a sense for what this business does, they list a competitor called ScreenCloud.

This is not ScreenCloud. This is a competitor of Screen Clouds. Screen Cloud is software that lets you put up signs in your business, like digital menu boards or, you know, special of the day, you know, basically mount a TV on the wall. this is software that lets you control that television and to schedule how often the slides change and pull in the local weather and all that stuff. So that's what this software does.

I assume it runs on a computer that's attached to the TV, maybe a little Raspberry Pi or a dedicated Mac Mini or something. They've got $2.5 million in revenue, which throws off $100,000 of TTM profit, which seems way low for software business of this scale. $250,000 in revenue last month, which is weird because that would indicate about a $3 million run rate in revenue, and $15,000 of profit last month. They are asking $30 million for this. So that is $15, 12 to 15 times revenue. And 300 times earnings.

300 times earnings, yes. Very reasonable SaaS valuations these days. They say it's been around since 2011. They have 18 team members, which is probably why they're not as profitable as you would expect. And they have between 1,000 and 10,000 customers. So, interesting, I think. They've been around. Clearly, this is a sticky product. What do you guys think about this?

Valuation aside. Well, it seems like quite the bargain. That public price of 30 million makes me happy that there's this one-click link where I can finance the purchase with Pipe. top of the micro-acquare links. So, yeah, I mean, I've seen, when you describe this business, like, I've seen this business a lot. It's one that there's seemingly, especially regionally around the world, like I looked at a business in Columbia that did exactly this. They had kind of the same exact everything, by the way, like the same exact revenue, same exact profits. In that case, the founder was a little bit aggressive, a little different. But, but yeah, I mean, it seems like this

the business that especially does well regionally, but hasn't broken into one that's kind of a more global type thing. So, Steve, what do you think? Yeah, I mean, the nature of these teasers is such that you only have so much information to go off of. So while we have the teaser on the screen, if you guys could maybe scroll up to the very top, we'll start at the very top and work our way down. So I think, you know, the way that I look at a company like this is let's start with value, right? So from a valuation perspective, they're asking for 12 times LTM or last 12 months revenue or 10 times their run rate revenue. And the difference between those two is as a company grows, their run rate revenue,

i.e. the revenue that they're earning this month multiplied by 12 can be larger than what they have earned over the past 12 months. But to put 12 times valuation into context, I'd compare that against both public SaaS companies as well as private M&A transaction comparable. So it's actually reasonably in line with public SaaS comps. The average public SaaS company is trading at about 15 times revenue, but it's important to highlight that the average public SaaS company has $600 million of revenue, not $3 million.

So though the headline number may suggest that it's in line with public comps, I would suggest that it's actually reasonably inflated, given that this is a very, very small revenue business, as well as the fact that public SaaS M&A is hugely inflated, in my opinion, over the past couple of years, as we've seen a huge run-up in valuations. Compared to M&A comparables, the average M&A deal done in SaaS and North America in 2021 was done about seven times revenue. So this would suggest that it's kind of more valuable than average, and I would suggest

that based on the information that I have in front of me, I'm not sure if that's a warranted ask. So the first thing that I would do is look at the valuation request, try to situate it in some sort of context. In terms of their revenue, they're saying that they have $3 million of recurring revenue. On an LTM or last 12 months basis, they've produced $2.5 million. So I assume that they're talking about run rate revenue here. And again, run rate is defined as essentially what have you done this month and multiply it by 12. So, you know, what I'd want to know from a business like this, that of course I don't know from a teaser like this is, is this 100% ARR or not? And is this revenue from truly recurring sources?

I think in some instances, when you look at software companies, they try to position revenue as recurring. But when you get deep down into it, it's actually reoccurring revenue. And there's a very important difference between recurring and reoccurring revenue. The former typically justifies a much higher valuation than the latter does. So I'd want to understand the sources of that revenue to make sure it is truly recurring revenue. The other thing that I'd like to know, especially for a company that's asking for 12 times, that would suggest that this is a very, very high-quality business. And so I would want to look for the consistency of year-over-year growth. Have they been able to grow revenue through economic cycles? I mean, the last down cycle was in

2008-2009, which the company didn't even exist back then. So I'd maybe want to look at 2020, see how they fared there to see if that this is actually cyclically defensive revenue. in terms of the number of customers, they list between 1,000 to 10,000, so that's a pretty darn big range. However, it seems to be good on the surface in terms of the quantum or the size of the customer base.

A couple of things that I'd want to look at in my first tier of diligence would be concentration. Do they have any sort of concentration, asymmetric concentration, with either one customer or a small number of customers? If they have 1,000 customers,

the answer to that is probably know, but I'd want to check that out anyways. I'd want to check out their NPS or net promoter score. A net promoter score is a very simple, singular data point that essentially tells external viewers how happy customers are with a given product and with a given company. It's kind of become an industry standard measure, particularly in software. So I'd want to know if they have any data on their customer NPS or net promoter score. As it relates to a small business like this, they have 18 employees. So what I'd want to make sure is that the customer relationships

and the ability to generate new sales are not proprietary to the selling shareholder and or a small number of employees in this business. What you often see in really, really small companies is that customer relationships are kind of proprietary to a business owner who's been running his or her business for, let's say, 20 years, and or it's the business owner who is selling,

who is responsible for a large majority of new customer, acquisitions. If that's the case, then there's huge keyman risk. And so you want to make sure that new sales and existing customer relationships are not proprietary to a seller and or a small number of team members. And then lastly, this is kind of a software metric that most folks, at least in my ecosystem, would be familiar with, but look at the unit economics. And unit economics is just a way of looking at when they sell one unit of software, is that profitable or is it not? And the most convenient and common way to measure that is something called LTV to KAC, otherwise known as the customer's lifetime value expressed as a multiple of the customer's acquisition costs.

So a way to say that in English is, if I acquire a customer, how much money do I spend on acquiring that customer? And over the course that customer's lifetime, am I making money off that customer or not? At the very least, you want that to be a positive number because that suggests that the customer provides you with more money than they cost you to acquire them. A reasonable rule of thumb. is three times. You want to earn three times more money over the course of any given customer's life than it costs you to acquire that customer. So we don't know the unit economics in this business, but that's certainly like one of the first questions that you'd ask in terms of due diligence. The one thing that I would caution for all the folks listening is for companies of this size,

it's not at all uncommon to have really messy financial statements. And in many cases, selling shareholders don't know what the customer lifetime value is. And they also don't know how much it costs to acquire those customers. There are ways that you can figure that out, but when acquiring SMBs, it's rarely as easy as the formula kind of might suggest. Steve, I have a question on kind of LTV,

both LTV and KAC, but particularly KAC. There are lots of software businesses out there, especially in the smaller end, that don't necessarily advertise, right? It's easy to say, oh, well, you spend $1,000 on advertising, you know, last month and you acquired 100 customers, that's a $10 KAC. But there's plenty of businesses that just acquire customers naturally or via referral

or maybe they have a referral program where they're paying out 10% of sales, or maybe they've got an in-house sales team that's picking up the phone and dialing for dollars. You know, what goes into KAC? Like, I mean, you could say, you know, the cost of, you know, me buying all those salespeople laptops goes into KAC. You know, like, this is a very flexible definition. do you think about what goes into CAQ?

Yeah, the thing I always cautioned people on LTV to CAG, it's become such a ubiquitous metric in software, but it's by no means a perfect metric, and there's a lot of gray area that can work its way into this. So, for example, a lot of customers don't know what the lifetime value of, or, pardon me, a lot of businesses don't know what the lifetime value of their customers are, because, you know, company like this, June 2011, maybe they haven't been around long enough to know how long the average customer sticks around. Because the way that you can find out a customer's lifetime value, or at least the number of years that the average customer stays with you is one divided by your

gross logo attrition rate. So it's entirely possible that a company like this doesn't even know what their customer lifetime is. To your point, on the denominator of that fraction, it's also entirely possible that they don't know how much it costs to acquire a customer. So typically you'd look at like a marginal expense. So in the example that you gave, If you give a 10% referral to a partner, whatever the dollar amount of that 10% is, you can argue that that is a cost that is required to acquire any given customer. So I would put something like that into CAQ. Generally speaking, at a high level, you put your sales and marketing expenses that are

specific to acquiring customers in that denominator. But again, like so many metrics, there's a lot of massaging that can go into them. So, you know, let's say that a listing on Microrequire said, hey, this business has an LTV to KACA of 5. Yes, the headline number looks attractive, but it's really important for purchasers of business to look into specifically how that's been calculated because there are many, many ways that this number can be massaged. That's a good question, Bill. So I have a question. So, and it's maybe seller psychology, right? Like, so clearly you can kind of do the back of the napkin math here, right?

So they did a $3 million run rate at the end of December. And trailing 12 months was $2.5 million. So this business is growing healthily, but not super healthily, like many SaaS businesses are. So 20% per year plus or minus. And so without that high level of growth and in a very crowded market, this asking price is, I think we can all agree, is crazy town. Like, it's just, it's insane. So, like, as you as a buyer, whether it's in tech or not, you see a seller who puts out

something as a crazy number like this. How do you approach that, right? Do you say, okay, well, like, I'm just not even going to bother? Or do you make sure you talk about price with them at the very beginning and say, hey, when you get your mind right, call me? Do you try to change their mind? Do you just move on to the next one and look for a deal? Like, how do you think about that in the context of you as a buyer trying to look for a deal

that you can make work above your kind of return hurdle? Yeah, I think you hit the nail on the head when you said, get value expectations on the table early. So when I was searching for a business to buy, that was my full-time job for almost two years. What I came to learn and appreciate was that time was not only my most finite asset, but it was also my most valuable asset. And as a result, it was important for me to be what I often referred to as ruthlessly efficient with my time, because that's all that I had. what I found to be the biggest time suck, so to speak, was really two things. A, do I have a real seller or not? It's common that business owners want their ego-stroked or they want a free valuation, and they were kind of never going to sell to you in the first place. Big time suck number two is valuation expectations are all over the place.

And as a way to combat, you know, large time suck number two being valuation expectations, in the first conversation, I would try my best to get value expectations on the table. Because if I thought a given business was roughly worth, let's say, like six times cash flow, but their owner thought it was worth six times revenue, the delta between those two valuation expectations is just so large that you know with certainty it's never going to be bridged. So because time is your most finite asset, you move on that conversation. You don't even bother with a second one.

but if I think that a business is worth six times cash flow and their owner thinks it's worth eight times cash flow, well, that's at least worth another conversation. So I always try to get value expectations on the deck early because the question that I wanted to answer with every conversation is, is this worth my time on the next conversation? The answer is yes, you have it. Then you try to answer that question again. The answer is no, you move on. Don't you think, too, that this type of, this type of headlines,

price is probably just like a fishing exercise, right? Like, they're hoping that somebody comes along some strategic and is like, oh, that's nothing. We really want, you know, the software or the intellectual property or the customer base that you have. I mean, to me, there's just nothing even remotely realistic about this. And so that tells me that they're just kind of, like, it didn't cost them anything, right, to list their business on the site. They don't really have any sunk cost. So, you know, kind of no harm, no foul. Look, it could be. The other thing that it could be is a combination of an unsophisticated seller, financially

unsophisticated and or an unsophisticated advisor. So what I found in buying and selling businesses in the SMB ecosystem is there's a very common misconception that having an unsophisticated buyer and or an unsophisticated seller is an unambiguously good thing. That's actually wrong. having unsophisticated advisors is a hugely, it's very much not a positive thing. So unsophisticated business brokers or investment banks might list a company that's actually worth two times revenue for 10 times revenue.

That makes the deal very, very hard to get done. Unsophisticated legal counsel takes a purchase and sale agreement that should take a month to negotiate, but it actually takes eight months to negotiate because they're not familiar with with what market terms should be. So it could be a fishing exercise mills, but this could also be evidence of an unsophisticated advisor. And anytime that you see an unsophisticated advisor, I would suggest that that's more of a challenge

than it is an opportunity. Completely agree. Good, good point. Yeah, that is like the single biggest deal killer I run across in S&B is misaligned value expectations between buyer and seller. Yeah, and I found also in my career that It's also interesting to ask how owners arrived at their value expectations. Guys like us situate values in the context of revenue or cash flow or EBITDA, and that all makes good intellectual sense for us.

But when I was looking for businesses to buy, I would often ask the owner, hey, how'd you arrive at your number? And they would say to me, kind of stoneface, well, that's just what I need to retire. And guys like us might kind of chuckle at that. But for a selling business owner, from their perspective, that's a person. perfectly reasonable justification for valuation. Now, for buyers, that could represent a great opportunity because if a software business wants to sell for 10 million bucks, but they're generating $10 million of ARR, hey, that's a great buying opportunity. But if this particular business owner

wants $30 million to retire and she's only generating $3 million of ARR and her business doesn't warrant a 10 times revenue valuation, then it's a pretty quick deal. killer. So the reasons for any given business owner's request for value isn't always as logical as buyers like us would assume that it is. We call this on the podcast, business is worth my mortgage balance. That's exactly. That's exactly right. Yeah, that's extremely common. So for this business though, sorry, Michael, you go ahead. Oh, I think you were about to ask the, is there any way, how do we make this work or could we make it work? Maybe question. Yeah, well, I was going to say, yeah, Like, does this suck?

I mean, not necessarily. It's mispriced, okay. But does, like, the price aside, is this an okay business? So, I mean, I think the qualitative dynamics of this business, like the market dynamics, like, they're not good. And you can see it, like, this business is nine years old and it's $2.5 million and it's barely profitable. That's telling me something about this market, which is that, you know, unlike most

software markets, there's no winner-take-all dynamics here. There's actually dis-economies of scale, like, as the business, gets bigger. Like, I think also, you know, we click through on the listing. The founder is Israeli. So, like, I think you're, most of these businesses are probably, like, not in the places that is North America. And that shows in, like, like, I Googled this space, right? Like, okay, show me small business digital signage software. Like, these guys don't even show up on, like, the rating sites, because that's how many people there are dealing with this kind of stuff. And then the other, like, look at this. It just keeps going.

And then here's the other one that scares the crap out of me. Look how much people are spending to try to get the top of Google here. Like, I was like, oh, like, these are not the kind of customers I want to be necessarily going after because you're being held hostage by Google in terms of trying to get customers. Price points on these things are closer to like $8 a screen too. Like some of their competitors are priced at $10 per TV monitor. So, I mean, that's low AARR value. customers. I think if you buy a business, like, if you buy this business, the seller is going to sell

you a growth story. They have it in their deck that we click through on. But really, I would buy this as a multiple of EBITDA and just say, okay, that's what I can do. So the problem with that is a multiple of EBITDA on this business, especially when you're servicing and selling to small businesses across the world is going to be 0.5 to 0.7 times revenue, right? If you're looking for, say a 5x EBITA multiple. Like it just doesn't, it just doesn't work unless you think you can grow this and qualitatively like this has all the harm marks of incredibly difficult to grow. And for me, like, like, I'm going to be at like 3% of the guys asking price to make this deal attractive. Which is why you, which is why you probably kill this before you even do any

of that analysis because it's likely a waste of time. The other thing I would say just about the nature of the product that they're selling is that I, of course, me and every other investor in the world like to look for businesses that sell a mission-critical product that is either very time-consuming, very disruptive, or very expensive to get rid of. Often these are mission-critical pieces of software that operate in kind of the back end of the plumbing, so to speak, of the business. This is not a mission-critical buy. This strikes me as a discretionary expense. This is likely more cyclically exposed than the type of investment that I typically like to look at. doesn't strike me as mission critical.

I don't know what the customer attrition rate is, but my guess is a business like this when their customers are suffering financially, that probably manifests in a higher-than-normal attrition rate. And especially for a first-time operator, it's a lot easier and a lot less expensive to simply keep a customer than it is to acquire a new one. So particularly if you're a first-time operator,

I would suggest that you want to look for a business that has much, much stickier products and much stricier revenue streams in this one likely does. awesome all right cool let's move on to deal number two but before we do we have a new sponsor today that is starting with the podcast so i get to read this one it's actually another podcast it's called the beyond eight figures podcast and they're my favorite type of advertiser because they gave me ad read that makes fun of me to put into the pie i don't know why people do this but maybe it is what it is

But the folks behind this are big fans of the pod, and they bring out some pretty cool guests. So I have, if you're on YouTube, I have some of their guests. And there's a few of the people that we know, here's Mike Boyd, we know him, he's in front of the pod. So A.J. Lawrence and those folks that do this podcast, successful entrepreneurs, and have a good-looking website. We need a good-looking website like this someday when we grow up. But bring on these folks. And they talk about stuff that I think is really impactful in terms of operating your business. So, like, talk about personal growth or using delegation as a tool.

Like, these are some of the cool operational things that are really important if you're somebody that's running a business. So thanks to these guys, the Beyond Eight Figures podcast. You can find it at Beyond Eight Figures.com. It's done by A.J. Lawrence. And, you know, thanks again for helping us on our never-ending quest to break even here on the acquisitions on this podcast. So who's got the second deal? Is that Bill, or Mills, you have that one? Yep, so this is, Michael's going to pull it up.

This is a company that's listed on bizbysell.com. It's a nationwide full-service software company, 100% ARR with 110 plus employees. It's based in Florida. They are asking $16 million for the business. The cash flow is $1,414,000. On gross revenues of $3.9 million, 3,965,000.

The business has been around since 2001. A quick description here, 2021 adjusted EBITDA, they're saying, is 2 million. So there's some delineation there between their cash flow and adjusted EBITDA of about $600,000. This near-shore company is a highly profitable, full-service software company that operates all over the globe, but has a majority of the concentration within the U.S. 80%. The company specializes in software development with a team of highly specialized software professionals who offer high quality products and services based on their business knowledge and use of the latest tools in information technology. The company has 110 plus employees with managers in place.

They provide software services all over the U.S. in Canada, Latin America, Europe, and New Zealand. The company's success is evidenced by its nearly 15% year-over-year growth in 2020 and a software. sustained upward trajectory since 2017. Maybe they had a negative trajectory before then. The company surpassed the test of COVID-19 pandemic with its operations indicating positive growth in 2020. The company's opportunity has no ceiling in 35% profit margins in 2020. Ideal service business is easily scalable with expansion into other markets and regions. To complete this offering, a new owner will benefit from intuitive leadership by current management and owners in inheriting a motivated and skilled staff who are ready to stay.

Founded in the early 2000s and ISO-9,001, 2018 certified with extremely high customer on HR satisfaction. The company leverages its 20 plus years of experience to develop software solutions for its clients. I'm hoping to get to some good details here. Web and mobile application development, data integration and migration, IOT, and artificial intelligence, among four other service offerings. the company has really good engineers working with high knowledge and cutting-edge technologies.

The employees offer professional behavior, timely execution, quality service, high-performance, responsibility, and abundance of knowledge. All right, I'm going to skip ahead. The facilities are leased. The owner's willing to stay on for an agreed period of time. The owner of this company is ready to retire. That's what we've got. What do we think of this nationwide full-service software company?

Well, holy cow, we had a service. software company that was trading for 300 times profit before. And now this one seems like a huge bargain. Like, it's only 10 times. Like, Steve, what, what is wrong with this deal? Yeah, it's always interesting. I find that folks who aren't terribly experienced in acquiring small businesses tend to get blinded by the prospect of a good price. I would suggest that this still isn't a good price, but I guess relative to the one that we saw before, it sounds like a better one. So this one's ask is four times revenue, eight times EBITDA, 11 times cash flow. So it's a lot cheaper than the business we just looked at.

It's actually a lot cheaper than both public and private comparables. But of course, the question is why. And it looks like based on what I'm seeing, based on the information that I have, there's kind of two primary reasons. The first is that, look, this business does have 35% cash flow margins. Again, on the surface, wow, that seems great. But I think the question is, why? Why does it have 35% cash flow margins?

I think when you look at a business like this that was founded in 2001, assuming that this business is still being run by its original owner and they're generating 35% cash flow margins, one of the first things that I would look at in this business is to look at whether or not it's being run as a, quote, lifestyle business, which is the owner is extracting the maximum amount of economics for themselves personally by purposely underinvesting in the business. I'm not saying that that's what's happening here,

but 35% cash flow margins and a business that was found in 2001 suggests that that is at least a possibility. So that's the first thing that I would look at. The second thing that I would look at in that same spirit is, as a new acquirer, does the current margins of 35% represent the actual steady state margins of this business under new ownership? Because if this is indeed being run as a lifestyle business and they're just trying to maximize the profitability, either for the personal economics of the owner or to kind of prepare it for sale, if they have done that by kind of underinvesting in the business,

then the true steady state operating margin of this business could be much, much lower than that. And the only reason why it's high is because it's kind of been artificially inflated. So that would be another thing that I would really look at and just I need to ensure that I'm comfortable with this 35% actually represent the steady state economics of this business, particularly under a new ownership with new goals.

And then I think the second thing, thing, kind of the big reason why this is priced in a much more palatable way relative to the first one is because this isn't actually a software company. The first one that we looked at is a company that sells unique instances of intellectual property and as a result can scale their revenue in a non-linear fashion, meaning that to get an extra dollar of revenue, they don't need to always incur an extra 50 cents of costs. And in fact, that's one of the reasons why the software business model is so beautiful and is why they're trading at 15 times revenue. In this instance, this appears to be a custom development shop.

So let's say I am a widget producer and I want an app for my customers. I would contract with a third-party development firm like this who has mostly just developers on staff, and they would charge me to build an app for me, typically on a time and materials basis. And the problem with that is you can't really scale your revenue non-linearly, which is to suggest that if I want an extra dollar of revenue, really what I'm doing is just renting out an extra hour of my employees' time and materials. And it is generally for that reason that outsource development firms like this are just, they just have a much less fundamentally attractive business model than that of a software company. So this is called full service

national software company. That strikes me as really utilizing poetic license. It doesn't seem like this is a software company at all. So I did do the math. They have 110 employees in gross revenue is 3.9 million. It can tell you what country they're outsourcing all these people to, actually. This whole business is selling Indian or Pakistani developers to American, North American companies. It was like basically, if you say, if you say, oh, I wasn't doing revenue. I was doing payroll per employee. So payroll per employee, if 100% of the difference between the revenue and the cash flow goes to employees, like no lease, no overhead, any of those things. It's like $20,000 per employee is what folks are making.

And that's the high end, right? Because there are other expenses. Exactly. And they're saying, hey, we have experienced managers. We have top tier talent, all those things. Some of that may be the case, but it feels like very, I like what you said. The autoetic license. This is a software company in the same way that, you know, my business is a dog supplements

company. Like, yeah, it makes software. But it does it, it sells you software in a way that you take it from them and then you run the software. This is not SaaS. That's right. Yeah. Well, I mean, there's tons of headwinds for this business. If they get $16 million, like, go for it. But like,

you're seeing like the increased because of COVID, more and more people pushing these jobs overseas and trying to hire directly these types of folks, right? Like, you talk to folks that have historically offshoreed or near-shored labor like this and seeing that they can

get it for 30 or 40 percent for equivalent talent versus the U.S. You can't do that anymore for developers. You're seeing companies going out, and if you're good, they're willing to pay. They'll pay U.S. rates because they're just so desperate for people. The other thing is eventually the U.S. government is going to start to look up and realize that it's subsidizing all of these offshoring of jobs, especially knowledge worker ones, because we're not getting taxed as business owners when we ship money overseas,

but we get taxed when we hire U.S. employees. So, like, there's going to be a bad, a reckoning for this kind of stuff. stuff. I don't know when it's going to happen, but you're starting to see it coming up. So those two things make me really scared about that. And then no offense to these people, but if you're paying $20,000 a year for a software developer these days, they are not good. Like, good software developers are making a ton more than that. So this is prototypical, like, how many bodies can I get for how cheap and the stuff coming out is Class A garbage. Like I can just tell you, look at everything into this. So other than that, I love

the deal. It's a great deal. Yeah. Yeah, it definitely feels like a boiler room to me. In fact, they actually call it a service business later in the deck. So they actually contradict themselves between the title and the end of the deck. So that's interesting to note. It was also interesting to note how they noted growth in 2020. Given that we're in 2022, that strikes me as a business that actually declined in 2021, but they just kind of hand-picked the year that they, they grew in. So there's always kind of little tricks like this that business brokers try to put in. They always try to

naturally paint these businesses in the most favorable light. But I see a lot of red flags in this one. Don't you think, too, guys, with this. Big red flag. There's two things. I'm sorry, you go ahead. You go after me. This is good. There's two red flags in businesses for sale listings.

Number one, brokers that have a photo with a hat on, never trust those guys. Number two, don't put your hand on your face. You can see it if you're looking on video, don't cover your mouth because people don't trust you when you do it. Those are the two things that always scare me. When I see a business listing, I just move on. No hats, no covering your mouth and your headshot.

All right. Sorry, Bill's, go ahead. I'm just thinking directionally about this business. Like, if we had looked at it and, you know, their profitability was realistic and they had a, you know, a reasonable head count, and like there was something here. To me, the need for this type of business, and I don't know software, so you guys can poke holes in this, but it seems like the need for this type of custom web and app development is just dramatically declining because of the proliferation of turnkey software, right? So I may have had to go

get somebody to custom build me a CRM platform or a web app for, I don't know, you know, delivering goods and services. But now there's so many off-the-shelf options that are, you know, $10 per month per seat, why would I go spend $20 or $50 or $100,000 getting a custom app built for like my local coffee shop, right? You could just use somebody else's service. Maybe there are still instances where this is required, but it seems like they're dramatically reducing each year. Well, I think you're talking about, you're talking about two things that are trends that are happening at once. It's like it's getting so much easier year after year to build apps, right? And is that a headwind for this? And so you're seeing things like Webflow

and Gatsby and all this stuff where people can drag and drop these things together or or systems where you can upload an Excel file and it creates a web app for you and suddenly you have it. So that's happening and that's definitely, that's definitely a drag. What I think is happening is happening even faster than that is those types of innovations are making sophomore even more useful and able to penetrate niches where it just wasn't even effective before, right? Like, it was impossible, for example, to probably make a vertical piece of software to target like, I don't know, fireworks companies, right? But now, like, you can penetrate there.

So, yes, I agree with you that there's a headwind in terms of it's getting easier and you need less developers and developers are getting more productive. The other side of the coin is, like, that is causing software to just explode in terms, continue to eat the world, right, as Mark Andreessen says. So, yeah, I feel the same way. I think it's actually, there's a bigger trend that's overriding the fact that it's getting easier and there's more software out there that's easier to access. Yeah, I mean, what do you think?

Yeah, the other thing is like, look, this is not a software company. is a professional services company. So I think that's kind of where we have to start and finish. To your point, Mills, this is an industry that has incredibly low entry barriers. You need one person in a computer to start an outsource development business. And with almost all businesses that have low entry barriers,

you see incredibly high competitive intensity. And what we're selling here appears to be like grade C or potentially grade D level software. The other thing that I would say, again, businesses like this, professional services companies, you don't have the ability to scale your revenue in a non-linear way, which is what most investors would want to see. The second thing that I would say here is that unlike an actual software company, your IP can walk out of the door tomorrow in this business. So these guys have 110 plus employees. It's only $36,000 of revenue

per employee, which is very low. Good software companies are probably around like 200,000 mark or so. but you don't really have any IP that you own. You basically just own the time and materials of your employees. And then I would also suggest with what's happened over the past two years with COVID, the increased proliferation of former engineers at Google and Facebook and Amazon and Microsoft, just kind of freelancing and doing this on a personal basis and not working for a company that has overhead that they have to bake into their pricing is another reason why a business like this,

particularly in this environment just does not strike me as an attractive one. Yeah. Well, I do think there's, I do think there's a flavor of this that I would find attractive, like, and I've seen some of them

where you actually figure out how to have a cornered resource of some sort. So, for example, let's say that you created a methodology or a set of infrastructure that only you have and you can provide software

more efficiently or better than other people. That's great. Or, like, you've picked a niche, like, say, like a very specific type of DevOps where you're like, okay, we're just going to be the expert, in this one thing. And if people want this, they have to call us because nobody else does it. But it's totally the opposite end of the spectrum of where this is, which is like, oh, you need a

body? We'll get you a body. Like, what a toe? I'll get you a toe. Like, this is the other end of the spectrum. And so not a good business. So one of those niches that I've run across, Michael, that's a good example of that is a software company that is really, really good at building unique software in each occurrence to basically be a translation tool from an old bank software. software to new bank software. So migrating accounts, migrating account balances, all those things. But it's like you build one for each application, hyper-specialized, hyper-focused. You have to know the, you know, giving and receiving language. But this is very one-size-fits-all. Yeah, take it. Okay. Well, great job. Consensus hate this deal. So we'll go from there.

I feel I'm very, very positive on the podcast today. It's usually that way. Well, I mean, I think one of the things that is realistic about this podcast is we don't like most of the deals, right? And that's just, that's the nature of hunting for a deal. And I think people can learn from that. Like, you have to kiss a lot of frogs to find the princess or prince. And like, that's just part of the nature. Like, yeah, we see stuff every once in a while we like, but it's pretty standard. You're going to spend a whole day looking at 30 things and they're all going to suck. But the good news is when you do that, you'll actually know what a good deal is when it comes along. That's bang on. And when I was searching for a business to buy, like I said, time is your most finite and valuable resource.

I would often say that every deal is guilty until proven innocent. That's the lens that I would look at deals from. Love it. I love it. I love it. Well, cool. Well, let me thank our sponsors today. So we had, again, Trout CPA, a place to go if you need to get ERC or any of the tax credits and the Beyond Eighth Figures podcast.

So thanks to Mr. Lawrence and those guys for supporting us and check. out their podcast for a lot of different stuff around entrepreneurship and that sort of thing. So on that note, Steve, how can our audience be supportive of you? How can we help you? What would be best? Yeah, look, I think the question that I'll turn on its head is, how can I be supportive to your audience? As I mentioned, I've been a searcher, a acquirer, a CEO, a seller, and now an investor in small and medium-sized businesses. I often say pretty unapologetically that nobody knows what it's like to be a CEO or entrepreneur unless you've been one. It is an incredibly important job from a macro perspective, and it's also an incredibly difficult job that most

folks just aren't aware of what it's really like. So as someone who's kind of been there and done that, I've now decided to dedicate my professional time to genuinely helping entrepreneurs and CEOs looking to buy and operate small and medium-sized businesses across North America. I know that I got a lot of help when I first started, and I would like to kind of pay that forward and help others in any way that I can. So for anybody raising a search fund, contemplating a search fund, searching, operating, if I can be helpful to you in any way, I love nerding out on this kind of stuff. So please don't hesitate to reach out to me. And I have my own blog and podcast called In The Trenches. It's at in the trenches. It's at

in the trenches.net. I blog about all the mistakes that I made as an entrepreneur and as a CEO. I talk about managing the company, buying and selling companies, and most importantly, managing yourself and managing your own psychology as a CEO and entrepreneur, which isn't talked about enough in the business literature that I'm aware of. So if I can be at all helpful, please find me and I'd love to chat. Cool. And I have your LinkedIn profile up. You're one of the only Steve DeVittcos in Canada, so kudos to you. And then you're on Twitter also at DeVitkost, right? Yeah. And as they would say, I'm pulling it up, as they would say in Twitter parlance, criminally underfollowed with only 59 followers.

So I follow you and check it out at Davidkos to catch up with Steve. Awesome. Great job today, guys. Love talking some software and we'll see you next week. Thanks, guys.