Acquisitions Anonymous - #1 for business buying, selling and operating - Two SBA Businesses for Sale - Heather Endresen of Live Oak Bank - e53

Episode Date: November 25, 2021

Want to receive this listings in your inbox? Signup for our weekly newsletter:https://landing-newsletter.acquanon.com/-----Guest is Heather Endresen, Director, Search Fund Lending at Live Oak Bank.This week, we discuss two deals for sale relevant to SBA lending (Small Business Administration loan programs).Enjoy!THANKS to our sponsors:SMBash.com - Join us in Orlando, FL for one-on-one interaction with others who focus on buying, operating, and investing in the SMB and Micro-PE space.Tiny Acquisitions - Where the BEST tiny projects are acquired.-----* 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#66 Analyzing Software Businesses for Sale with Steve Divitkos, experienced industry CEO#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: https://anchor.fm/dealtalk/supportSubscribe 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 Acquisitions Anonymous. The Internet's number one and also last place, because there's only one of us, podcast about small businesses for sale. Each week, me, Michael Gridley, Bill Delessandro, Mills, Snell, and often a guest, where we have a guest today, get together, and we talk through two small businesses that are currently for sale, and we learn a lot and have a good time doing it. And every once in a while, we actually like one of the companies for sale,

though often we don't. So today we're very excited. We have two sponsors. We also have an amazing guest in the form of Heather Andreessen, who is joining us from Southern California and is an SB lender with Live Oak Bank. So Heather, thanks for being here today. Thanks for having me. Cool.

Well, we'd love to take about a minute or so. Introduce yourself. Tell us about what you do and how you got to be on this wonderful podcast with three Dufuses today. Hi. I've been an SBA lender for over 30 years. I moved over to Live Oak Bank with my partner Lisa Forrest about four years ago to start up an M&A search fund lending vertical. So rather than being a general SBA lender, we're a vertical that focuses only on acquisition financing and specifically on search funds, although they don't have to be search funds.

So that is me. Super cool. Well, good. So we have two deals to talk about today. and I think we've picked some good ones because they're right in your wheelhouse and the stuff you do every day. And we're excited to dig into that and also understand more about SBA lending and how that's a tool for people to get a start in entrepreneurship and acquisition entrepreneurship as well.

So before we do that, I'm going to jump in and thank one of our sponsors. So the first one is our longest running sponsor. It's the guys over at tiny acquisitions.com. So I will pull up their website here and talk through them. But that is a site where people who are wanting to get into entrepreneurship or wanting to own a business can go. And for $5,000 or less and a few clicks, buy a small business. And it's great as a way to get into entrepreneurship. And thanks again, I think, I think, Bill, this is the 11th or 10th time that Tiny Acquisitions is sponsors an episode.

So I'm pretty excited and grateful for them. And, you know, if you're just wanting to get your feet wet in terms of entrepreneurship and not take a ton of risk. and starting with a small project, the stuff they have there, mostly online businesses, is definitely available. So give them a try, tiny acquisitions.com. Super cool. Okay, well, let's go on our first deal. Bill, you have that one. So this is cool. This one is, this would probably be sexy to a lot of people. So it is a 16-year-old SaaS business. It says launched in early 2005, this impressive SaaS business, has 16 years of success, and consistent growth of 9%

year-over-year, providing public safety organizations with workforce management software. The software is an essential cost-and-time-saving tool for the users. We focus on flexible and robust functionality, great retention, and consistent revenue growth year-over-year. An average customer lifetime of four-plus years, and they say the average is pulled down due to new customers consistently being brought in, recurring monthly revenue of about $49,000 across 244 customers with an average monthly ticket per cost. customer of $202.

They say they've got diversified customer acquisition across channels, email referral, organic pay traffic. There's huge opportunities for growth. And the team consists of a full-time lead programmer, a customer service analyst, and a sales team while the owner oversees each aspect of the business and supports the team. He's planning for retirement, and that's why he's selling, but he's open to a reasonable transition.

So it doesn't tell us much. Oh, yeah, here we go. We've got financials. So it's got $577,000 of revenue and $256,000 of income. And they want exactly $1,025 for it. So not $1 million, but $1,025, which they say here, pencils out to a multiple 3.9 times their income. So at a time in life or a time in the world where SaaS is very sexy,

this is a small SaaS business with sticky customers for sale. So what do we think about this one? Well, I like the monthly recurring revenue, and I like the multiple. Like how long it's been around. That's not common for a SaaS deal. You know, usually they're a lot newer. I want to know a lot more about the product itself, whether it's cloud-based. Sounds like customer churn is pretty low.

Yeah. I mean, you know, on the surface, there's a lot to like here. What do you guys think this software actually does? does. So workforce management, but for public safety organizations, not like workforce management for, you know, construction businesses, but for public safety organizations. I'm just wondering, is it time tracking? Is it, it's more than maybe just project management? I'm just kind of speculating. Yeah, I'm not clear on what it does and who actually the customer is. Public safety. Could that be police organizations, fire departments? That would be interesting because that's a

That's a very niche business. Those customers tend to be pretty sticky, but it's not clear. And you'd think, well, that would be the first question. Who are the customers exactly? So, Heather, how does something like this fit into the universe of what the SBA program does here in the U.S.? So the SBA program, it's from the Small Business Administration, right? It helps people who are buying businesses get loans or expand their existing small businesses. So, like, how does the universe of, like, lots of assets?

versus an asset light business like this, how does that affect the ability for somebody to use that program? So you have two different types of lenders in the SBA program. One is more asset based and they're focused on collateral. They like to do real estate loans or they'll do these M&A deals only if somebody has a home to pledge, you know, real estate collateral to pledge. And then you have cash flow lenders who don't really care about any of that and really want to see a good debt coverage multiple. So for a SaaS deal, you know, you really probably want a cash flow lender. Cash flow lender is going to appreciate the recurring revenue because that's going to be a very stable source to pay the loan back from. It's a little small for most lenders for an M&A deal.

Anything under a million dollars of enterprise value is often considered just too risky for most So it's kind of just right on the cusp of that. And for us, we would probably really want to know, does the buyer have expertise in this space? This is one of those industries where we'd rather see some experience. We don't always require it, but here we might. And we'd want to know what the growth plan is. What is the customer acquisition cost?

You know, what does that pipeline look like? And how could they sort of grow into a safer size company from here? It's a little small, barely big enough for us to consider as an M&A deal. And then how much would somebody borrow, like, as a percentage of the total value of the deal? And how does that work? Yeah. So typically, the typical structure is going to be 75% of the deal is an SBA loan. SBA will be a 10-year amortization, so that's a nice advantage.

About a 15% seller note. Cellar note should be at least five-year amortization just so it doesn't cut into the debt coverage. And then they should have a 10% equity injection. And the equity in a lot of the deals that we do actually comes from investors. So it doesn't all have to come from the person that's going to be the CEO of this business. At what point, Heather, does the SBA or you guys as an SBA lender want information on the investor pool? Is it based on percentage of ownership? Yeah.

I mean, as a search fund lender, we always want a little bit of information on the investor pool. So we sort of define them as either serial search or serial SMB investors. which is the preferred class of investor for us because they add so much experience to the dealmaking and to the operating years. And then, you know, or are they friends and family without that kind of experience in SMB? You know, definitely one is better than the other from a risk perspective for us. And then, of course, there's always the buyers who do have all the equity themselves. A lot of lenders will think that's the best risk profile. We disagree because it's, we've learned over time that the oversight of a board of directors,

especially if they have experience, who have some skin in the game, is actually better than someone just kind of making all their decisions themselves as a whole, as in general. What's the line and kind of threshold for personal guarantees? Is it congruent? I'm just thinking, right, I've been in some deals where if you end more than 20%

of the real estate deal, right, or an operating business, then the lender wants full financials, full tax returns, you know, personal financial statement, personal guarantee. Is that similar with how you guys think about it? That's the SBA rule. So that one is hard and fast across every lender. It's said, and it's not even just 20% direct ownership. It's 20% economic benefit. So you can't get around it through the operating agreement and, you know, other means. But yeah, so if you're going to use investors who don't wish to give a personal guarantee, you're going to have to keep them below that 20% threshold. Heather, Heather, you mentioned that the $1 million. Well, a lot of SBA lenders have kind of this $1 million threshold. Is that just customary? Or how did that end up coming about in terms of not wanting to do smaller stuff?

Or is it just, it's harder to get paid on smaller loans? It's just harder to get paid. And this is a subjective issue. So this is a bank-to-bank sort of credit decision rather than an SBA rule. The SBA allows us to do very small loans if we wish. But when you do an acquisition loan, you're doing a leverage buyout of a small company. So right there, there's a lot of risk that you just kind of, that's a big red flag. We're levering up a small company without assets to fall back on.

So we want to be a really strong deal that we almost never have to worry about a default. So the smaller the company, the more that one little thing can happen and cause them not to even be able to pay the loan back. The bigger the company, the more diverse, the less that that hiccup might actually result in a defaulted loan. Yeah. I'm involved in, you know, a serial acquirer of small software companies, and we actually don't buy stuff this small because we found it was harder to run stuff this tiny than it was to run slightly bigger businesses. There's like an inflection point like at 2 million where it's just below that it's so much harder than something this tiny. So we just, unfortunately, there's so many of these little tiny ones, but yeah, it's just hard to run. So Bill, you're about to say something. Yeah, I had a question about kind of the capital stack and acquisition. Heather, you kind of outlined it as 75% SBA, 15% seller note, and 10% equity from either investors or the acquirer. I have run into various other, admittedly never work with you, run to other SBA lenders where that 15% seller note got pretty sticky because SBA loans are 10-year term. And I have met a lot of other SBA lenders that if there was going to be a seller note, It needed to be, they used the phrase on full standby, meaning it needed to be, you know, no payments, no interest, no nothing until 10 years in one day. So it basically looks like equity to the SBA loan. Obviously, all sellers hate that, right?

With just, you know, all pick interest accruing for 10 years and, you know, you're really basically rolling equity at that point with no upside. So talk to me a little bit about the structure of what is allowable on a seller note in an SBA deal. So the SBA rules have changed in the last few years. And I think it was about three years ago that the SBA required a 25% equity injection instead of 10. But you could make up 15% of that with a seller note as long as that seller note was on full standby. That's where that came from. So that was the practice for a long time. then like I said about three years ago, I don't remember exactly the SBA changed it and said just 10% equity, period.

They don't say anything about a seller note anymore. So now what's being, and then there's one more situation. I'll explain that the SBA allows. But at the 10% equity amount, the 15% seller note is a credit decision by bank to bank. So another bank, sometimes we even allow 10%. And there is no rule that says that the seller note can't amortize right away, which all of ours. do or can't be amortizing on a shorter scheduled than the SBA. So most of ours are five-year amortization. So that's all permitted by the SBA rules today. There's only one other situation that confuses people. And that's what we call a five and five. This is in the SOP today. You could put as little as five percent equity if the seller will carry the other five on full standby for the life of the SBA loan. The old rule, the 25 percent rule, the standby period was two years. This five and five

standby is for the life of the SBA loan. Banks like us, we don't use that five and five structure unless it's a key manager buyout where there's no transition risk, maybe even a below market sale price. That's the only time we use it. So we don't recommend it for a third party buyer's just too much risk. But that's the other situation where there's a standby. Otherwise, if a bank wants you to put the note on standby, if you're putting your 10% in, that's just their own credit decision. That's not something that the SBA is dictating. Sorry to be ignorant on this. What does the standby mean? Oh, no payments.

They're always subordinated. The interest accrues, basically? Yes, the interest accrues, but you can't pay the seller anything until the SBA loan is paid off. So no principal or interest payments. The interest accrues. And then you have a, you basically start, you would start the clock then after 10 years to start paying it down. Or maybe it balloons or something like that. It's usually bullet. on 10 years in a day. But still, that's disgusting for a seller. Like, they hate it.

If you put 10% down, I almost never see a seller note on standby like that. That's great. So that must have been either a function of the banks that I was working with, or maybe it was a couple years ago and maybe industry practice has changed, which is fantastic. So it sounds like you could, by SBA rule, go up to 90% loan to value, either on the 5-and-5 structure or just a 10% equity slug from the acquire. So is that also a credit decision to go to, that you guys like to stay at 75% loaned value? Absolutely.

That's a credit decision. So we just think it's a bad idea to use bank debt for 90%. Again, if you have that hiccup, if you have a seller note in place, we can put the seller note on standby. So we actually say in our subordination agreement, if debt coverage falls below 1.5, we're suspending payments to the seller.

And the seller signs up for that. So you have a safety valve on cash flow with a seller note. You also have recourse. A lot of people, you know, kind of don't think about that. But if something was misrepresented in the deal and you get in there and find that out later, you're really, your only practical recourse against the seller is going to be the seller note. So it kind of serves to, yeah, you're going to default on it basically and say, you know, you misrepresented.

You're far more likely to recoup something that way than you are suing the seller for misrepresent. presentation. That's something that people who have not done deals a lot kind of fail to understand. They'll say, oh, well, I have reps and warranties or protections with the seller. And if they lied to me, I can just sue them and recover my money. But in M&A deals, and like in many things in life, possession is nine-tenths of the law. It is so much harder to reach back into a seller's bank account and rip out 100 grand. Even an escrow. Even an escrow. Even in escrow, right? Unless it's an escrow. I mean, even then, right? I mean, it's not, even if it's an escrow. I've seen, you know, very litigious situations where it's not, it's not just like you can walk in there and, you know, sweep the cash. It's, it's a very, it's still very procedural. Whereas, like, Heather and you are saying, Bill, if it's, if it's a seller note, then, you know, you can, you can default

on the note and say, hey, look, I have grounds for default and you don't have any recourse. Well, so it really comes down to who's suing who, right? So if there's no seller note or anything, you have to sue him to get your money. If there is a seller note, you can just stop paying it and go, sue me, right? You sue me to get your money, right? And then we'll argue about it. And so that kind of standoff is very advantageous for the person that does not need to sue in order to reclaim their value. Absolutely. Heather, how, say like in a deal like this one, it sounds like, you know, you started to speak very intelligently about it, and then we cut you off about kind of the growth prospects and stuff like that. And growth prospects, especially on small deals like this, you know, earnouts or performance-based payouts tend to be part of the structuring.

How does that affect y'all's ability to loan against an asset and how do you think about those kind of performance-based earnouts as opposed to just plain old seller notes? Yeah, I'm glad you asked that one because SBA does not allow any sort of seller upside. So they don't allow earnouts. They don't allow anything that looks like an earn-out, warrants, anything like that. So the seller has to be fully bought out and can't participate in any upside. Meaning no rolled equity also, right? No rolled equity, correct, all of that. And they can't even stay.

The seller can't even stay in a key role after 12 months. So they're allowed to give 12 months a transition, but then they have to be fully out. So some of those rules, you know, make it tough to structure a deal in a way that, you know, you might want to. And the problem with something like that is let's just say you have a small company, you want to structure that. it makes a lot of sense to do so, you're going to have a hard time finding conventional financing for a small company, a very hard time. For example, our conventional program for acquisitions

starts at 1.75 million EBITDA, and you'll find a lot of other lenders might even have a higher threshold, 2 million and above. So it's actually, the small company space for acquisitions is almost 100% financed by SBA. And then you have to live within the SBA, you know, rules and regulations, which don't allow for earnouts. Can we zoom out from there, Heather? Because I feel like this is kind of a critical question that we blew past. Let's talk about the differences just briefly between SBA and conventional. And why would someone other than maybe credit profile,

the SBA comes with some extra hoops to jump through, but it brings some structural advantages in terms of derisking because the SBA is a backstop. Will you just kind of talk about that at a high level? Sure. Yeah. So what the SBA does is actually guarantee 75% of the loan to the bank. So if we made a million dollar loan and it went straight into default,

let's hope that never happens, it had no collateral. You know, it's a million dollar loss total. But the SBA is going to take $750,000 of that and the bank is going to take $250,000 of it. So the bank always has something at risk in every deal that we do. But obviously, it makes it a lot easier for us to make these leverage buyout loans to small companies. with that extra security from the SBA. So that's really the advantage for us. And so, as I mentioned earlier,

the smaller the company, the higher the risk from a credit perspective, we're below a million enterprise. We don't even want to do an SBA loan. That same principle kind of applies when we want to go conventional. Now we don't have the SBA behind us, so we need an even bigger company

to feel safe doing a leverage buyout. And that's where we have that 1.75 million EBITDA cut off. Yep. And talk about max loan value. We've talked about kind of some of the covenant thresholds and, you know, amortization term and some of the capital structure requirements, but talk about kind of maxed loan amount where the SBA maxes out. So the SBA maxes out at $5 million and that goes against each personal guarantor. So for example, if two partners went 50-50 on a $5 million SBA loan, they're both tapped out until they pay it down or pay it off and then they can borrow more. Live Oak actually offers a campaign. loan. So if you need more than $5 million on a project, we'll go up to $8 million total debt.

We'll do a $5 million SBA to $3 million companion loan. So those are nice for those kind of tweener deals or maybe not quite, you don't quite want to put as much equity as you would need for a conventional debt. You want that extra leverage, but it's a little more debt, you know, than $5 million that you need. And how does that product, Heather, kind of work in tandem with the SBA loan? Is it subordinated to? Is it kind of function like that seller note? How do they work together? It can be either way. It kind of depends on whether there's assets involved or not. So let's just assume if there's no assets, no collateral, then it's going to be subordinate. It's going to be below. There's another term called Perry Pesu, where sometimes it's shared collateral, but that's only if there's collateral

or real estate involved. So usually it's sub. So once again, we're underwriting to the cash flow and the strength of the overall deal. And we're trying to underwrite a situation where there's very, very low likelihood that there will ever be a default. The larger the deal and the larger the multiple, the more equity you have to put in. You know, so I'll take multiple first. If you pay, if you're paying a higher multiple for a small company, most of them are between three and four and a half. So this is not usually the case, but there might be a good reason to pay a higher multiple than that. Then you're going to need more than 10% equity to hit the 1.5 debt coverage that we require. So if you're going to do that companion loan situation, I mentioned, you're probably talking a nine,

a $13 million enterprise value, which is not going to be a four multiple, most likely. It's going to probably be above a five. So anytime you're talking above a five, you're going to need more like 20, maybe even 25 percent equity to make the debt coverage work. So those are the considerations. Okay. And the companion loan product, because it is usually subordinated, is probably going to be priced higher than the SBA. It is. That's correct. It's got a little bit shorter amortization. It's got a seven-year amortization, and it's usually going to be priced a point or two higher than the SBA loan. Only a point or two higher. That's not terrible. Not bad. Well, we're probably a good spot to go through and just kind of close out on this particular deal and then move on to deal number two.

What do we think about this one? Is this one that we're excited about, or what would you do if you're interested in this one? So coming back a little bit to the merits of this business, that was a fascinating, an excellent digression into SBA lending, which is the reason that we have Heather with us. The big question for me that jumps off the page on this one is why is it so old and still so small? That's just the headline question here, right? I mean, it's been around since 2005, and they have very sticky customers, and they have a 9% annual growth rate over a 16-year period when SaaS has absolutely exploded, right? So how has this business possible, what are they doing to keep it from growing faster?

Is almost the question. How are they holding this back? So I looked into early on, I looked probably three years ago, looked into a business that was about $1.5 million in revenue. And it was a very similar story where they sold to small local governments that sounds like that's what this does, where you go into one particular department and you're selling one guy and you're selling Argal and you're selling specifically to a,

to a specific size municipality, and oftentimes it's done regionally. So when you put all those that draw the Venn diagram of all that, like you have slow budgets from municipalities, tough and slow sales cycles from them, very nichey person you have to talk to, and you're at the mercy of whether they decide to you're the right vendor or not. Like there's one buyer because you're not like citywide infrastructure

or countywide infrastructure. So you end up having these incredibly slow sales, And so, like, the one I looked at was, like, a mass SMS for emergencies product. And they had topped out after 30 years at a million and a half dollars in revenue. They had like 70 customers. So kind of similar thing. But we dug in like, okay, how do you grow this thing? Like, yeah, it's sticky as all heck. But when you sell to this type of environment, like, it's hard to get and grow your revenue at all just based on the customer type. I would have a lot of questions, too, about, you know, is this is basically the software platform 16 years old? Because I know they weren't calling it SaaS. in 2005, like, did it migrate and kind of, you know, upgrade from something that was maybe desktop focused or kind of native on site to now being SaaS? And is that old kind of software code still, you know, embedded? Or has it been drastically revamped and you have a ton of runway with the software? Yeah. You know, there's a huge difference between kind of the on-prem stuff

that you're talking about where they're downloading package software and all that kind of stuff, often sold with permanent licenses, which is a difficult business to be in compared to recurring revenue SaaS. Then there's the second category of these where people have taken some of the online systems like Amazon has one where you can take like an on-prem thing and magically turn it into a cloud thing. That sometimes works. It often doesn't. And then there's the ones that you're looking for that have actually gone and made that transformation to be a full cloud-based thing using modern tech and is not some native C++ app on Windows. knows. My guess is that the multiple this is trading for, it's probably the first one.

Like, they haven't made any migration whatsoever. And the SaaS that they've done is just they've changed their pricing to annual contracts as opposed to one time with maintenance. But that would be something to dig into. Because stuff like this is not trading it four times unless there's something really wrong with it when you dig in. So Heather's original point, like what's up with this thing? You really want to go figure out what that is because everything sounds too good to be true right now. Yeah, I would agree. The revenue model is the key. They're calling it SaaS, but maybe it's really not. Super cool. Okay, let's move on to deal number two. But before we do that, we have a new sponsor this week. It's the SM Bash guys, which is a conference that's going to be

held this coming February, and the three of us are going to be there. So we're going to record a live episode of Acquisitions Anonymous on stage, I think, guys, and it should be pretty fun. No pressure. And we'll do that. And so pretty excited about it. with Sam, Brandon and Matt have put together. I have the website pulled up. A number of folks are going to be there. It's kind of the who's who of like Twitter small business. So yeah, yes, we made the club.

But some of our favorites and friends have been on the podcast, Steve Ressler, Alex Bridgman, Nick Huber. And it's going to be more intimate than some of the other shows that have happened in conferences like reconvene and stuff like that. It's going to be 100 people or less. Totally focused on micro PE. And the first day is all about like how you find deals. and then the second day is like, how do you operate them?

So if you're interested, go to smbash.com. Should be fun. You can be there. We're going to have an autograph signing of our. Did you know that, Mills? We're going to have an autograph. No, we're not going to do that. Nobody can't.

We're all going to sign Michael's head. I can't sign my head. I think there's like less than 50 spots left, too, is what I saw recently. So, yeah, we'd love to see you there. That's great. my partner is going to be there. Oh, awesome. Okay. Well, we would love to hang out with her and meet her as well and excited about what these guys are doing. These guys just seeing their Twitter's, they're good people. So I'm excited about being there. And yeah, so thanks to S&Bash for sponsoring this week.

And you can go sign up at Smbash.com. So let's move on to our second deal. So Mills, you have that one. Yep. And I'll pull that one up, but we can dig into it. So this is a managed IT services and web services and IT solutions provider, 13 million in sales. The headline says over 450 clients and $200,000 in recurring monthly revenue. The cash flow, so just again headline 13 million in sales and about $683,000 in cash flow. They are asking $2.2 million for the business. Revenue is just over 13 million. Cash flow again, $683,000. It's located in the Twin Cities. The service area is about 75% local, 10% regional, and 15% national. They're selling because they're

looking to grow the company by leveraging areas outside of the owner's expertise. There's $161,000 worth of equipment, 39 full-time W-2 employees for admin, 6-in-operations. 10 in sales and 19 in service. So for a total of 39, that's the breakout. Intangible assets, they have strong recurring client-based, word-of-mouth referrals well established in the industry and region. This is the, I'm just going to read through this description briefly. With over 450 clients and 200,000 in recurring monthly revenue,

this IT management company has been established in the Twin Cities area for nearly 30 years. They offer a variety of technology services and products that include technology, lifecycle management, IT staffing, cloud solutions, data storage, data security, and remote access, and web services. They also provide new and recertified equipment from leading manufacturers, as well as sales, repair, maintenance, and installation of Windows, desktops, and servers. Highly skilled team, they cater to each customer's specific needs for their company and implement customized IT solutions and services. Clients are in a wide variety of industries like education, finance, health care, insurance, manufacturing of their 450 clients, 288 of them

purchase $1,000 or more per year, 122 of them purchased $10,000 or more, and 24 purchase $100,000 or more annually. 2021 is on track to be a record year, and the remote workforce, oh, as remote workforce is now entrenched in the workspace, they see double-digit growth for the foreseeable future. They're based out of 18,000 square feet. 9,000 of that is used for warehouse and production space. 4,500 is office space and the remainder is rented by tenants. So it's not clear whether or not the real estate is for sale or not.

Maybe we'll get into that. Let's see. They have their equipment is like computers, notebooks, servers, sands, network gear, warehouse equipment, office furniture and fixtures. The current owner handles HR, finance. AP, AR, policies and procedures, and contracts, and is willing to stay on board for one to five years to help grow the company. So it sounds like this person really is saying, hey, look, I just, I want to grow this thing and I'm maxing out. Priced at $2.2 million, business already has a strong referring client base, word of mouth referrals.

Marketing is the key to organizational growth. They want better SEO, email campaigns, lunch and learns, old school. They think it could generate more client interest and boost revenue. I think the recurring revenue is a little low, unless I got my math wrong. It looks like it's about $2.4 million of recurring revenue out of $13 million total, which is 18%. And so for an MSP, I feel like that's a little low. And maybe it says that they do a lot of project work. Maybe there's some repeating revenue, repeating customers, but not recurring revenue.

So I think maybe that's why the multiple is pretty low. Yeah, it's interesting. I mean, I think you're totally where I would want to go with this, Heather, like understanding how much of this is just value-add resale, so project work, and then how much of it is actually recurring revenue services? Because those are really two different businesses. And given how small their kind of, you know, their free cash flow is as a percentage of revenue, which is what you're talking about, $13 million and only about 5% turning out in cash flow

profit, that has me worried that this is an MSP that's really much more in the value-added reseller side than actually in kind of that high-touch, recurring revenue, high-margin services where you want to be if you're an MSP like this. Yeah, I think so. Maybe a strategic buyer might be more interested in this. We've seen, you know, a lot of MSP deals lately, and some of them are strategic buyers, you know, and trying to grow through acquisition. So I think this might be a good fit for someone like that where they could absorb, you know, some of this revenue and maybe there's some value there. But it would be a tough one to finance for a for a single buyer, you know, that this was going to be their only company.

Especially when you look at their, I mean, they're adjusted, you know, with the ad backs, their adjusted profit margin is, you know, hovering around 5%. And the adjustments are very, very questionable in some cases. Yeah. But my favorite and also that's my favorite topic. Yeah, least favorite of these is the management bonus of between $50,000 and $100,000 in the most recent year. Unless that's just a

discretionary bonus to the owner paid himself. If it includes anybody else in the workforce, I've seen these adjustments before and I think it's kind of crazy to say, hey, look, we've been over bonusing our management team, but you can stop doing that. It's like, how does that go over? Right. Hey, I'm really glad

to be here. I really, you know, want to grow this business. I want to build trust with you guys as a team. And we're not doing the bonus anymore that you've been doing every year. I think also to Heather's point, not all MSPs are created equal, right? It's a pretty big category. And like, I've seen MSPs that say just focus on DevOps, right? Or just focus on a very specific niche industry in terms of catering to a specific vertical. So they learn all the software in that specific vertical and they can charge higher prices and get a back. better margins for it. This looks like one of the, we just took whoever showed up, Main Street-style MSPs that's targeting small businesses and just, it's much more of a painful business

compared to the ones I just described where you have more of a mode or more of a specialty that you focus on. So, yeah, not so excited given that given as we double-clicked on the details of the teaser. I agree. The MSPs that we have lent on absolutely specialize in an industry. In one case, they specialized on just high growth kind of VC funded companies as one example, you know, so that they could handle that high, that rapid growth. We may have looked at the same deal. Oh, really? That happens.

The DevOps one that I looked at was just precisely targeting everything you just said. Anyway, it looked like a cool deal. And the other thing that I see in MSPs is customer concentrations. So this one sort of says they're pretty diverse, but a little. lot of successful MSPs tend to have a big fish customer, and that can be tricky to underwrite as well. As a lender, what we do with customer concentration over 20 percent is we try to back it out of EBITDA and say, gosh, if we lost that customer, could you still pay the debt at at least one to one or somewhere above there? That's kind of how we handle those. Well, and that's doubly hard

to deal. One solution for customer concentration is often a performance-based earnout, and you can't do that under SBA, unfortunately. There is something you can do. So there's a forgivable seller note, and it is for this kind of situation. So an earn out in SBA's eyes is upside. But a forgivable seller note could be tied to retaining something or maintaining a certain EBITDA, whatever it might be. So you could tie a forgivable seller note.

You put it on standby for maybe two years or whatever you think is appropriate time frame. And it's earned and it begins amortizing. that customer at a certain level, if you lose it or diminishes, it gets discounted. So it's not an earn out if you look at it that way through SBA's eyes. So in this case, you would be looking at, if it was a really significant customer, you may only have 50% loan to value with the SBA, 40% in this seller note that will only be realized if, you know, if this customer sticks around. That's right.

Yeah, depending on how big the customer is, you need to structure the note appropriately. Yeah. What thing really fascinating here is why does an MSP need 9,000 square feet of warehouse and production space? What are they doing? I wondered that. That's so weird. It's a lot of servers maybe. And then, yeah, they're carrying a lot of hardware costs, although it only said 161,000 of equipment.

So that is strange. Yeah, everybody who owns a business like this, they do like 50 million a year in revenue, and they run at like 5% net margins. It's really fascinating. Scroll down to the funding example part, because I feel like this would be good to have Heather's input on. So I really loathe, if you keep going, yeah, right there. I loathe when... Oh, you hate these.

Yeah, yeah. I mean, this particular one is a good example, but I feel like it, I don't know, it's too heavy-handed when the broker tries to say, hey, look, here's how you can fund the deal, because I think you all of a sudden get anchored to something that's not even necessarily relevant or accurate are doable. So this example, right, Heather, that says, hey, 75% bank loan for $1.65 million on a 10-year,

term at 6% gives you a monthly loan payment of $18,000. Do 12.5% seller financing, 12.5% buyer-down payment. And it almost make it seem like, hey, this is just so easy, right? And then, look, it results in 125% return on investment in the first year. Like, almost like you'd be stupid not to do this is kind of the way that it's portrayed. Heather, why won't this deal as it's presented work? Well, there's, we do a program every Wednesday where we talk to folks who are buying businesses and we show them how we calculate the numbers. There's the quantitative and there's the qualitative. This is strictly quantitative, right? This is just, oh, here's this math. And, of course, what he betad did he use here? He's not even showing you. He's just telling you you're going to get this

certain rate of return. This one stops short of something I really don't like. He stopped short of saying it's SBA pre-qualified. Nothing's SBA pre-qualified. When you don't have a buyer, you don't have a structure, there's no such thing, but lots of Sims say that they are pre-qualified and someone from a bank will give them a letter. It's really just a marketing tactic. So at least he didn't do that. But yeah, this sort of ignores the whole qualitative discussion about the deal and just says, is just based on these numbers, this is your return. And he's using all of his ad backs, of course, he's using an SDE rather than an EBITDA. And SDE is also one of my least favorite things that I see, you know, where they add back the seller's compensation and those extra bonuses and things like that and say that that's all part of the EBITDA that you're buying, you know, sort of ignoring the fact that you need to actually pay a CEO, a salary to run the business.

So I don't like this kind of stuff either. This is the page that originally triggered Mills to scream. It doesn't even pencil originally. This section be titled, it doesn't even pencil. There was a deal, Heather, where they were saying, hey, look, here's the deal, here's the mechanics, whatever. And it was based off of EBITDA, but the business had very little EBIT and a lot of DA, a lot of depreciation and amortization. So they were like, look, it's wonderful. This works great.

But when you actually looked at it, the total. debt service amount, just the total debt service was more than the actual net income that was available. And so that it, yeah, Bill's right. It absolutely triggered me and I flipped. Yeah. And depreciation is the other one. So so SDE where they add back the seller's compensation, but they don't take out replacement salary. And then the second one is adding a big depreciation number back. Well, that's probably your CAPEX. That's your maintenance CAPEX cost. It doesn't go away. So it doesn't go away. I mean, that that's, it's a proxy for that. Maybe it's excellent. rate depreciation, your actual maintenance cap-ex is slightly lower. But as I mentioned earlier,

when you have a lot of equipment, any kind of asset-heavy businesses, it's not easy to calculate what maintenance cap-ex will be. And I've never closed a deal with a lot of equipment where the CEO didn't come back later and say, the equipment was not in as good of condition as we thought. And I had to spend more on it than we estimated. So, yeah, absolutely watch out for big depreciation numbers, I would not, that's not really an ad back in most cases. I will say they do, they do add in 80,000 in replacement costs on this. So that's so their credit. They've at least thought, thought about that. So it sounds like in closure on this one, it sounds like we feel like this is one,

maybe for the right buyer who's already, you know, at scale with this sort of, with this sort of kind of commoditized MSP work, this could be a good purchase, but tough for somebody, you know, entering into this business as an acquirer. Yeah. And as a strategic acquirer, you also have the benefit of the cost saves. You know, you're going to have some redundant employees there, and you're going to probably eliminate a number of salaries. And your EBITDA is going to be, what you get to absorb is going to be a little bit bigger than this. So that's probably the only buyer that I would finance for something like this, I wouldn't probably finance a standalone buyer. Heather, do you ever see instances that kind of pass, you know, pass credit and underwriting

that have, you know, 5% margins? Yeah, I guess so. I have to think about that. I guess there are some businesses where the margins are pretty thin, but there are reasons why we might get comfortable with the deal, you know, very, very diversified customer base, very stable earnings, you know, kind of good reasons for that. But not too many. You know, that's pretty razor thin, and you need to be a good-sized company for a lender to get comfortable

with that thin of margin. Super cool. All right. Well, I think there might be a scenario in which somebody does this, but it's probably not one of our listeners, unless somebody who's a strategic MSP owner decided to. For me, I would just look for another pitch besides this one.

Some of the other niches we've talked about in the MSP space are much more appealing than this one. Yeah. Cool. All right. Heather, in closing, love to give you an opportunity in a platform. How can our listeners support you? How can we help you?

What would be helpful? Well, if you're thinking about buying a small company and you're going to use SBA financing, reach out to me in an email. We hold a session every Wednesday and every Thursday where we go over everything you want to know about using an SBA loan for an acquisition. And we walk you through our debt coverage model and a deal teaser memo so that you can actually model your own deals from a debt perspective and see what's going to qualify and what's not. That's great. Yeah, and you and your partner have been fantastic on Twitter in terms of engaging

with folks and kind of bridging the gap because there's just a lot of misinformation put forth by people on the M&A side. So kudos to you guys for doing it. Thank you. If I could just, I just would love to add just even a little bit of color in support of Heather even further. While Heather and I have not worked together directly, you know, on a loan at Live Oak, I've worked with a lot of other, a lot of other SBA lenders. And if you are just anyone out there looking to buy a business, there are a lot of small banks that say they do SBA deals, but they are not used to doing them in support of acquisitions necessarily, or they don't do a high enough volume, or they're not really professionalized.

But the team at Live Oak, you know, Live Oak, I believe Heather is the largest SBA lender in the country or one of? We are number one. Number one. Wow. So the fact that Heather and her team focuses not just that they do a lot of volume, but I mean, you probably heard during this episode she's got specific thoughts on how to finance an MSP, you know, or how to finance a SaaS business because they've done those deals. So going to Live Oak, and I'm not being paid to say this, seriously. If I were to do another SPA deal, I would go straight to Live Oak and not talk to anybody else because of their volume and then also that kind of SBA plus product where they that Heather mentioned where you can bridge up to $8 million.

That's a pretty unique product in the market. And I'm not aware of a lot of other banks that do that. So a totally unpaid plug. I would call Live Vote first. Yeah. Thank you, Bill. One more. Well, now over to our paid advertisers.

Hang on really quick. One other thing, Michael. One other thing about Live Oak that I think is interesting and every lender has this right, but you have a vertical specific focus. And I went down this path years ago in a previous life looking at it for buying an RIA or acquiring an RIA and already owned one. You guys have verticals that you underwrite maybe more aggressively than just kind of something generic. So will you just maybe mention what some of those are? I know like dental practices and some things like that. Yes. We have over 30 industry verticals. That's kind of how the bank was founded on

the principle of verticality. And yes, so that means you, you have experts in all these industries. So some of them are, we have government contracting, federal government contracting, which is a very niche space. HVAC, plumbing and electrical contractors. A lot of folks really like that space. Restoration, like you said, dental, CPA. Gosh, I can't even remember all of them.

And we're always growing them. We're always exploring. In fact, we're thinking about maybe an MSP vertical because we've seen so many and we like the space, you know, if it's the right kind of company. So if you come to us with a deal and we have a vertical for it, it's a plus. It's a huge plus because we have domain experts who really dig in deep on that industry. Thanks. Not paying to say that.

I just think it's a plus. Super cool. Thanks for doing it, Heather. And thank you to our two paid sponsors for today, tiny acquisitions, longest running sponsors. So a place to buy small businesses and get your feet wet in entrepreneurship, usually for less than five grand. and the S&B Bash guys where we'll be making appearance and evidently signing my bold spot as part of the process. So very excited about doing that in Orlando in February.

So check that out at Smbash.com. So thanks again, Heather, for being here today. Totally killed it. And this turned out to be a great episode. So thanks for educating us on what you do and how SBA and then your insights on the deals were just awesome. So thanks, Heather. Thanks for doing it.