Acquisitions Anonymous - #1 for business buying, selling and operating - Vertical Saas, Painting Contractor, Engineering firm - Pilot Episode - E1

Episode Date: September 23, 2020

Topics this week:- What the heck is this podcast about?- We look at three businesses for sale:1) Vertical Saas Software for asset managers2) A very specialized painting contractor for sale3) A specialty engineering firm based in Toronto, CA-----* 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 GroupSubscribe 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]

Cool, welcome to Deal Talk. This is the pilot here with my two co-hosts who I've met through Twitter. So excited to have you guys here. And what we're going to do is pilot this idea of having a podcast about talking about small business M&A. So I want to introduce myself and Michael Girdley. I do small business M&A. And then my two co-hosts, if you guys want to introduce yourselves, that would be awesome. I'm Mills Nell. I've been in the M&A world for about a decade. I used to own a sell-side M&A firm and then worked for permanent equity, kind of unique, buy-side shops, permanent old type structure. And then I'm under LOI on an acquisition for myself right now in South East. Nice. And Bill? Yeah, I'm Bill Dallessandro. I'm the founder and CEO of Elements Brands. We are a CPG holding company. So I have been in M&A since I graduated from college, did a couple of years in sell-side investment banking, worked with a private equity firm doing a roll-up in the data center space, and then founded my own holding company in 2010 and have done six acquisitions

under our platform, looked at probably a couple hundred more over the past kind of nine years or so, all kind of micro market or small, lower middle market. Nice. Well, cool. Glad you guys are here. So we have four deals that we've put together to talk about today. And they're to cover the span of everything, but the thing they have in common is are all small. So kind of sub-20 million EV enterprise value. So the first one we have is actually a teaser to talk about a software company. It is a fintech software company that comes out of a brokerage called Woodbridge International. It is a fintech company, so it's software. The headline is they serve eight of the 15 largest asset managers of the world, does $4 million in revenue as of their last

fiscal year. Well, actually, as of their, I guess, their estimated 2018 fiscal year, this one's a couple of years old, at $1.7 million at EBITDA and is located in North America. They cover eight of the top 15 largest asset managers in the world with this software. They use it for things like document automation, sales enablement, digital enablement in that single platform. Interestingly enough, the teaser has them growing like crazy over the next few years at crazy high EBITA margins, 30%, 43%, 52%, all kind of really high numbers. It is cloud-based for client reporting and whatnot, and they claim to be growing like crazy and are searching for bids through the broker.

So I'll pause there and see what questions or thoughts you guys have about this one. Are they looking for full buyout, Michael, or are they trying to raise capital? According to this, it looks like a full buyout. All right. on, it looks like, from the teaser, you showed me 4 million in sales and 1.7 million in EBDA. Right. Yeah. So it's some of the stuff that from a software perspective is interesting is every single one of these deals, the broker always shows the thing going from slightly growing to ridiculously fast growing. And in my experience, that is often not the case that you get that hockey stick stuff.

It is also interesting how profitable this is, especially at this size. something weird is going on if somebody's doing 50% EBITA basically on $4 million in revenue. So that would be kind of the first place I would look if I started to dig into this deal is understand why are they so ridiculously profitable, you know, kind of at that scale. Yeah, another thing that jumps out to me is they say that their subscriber base includes eight of the 15 largest asset management firms in the world. It kind of makes me wonder why they only have $4 million in revenue. You know, I would think that, you know, if this software were so integral to these

guys, they would be charging them a lot more. If these are their only eight customers, it's about 500k a year for each of them. So on one hand, that's great. On the other hand, if you take the whole market, you can only double in size, right? Because they've got eight of 15 and they're doing four million. So if they get the other seven, they'll be at eight million and that's about as big as it gets, which is interesting considering the broker has them at nine and a half million in sales in two years.

So I would have some questions there. Clearly, the broker anticipates that they're going to capture 150% of the market. Yeah. So that would be interesting to me. You wonder about how they actually, like what the underlying economics are for them. Is it, you know, for example, is it a $500,000 per license type fee and then you do max out or is it kind of per seat or per, you know, installed base? I mean, we can't tell any of that. But obviously, like, for example, if you're working with like Schwab and Fidelity and Vanguard, you know, those folks aren't going to let you feed them to death. To me, it's a little bit of a kind of scary, you know, profits to track competition.

I would think that at some point, the really large asset managers of the world may, you know, either be a potential buyer for this or they'd be somebody who's saying, look, we're going to do this ourselves. Yeah. I would also wonder about the sales cycle. So they've got, you know, if you're into 8 to 15 largest asset management firms, when I hear asset management firm, I hear red tape and compliance. And so typically these guys don't drop 500K or anything close to that, you know, without an entire RFP, and it can take a year or two often to sell into these organizations.

So I would be wondering, A, can I really grow this business as fast as the broker projects I can if I've got a 12-month sales cycle and if my addressable market is perhaps only, you know, seven to ten additional firms. And then I also want to understand what my contracts are like. So I'm going to spend a year selling in. And if I have some customer concentration, I want to know, are they going to churn? Can they leave at any point? Or do they have to stay? stick around and they locked up for five years. Well, I guess, so an interesting question, you see this teaser, would you put in, if you were a software buyer, would you put in the time to see the SIM, right?

And to get the, to sign the confidential agreement, go through all of that. So it's an interesting question. Would you spend the time on this one or not? Is it worth thinking it further? Well, Michael, you are a software investor. Are you not? Yeah, look, I would tell you, this one has the red flags of the type of buyer that's going be looking for a ridiculous multiple for something that's tough to justify from a buyer's standpoint,

right? You're looking at a limited tam, you know, when they say they have half the market and they're only doing $4 million in revenue, and then you have a broker that's showing you a crazy hockey stick growth production. They're doing that to try to justify a really high multiple sale. And so for me, like, yeah, you want to see all the pitches, but it doesn't look like this is one of those ones where I would, you know, bump it to the top of the pile, thinking I can either make it run more profitably or realistically execute on the type of gross strategy that the broker thinks they're going to do. So that raises an interesting question to me, which I sometimes struggle with all the time, is, you know, let's say these guys are asking for a high

multiple wealth. That doesn't mean they deserve to get it. And, you know, something is only worth what the market is willing to pay. And if you're the only bidder, you're the market. So at what point do you, you know, put in some time, and they might be asking for eight to ten times divit da, but do you put in the time bid 5x? And if you're, you know, if that's what it's worth. So it's too bad if their expectations are too high. How do you guys wrestle with that? Sometimes, you know, my view is, you know, if this is a business we'd want to own and I'm not going to, you know, I'm going to bid something fair. I'm not going to try to steal it from them, but if their valuation is out of line with the market, you know, that's their problem.

I would still like to submit a bid that I feel as fair. Yeah. And that's where I think the, you know, adding the I.O.I, the indication of interest, to the process is really good, because then you can give them a range and say, I think I'm going to end up, you know, four to six times EBITDA or whatever that might be as the range where you think you can make it work. But also, you don't spend and do all the time that like a binding or even a non-binding LOI and all the models you're going to build and stuff like that. Like, that's a lot of time. The Ioys at least can give, you know, let you know if you're in the ballpark or not. So, you know, that's where something like this. And most the brokers and I bankers will run that kind of process where it's a two-step I-O-I and to

LOI. And yeah, I think that's perfectly good to do it. You know, when you do see a profitable company like this and, you know, high gross margin recurring revenue software companies can be pretty profitable and profitable whenever they want to be. A lot of times you'll see that they're batina, their best alternative to doing a deal, is just to keep it. Right? So you end up wasting a lot of time making offers they would deem to be kind of lowball. Just really quick. The other issue with this intermediary is that, you know, the bar is really, really low. You can design the NBA, and they blast it out to a massive email list, which to me is nice if you just want to see films, right? But if you actually want to be competitive and you want to, you know, be able to

differentiate in some way, it's really, really difficult. So it's probably a good one if you're just kind of getting started and you want to get at that. But just from my own experience, these are pretty broad processes they run. And that's also a function of just how easy it is to sign the NDA and how easy it is to get the information. Then you get 100 people, you know, who are looking at it and kind of kicking the tires, which is also a little bit concerning if you're going to be the eventual owner. Yeah, look, if you're looking for value, finding an inefficient market is much better than,

you know, FI International or one of those places that's going to spam everybody with every deal. So in the interest of time, let's move on to deal number two. Mills, you have one? Yeah, kind of an interesting company that's based in the Northeast that is a niche painting contractor. So typically, if you think about subcontractor relationships, painting is not really high on the pecking order. But this company, they've got pretty decent margins, about 11% EBITDA margins, enough that the niche kind of grabbed my attention and I wanted to know more. And what they do is kind of hyper-focused in an industrial sense. So they're not, you know, paying one-off, you know, residential homes.

They're not, you know, even doing really commercial paying. It's a very kind of strict industrial focus. So, yeah, you guys had a chance to see some of the materials. What jumped out of you guys? What did you like just kind of at face value? Yeah, I mean, I think with something like that, I'm always interested in, from a contractor standpoint, like how much of the revenue is recurring, right?

That helps you establish so much more value in the business versus kind of project work. And then also, like, what are the competitive modes for a contractor like that? And, you know, it felt like there were, you know, as we dug into that one, it felt like there were good explanations for that. These guys weren't providing really a commoditized service when it came down to it. Yeah, yeah, exactly. The interesting thing, you know, in talking to the investment banker on it, though, that it's not, it wasn't readily available in the teaser and then it wasn't even disclosed in the STEM, two kind of major, I would say, strikes against the company. One is that they have DVE status, disadvantaged business owner status or minority business owner status, which could be a lot of different things, right? It could be

female, it could be Native American, it could be a former veteran, disabled veteran, all these different things. So these guys, this particular company has that status, which is nice because you get set aside contracts on federal and government and state government work. But it is very, very difficult to convey the value of that revenue stream if you don't meet those criteria yourself. So most private equity firms, most funds or even search funds, it would be very, very difficult to check the box on that. You'd have to be an individual, probably a majority owner, in almost all cases, at least a majority owner of the deal. All of a sudden, you know, and you guys have probably heard this a million times too, but every single investment banker or business

center I talked to who has DBE status will swear up and down. It's not that important to our business. That's not the reason we get awarded work. Our customers are going to give us work even if we don't have this status. And then I think, okay, well, why do you still have it, right? You know, if it's so neutral, then why wouldn't you take care of this before a transaction? Because surely, you've got to know what's going to impact. So that was a big strike. The other is that out of their, you know, roughly, I think 90 employees, the painters themselves, because where they do work, it's almost all union labor. It's about 75, you know, trained kind of technical employees. And this is a two-edged sword. On one hand, dealing with union labor, especially for folks who

run parts of the country where it's not as prevalent, it's just a big kind of red flag. It's just all the complications and potential liability with unions and their pensions. It's a real struggle. The other thing, though, the big pro is that every industry has an issue with skilled labor. And if you talk to any business owner, they're like, man, if I could just find more good kind of trained people. Dealing with a union hall, you can just call up and say, hey, look, I need a journeyman, I need an apprentice. I need a master, you know, electrician or painter or carpenter or whatever. And they send somebody and the labor is fixed. So it goes both ways.

But if you aren't kind of, you know, educated in the nuances of that, it would be a really, hard of bill battle, especially if it's kind of your first or second view. Yeah. And I mean, the one thing I liked about this one, they seem relatively reasonable about the price, right? And there were some seller adbacks in it, but it was, you know, basically list price at three and a half times or three point six times free cash flow, which had a lot going for. Of 2020, of 2020, projected. I didn't say anything about the numbers, but it looked like, So they're asking price is $18,000, $250,000. And 2019 sales was $33 million in change.

And 2019, you know, free cash flow to the owner was about $3.7 million. So little over 10% net margin, 11% net margin. And they're asking price on 2019, SBE, seller's discretionary earnings, is right around 4.8 times. So I hear you guys saying, you know, maybe that's kind of reasonable. to me in this segment of the market for a business that has this much hair on it, the DBE status, the union labor, you know, I would say that's probably a little bit rich. It's interesting, though, I don't know if you guys saw this, but the way that this broker pitches this deal is,

look, put 15% down, get seller financing for 15% and get a 70% bank loan. So it's about two and a half million dollar financing and, you know, a little over $12.5 million in debt. And the way they model it out, how conveniently is that, look, you put down $2.7 million and you get the $2 million back in the first year. If it were that easy, right? Yeah. One thing that struck me about the price on this one is their cash flow, it was $3.6, $3.6 million in 2018, $3.7 million in 2019. And they're projecting $4.9 million in 2020. As we sit here, I think this teaser is data kind of halfway through the year. So I immediately want to know, why has suddenly your cash flow grown 50% conveniently

in the year you're trying to sell it? You know, what's going on there? It reminds me, you know, and you'll start to see this kind of in the back half of years where sellers will want credit for kind of the project, like nine months of trailing and three months of projected, right, the full year 2020. And this reminds me of a deal that we actually, you know, are looking at putting under L-O-I right now where the founders were projecting a big Q4 and they wanted to be paid on projected 2020 EBITDA. Well, 2020 EBITDA depended entirely on how their Q4 went. So we said to them,

you know, guys, don't sell us your business right now. You know, you need to put your heads down for three to six months, you know, put up that big Q4 and then we would be happy to buy your business on a reasonable multiple of 2020 when it's in the rearview in January 2021. So that typically is what I say when folks want, want the credit on the forward number about halfway through the year. And actually, I've even put a deal under LOI before on a pre-agree upon a multiple for three or four months of exclusivity while they put their heads down and did that. So that would be, you know, if I was really interested in this deal, I would be curious as to why the EBITDA spike so high. And then I'd also be looking at some sort of structure or timing to give me and also probably

my financing partners who typically like to underwrite on trailing, not forward numbers and comfort that this was going to materialize. Yeah. The other thing that the financials kind of scream is the lack of professionality and the way the business has been run, my experience is at this end of the market, there's a lot of these companies that get run more like the owner's piggy bank than run like a professional company.

And it detracts from the value because you have to extract all that stuff out. So in this case, they have a bunch of adbacks for repairs on somebody's rental properties, like I think it's the owner's rental property. It's just like, oh man, what other kind of stuff is going on under the table or, you know, in the accounting department if they're not running this thing, you know, like a real business. And that kind of, for me, hurts the value and the, kind of the, the assumable value for an acquireer with this one. Yeah. The other thing on this one that I'm kind of learning firsthand right now on the deal I'm working on is that they kind of flash, the investment banker does, flashed this huge work in progress.

number. It's like two years worth of revenue or more. It's over $70 million of work in progress, which tells you, great, you have a good backlog. The problem, though, with a lot of these contractors, is that if you're going to do an asset purchase, which most people would want to, then you're going to have to work on assigning all of those contracts, which is just a very onerous process as a part of the closing and the actual documentation of the deal. And it also is going to involve you and the owner, the existing owner, the seller, going and sitting down with all those general contractors or all those customers and saying, hey, look, I know we have a contract in place with you. It's got, you know, a cause in our contract that we have to get your consent to assign this

contract to somebody else. And if you've got, you know, two years worth of work that you've got to go, I mean, that's going to be a full-time job for weeks and weeks just to get, just to make sure you can keep the revenue that you think you've got the pipeline. So to wrap up this one, it sounds like we love it. I mean, hate it. It's got some hair on it, is what I would say. It got some hair on it. I mean, it does feel like one that would be pretty darn tough to do from South Carolina. Yeah, no doubt about that. For sure. Well, I think we got time for one more. If you guys are up for that. Do you guys want to do the engineering firm or the other software

firm that I got? How about the engineering firm? That sounds like fun? Sure. Yeah, it's good with me. Good. Okay. Well, I brought this one. It's pretty interesting. It is in Toronto. They have a list price of $8 million. That is $4.5 million in revenue for 2020 projected, which is growing a little bit over 2019. It is an engineering firm located in Toronto, which the teaser describes as beautiful Toronto. I've never been to ugly Toronto, but I heard that's bad. And basically what they do is a level. of geotechnical instrumentation, monitoring, architectural stuff. So very niche engineering stuff that focuses on a number of clients, transit systems, tunneling, bridges, who are kind of civil engineering specialty firm. 50 people, and that's kind of full service. So they have professional engineers, architects, SMEs, programmers,

surveyors, accounting, administrative people. And it's run by the owner, sell. who I assume has to be a contract or has to be an engineer by background. They say that the owner is highly involved and the resident expert on this type of engineering and also is very good at maintaining the client relationships. And they have an office in Toronto and what else here is kind of interesting. Negligible assets, $750,000 in furniture, fixtures, and equipment. 1.5 million in accounts receivable as of the date of this,

and has been pretty steady with revenue somewhere between four and a half to bid over five in some good years, profiting kind of mid-to-low-low-one millions each year, 25% profit margin. And so asking a multiple of basically five-and-a-quarter, I guess their average of the past five years, free cash flow. So what do we think? Does anybody want to own an engineering firm in Toronto?

I think this is one of those businesses that is near impossible to sell to an outsider because of how much kind of professional and non-transferable goodwill there is. The issue for me, right, if I'm thinking about being the buyer of this business, is that the owner probably has, you know, the vast majority of the relationships which they've owned. But also, right, like if all of a sudden you say, well, no, no, no, you know, he successfully transitioned these relationships to his lieutenant and he's got 10 people. The revenue seems kind of low for 50 employees to me, just based on what I've seen in this industry before. But even if you say, okay, look, he can transition relationships to those lieutenants. There's nothing really that keeps those folks engaged, right? They could very easily say, look, we're going out on our own. And that's a very sticky situation.

I don't think this is the type of business where you come in and say, look, we need non-confeats from, you know, your top producers. I mean, that would just, that would just implode the deal, I think. So I would say way too risky, but I'm an outsider, right? If I were an engineer and I lived in Toronto, totally different scenario, maybe. Yeah, I think that's a problem you see with a lot of service-type businesses. I've seen a bunch of advertising consulting firms for sale. They do, they manage your Facebook ads or, you know, they do graphic design or whatever. And the problem is, you know, all your intellectual property walks out the door every night.

And oftentimes they're pretty loyal to the previous owner. So, but they're also two junior, you know, it's not like you got two rainmaker sales guys. You can't lock them up with non-competes. So it becomes really tough to transfer the value of that business in a way that's durable. There's not really a ton of franchise value there. So I've always thought it pretty surprising when folks are able to successfully transact on professional services firms like this. Yeah. Well, and there's a lot of, if you kind of read between the lines, you know, in this teaser, there's a lot of words here that even make it even worse.

worse. You see how critical a lot of what's going on here and the enterprise values based on this owner's relationships and expertise. And it just, it screams all the concerns you guys are talking about to where, you know, if I saw something like this, well, first of all, from Texas or either one of the Carolinas, like there's no, there is no way that, you know, somebody not from Canada is going to be the right buyer for something like this. The other thing is, I've seen companies that I think do at least at face value something very, very similar that are five times the size and don't get a five and a quarter times more. I just think it's kind of mispriced for several reasons, but also kind of if you just took like market comps, I don't think it's, I don't think it's

close to market. Yep. It sort of exhibits the same thing we've seen here on a few of these deals, which is kind of owner centricity and even location centricity as well. It could be very hard to buy this business and not be located in the market where it's based, which I think is a thing that that kills a lot of deals where the deal kind of revolves around the owner or at least revolves around the local market. I mean, even if it's a chain of restaurants in a certain local market, it's very tough to buy that if you're not located in the local market. Well, and given this kind of default pattern for engineering firms like this is to slowly sell equity in it to the next generation of leaders, you know, inside the company. You have to wonder, what does that say about this guys

are this person's company that there aren't any people that he's hired that are good enough to be the next generation of leaders? So it's even another kind of double whammy that makes it unattractive. So good. Well, we love this one too. Fantastic. We'll have to do some ones that we like on the next episode. Totally cool. Well, look, it's more fun to just poop on them because That's the nature of this thing, right? I think we talked about you've got to just look at a lot of pitches. It's just part of the deal and really think deeply about them and just how you eventually find a good one. Cool.

I think we killed it. I feel good about this one. So we can go ahead and wrap up. Any last thoughts from you guys? No, I think just generally, we did three of these here in 30 minutes. And you can even as a listener, if this first time you've heard this podcast, which it would be because it's the first episode, you'll start to see even patterns in the three that we've talked about here today. and that's really the value on seeing a lot of these is you start to see these common pitfalls

or common strengths and you start to get a sense for where the market is and you know what questions to ask. You know, you might be listening to this episode and go, God, how do these guys know, you know, how does Mills know about, you know, minority-owned firm status to even ask that question? Well, it's because he's run into it because he's looked at hundreds of these.

So it really is a numbers game. So if you stick with us for a few more episodes, maybe we'll get your numbers up. That means you're coming back, Bill? I'm pretty stoked. Well, I want to do an e-commerce thing one in the future, which would be fun. Oh, man. Well, you've been so good with these things out of your wheelhouse.

I can't wait to see what happens when you get something, you know, right in your wheelhouse. It'll be great. Yeah, it'll be fun. All right, guys. Thanks a bunch. We'll wrap it up here, and we'll be back. Take care.