[00:00:04] Speaker A: Hello and welcome, everyone. I'm Peter Lehrman, and this is Masters in Small Business M A. This show is an ongoing exploration into the vast and undercovered world of small business M A, where we interview both the proven and the emerging owners, operators, investors, and advisors whose strategies and methods for transaction success have been put to the test. The show aims to us the nuanced intricacies, the key ingredients, and the important factors that can improve your decision making in your own journey in the world of small business M A. This podcast is produced by Axial, an online platform that makes it easier for business owners and their M A advisors to find, research, and privately connect with a diverse mix of professional buyers of small businesses. In addition to learning more about Axial, you can find this podcast, show notes, edited transcripts, and many other related resources, all for
[email protected].
[00:01:02] Speaker B: Peter Laraman is the CEO of Axial. All opinions expressed by Peter and podcast guests do not reflect the views or opinions of Axial. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Podcast guests may have ongoing client relationships with Axial.
[00:01:21] Speaker C: Welcome back, folks. This is Peter Lehrman from Masters in Small Business M a podcast produced by me in partnership with my company, Axial. I'm very excited to have Linda Rose join the podcast. As I was saying just before, delighted to have her be the first woman to appear on the podcast. And Linda, thank you very much for making time on your Friday to jump on the podcast with me. It's great to have you.
[00:01:42] Speaker B: Yeah, thank you so much for having me today. It is Friday, and I try to make it a half day event. So it's you. And then I'm heading out to the glorious sunshine here in Southern California.
[00:01:52] Speaker C: You've got a much better backyard in California than I do here on the streets of to just. I'm sure there are plenty of ceos and owner operators of businesses who in their next life become brokers and M A advisors. But it's not necessarily the most common path. It's a really interesting place to start our conversation, and in your case, you could start even earlier, just given that you weren't necessarily on the entrepreneurial track based upon what you studied in school. So let's quickly just hear a little bit about how you found your way from finance and tax and accounting into the world of owning and operating and running a business. And then we will fast forward to what you've been doing with Rosebiz thereafter.
[00:02:31] Speaker B: Sure. So I graduated college with a master's degree in taxation. I decided really early on that numbers was my thing, and so I was going to become a CPA. I didn't even know what one was when I first decided it, but then I stayed on to do a master's degree and went to work for one of the big eight at the times. There's only big four now, but after three years, four years with the firm, actually met my husband. And back then you couldn't date, let alone get married. And he was up for partner, and I didn't want to ruin his chances because usually you're with the firm for twelve years and it's this huge event to become a partner. I said, you know what, I don't really think this is going to be my whole life. I can't see myself spouting code sections for the rest of my life. So I'll leave the firm, let you become partner, and we'll see how that goes. And it was a good decision. I'm still married after 33 years, so it was a good decision, but it actually pushed me in a whole nother direction. I really, actually like to ski in the wintertime, and that was a problem being a tax accountant. So I found myself implementing an accounting system. It was fluky how that happened with a small company here in San Diego, and really, really liked the technology part of that. But actually, while I was with Anderson, I worked at world headquarters for six months and wrote some software for the firm. And that was really early on. I was one of the very few people that graduated from college that actually knew their way around a pc. And they shipped me to world headquarters and said, hey, can you help on this project? And so that was my first sort of entree into technology. Anyway, fast forward over the next 25 years, I basically started three companies. The first one was an ERP CRM consulting firm. Then I started a staffing firm to help all the life science and biotech companies that we serviced here in southern California in a turnkey solution so they could have people just immediately run it right into their accounting department and begin doing operations for them. And then somewhere in around 1999, I decided that cloud was it, although it wasn't called cloud then, it was called ASP. And so I started that in part because I had a golf company up in Carlsbad that sort of encouraged me to do it. So it was a client of mine that said, hey, can you do this for us? We'll pay for the servers, put them in a data center. Like, yeah, I could do that. So for about ten years, I actually ran three different companies. It was a crazy time. I was in my late 30s, early 40s. Just when you have three companies, you really have to rely on a management team. So I built out a management team in all three locations. And then the recession of 2008 hit, and it was, I would call 2009 my character building year. I had to shut down my LA office, lay off half my people, and by then I already sold the staffing firm. I sold that in early 2008, saw the tea leaves and got out of that. So I was just left with the other two firms and really started focusing in on which one was more profitable. I got out of the whole ego trip of building my empire on the west coast, which was where I was headed, with firms all up and down from San Francisco, Seattle, La to San Diego. And that was kind of my dream. And to roll that up and go public, the whole nine yards. And I just said, no. Something in that recession just really opened my eyes. And I said, I am going to focus on my recurring revenue, which was my hosting business at the time, which now became a cloud business, and ended up selling the ERP CRM consulting firm to a national CPA firm. Half my staff went with them, the remaining staff stayed with me, and we spent the next three and a half years building out our revenue on the hosting side. Got it to 98% recurring revenue with a 95% customer retention rate, and we sold it for 100% cash to a private equity firm. And I walked out the door 45 days later. So I then realized, oh my God, I don't have a job. I'm 55 years old. Not that I needed to work again, but my whole identity as a CEO was wrapped up in my business. Like all my friends were either my employees or people that I knew across the country from being in Microsoft channel for 25 years, that I had a little bit of an identity crisis. It's like, what am I going to do now? And I ended up going on a very long backpacking trip. Actually hiked 500 miles of the Pacific Crest Trail, and the trail is actually 2650 miles, but I didn't have time to hike the entire portion. So my husband dropped me off in southern Oregon and said, see you later. And I headed north. I had a satellite phone, and basically I said, I'll let you know. And I'm done with 500 miles, which put me somewhere in central Washington. Didn't quite work out that way. Hit some fires along the way, got off the trail for a bit, met a guy, brought a whole complete stranger home from the Czech Republic, who I met hiking along the trail. But that hike, when you're doing 18 to 20 miles a day, you get a lot of time to think. And somewhere on that hike, I decided I was going to write a book because I actually learned a lot in selling three companies. And I made a shit ton, can I say that? A shit ton of mistakes. And I didn't want anybody else to do the same thing. And so after I got off the trail, I spent basically the next year and a half writing a book. Of course, I'm a numbers person, not a writer. So that was a little bit of a transition for me. And there were days where I actually had to get up in the morning and have a mimosa to get that side of the brain working versus this side of the brain. But I ended up with what I think was a really good book. It did really well on Amazon. When it came out, it was one of the top business selling books. And I'm constantly getting emails from people who read the book, and I've just. I had no idea. I've learned so much. And it's not an M A book, it's basically a CEO's bible on how you get your company ready to sell and create the most value in that process. And that is what landed me in the space of M A. So before the book even came out, I had people call me up and say, hey, Linda, we've seen that you sold two of your own companies. They probably didn't know about the earlier one, the third one, staffing firm. And they're like, can you help us? And I said, sure. And here I am three years later, and over a dozen deals done of varying size, but all in the technology space. I stay within this lane. This is what I know really, really well. And those are the only types of clients I take on. So it's sell side only. I'm very passionate about getting the most amount of money for those people who have spent 2030 years building a business.
[00:08:51] Speaker C: I want to talk a little bit about the three businesses that you built before we move forward in your biography. I guess so. One was the staffing business, right. One was a business related to ERP. Can you just clarify that for me? What kind of ERP related business?
[00:09:06] Speaker B: Yeah, so we were really focused around the Microsoft dynamic stack and the different ERP solutions that Microsoft owned. They didn't own them all when I first started selling them, but over time they ended up buying them. And so we implemented those throughout the US, basically.
[00:09:21] Speaker C: Okay. And then the third was the ASP business. And was that a Microsoft ASP business as well?
[00:09:27] Speaker B: Or was that it was built on the Microsoft Stack? It wasn't on Azure, because Azure didn't exist back in 2000 or 1999 when I first started. So we colocated a number of different data centers, replicated across data centers, and my client base was heavily regulated companies. So people who were publicly traded had Sox requirements, we had people who were life science biotech companies who had FDA CFR part eleven requirements, some other financial services. So pretty much heavily regulated people who needed to have an extra layer of security and services around their data in the cloud. And we did all the testing and provided the results of the testing so that they knew their backups were happening every night and so on and so forth. My husband actually joined the company and became our chief compliance officer because he had an incredible background in audit and had worked with a number of publicly traded companies in the capacity of controller and CFO. So he was really good in it and I needed his help, so he came and joined us. In the end we didn't cover.
[00:10:31] Speaker C: When we got connected the other week for a little prep session, we didn't really cover. Like how did you find yourself starting three different businesses? How did you get there?
[00:10:39] Speaker B: It was all out of the needs of my client base. I mean, the first one really was just to put food on the table, right? I just left public accounting and decided I was just going to be a part time controller for a little while. And that led fairly quickly into implementing an accounting system for a boat company down here in Shelter island in San Diego. And then that led me into other clients and what was a hobby. All of a sudden I had twelve employees, and then I bought an office in LA and grew up into the LA area as well. And then that need, because I serviced a lot of life science companies in San Diego who are all startups just coming out of some vc backing, nobody on the admin team. So I put people out to run their accounting systems. They didn't need people full time. Initially it was just part time, so that's where the staffing firm came into play. But then that broadened out as well. And then the hosting again was the request out of a client. And I said, sure, I can do that. I mean, we've run some Citrix stuff before, some terminal server stuff, so we're capable of that. And that was actually the only company I ever wrote a business plan for and bootstrapped all three of them, never took on any debt other than the line of credit that we always had, just in case receivables didn't come in when they did, but the hosting business just really took off in 2010. It was a perfect storm between being able to buy everything now on a subscription basis. Internet was great for everybody, and people just didn't want to spend money on software and hardware. They were conserving their cash after this recession. So it was a perfect storm for us.
[00:12:08] Speaker C: You sold all three of those businesses successfully? Successfully. Meaning a transaction was completed. Right. But some big contrasts in terms of outcome there. What are the big takeaways for you? I know that one of the big takeaways was just the importance of having a really high quality advisor at your side. That's one of the things that we discussed the other week. What were some of the other takeaways from going through the process of selling three businesses over what, about ten years? Right. You sold the three businesses between 2008 and 2017, right?
[00:12:37] Speaker B: Yeah. It really was. Making sure and understanding. Well, I come to understand that the buyer wants revenue that's going to be secure going forward. And while I had a very thriving consulting practice, they were one off projects. They would start, they would go for a year, they would end. Whereas the cloud infrastructure business was 724. The servers always worked. I didn't have to worry about anybody being on vacation and not having billable hours. It was just a question of keeping the servers running. The uptime guarantee, we didn't have a receivable problem. We billed in advance. People always paid us on time because if they didn't, they'd get turned off. No one ever got turned off because they always bet us. And it was a virtually 100% recurring revenue stream. The only thing that wasn't recurring revenue was the initial onboarding. And who doesn't want that? Right? That's what everybody is striving for, is that kind of recurring revenue stream. It's almost unheard of to be at 98%, but we got there, and that just pretty much allowed me to walk out the door. They didn't need me to make sure that the revenue was going to continue on, because most people didn't even know who I was at that point anyway. My name was on the door. That was it.
[00:13:45] Speaker C: What was the transition process to that much revenue becoming recurring? It sounds like there was a significant period of time in the life of the business. It's not like revenue by default, if you run an ASP, is recurring. It sounds like you made a pretty explicit effort to get a very, very large percentage to be recurring. So maybe we could talk a little bit about that. What is the spectrum of recurring versus non recurring revenue that sort of occurs within this category of business. And how did you guys go about pushing more and more of it to recurring? Were you doing that by removing customers and getting rid of customers who weren't paying you on a recurring basis? Or were you finding ways to transition revenue to a recurring model with existing customers that historically hadn't paid you on a recurring basis?
[00:14:27] Speaker B: But consulting always remained in the ERP CRM side of the house. Right, which we ended up selling in 2013. The hardware side, the infrastructure side, always remained on the cloud side of the business. So actually selling the consulting service catapulted us even more because we were now no longer competitors with everybody else in the Microsoft ecosystem. Right. So they would send us their deals, they would send us their clients who wanted to be put in the cloud because they didn't do it at the time. We were the only people that were doing it. So where we were selling direct, initially, when we had both firms, we started selling through the channel. And that catapulted our sales tremendously in the last three or four years, because it was the last three or four years that I had just the last firm that catapulted those sales in terms of just cloud only. And we didn't do any consulting in that group. It was just a monthly server maintenance, uptime, storage guarantee that we did as that was our revenue. And the only sort of what I call hourly service was the initial onboarding and getting that data onto our servers, onto our platform. So by definition, it was a completely recurring business.
[00:15:43] Speaker C: I see, yeah. So let's get into the exits a little bit of these businesses, because that sort of sets up the vision quest on the pacific trail and everything that came after that. So you want to go through each of those three, or do you want to, like, I know that the final one was probably quite substantive, the business that you sold to ESW.
[00:16:00] Speaker B: Yeah, that was definitely the one that allowed me to sort of retire completely. The ERP CRM firm, again, very project based, very driven by sales of new clients selling software. Whether that was on premise, it was mostly still on premise at the time, but we did start selling some cloud solutions. But a lot of that revenue was still like 60% of that revenue was still implementing those systems. Right. And I had very senior people, I was paying people even back then over $150,000 a year. And so the margins even on the services were getting slimmer and slimmer all the time. You couldn't continually increase your hourly rate, so didn't have the same appeal as the hosting side, because the margins on the hosting side were so much greater as well. We would just wrap all these services into everything, and it was just one monthly fee, and so we could build more margin into that. And as servers got older, we could move them off the heavier, dutier clients onto the lighter clients that didn't need as much capacity. So the life of our servers lasted so much longer. And when you really manage your servers in a good environment, it's crazy how long they do last. So we got a lot of mileage out of everything we did on the hosting side. And again, because we had three year contracts, for the most part, with all of our clients, you knew where the revenue was coming for the next three years. You could never really do that in a consulting firm. People don't sign up for a three year ERP implementation, or at least not in what I was selling. Right. Everybody wanted to get done in six to nine months. So the margins were different, the multiples were considerably different. I had an earn out on the consulting firm. I had absolutely no earn out on the hosting firm because they were so different. And the revenue was there, it was already booked. You just had to make sure the service stayed up.
[00:17:52] Speaker C: You hired an M A. Advisor to sell the business. Let's hear a little bit about that. How'd you hear about the m. A. Advisor? How'd you select him or her?
[00:18:00] Speaker B: Yeah, so I got the random email, hey, are you interested in your firm? We specialize in the IT space. So I called up the group and they said, oh yeah, you're a little bit too small for us. So they sent me off to their sister group. And I don't want to mention any names, but I ended up using a smaller offshoot of this larger firm. And they were really good in helping me find buyers. I really wanted to look into the PE space. I had no experience looking into the PE space. I looked around at my colleagues in terms of who could buy me, and I knew what their cash situation was for the most part. And I knew how much I wanted for the company, and I just didn't think there were too many of them that could come up with that amount of cash. So PE was really where I wanted to go. And I almost exclusively just looked at PE at that point in time, private equity firms and I needed a broker to do that because I didn't have the capacity or the know how to find those people on my own. And it was good. They brought a ton of people to the table. I think we came really down to three that were interesting. The offers were very different. I actually took a lesser offer because the other offer had a two year earn out, and I just couldn't see myself hanging out for two years with these guys as the owners. It would have been just too much of a conflict. And I knew enough about myself that I wasn't going to be somebody's good employee. I probably had too many of my own thoughts still, and they wanted to take over the company. So I really did know the best thing for me was to take the money and run.
And so that's the offer I took. But my broker got me there. He wasn't FInra authorized, so he hid behind that a little bit. Didn't really help with the normalizations, didn't help with negotiating anything beyond the Loi. I did have a good attorney. I'm a CPA in a form of life. So I came up with most of my EBITDA adjustments and normalizations. But knowing what I know now, I absolutely left money on the table. And again, that was the impetus a bit for writing the book, because I realized once I was done with that transaction that I could have done better because I learned so much during that process.
[00:19:57] Speaker C: Can you say a little bit more about the FINra aspect of this and what you're referring to that? Why do you mention that?
[00:20:02] Speaker B: Sure. So to be an investment banker, there's a number of series exams. I think you start out with the seven, and then you do a couple other exams to become an investment banker. I get hit up on that pretty often, by the way. But at my age, I don't really want to take any more exams. So if you're not FINRA or by the SEC to do transactions, there are certain transactions you can't do. You need kind of stay away from stock transactions, and there's a certain amount of negotiation you can't do either. Right. So as the advisor, you can advise and give your client advice, but the client really theoretically needs to come back and say, okay, based on your advice, I'd like to go this direction. I can't really be negotiating directly with the buyer and saying, well, this is what we're going to do, without really consulting my client and getting their input and that sort of thing. So there's just some lines I can't cross there. I have to be very careful, but I pretty much do everything an investment maker does. I prepare a blind profile, I prepare a sim. I look at all the lois.
When there's multiple lois coming in, I let my prospective buyers know these are all the things I want to see in my lois that come in so that we pretty much have all the broad breaststrokes already covered in the lois. So when we get to the legal documents, we're good. I prepare my sellers and make sure that we have a fully stocked data room so once we do sign an Loi, we're ready to go. We're not hunting down documents, looking for things, looking for agreements, looking for S Corp election. All that stuff, all that stuff's already in the data rooms. We take that pressure off the sellers, which, again, my broker didn't do that for me. I kind of did all that hunting afterwards. And when you don't want your entire management team to know that you're selling just yet, that does put the onus on the owners to do a lot of that due diligence initially. So we do that in advance now we do that in advance of going out from that perspective. I take it from soup to nuts, I'm there holding their hand all the way to the end when they tell their employees how to figure out their bonus checks, how to announce to the public, how to announce to the customer base the difficult, the conversations that happen between buyers and sellers, which I remain in the middle and sometimes have to tell my seller, do not say that on this call. I do not want to hear you say that on this call and just really counsel them on the etiquette because things get heated in the end, right, people? It's a very emotional event, especially if you are tied to your business. If your whole life is tied to your business, it's a very emotional event. A selling in the end, whether you stay or whether you go, it doesn't matter.
[00:22:29] Speaker C: You stumbled into becoming an advisor yourself. You wrote the book, but your plan after writing the book was not to become an advisor, is that right? You still hadn't made that choice. You just planned to write a book.
[00:22:42] Speaker B: No, I really hadn't, 100%. But when people started calling on me, because people saw me as this owner of these technology firms and the book moved the needle the other direction, where they now saw me as an expert in being able to sell technology firms, because I put everything into the book that I learned. Plus, I interviewed countless people, both buyers, sellers, strategic buyers, pe buyers, put together a whole valuation maximizer. So there's a whole assessment that goes with the book because the other thing that really is a problem for me is when sellers come to me and say, oh, my company is worth ten x. And I'm like, but it's not. And here's the reasons why. Let's take this assessment, answer these 38 questions, and we'll come out with what the value of your business is. And this assessment that I wrote has got a ton of algorithms in it. I spent six months writing it and coding it, and it is pretty spot on with determining the value of your company and then also telling you where your value gaps are, what you need to work on to increase the value of your company. Right. And so when people get through taking this assessment and get the results, the light bulb goes off and they realize, okay, I get why I'm not worth ten x now. And I know what I need to work on as part of writing the book. I also wanted to give people a tool to help them determine their value, because it's the biggest asset we own. It's bigger than what we own in the value of our homes, right. But we can go out onto zillow every day and know what the value of our home is. But our asset, which is our company, we have no idea what the value is. This assessment that I wrote, which is part of the book, gives people that idea of potential value and really what they need to work on to increase it.
[00:24:19] Speaker C: How's the book doing these days? I mean, when did you publish it?
[00:24:21] Speaker B: I published it three years ago, so August of 2019. And the royalties keep coming in every month sells itself, and it's great to run into people at a conference and all get up on stage and say who I am, and they're like, oh, my gosh, I read your book.
I had one guy that actually called me, and he's like, I'm not a stalker, but feel like I totally know you. And your book has transformed the way I look at my business, and I just want to call you and thank you. And it's those kinds of outreaches. Whether somebody calls you or sends you an email, it just makes it so worthwhile that you've touched somebody's life and they see the light and realize what they need to do. Because until you go through this process, you really don't truly understand it. And most people only get one chance at it. Thankfully, I had three and made tons of mistakes all three times. But if you only get one chance, you really want to do it, right?
[00:25:12] Speaker C: Right. So on your LinkedIn profile, you call yourself a channel partner. M a advisor. So where channel partner, in the context that you're thinking of it, is technology resellers. Right. That are reselling technology from the major technology organizations. Let's spend a little bit of time just sort of hearing how Linda thinks about the quality of businesses that are part of this channel reseller category. Like, if you could dive into the category a little bit and sort of, do you have a framework for thinking about the quality of the different types of businesses? Of course, recurring revenue is very clearly, that's a very understandable concept. And if everybody can have high retention and recurring revenue message received, that's obviously a well known. That's a well known thing to solve for as best you can. But separate from that, what are the other things that distinguish the different types of channel partners that are in the sort of technology services category? Like, walk us through the category a little bit.
[00:26:04] Speaker B: Absolutely. So when I wrote the book, I identified six categories of it professionals. And you can say you're an it, but unless you can really delineate these six, you don't really understand it because the valuations and what makes them unique is different among the six. So you can start out with a value added reseller, VAR. We're all comfortable with that acronym. Then you have your MSP, which is your managed service provider. You have your MSSP, which is an offshoot of an MSP. So now we've thrown security in there. You have a CSP, which is a cloud services provider, which is different than a VAR, which is different than an MSP. And then you have an ISV, which is your independent software vendor, which are people who maybe have created add on solutions to some larger applications, like Netsuite, Oracle, Microsoft, SAP, those. And then you have what I would call your SI, your system integrator, which is your over 100 million dollar firms that kind of do it all from soup to nuts. They do bi, they do power objects, they do the whole stack across multiple different platforms, not just azure or Google or IBM. They'll cross all platforms. And the valuations are different. And the uniqueness about each one of these is quite different. And I talk about each one of these in the book, and I have a chart in there and said these are basically the valuations based upon your revenue that you can expect to see. And this is the appeal for each one of these.
[00:27:28] Speaker C: What drives the appeal? Is it purely quality of revenue and quality of earnings in the recurring nature, or is there something else that's driving it as well? What are the big drivers of appeal and value?
[00:27:37] Speaker B: Yeah, so usually on the VAR side, it's very industry specific. So if you have an industry specific solution that is going to appeal to somebody versus being very horizontal on the MSP, MSSP side, more people are interested in security. MSP has become a commodity. It's like almost a little bit, unless you specialize within an MSP, legal or some other specific industry, it's almost a little bit of a race to the bottom in terms of how low those fees can go. But when you move into that MSSP space now, you're adding a layer of stickiness so your clients are not going to bounce off you so quickly because you're putting a lot more in place to monitor that data and pings to their hardware. With a cloud service provider now everything's cloud based. So you're not only selling a cloud solution, but you're maybe managing their other data on Azure or whatever cloud you choose. So there's a component to that, there's a component to moving that data, managing it, monitoring it, and backing it up, because it doesn't happen magically in the cloud by itself. And then with your independent software vendor again there you're creating a product that hangs on to a much larger solution where now you've got an entire channel that can potentially sell that for you. You're out in a marketplace where people can shop your solution, 724. And you may have started out as an on premise solution, but over time have migrated into a cloud solution where the margins are much higher. And again, we're now back into more of a recurring revenue stream versus a one time sale. Each of them have appeal. Some people are only looking, sorry, I forgot about the custom developer. And those are the people that don't have recurring revenue, but they may have repeat revenue where they do large scale development projects for clients that can go over multiple years. And some of them offshore a lot of their work, so their margins are much higher. They keep for the management team here in the US, and then they may offshore the rest. There's a lot of value in those firms as well. And ISV might be looking for a custom developer, an MSP might be looking for a bar. I mean, even we have some people that are consolidating all these together, especially in the PE space. I see a lot of them starting out with, let's say an MSP and now wants to tack on a CRM ERP partner to it, or wants to tack on a business intelligence partner to it. You can do that and you just look in these different buckets for those different types of people. But the valuations are different really, and.
[00:29:58] Speaker C: Separate from the valuations being driven by nature of business model and recurring levels of revenue and revenue retention. Are there substantial fault lines in terms of the technical, the technical moats or the technical barriers to entry, or the technical complexity of the different organizations. Like if you had one of these it organizations that had 90% recurring revenue and you had another one that also had 90% revenue, what would be the other considerations against which they could drive up or drive down value?
[00:30:28] Speaker B: Yeah, that's a good, very good point. So there are some channels that provide better margins than others. Right. And you don't want to be in a low margin channel, and you don't want to have all your eggs. If you get to a certain size, if you get to over 10 million, 20 million in revenue, you don't want to just be in one channel. You actually want to be in multiple channels, because if one channel decides to reduce their margins by 5%, every customer that hits every customer. But if you're in multiple channels, it may only hit a third or affect a third of your customer base. So that does become an issue with investors, PE, especially when they see all your eggs in one basket, in one channel basket. That gets them a little uncomfortable. So when you get to a certain size, you really actually need to disperse amongst multiple channels, which is hard to do because it's hard to learn multiple products. Right. It takes a certain level of expertise. So what you try to do is get things that are as close together as possible, and the learning curve to learn the next one is a lot easier. It's like learn Spanish and then learn Italian or learn Italian, then learn Spanish, because they kind of overlap a little bit. I'm not sure how learning Russian and Chinese are going to overlap. That's just two very different things. Right. So you pick something that's close.
[00:31:40] Speaker C: Do you encounter a lot of customer concentration dynamics in these types of businesses, or does that tend to be less of a consideration?
[00:31:47] Speaker B: Usually not every once in a while I see that at the MSP level, but typically not usually no customers more than 10% of your revenue.
Sometimes I don't even see that.
[00:31:59] Speaker C: And why is that true? Just because of the nature of the customers that they tend to serve?
[00:32:03] Speaker B: Yes.
[00:32:03] Speaker C: Let's talk a little bit about the financial side of this. You were trained in accounting and tax.
That came full circle for you as an advisor. We spoke the other day a little bit about this. I think the most interesting area is just to hear a little bit about where people go wrong, either as investors or more commonly as operators, in terms of how they think about gross margin and what's in the cost of goods line. Let's dive into some of the accounting and financial considerations that can hang up a deal or can surprise a business owner.
[00:32:35] Speaker B: So when I take on a client, I don't take on very much. I consider myself a very boutique advisory firm, partially because I don't really take on more than half a dozen clients a year. That's what keeps me somewhat semi retired. Right. Only want to turn this into a 40, 50 hours job that I did before. I actually want to enjoy my time. So when we do take on a client, I want to be absolutely sure we're going to make it all the way through this transaction and that we're not going to get retraded in the end. Right. No one wants the value of the company to go down at the 11th hour after the quality of earnings report has come back. And, oh, guess what? Your gross profit margin isn't 60%, it's really only 40. And because of that, we made you an offer based upon a 60% gross profit margin, not a 40% gross profit margin. And now we're going to change your offer. No one wants that. And unless you understand financials, that can happen all the time. And honestly, even with the ERP firms that sell ERP solutions, they know accounting. And a lot of times I have to go in there and look at their books and say, hey, guys, we need to move some of this labor up into cost of goods sold. It's not GNA. It should be up in the cost of goods sold so that we can accurately present gross profit margin. And you would think, okay, well, that's probably an issue with the smaller companies. One of my earlier clients was $80 million in revenue and basically on a cash basis. I mean, I looked at their PNL every month and there were months where the cost of goods sold was greater than sales. I'm like, how could this possibly be? We just had this roller coaster of bottom line net income. I'm like, we can't go to market like this. We actually need to get on, like, an accrual based accounting. And they're like, oh, we're accrual. We have accounts payable and accounts receivable. And I'm like, well, that's just half the story. We actually need to match the revenue with the expense. And that's where people kind of fall off the wagon. They'll pay for the software in one month and bill the client in another, and the cash comes in in another month. Everything's kind of crazy. So making sure that everybody's gap based financial statements to the extent that we can, it's not going to be 100% gap. There's always going to be some little thing that we didn't allocate over twelve months, but usually immaterial at that point by the time I'm done with them. But I spend time getting their financials ready because we don't want any surprises in the end. Right. And so sometimes I need to spend.
[00:34:49] Speaker C: Right. And within the cog seems to be like a specific area. It may be a specific area in a lot of businesses, but I want to make sure that we unpack it within the channel partner and the it services category. Is there a judgment call related to what goes into cogs here or is it really clearly spelled out?
[00:35:08] Speaker B: It's really spelled out.
[00:35:09] Speaker C: Okay, so what are people not appropriately inserting into the cost of goods sold line and therefore messing up the gross margin?
[00:35:17] Speaker B: A lot of times it's the labor, the benefits. They'll put the software costs in there, but they won't put all the people costs associated with making sure that the implementation is done or the servers are running and they'll leave the benefits out completely. It all belongs up there. It needs to be fully loaded. You got to go back to your. Pull out your cost accounting book and see what belongs up in the cost of goods sold. Most people don't do it because they don't need to. The tax returner doesn't require it. Even the bank doesn't require it. No one's really diving into that gross profit number, but buyers do because a lot of times they just. Especially if they're looking to consolidate. Once the acquisition is made, everything below cost of goods sold is subject to getting removed. Right. You want to reduce some of that GNA. So you have to have a strong gross profit number to be enticing. And it needs to be the right number. So it is an important part of somebody's financials. Very important part.
[00:36:13] Speaker C: Is there a sort of target, sort of good, better, best target range for appropriately allocated gross margin?
[00:36:20] Speaker B: There is. And again, it varies by those different types of partners that we talked about. Right. So the bar usually have the lowest gross profit margins. They're sitting around 35, maybe 40 at the best. The isvs, they're up in the 80, 70, 80%. Right. But that's the expectation. Msps, I'm usually seeing them in the 50, maybe the really good 160 percent gross profit margin. Again, they vary by the type of it firm. The savvy buyers really do know what those should be and they look for it.
[00:36:55] Speaker C: You said the bank doesn't care. What do you mean by that why doesn't the bank care? And in what context?
[00:37:00] Speaker B: Bank is more interested in bottom line cash flow. Right. Are we cash flowing and what's the bottom line? Net income? They're not as interested in gross profit margin, not unless you're selling goods like inventory. But most it firms are not selling inventory. They don't have inventory that turning around.
[00:37:15] Speaker C: But buyers care about cash flow too. So what accentuates the distinction in terms of caring about it so much? Why do the buyers care so much more differently than the banks? Because they both care about positive cash.
[00:37:27] Speaker B: Sure. But the buyers now are maybe taking on some additional debt service to finance the deal. Right. There's going to be some debt, probably some equity, maybe it's all debt, who knows? And so the cash flow has to be able to support the additional debt that's being taken on. So we're looking at cash flow pretty heavily as part of the quality of earnings report that's usually done by the buyer.
[00:37:47] Speaker C: Do you feel like the revenue recognition side of this world is easier or similarly messed up than the cog side? Because that was another point that we discussed last week. Just deferral of revenue. Recognition of revenue.
[00:38:03] Speaker B: Yeah, I think most people are getting in their arms around that. It's gotten better over the last three or four years. More people getting savvy about it, understanding that if they're going to build the client for the entire year, they don't recognize all that revenue one month, they need to defer it out over twelve months. So people are getting a little bit more savvy about that. Even at the under 5 million revenue.
[00:38:23] Speaker C: Level, you're seeing less and less of that when you explore working with a.
[00:38:26] Speaker B: Client unless they're fully cash basis. And typically, if you're over 3 million in revenue, you've kind of moved to some sort of modified accrual.
[00:38:35] Speaker C: Linda, is there a questionnaire that you send an inbound business owner who pings you about potentially working with you on the sale of their business?
You said you have 38 questions in the book organized around arriving at value. Do you have an equivalent to that that you use to sift through the potential clients? How do you think about taking on assignments?
[00:38:56] Speaker B: I don't do that initially. It's a little bit too.
I like to make it a little bit more personal. So we get on the phone, we have the conversation around first, the mental readiness and why do you want to sell and how long do you want to stay and do you want to stay around for a second bite of the apple if that's applicable or do you just want to stay for your earn out? And if you don't even want to stay for your entire earn out period, let's talk about your management team that's going to execute on your earn out. And who are they? And then that's when people, some people realize, well, no, I probably need to stick around. I'm like, okay, well, good. We've had that conversation. But then I have other people that are like, you know what? We can exit left anytime. We've got a great management team. We're just going to be there, the transition. So I like to understand that I don't want to see sellers, that the whole business revolves around them. They're like, we want to get cash and then walk out the door. And I'm like, you know what? That's not going to be appealing to any buyers. So if that's really what you want to do, I don't think we're going to get much traction there. So let's get real about that. I talk to them about the state of their financial statements. I want to know how savvy they are in terms of having prepared them. How realistic are they about their projections? I'm always amazed at how people, even in February, don't have projections for the rest of the year. And I'm like, we need some. We need real ones. And a lot of times I help them through that process and they'll give me something and I'm like, this doesn't look real to me. You got to up these numbers, too. It's a discussion around how ready you are mentally, how prepared is your team, how prepared is your infrastructure. Do we have any high customer concentration that we need to deal with initially? Do we have all of our customers under current contracts or do we need to spend some time working on that? I mean, a lot of times I tell people, here's your laundry list of things you need to do. Go away. Come back in a year when you're ready and we'll talk again. Other people are ready and just need a little handholding in the process that I can determine in half an hour, honestly, and if they have what it takes and understand what this process means and how long it takes and have a realistic understanding of the valuation of their company. That's when I send them the intake form and that's when we start pulling together a bunch of financials and other data that we start stalking the data room with.
[00:41:06] Speaker C: I'm curious, we didn't discuss this last week. I'm curious how much time do you spend thinking about buyers and how much time do you spend thinking about your relationships with buyers and what do you do in the realm of buyers and knowing different buyers and how much time is just dedicated to the buyer side of the table versus evaluating different sellers and just what do you think about there and how do you prioritize? How much time does it get?
[00:41:32] Speaker B: Yeah, it gets a lot of time. We start with the seller and what they're looking for first. But let me give you a recent example. So I completed a transaction the first week of January because we couldn't get it done at 1231, which my client had gotten twelve offers. We probably had 65 signed NDAs and we ended up after our chemistry calls and second and third calls with the buyers, we ended up with twelve offers and they were fairly close to one another. And then that then brings up the point, well how do you choose between those twelve? You do it completely on price. No, you don't. Do you do it completely on terms? No, you don't. You do a combination of who understands your business, how successful they've been in this industry? Have they had other exits in this industry? If they're a PE firm, how involved are they going to be going forward? So part of it is understanding where the weaknesses are with my client and where the right buyer is going to shore up those weaknesses or there's going to be a good complementary fit. I do know always my client's unique value proposition and I can tell early on if that value proposition resonates with the buyer or if they even understand the value proposition. There's a lot of people that want to get into the space and don't understand the space. And I can tell fairly quickly because I've spent 25 years in it and every once in a while we'll do a chemistry call and I'll get off the call with my seller. And I said, so would you work for that CEO? It's almost the first question I'll ask, so would you work for that CEO? And you can almost tell right away what that answer is going to be to them to go, yes, I saw some great energy there, or absolutely no, they have no clue what I do. And you can tell very early, but usually it's those calls. I haven't done my job because I usually confess that out in advance. I know space well enough and who's going to really provide value to my seller and whether it's going to be a good fit. And I don't want to waste buyers time either. Sometimes I pass on people never even have a call because I can just see from their website what their experience has been. And if I don't see anything in it, we're probably not going to have a conversation unless you really hunt me down.
[00:43:38] Speaker C: And so that's in the context of a transaction that you have in market, right? The answer you just gave is all in the context of like, you're working with a seller, you've got a live transaction in the market. And this is how you're engaging with buyers. When you're not working on a live transaction and you're not engaging with buyers on that specific transaction, what is the nature of the interaction that you just have with the buyers that are in your category or interested in getting into your category?
We both know, right. Everybody has email blasting machines. Everybody has databases of brokers and advisors. Everybody has databases of business owners. So there is this continuous spam machine that is underway in the world of M A. Where people are trying to sort of get in front of one another prior to a transaction or get on your radar, try and be top of mind. So I'm just curious, how do you engage in that fray, again, outside the context of a live transaction, where you're talking about a specific deal and you're meeting with buyers in the context of that deal?
[00:44:41] Speaker B: Well, you hit the nail on the head. I probably get five to seven emails a week of PE firms or independent sponsors or family offices that are specifically looking to get in it and somehow came across my name, however that might have be, and are asking, hey, do you have any projects coming to market? This is what we're looking for. Some of them will send across a one pager specifically. And usually I look at usually all of them. Every once in a while, somebody will send me something that kind of turns me off. But for the most part, I look at every single one of them. And some people, if I see some interest and I see, because again, I'm very niche, right? It is my space. And I see there could be a good fit. Or I go to their website and I see a portfolio company that I can see would be a good tuck in for a client because I do more tuck ins than I do portfolio companies. Then I'll call them up and say, yeah, tell me about this portfolio company. Tell me what you're looking for. What appeals to you. Is there in a specific area of the country? Are you looking for specific EBITDA? We have those conversations and that goes into my database. And then when I'm ready to take a client's market, or if, even if I'm just doing a small outreach, I'll reach out to those folks.
[00:45:48] Speaker C: What database do you use?
[00:45:49] Speaker B: I use clarity soft.
[00:45:50] Speaker C: Got it. Yeah. So it sounds like if the buyer that reaches out to you in just a general way has enough specificity of interest and has enough overlap within it, you engage, but otherwise, it just kind of hits the archive box.
[00:46:05] Speaker B: Right.
[00:46:06] Speaker C: A couple of weeks ago, I interviewed Taurus Richardson, who's a really accomplished lower middle market investor who's bought a lot of businesses in the utility services category. These businesses tend to have sort of single source contracts with either the government or investor owned electric utilities, and they very routinely have as much as 80 90% of their revenue concentrated in a particular customer, maybe even 100%. And many cases, Tars has either acquired minority owned businesses or acquired non minority owned businesses and made them minority owned businesses through a lot of diversity efforts that are a personal priority of his, both because he believes in it and also because he believes that it can lead to great business outcomes, and he's been able to create a double bottom approach there that he feels good about, and that works well for him. You and I talked about this a little bit in the context of women in tech and women owned businesses specifically. I was surprised by your answer, which is why and your point of view on it, having read a bit of it on your blog. So I did want to touch a little bit on this, just because it represents a different point of view from what I learned about a few weeks ago. So just take me through women owned businesses, having the women owned businesses designation, and the risk factors that you've seen and the considerations you've seen. And then what I'd love to do is see if you have ideas for how that could be improved or what would be a way to change things so that it doesn't have some of the scarlet letter issues that I'm sure you'll lay out.
[00:47:37] Speaker B: Yeah, definitely. So I have actually represented a good number of women. I think women sort of gravitate to me because there are too many women in MNA, and so I think they just feel more comfortable working with me. And they are all the majority owners, 51% or above or 100%. And it is the absolute first question that a buyer usually asks, is this a woman owned business? This is a certification. And, I mean, it's just front and center. It's the elephant in the room, and I have to answer it. It is something we have to deal with, and it has come an issue, and we've had to work around it on deals because you can't be woman owned one day and not the next. My advice in advance, if you know you're going to sell in the next three to five years, I would discontinue the woman owned business certification. You can keep it over on the side, but don't file it with your clients every year and start transitioning those clients to saying, look, we've worked together 510 years. Hopefully you're working with me because I do a great job, not because I'm a woman owned business. Although the customer may say, but, yeah, it helps us check that box. And I think that's when you have to be honest with your customer and say, you know what, I don't want to be put in that box. I want to be viewed as a good vendor, not because I'm woman owned. And that's really hard for some women to get their arms around because they're like, well, I'm getting projects because I'm women owned. Okay, great. But at this point, when you're ready to sell, we shouldn't be so concerned about getting projects anymore as we should be able to demonstrate that we can get projects and not be women owned. Because the reality is whoever buys you is probably not 100% woman owned or greater percentage women owned. And it's going to become a problem for you. And it's really hard when you're in the middle of the due diligence process to go, okay, well, we're going to go talk to the customers and see potentially if they're not going to use you, if you're no longer women owned because you're going to get bought, you can't have that conversation. Right? I mean, I had two years ago a lady who had a phenomenal business, massive margins, right. Women owned business, huge problem. And it created an earnout where there didn't need to be an earnout because we had to wait for certain master service agreements to be determined so we could re add them later on and not be in a women owned business status. So while I'm sure it has served you well to this point, I would say the last three years before you decide to sell, you unload that status as quickly as possible because it will become an issue. Absolutely.
[00:50:13] Speaker C: Can you give a sense for the scale of that earnout and how you think it impacted the economics?
[00:50:19] Speaker B: I think they could have gotten 100% cash offer, and in this case, it created a three year earn out.
[00:50:25] Speaker C: A three year earn out on roughly what percent of.
[00:50:27] Speaker B: Because the MSAs were tapering out over three years for the women owned status.
[00:50:31] Speaker C: And do you remember roughly what percent.
[00:50:34] Speaker B: Of total enterprise value they probably ended up at? About 32 million. I would say a third of it ended up in an earnout.
[00:50:42] Speaker C: A third ended up in a three year earn out. Wow. Okay. So that's a lot.
[00:50:46] Speaker B: Yeah, it's a significant amount.
[00:50:48] Speaker C: So you board your plane, you head to Washington DC, and you have whatever audience you need to have in terms of changing the way that a designation like this works, what do you recommend?
[00:50:58] Speaker B: What would be better in the government space? That is tough. That is really tough because I think that is one space where especially if you're minority owned women, I mean, almost being a woman owned business is almost a bit passe these days. If you're a minority owned woman business, that's a whole nother ball of wax like that gets you indoors. I'm not sure 100% how much being a woman owned business really does for you. It may in the government space, but I don't play in that space. I don't know for sure. I play in the private space. I think in the private space it's a box that large vendors like Microsoft and IBM and Oracle, and they want to check that box to say they can be diverse. I don't know that it's going to affect the project in the end, whether you win the deal or not. In the end, if you've had a previous relationship with them for many years and you just continuously go back to that well from new work, I don't think it's going to affect it. I can't speak to that in the government.
[00:51:54] Speaker C: What does it take to unwind the designation?
[00:51:56] Speaker B: You just don't file it. You just don't file it. When you go to renew your vendor certificate, you just don't file it. Now you're probably going to get pinged with ten emails and saying, hey, we haven't gotten your blah blah blah status. And then at which point you say, look, we've decided not to renew it. Now I on the side would renew it. I would do it renew it but not use it. Right? So if somebody said, well, there's just no way we can work with you unless you have it, then you just plug it back in again. But behold, it's only one client and not all your clients, right? So that's how you test the waters in terms of who really needs it and who doesn't.
[00:52:28] Speaker C: But it comes out as part of diligence, right? So if you are women owned and you have a registered. You can't withhold that, right? It will come out as a representation.
[00:52:36] Speaker B: No, you can't. Then they'll ask for which clients you've filed that certification with.
[00:52:41] Speaker C: I see. So you can file it on a customer by customer basis.
[00:52:45] Speaker B: Yes, you usually do.
[00:52:47] Speaker C: That seems like the way to manage this. Right. Maybe it's something that you use as a mechanism by which to acquire certain customers and begin to build a book of business, but then you competitively deliver a great service. And so you're comfortable that you can renew the business without refiling that certification.
[00:53:05] Speaker B: Yes, exactly the way to do it.
[00:53:07] Speaker C: And so you unwind it after you've acquired it. Okay. Roughly speaking, how long does it take before you meet a client, before you're in the market? What is the range of time when you factor in these kinds of things? You factor in preparedness, readiness. What does it typically take? You get an inbound lead because of your New York Times bestseller. You've got a great blog. You diligently write on the blog, so you get an inbound lead. What do you think is generally the lead time between when you begin to have an initial conversation with a sufficiently qualified seller, where sufficiently qualified means sufficiently qualified from your perspective to where you find yourself in the market. And I'm sure it varies, but I'm just looking to get like a min max and a range.
[00:53:44] Speaker B: So I do believe there is cyclicality to M A. We work on a calendar year. I think for the most part, we are all looking for new deals in the beginning of the year. We get a little saturated in the summer months where we're in due diligence or we've issued some lois. And now we're kind of deep in the redlining of agreements and the capacity to look at new things, depending upon the size of the firm, may not be there. So I really like to work on a calendar year with my clients. So if somebody comes to me in September, I'm like, we're not going to market this year. This is what I need you to do. For the next three months, we're going to work on X, Y, and z, so that come January, after we close the books in December, we're ready to go to market. Most of my clients are in the market by March 1, which is a lot of work on my team behalf because we have a lot of numbers to get through. But a lot of that data has been collected already. The stuff that we really just are waiting on is the 1231 data to finalize stuff. We've got the previous year's numbers. We've looked at the data. We've looked at the customer concentrations. We've looked at a lot of things already because to me, you want to get the deal done before the holidays, ideally before Thanksgiving, and then if not, it's going to drag into early December. Nobody really wants to work on a deal after December 15. Now I have closed deals on December 31, but that's not anybody's idea of a good time. Right. Legal wants to go home. PE wants to go home. Everybody wants to go home for the holidays. So the ideal time to go to market is not January because people are still cleaning up in January. Clients don't have their 1231 numbers ready yet, so they're not prepared to go to market. February is kind of like, let's get everything together. So starting mid February, beginning of March, we go to market, which, again, depending upon when they ping me, I get time to work with them in advance. If they come to me in December, got a lot of work to do to get ready, and we have to do it quickly.
[00:55:35] Speaker C: And you're doing three to five transactions a year if you have your druthers, right?
[00:55:40] Speaker B: Correct.
[00:55:40] Speaker C: And so just to be clear, does that mean that because you kind of like to calendarize things, does that mean that you tend to be in the market with multiple businesses in the first one to two quarters of the year? Like you're going out the door with sort of the calendar years. Okay, got it. So you've got them somewhat synchronized in terms of going out and going to market in the first quarter. You don't have two that you go out between sort of February 1 and March 15, and then another two that you sort of go out the door after 4 July. It tends to all be organized around the first quarter.
[00:56:15] Speaker B: There are occasions where somebody has identified a buyer and just needs me to help put the deal together.
And actually, last year I got brought into a deal like Thanksgiving weekend, where the deal should have closed in two weeks, but counsel for the seller was just not the right fit. So I came into the deal at the request of the buyer. Actually, the buyer introduced me to the seller and said, here, use her and ask her to bring her counsel with, because we've used her before and her counsel, and we know we can get this deal done. And so the seller calls me, we have this conversation, and we put everybody together within three days. And I had to renegotiate a few things, but to be expected. Right. And we got the deal done by 1231. But that's unusual. But occasionally I get brought in towards the latter part of the year where somebody has already identified my one or two buyers. Can you help me pick? Can you help me negotiate the Loi and take it to close? And so those I'll hop into sort of mid year. But people who, I'm going through a whole market, the whole process, I do start in the first quarter. Ideally, sometimes it'll happen in April, but that starts to get a little late for me.
[00:57:25] Speaker C: Well, we're getting close to lunch hour in San Diego. We've done more than an hour of Q and A. I want to make sure that everybody knows the name of your book, which we've kept shrouded in mystery for 65 minutes. So go ahead and tell everybody your book. What's the best way for them to get hold of it?
[00:57:39] Speaker B: Well, you can find it on Amazon or barnes and nobles, and it's called get acquired for millions. Once you see it, it'll pop right out at you. It's big gold letters, but there's a subtitle too, as well. But I want to bore you with that. But it's available hard copy, soft copy. I went into recording studio during COVID and put it on audible, so it's Kindle, whatever format pleases you. I have a lot of people that start out with it on audible and realize, oh, my gosh, there's a lot of content here. And then they pick up a hard copy or a Kindle version. So whichever you prefer.
[00:58:12] Speaker C: Linda, it's great to sit down with you and to hear about your story and to get a chance to push record and let other people hear about your story. You've combined being an entrepreneur and a founder, an accountant, an author and a trusted advisor in the IT services category all into a really interesting career. And we're obviously grateful to be working with you in the context of Axial, which is how we got to meet you. And so thanks for giving us this Friday morning to get to know you better. It's been time well spent.
[00:58:39] Speaker B: Well, it was great, Peter, finally meeting you as well. I've very much enjoyed working on the platform. I think you've built a tremendous application there. And we've had some good successes with the platform. So it's great to finally meet you as well.
[00:58:52] Speaker C: Yeah. Well, enjoy the rest of the day, and hopefully we have a great year working together again here in front of us. Thanks again, Linda. Really, really enjoyed it.
[00:59:00] Speaker B: Look forward to it, Peter. Take care.
[00:59:07] Speaker A: If you enjoyed this episode, check out axial.com. There you'll find every episode of this podcast, as well as our recorded Axial member roundtables, some downloadable tools for dealmakers, Axial's quarterly league table, rankings of top small business acquirers and investment banks, and lots of other useful content that we've created over the course of time. If you're interested in joining Axial as either an acquirer, an owner considering an exit, or as a sellside M A advisor, you can get started for
[email protected] as well. Lastly, if you have ideas for podcast show guests, feel free to reach out to me directly at
[email protected] I promise I will respond.
[00:59:45] Speaker C: Thanks for listening.
