Emma

Welcome back to Ask a DHJJ CPA, the podcast where real CPAs answer real questions from business owners.

I'm your host, Emma Yurchik.

Today we're talking about something every business owner will eventually face - exiting their business.

That could mean selling to an outside buyer, transitioning the company to family or employees, bringing in a partner, or simply stepping away.

But whatever that exit ultimately looks like, it usually takes more planning than owners expect.

I am honored to have two guests today, Ed Brooks, Principal and Chief Growth Officer at DHJJ, and Rick Burke, Outsource CFO and M&A Advisor.

Both have decades of experience working with business owners and helping them navigate transactions and transitions.

Ed and Rick recently presented on this topic at the Illinois CPA Society Summit, and I've had the opportunity to hear them speak about exit planning several times.

There's always something new I take away from the conversation, so I'm excited to have them here today to bring that discussion to the podcast and break down what business owners really need to know about planning their exit.

So before we jump in, Ed, why don't you start by telling us a little bit about yourself and your experience working with businesses on exit planning.

Ed

Thanks, Emma.

Yeah, so I've been with the firm since 1986.

So I've spent my 40-year career working with entrepreneurs in family-owned businesses.

So over that long time, all the different stages of the business, I have on a regular basis worked with business owners exit planning.

So it is something I've worked from startup to exit or succession, whatever that might look like.

And I've enjoyed doing that. It's very rewarding work.

And the best way to become an expert in this area is to do it for decades.

Like you said, this is something that Rick and I have a lot of experience, real life experience with.

We've seen what worked and of course you learn a lot from what doesn't work.

Maybe more from the ones that fall apart for whatever reason.

So excited to talk about this important subject today, and thanks for having me.

Emma

Absolutely. Thank you for being here.

And Rick, tell us a little bit about your background and your experience in M&A and working with owners through sale and transition of their business.

Rick

Yeah, thanks.
So I've been doing accounting and finance for about 38 years, just a little bit behind Ed was his 40 years.

And probably about 26 of those years, I've been in the M&A field.

Some of my certifications, in addition to being a CPA, I'm also a CGMA, Chartered Global Managerial Accountant, and also a certified M&A advisor.

Lastly, I'm also a licensed business broker.
So early on in my career, I worked for a couple of different private equity and debt funds.

And I've been a consultant in M&A and exit planning for a number of years and have literally closed hundreds and hundreds of deals.

Emma

Awesome, thank you, Rick.

Thank you so much for being here as well.

I'm really excited to get into all of this.

You know, you both bring a little bit of a different perspective to this conversation, which I think will be helpful as we walk through this process.

We're going to keep today's conversation at the 101 level, what exit planning actually means, when you should start thinking about it, the different options available, what makes the business valuable, and what you can do now even if an exit is still years away.

So let's start at the very beginning because I think when business owners hear exit planning, they often jump straight to selling the company.

What do we actually mean when we talk about exit planning?

Rick

Well, I think it involves a lot of different aspects.

I like to think of it as almost like a three-legged stool in different areas.

So you need to leave; the business has to operate on its own without you as the owner, right?

So that's the toughest piece of the puzzle.

But also the owner wants to maximize their value.

And we probably want to minimize their taxes.

And they have a third part, and that is what is their personal strategy?

How does it fit into their retirement funds? And what are they going to do after they're done working every day?

So incorporating all those different aspects can be a lot more complex.

And if you don't think them through and plan for them properly, it'll probably not be the desired outcome that you're looking for.

Ed

Yeah, it's a good way of putting it.

Rick in our presentations has a good definition, which he touched on there.

It's the strategic process of preparing and executing a plan to leave or sell a business in a way that maximizes value, minimizes tax, and really the key thing aligns with the owner's personal and financial goals.

Actually, the toughest part is probably that last part, getting business owner to understand what they want to have happen. What are their goals?

And they can lock up. They can get kind of frozen at that level.

The other key point I think Rick brought up is the operational side of it.

Some businesses have a hard time operating without that business owner or founder. That's not all businesses, but it certainly is some.

And that would be an important first step because it's hard to transition if that business can't run if you don't come in every day.

So there's ways to attack and plan for that so that it is prepared.

So great point on that, Rick, 'cause that's a non-financial issue.

Rick

So another interesting point is according to the Exit Planning Institute, they publish stats on exit planning and a scary one is that

Only 50% of the people who are going to face exiting their business actually have a plan.

Emma

Wow, that is an incredible stat and one that I imagine most people don't know.

And everything that you guys just brought up, I mean, there is a lot there when it comes to exit planning and succession planning.

So when should a business owner start thinking about their exit and is there such a thing as starting too early?

Rick

You know, I think I would answer that based upon a book that I read, Stephen Covey's Seven Habits of Highly Effective People.

Habit #2 is start with the end in mind.

And so, is it ever too early to start exit planning? No, it's not.

Sometimes it makes it a more challenging job than if it's going to be a short time period because typically there's a lot of things that need to be not only thought about, but perhaps fixed to maximize value.

And minimum amount of time that I like to see when I'm working with clients is at least two or three years, but that's not always the case.

So the goal isn't necessarily to decide to today exactly how or when you're going to exit.

It's really about giving yourself enough time and enough options when that day comes.

Yeah, and I think it takes more time when people don't have a preconceived roadmap.

They may have children, they may not have children, and they may be interested in it, they may not be, there may be some key employees, and it's going to be a harder process if you go to the outside market and sell.

Emma

Got it.

I do like what you were saying earlier about, you know, having that goal in mind.

I think that's an important thing to consider.

So what questions should a business owner be asking themselves before they start building an exit plan?

Rick

The where, what, when, and why.

So typically they haven't thought about it.

So they kind of need a roadmap as to what's important, what their options are.

And when we sit down with clients, we'll sit there and kind of just have a planning session to explore what their goals are.

What are their personal goals? What is their retirement plan? Have they done retirement planning?

What are the different options of transferring the business or selling the business?

What does that look like?

So we kind of do it like an exploration type of interview as our first step.

Emma

Okay. How much can those personal goals change the exit strategy you ultimately recommend?

Rick

Yeah. I'd say dramatically.

Ed

Yeah. It's basically, and that's why it's such an important first step, you know, because whether you're looking for the highest and best cash offer without regard to getting family members involved or, you know, that sort of thing.

It's everything, versus an ESOP, versus a key employee, management buyout, gifting.

Gosh, there's a number of options, and you got to answer that question before Rick and I can really help you.

But it's a process.

So back to your original question, is it ever too early to start?

It really isn't.

I mean, the only time I can think of where it might be too early is when the business has just started.

I mean, you're in your first year, you're not established, you don't even know who you are yet or if it's going to work.

Okay, maybe that's a little, even then I'd still be thinking a little bit about the exit and that sort of thing, but it's probably not critical at that early, early stage.

But yeah, that first step is critical.

And the only one that can answer that question is the business owner.

We cannot answer it.

Emma

The business owner is asking themselves, you know, what do I want my life and my business to look like after I leave?

And so once they know that, then they can kind of start looking at the exit options that actually fit.

Right?

Rick

Yeah, so they can stay in control of the exit, right?

When we plan it out, but that's not always the case.

Some people will get ill, right? And then it becomes more of an urgency.
And that's a difficult situation in and of itself.

Emma

So at a high level, what are some of the most common ways a business owner can exit?

Rick

Yeah, we kind of touched on earlier, but do they have family members, and are those family members interested, is probably the first look.

The next would be like an internal sale or transfer.

Ed had mentioned an ESOP, giving it to the employees, basically selling it to the employees.

There's other vehicles like an employee trust, employee ownership trust, which is a lot less complex than an ESOP is.

And we could talk about each of those for the entire session.

But in terms of options, then there's selling to the outside world and there's a lot of different types of buyers out there from strategic buyers to equity buyers.

Family offices are really, really huge right now and they invest in businesses.

So looking at each one of those is very different animal and we kind of explore all those different options with the owner.

Ed

Yeah, if I had to kind of come up with three tracks, Emma,

You're looking at that outside buyer, could be private equity, could be a strategic buyer or a competitor, family office, private equity.

Internal, just to recap on that, key employees, ESOP, something along those lines would be critical.

And then I guess the last one would be gifting.

Usually a business owner is counting on some payout for their life's work.

But if they're in a financial position where they don't need to be paid at all, they have the option of gifting to family members who are involved in the business and want to carry it on.

Emma

So how do you start narrowing down those options and determining what's actually realistic for a particular owner or business?

Rick

You know, one question kind of leads to the next.

So, for example, let's say you do have a son or daughter who's been working in the business with you and you want to transfer it to them, but you need to fund your retirement.

So you can't just necessarily give 100% of it away, so you could sell it to them.

And then that leads to the next question is, well, how much debt does the company already have?

Is there room for another slice of debt?

What is the debt capacity?

And the number of times I've run into that issue where they have a high amount of debt from the business and

There's really no room in the earnings to pay off yet another loan.

And so it takes that option off the table.

Emma

You mentioned earlier all the different options, the private equity or strategic buyers.

For someone who isn't familiar with M&A, what is the basic difference between those two types of buyers?

Rick

I would say the basic difference is the motivation of the buyer.

So private equity is in it for making a profit.

And the way their model works is they'll buy up a bunch of small businesses at a discount and then form one large company on that.

And then they get a better price tag for a bigger company.

And so they flip it.

And usually that model takes five to seven years to build it and then flip it.

And a lot of times they'll say that they're in it for the long term, but it's really not part of the model because they have a return on equity that they have to give to their investors and they have to flip it.

So, whereas a strategic buyer, very different motivation.

So it could be that they're looking to expand their market share, get better human capital or technology or whatever it is, and they're usually in it for long haul.

The only time that the strategic buyer would flip it is if the business wasn't working, they weren't making the return and they have pressure from, you know, it could be a big public company, they have pressure from the markets that they have a certain return to do to hit as well, but they'll do it for a long haul.

Emma

So when you're looking at those two different types of buyers, I imagine that they can come in with different offers.

So does the highest offer always mean the best deal for the seller?

Rick

Ed you want to take that one?

Ed

Well, I think being an M&A advisor, you're going to give a better answer, but I'll give you my version.

So my thought on that, Emma, is, you know, we do if a client chooses to do an outside sale, we're all we almost always recommend that they go through a process.

They go through, you know, they get multiple companies looking, multiple offers in, so they can evaluate the pros and cons of the different offers.

So, and there's gonna be pros and cons.

And someone with Rick's background, and even mine, could help the client sort it out.

One of them might have more seller financing.

One might bring more cash to the table.

One might have a better cultural fit to it.

So many different elements you want to balance out to help select the best one.

That's my take on it, Rick, but you might have a similar view.

Rick

You know, the other things, there's a lot of different options typically, and sometimes those options are hard to understand for the layperson who doesn't do this for a living, right?

Because we, in the industry, we like to use a lot of acronyms.

And, you know, what does it mean to be a cash-free, debt-free deal?

Is there an earn-out provision, meaning that you're not going to get the full purchase price unless you hit certain
targets with revenue or earnings over the next year after you sell it.

So all these things we're talking about are what we kind of label as the structure.

Is it an asset purchase?

Is it a stock purchase?

And they all impact the flavor of the deal and the timing of when you get paid and the riskiness of do you get paid or not?

So when these offers come in, they're never the same.

Right.

And so we would compare them, like Ed said, and sometimes it's more of a personal preference if you're more worried about your legacy and your employees and if they're going to be in it for the long haul.

And typically coming back to the strategic versus private equity is typically the strategic buyer is the golden nugget, if you will, because

It also takes care of a lot of cultural things because they've worked on that stuff for a long time, and your employees have opportunities that they wouldn't have elsewhere.

They can go different directions up or down or sideways with their employment if they're interested in it.

And that usually makes business sellers kind of feel warm and fuzzy about, hey, I'm leaving my employees in good hands.

This is my second family and I want to take care of them.

Ed

Yeah, often the strategic buyer will just culturally seem like a better fit.

We'll hear the business owner; they just like that buyer better a lot of times.

And maybe they're willing to take a little less potential sales proceeds for the better overall fit.

The thing I'll add on to that, Emma, is the, you know, this is kind of where a good investment banker comes in because their job is to position that business in its, you know, in the best light to get the most, to get a competitive environment going, you know, getting multiple offers.

It's like if you're going to buy a house, would you buy the first house you looked at?

Sometimes you got to see a couple bad ones to recognize

This is it.

So I think getting a good market process going, getting somebody with Rick's background, and of course there's other investment bankers that do this, they add a lot of value with that.

And then they can help guide that business owner as to, back to your original question, what is the best offer?

They need to make the decision, but at least we can definitely help them sort through the various deal structures, which include tax structure.

You know, I don't want to get deep in the weeds on tax because that's a whole other thing and we're keeping it at 101 level, but that's part of it as well.

So great question.

Emma

And you know, even in your answer, you kind of started to touch on something that I definitely want to talk about, and that's value.

You know, owners understandably want to know pretty early in the process: what is my business actually worth?

So how do you begin determining what a business is worth?

Rick

There are a lot of misconceptions about business value.

And one of the biggest ones is people using what's called market multiples.

And some people understand what that is and basically just explain it.

When a business is sold, you compare the enterprise value to the sales price.

And if the sales price was three times the earnings, that's the multiple.

It's three to five times.

So the misconception is when people hear about this business or that business sold for three times, so I should be able to get three times my earnings.

And the truth of it is that's not necessarily true.

So let me use a home analogy.

So if I'm selling my house and I haven't replaced my shingles in 20 years, and a person looks at Ed's house and his is immaculate, right?

And he keeps up with the maintenance; everything's perfect.

He doesn't have the purple shag carpeting as I do, right?

So when the buyer looks at my house, there are a lot of things that need to be fixed.

Guess what?

The value just went down.

When they look at Ed's house, which is perfectly maintained and decorated beautifully, that prices went up.

That's why the market multiples don't work because of these qualitative factors in every business that drive value more so than just the bottom-line earnings.

Emma

Got it.

So what kinds of things can make one business riskier, in other words, less valuable to a buyer?

Rick

Yeah, there's a lot of different things, but I would say the first one to consider is: does the owner work at his business or in his business?

In other words, can the business survive without him?

So let me give an example: if the sales process at business A was the owner does the entire process.

He's the salesperson, and it's not written down anywhere.

It's all carnal knowledge, and nobody knows how he does it.

But when we start looking at it, it's like, oh, well, that's your brother-in-law you're selling to, all your goods or services.

And so maybe there's a concentration risk where 40% of the revenue is being sold to that one person.

If you lose that one customer, that's a big risk for the buyer, right?

So concentration risk, process, and there are all the due diligence areas, the functional areas of the company.

So I mentioned sales, there's financial reporting, there's... human capital and HR issues, there's legal and compliance.

And so when we're prepping a company for sale, we look at all these qualitative factors because we know the buyers can be ultra-critical of all these things.

So if anything is on the weak side, we want to either fix that or at least present it in the best light.

And minimize those things that are maybe not as strong.

And if we have enough time, going back to your first question, we can fix them, not just say they look pretty.

Ed

Yeah.

And just expanding on that, I think there's a lot of misconceptions on the valuation side where people reach out to business valuation experts who I think they're good for gifting, tax compliance, compliance related.

But you probably need somebody with Rick's background who takes some of what your CVAs, your certified valuation analysts can do, but has a market-based approach that he's going to look at a few different things.

And like you said, customer concentration is a key one.

Hey, you've got a nice sales level; you're profitable. But 60% of your sales are with one customer.

It's a little scary for a buyer.

What are they going to do? They're going to discount. They're going to bring less money to closing. They're going to make more of the sales price contingent.

And with planning, you can kind of help mitigate that discount.

Same thing, I guess the point we've touched on, if the business owner, he or she, is so critical to operations that it can't run properly without that person, I mean, there's a big discount on that.

They're going to be worried if he or she leaves the business, can it stay?

Will the customer stay?

I like the concept of corporate goodwill versus individual goodwill. Where does the goodwill and the intangible value lie?

Does it lie with the individual person or does it lie with the brand or the business itself?

Obviously, we don't want it to lie with the individual person completely.

And that's something in an early stage with a business. Early-stage businesses are going to have high customer concentration typically and a lot of individual exposure because that one person started it.

So hopefully, as a business evolves, these issues are mitigated as time goes by.

If they're not with the proper planning, Rick and I can help them develop a plan to take care of those things.

Emma

I definitely want to get into that.

If an owner learns that their business isn't as valuable or as marketable as they had hoped, what can they realistically do over the next few years to change that?

Rick

So that's a great question, Emma.

And kind of to build on what Ed was saying is somebody may be listening to this and say, well, how do I know if I'm good at it or not?

How do I compare myself?

So one of the things that I've developed over the years is a thing called operational effectiveness assessment.

And it looks at the eight functional areas of the business like planning, leadership, sales, marketing, the people, the operations, finance and accounting and legal.

So those are basically the core areas of what the due diligence process is.

And so within those eight functional areas, we ask 250 different specific

How do you do this? How do you do that?

And we rate it if they're doing it best in class or worst in class.

Right.

So the lower the score is, the higher the risk rating is.

So to kind of come back to what I was saying about the difference in valuation techniques of a business is from an M&A perspective, we incorporate all those qualitative factors into the valuation.

So I do both; I look at market comparables as a, you know, a starting point. But then we scientifically put the earnings into a future earnings model that brings it back to present-day value. It's called discounted cash flow analysis.

And then both of those things are weighted by whatever the risk factor is.

And so it's a little bit of a science, but it's a little bit of an art as well.

And if you if you've done 100 deals or so, you know what people are looking for and how they're going to view it.

So looking at the value from the buyer's perspective, not the seller's perspective, this is what I want to get out of versus this is what you can get.

Ed

Yeah.

And I like what that is something I think uniquely that Rick brings to the table because he's probably completed a couple hundred buy side transactions.

He sat on the buy side for decades and it's nice insight to have when you're selling to just understand how's a buyer going to look at things?

What are they going to have a problem with?

Let's anticipate those issues.

Let's position ourselves so it's not as big of a concern.

So good points.

Emma

Yeah, absolutely.

Are there any improvements that tend to make a particularly big difference to a potential buyer?

Rick

Things that you can quantify are easier to figure out what's broken, right?

So, like Ed was mentioning the customer concentration risk, there's things like compliance, and I see this one a lot.

So state and local tax compliance: if a company is selling in multiple states, and a lot of times they may not have a big accounting firm backing them up and teaching them, helping them stay compliant.

And it's difficult to keep up with all the tax rules.

So I've seen this on a number of deals.

And what I like about working at DHJJ is we have experts in all different areas here.

So I can just go over to somebody else's desk and say, Who specializes in state and local tax, we call them the salt department.

Right.

And they can not only figure out if they're in compliance, they can figure out what it's going to take to get into compliance.

And we can give them that project within our firm and get them, you know, tidied up so that if you have a, you know, a potential horrible tax liability, people are

we're gonna discount that pretty heavily or walk away from the deal.

Ed

Yeah, that's something that can bring a good deal.

It's going to come up in due diligence.

So being prepared to get through that with the least problems is key.

As an accountant at heart, I'm probably more business advisory now than I am debits and credits, but I am an accounting nerd, and that's still there.

I like to see good, clean books and records, and I know buyers want to see that as well.

And when I say that, it's not just for the year-end close.

Hey, we closed the year-end. It's good. What about April, May, June, July?

Do each of the monthly reports that an outside buyer is going to want to see? Do they make sense?

Or within those months, are there various errors that we didn't address?
So I mean, that's something that can help the integrity of the records and reduce risk factors and hopefully get you a little bit of a better value and offer.

And it's one thing I definitely want to emphasize with business owners.

I think too many businesses do not put in a little extra time to formally close each month, almost like it's a year-end.

So your bigger middle market companies, their month-end close is rock solid.

You ask a controller of a $500 million company what the difference is between a month-end close and a year-end close, and there really is no difference.

Right now, you ask a lower middle market company in the 10 to 30 million range of revenue, and it could be night and day.

And so that's a big area where maybe a lot of our clients might fall into that last example where, okay, at the end of the year, it's good.

And then they kind of close each month, but they don't really make all the entries that they should make.

So each monthly, an outside buyer is going to say, well, what the heck?

All these entries are made in December. What are you making each month?

Because they have to go to a bank. They need to get financing in a lot of cases.

And they need good records to bring to their investors.

So that's something I think that's important too.

Rick

A lot of that stuff does get flushed out in due diligence.

And to your point about the clean financials,

It tends to convey to the buyer that, look, our books are perfect.

We do our accruals every single month.

You know, if it's like unpaid commissions or it's bonuses that should be accrued so that they can trust the numbers.

But there are other things that we're talking about, primarily things here that are tangible that we can quantify.

There are a lot of things with companies that you can't necessarily quantify, and something like that might be the culture, right?

So if it's a toxic culture, that's a turnoff for a buyer as well, right?

Because then they have to determine, well, I'm a good leader and can I come in there and fix these people or the process or the culture and they have to make that decision.

Or is it, I'm going to walk away from this one because I'm too old to deal with this anymore.

It could be more subtle things like their planning process.

Do they do annual budgets and compare themselves to that? Do they do a strategic plan every three years? Do they have a roadmap on how they're getting from point A to point B?

Those are all positive features of a well-run company.

Emma

Yeah, all of these points that you guys are bringing it up is really making it that much clearer that the planning needs to start early because there are a lot of things to address.

You know, and let's say the owner has done the planning, they've improved the business, and now they've decided an outside sale is the right path.

You know, I don't necessarily want to go too deep into this topic, but I think that could be an entire episode on its own, honestly.

Rick

To your point, Emma, is we kind of start out with listing some things that were qualitative factors.

And I was saying earlier that most people, business owners, until they look at it through this lens of how a buyer would, they don't know whether they're good or not.

And to them, in running a business, it may not seem important to do a strategic plan or to

You know, we're getting around to doing sales tax in Ohio, but we got Illinois covered.

They don't understand how critical that is to the mission of selling it.

Ed

Yeah.

Looking through the lens of a buyer, even when you're not going to market, all of the things the buyer is going to want to see are good things, are best practices anyways.

All we're really saying is adopt best practices because if you don't,

It makes your business better. It makes it stronger.

And in the event that you decide to sell, you're going to have a better outcome if you go down that road.

Yeah.

One of you guys mentioned forecasting and that sort of thing.

I can tell you that that is like pulling teeth with certain business owners.

They don't want to forecast. They don't I don't know why they'll hesitate to put revenue goals out there.

But if you do go to market, they're going to ask you for a forecast.

How do you see 2027? We're in third quarter, getting ready to get in the fourth quarter. So people are going to ask you what your 2027 forecast is.

Because they're looking to buy the future anyways, not the history. And so I think they'd like to see that.

So that's something that I think a business owner needs to be prepared to work on a little bit, put some thought in.

Emma

Yeah, definitely.

You know, we've talked about that piece a lot here today is, you know, what does the prep look like?

Can you guys walk me through a little bit of what the entire process looks like?

And again, at kind of that 101 level, but what does the process actually look like once an owner decides they're ready to sell?

Rick

Yeah, so the way I approach it is, first we have those kind of strategic planning sessions on what the options are and what the goals are.

And then the next part of the process is we take a pretty deep dive into the financials.

So we're in a data-gathering mode. We know what we need to get to do what's called a quality of earnings assessment.

We're also exploring all these qualitative factors as well.

And we put that together in a very comprehensive, detailed presentation, if you will.

One part of it's called the data book, which can then be handed over to the potential buyers.

But we also look for those things that are not perfect, like on the numbers we're talking about, for example, not accruing for certain expenses.

So understanding liabilities is a big no-no.

We'll fix it in that data book so that what's being presented is the perfect scenario.

This is what they should have been doing and here's how it should look.

So we do all that work.

It takes quite a bit of time because it's pretty comprehensive.

I would say anywhere from six to eight weeks to compile that.

And then that information goes into what's called a confidential information memorandum.

Like I said, I like to use a lot of acronyms.

And so CIM is refer to it as a SIM.

That's like an page to page booklet, if you will, on everything about how that company operates and what their mission is, what their performance has been, what the management is, and it has all these different sections in it.

So it basically answers the first questions or questions that a potential buyer would have when they're looking at a company to buy.

And so we just knock that out to begin with and they'll come back to the broker or the advisor and have some detailed questions about some of that stuff and we'll work with them.

And then the next part is letting them meet the owners and the owners will give like a similar but like a presentation on the history of how they got started and what they've accomplished and so on and so forth.

And they get to know by just having that conversation with the owner, how well the business is run, how well do they understand it.

And it's so important for us when we put owners in front of buyers that we prep them to put their best foot forward, right?

And we'll help them with the presentation; we'll help them with the delivery of it; we'll help them with what not to talk about and stuff like that.

So after you kind of go through that several times with several potential buyers, then you start receiving offers.

And if it's an outside sale, like we're talking about, those are called letters of intent, which it's not binding, but it's basically here's an outline saying that I'm interested in buying you for either this dollar amount or this range of dollars.

And under this particular structure, which may change a little bit once we go through due diligence.

But this is what I'm thinking here.

And I want you to go down the path with me so we can go into due diligence and be exclusive with me as the buyer.

And that's a big, important part of it.

That's the thing that is binding on that letter.

And so at that point, the seller, the owner, has to stop talking to all the other potential suitors.

They have to pick their money and go with one buyer.

And because the buyer is going to invest a lot of time and money.

And a lot of times, the bigger the deal is, the more money it is.

They'll bring in professionals like accounting firms, legal teams, and stuff like that to help them quickly get through all these diligence items that takes 30 to 45 days, maybe sometimes 60 days to get through.

Ed

And yeah, and that's what I wanted to kind of go back on.

Remember earlier we were talking about the value of getting these multiple offers.

So they call it LOIs, letters of intent, very common acronym and non-binding at that point.

But that selection.

All right. I've got I mean, hopefully you've got five really strong offers.

Yeah. Which one do I go, you know, make that commitment to go through a process with?

You know, I want to go back and re-emphasize what Rick said. No commitments. You got offers. You are getting a feel for what your company's worth.

Obviously, when you get five offers, you have a rough idea. The market is telling you what this thing is worth.

Rick

Just to add another point, Ed.

So when you're looking at these different offers, right, and in that management meeting where the potential buyer is getting to know the owner, the opposite is true too.

You get to know who the buyer is and if it's a good fit personality-wise or not.

And that's important for two reasons. One is you have to finish the deal and work together to come to an agreement. But then the second part of that is who are you leaving it to?

Is it somebody who's going to do justice for the business?

Ed

Yep.

And then the last point then is that when you sign that letter of intent, you are, I think the key thing to keep in mind there is you're kind of under an exclusive period of time where you're not to negotiate or discuss anything with any other business owner, businesses that have interest.

So now you're committing probably a significant amount of legal and professional fees on both sides.

And I don't know, Rick, is that usually like a 90-day, 120-day type of time commitment to see if you can get a deal done?

Rick

It's usually 60 days at the longest.

Okay.

So it goes pretty quick.

You tend to see some pretty big deal teams on the buy side.

So we represent

And I have a lot of people on the sell side, and we have a lot less people typically; you know, we have like maybe a handful of people from our firm, a tax guy, a couple of operational people, the typical accountant, and your M&A.

So we have like maybe five.

Right.

And on the last deal I closed, they had 35.

Emma

Wow.

Rick

There was there was like 12 attorneys.

There was an entire accounting firm that had, I think 10 members were part of the accounting team.

And you're moving fast.

But the other thing that came to mind is we're talking about the outside sale here.

And there's a little bit different process if you're transferring to a family member or to your employees.

It's still a complex process, and there's still documentation.

You don't just flip the keys to your son and say, okay, there you go.

There's a formal process that you're going to go through to actually transfer it.

And it could be complex.

And what I typically do with that, with our exit plan, is once we figure out how we're going to transfer it, then I go through the scenario of mapping that out with the company's financials.

So like on the deal I'm working on right now, is it's a combination of gifting it to the children and selling it.

So it's both.

And there's a lot, a lot of mathematics involved in that.

There's a lot of legal documents that have to be completed for that.

And so then I work with the attorneys to help them get everything prepared.

And we actually have a closing that's transferred to the family member.

And if you go to ESOP or something like that, then it's even three times more complicated.

Emma

A lot of different processes here.

All depends on which route that people go, right?

Rick

Well, yeah.

Actually, let me say something about that because the processes that we've come up with as M&A advisors it helps us be more successful in actually closing the deal.

So some more stats for you is: you know 50% of people didn't do an exit plan, but 50% of people also think that they can sell it themselves.

And of those 50% who do try to sell it themselves, who aren't familiar with a tried-and-true process that we follow time and time again, because we know what works is those do-it-yourselfers have a failure rate of 70% to 80%.

They don't get it sold.

So hire the professionals that can do it the right way and have experience in doing it, and most importantly, can solve the problems as they come up.

And that's really what the success of transferring our business is we have to be problem solvers and we have to quickly resolve the problem, whatever it is that might come up.

I can give you a hundred examples of every deal is you have at least five to seven big deal problems that, oh, that was a surprise. And surprises are bad.

Emma

I actually wanted to ask about surprises.

You know, what tends to surprise business owners most once they actually enter the sales process?

Ed

Could be bad inventory.

Hey, we've, you know, or accounting errors, something they weren't recording correct.

bad, you know, they weren't, they didn't have a handle on the inventory like we thought they did.

Now we're digging in deep and we see obsolete or slow moving product that was on for a certain value, but the buyer's going, I can't sell that.

And that's $500,000.

So those are surprises.

Rick

There's a lot of financial surprises that come up.

One of the things that we didn't talk about that actually is typically a surprise to the seller, the owner, is it's an emotional process and they weren't prepared for it.

And believe it or not, I end up spending a lot of my time as a financial M&A advisor being a psychiatrist for them.

And sometimes they just need to talk things through and talk about what it looks like.

And they may get cold feet and not want to go through that. Am I doing the right thing? This is a really big deal and there may be family problems.

Maybe there was a son and daughter and dad's not selling to them because there's no way we can do it because I need some money to go into the retirement account and there's no room for additional debt.

Therefore, I have to sell it to an outside person who's going to pay off my debt and give me some retirement funds.

So those are kind of structural and emotional type things that always come up in deals.

Emma

I can definitely see how that would be a surprise that people wouldn't necessarily anticipate.

A lot that goes into building a business and a lot of it is emotional and to then be transitioning out of the business.

You know, we're sitting here talking about all the logistics.

They poured their heart and soul into that, building that business and just walking away from it is an emotional process in and of itself.

Ed

Yeah, but getting back kind of to the exit plan itself, if you really go through an exit planning process, Emma.

You might be able to catch some of these surprises early.

You know, you might be able to work them through like, you know, Rick's got a really nice process.

He calls it the discovery phase where you're talking about the owner's goals, their needs financially and otherwise.

The assessment phase where he's going through looking for quality of records, risk issues, you know.

And then what I like that he does is he models out the different options.

So maybe you go through all this and the business owner is like, well, what would it look like if I did this? What would I look like if I did that?

So it's important to model those out. Well, if you go down this route, here's kind of what your cash flow would look like. Here's what it would look like.

If you sell to an outsider, here's what you could expect. If you do gifting, And of course, once they go through that and they may not be ready to do anything if we're really doing this years in advance, great.

Now they've got time to think about it.

I've got a client reached out to me. We went through a little bit of this three, four years ago. Now they want to get back into it again and look at everything.

And maybe this time the timing is right for them to execute a plan.

Not seeing what the plan is.

The plan could be to sell, could be to sell to outsiders, insiders, could be ESOP, but it's not like a one and done.

Rick

It could be to do nothing too. It could be to take the time to go back and fix all the things that are broken.

So I had a client one time, not so long ago, that they were riddled with that.
They had issues with, well, generally good that you have long-term employees, but the problem is that those long-term employees end up getting a wage increase every year 3-4%, right?

And now you have a workforce that you're no longer competitive because you're paying way too much for wages and you never created your bench players that are going to cycle the employees.

When we're talking long-term business runs 30, 40 years, all those things are important so that you're benchmarked to be good performer in all these different areas.

So this particular client, after we kind of went through the process of what the exit plan and options were, said, you know what?

I'm gonna fix it. I'm gonna take three to five years. I'm still young enough.

And he actually checks in with me every few months and tells me his progress. And he is making a lot of really good progress.

And he's basically taking the work that I did that says that here's all the issues and turn it into his task list. And he's taking them one at a time and he's resolving them and very proud of him.

It's great. And he knows that he's going to pay off because now he's going to get the money that he initially wanted.

Emma

Yeah. And another reason to get started early. So you have that time to address those things. That's great.

Rick

Yes, exactly.

Emma

But you know one thing that I definitely want to talk about before we wrap up today is, what does the team look like when we're going through succession planning?

Rick

Yeah, there's at least four or five people, and the quarterback is usually the M&A advisor, okay so they're not doing all of the work but they're instructing in helping the other team members.

Emma

Calling the plays.

Rick

That's right. You have to have a legal person.

And I highly recommend that it's somebody who has experience in M&A because any attorney will just take it and do the best they can.

But unless you have years of experience on what the trickery is and negotiations and stuff like that, you don't want to get find out that, oh, well, I don't have the best deal because I didn't have the best negotiator because they've never done it before.

So those two are key people.

And of course, you got your blocking and tackling people. You know, you got the accountant, you got the tax specialist.

And the last piece of the puzzle is going to be the financial planner, you know, for the retirement planner to actually; that's so integral with the sale of the business that they're inseparable.

And you have to do both of the processes. You have to do the retirement plan with the guidance of a professional, licensed professional.

And that kind of incorporates to the exit plan.

And at our firm, we have those people here at our firm.

We have a whole division of CPAs who are licensed financial personal planners.

And when I have a client that we're doing the exit plan, I pull them in, and we actually marry both documents of the plans.

And I think we come out with a better product than somebody who doesn't.
I can incorporate that.

Ed

Yeah, it's a good question, Emma, because it is a team.

You know, at the planning phase, it might just be
Let's say it's a client I've worked with for ten years and they want to do the planning.

It's probably initially going to just be me and Rick doing the planning part.

Now, if they decide on one of the options, now you got to bring in legal, the personal financial planner.

We got to run some tax scenarios on hypothetical situations, but it does take a team.

Quarterback is usually like someone with Rick's background or mine, making sure we've got the right people on the team is a big part of it as well.

Emma

With the football season having started, I really appreciate the football analogy.

Well, I want to finish up our conversation today with something practical for the business owner listening who may not be ready to sell, but is realizing they probably shouldn't wait until they are ready to start thinking about this.

So if someone is listening, and they are 5 or even 10 years away from an exit, what's one thing you would tell them to do right now?

Rick

Obviously, I would want the person who's thinking about it to work with a professional, but there's a range of things that you can do from no cost to it's going to cost you some money, right?

So having them educated on what the process is and what the transaction process is and what it looks like, the more they're educated, the better off they'll be.

And then getting that education, whether it's through reading a book or searching the internet or hiring a professional, it'll make them better prepared.

And then they'll see other things that need to be done.

Now, from a formal perspective, I would prefer they hire people like us.

And there's two things that we do as we're prepping the business as a service. One is doing what's called the quality of earnings analysis.

And that's the data book that I was talking about, right? And it incorporates a lot of qualitative factors as well.

So doing that gives them a punch list of here's the things that are broke, go fix them.

And the second one is the operational effectiveness assessment.

So we really married both of those things.

They have all the information they have and we do indication of value as well in that process.

So they know what they're worth if they fix these things and have a good set of books and records.

And it costs a few dollars to get done, but it's going to save you more money on the transfer.

if you have this stuff done ahead of time, it'll get you more a better offer.

Ed

Yeah.

And even if they're 10 years away, Emma, I mean, I would recommend really the things that Rick talked about.

But at a bare minimum, how about finding out what the value of the business is?

We have 401k accounts; people have stocks; they look at those values periodically.

Business owners I think at least once a year should get an idea of what is my company worth once a year?

Did the value increase over the last year? If so, why? Did it decrease? If so, why?

So I would say that, as a parting thought is people, even if they're not ready, they're 10 years out.

They should know what their business is worth.

Is it what they thought it was worth? Why isn't it what they thought it was worth?

What are ways we can get it to that point?

So it helps them with their decision making process short term and long term if they go through kind of a value discussion once a year.

So that's something that at a pretty minimal investment level, they can just schedule it once a year.

It's time for that value update.

Emma

Yeah, those are both great tips. Thank you.

If there's one theme I've heard throughout this conversation, that starting early really just creates a lot of options.

It gives you time to understand what you want, strengthen the business, address risks, and make decisions intentionally instead of reacting when you're suddenly ready or forced to exit.

Ed and Rick, thank you both so much for joining me.

I really appreciate this conversation, and for business owners listening, you don't need to know exactly when or how you'll exit to start that planning.

Understanding your goals, knowing what your business is worth, and identifying the things that could help or hurt a future transition can put you in a much stronger position when the time comes.

If you have questions about exit planning or want to start a conversation about what an eventual transition could look like for your business, you can contact Ed, Rick, or the DHJJ team at DHJJ.com.

Thanks again so much for listening to Ask a DHJJ CPA, the podcast where real CPAs answer real questions from business owners.

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We'll see you next time.