E131: Elliott Holland Discusses The Importance Of Due Diligence In Acquisitions

===

[00:00:00] Ronald Skelton: Hello, and welcome to the How2Exit Podcast. Today I'm here with Elliott Holland. He is with Guardian Due Diligence, and we're gonna talk about everything about making your acquisitions safe, doing due diligence, and, what's happening in the market today. Thank you for being on the show today Elliott.

[00:00:15] Elliott Holland: Yeah, I'm happy to be here. I'm excited. Let's have some fun.

[00:00:18] Ronald Skelton: Yeah, let's have some fun here. Let's just jump right in with the origin story, man. And we were talking beforehand. You got some really cool background. You've got a lot of experience in this and started off with some of the best schools and stuff.

[00:00:27] So how did you end up in in mergers and acquisitions? And, I jokingly always say like, you were born and you ended up on a show about mergers and acquisitions. Could you fill out the gap in between? 

[00:00:36] Elliott Holland: No, absolutely. So crazy enough, I do the same kind of work my dad did. So I actually have his SBA binder, on a bookshelf around here. So I kind of got it honestly. Both my parents were accountants. Grew up in Detroit and that era of Detroit business was very interesting. And, so I, I went to school at Morehouse College and Georgia Tech. So they have a dual degree program.

[00:00:57] I got an engineering degree that I, I did a couple of internships and saw the mediocre business dudes were bossing the engineers around. So I had to get out of there. I did some strategy consulting and then I went to, on this fancy place called Harvard for business school. And when I was at Harvard, I quickly realized, Ron, like I was poor. Like really poor. Like I segmented Harvard into three areas. Like the first were like so rich that it didn't matter if they ever worked a job in their life, they'd be set. So you're like, you're not competing with them. Then like some middle people had been to like, Two Ivy League schools, two bold racking investment banks working at a private equity firm.

[00:01:36] They knew Warren Buffet personally. You're not competing with them. So I'm in like the bottom third on the poor side. So I'm like, Hey, I gotta write this ship. So, private equity initially was all about mergers and acquisitions, all about, making that Harvard degree worked for me. And then when I got into it, I sort of realized quickly that a lot of the people in it don't actually own equity. So a private equity general partner, the partners that you see, they don't own equity in the truest sense. They represent pension funds equity, that they then put into deals for a management fee on an annual basis and 20% of the and so I realized that the real game was owning equity.

[00:02:17] So I started at a family office doing private equity work, and then I spun out. I was an independent sponsor for a while. Then I was a self-funded searcher with my business partner. Kind of retired effectively, and this is around 2017, 2018. And I looked around and I saw all these new folks coming into the deal world. I saw kind of deal novices that hadn't run a company, even bigger than that Ron, you'll appreciate this. So like inside of companies, you have like this HR referee and like this brand name, honor badge. So like I represent Coke, we don't lie. And if I do lie, HR is gonna get me in trouble. So when I negotiate with you, it's very safe to assume it's in good faith.

[00:03:04] In a open air negotiation in the real world around business, it's almost like I'm a liar that's trained to negotiate and you should be too. And so, I saw these folks coming in that didn't recognize that, and I thought they needed some help. So I started Guardian, A: because I thought the diligence solutions for small deals were kind of crappy, but B: I knew a lot of folks coming into the market would get fleeced, without the right support. So kind of, I'm like a player coach. 

[00:03:32] Ronald Skelton: Now I got a question for you real quick. The area of due diligence that you work with, is it just the financial side? Or like, I'm just doing, working on this article for, one of our newsletters and I didn't realize there's like the 10 segments, like 10 areas of due diligence in financial, legal, hr, operations. I won't name 'em all, but like what areas do you guys help with on the due diligence? 

[00:03:56] Elliott Holland: So, historically we've done financial. Primarily because, and your audience is SMB folks. Nobody wants to pay. And I get it, I was a self-funded searcher.

[00:04:06] So once you start using all those other words, people just think you're trying to charge 'em and they turn off. But really, we're actually moving into being an investment bank for SMB deals. So right now we do three types of diligence. So we do financial, which is primarily the quality of earnings. Then it's, operational, which is all of the internal people and structures and processes that allow a business to make money. Like is Junior working in the business and will he ever work for a new owner. Or is the CFO dating the owner? And so you hearing somebody that never had performance reviews. Or can the controller even count?

[00:04:42] You know what I mean? Is the salesperson,doing sales or doing nefarious things to keep customers? So all those operational things. 

[00:04:50] Ronald Skelton: I laugh cuz one of my favorite questions for a small business owner is, what does your wife do? And cuz often I find out wife's doing the books and not drawing a salary for doing the books, right?

[00:04:58] Like, I look at an org chart and figure it out you got a normal org chart for a business and most of those roles are taken by somebody, whether they have the title or the pay, payroll for it or not. Somebody's doing that role. Somebody's doing sales, somebody's doing accounting, somebody's, off managing the office. And then you gotta figure out who's wearing those hats because, I know for me as a new guy coming in, if I'm buying something, I don't wanna wear all the hats. Right?

[00:05:19] Elliott Holland: And you don't wanna be surprised how many hats the owner or the owner and the owner's wife or the owner, and the owner's wife and like the main dude are doing.

[00:05:26] And a big piece of operational is like figuring out what jobs to do. what jobs does this business have to do? Sales, operations to accounting. Maybe not a full-time equivalent, but has to do 'em and who's doing them. So that's the operational stuff. So financial, operational. And then commercial is the external industry environment and the internal sales office. And how does the internal sales and marketing office interact with the outside industry world to generate outside returns? So are you going into an industry with tailwinds or headwinds? Are you doing better than average or worse than average from sales and marketing? Do you have processes and systems? Or is it some one dude that's been in it for 35 years? It's got the hunting license and the seats to the fricking Dallas Cowboys.

[00:06:08] And as soon as that dude goes, you're done. So those are the pieces that we covered now. And increasingly, I'm trying to be more communicative about that because we always sort of denim Ron. Just, people just wanted the financial 

[00:06:22] Ronald Skelton: Yeah. I looked at a business, I guess it's been about three years now. Two years ago, two and a half, three years ago.

[00:06:26] And the, owner was a local. He was local pro, but he was a pro golfer. And he, he taught at one of the better golf courses in town. And I asked him, well, tell me your sales strategy. He goes, well, I just take the dealership owners out on the golf course, give 'em lessons as we play, and then sell 'em, our services. Like I don't play golf, man. He just knocked me right out of it. Like, you can hang around the deal.

[00:06:47] The funny thing was, that wasn't the deterring factor. The deterring factor he said, you know, I'd be willing to stay on as long as I got the work less. I said, cool. Well, what does working less look like? Yeah. If I could work only 40 hours a week, I'd be good. Like, how many hours a week do you working now? He was pulling 80, 90, a hundred hour weeks and just wanted to drop back to 40. So then you start looking at what hats are, is he wearing, right? And,now the business doesn't look nearly as appealing because the profit margins got stuck up because, you got a $80,000 a year operator.

[00:07:14] Now you need, the accountant, you need the sales rep, you need, all the other different stuff that he's just putting his hat, pulling in hours for and not paying himself for. 

[00:07:24] Elliott Holland: Exactly. There's probably no margin in the business because by the time you hire two full-time equivalents to do some of the stuff he's doing. Because it couldn't just be fit into one sort of Swiss Army knife persons 80 hour a week and the people who are getting paid salary are not gonna work as hard as the owner.

[00:07:41] It eats up those that, those SDE dollars. It eaten up real quick and I'm not a big fan of SDE to begin with. But you gotta be careful because these brokers are adding back everything, man. And then fighting for it like you're a dummy just because you just showed up at the, I'm doing deals convention. If it smells funky, it probably is. 

[00:08:03] Ronald Skelton: So what's some of the more interesting things you've found in some of that? Like you're doing due diligence, quality of earnings reports and stuff. What are the, some of the more interesting things you've found? And let's start with the most, like, the craziest thing. And then we'll go into what looked really legit until you dug into it. That's the second one. 

[00:08:17] Elliott Holland: So the craziest is the story, I'm actually gonna tell a story of a friend. Only because I really want to get the shock value. So, had a buddy, bought a business. Like a HVSC type business, home service business. About 3 million in purchase price. Used the SBA loan. 

[00:08:34] He wasn't able to talk to the employees before, before he, got into the business. And we were talking about this a little bit, but he is riding around with the sales dude, trying to get like accustomed to where the customers are and where the centers of influenced are. And he hits him with a question like, Hey, so how do you sell? And what if I wanted to like double sales next year? And the guy responds, well, maybe you should hire more prostitutes. 

[00:08:57] Ronald Skelton: You're kidding, right? 

[00:09:00] Elliott Holland: Nope, nope. So that's one interesting one. That's really catchy. But like, here's a couple of ones that, are more recent. So I had a company that was selling, it was a serial entrepreneur who had started three businesses and was moving onto us forth. He had a management team in the business, which everybody loves cuz they can passive income.

[00:09:23] So, there's like five people that all have been digital marketing and executive level for like 15 years. And so I'm going through diligence and the numbers on the financials checked out, right? But I'm looking at the management team and I'm like, hold on. Each of them is pulling $60,000 out of this? You couldn't replace these folks for under 150 k salary, 200 k, all in. So that's like 150 K per. You're talking like $700,000 of EBITDA that really isn't there. That if you hadn't really thought about what it would take to replace these people, you wouldn't have found it.

[00:09:58] And then I was talking to my client and I'm like, Hey, if you know anything about equity,you'll understand this. If I'm working with a serial entrepreneur for three companies, I probably have some equity, whether it's real or like goodwill equity with the owner. So am I gonna go work for some new schmuck and not get any equity? Or go run to my former bosses who I've been with for 10 years, his new thing, and get some equity? Those guys are gonna be out of the door in three minutes. So, we stopped the deal and once again, that's not financial diligence, that's operational diligence. That dog wasn't gonna hunt.

[00:10:35] Ronald Skelton: One of the things I like to look at is you can actually look at like history. So if you look at the key players, say, so you got a software engineering company. And your lead engineer has a team of six people. I go to his LinkedIn page, look at his last six or seven jobs, write 'em all down, and then I go to his whole team and look at everybody on there, right?

[00:10:54] And where there's last six jobs. Cause I, I was in IT. I know this works this way. When I would go from one coming to the next, I record, my guest guys, I brought 'em with me. And not even just like intentionally right off the bat, but they just knew that if they ever needed a job, if they ever wanted to switch, I'll write a job description for you and I'll make one. For the top two or three guys. There's a guy right now, I mean, but no ones called me for a job right now. I'd go buy a tech company I'd buy something the guy could. I'd figured out a way, raise funds, buy a tech company and put him to work cuz he is the best, best Oracle DB I've ever seen in my life.

[00:11:24] There's just certain people out there like you would jump over hoops for. I love what you just said there and the, if you're key guy leaves,who's he taking with him. 

[00:11:31] Elliott Holland: And where are their incentives? People get so caught up in their own, that management team that's there, they're not incented to go be your employee. 

[00:11:40] Ronald Skelton: I seen one here recently. It's about two years ago now. We were, looking at an engineering company. The owner was 78. He really wanted to retire. Son didn't want it. And then I looked around, I finally got to see his org chart and a lot of the names reminded me of like my grandfather's name. They were old school names. And I started thinking, what's the real demographics here? So I just asked the guy. I said, do you mind, I know this is a weird question.

[00:12:01] Cuz he kept telling me, all my executives been with me for 20 years. Like cool. What's their age? 75, 76. One of 'em was 82. I was like, the only reason those people are staying around is there's loyalty to him. When he retires, they all retire. So I had to ask him, I said, I need to talk to every single one of 'em. He says, why? I said, I honestly think they're all gonna retire the day after you do. I said, I bet if you were truly honest with me, the reason you're selling this and retiring is they're telling you it's time, they're done. 

[00:12:25] I was like, this is a engineering company of like 25 people and the top eight are gonna leave? She got a problem, man. 

[00:12:31] Elliott Holland: So let me double click on that because this isn't talked about enough. This is why I started this business. So let's just say you were a novice and didn't know to ask that. And you would've written up in your one pager to the banks and to your equity folks.

[00:12:45] Strong management team, 20 years experience with the founder, 10 years experience outside. And you would've bought that thing for whatever. Call it a million bucks. Put a personal guarantee on the loan. And then, all those folks would've retired the day after you finished the deal. You'd be without a management team. I guarantee you all those people were the relationships to kept the sales going. And you have an engineering, less engineering company. And you'd be essentially creating a startup engineering company to just go pay X is the name bank, right? And so when people try to pull stuff on my clients, I stay professional, but sometimes it's almost like fighting words like you were trying to bankrupt me.

[00:13:31] Ronald Skelton: Lucky for me, I had a really good, they sold it now, but I had a really good friend. Actually I hired, he became my friend after I hired him to be my performance coach. So, he's the one that got me kind of in this space.

[00:13:41] I was doing real estate and one day he's like, with everything you know, you should be playing a bigger game. I could flip a freaking house with my real estate firm, put $40,000 in our business account, and I still hear his voice in the back of my head. But you should be playing a bigger game. So I got into this space. But, his soon to be ex-wife, now his wife actually owned a headhunting firm, that they sold. That would hunt, recruit, recruited engineers. So I just called him up and said, Hey, if I lost the top four or five engineers, what's the cost to do the search and how long does it take?

[00:14:10] And he says, well, you'd be paying us at least, a third of the salary, 30 to 40,000. Their salary's this, and it takes six months sometimes to find a good one. So it's like, okay, so this business isn't gonna survive. Especially if they all leave within the same year. And it's gonna take me six months to find a qualified engineer to replace them. Paying a search firm to do it. I thought maybe I had an insight that, can negotiate a better price. And I have an insight cuz I have a recruiting firm. That's all they did, that they found engineers. It's like, maybe I could solve this and nobody else can't. 

[00:14:35] Elliott Holland: You can't put it together. And that's one of the hardest things for my clients oftentimes is just, how do I say this? In corporate worlds, let's say, I'm supposed to go work with, I'm Home Depot and I'm gonna do a partnership with Lowe's or something. And it makes sense for both sides and we're talking about it. And once we start spending real money, because like these tens and 20 thousands of dollars that individuals invest, or probably hundreds of thousands of dollars for corporations. Once they start spending that kind of money, most times something happens.

[00:15:05] Something consummate cuz nobody wants to hold the bag on that quarter million dollar, million dollar investment in something that they didn't go. But in SMB deals, man, you invest time just to find out it's a complete farce. And your best bet is running away and going, finding the next one because like when you try to figure out how to make your past suck costs, like activity work, it's like, well, how do you do a six month thing? You'd almost have to have the current owner spend the money, replace the engineers and then sell the business. And if he did that, he wouldn't sell it to you at the price that he's selling it at, but a whole new other price. And who wants to take on that risk at 78? He's gonna have to probably wind this thing down or sell it differently. And I struggle at times with a lot of clients that they're not used to switching gears that quickly. 

[00:15:58] Ronald Skelton: I tell you what I do with those guys,cuz I made friends with the owner. He was a really cool guy. He's 78. He didn't, I wouldn't say he was like, offered all the information.

[00:16:06] He told me what he wanted to tell me, but he never, if I asked him a question, it reminded me of my father. If you ask him something, he'd tell you the brutal, honest truth about what's going on. But if he didn't ask, he just, told his story. Which is I can respect to some extent. So, when it came down to us, I was like, look, guy, I can't buy this. And I was working with somebody else. I was like, he can't buy it. I said, the only play you have here is you've gotta do strategic. It was a pretty good size. It was down in Dallas. And I said, and your only play here is a strategic. You gotta go find somebody already has the engineers and staff and they just want your client list. And, they'll keep your junior engineers, it'll be around.

[00:16:36] They don't want to hear your senior engineers opinions anyway. So they'll be glad that they're gone. And, that's your play here. I'm like, as for finders fee, I'll go make the introductions for him, but I think you already know 'em. He's like, yeah, I didn't wanna sell to my competitors. They've been at it for a long time. I said, now's the time to give that up. Cause that's your best buyer. Go make friends with those guys. 

[00:16:52] Elliott Holland: Or go get paid. I mean, it's not you doing that deal. Now you're being nice and being his investment banker or broker and saying, here's how you can salvage some value or achieve some value rather out of this. And I think, look man, here's another story I'll tell you. So I got a client. so most time we look at EBITDA as the metric for valuation, seller's discretionary earnings, one of the two.

[00:17:16] But the reason we look at that is cuz it's the lazy man's cashflow. All that really matters is cashflow but cashflow is hard to calculate. Well, in asset heavy businesses, manufacturing, trucking, those kind of things. Really, you gotta look at EBITDA minus CapEx, because the CapEx is so high that it affects cash flow tremendously. So a $2 million EBITDA business may be under a million dollars of EBITDA minus CapEx. Well, some brokers have put together a package on a trucking company blasting, it's like $6 million of EBITDA, right? And one of my clients, was a novice and rightfully got me to help him with diligence. And the first thing I'm saying is like, EBITDA isn't the valuation metric.

[00:17:57] Like you're X times EBIT. Like it should be EBITDA minus CapEx. Well, what's CapEx? Oh God. We're in for one. So we go in there and show 'em what CapEx is, show 'em that the EBITDA minus CapEx is truly more close to value. But then the sellers and the broker and the seller's CPA were in cahoots and they were trying to artificially boost the profit by not doing the work to consolidate two entities and forcing us to do it with far less data than we should, hoping we wouldn't catch it. So all of a sudden, on top of the EBITDA minus CapEx, which is like $800,000 difference. Now there's a $500,000 hole in EBITDA that they keep trying to move where depreciation was and move where the owner's salary, but it was 500 k.

[00:18:48] These jokers showed up six months after the sim was published. Two months after the letter of intent was signed. They're like,oh man. Wait, we got $500,000 worth of prepaids we forgot to tell you about, man. Here you go. And I'm sitting on this call, Ron, and I'm like, do we just hang up on these folks? You know what I mean? Had it been my deal, I'd have been done right there. Like respectfully, I'm just gonna end this. Now we finally, I think, got to a better place. But, you gotta understand, and I had to tell my client this and you'll appreciate this, Ron. And I hope if you're listening and you're trying to transition into this, you hear this. My client was probably more interested in finding a way that everybody could be happy, then making sure he didn't go bankrupt in the deal. 

[00:19:36] So he was telling me what the broker was saying, what the seller was saying, what the owners were saying. And I was like, so none of them have the $10 million to go buy this. And if you want to test it, tell 'em if they want to pay that high price on that business to go half with me and you'll see how quickly they don't have the capacity to. And understand that doing well by them is bankrupting you. This is one of those, I'm not gonna call it zero sum, but pretty close games. So you actually have to assert your selfish, capitalistic interest in ways that you might not be used to. 

[00:20:12] Ronald Skelton: I get that. I get that. So I have the mentality of the, from my previous role in the real estate world, everybody gets an offer, right?

[00:20:21] Everybody gets an offer. You may not like the offer and, my offer stands until you fix it. So, I'll give you kind of little synopsis or a story I guess. The favorite thing I like to do in the beginning is when the owner starts telling me what they need or what they want for a business, my natural instant response is, cool let's see how we can get you there. And then we go through everything. We do our things and I always tell people it's like, look, I've interviewed over a hundred and a hundred plus, 160 people now, over 160 people. I know this industry. I know a lot of people in the industry.

[00:20:49] I'm not your buyer. I probably know somebody would be interested in it. Let's just go down and let's hear the story. Let's figure out what you're trying to do, and if it's not me, I'll point you in the right direction. I'll keep moving. So it gives me more leads by just like the, hey, I'm open to hear about it. And, the problem with that is I've got a couple and I'm also on natural born empath. So, meaning I feel people's emotions and their stress and their pain, and I wanna solve the problems for 'em. I've made a few offers before. I'm kind of glad they didn't accept. We had one where, I say this story a lot on the show.

[00:21:15] There was a concrete plant that was, I forgot what the numbers were. It was in the tens of millions, of revenue. The last year I seen their books. They claimed they only had 15,000 or 15,000 of profit on a, I think a $19 million revenue. We got digging into this thing. The books were a mess. And, there was stories of, one of their divisions went down because a relative had embezzled the money. I was 90% sure the sister of the two partners was, she was doing it too. The CEO had, she didn't know. And I actually had, I pulled 'em aside towards the end, I said, look, you need, really need to have your books audited by a third party.

[00:21:49] In six months, we've never received a clean set of them. We barely receive anything. It's mixed. It's a mess. It's the messiest thing I've ever seen. She goes, are you gonna make an offer? I was like, sure. Offer 'em a dollar down and take over their debt. All right? And to buy 60% of the company and let them participate in 40% of the back end when we fix it. Cuz it was a third generation company. But I'm kind of glad they didn't cuz I mean, I had to build an entire team around that. They had trouble with the IRS. We already had like, started the process to retain a, a tax attorney to fix that cuz they never contested it.

[00:22:18] We were looking at forensic CPAs to go in and audit the books and fix the books. Anyway, I like what you just said. Sometimes you just gotta be able to look, this is gonna bankrupt me. I can't give everybody an offer, right? The offer here is go find somebody else. 

[00:22:31] Elliott Holland: And I think, look, Ron, what I love about this, and even fellas hanging out back in college looking for our wives.

[00:22:39] You can get five dudes that have five different smart opinions about the same thing, right? And depending on the situation, different people will win. So let me say this. Ron's right. I'm right. Three other dudes that came up here are right. I think what people have to think about is what is your opportunity cost of spending three years fixing somebody else's mess. And how hard will they push you inertia wise, because they got in the mess because they couldn't fix it and do the painful stuff themselves. And I tell you another thing I get a lot of times. Ron, how many times do you think people call me for QOE say they wanna start, but they tell me the books are simple. It's a simple business. Clean. I trust the owner. 

[00:23:20] Ronald Skelton: 80, 85%. Oh yeah. This is gonna be easy for you, man. I mean, I want to discount cuz it's gonna be, this shouldn't take you much work at all. I just want a second set of eyes.

[00:23:28] Elliott Holland: All the time. And I'm like, hey my disposition is I want to keep goodwill in the ecosystem. So it's funny, I think my thing with offers is I do that with clients. I'm like, Hey, if you're thinking that it's simple, I'm probably not the solution cuz I'm not the cheapest, I think I'm the best.

[00:23:46] However, I'll tell you outta the last 10 deals I've done, seven where clean financials, trust the owner, really simple. And half of those didn't close cause they didn't pass QOE. And they didn't pass for reasons that not even a investment banker off of Wall Street would've found. And that's why I do what I do. So the other thing that happens is people get into deals that the owners are familiar to them. So I have a current client who, was working at a business run by a family office. And now he's looking to do a search and the family office is gonna back him on the search. But then the family office taps him and says, Hey, well, Why don't you buy this asset that we already own? Red flag one. 

[00:24:30] This one's part owned by us, part owned by an entrepreneur who we think is making too much money off of us and not really pushing the agenda to get this thing growing. So you gotta negotiate with him and he's a little hostile, red flag two. Then red flag three, he's like, I'm just financial enough to kind of kick the tires on these things, but I don't really understand due diligence or even like stock versus assets. And I'm like, gosh, dude, this would be the perfect time to pass on a whole bunch of debt to you through a stock sale because you think it's all familiar parties and they offload this thing to you.

[00:25:05] And now not only do you work for them, but you work for the bank. And because everybody knows each other, you're gonna want to not do the work, not read the legal document, not ask the question. And you're in like shark lurking waters here. And I hope this is the greatest deal you ever do, but you almost need more protection, not less, because you're gonna,your sensors are gonna be depleted or sort of run down because you know these folks.

[00:25:34] Ronald Skelton: So, the bigger deals like, in history, like $25 million and up, they do reps and warranties and there's insurance policies for 'em on the reps and warranties deals, right? There's just now a company, they're underwritten by Lloyd's of London, I think outta the, the big guys.

[00:25:47] But there's just, I think there's only two people that I know of in the United States selling it. But there's actually reps and warranties for these small deals now. And, not very expensive. Worth doing. But in a case like that, not only would I, want somebody like you to go through it and like, okay, didn't find anything. Probably ought to have a pretty decent reps and warranties things. Usually the policies are bought by the seller though. You might want something like that just because, it covers,all the, the hidden agenda or you just move on. 

[00:26:14] Elliott Holland: Well, I can agree with you more. If security is available at a reasonable price.

[00:26:19] We're talking tens of thousands of dollars on a million or $10 million deal. Like, don't be a dummy. Nobody sits like, Hey man, I'm so glad I saved that $10,000 on this million dollar deal that's going sideways. Like, no. And the other thing that people don't get,hey, is the engine and the transmission good in that car you're selling, Ron? Okay, it's a $3,000 thing. You know what I mean? What do I get for lying to you? A thousand bucks? Now we're talking about $800,000 SDE at a four times multiple. So that hundred thousand dollars thing that they could lie about is actually a $400,000 thing. Even people full of integrity get lured into lying in this environment.

[00:27:01] And then on top of the lies, Ron, a lot of times people just don't know. Like I've seen stuff in diligence that it wasn't a malicious lie, but rather a high school level controller, a owner that graduated high school, so trucks for 10 years started a trucking company and now it's worth a couple million bucks. And an accountant that gets paid 1500 bucks to do taxes and doesn't look at much of anything. And they all just didn't step up above what their competency was. And there's all kinds of stuff that affects cashflow in here that you don't know. 

[00:27:37] One thing I'm gonna toss out here, Ron, this has been a really interesting year because a lot of companies had their best year in a long time in 2022, and had been outside of that Covid bump, which a lot of people didn't feel because the government stepped in. And only like a 20 year run up of good solid economy. And now there's just some question about, there's some softness in certain industries and markets that haven't fully been realized. And so, I urge everybody listening to be really careful about those sims that were written November, 2022. On first three quarters of 2022 numbers and you're bidding on 'em and you get in there and they're holding back, you're to date stuff. Or they don't have the add backs for the year to date, so they're saying it's about on par.

[00:28:24] There's a lot of these companies that they're not able to hold up their 2022 performance in 2023. And people are trying to hide it and sate it and make sure, as a buyer you get behind the, get behind the numbers on that. 

[00:28:38] Ronald Skelton: Yeah. I like to, I'm in a different world because, everything we do in the media space, the websites, digital sites, newsletters, podcasts, all that, that we buy and look at, it's done off a trailing 12 months.

[00:28:50] So we use TTM. And the multiples are done different too. So instead of buying a, a three x, SDE, or EBITDA, we do, it sounds incredibly like lucrative for the seller cuz we, we do 36 to 42 x, but it's of trailing 12 month average revenue. Make the math easy, if you're doing a thousand dollars a month in revenue, the profit margins are so high on these. Usually like content sites, blogs, newsletters and stuff like that. We just go off of that. And it's, usually three, three years to, to just a little over that in revenue.

[00:29:23] When I look at brick and mortar business and stuff like that, I still wanna see the trailing 12 months, right? I wanna see month by month performance, the trailing 12 months cause it, it tells a story, right? And the other thing is you don't, a lot of people miss, and I bet you catch this all the time, is not ever seeing cash flows and not knowing a lot of businesses that you wouldn't think are seasonal or very seasonal. 

[00:29:43] Elliott Holland: And then buying 'em at the wrong time, not realizing they're seasonal. Or people need to be wary of,I'm gonna use a fancy term, but I'm gonna explain it. So channel stuffing. What the heck is that Elliot? If I'm selling and I know that I'll likely close cuz I got you under a letter of intent, in two months.

[00:30:01] What stops me if I'm a HVAC from clawing all my customers and saying, Hey, why don't you pay me up for the next, year at a 20% discount? Or like a landscaping company. I typically go month to month. But hey man, why don't you do like a rest a year service, at a 20% discount? And if I'm a e-commerce business, let me just send double the products to everybody that's paying monthly for the same stuff. No one then in a couple months to realize that I overbuild them. But it'll all fall on the new owner. And a lot of these companies will like be steady, steady, steady.

[00:30:33] And then like in the two or three months heading into close, it's like, What the heck is pushing this up? And a lot of times it's artificial. And for folks who haven't run a company and haven't realized what it takes to get 20% growth two or three months in a row, you don't really, it doesn't ladder up like your alarm system that this is highly unlikely to be real.

[00:30:54] Ronald Skelton: I was looking at a,security company, like they do home alarm system, security monitoring stuff. And I didn't realize how sick, I don't know if it was all of them, but that one was so cyclical. It was a high crime area. And when do you have a lot of stuff in your house that people wanna steal?

[00:31:08] Elliott Holland: Christmas. 

[00:31:09] Ronald Skelton: Yeah. So, I'm looking at this thing in January. They had a killer last quarter. And that's all they wanted to really show me. And I kept saying like, no. Show me, I need to see the last three years. And I wanna see it month by month for the last three years. Well, they're trying to sell it on January at a premium, not knowing that nobody's buying anything from January, February, or March.

[00:31:27] They don't have anything in their house that they're worried about people running off with. And the news isn't talking about like, that's another thing. There's a lot of media hype around the Christmas time about break-ins, picking up. So the fear factors there, the neighbor's house got broken too, and those alarm companies play off that. They watch those scanners and they watch the news reports and they go knock on the door and say, Hey, three houses in this neighborhood have been broke into, you want me to install an alarm system?

[00:31:49] I would've never thought it was cyclical or very seasonal, but it is. 

[00:31:53] Elliott Holland: And then they always try to push you on, oh, we don't have monthly, it's just annuals. I would tell you that is bull. Not a financial system alive that only creates annual financial.

[00:32:03] Ronald Skelton: And, you need to know those things, right? Because,if nothing else, even if you bought it right and you have cash in the bank and you can do things, if you don't know that you're, you're not gonna have much sales in January for every March that you know, and you think you got six months worth of, operating expenses laying there. And all of a sudden what you really have is probably two or three months because you're not gonna, again, you're gonna be paying salary out of that, right? 

[00:32:26] Other people don't see that, but I, I wanna see a cashflow analysis. I wanna see, month over month, over the last three years, and understand. A lot of times I don't even understand it. I'm not accountant by any means. I've got my master's, but my MBA is in business, but it's in marketing. I took enough accounting classes to pass. 

[00:32:41] I always say I study everything enough to get my BS meter and go, I'm gonna have to have somebody else look at this. A lot of times cashflow analysis is,when I see cashflow statements or I see something, even, a lot of these things where it's like they're giving me, they're, profit and loss statements broke up month by month over the last 12 months or something like that so that I can do a trailing 12 months. When I see spikes and dips and stuff, I bring somebody in. I used to have this gal Kat. She's semi-retired and doesn't really wanna do much anymore. But she was a forensic accountant and a lot of times I would look at things and go, I don't know why this is there or why. And I thought there'd be something wrong.

[00:33:15] Half time she'd look at, yeah, people just do it differently. That's fine. Or sometimes she would look at things and go, we really need to dig into this one. This is something's, odd here. When she was working in the corporate world, she got flown around. She worked for big corporations, and they would send her to divisions that had financial, irregular. She was a forensic accountant. She would dig in and figure out where it was going, why it was doing that, she would figure it out. But, she just doesn't wanna do it anymore. 

[00:33:39] Elliott Holland: I understand it. I mean, the stuff work. I love it. So, just so people are clear, I work for self-funded searchers. My average deal size is, it was lower last year.

[00:33:48] It's about four or $5 million. So I'm in the SBA lane as well. And each one of my clients are betting, a million bucks on a personal guarantee. So even when they get in my behind or I make a mistake, cuz I'm surely not perfect, I gotta respect the client and the risk that they're taking on and also the human that they are. Somebody who's willing to go get a chance at wealth. And willing to bet a bit and take on some risks. So I'm very happy that I'm in this part of the market. My big deal friends on Wall Street always, well they used to call me crazy. They don't call me crazy as much anymore, but I love it here.

[00:34:23] Ronald Skelton: So tell me, I dunno if you're willing to share this or not. Is there a price range or something? So, standard, SBA $5 million max loan. And it's, a 15, 20 year old company. Everything is, should be easy. What are we looking at in the price range? Is it by hour? Is it by job? You guys like, I mean, how does it price and what does it cost to do a quality of earnings? Due diligence workup.

[00:34:46] Elliott Holland: So we do fixed fee pricing, because I used to hate when I was buying companies and you call an accountant, ask for a price, and they give you a rate sheet. And like 60 to 160 hours and I don't know who's gonna be working on it.

[00:34:58] So I don't know. And I'm like, how does a numbers person not know? So we're fixed fee. So we charge for deals under $5 million in enterprise value, and we're a little bit flexible on that. We charge $20,000 for our QOE light. We charge $25,000 for our QOE. And then we have a sort of VIP package for $35,000 that has like projections, keyman risk assessment, red flag assessment, and some other things. So we keep it there. And then for deals that are bigger than $5 million enterprise value, we just increase everything about 5,000 bucks. So it's not a huge increase. And the pricing is all about surety. And a lot of what we do, Ron, is we try to hurry up and get a sense on does the dog hunt.

[00:35:38] So the first two weeks we're kicking tires. We're looking at bank statements, financials. And most of the time when something is like irregular or sort of totally off, we catch it within the first two weeks. And then we prorate everything around each week mark. So people only have sort of half the bill because we only did half the work to figure it out.

[00:35:56] Ronald Skelton: Yeah. I was gonna ask you that. Like, if you pull the trigger early and go, Hey, you guys gotta walk from this, is the bill different? So that's cool that you do that. You actually can prorate it and go, Hey, I didn't have to finish this one. I'm gonna prorate this one. Let's go find you something else, or bring me another one.

[00:36:08] Because it can get real expensive real fast if you're, especially if you're a new searcher and you don't know how to do some of that work yourself and have your own BS meter. People ask me all the time, the top questions I always get asked is, how much does it cost to do all these, due diligences right? And I always kind of knew the ballpark for legal due diligence is around 20 K. 25 k for a small, SBA. My world's a little skewed because the guys that do the, due diligence for web properties and stuff, often, it's everything's online and everything's like right there. So I can get like, all the technical due diligence done for a web property, a six figure, seven figure web property for probably three or four grand, five grand.

[00:36:46] And, because it's, it's basically they're just logging into a bunch of stuff. Now the accounting one, that's a totally different, but I didn't know what that number was. And I get asked all the time. The other one is asked, I'm asked all the time, is when should I, when should I pull the trigger? And I always say, you want it early enough that you're, you got your LOI signed probably. But you need to have enough information gathered up that you don't have any red flags up because now you're gonna start incurring costs. Cuz they ask, do they charge me up if we don't close or do they get paid at close?

[00:37:14] I was like, they're putting in hours. They're gonna get paid something no matter whether you close or not. Have a pretty good gut feel that this is gonna go through. Like for that concrete plant, I made him an offer. I never brought in anybody to do the, I'm brought in cats from other people, but I did it on equity,potential equity. But we didn't pay any out money out because it was like, I just had to tell people there's a better chance we don't do this than there is that we are. We're gonna keep moving forward.

[00:37:40] It's a big win if we get it and if it's,it's a lot of work if we get it. 

[00:37:43] Elliott Holland: And here's the other thing. So if you know how to do some of the analysis, then absolutely do it upfront. And sort of kick the tires to your level of understanding before you start incurring fees.

[00:37:53] But if you're just sitting there looking at stuff you don't understand for three weeks, just so you can tell somebody you looked at it, go get some help. I've had clients that are both ways and then, 25% of my, sort of client base or like former investment bankers, private equity folks, accountants, paying consultants, whatever. And so a lot of times they could do a lot of the work that I do, but they recognize in a 60 or 90 day condensed process to close. They have to go understand the industry, get to know the seller, get to know the employees, get to know the industry, put the debt together, put the equity together. Most of my clients are married, kind of get their family set up in this new location.

[00:38:32] Think about what a real personal guarantee looks like and they don't have the time to, to put, 40 hours a week for a month into this. So I would say do what you can for sure, but don't wait too long because you can spend two months on a deal where the numbers are off, telling yourself that you were waiting to start QOE. And I've got people that call me like, you got a week of exclusivity left. And 30 days to close, hey man, I found some wonky stuff. Can you do a QOE? And it's like, well, how long I have? Well, a week and a half? Like, no, I can't. I can't do that. 

[00:39:09] Ronald Skelton: Now you gotta go back and negotiate extensions. What do you say to some of these people? There's, I'm not gonna call out any names here cuz I just don't do that on this show. But there are some gurus out there, there are some people teaching, buying and selling companies that teach. If you're gonna do the SBA, you don't have to pay for quality of earnings report. You don't have to pay for due diligence cuz the SBA is gonna qualify.

[00:39:27] You can't qualify for the loan if finances are not good. I don't think that's true at all. What is your gut feel on like, is the SBA gonna find some of the stuff you find? I mean, probably gonna find some of it, but they're not gonna find. 

[00:39:39] Elliott Holland: Some of it. So there, there's two things that I would say to that. First off, I keep a folder of about 14 stories that have been publicized. The people on podcasts and articles. Where they did diligence themselves, ranted about how smart they were. Got into the deal a year, missed a whole bunch of stuff in diligence that got underwritten by the SBA. And now they got a two, three, $4 million personal guarantee on a business that's, they should have only paid half for.

[00:40:05] So they have half the cash flow. They're already in trouble with the bank. And now they're like, gosh, I wish I could have rewind this thing back 18 months and not did this deal. Cuz now I'm in a financial hole. So I created a sinkhole for myself. The other thing I would say, you gotta think about what the SBA is actually underwriting. So let's get real for a second. So this loan product is 90% guaranteed by the government. So 90% of the bank's risk is taken off. Most of these banks sell these loans after a couple of months. So they're not even holding 'em on their balance sheet. And then what recourse do they have if they underwrite a loan and, the buyer can't deliver the money through the company?

[00:40:46] Well, they like to lend to people that have assets. And they personally guarantees will keep you either selling your assets or working a job to pay them. So what the SBA is actually underwriting is a couple of things. That the government will backstop them, that the borrower will backstop them and that their bank will accept the loan. And so do they catch something? Sure. But they're not, they're so covered. They're like double collateralized. 

[00:41:12] Ronald Skelton: I get that. And,I've actually heard a few people, in our networking groups, like, I'm just gonna let the SBA do it. And we're getting the umbrella policy and the insurance company, with Keyman Insurance and everything else. They do their due diligence. Between the two of them, I'm covered.

[00:41:25] I was like, no, you're not. They're covered. Those guys covered their butts, but you're not. Like I explained this something like, here's your gamble. Are you willing to give up everything you guaranteed? Because I've seen some of those SBA guarantees. Everything you own, everything you are ever gonna own in the future and everything you might think you wanna own. It's really broad on like, they start, your house, your stocks, your bonds, your investments. I thought I was smart. I have everything, in the trust and we have family trust set up and stuff. And like, you gotta list that stuff. 

[00:41:53] Elliott Holland: And then here's the thing. So as a QOE required now, neither is life insurance, car insurance is regulated by the state, but I know a lot of people that drive without it. You rent a car, don't get the extra insurance. A helmet when you ride a bike. Like there's a lot of dumb things you can do that nobody told you you had to do.

[00:42:11] What I'll say is, and I ask this all the time, who can lose a million bucks? Which is just like your question. And if you're willing to not invest 10, $20,000 in insurance on your million dollar bet, I'm not even upset. I wish you the best. The people that I deal with recognize that that risk doesn't make sense. Particularly, it'd be different if you were a forensic accountant. Where you're buying a roofing company and your family's been in roofing for three generations. But a lot of my clients are, middle managers in corporate, that I love them because they've invested enough and they're thinking about buying a seven figure business.

[00:42:51] In the industry they don't understand and location they don't live. But you're way outside your depth. Get some help. Nobody's gonna think about the $20,000 they spent eight years from now, when you bought a solid business, paid it off, you're now a millionaire. And also you could sleep easier, cause a lot of this stuff, the reason a lot of the banks will call me when I do a QOE is because they didn't figure it out. 

[00:43:17] Ronald Skelton: I tell you, I've interviewed a few people and I know some guys that like own accounting firms and I say, we talk about due diligence and like, oh, we did our own due diligence for financial.

[00:43:26] He goes, but I hired an attorney to do the legal due diligence and I brought I brought an operation. If it was not in their bailiwick, if they bought something like not a, a non accounting firm, like they would bring in the operational guy and to look at the operations, right? Or they would bring, they get third party opinions on some of those other stuff that they didn't know cuz they're smart enough. Like, it's kind of biased cuz accountants tend to be risk aware. I wouldn't say adverse, but they're aware that there's risk there and they're willing to manage and mitigate them.

[00:43:51] But, yeah, I've seen accounting firms like, well, yeah, we'll do our own, but we're not doing the legal due diligence. Yeah, I know how it's done. You gotta go to every, every state that company's ever done business. Look at all, any continual lawsuits. Look at all the contracts. I know what needs to be done, but I'm not qualified to do it. And it's the same way with me. I know what needs to be done in the financial stuff. Maybe not all this steps, but I have a checklist of due diligence items. But am I qualified to look at something and go, yeah, that looks right. Or, oh, that add back sounds fair.

[00:44:15] Wait a second, a guy like you would go, yeah, no. You're missing X, Y, and Z. 

[00:44:18] Elliott Holland: All the conversation and accounting words to justify it. Whereas you might smell it and think it's funny, but not have the words to knock it out and then spend three weeks arguing. And again, one of the things I like about my business, Ron, is years ago I used to get more calls.

[00:44:34] Like, Hey man, like I'm doing a small deal. I don't think I need diligence, so and so. The class that I took said shouldn't really do diligence on deals under 2 million bucks. Like, explain to me why I should do this. And I kind of ended those calls early and just said, Hey, if you think that you don't need to do diligence or that you don't need my diligence, then let's just be friends. And if that changes come back because if you have the, to go out there and do a seven figure deal and not have done it before and not be a forensic accountant and not check those numbers, then, hey Rocket man. Go have fun. I wish you the best. 

[00:45:12] Ronald Skelton: Yeah. I think in some cases where like, I do know I, I have at least two mentors that they'll preach you don't need due diligence, but they're doing like work in wibo, work in buyout. Work in deals where they're coming in, they're putting in work. Very little down payment, if any, and they're taking over the business.

[00:45:28] And within six months you kind of know what's going on. Within a year you certainly do. And no money's really changed tans until then. And there's no personal guarantees cuz they're not doing,the different types of loans and stuff. I can see a way to work in without it where your due diligence is. I'm gonna be an operator for the first, 12 months. And earn my keep here. But I still think it's dangerous. Now real quick, a question that was in my head when we were talking about the fees and stuff. Can those be financed in with the SBA loan as part of the purchase package and stuff?

[00:45:54] So if the guy's got, say you've only got $150,000 down, or I guess you need 20%. A hundred thousand dollars down and some operating costs. So maybe you got $150,000 and I'm gonna put 20 to you, 20 to my attorney, 20 to that. Can I finance that stuff back in? So I still have operating capital, after the acquisition. So it sounds like we can. I didn't know for, I don't think I've ever asked anybody or that, but it's good to know we can. 

[00:46:17] Elliott Holland: And then, so like you said, we have real hours, so we have to get paid. So I charge half when we start, half when we finish our work.

[00:46:23] But I'll refund the money and get paid through the deal so you can finance, the fees that you pay me. So it's almost like a deposit that you get back when the deal closes. 

[00:46:31] Ronald Skelton: Okay. So let's do something real quick. Before somebody comes to you, they're about to do their LOI. What do you think they should look at as financials?

[00:46:40] Kind of a, 50,000 foot view. You should look at X, Y, and Z and be comfortable with this before you do an LOI. And, what I'm looking for is, do these steps before you call me, but then I need to take over at this particular point. 

[00:46:53] Elliott Holland: Sure. So I would say you're only gonna get probably 10 to 20% more than what the broker sends you initially.

[00:47:02] The whole, like, what should I look at pre LOI? I would actually say that you should look at what the broker gives you, realize everybody's looking at that and bid based on that. If you're doing a, proprietary deal, then I think you want, the last two years, tax returns, the last three years financials. And I think, a description of the business, if you don't fully understand it. It may be marketing material, it may be a conversation. I think that's enough to get to an LOI. We do free LOI reviews on offer from elliot.com, so you can sort of, if you're worrying about how to think about your LOI, you can come and sign up for one of those.

[00:47:39] And then, once the LOI is signed, then I think you start asking for the other stuff. And what I'll say is a lot of my clients try to over-engineer the pre LOI analysis. And I would commit to you that the pre LOI stuff is probably plus or minus 20 to 40%. So use it as a guide, but just know that you're gonna really get behind the kimono after LOI.

[00:48:02] Ronald Skelton: Okay. So, we're getting close to the top of the hour. Let's tell people how to get ahold of you. Think you actually had a free offer for the people. Let's talk about that a little bit. Yep. So let's do that. 

[00:48:13] Elliott Holland: Sure. So guardianduediligence.com is where you can find me. Also, I'm king of QOE or Elliot E. Holland on Twitter.

[00:48:21] That's my number one social, so I'm very active on there. If you need your LOI review, we do that for free at offerfromelliot.com. And then we have, lots of programs to help you get moving. So we have a pre LOI program. That's free or small, investment to kind of help people get their LOI signed. And we have a pretty self-serve website. So there's like 14 to 15 downloads. We've got over 150 articles, YouTube channel. So there's a lot of stuff you can consume and, we'd love to sort of hear from you. 

[00:48:53] Ronald Skelton: Awesome, awesome. And, if somebody could walk away today with maybe two or three key points and that's all they remember from the show, what would you have 'em? What would you want them to remember?

[00:49:03] Elliott Holland: Don't be a dummy and bet a million dollars without due diligence. Seriously, I don't want to hear anybody else on these podcasts talking about, they say 10, $20,000 and lost a million. You gotta be street smart in this environment, which is why I think Ron and I are kind of going back and forth on some of our fancy degrees, didn't help us all that much in some of the things that we do now.

[00:49:23] So if you don't kind of have some of that negotiating street smarts, recognize that you're gonna have to learn it quickly. And then, the third I would just say is there's a huge ecosystem of people like myself, like Ron, others that are putting out free content for you to learn from. And are way more accessible than my former private equity colleagues. So leverage the network to learn as much as you can. Take lessons from other people's failures and, get out there and succeed. That's what I'd be doing. 

[00:49:53] Ronald Skelton: Awesome. Well, I think we'll call that a show, and I appreciate you for being here today. 

[00:49:57] Elliott Holland: Ron, thanks for having me, man.