Are you planning or thinking of planning to sell your business? In this episode, Tad Render gives an insight into the preparation that goes into making the decision to sell. Tad is a partner with Miller, Cooper & Co., Ltd. where he leads the Transaction Advisory Services Group. His decades of experience working with buyers and sellers in varying industries taught him what he knows and shares with others. Tad insists that hiring the right professionals and knowing the importance of networking capital is key. Join Tad and host Domenic Rinaldi as they discuss the approach to be taken in these transactions, both as a buyer and as a seller.
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Tad Render: The Power Of Preparation
I would like to welcome my guest, Tad Render, who is a partner with Miller Cooper & Co., Ltd and leads the firm’s Transaction Advisory Services Group. Miller Cooper is a Chicago based accounting and consulting firm with 335 professional staff serving middle-market businesses and their owners. Tad has years of experience working with a host of financial and strategic buyers and sellers in a diverse range of industries including manufacturers, distributors and service companies. His experience includes buy-side and sell-side, financial and tax due diligence and general consulting related to mergers and acquisitions. He also serves as the Treasurer and Chief Financial Officer of Miller Cooper and its affiliated entities. Our firm has had the opportunity to work with Tad and his team at Miller Cooper and they are top-notch. Every one of our clients has been more than satisfied with the results of the work that they’ve done with Miller Cooper. Tad, welcome to this episode. I’m glad to have you.
Thank you, Domenic. I’m excited to be part of the show.
I’d like to start with how did you get into the transaction services side? Talk a little bit about your background. How did you get into this part of the business?
I started my career with Miller Cooper on the audit side of the practice. At the time, the firm was a fraction of the size of what it is now. You join the auditor tax group. I decided on joining the audit group. I worked in a number of middle-market, family-owned, closely-held businesses and enjoyed that. I did get an opportunity to help a partner on several due diligence engagements. I liked it. The main reason was we were able to add value. When you’re part of the audit team, it’s a requirement for a lender or for an investor group. It’s difficult to add value to the audit side but easy to add value to the transaction advisory services side. I started working on more and more engagements and now I run the firm’s Transaction Advisory Group and spend 100% of my time on the M&A space.
Not to embarrass you, but the opportunity we’ve had to work together, you and your firm are top-notch. The work that you’ve done for our clients has been incredible. We’ve appreciated getting to know you and your firm. I imagine that you’ve been in a lot of transactions. You represent and do both buy-side and sell-side. I’d like to spend time talking on both sides of the transaction. Why don’t we start on the sell-side? I’m curious and I’m sure there are a ton of things that you could talk about. If you were to bring it down to the top two or three things that you see in sell-side transactions like pitfalls or areas where you think sellers could have a better transaction. What in your experience have you seen from a sell-side of things?
Number one, the most important aspect of a company considering going through a sale process is preparing for sale. Ideally, the company is planning an exit even years in advance. A lot of times, the sellers we work with wake up one morning and decide it’s time to sell their business. With the active M&A market, they may have a friend, customer or vendor of theirs who recently sold their business and they think, “Maybe it’s time for me to sell and jump headfirst into the process.” The number one thing is preparing for the sale. There’s a lot of aspects that go into that from a financial reporting perspective to a legal perspective to an operational perspective. The more a seller can plan ahead, the better the process will be.
We say this to sellers all the time. In fact, I wrote something related to this because I get asked this question all the time. What’s the number one piece of advice that I offer to people? I always talk about preparation as being the number one thing. Let’s bring that to life for owners of businesses. What does it mean to them? How can you move the needle? How can their advisors move the needle when they do the preparation? A lot of owners look at this and say, “These guys are going to charge me a lot of money and they’re going to work with me a couple of years ahead of time but is it going to move the needle?” What is the difference? Maybe you can talk about some examples you might have of clients who did it the right way, who prepared and you could document for them how you move the needle.
Number one, it starts with hiring the right advisor, whether it’s the right accountant, attorney, sell-side advisor, well in advance of going to market. From an accounting perspective, we would like to see a company go through reviewed financial statements or even audited financial statements, depending on the size of the business. Typically, smaller businesses have more lenient debt reporting requirements to their lenders. They may not have reviewed or audited financial statements and it’s something that takes time to put in place. The sooner the better on the accounting side.
The other way that a seller can prepare for sale from an accounting perspective is to start quantifying one-time nonrecurring expenses or normalizing certain expenses that are out of the market. For example, an officer’s comp. Going out there and getting good comp studies on what a fair market comp structure would be for the executive team. Whether the current comp is over or understated. If the company is leasing from an owner-occupied real estate, going out and getting what fair market rent values would be, all for the purpose of validating some of these adjustments to historical earnings before a buyer and buyer’s advisors come in and ask these hard questions. These are only a few examples of some of the things that can be done proactively on the accounting side.The most important aspect of a company considering going through a sale process is preparing for the sale. Click To Tweet
Do you have any tangible examples of clients where they came to you 2, 3, 4, 5 years ahead of time and you were able to work on this? You did a snapshot of what their estimated value might be before you started the work and after. Can you demonstrate how it moved the needle for them?
One example that comes to mind is an electrical components distributor that we initially started speaking with a few years ago. Luckily, they were a seller who was proactive. They realized there was no succession plan within the business and there would be an eventual exit. When we walked in, their books and records were in shambles, that would be an understatement. They wouldn’t stand up to a buy-side quality of earnings exercise.
The first step was hiring a proper control. They have been using a family friend bookkeeper for years. We’re able to place a full-time experienced controller. At the end of the day, that comp for a real controller was slightly more than what they were paying for a glorified bookkeeper. With that controller’s help, it cleaned up the books and records and accounting policies. Without doing that, it would have significantly hurt the value. Now with the new controller in place, we went the next step further and identified a lot of these out of market accounting policies they had. They had out of market comp with several people, out of market rent, they weren’t taking advantage of vendor discounts that were offered. When you put your buyer’s hat on and the company goes from breakeven to $700,000 of adjusted EBITDA.
That $700,000 is completely comprised of adjustments to EBITDA, not historical factual earnings. The buyer has a little bit of pause. When you look at 100% of the adjusted EBITDA, it is comprised of adjustments. We worked with them to put these cost savings in place over the next few years. By the time we went to market, the actual reported earnings had gone from breakeven to $700 of actual EBITDA and we kept our adjustments to a minimum.
That’s a great story. The banks and buyers, as we both know, want to see the earnings. All these adjustments cause people to pause and it’s not only the buyers. The banks are going to look at that and they’re going to have a ton of questions. Even the nature of those adjustments may or may not be accepted by lending institutions. That’s a great example. You mentioned something in the middle of all of that. I’d like you to talk about it. You mentioned the quality of earnings. Can you talk about the importance of it and the timing of it? Should sellers do it before they go to market because we know, often buyers want to do it? If you can talk a little bit about that, that’d be great.
A quality of earnings report oftentimes is referred to as a Q of E report or a Q of E exercise. It looks at the company’s historical normalized earnings and the ability for that company to continue to generate those earnings on a go-forward basis, which any buyer or lender is going to be interested in. It starts with the company’s historical earnings as reported financial statements. Whether those are internally compiled or they have an external firm involved. It doesn’t matter, but that’s the starting point and you adjust those historical earnings based on a number of factors.
I’ve been referring to normalize one time or nonrecurring expenses and making sure those are removed. Another typical adjustment in the Q of E process is making sure that those financial statements are GAAP compliant. When I say GAAP, I’m referring to Generally Accepted Accounting Principles. It’s the common language of accountants. The more the GAAP compliant your financial statements are, the more a buyer or lender is going to understand those statements and have faith in them. That’s another part of the Q of E process. As far as timing goes, the earlier the better. On the sell-side, we have always been big proponents of doing a sell-side Q of E process prior to going to market. It gives us the ability to uncover issues and develop stories around those issues and potentially fix those issues before a buyer comes in and asks the same question and catches us off guard. It’s a process that’s well worth the exercise prior to taking a business to market.
How much prior? Here we are in the middle of 2019 and let’s say they wanted to sell in 2020. When would they ideally have come to you and asked for this Q of E exercise?
It’s a bit of a catch 22 because you want to perform the Q of E work well in advance of going to market, but yet at the same time, you want to present recent financials. If someone were to plan it to go to market and Q1 of 2020, I would recommend starting the sell-side Q of E process using a trailing twelve months of June 19 period or a trailing twelve months, September 19 period. When I say trailing twelve months, I’m referring to the last twelve months of performance. Buyers and lenders always want to see full twelve-month reporting periods. It gives them the ability to compare to annual financial results a lot easier.
Before you’re thinking of taking the business to market, 6 to 9 months is the right time to do this sell-side Q of E, but they should have been working with you a couple of years in advance of that to make sure that everything was in order. By the time you’re doing the Q of E, you’ve probably addressed most of the issues.
It’s not only us as the accountants, it’s also yourself. I know you and your team are happy to meet with potential sellers years in advance of them pulling the trigger to develop that rapport and learn more about the business. You start to vet out some of the operational issues and what are the challenges through the sale process. It’s the attorneys who are making sure that the company has all their contracts in place. A lot of smaller businesses operate under a lot of handshake deals. It’s important to get the attorney involved years in advance.
To the M&A Unplugged podcast community, Tad is giving you a tremendous nugget here. If you’re a seller and if you’re going to sell your business in the next five years, you want to do all the things to prepare your business. Don’t wake up one day and say, “I’m ready to sell,” because you’re invariably going to either leave money on the table or not maximize the value of the asset that you have. Some forethought, planning and preparation can yield you tremendous upside. Tad, before we move over to the buy-side, anything else on the sell-side? Any other things that you see or pieces of advice that you would offer to anybody on the sell-side?
I’ll go back to hiring the right advisor and hiring someone who has been through the process before that can help you navigate through the entire process and ideally someone who also represents buyers. It gives you a unique sense of what the information the buyer is going to want and what their ask means. Especially if you haven’t been through the sale of a business before and you’re working with let’s say a private equity buyer who’s sophisticated. There are a lot of nuances to the transaction where you can easily get taken advantage of by someone who’s more experienced.
That’s a great point. Let’s move to the buy-side and the buy-side transactions that you work on. I’m curious to hear what are the 1, 2, 3 things that you offer to people who are looking to go out there and acquire a business?
I’ll start with the importance of the quality of earnings exercise and verifying the historical adjusted earnings of the seller. It’s similar to the sell-side Q of E process. On the buy-side, we’re going to want to vet out all of the adjustments. A lot of times sellers will throw everything under the sun as an adjustment. As a matter of fact, I was on a phone call with a buyer. We received the sellers adjusted pro forma and they’ve eliminated almost the entire SG&A section of the P&L with the premise of, “You won’t need that going forward because you’re already in the business of paper distribution.” This happens to be a paper distributor. “You’re not going to need our rent, utilities, and sales commissions.” When you tick down, all those things will continue on a go-forward basis. The importance of verifying the seller’s add-backs is priority number one.
In that case, was this seller trying to create a creative value for the buyer, thinking the buyer’s going to merge that operation into theirs and those expenses disappear? What’s the faulty thinking around that?
The seller is represented, in this case, by a sophisticated investment bank that’s trying to create value, when, in fact, with this specific buyer, that value is not there. I can’t blame the seller for trying but it’s our job to help the buyer vet out these adjustments and what the historical run-rate earnings are.
It’s interesting you talked on the sell-side and about the importance of sellers doing a Q of E and now we’re on the buyer’s side and you’re explaining the buyers the same exact thing. I’m assuming that exercise, when you’re buying a business needs to be separate from anything that a seller might have done. Is that correct? Are you in situations sometimes where you’ll look at a Q of E that a seller has done more to validate their work or are you undertaking that work separately?A lot of smaller businesses operate under a lot of handshake deals, so it's important to get the attorney involved years in advance. Click To Tweet
We use a sell-side Q of E as a starting point, but we would look to independently verify any adjustments that were made within that sell-side.
When you’re representing a buyer in the transaction, if the seller has done a Q of E, you will take that Q of E and you’ll vet it rather than do your own from the ground up.
We do use that as a starting point and it’s a great tool, just as audited financial statements would be a great tool. On the buy-side, if we were to evaluate two different sellers, if it’s the same identical business, but we have seller A who has audited financial statements and has a sell-side Q of E delivered to the buyer. Company B has internal financial statements, no independent accountants oversight. We can turn our finance team, 9 out of 10, that the buyer is going to go with company A.
I’ve seen this many times in many different transactions. I’m going to take you out of the accounting world for a second and I’m going to ask you to be a psychologist. What have you seen in the mentality of a buyer when they’ve seen that the seller has gone to the extent of doing a sell-side Q of E? I’ve seen it. I’m interested to hear what you see in that buyer when they know that the seller’s done that work.
A sophisticated buyer is going to realize that it’s a starting point as opposed to the end result when they see a sell-side Q of E. We do work with a lot of newer buyers and independent sponsors who are looking to buy their first business. Typically, it’s a smaller business who maybe had been in the process of searching for a business for 12, 18, 24 months. They may have put the blinders on when it comes to identifying some issues with the selling company. That’s where we step in and you and your team step in to harness that buyer in and remind them that they need to be patient in their search. Just because they want to get a deal done doesn’t mean they should get the deal done. They need to get the right deal done. I see those independent sponsors relying on a sell-side Q of E a lot more than they should be.
I completely agree but when a seller is taking the time and expense to go do something like that, assuming they used a top-notch firm, it does speak to the seller’s motivation and desire to do a clean transaction. The buyers that we represent, when we bring them into a deal and the seller has done that work, we see them perk up. They get excited. They see somebody that was willing to spend the money, do the preparation and immediately think, “This could be a clean business.” They still have to verify everything, but they get excited when they see targets that have done the pre-work.
To put it into perspective, when that is in place, you see half to a one-turn more in evaluation and at least 2 to 3 months of that transaction cycle.
To the M&A Unplugged community, that is massive. When you talk about generating additional value, the thought of doing some preparation and you can get an extra half a turn or turn on the value of your business. For people who don’t understand what a half turn or a turn is when you look at your EBITDA, every turn is a multiple. When you can generate that increase in value because you adjusted the preparation, that’s significant. Tad, why don’t we move into diligence? I’m interested in hearing your thoughts on the diligence process, the pitfalls that you see there and the advice that you would offer to people once they get into the diligence process.
One thing I did want to touch on, we talked about the quality of earnings. That’s the quality of the underlying company’s P&L. Another big consideration that we have when we go into diligence both buy-side and sell-side is the quality of the assets and completeness of the liabilities. It’s often referred to as networking capital elements. We want to make sure that, the historical AR that the company has been reporting is good, valid and clean receivables. There’s no concentration in those receivables, no stale aged-old receivables and no outstanding credits hanging out against the receivables. When we look at inventory, it’s a similar concept. We want to make sure it’s good saleable inventory that’s going to turn the next operating cycle and not a bunch of aged-old inventory collecting dust. We want to make sure that inventory is costed appropriately. Is the seller applying GAAP costing methods? Are they overstating inventory or understating inventory? All of this gets back to the sufficiency and the quality of the networking capital that’s in the business. That’s a big part of the quality of earnings process.
You talk about inventory. I would love to hear a little bit more about that because that one area in a lot of transactions tends to be a massive stumbling block. I can’t tell you how many times I’ve heard sellers say to me, “This inventory never goes obsolete,” yet it hasn’t moved in five years. You’re asking a buyer to pay for something that hasn’t moved in five years. I understand it might be a piece of steel and it’s not perishable but there’s that litmus test of, “Is this valid inventory?” Talk a little bit about inventory and how people should approach that.
The inventory is an issue on 9 out of 10 deals where inventory is present in the business. It’s a number of things. It’s an obsolete inventory. It may be steel but the last thing I want our buyer to do is to have permanent capital in the business supporting this inventory that’s not moving in the normal course. There are a lot of ways that you can address this issue. We worked on a deal that closed where there was some question as to whether or not the inventory had value and was going to turn. In that situation, the buyer agreed to pay for the inventory.
We isolated this bucket of inventory that was roughly $500,000. The buyer said, “If it’s good inventory and we’re going to sell it, we’ll buy it from you on an as-needed basis over the next twelve months.” The seller agreed to when they came to terms with what value would be assigned to that if and when a customer calls and orders the inventory and we need to fulfill that order. The inventory will still stay on-site and be housed in the buyer’s warehouse. It won’t be on our books until we need it. There are a lot of different ways you can bridge the gap. You have a seller who is saying, “This stuff is worth a dollar for dollar.” You also have a buyer may come in and say, “Maybe it’s $0.50 on the dollar”
That is a great solution. There are many others but that one in particular is a great solution. When you’re working with sellers, you’re helping them prepare and you get to this inventory issue like we do when we’re working with sellers, how do you help them overcome and realize what’s obsolete and what’s not obsolete? It’s been a hard thing to get sellers because they’ve spent that money. They’ve spent that dollar. It’s sitting on their shelf and they want to get paid for. I understand that. I can put myself in and sympathize with owners who have all that inventory sitting there but at the same time, those buyers don’t want to buy stuff that’s been sitting on the shelf. It’s tying up capital. How do you help them overcome that? Are there strategies that you help them deploy so they’re not long on inventory when it comes time to sell?
I have a couple of comments. Number one, it’s an emotional process to go through the sale of your business. They may not always be looking at the hard facts. What we can help them do is understand in black and white numbers the obsolescence they have in this inventory bucket. I’ll tell you, 9 out of 10 times a seller isn’t even aware of how old some of this inventory is. If you were to ask them to isolate this bucket of obsolete, they say, “We’ve had that for maybe, maybe 2 or 2.5 years.” We go back and look at purchase records and sales history, that stuff’s been on hand for five years. That happens a lot when you lay it out for them and setting expectations.
We talked about getting involved ahead of time. Having a conversation with the seller in advance and understanding what issues the buyers are going to have with their inventory. Maybe it’s liquidated and some of this old inventory to make it a non-issue by the time a buyer comes in to look at the business. If we can liquidate for $0.10, $0.20, $0.30 on the dollar, it eliminates a difficult conversation to have with when a potential buyer. We’re always in favor of eliminating issues 1 or 2 years in advance.
When you talk about boosting the confidence of a buyer and their willingness to do a deal, the cleaner the business is when they’re looking at it, the higher their confidence level and the more you’re going to get paid. If they have to address issues and negotiate things that reasonable buyers are going to expect in a deal. It can bring down the deal and there’s plenty of transactions to be had. You need to stand out and have your business stand out if you want to command the highest multiple.
It’s not only convincing a buyer to get over a certain hurdle. Whether it’s inventory or any other issue. We may be successful in that but there’s typically a lender involved on the buyer’s side. We also need to convince ourselves to get over this hurdle. A lender is going to come in and do what’s called a field exam or they may come out and physically count the inventory and do the dust check. If there’s a lot of dust, it doesn’t bode well for the buyer getting financing. We see that blow-up deals often.
I asked you this on the sell-side, I want to ask you it on the buy-side. Is there any place or any examples where you’ve worked on a buy-side deal and you were able to move the needle for that client on the value side? I’m curious if you have any live examples of that.Inventory is an issue on nine out of ten deals where inventory is present in the business. Click To Tweet
We’re working on a transaction. It’s a metals processor. We’re helping a strategic buyer acquire an existing competitor of theirs that they know well. We’ve received some pretty good internal financial statements from the seller, but a couple of things stuck out. One, not to get too technical but it shows the value that a good buy-side advisor can add. The seller is making an argument that because they paid their payables within the first couple of days and there’s not as much working capital required to run the business than what’s been reported on the financial statements.
Their argument is they could stretch their vendors to normal 30 or 45-day trade terms and still continue to operate the business in the normal course. What that means for the seller is they’re asking for a lower networking capital target. We tend to agree with that position, but one thing we noticed was because the company is paying their vendors within the first 5 to 10 days, they’re taking advantage of significant early pay discounts. In this case, it’s to the tune of a $100,000 year of prompt payment discounts with their vendors. We came in and said, “You can’t double-dip.” You can’t ask for the additional working capital because you’re going to assume that we’re going to extend the payment terms with our vendors at the same time get credit for this $100,000 of earnings that you’ve created by paying your vendors early.” This happens to be a five-times multiple. In that case, we’re asking for and successfully negotiated a $500,000 purchase price discount based on a five multiple of the 100,000 of prompt payment discounts that won’t be there going forward.
That’s outstanding. You earned your keep right there.
When you put that in perspective, that’s one of many adjustments we help the buyer identify. This one was successfully negotiated for the return on investment of hiring a good advisor who can be astronomical in certain situations.
We could probably sit here and talk for hours about all the nuances. We’re only scratching the surface. There are many nuances and areas in a transaction that you need to pay attention to. We could go on with more people probably. If you were to put a bow on all of this, what advice would you offer sellers and buyers as it relates to their M&A transactions and what they should be doing?
Number one, preparation, especially on the, on the sell-side. Number two, hiring the right professionals across the board. Those are your accountants, attorneys, sell-side advisors, insurance and environmental people. If there are environmental issues, it’s getting the right people involved. Three, digging deep. When I say digging deep, that applies to both buyers and sellers. The seller should dig deep into their financials and make sure they’re going to stand up to scrutiny. A lot of times we hear sellers say, “I have an accountant who prepares my tax return every year, so my numbers are good.” Dig deep and understand what’s in your financials and make sure it’s going to stand up to a buyer’s scrutiny. On the buy-side, digging deep into a seller’s financials and not taking the seller’s word for things.
I appreciate all of that. Is there a book, business or non-business that you’ve read that’s resonated with you? I’m trying to collect this information and gather it. I’ve got three books on my list that I’m going to read that I hadn’t read before as a result of this.
I’m reading a book, Eleven Rings: The Soul of Success. It follows Phil Jackson’s career, the former Bulls and Lakers coach, and how he’s applied leadership principles to the teams he has run and how that can be applied to the business world. I’ve started it and it’s been a great read.
Tad, thank you so much for being on the show. I appreciate all the information that you’ve given. If people out there wanted to get in touch with you, how can they reach you?
Tad, thank you so much for being a guest. To summarize the key points that we heard from Tad, which you’re probably going to read on most episodes. Number one, preparation. Preparing for your sale or your acquisition is important. Tad discussed the fact that he’s been able to move the needle for several of his clients because there was some preparation involved in the transaction. Who doesn’t want to walk away with the maximum dollars if you’re selling? If you’re on the buy-side, who doesn’t want to get the best value possible?
I can’t emphasize enough on the value of preparation. Q of E, quality of earnings. You heard the importance of that both from a sell-side and from a buy-side. Miller Cooper, I’ve seen their work. They’re great at it. I highly recommend both sides that you want to look at doing the quality of earnings. The other pitfall, the other key learning here is the importance of networking capital in every transaction, getting the number right and testing what’s in the balance sheets. The quality of the AR and the inventory, all those things matter because as a buyer, you don’t want to be left with too little networking capital.
As a seller, you don’t want to give away too much. Understanding what that quality networking capital number is critical. The last one, inventory in particular, 9 out of 10 deals run into some turbulence because inventory wasn’t handled ahead of time. On acquisitions, we see this issue all the time. If you’re a seller of a business, bring somebody in well in advance, have them look at your inventory and clean it up. It’s going to make for a better transaction. It’ll give you time to go liquidate or do what you need to do with the inventory that’s slow-moving and stuff that doesn’t need to be there.
I appreciated having Tad on the show. If you would like to learn more about the process of acquiring or selling a business, please visit our website at SunAcquisitions.com or feel free to reach out to me at [email protected]. I look forward to seeing you in the next episode of the M&A Unplugged podcast. Until then, please remember, scaling, acquiring or selling a business takes time, preparation and proper knowledge.
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About Tad Render
Tad Render is a principal at Miller, Cooper & Co., Ltd., and possesses experience serving middle market, privately-held companies. As a principal, Mr. Render is responsible for the direction of day-to-day client services.
In addition to accounting and audit services, Tad assists clients with individual and corporate tax planning, financial analysis and business consulting.