Podcast Transcript

[00:00:00] Sean: G’day everyone, and welcome to the ScaleUps Podcast where we help first-time Founders learn the secrets of scaling so they can fulfill the potential of their businesses, make bigger decisions with greater confidence and maximise the value and impact they can have in the world. I am your host Sean Steele and I'm joined today by Shawn Flynn - Principal at a Mid-Market Investment Bank, focusing primarily, Shawn, on mergers and acquisitions, growth capital for the kind of, would you say like 10 to 250 mil revenue range, maybe like 3 to 25 mil EBITDA, would that be right?

‍

[00:00:54] Shawn: That's right. I mean, we focus on those transactions between 10 and 300 million and the numbers you just said, those are the companies that fall in that space.

‍

[00:01:01] Sean: And I guess if it was a SaaS company or something, it might be like, you know, one mill plus in recurring revenue or two mil?

‍

[00:01:07] Shawn: SaaS has been insane the last couple years. Like literally it could. I mean, I've seen some crazy things, the craziest one I've ever seen so far was 40 times revenue.

‍

[00:01:22] Sean: 40 times revenue. What?

‍

[00:01:24] Shawn: 40 times revenue by a company that did barely 1 million in revenue that year. That's the craziest one I've seen to date.

‍

[00:01:31] Sean: That's pretty insane.

‍

[00:01:33] Shawn: There had to be something there in the tech that I just didn't know. But yeah.

‍

[00:01:38] Sean: Somebody makes money out of that. So, that's good. Well, you know, Shawn, you and I, offline realised that actually we're twins, which is quite exciting because we've got the same first name. We discovered we have the same colour in our virtual background. You're the only other person that I've seen, like me who has a QR code linked to his LinkedIn profile in his virtual background. We're probably the same age. And although you've got a nice clean-shaven head, I'm still working towards mine, but I'm getting pretty close. So nice to meet my brother.

‍

[00:02:10] Shawn: Well, you just got me on the right day of the week. I mean, if this was any other day, you'd see stub on the side.

‍

[00:02:16] Sean: I love it. So, Shawn, you like today is really about M&A, right? So, we'll talk a bit about our community, but our community is probably at that lower end of the kinds of clients that you work with, but therefore there's so much value for them to learn from the kinds of clients that you support. You know, we've got a lot of people that are in that probably 1-3 mil EBIDA range. And I'm keen to come back to your background before we kick off. But you know, that's the space that I actually spent the last four years of my time doing acquisitions as well. And so, there's probably a multipart series for us here to unpack all the things that we might like to share, but really I'm keen to unpack, you know, we've got a lot of people in the audience who are likely, this is likely they last business, you know, many of them are in that sort of like a 45-to-60 year old range. They've built this business. Maybe it's taken them 10 years and they've got a certain amount of energy left for it. They want to realise some value at some point. So, they're starting to think about their exit strategy. And so, today is really about talking through your experience and thinking about how do we help them optimise that? What does, what does the process look like? What drives better valuations? How should they think about preparation? How do they think about incentivising management? Should they be selling to a strategic or a financial? Like there's so many questions and there's no way we're going to cover them all today, but I think we'll just get started and see where it leads us and if we need to do another episode, then we will. But your background, I just thought I'd start there because you didn't start life as a typical kind of investment banker, you know, kind of following the typical path straight out of university into a top tier consulting firm, into graduate program, and then straight into a investment banking and junior analyst roles. And there seems like there's like a designed path to get people into your role. And you took a completely different path, starting with founding and scaling and exiting a business in Beijing. Can you just give us a quick insight into that journey? Because I think people really will get some value out of the fact that you come with a different perspective.

‍

[00:04:09] Shawn: I mean you're a hundred percent right. I'll go to many events and people go, wait, wait, what? What'd you do before? Like that background, I've never heard it before. It doesn't make any sense, but it kind of does make sense when you put all the pieces together. After uni, well, during uni, I really wanted to travel abroad, but I was doing mechanical engineer because of that major, I just had to be heads down in my books in order to graduate. Whereas all my buddies were taking a semester or quarter abroad. We were on the quarter system. And so, the whole last two years of university, I was like, okay, as soon as I graduate, I'm going abroad. Once I graduate, I went down to Costa Rica. I thought I was going to be there for a couple weeks. Stayed almost two years. From there, I was doing some research. This was 2005-2007. I was seeing that China was taken over the world. They were opening up call centres in Costa Rica to speak Mandarin. And I was like, oh my gosh, this is just crazy. What's happening here. And I thought I don't want a real job. Let me go from Costa Rica to mainland China. I'll stay there for a year. I'll learn the culture, language. I'll do everything that I did in Costa Rica, but there, and it'll really put me in a good position for the rest of my life being a mechanical engineer that speaks Spanish, that speaks Mandarin, from Silicon Valley, I was thinking, okay, every door will open up in the future, and we'll get back to that because it really more closed than opened because of that. But I went to China. It was more difficult than I thought. I ended up staying there almost five years. In that time I did go to Europe for about six months before going back. So, I was abroad for a total, about eight years after college, had an okay exit, partner bought me out for a company we started, that was the third company I started in China. The first two were complete disasters that I learned a lot from the allowed the third one to actually be successful. And those two others are stories that whenever I even tell people here, they shake their heads like, nah, that didn't happen. That didn't happen. I'm like, no, that really happened. And even the third company people, most of the time don't believe me. But yeah, partner bought me out, came back to the US 2013, normal corporations, big companies thought I'd all quit. They're like, you're going to get bored here in a year. I mean, I was interviewing at some of the sales force who's all these big companies here in Silicon Valley and they all said the same thing. You'll get bored, leave. The start-up ecosystem loved me. Because of that, I got connected with a bunch of angel investors. I started helping out one angel group, the second oldest angel group in Silicon Valley. It went for me just helping to then being one of the deal screeners. And then after a while I was the investment director of this group, I'd look at a hundred companies a month, filter it down, get on calls with 20 or 30, filter that down to meet with 10-15, and then bring in 5 or so to meet with the members to actually pitch to. And maybe one would get a check. And then I was doing deal flow agreements with all this new money coming from mainland China. This was back 2017-2018. I spoke Mandarin. I was with this angel group that had 20 years of connections in Silicon Valley. I could speak to this one group that had no connections, but had money. And I was pairing them off in some deal flow agreements. One group said; Hey, you know, come on board, work with us. We're backed by this very large land of development company in China, they're building all these tech parks and we want someone to help take companies from here, set up their operations in China and vice versa. I did that for a number of years, got to know a bunch of investors in that process because I was making intros to everyone and an investment bank that I made an intro to that made a lot of money, was like; Hey, you know, you should just come on board, we'll sponsor your licenses. And then that was one. And then when the pandemic started, I switched over to the one I'm currently at. So, you had this crazy path of just doing one thing after another, after another always pivoting. But when you look at the skillset you have, okay, good with people, adaptable, able to listen, able to create stories and match people based on investment thesis from listening, you know, mechanical engineer background, there's a lot of components that really apply to the investment banking that I'm doing right now. So, there's a lot of times when people literally call me out in groups and be, and say; Hey, you never wanted to Harvard or Stanford, any of these places. What makes you qualify to investment banker? And I'll say, I've been parts of billion-dollar real estate transactions, and I've been parts of this, and I've been parts of that throughout my career. And if I'm able to at one time do contract negotiations and Mandarin, the writing and everything, I think I can handle the deal we're working on now. And that normally shuts them up.

‍

[00:08:51] Sean: I love that. Well, you know, it's funny though. It's not until you've actually got the hindsight later on that you seal the ingredients that have come together that all help you with whatever it is that you're working on today. Like I've got a 17-year-old, so he's just about to go out into the world. And so, helping him think about his future and going; Hey mate, like don't get tied up in the path because, that's just such a great example of every pathway leads to another pathway, just be decisive, like just go after stuff that seems interesting where you're going to learn. And each one of those will fork off into something else. And at some point, those ingredients will come together and really help you, but like, don't get all swept up and I have to design this perfect pathway because that's where everybody else is going. It's like, just forget about it.

‍

[00:09:30] Shawn: I mean, some of the craziest stuff I've done in my past have turned out to be the most beneficial. There was a time there I was a personal trainer. You would think like, how does that have anything to… it taught me how to take goals, break it down into smaller goals and smaller chunks and create this six-month, one year timeline. I substitute English teaching sometimes when I was in mainland. It taught me same thing, course catalogues, all these things apply to investment. All these things apply to business. All these things apply to processes, everything. And we could talk about that later, but it's crazy, the things that one time in your life people laugh at. And the other times they're like; Hey, that's it's money maker now.

‍

[00:10:09] Sean: Yeah, absolutely. No, I'm with you. Well, I mean yeah, probably that gives to our audience a good sense of the fact that you've done a lot of things that are going to be pretty relevant to our conversation today and taken a bit of a different paths. So, I really like that. Maybe we can set up just a, almost an EBITDA if you like, because there's such a range…you know, we had a good chat offline about the fact, well, a business that's doing a million bucks in EBITDA versus a business that's doing 5 million in EBITDA actually has quite a different set of, I mean the business obviously looks quite different in terms of its maturity, in terms of leadership structure, in terms of the kinds of buyers that are going to be interested in that sort of size. So, maybe I thought we'd take a bit of a sort of hypothetical based on maybe a typical Founder in our community. Well, let's say someone who is 10 million rev. 2 to 2.5 in EBITDA. So, 20 to 25% in EBITDA, let's say they're a training business, maybe they're selling courses for people to look to change careers. So, they don't really have recurring revenue. They've got a pretty transactional services business, but it's consistent and it grows each year. And it's got some key leaders in place. You know, there's some sales managers and marketing people and a reasonable, no C-suite, but a reasonable management team that's capable of running the operation, but fundamentally the Founder is still the CEO, you know, late 50s, this is the last business, not interested in doing anything else. So, happy to stick around for earn out period, like not in a rush to get out but trying to figure out the right time, maybe to sort of create value in thinking about what their options are over say the next sort of three years as the business grows. So, we can come back to that as a, you know, almost the person that we're talking to today, but maybe if we start from your perspective, Shawn, what a lot of Founders, because the vast majority of Founders in this community will not have sold a business before. And so, they don't even know what the process is like, what is involved for a Founders? Can you just maybe just take us through at a high-level steps in the process?

‍

[00:12:05] Shawn: I really like that example or the company to use, I really like the number. I like everything there. I think that's a perfect example to use. So, before the transaction, so we'll break it down into, I guess, three parts and then that middle part, even break it down further. So, you'd have the before even going out and hiring the investment banker to go out to market, you'd have the whole process and then you'd have post-closing. So, even before the investment banker comes in the picture, you probably should talk to a wealth advisor, tax advisor, all these people on your core team, find that lawyer that has some experience in MMA that you like, that accountant, just all these people that have that experts in the past. The reason why is, yes, you can find them during the process, but then you'll be rushing it. You might be getting recommendations and you're like, you know, this person doesn't really fit my risk profile. We don't mesh, like you don't want that lawyer that's sitting there going, okay, at the littlest thing, I'm stopping this deal. You know, if your personality is; Hey, we're going full steam ahead, I'm selling this. That's it. You know, what's that on scale of 1 to 10, that risk tolerance, if you're a 2 or 4 and your lawyer is a 9, you know, that doesn't work, but if you're a 2 or 4 and the lawyers are 2 or 4 and the account, you know, everyone involved has a similar risk profile for the deal. The deal's going to be comfortable for everyone to move forward at each of the steps versus this person fine with this person is fine with this one is fine with that one. So, get to know your team early on. And you know that first year, even before you hired in the investment banker, you know, talk to that investment banker, say; Hey, a year from now, two years from now, I'm thinking of exit, what should I do? And he'll probably say, or she'll probably say, give me your last year’s financials, let's create, you know, do you have everything in like a mini data room, just so I can kind of learn about this business so I can give you some feedback on it. Is your customer concentration too high? Do you have all your sales and marketing processes built out? Have you been tracking these metrics? You have, or you haven't? If you haven't, okay. You know, for your industry, we should really be tracking these, let's look at the lifetime value, the cost of acquiring a customer. Let's talk about all these, maybe your net promoter score. Let's see how those change over time and let's see them going in the right direction. Because we can fix some things, but some things take longer time and maybe you'll want that 1, 2, 3 years of this data before going out to sell it, so you have that maximum value. And every industry is different. So, one industry might want these metrics. Another might want these other, you know, find out what your business focuses on and see if you can get those numbers better than average, better than the competition out there so you can get that premium. So, now we're moving into, okay, it's time to actually sell the business. And that process, a lot of people think, okay, if I start October, we're going to be done by years end. And that's not the truth at all.

‍

[00:15:11] Sean: That is not happening.

‍

[00:15:12] Shawn: I’ve had people come to me saying; Hey, you know, this is going to be a quick transaction. I want to get this done before Christmas. And you're sitting there going, wait, what? Excuse me. Hold on. The reality is these processes take time. There are a lot of steps involved, but some steps can be moved a little bit quicker than others, especially if you're prepared for it. So, think six to nine months, I mean, really think six to nine months on average, and it might go longer. It might go up to that year, because who knows what's going to happen in due diligence. Maybe the economy changes. Maybe something happens that buyer is 30 days in. They pull out, they say; Hey, I can't for some reason. And then you're going back out and to one of the other people that might have submitted an LOI and we can go into all that and then having those conversations again. But let's go back to this whole process of, step one, you're going to be building out a data room. Now, if you've gone out and raised capital, you're probably familiar with it. If not, a data room all it is, is put in all the information of the business in one central location. And that information would be the last couple years of financials, a proforma, a proforma that's thought out and believable, not just; okay, we're going to scale 300% next year. It would have…

‍

[00:16:30] Sean: But we only did 15% last year.

‍

[00:16:33] Shawn: We only did 15. And our discount cashflow analysis puts us at a hundred million company because look at this, we go from here to here.

‍

[00:16:39] Sean: Yeah, all we have to do, we're just going to add 20 sales people at exactly the same time, and they're all going to start delivering to a hundred percent capacity on day two. So, it's an easy spreadsheet calculation.

‍

[00:16:50] Shawn: And zero account executives to service those accounts. And somehow, we have an app in the Apple Store, but we don't have an iOS developer.

‍

[00:17:02] Sean: Yeah. I've seen those spreadsheets.

‍

[00:17:04] Shawn: I mean ...Oh, my gosh. Yeah, it's pretty hilarious when someone's like, yeah, I just take this one spreadsheet I found online and I adapt it to my business, even though it's not relayed to my business and come up with something else.

‍

[00:17:19] Sean: Actually, let me tell a story about that briefly, Shawn, because last year I was helping a public listed company to do some acquisitions in the education industry. And we were looking at this business and it was in a business that had basically was going through a bit of a turnaround. It had a sort of a tail off period, they'd installed a new general manager. A new general manager was absolutely the right guys doing excellent job. He'd turned the business around. He'd restructured the cost base. He'd restructured the products like everything was going in the right direction. And they'd sort of had this bounce from, they were doing 2 million EBITDA. Then they did 1. Then they did pretty much nothing. Then they'd bounce back to 1. They were back to maybe 2 or something. And then the next year they were going to do 7.5. And the following year they were going to do 17. And I was like; Hey guys, this is great. But let's just talk about the assumptions that underpin this model, and what was really interesting was, and people don't necessarily recognise this in the process, but that document was the primary thing that made, this was an excellent business. And I was having to advise this company to say; actually guys, just forget the financial model that you've got in front of you, we'll build our own model. But the business is excellent, it's got the good bones, it's got a great leader. It's got all the things that we want and it's not going to do those numbers, but it is going to do something that's positive that we're going to get a return on. So, we'll obviously rebuild that model and then we relook at it. But as a result of seeing that document, they were like; well, I just don't believe it. Like, if they're going to put that document in front of us, what else are they going to put in front of us? What else are we going to find in due diligence? And people don't often appreciate that. Like a big part of this process is building trust and transparency and believability. And so, I said to the CEO, I'm like; mate, you didn't put this document together. Did you? And he was like, you've met the owner. He's like, that's what the owner wanted. And I was like, the CEO just could not get the owner to put in the data room, the financial model that the actual CEO believed in. He had a model. He knew what the numbers were, but the owner wanted to really inflate it thinking they were going to get some massive sale price as a result because everyone was going to believe it. But actually, everybody not only didn't believe it. We didn't buy that business. And we exited the process because they'd just gone to town on some crazy assumptions that were not believable. So, they absolutely scuttled the deal that could have been a good deal for them.

‍

[00:19:39] Shawn: I mean, I think you're right on the point when you said trust there, because I mean the data room, this whole process is de-risking the investment for the buyer. And if they can't see that, if they… You're right on point with that. I mean, the whole process is to build that confidence to that end person that this company that is going to be predictable transferable revenue that this is how our models are actually going to play out. And if they see something like that and, yeah.

‍

[00:20:11] Sean: And actually, interestingly, as you say that when I think about a data room, I've seen Founders before have this desire because they've never had to open up the coat before. And so, they're a bit scared of kind of putting creating a lot of transparency in there. But the advice from me is always, if you don't put that information in there, you are incrementally increasing two to three weeks of time, every time there's a key document that's not in there because someone discovers it, they're always going to ask for it. Like, I give most clients the sort of standard list, a hundred points sort of DD checklist. I'm like, this is the standard stuff before we even get to your industry, you know, this is like everyone is going to want to say these things. So, just get on with it and giving it to them because otherwise they're going to ask questions in the process, which is going to take you time. You won't have developed it. You're going to have to go and develop it whilst you're trying to run the business. It's actually just making your life way harder. Like do that upfront work, get all the information in there, to your point. So, they go through the DD process and go, you know, the best thing that you could get as an outcome is they come out of the DD process and say there was nothing that we discovered in the DD process that you hadn't told us, like no red flags, it was exactly as you said it was going to be.

‍

[00:21:22] Shawn: Well, to add on that, I mean two things. One, when you add everything to the data room at the very beginning, that investment banker, whoever you're working with to create the market materials has more information to go on. And the last thing you want is to create this SIM or this piece of information that gets sent out there that has a number that when they check a data room later after they've gone through that, they see something that's contradictive

‍

[00:21:46] Sean: Shawn, people may not have heard the acronym SIM. Can you explain what you use as a SIM?

‍

[00:21:51] Shawn: Sorry. So, Confidential Information Memorandum. So, the data in the data room will be made into a piece of marketing material. Normally there'll be a blind profile. So that has like a teaser, something that just has enough information on a company to kind of wet their appetite to find out more. It's not going to have the enough information to know which company it is, but it'll say the sectoral, talk about maybe the financials of the last two years and the next three years predicted, maybe some key customers, some things about the business where the person that gets it, the private equity group or the strategic will go; Hey, I want to know more about this company. I'm very interested. I'm going to spend the time. Then they'll sign normally a Non-Disclosure Agreement - NDA. Which says, this information, you know, you can't share with people, it kind of protects that confidentiality of it. And then they'll get a SIM, which is a Confidential Information Memorandum, which is basically a summary of the data room. So, think of a 60-page document that really goes into the weeds on this and really gives the end, either private equity or strategic or whoever enough information for them to go; Okay, we're really going to dive deep into this. We're going to make an offer. We want to set up a management meeting. We want to spend a lot of our resources to find out about this company because we're really serious about moving forward with this. So, that SIM, if you create it and then later on there's information in the data room, that's been updated since the SIM got sent out and is conflicting or this information, they're like; Hey, that's kind of key. Why wasn't that in the SIM? Huh? It brings up questions again. And that trust factor, because their side is going to be analysing everything because they don't want any liability. They don't want any surprises. They want to model out everything. A lot of people on that side of the transaction, the buyer side are looking for ways to kill the deal. There are those definitely those champions that want it to happen, but then there's other people on that team that; Hey...you know, their goal is to make sure it doesn't. So, back to the process. Oh, and talk about the data room. How granular I've seen it, the most granular one I've ever seen so far or hypothetically because I don't know if I'm supposed to talk about things I guess is, one Founder had the transcriptions for every podcast they've ever been on in the data room. And the people on the other side went, oh my gosh, I've never seen this. And because of that, completely trusted the whole process. They were enamoured. They're like, I've never seen a data room so clean and so thorough in my life. And these people had been doing transactions for years and years. And when they saw the, every podcast the host had ever been on transcribed in its own folder, their jaws drop.

‍

[00:24:51] Sean: … Organised, willing to be transparent. Like, yeah, it breeds trust. And you know, some people, people may not realise this, but I've been in organisations where as part of the deal team, we might have six or seven people working on this deal. You know, there's a lot of resources often being deployed to, and it could be obviously significantly more if it's a really big business, but also the deal team would get split into two and would essentially debate the deal. You'd have a kind of a team voting for the deal and having to present the reasons why we should do the deal. The other half of the team's job is to figure out why we should kill the deal. And they basically, that's kind of the investment committee is like the two opposing sides present the case. And then a decision's got to be made. And it's a really interesting process, but so to your point, there are people looking and there are people who will have their rose-coloured glasses on looking for all the reasons to do the deal and say, yes, your financial projections and how amazing the business is going to look is going to be key but there's just as many people, if not more looking for every reason not to do it, because this is a risk assessment, right? Like if we deploy this money, how risky is it? How likely is it that we're going to blow that money up or go backwards because that's not going to work well for anyone. So, they're going to spend time it.

‍

[00:26:05] Shawn: All right. Going back to that whole process. So, data rooms being built out, it's got all the articles incorporation, everything you can think of there, you've built out the marketing materials. We talked about the client profile. We talked about the confidential information memorandum. We're also creating the buyers list at that time. If this is an active process, if it's a passive process, what I mean by passive is there some people that will go to groups that just basically put the company on some websites, they might have a few buyers that they know for this size of a transaction. An active process, you're out there emailing, calling, everything. You're bringing the buyers in. You're contacting them directly based on their investment thesis. You know who you're targeting. You've created that information from databases, from your network, from 30 years or whatever in the space and you're going; okay, this deal based on the parameters that they invest in fit perfect. You know, you're matching it up sector size, check size. I mean, you're not going to bring a deal. That's a 50 million deal to someone that writes a minimum, a hundred-million-dollar check or maximum a 20 million check. It's got to be that fit on both sides to maximise everyone's time. Then it's going to go from there depending on the deal. It might just go to LOI or IOI - Indication of Interest or a Letter of Intent. Both are non buyin but the Indication of Interest is normally; Hey, you know, we are roughly estimating this company at a range between EBITDA 5-6 it's more broad the information and hopefully in advance, if you've kind of done the process right, you've told people; Hey, this is what we're looking for. We're looking for you to put valuation on this company. For what reasons? We're looking to show that, you know, you have the capital to actually invest in this company or where it's coming from. Hey, we're looking for just some overall information. Then from there, you know, you're narrowing the funnel. So, the whole thing is a funnel process. From that very beginning where you're messaging everyone to that more narrow, you're getting these Indication of Interest that more narrow, you're getting that Letter of Intent to hopefully you find that one buyer that fits perfect, whether it's strategic or financial, then you go into due diligence. Hopefully you can get that done in a reasonable amount of time, maybe 60 days. And then, definitive agreement, everything's transferred. You're good. And then it's that integration post transaction time. So, think maybe a year to two or three years to prepare. Six to nine months that transaction, and then however long the integration after. So, I mean, you're talking three to five years for a proper sale verse, hey, let's do this in three months, which a lot of people think.

‍

[00:28:56] Sean: Yeah. A hundred percent. So, let's talk about then because I'm conscious how much time we got today. I know one of the things that obviously the meat on this topic for a lot of people is how do I maximise the valuation? What are the things I need to be considering in a business this size, you know, so we talked about the sort of two and a half million dollars EBITDA on a 10 mil revenue base. We've got some leaders in place. What are some of the things that you think will help them optimise value? And then we'll talk about some of the things that are probably going to reduce the numbers of people they can sell to, or increase the risk profile fundamentally and therefore make it less likely that they'll get a decent price?

‍

[00:29:37] Shawn: So, to start. I mean, the first thing, even before to maximise the value is, think about maximising what you'll get out of the deal by talking to that wealth advisor, by talking to that tax advisor, because the last thing you want is getting this check and it's giving 40% to the government. When in reality, if you've done just tweaked little things, you give almost none to the government. So, talk to those people far enough in advance to also kind of plan out that exit of; Hey, what I want to do with the rest of my life will require me to have an exit of this size, and then you can kind of judge your company. So, for the example right there, maybe you're thinking, okay, I could sell this company for 10 million. Maybe you own a hundred percent of it. Well, you've talked to your wealth advisor, you've talked to your tax planner and they say, if you get anything above 6.5 - 7 million, you're going to live life the way you dream, it's all planned out here it is. And the person is going okay, perfect. So, I have that great margin on both sides. So, I'm pretty sure, you know, when I go out to market, I'll be able to fulfill everything I want to do, versus that other person that might go, I'm not planning out anything, I have this big dream. And then it's a sudden surprise when they go out to market and like, oh my gosh, I can't realise it because I'm paying all these taxes. I should have done these changes to increase it within this range. And so, before start planning, know those numbers that you want to hit so that you have that lifestyle post sale that you dream of. I mean, that's the first advice. Then for the company itself, and Sean, I'm sure you can share some stories of Founders you've talked to that you just kind of shake your head and you're like, wait, why did you start planning this after the transaction was done? Why not before?

‍

[00:31:22] Sean: No, I'm with you. And actually, I think probably one of the hardest questions for Founders is they haven't really thought about how much money they need post transaction. Like they haven't actually done the thinking to go, well, this is what I would be happy as long as that's the number that hits the bank account. They haven't actually done that thinking. So, it's quite difficult to reverse engineer it because as you said, once you… and they go, oh, you know, 5 million sounds like a big number. And you're like, okay, yeah. 5 million, less costs, less taxes. Oh, there's two of you. Okay. Like the numbers starting to get a lot smaller. Like this may not be a life changing amount of money anymore. Okay, maybe they can pay their house off, but maybe not a lot more. And so, fundamentally, what are you selling when you think about the multiple, you're selling future earnings. So, it's like, well, if I only can sell the company for three times EBITDA, well, if the business wasn't even growing in the next three years, I'd get that EBITDA into my own. Or you know, I could take that EBITDA out of the business, depending on the kind of working capital profile. It's like, well, that's what you're selling. You're selling future cash flow. And if the business is growing, you're going to find that you actually get that number pretty quickly if you just hang out to the business and keep growing it. So, there's a real dichotomy there, but to your point, the starting point is, well, what is my kind of walkaway minimum? And then assuming you've then understood taxes and thought about costs on top of it. Then you get to a sale price and then you're getting to a sale price versus multiple. And then now we're into the, well, is that a reasonable, do I need 12x or can I actually get that outcome on 3 or 4? You know, then obviously there's a lot of factors in terms of the business, but yeah, let's talk about some of those factors then. Okay. Let's assume they've, let's say in this scenario, as you said, let's say, if they were to sell this business for 10 million bucks, so 4x EBITDA, they're comfortable with the walk away price, they've done the tax planning, they think that's going to give them the lifestyle they want and they think that that's sort of achievable. How do they then think about the optimisation of that? How do they get sort of more and what things would be likely to contribute to them getting less?

‍

[00:33:25] Shawn: Perfect. And to add on that last, just one other thing that having that number in your mind that is key to the whole process is you'll have the number from your walk away point and that keeps you sane throughout this whole journey. Because one thing that I think your listeners, when it's their first time going through the process, they're not going to understand the highs and the lows until going through it. And I mean, Sean, you're smiling. So, I think you've seen it. Whereas, you go out to market, you might not getting offers that you thought on that first week and you hit these lows, or you start getting offers and your significant others already spent the money and you start freaking out going, wait a second, the money is not on the bank, what are you do in buying this or buying that, adding stress. Or keeping it secret from those colleagues or your, your employees that you've worked with for the last 8-10 years, thinking in your back of your mind, I might have to let some of these people go or what's going to happen. Or even that, this has been of my identity for last 10 years of my life, what am I going to do post? So, having that thought out before the transaction, having those numbers, having kind of that visualisation can keep people more sane throughout this very, very emotional journey. So, wanted to add that.

‍

[00:34:54] Sean: Yeah, I think that's super relevant.

‍

[00:34:55] Shawn: Now going into the numbers.

‍

[00:34:57] Sean: And actually, can I just say one other thing? One of the things that, I remember one of the first negotiation skills courses I did really talked about, you have to understand your BATNA, which is your, I can't remember what it stands for now. Best Available Alternative? Do you remember what it stands for? BATNA?

‍

[00:35:16] Shawn: Yeah, Best Alternative…

‍

[00:35:17] Sean: Best Alternatives. That's basically your sort of bear ass minimum, what is your walk away point is. But, you know, the number of processes that I've been in, I always just found this super fascinating. The first time I got involved in M&A, there was a deal where the seller had said, well, we can go through the process and we can talk and negotiate, yada, yada, yada. But basically, we're not going to be selling it for any less than 7x EBITDA. Like, that's it, like, it was just right up front. And that was probably a premium for that market and for the business. And actually, it was probably worth 5, but they were like, we will not be so, no matter what comes out of this process, we will not be selling to you for less than 7. So, please do your due diligence, please come and negotiate anything that you think kind of needs adjustment, but recognise we're still not going to sell it for less than 7. And I was like, that's so interesting that somebody would be that sort of bold and brassy, but in the end, the number of conversations that are influenced on our side as we were the potential purchases. People would come back and go, yeah, we could do this and we could do this. And we've looked at this in the model and we think there's probably a discount opportunity there, and this thing over here, like, we need to normalise that out and so on. But then it just continued to come back to this dialogue that had up front, was like, yeah, but they're not going to sell it for less than 7x. So, there's no point going to them and saying, well, we think it's worth 5. They're not even going to entertain the conversation. So, we've either got decided, are we in or we out? And it was so interesting that they'd actually, I'm not sure if it's always the right strategy, that's for sure. But fundamentally you're essentially setting a price, maybe you could have got more, but anyway, this actually, because they wanted a premium and it was actually a good business, it just put a flaw limit on the thinking of the purchaser. I don't know if you've seen that much, Shawn. I'm sure it works out badly sometimes because it probably could have knocked us out very easily, but in the end it didn't.

‍

[00:37:10] Shawn: What's kind of crazy with that one is, I mean, I've talked to other investment bankers about that going; Hey, what happens when you're working with that engagement where the person sets that floor that is just unrealistic? And some people just come back to me and they're like, it always changes when there's real money in front of them. So, I mean, I've seen different, I've seen where it doesn't change where that number is the number, but then I've also seen where; Hey, once there's a real check and they go, you know, this is real money. This changes my life. Okay. I will. I'm more flexible.

‍

[00:37:48] Sean: These guys didn't but yeah, I think it's definitely possible. Certainly not advising that that's a great starting point. But to your point, they had a very clear price. They knew what their walk away was, they wasn't going to have a conversation or anything less that. And so for them, it actually strengthened their position, didn't weaken it. So, let's carry on.

‍

[00:38:06] Shawn: One thing for that though, also for all the people you're talking to, your advisors that early on, talk to them about your flexibility. So, just piggybacking on that where you had that one that said, hey, this is the floor. You could always be, okay, this is the floor, but I'm going to be very flexible with my terms. Whether it's that cash component, that earn out, the seller's note, the roller of whatever, just; Hey, I got this number in my head but I'm flexible with everything else, so get there. Or, hey, this is a line in the sand for the cash component only, and everything else is gravy for people to compete against or whatever it is, but relaying that flexibility early on and having conversations, what all those mean is huge. And I mean, maybe I just threw a bunch of words out there. I've noticed a lot of people don't quite understand a seller's note or an earn out or roll over, all those terms. But yeah, so think of it this way. There's a lot of different components of that are possible in a transaction. You have that Cash Component, which is, this is the amount of money, great. It's most secure. You know what you're going to get, then you have the seller's note, which is the IOU, the debt component, where they're going to pay you back. And if not, you're able to have a recourse component because you're on the debt stack depending where you are, whether first position, second or whatever, but they'll pay you that money. The Earn Out will be tied to something, whether maybe it's your time of employment there, revenue, EBITDA, something like that. Where, if these things are met, then you'll get paid. Rollover is cash in the new entity and all that stuff. And there's more but you can play around with these so much where it's maybe that seller's note is over a five-year span. Maybe it's over three-years, maybe the first year there's a holiday where nothing's paid and then it's monthly, or maybe it's every quarter, or maybe it's small amounts with a huge balloon. Maybe the earn out is… so, with the flexibility of all this financial, however, you may call it. Those numbers can range quite a bit with what the buyer gives you, because they're going to look at their risk profile and go, okay, cash is this risky, sellers with this risky, earn out is this risky over this amount of time and we see in our models this way. So, we're able to give this higher number to them. And if you're open to these types of conversations, yes, it is more risky on the seller's point for each of these things, but you can get those higher numbers. And sometimes the seller would like that because, well, this money's deferred, I'm not paying taxes, this is part of that wealth building strategy. Hey actually, it's getting better interest because there's an interest on that seller's note that's higher than the banks are paying. Hey actually, I'm really liking these people that are acquiring us, this private equity group. And I think in the next three years, they're really going to increase this company. And when they sell it, I'd like to get a win then. So maybe I'll roll over some of this equity component. And you know, being open to these conversations can change the dynamics of the deal completely. So, have those conversations early on with whoever you're working with, because when they have their conversations, they can mention this; Hey, my client here, they want this number, but they're really flexible on how to get there. Or hey, the client is looking for at least minimum this much cash on closing and then these other components, they're flexible. It's just saying that expectations for the flexibility in the terms of the deal. And it could change everything in the conversations you're having with the buyers. So, something just to think about on day one going into this sale of the numbers you need to hit, when you're talking to your wealth advisors, your tax planners, because each one is handled differently. And that was a lot there. We could do a whole episode on that, I think.

‍

[00:42:10] Sean: Yeah, I agree. And I think, it really does, I guess it's like a property transaction, right? Where you may have a particular number. You might be really flexible on the settlement. You may be happy to fix some things before the place gets sold, or you may be like, no, I want this unconditional 30-days, no conditions whatsoever, but I'm willing to take a haircut because I don't want to have to deal with all the other stuff. It is about kind of flexibility. It turns into your point, there's a open conversation there so maybe that's when we return to in our next chat. So, then if you think about, because obviously those things can really help you to optimise the deal. As one example, your business might be on a great growth trajectory and you might be quite happy to hang around for the next 12 to 18 months because you love the business. There's no major kind of risks from your perspective, maybe you weren't even looking for a sale and you got an offer that you weren't expecting. Well, if you've got another 12 or 18 months, you might be quite happy with an earn out because you'll get a multiple on last year’s EBITDA but actually you'd really like a bit of better multiple on next year's EBITDA and the kind of the blending of the two gives you a better outcome. So, to your point, you might still want a cash component that's X dollars on day one, but you're happy to take a balance because you think you'll actually make a little bit more, but there's other, other Founders who'll be like, I want to be out of here in 30 days, like, you know, 30 days post sale. And I've seen one of those recently where the company that was acquiring wanted to hold back sort of 10 or wanted to have 10 or 15% of the price attached to an earn out essentially the following year's financials. But they also wanted the Founders to leave within 30-days. And I was like, hang on a second. So, they're going to be in control of the business, but then you're going to have 10 to 15% at risk? That doesn't make any sense to me. Like, if you're staying around and you've got influence over the outcome. Great. But if you're not, then that seems a little bit interesting. So anyway, yeah, it's probably a whole, maybe we do a part of a podcast two with you, Shawn, we'll talk about terms and some of the opportunities in there. What about just straight up things that you think an investor is looking for in a business like this, that's going to influence them wanting to pay a higher price, versus things that are likely to make them want to push hard for a discount?

‍

[00:44:24] Shawn: So, let's go back to the answer of de-risking. So, how can we create a situation where the buyer is looking this as little risk as possible with the business as a whole? So, you have, there's no concentration of clients. You don't have those clients that are making up 30, 40, 50% of sales. You know, there's a lot of clients making up small amounts. So, if you lose a couple, no big deal. You have those Founders or the people on the team that maybe step out, but the business is still running because the processes are so well laid out where everyone there knows step-by-step what to do. You have the numbers that prove this over time, where it's not; okay, for the last three months this is our lifetime value of a client. But no, no, it's actually been the last 2-3 years. We have the data and they keep getting better, better, better. And there's a trajectory. Here's everything we've changed. This is what we're doing. Now, it's basically this book that you can almost hand them like a manual for every component of the company. All laid out, thought out. I mean, that's when you get that premium on the company where it's; Hey, these systems have been thought out, they're proven, look at the track record, look at all the components. We're good with this, this is going to add to us. We're confident it's going to hit these numbers moving forward in all our projections and what they're telling us. I mean, those are the companies that get that premium when you look at their metrics versus everyone else in the industry and say, oh, they're better here. They're better there. That gives them confidence thinking that, okay, the money we're investing, we're going to get our money back at a multiple we're happy with. So, that's when you're building out that business for sale, you should be looking at it going; okay, where are my numbers that are not above industry average? The cost of acquiring customer, or maybe, there's things of that people, for some reason don't put value on, but there is value. Such as, likes and all that information on the web, 500 five-star reviews, the social media, the keywords, hey, there's companies I've talked to that are like, yeah, we're top SEO for these keywords that drive this much organic traffic of that. And they won't even mention that to me until months in the conversation. I'm like, hey, how do you get so much organic traffic? Oh yeah. Well, all this SEO and everything, we rank on these keywords. Like that has value, that has a ton of value. So, I guess I got a little off track there, there's a lot of value that people don't see in their companies. Just the other day I was talking to a buddy of mine and he was telling me that there's a company he's working with, I'm not sure if you are fans of basketball, if they've watched golden state warriors, and that. It's a health company here and they were interviewed years past with the golden state warriors going to their facility after a game to decompress and like the ice saunas or whatever they have there. And it was on page eight of their website that no one knew about. You're like, wait a second. The golden state warriors, best basketball team, one of the best in the world, you got Steph Curry video on the news. How come that's not everywhere, you know, homepage, everywhere? That's a huge marketing piece. So, there's all this collateral that has value but more than anything, I guess just a company that has the processes built out that step-by-step, that people can follow that everyone on the team and the culture, company culture is a huge value add. I mean, is that culture one of, we're going to be working if we get acquired in the right manner or is everyone going to take what they can and take off? Or, I mean, there's a lot there.

‍

[00:48:29] Sean: And if you think about even just the when you're often thinking about metrics and things that you're going to want to show, okay. So go back to our 2.5 million-dollar education business. And as you said, we're going to want to be able to show consistent improvement and planning and sophistication in our all the lead generation relevant metrics, the sales metrics, the lifetime value, the cost of acquisition, yada, yada, yada, but actually on the cultural side, people often leave that completely out. And I go, wow, like, where is your employee engagement survey that's got some transparency about actually how people feel about the company, how people feel about the product and the reputation of it and the leadership and their engagement with the leadership and are they getting what they wanted out of role? And, you know, you may not have, it's not about having perfect scores and everything. It's about showing, hey, we got these results 2 years ago, we addressed these top five issues. And then the following year that went from 78% engagement to 84% engagement. And that's a great improvement. Like it's actually that transparency and that proof that you know how to improve the business, you know where your gaps are, that builds trust. But also, it's an easy way to help people understand what the culture is, you think about a lot of this processes, there's some big quantitative elements You've got a lot of people who specialise in the quantitative side, lots of analysts and stuff and pouring over the numbers and building models and all the rest, it actually gives them something quantitative, but that talks to the qualitative element around culture, it could be a nice little addition.

‍

[00:49:55] Shawn: Oh, I think that's huge. I mean, especially these acquisitions now with people working remote and that, the cultures and I mean, is this something where you add this company to a platform company and everyone gets along and they grow, or is it civil war happening on day one? I mean, it's a big deal. And how do you really know these companies, how they'll gel pre-transaction? So, I mean, like you said, having that information on the company itself, it's huge.

‍

[00:50:33] Sean: But what I'm hearing you say, Shawn, for the benefit of our community is, in terms of thinking about maximising valuation or trying to get a premium over another business, if you put two businesses side by side; an A and B, and they've actually got exactly the same revenue, exactly the same EBITDA, exactly the same number of people, they sell the same products and so on, what other things that is going to get one a premium versus the other? And actually what you've articulated is reverse engineering what somebody is going to consider higher risk. So, it's like, what are the things that are going to increase my risk profile with this business? Okay, well, they don't have processes and systems well documented. So, if somebody leaves in the leadership team, that thing is going to fall over, or the Founders actually, it doesn't have a strong leadership team, full stop. And the Founder is doing six jobs. And so when the Founder leaves or if the Founder leaves it depending on whether they're staying or not, then you've got a massive problem and you've got a huge kind of vendor cliff sort of risk scenarios. You almost sort of reverse engineering all the things that people are going to be looking for as red flags or deal breakers and trying to make sure all of those things are being well thought about so that as they start doing that digging they're, actually, this is stable, this is believable, this is trustworthy, this is solid. And that's starts to… because if you think about what does the multiple represent for the buyer? Well, that also represents how long it's going to take them to get their money back. So, if they're like, well, what's going to make them pay 7x versus 5x? Well, they've got to be comfortable that if the business, they're obviously not going to buy the business, if not growing, but if the business wasn't growing, it's going to take them 7 years to get their initial investment back before they make a dollar. So, they then want the business to grow. They then want to have some other synergies they're going to be able to add on top. That's what is going to help them feel like they are willing to pay a premium. But if they can see all these red flags everywhere, they're quickly turning into the territory where they're like, well, this is going to have to be bought pretty cheaply because we've really got to protect our money here. And we may have some turning around to do or some major problems that might come up and it really starts to change the price someone's willing to pay.

‍

[00:52:35] Shawn: Sean. I wish I just said your answer.

‍

[00:52:38] Sean: No, I just got to summarise your answers. That was good. That was helpful. So, I'm conscious, we're almost at time, Shawn and I've got so many more questions that I would like to ask you. So, if you are willing to come back for an episode two, I would love to book some time with you to do that and to keep digging if that's okay with you. But can I ask maybe one, we had a little bit of dialogue offline about strategic versus financial buyers, because there's some people that are very wedded to that you're only going to get a premium if you sell to a strategic. And I understand there's a lot of benefits for that. So, maybe you could just explain the difference between a Strategic and a Financial buyer for a business this size, you know, 2.5 million bucks. So, maybe they've got that option. What does the strategic versus a financial buyer look like and why would you choose one over the other? Or why would you sort of go after as part of your strategy one after the other, talk to me about your thinking around that.

‍

[00:53:34] Shawn: I think that's really interesting, especially now because things are kind of changing in a way. For companies of that size, 2.5 million EBITDA for a strategic think of it as someone in that space that has that business, that this technology or the company could just be rolled into, fantastic. You got the financial buyer that's going to be looking at it as EBITDA and going, okay, whatever we invest in, hopefully we get these returns and they're looking at more of a financial base, or at least that's kind of been the history of it. And so strategic because there's so many other things that they can add to it. In the past have added a premium that the financial buyers, even with all their thinking, okay, I could pull this money out and recapture this. They haven't been able to meet, but at least the conversations I've been having recently, things are kind of changing where those private equity groups are getting in and given multiples similar to those strategic buyers. And some of that is because there's just so much money on the sidelines right now. There's so much money that these private equity groups have raised that they're going; Hey, we got to start deploying this ASAP. And you know, we're just not seeing as many of those companies as in the past. And there's so much money competing for them that we have to kind of change our risk profile. We have to kind of change what we're offering these companies. So, conversations I'm having strategic financial, lately they've been pretty comparable, which is pretty interesting. So, I mean, who knows if that changes in the future or not, but as of right now, the decision between one or the other, you know, it's a tough decision.

‍

[00:55:20] Sean: Yeah. It's really interesting because it does feel like that has changed a bit. And so, I guess, you know, even like if we went back seven months ago, you know, people were finding, getting money out of venture capital pretty easy. And then four months ago, not so much, locked up a little bit tightly at the moment. But I think to your point, if you think about, let's say you're this education business. So, in working with a public listed company that I mentioned before, that's really interesting opportunities. They had significant databases of employers. So, very tight relationships with employers who all wanted training. So, we were looking for businesses for training businesses who were really strong with consumers who didn't have good relationships with businesses, where immediately they'd be able to introduce those education businesses to the businesses. And all of a sudden, they've got a completely new revenue stream. It helps them or existing customers they're getting now access to the EBITDA of the business they've just purchased. So, they're going to be able to create a kind of accelerated amount of value out of that business because they can cross fertilise the customers in two directions. That's a good example of a strategic partner. Now they were willing to pay more than perhaps market rates as a result, because they knew they can create more value. They didn't have to take any money out of the business. It wasn't of a cost cutting. It wasn't a financial net engineering type opportunity. It was just purely, they could see revenue, they could see increased returns because they actually thought they had revenue synergies as a result of the nature of that group, or they also thought they could reduce risk because they had people in their business capable and already knew and understood this business model. So, if the Founder leaves or the directors leave, or some managers leave; no big deal, we've got people we can deploy straight away. We know we can turn that business around. We're not going to lose a lot of money because we know what we're doing. They're not buying something they don't understand. And therefore, it's all the risk is within the people who are running it. So, just for people's benefit, that's a kind of example of maybe a strategic buyer who would've perhaps in the past paid to premium. But if financial buyers are also really going; Hey, we need to get some deal flow happening here. Like we've got some capital we've got to deploy. And if you're in a financial business, then you've got a fund. So, you've got a whole bunch of people of people's money that you've just raised and you've got a hundred million dollars to deploy. That's an expensive problem to have if you're not deploying it. Like, you know you've got a timeline ticking until those investors want their money back and what their return. So, you've got to get deploying. So, to your point then that's probably putting some positive pressure on the amount they're willing to pay, which is pretty handy. So, I know we've gone for a bit of a longer than usual podcast, but this is a great conversation for me, Shawn, I'm really enjoying it having it with you and I think it's super valuable for our community. So, would you be willing to come back and do another episode with us?

‍

[00:58:02] Shawn: Well, I mean anything for my twin brother, so yeah.

‍

[00:58:05] Sean: Awesome. Well, and one other thing I should say, maybe I could put this, if there are people in the audience who would like a copy of a, sort of a due diligence checklist, you know, not a specific one for your industry, but just a typical one. Feel free to email us at [email protected]. Happy to send that over to you. It's not going to be a prescription. Obviously, you work with advisor, they're going to tell you exactly what it is that you need, but it gives you an idea of like, when you're building a data room, if you've never really thought about this before, the kinds of basic information that a potential purchaser might be looking for from you. So, we'll get you a copy of one if you would like that. Shawn, it's been wonderful chatting to you today. Where would you direct people to for more information or to get in touch or to follow along with what you are doing?

‍

[00:58:52] Shawn: So, if you want to find out more information about myself, what I focus on. So, you know, Midmark investment banking, mergers, acquisition, growth capital between that 10 and 300 million transaction size. Connect with me on LinkedIn, just Shawn Flynn, investment banker. Or you could follow me on www.TheSiliconValleyPodcast.com, where I interview entrepreneurs, venture capitalists and leaders in tech. So, between those, it's easy to get a hold of me. I love having conversations going back to our point today of a year, two years in advance of any type of transaction. I mean, that's the best time to start dialogue. So, please reach out to me and I'll do my best to answer ASAP.

‍

[00:59:34] Sean: Thanks a million, Shawn. Folks, I hope you got lots of value out of today. I'm sure you did. And make sure you tune in next time for my next conversation with Shawn Flynn as we unpack more about how to optimise your outcomes in a sale process. Let us know what you've got out of today's show on LinkedIn. You can tag myself, you can tag Shawn once this episode is live. You've been listening to ScaleUps Podcast (www.scaleupspodcast.com). I'm Sean Steele, and thanks so much for joining us. We'll speak to you again next week. Thanks Shawn.

‍

[01:00:00] Shawn: Thank you.