Accounting & Tax

Key Takeaways

  • There are three types of intellectual property: patents, copyrights, trademarks and trade secrets.
  • Trademarks are different from patents and copyrights; you don't own a trademark — you own the right to use it in connection with your goods and services. 
  • Primary areas that business owners often overlook include tribal knowledge, digital assets and social media accounts.
  • To do determine the value of your intellectual property, you look at the market, how that intellectual property fits into your business and how you monetize your intellectual property.

Read Full Interview

Jeff: Protecting your intellectual property rights. If you want to know why this is important as it pertains to the sale of your company and what steps you need to take to get started, you've come to the right place.

From our studio in Southern California, with guest experts from across the country and around the world, this is "Deal Talk," brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.


Jeff: Hello and welcome back to the web's number one content source for small business owners committed to building a business for eventual sale. Here on "Deal Talk" it's our mission to provide information and guidance from our vast, growing list of trusted experts worldwide that you and all small business owners can use to help you build your bottom line and improve your company's value. And I think our growing list of trusted experts worldwide has probably grown to about I think 125 experts. We're so glad that they've made us such an important part of what they do. We thank them so much.

Most of us know what intellectual property is. And we all have some of it ourselves. We all own some as part of our businesses. Some of us own way more than others. But not all of us may know exactly how much we have, or in some cases what it is, or why it's so critical, for that matter, to protect our rights to that property. 

If you're listening today to gain a fuller understanding of what your intellectual property rights are and why it's important to protect them when the value of your business is at stake, this show is for you. And to help us kind of understand the ins and outs and why this discussion of intellectual property and the protection of your IP rights is so important is Beverly Berneman, Intellectual Property Partner at Golan & Christie, LLP in Chicago. Beverly, welcome to "Deal Talk," so good to have you.

Beverly: Thank you. Thanks for asking me to be here.


Jeff: For those owners, Beverly, who are considering selling their companies at some point down the line, it doesn't necessarily matter when. Why is it necessary to take particular care to see that your intellectual assets are protected?

Beverly: In this day and age IP assets, intellectual property assets, tend to be the most valuable assets of a business. Let me give you some examples from my own clients. I have a manufacturing client who has unique technology. That technology allows it to stay ahead of its competitor. 

I have a client who's a microbrewery and they draw customers with their catchy names and their proprietary recipes that they keep secret. And another one, I have an author who wrote a book and she's now being courted by a producer who wants to adapt it for a stage play. In each of these cases it's the intellectual property that's the foundation of the business. 


Jeff: I think it's really important here that some of us can kind of see where you're going with this, and you kind of try to crystallize I think for us and very well in some of those examples. What some ideas or examples of intellectual property are. And some of us may already know and have an understanding of the basics here, understanding that you're not a valuation consultant, Beverly. How much might our intellectual property contribute to the value of our business?

Beverly: Value is really a combination of things. And as you pointed out I'm not a valuation expert, so I don't go in and tell you how much it's worth. But I can tell you that in terms of what it means to your business, in terms of that value first you look at the market. Is there a market for your great idea, for your invention, for your service. Because if customers aren't going to call, if nobody wants your services, your IP is not going to have any value.

The second is to look at how that intellectual property Fits into your business. You have to know what place it has, otherwise it's not going to have value. And the third is how you monetize your intellectual property. And for this I think I can come up with an example that will really show how this works. 

If you have a franchise, say your McDonald's, you're licensing trademarks, you're licensing recipes, you're licensing the process of how you run the restaurant, how it looks, and so on and so forth. And in return you receive royalties and licensees. So what McDonald's has done is taken all of its intellectual property and monetized it in terms of licensees. So you take all of these things and that's what creates the value.

Protecting your intellectual property assets should not be a matter of dollars and cents, because it's not cost-effective to allow your intellectual property assets to go unprotected.

Jeff: Talking with Beverly Berneman, she's the Intellectual Property Partner at Golan & Christie, LLP in Chicago. I'm so glad that she's managed to kind of carve out some time during her day to talk to us about intellectual property rights. When we talk about rights, Beverly, what are those rights actually? What does that mean to us? Is it different for everyone in terms of the rights that we have to our intellectual property? What kind of rights do we actually have?

Beverly: That's a really good question, and it can be confusing. Let me approach this by type of intellectual property. Let's first talk about patents. Patents are a right to exclude. So it's really more like a monopoly than a property right that we might be used to. You can own real estate, you can own a car, but you don't really own a patent. All you do is own the right to exclude others from using it. So let me give you an example.

If I patent the cure for say the Zika virus. I don't actually have to use it, but I can exclude other people from using it. The patent process warning here or caveat is it can be very time- and money-consuming, so we don't enter into it lightly. For instance, fees can, I'm not going to try to quote fees for other attorneys, but you could expect to spend anywhere from $10,000 to $150,000 for a patent. And it can take anywhere from three to five years.

By the way, speaking of chores, Jonas Salk refused to patent the cure for polio. He wanted to make sure it was available to everyone who needed it. Sometimes the altruistic business model can come into play as well. 

Going on to copyrights, copyrights are rights in the authorship of a work that sticks to an intangible means of expression. And copyrights come with what we call a bundle of rights or six primary rights. That's the right to reproduce the work, the right to prepare derivative works, the right to distribute copies of the work. In the case of some types of literary, musical, or dramatic works, the right to create audiovisual works, the right to perform the work. And in the case of sound recording, the right to perform the works digitally. 

All of these rights are exclusive to the author and these are more akin to the kind of property rights that we're used to. And one of the interesting things about copyrights is the owner can actually separate up the rights. So the owner of a copyright can license the right to copy and distribute the work to one licensee and the right to perform the work to a different licensee.

Trademarks, Jeff, you made a really good point about the “Golden Arches,” and the trademark, and the fact that it's a source or product identifier. Trademarks again are different from patents and copyrights because they are really a creature of consumer protection. You don't own a trademark, you own the right to use it in connection with your goods or services. 

Sometimes I get a call from a potential client saying, "I got the slogan I really like and I want to trademark it." And then I'll ask them what product or service is it connected with and they'll say, "Well, no product or service. I just like it and I want it to be mine." Trademarks don't work that way. You also can't adopt a trademark that's going to cause confusion as to the source of sponsorship of your goods or services.

And the fourth primary type of intellectual property are trade secrets. That's something that's not generally known or easily ascertainable, and that it is such a reasonable measure of secrecy. Trade secrets are sort of a late comer to the IP world. Patents and copyrights are actually covered in our Constitution. Trademarks have been around for hundreds of years, although the statute that protects them here in the U.S. wasn't passed until the 1940s, that's the Lanham Act. But trade secrets sort of came into their own in the mid- to late-20th century. And they are covered usually by state law. 

However, as of May of this year the Defend Trade Secrets Act was passed. Now there's a federal cause of action for protecting trade secrets. To give you an idea of what trade secrets are, I'm going to name some famous ones. The Coca-Cola recipe is one, although people say it's not really a protected trade secret. However, recently two employees of Coca-Cola tried to sell the formula to Pepsi, and you got to give Pepsi credit, they called Coke and said, "Guess what, somebody's trying to sell us your trade secret."

Some of the interesting ones are Google's proprietary search algorithm, WD40, some of my favorite comfort food: Mrs. Fields' Chocolate Chip Cookie recipe and the Twinkies recipe.


Jeff: That's actually some of my favorite comfort foods as well, Beverly. Well done.

Beverly: And my favorite one, because I didn't know those until I started doing research into trade secrets, The New York Times Best Seller List, the methodology for figuring out which are their best sellers for their list, that's a trade secret. Nobody knows exactly how they do that except for The New York Times.


Jeff: So what you're trying to say is that maybe The New York Times Best Seller List is actually not a list of best sellers based on volumes sold or number of books sold, but they could be best sellers, in fact, after The New York Times puts the fact that they are on The New York Times Best Seller List and make that public. Then the sales actually start to shoot up. I see how that works.

Beverly: That could be. And there could also be something else in there, evaluating who buys the book, how many libraries buy the book. There could be all kinds of variables that they use to create the list.


Jeff: That's why it's a trade secret. Exactly.

You can own real estate, you can own a car, but you don't really own a patent. All you do is own the right to exclude others from using it.

Beverly: Yeah, that's why it's a trade secret. Keep in mind that all of these types of protection I talked about are for the U.S. only. If your business has an international component there are ways to get cross boarder protection. But there's no system of protection that's going to give you global coverage.


Jeff: I'm just kind of wondering, many business owners have a trademark, or a logo perhaps, or a service mark that they have not registered, and we know this by the little R with a circle around it. It's kind of something that you have to do through a federal office. But how much protection if any do we have, Beverly, as business owners if we don't in fact register that trademark with the federal government?

Beverly: Certainly there are some famous trademarks that have not been federally registered. I think Scrabble is one. You just see a TM on there. But that just says that you're claiming common law rights. And to me this is sort of a last resort if you don't think you can get registration. Should someone begin using a confusingly similar mark and thereby confusing your customers or your clients, your remedies are going to be limited to adjunctive release and national damages. 

That's why wherever possible I recommend federally registering your trademark. Not only does it become  proof of your rights, it gives you an arsenal of remedies that you wouldn't have otherwise. So you'll get your adjunctive relief in damages but you can also get the defendant's profits. And in some cases you can even get your attorney's fees. So that's very valuable.

And there's one other advantage, and that is if you have registered your mark for more than five years, you can have the mark declared incontestable. And what that means is it limits a defendant's ability to challenge your trademark. For instance, somebody's using a confusingly similar trademark. You sue them and they say, "Your mark is merely descriptive so it shouldn't have been registered in the first place." If it is an incontestable trademark the defendant does not have that defense any longer. So that can be really, really valuable.


Jeff: What is that contingent on? You said five years.

Beverly: Right. You still have to be using it because, as I said, a trademark is based on you. There is a way to protect a trademark that is not already in use, but say you're in product development and you've come up with a very catchy logo design, and you're afraid your competitors knew about this logo design. They might to try to jump in and take it away from you, try to register it out from under you. While you're in development you can file something with the USPTO that's called an Intent to Use Application. And basically it's exactly what it sounds like, I intend to use this at some point in the future within three years, but I'm not ready to use it yet. I want to have that placeholder for it. 

So the trademark is going to go through the same vetting process with an examining attorney at the USPTO that a U.S.-based application would. But then they wait for you to file a statement of use. And then once you file the statement of use it relates back to your original date of application. So you've gotten priority in the use of that logo design and you've protected it. For the most part, however, getting your protection you have to use the mark. If you don't use it for three or more years, the law presumes that you've abandoned it. There are some exceptions and there are ways to prove to get around that. But that is a presumption and you got to be careful of it. 


Jeff: Fascinating stuff and very important. Beverly Berneman is joining us and she is an Intellectual Property Partner at Golan & Christie, LLP in Chicago. We're talking about intellectual property rights and really why it is so important that you get your arms around your intellectual property. You have an understanding of what it is, all that you own, and what you need to do to protect it, to protect yourself, protect your business, and protect your business's value. Why is that important? Well, because when you go on to sell your business, obviously, you want to get as much as you can out of it. But if there are any issues with your property, intellectual property that is, you could be leaving a lot of money on the table, and you could actually be costing yourself quite a bit of money down the line.

My name is Jeff Allen. Beverly Berneman will be back to join me once again as we continue our discussion on intellectual property rights when "Deal Talk" continues right after this.

If you'd like to share your knowledge and expertise on any subject related to selling businesses or helping business owners improve the value of their companies, we'd like to talk with you about joining us as a guest on a future edition of "Deal Talk." Interested? Contact our host Jeff Allen directly. Just send a brief email with "I'd like to be a guest" in the subject line. In a brief message include your name, title, area of specialty, and contact information, and send it to jeff@morganandwestfield.com, that's jeff@morganandwestfield.com


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Without the right team behind you, you could be leaving money on the table. So don't leave your most important business transaction to chance. Call Morgan & Westfield for a free consultation at 888-693-7834, 888-693-7834, or visit morganandwestfield.com.


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Jeff: Don't forget, you can listen to "Deal Talk" on any one of four channels. You can hear it on iTunes, Stitcher and Libsyn. Stitcher and Libsyn, two of the largest independent podcast hosting sites in the world. But by listening to "Deal Talk" on morganandwestfield.com's podcasting channel, the "Deal Talk" channel, you can also receive the full show notes right as you listen. And you can even download those and save them to your device so that you can review them later on. Once again, the show notes available on the "Deal Talk" podcast page at morganandwestfield.com.

My name is Jeff Allen with special guest Beverly Berneman, our expert today talking to us about the importance of protecting your intellectual property rights with your company. Beverly, we talked about some examples of intellectual property, many of them common and that we have seen throughout the course of our daily existence as consumers. But as business owners, give us some ideas of some other types of intellectual property that we may in fact own, or maybe we haven't given much thought to with respect to our own business.

Beverly: I want to go back to trade secrets, because I think that that's sort of an unsung hero of intellectual property. Just a short story, a client of mine long ago, a long-time client. When I first started with them I went for a site visit to their plant. They took me on a tour, they showed me their inventory of patents and trademarks. And what I realized as I was walking through the plant was that a lot of what my tour guide was telling me was about their tribal knowledge and their proprietary technology that didn't rise to the level of a patent. 

And then when I talked to the CFO and the CEO when I debriefed after my tour I said, "You guys have a lot trade secrets here. We’ve got to properly protect them." They were surprised. And what we did was we had a contest and let employees of the company identify trade secrets. And last count we came up with 28 separate secrets that are now being properly protected. You may not know that your tribal knowledge is protectable, is proprietary. And so that's an area that I think really every company, every organization should be looking at. 

Second is the digital assets, such as websites, how they look and feel. They can be protected perhaps as trade trust. And domain names, very important in terms of how they're properly protected. A third is your social media. Virtually every merger and acquisitions case matter that I worked on in the last several years we've had to look at and transfer social media accounts.

These are three primary areas that I think people don't often look at and understand that they have value and rights, and should pay attention to them.


Jeff: I appreciate you bringing those things up, very, very important. Now, I'm just kind of wondering then, let's say I am preparing to sell my business and I'm just kind of wondering if there is any difference in the way my company's intellectual property rights should be protected when considering an asset sale versus, for example, a stock sale.

Beverly: The most important issue is proper due diligence, always. You have to know who owns the intellectual property. For instance, I just recently had a situation. A company was selling its assets. When I did the due diligence I found out that the domain names were actually owned by an individual who used to work for the company. That individual was summarily fired years before for reasons that you would probably imagine, and was long gone. But now we have to trace that person down and we had to try to get past the bad blood to get an assignment from that person, and it wasn't pretty. That's an area where due diligence, it could've cost the company the whole sale if the domain name didn't go along with the company.

Another thing to look at is are your federal registrations up to date? Because both patents and trademarks require regular filings to maintain their status. Another thing to look at is are proper measures and secrecy in place for your trade secrets? Again, when somebody knows about your trade secret it's not a trade secret anymore and it can lose value, and it could taint the deal. Whether it's an asset sale, or a stock purchase, or venture capital, any of these sorts of things, it could be a real problem. 

And the final thing is to make sure that there are no liens on the assets. There are different ways to attach liens to different types of intellectual property, so the due diligence in this area you really need to have somebody who understands how they all work in order to make sure that there are no liens.


Jeff: And I would imagine that, Beverly, you would probably agree and state with a certain degree of authority on this that you really do have to contact an attorney who likely does specialize in this somehow, someway, or an attorney if you've got your own business attorney already and they may not necessarily specialize in this area, that you need to somehow try to find out if they can refer you to one. Is that correct?

Beverly: That's correct. Because the intellectual property practice has some really unique aspects. One of my partners always says that I make up the rules. Every time he comes and asks me a question it sounds like I'm making up the rules. But his practice doesn't touch this area, so he doesn't quite understand it, but he knows enough to know when his client has an intellectual property problem that I'm the one that should be talking to the client. As you could see from the things that we've been talking about, all of these different rules and how to navigate the protections and the proper registrations, and how to navigate the due diligence, all of those things, an intellectual expert … well, maybe not an expert but an attorney whose practice is emphasized in intellectual property is the proper person to talk to.


Jeff: Would that individual also be the first person that you would recommend that we get in touch with in order to simply identify all of the intellectual assets that we might have so that we don't forget any? Or is that something that we're capable of doing on our own before we call the attorney?

Beverly: An attorney can really hold your hand and walk you through the process of due diligence. When I was talking about due diligence I don't go into the client's headquarters or plant and do the leg work myself, but I ask the right questions and that can be done in-house, that actual leg work to answer my questions. 

But I as an intellectual property attorney, I know how to determine whether or not this particular asset is properly protected, whether there are any liens on it, whether you've gotten the assignments from the inventors, which is really important in patents, and all of those things. You really need an intellectual property attorney to help you. 


Jeff: In terms of cost on this, and I know it's different for every situation, I understand that, but it seems to me that maybe some business owners don't want to get involved with attorneys in protecting their intellectual property, because, number one, they don't have a clear grasp of what kind of intellectual property they own. Number two, they're not aware of their intellectual property rights. And number three, when they hear the word attorney they're thinking a bunch of money. Not only do I have to pay my attorney but I'm also going to have to pay for whatever kinds of filings are involved here.

In terms of cost and time that it takes to protect ourselves once we have a pretty clear understanding of all of the intellectual assets that we own, what are we looking at here? Are we looking at potentially hundreds of thousands of dollars, or is it something that is probably a little bit more manageable and somewhere kind of in between where we think we might be, and how much we'd love to pay if we knew that we could get away with it?

Beverly: There's two sides to this coin here. The first is protecting your intellectual property assets should not be a matter of dollars and cents because it's not cost-effective to allow your intellectual property assets to go unprotected.


Jeff: Boy, isn't that for sure. Yeah.

Wherever possible I recommend federally registering your trademark. Not only does it become proof of your rights, it gives you an arsenal of remedies that you wouldn't have otherwise.

Beverly: It's way more expensive to not protect it than it is to protect it. For instance, again just from my own practice, I had a client who was basically a software architect and he went into business with three other people. So there's four people altogether. He was the brains. He was the one who created the software and the other three were the money people. And they went into it without any attorneys helping them create their LLC and their operating agreement. And when they had a falling out, my client wanted to leave and they wanted to stop him from taking the software with him. 

And so they brought suit against him and we were in litigation about who owned the intellectual property as well as what was the deal, how people were going to get paid, and so on and so forth. It really affected the business because they were so focused on fighting with each other that they actually couldn't operate the business at all. 

And in the end the litigation costs were way higher than they would've been had they contacted counsel at the beginning, negotiated an operating agreement, because this was a limited liability company, negotiated an operating agreement that made it clear who owned what and how much people were entitled to. And in the end the business had to shut down and everybody had to go their separate ways.

There's a good example of how if it crossed your company, whereas if you had just started at the beginning with counsel these issues can come up but at least you have a road map for how to deal with them. And I should let you know, it's really important to me that my clients protect their IPSS, so I'm very flexible on my fee arrangements with my clients. I try to really help them with affording me. Because I don't want to be a drain on their resources; I want to help build their resources. And I know that there's a lot of other attorneys out there who are just like me.


Jeff: Beverly, I can't thank you enough for your candidness and really sharing that horror story in real life because it actually did happen and it's just an example right there that had certain conditions been met had they protected their intellectual property rights in the beginning. Maybe those friendships wouldn't have dissolved, maybe the company might still be in business. And look at all of the money, and all of the promise, and all the dreams that were broken that went along with that, and it's just not worth it. 

For so many of us our business is such an important part of our lives, it's almost like an appendage, it's part of us. It just doesn't make sense to take and put intellectual property rights and your protection of those rights on the back burner thinking that you're covered, thinking that nothing will happen. Because as soon as you develop that weak mindset stuff happens and it can really impact not just your ability to sell your company but your ability to continue to stay in business at all. And I want to thank you so much for all of your time today.

If someone should in our audience be interested in contacting you about their particular situation about looking into their intellectual property rights and helping them protect those rights, how can they contact you?

Beverly: They contact me by email. That's the best way, at baberneman@golanchristie.com. I'm always happy to field questions. Of course I can't give advice until I'm retained, but I can certainly field questions. I also have a weekly blog called IP News for Business. It's accessible under the knowledge tab on the Golan & Christie website. And you can follow me on Twitter @IPBevB.


Jeff: Beverly, just a wealth of information and so good to talk to you. It's been very, very pleasant. We sure do appreciate your time. Thank you so much for joining us today on "Deal Talk." 

Beverly: And thank you for having me.


Jeff: That's Beverly Berneman. There she goes. She is Intellectual Property Partner, Golan & Christie, LLP in Chicago, such a treat to have join us and really just a fount of information. I hope you got a lot out of it.

Let us know how we're doing, won't you? We'd love to hear more from you. Send us your comments, compliments and, yes, you can even send your criticisms to us at dealtalk@morganandwestfield.com. "Deal Talk" is brought to you by Morgan & Westfield, a nationwide leader in business sales and appraisals. Learn more at morganandwestfield.com. That's morganandwestfield.com, or by calling 888-693-7834. I'm Jeff Allen, until next time, here's to your success.

While we take reasonable care to select recognized experts for our podcasts please note that each podcast presents the independent opinions of such experts only and not of Morgan & Westfield. We make no warranty, guarantee, or representation as to the accuracy or sufficiency of the information provided. Any reliance on the podcast information is at your own risk. The podcast is for general information only and cannot be considered professional advice.

Key Takeaways

  • With the financial collapse, small business owners have a more difficult time getting a loan from a bank, which makes alternative methods for lending necessary.
  • The top alternative for lending is ABL lending, asset-based lending, which uses the business’s inventory as collateral.
  • Factoring allows business owners to solve their cash flow problems and regain some traction so they can move forward and grow the business while waiting for receipts from customers to come in. 
  • When considering alternative sources of lending, a business owner should have thorough knowledge of stand-alone accounts receivable and purchase order funding in order to determine if factoring would be a good fit for their particular cash flow issues.  

Read Full Interview

Jeff: Still struggling with cash flow problems? Well, if you're looking for different ideas on how to deal with this global accounting epidemic, that's what I'd like to call it, then you've come to the right place.
 
From our studio in Southern California, with guest experts from across the country and around the world, this is "Deal Talk," brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.
 
Jeff: Hello and welcome to the web's number one content source for small business owners committed to building a business for eventual sale. Here on "Deal Talk" it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.
 
Cash flow, we've talked about it on the program before. And cash flow as you know is something that you and many business owners, in fact, I would say probably most small business owners would have to deal with at some point in time. Today on the program I have somebody who is going to provide us with some different ideas on how to deal with your cash flow issues. And these are some things that we haven't talked about in the past. 
 
And to help us do that, I'd like to welcome in a gentleman by the name of Mr. Donald Jacobs. He is Senior Vice President of Business Development at Midland American Capital. Don Jacobs, welcome to the program. It's nice to have you on "Deal Talk," sir.
 
Donald: Thank you, Jeff. 
 

The easiest choice and the most traditional way for a small business to get capital is to go to a bank. The problem is that banks have gone through a dramatic change in the last 12 years since the financial collapse, and they don't necessarily have the ability at the present time to lend out as much money as they previously had in the past.


Jeff: Don, when I contacted you about joining us on this program, we spoke about ways to deal with cash flow that are kind of unique. But these, according to what you've told me, are not necessarily new ideas. Before we get into it I was wondering if you might be able to take just a minute though to kind of talk a little bit about yourself, who you are, and where Midland America Capital is, and what you guys do over there.
 
Donald: Midland Capital handles United States and Canada. We are a factoring alternative lending company, which means that we offer two core services. We offer accounts receivable funding. And then we do a combined purchase order/supplier funding, combined with accounts receivable so that if you needed help getting goods from China or across the street to pay for the supply for an order that you're fulfilling, we will be able to pay for 100% of those goods.
 


Jeff: We're going to get into the nitty gritty on these here in just a moment. But first of all I kind of want to hear from you, Don. Many businesses we've talked about on the program before deal with cash flow issues, regular basis, but business owners may decide not to seek funding through bank loans, etc. Instead they might opt to drive improved sales, get out there and pound the pavement. We just got to generate more sales, generate more revenue rather than incur more debt. Is this a sound approach to take, and if not why not?
 
Donald: In most situations what happens is a small business owner needs to grow his business and he needs capital to do it. So he has a relationship with the bank. He has a DDA account or a business checking account with the bank. And he goes to his business officer and he says, "Hey, I would like to get a loan." 
 
And the bank after the financial crisis has gone through some major changes where in the past he may have been able to get a $50,000, $100,000, $300,000 line of credit, or a term loan that he could use as collateral to grow his business. 
 
But with the world changing so dramatically after the World Trade Center and the financial collapse, banks have a very difficult time lending money now. You have reserved requirements have increased, their compliance requirements have increased, and it's very difficult for them to lend out money. So it may be that the business owner needed $100,000 and the bank is willing to give them $25,000. The $25,000 may not be enough for him to grow his business properly.
 


Jeff: I was just going to say, Don, I don't mean to jump in here and interrupt. But it would seem to me that this would be one of those things that for small business owners in particular this would be a particularly difficult problem for them to deal with when it comes to changed qualification procedures and processes in place with the banks, making it more difficult for them to get money. Would that be true?
 
Donald: What has happened is exactly that, Jeff. And that banks used to lend out X amount of money for loans. And they basically chop that into half so the amount of money that the bank is lending out is half the amount that they gave previous to the financial collapse. 
 
So, alternative lenders have come up to step in and say hey, the fact that it's not going to lend you money there are other alternatives out there so that you can get money to grow your business. The problem is is that a lot of small business owners aren't aware of the many alternatives that are out there.
 


Jeff: Let's talk about the different sources of funding that are available in most cases right now to most people. And all they would have to do is go to Google or make a couple of calls to their accountant, or maybe even possibly an attorney or another business consultant that they might know and they'd be turned on to all these different sources and maybe some key contacts at these sources. 
 
Let's talk about those first of all. If you will kind of a ranking order or a hierarchy, or maybe even call it a pecking order of those types of institutions or firms that provide capital. And maybe you could kind of tell us where they all kind of line up. 
 
Donald: The path of least resistance that you see for most business owners is to go to the local bank and see if they can get a business loan. So a bank would look at their financials, would look at the FICO Score for the business, the FICO Score of their owner. And based on historical records, the last two years the profitability of the company, they would decide whether that should be green-lighted or was a loan they couldn't do.
 
They couldn't go to the bank. There are SBA programs which is a hybrid loan. So 50% of it is a government loan, and 50% of it is through the bank. So there are certain requirements that are structured in order for it to qualify as an SBA loan. And then there are certain economic loans that are out there, but most of the economic development loans are geared up and how many people that you would hire. And a lot of it is geared up to real estate type loans.
 
So taking that type of loan structure aside then you would get into alternative lending. The top of the hierarchy for alternative lending is ABL Lending, asset-based lending. Asset-based lending is using your inventory as collateral so that if something were to happen they have your inventory that they could take to compensate and reduce the risk so they wouldn't take a total hit if the loan went bad.
 
Then there's factoring. Factoring uses the invoice as collateral. So it's a different kind of structure than the ABL lending, which takes the inventory. Then there would be ACH lending, which is automatic clearing house where they reduce their risk by taking the money out of your account automatically on a daily basis. It's electronically transferred so you make the payments on a daily basis as long as your account is operating. 
 
And then the last choice would be hard money. And hard money in many situations they would say, "Hey, make 12 payments, make 12 checks out, sign them, and pre-date them per month, and I'm going to cash those checks. If one of those checks bounce, you're going to be hearing from my lawyer." So those are basically all the terms that are out there.
 


Jeff: Donald Jacobs is Senior Vice President of Business Development at Midland American Capital. You're hearing his conversation with me, Jeff Allen, right here on "Deal Talk." We're talking about alternative ways to deal with the cash flow issue that you might be facing. 
 
Donald, in all of those scenarios or with all of those choices we just talked about, the traditional and the alternative choices, where do most business owners do you think tend to gravitate? Or to what do they gravitate toward to help them of all of those choices that we just talked about?
 
Donald: The easiest choice and the most traditional way for a small business to get capital is to go to a bank. The problem is that banks have gone through a dramatic change in the last 12 years since the financial collapse, and they don't necessarily have the ability at the present time to lend out as much money as they previously had in the past. 
 
But that's normally the path of least resistance. The problem is that in this economy that is so sluggish, lots of businesses don't show profitability. So if you don't show profitability, the bank is not going to say yes, so what do those businesses that are breaking even or making a small amount of money do? And when they get a big order that comes in and they can grow their business, do they have to pass it up, or are there other alternatives for them to gathering money?
 


Jeff: And that's where we're going to go ahead and we're going to now make that transition in this conversation Don, and we're going to talk about something that I know that you know a lot about. And we're going to key in on one particular source of alternative funding, or maybe it's a process of alternative funding that we'll be learning about for the first time. 
 
The alternative out there that many people may not be aware of but that could prove very fruitful to them does have to do with this factoring methodology that you've talked about. First of all, tell us what factoring is and how long it's been around, and why it's worked so well?
 
Donald: Factoring has been around for a very long time. It started really in the 18th century, ancient Roman times that merchants used it. It's a guaranteed trade credits. So Rome was shipping to Egypt, and they needed some type of funding for it to go on to the boat and to pay for it for that long passageway from Rome to Egypt. So factoring really started that way.
 
And then it really took over the medieval times and Europe. They really took hold and became a very popular form of lending. And currently if we're going to the time chart, the number one country when it comes to the most amount of factoring done in the world happens to be China. And the second country would be the United States. But if you combined all the European countries together, probably European block there's more than the United States. It's about a 3 trillion dollar industry. 
 
And in 2015, believe it or not, it was at an all-time high. So the most amount of factoring ever done was done last year. And I would imagine that this year we'll probably have 15%-20% growth from there. So it is gaining in popularity even though it's been around for a long time because it's tough to small businesses out there. And the way that the banks really stop lending has created a lot more popularity towards factoring.
 

So the beauty of factoring is that it has a tremendous amount of flexibility. But the biggest advantage of factoring is that there's no real dollar limit.


Jeff: Why do you think that factoring has not grown so much in this country and why is that it's kind of been slow to catch on here?
 
Donald: I don't know if it's slow, but in China there's a tremendous amount of businesses out there that are growing very rapidly. And I think that factoring, just because of the enormous amount of growth... GDP in the United States is somewhere around one- and three-quarters to two percent, where in China even though it has gone down dramatically it's still 4%-5% growth. So the GDP growth is much stronger in China than right now than the United States.
 
So I think it's just more common practice. If you see the amount of factories and the amount of orders that are coming in, many factories don't have enough money in order to fill their orders, so they use factoring instead of going to the bank. An order comes in from an importer in the United States for $300,000 and the factory needs $100,000 in order to produce those goods. It's very easy for them to show, "Hey, I got this purchase order coming in, can you lend me the $100,000? And then when the client pays me I'll pay you back.” It's a very easy way to conduct business.
 


Jeff: We're going to continue our conversation on factoring as a way to deal with your cash flow issues, as a way to solve those problems if only temporarily, but it'll really help you to regain some traction and continue to move forward with your company and grow your business all at the same time while you wait for those receipts from you customers to come in. 
 
My name is Jeff Allen. My guest today is Mr. Donald Jacobs from Midland American Capital. We'll continue our conversation when "Deal Talk" returns right after this.
 
If you'd like to share your knowledge and expertise on any subject related to selling businesses or helping business owners improve the value of their companies, we'd like to talk with you about joining us as a guest on a future edition of "Deal Talk." Interested? Contact our host Jeff Allen directly. Just send a brief email with "I'd like to be a guest" in the subject line. In a brief message include your name, title, area of specialty and contact information, and send it to jeff@morganandwestfield.com, that's jeff@morganandwestfield.com.


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Without the right team behind you, you could be leaving money on the table. So don't leave your most important business transaction to chance. Call Morgan & Westfield for a free consultation at 888-693-7834, 888-693-7834, or visit morganandwestfield.com.


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Jeff: If you'd like to listen to "Deal Talk" and have something that you can refer to with regard to the content over and over again as you need it, morganandwestfield.com, that's where you can find the complete transcript of this show. And don't forget also too when you're on the road or wherever you'll go, you can also hear this program "Deal Talk" available on iTunes, Stitcher and Libsyn as well.
 
My name is Jeff Allen with my guest today Mr. Donald Jacobs. He is Senior Vice President, Business Development at Midland American Capital. And we're talking about alternative solutions to help you deal with your cash flow issues. And we're talking about the idea of factoring. This is something that Donald knows quite a bit about.
 
Donald, we spoke a little bit. You kind of talked a little bit about what factoring is, how long it's been around, and that it is growing as far as the solution is available to many businesses all across the country through companies in fact like yours, Midland American Capital, for example. But what I'd like to talk to you now is about instances where in fact factoring can be used, the types of businesses or operations that could benefit by factoring, and how those companies actually use this to combat their own cash flow issues.
 
Donald: Thank you, Jeff. We offer basically to different services, which is rare in the industry. At Midland we offer both purchase order and accounts receivable funding. So what is accounts receivable funding based on the invoice amount that you have. So if you had an invoice for $100,000, we would advance you $80,000 at the time that your goods ship. So rather than waiting with 30, 60, 90 days with your client's pay, you get paid right away. 
 
And when the client pays what we call the getter. you get to 20% that we haven't paid you already minus our fee. So what does that do for you? What it really does is it increases your cash flow. So if you have an order that's going out, sometimes it could be very, very critical on your cash flow if you have that $100,000 ad on the street. 
 
And you have to pay your employees, you have to pay taxes and other types of expenses out there, you don't have the cash flow to do it so you get behind and it creates all different types of wrinkles to your business. So by us giving you that money we could basically improve your cash flow so you don't have those issues. 
 
The number one thing that that really does is it rebuilds your credit so that down the road you may be able to go to a bank and say, "Hey, look, I pay all my bills on time and therefore I should be able to get an increase on a distance revolving line of credit that I haven't been able to get into the past.” So many people use factoring in order to improve their credit. The increase in cash flow allows you to grow your business where before you had to pay off, you had no cash in order to pay for goods. So by the increase in cash flow you also have more goods to be able to build up your inventory and have a much stronger business.
 
We also do purchase order funding. And what is purchase order funding? Another term for it is called supplier funding. So say you got a big order in from a big box store for blankets, and you needed to buy a container load of blankets. And that container load of blankets is going to cost you $300,000. Many businesses don't have the $300,000 in order to pay for the goods to the factory because, especially if it's a new situation, the factory's not going to give you terms. If it's a situation where you're buying overseas it's very rare that the factory would give you terms. So you need to come up with that money.
 
A company like Midland or a factoring house with those purchase orders would be able to give you 100% of the cost in order for you to buy those goods. For example, I presently have a deal where it's tequila. And he is buying tequila and he got a huge distributor in the United States to carry his goods, which is a wonderful thing for the business. But the first order for the tequila is $200,000. And he doesn't have the $200,000 or he doesn't have the $125,000 that he needs to pay for the supplier to fulfill the order. 
 
By him going to a factoring house he can get those goods paid for, and we will pay directly to the factory so that he can fulfill that order and to grow his business. So it basically allows a business that if they needed funding from soup to nuts we could pay for the entire transaction. And the beauty of factoring is that it does it without incurring any other debt. So if you went to a bank and you borrowed money from a bank on your balance sheet, you would see that you borrowed $100,000 and $200,000, or whatever the amount of money that you borrow from the bank. 
 
When you go to a factoring house, instead of you making a dollar you may make 90 cents, but the debt never shows up on your balance sheet. So it looks like it was funded through the business. So you can use our money and we don't take any percentage of your business that an angel investor or an equity house will take with it. So you don't have a partner. You could do whatever you want with the money; it's an excellent alternative if you can't get traditional funding.
 

You can use our money and we don't take any percentage of your business that an angel investor or an equity house will take with it. So you don't have a partner. You could do whatever you want with the money; it's an excellent alternative if you can't get traditional funding.


Jeff: How do you get your money? In other words what slice, what percentage here do you kind of if you would extract. You mentioned that the invoiced amounts are actually kind of invoiced at a discount, which means that you get that percentages taken out, which is what?
 
Donald: The way that it works is that we don't get paid directly from our client. So if it's the case where it's combined purchase order and accounts receivable, and the factory needed $80,000 to complete their order, we would pay the money directly to the factory. Then the order would come in and an invoice will be generated to the client that’s ultimately going to buy the goods. At that time it would convert over to accounts receivable and there will be a bump up, so that it would be 80% of the invoice amounts with it.
 
Then the client would pay, the debtor, the one that's going to end up with the product, we'd pay to post off this box. And once we receive that check we would give the 20% we haven't given already minus our fee. And that's how it would be.
 


Jeff: OK. And as you mentioned, too, this is helpful toward the credit standing of the company as an added plus. Are there any companies that would just rather choose to continue to work with a company such as yours, for example, Don, on a regular, ongoing basis to handle their receivables or entirely for them? 
 
Or is that not the business that you provide? In other words, you're there for a specific purpose for such an occasion when cash flow is difficult. But you're not there to handle receivables at all times, 100% of the time for a company are you?
 
Donald: Most factoring houses do have a year annual contract because there is a certain amount of start-up cost for any factoring and fees to do it. So a normal account really does last for a year. 
 
But we also have accounts that you have for a long time. For example, the hospital industry is famous for paying very, very late. So many people that are on the hospital and supply hospitals cannot wait for 90 days that a hospital normally takes in order to pay. 
 
So we have many of those type of accounts that stay with us. We also have a lot of staffing companies. And staffing companies, they're the model of cash flow issues in that the more you grow, since you're hiring people in order to be used in other companies, your payroll. The more people that you hire the higher your payroll is, the tougher it is for you to manage your cash flow. 
 
So there's large numbers and a high percentage of staffing type companies that use factoring just as common center and others. So there are companies that basically really need factoring in order to survive and use factoring for long periods of time. Basically for the time that they're in business they will continue to use a factor. 
 
What has happened though, because it's a sluggish economy, is more mainstream companies are coming into the fold and also using factoring, saying, "Hey, I'm having a tough time. I can't get money from a bank so I'll use a factor.” And basically you're going to use factoring for a year or so, get through the difficult time, build up enough of a cushion where they may not use this. 
 
If they use this for specific transactions, so they get a big order from a big box store and they need to fulfill that order, or they get a big military contract, or they get a government contract, or they get a big order from Home Depot and they need money in order to fulfill that order, they would go to it. 
 
So the beauty of factoring is that there's no minimums and you can factor as much or as little as you want so you can use it for a specific transaction. And then not use it for a couple of months, and then get a big order in and use it. Or you can just use it for parts so that you could take four or five accounts and say, "Hey, these accounts will generate enough money, or if I get advances off of them, I'll have good cash flow and I won't have to worry about meeting payroll, or taxes, or having enough inventory, I'll only factor part.” 
 
So the beauty of factoring is that it has a tremendous amount of flexibility. But the biggest advantage of factoring is that there's no real dollar limit. So if you got an order in and you're lucky enough to get an order in from a big account, and it was a million dollar order. And say you were a half a million dollar business, how are you going to be able to fulfill that order? With factoring there really, really is no issue. The bigger the order is and it's a good getter, you have no issue fulfilling that order. 
 


Jeff: We kind of now have a really good lay of the land here, I think, Don. I guess my last question might be for this discussion is who would not be suited to factoring as far as a business is concerned that is in need of a solution to help them with their cash flow issues? Is this something that is appropriate for all businesses?
 
Donald: In order for it to work in the factoring type situation, you need an invoice. So retail is not good. It is online and customers are paying you, it's no good. So you need to be business to business, and it needs to be in a situation where you're waiting 30, 60, 90 days to collect your money so that there's an invoice.
 


Jeff: Don, let's go ahead and wrap up then by providing your contact information should anyone have any questions or be interested in obtaining that information you say that you have there.
 
Donald: The name of the company is Midland American Capital. My name is Donald Jacobs. I'm a Senior Vice President, Business Development Officer. And my direct telephone number is 516-393-2659. And my toll-free number is 800-753-3300. And my email address is donald.jacobs@midlandamericancapital.com. 
 
And I'd be happy to send out information about the industry, not necessarily specifically about Midland, but you should have a thorough understanding of what factoring can do for your company and a thorough knowledge of stand-alone accounts receivable and purchase order funding, and if it would be a good fit for your particular cash flow issues.
 


Jeff: The gentleman is not only knowledgeable but he's extremely sincere, and I want to thank you so much for joining us today.
 
Donald: Thank you very much, Jeff.
 


Jeff: That's Donald Jacobs. He's Senior Vice President, Business Development at Midland American Capital. I hope that you got a lot out of this discussion today, I know that I did. I try to learn something each and every time I step behind this microphone with our guest. Once again, we want to thank Don for joining us on this program.
 
"Deal Talk" is brought to you by Morgan & Westfield, a nationwide leader in business sales and appraisals. Learn more at morganandwestfield.com. My name is Jeff Allen, thanks so much for listening. We'll talk to you again soon.
 
While we take reasonable care to select recognized experts for our podcasts please note that each podcast presents the independent opinions of such experts only and not of Morgan & Westfield. We make no warranty, guarantee, or representation as to the accuracy or sufficiency of the information provided. Any reliance on the podcast information is at your own risk. The podcast is for general information only and cannot be considered professional advice.

Key Takeaways

  • In order to avoid being surprised by the value of your company when beginning the process of selling your business, start the valuation process early and continue to have a business valuation every couple of years so.
  • A business is less desirable to buyers if it relies on one or two vendors, or one or two customers.
  • Reducing the areas of risk in a business will increase its value.
  • Ways to cut expenses, without jeopardizing revenue, and show the highest earnings possible include adjusting officer compensation to industry standards, putting a management team in place so that customers are not dependent upon one or two key employees and broadening your customer base. 

Read Full Interview

Jeff: The results of a business appraisal can be surprising, and sometimes even shocking. If you want to learn how to improve value after a less than desirable appraisal, or how to avoid shocking results in the first place, then you've come to the right place.
 
From our studio in Southern California, with guest experts from across the country and around the world, this is "Deal Talk." brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.
 

Jeff: Hello and welcome to the web's number one content source for small business owners committed to building a business for eventual sale. Here on "Deal Talk" it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use that information to help you build your bottom line and improve your company's value.
 
What's all the big deal then about business appraisals and valuations? Well, sometimes we found out that oftentimes we get those calculations back and they are far less than we expect. At least they're different anyway. Sometimes they're maybe a few thousand or a few $10,000 off what we kind of expected in other times, for most of us anyway. Those folks who order valuations are often mystified by the gap, the difference between what you believe your business might be worth or might have been worth, and what your valuation consultant says. It actually is in fact worthwhile. 
 
I want you to stand up and take notice, or sit forward and take notice of this program, because it is in fact for you if you have had a valuation in the past that did not meet your expectations. And you're not exactly sure what you need to do to bridge the gap between the information that you got back and where you think your business needs to be. And this is particularly important if you have designs on selling your company sometime in the next few years.
 
Here to talk with us all about this particular subject, Matt Turpin. He's joined us in the past here on "Deal Talk." He's a CPA licensed in Florida and Alabama, and also a certified valuation analyst with Carr, Riggs & Ingram, LLC. Mr. Turpin carries additional designations, including certified mergers and acquisitions professional, and chartered global management accountant. Matt Turpin, welcome back to "Deal Talk." It's good to have you back on the program.
 
Matt: Great to be back, Jeff. Thank you for having me.
 

Jeff: Well, it's good to hear the gentleman with the Southern draw back amongst us here and providing his information that we have really been looking forward to you sharing, Matt. I get these numbers back, and the first question that pops to mind, well this can't be right. How do I know that these in fact are right? How do I as a business owner know, Matt, that the valuation that you've calculated for me and my business is in fact complete and accurate?
 
Matt: That's a great point, Jeff. The quickest way and probably one of the easiest ways is to look at the valuation report. Is the valuation report under the guidelines of a governing body such as the National Association of Certified Valuation Analysts, or NACVA? Or is it under the American Institute of Certified Public Accountant, the Accredited Business Valuator Designation, or the ABV Designation? Those are just two of the designations, but probably the most common when it comes to a CPA-backed valuation credential.
 
We have guidelines and standards that we have to follow in preparing a business valuation. You're right. A lot of business owners, particularly member-managed businesses, are not particularly thrilled when they see the results of their business valuation. So the best way to not be surprised is to start that process early and fairly regularly, or often, to have a business valuation every couple of years so that you are not surprised when you see the value of your business. 
 
I tell potential clients this almost every meeting. If you are a business owner that is relying upon your business for your retirement, if you had a retirement account with one of the large financial institutions, you would get a monthly if not an annual statement that shows the value of your retirement plan. If you're using the sale of your business more importantly as the indicator of when you can retire, or that money will be used for your retirement, it would be questionable not to have a valuation done every few years, so that you do know the value of your retirement.

There are no two businesses that are alike.

Jeff: Is it flawed thinking on a business owner's part, Matt, to believe that, OK , I get this calculated value here and I'm not exactly thrilled with it. But I'm inclined to believe that I can get more for my company than what these numbers are telling me I can get. Is that wrong for a business owner to think that way and would they in fact be making a mistake by listing their business at a figure that is much higher than that valuation that you've calculated for them?
 
Matt: The answer to that is probably yes and no. The business owner can list or can ask whatever price they think the business will cost it to for a sales transaction, much like a house. 
 

Jeff: OK.
 
Matt: The issue is if you have a strategic or a financial buyer, there are certain things called synergies. If a competitor wants to buy another competitor, there may be economy, the scale, where the two businesses combined can make more money than the two business separate. So that's your financial or your synergistic buyers. 
 
In those types of situations, yes, absolutely. There would be a situation where the business could sell for higher than the calculated value. In other situations where it would be a top lieutenant in the company that's buying out the majority shareholder, there could other factors or indicators that bring that value down. 
 
Say, for example, a dentist practice. If a dentist has the key relationships with his or her patients, that really does restrict the value in "handing the baton over." Any type of service industry has that risk of when you sell your business, the customers, patients, clients will not automatically transfer over to the new owner. So that is your risk in selling for less than what the value has arrived at.
 

Jeff: Joining me again today is Matt Turpin, if you're just kind of listening over someone's shoulder. He's a CPA and CVA, certified mergers and acquisition adviser at Carr, Riggs & Ingram, LLC. Joining us for the second time, today on "Deal Talk." My name is Jeff Allen. 
 
Matt, why is there such a gap between what I had estimated the value of my company to be and the number that you calculated? Where do most of those differences lie?
 
Matt: Jeff, most of the differences lie between the, it's what's called discounts. It could be a discount for lack of marketability, which, if you're a member-managed, or traditionally what we've known as a smaller business, you've got discounts for lack of marketability. This is not a business that can be bought and sold on a publicly traded market much like the NASDAQ or the New York Stock Exchange.
 
So you have a discount for lack of marketability, which can range anywhere from below 20% up into the high 30s, maybe even 40%. If you go along RS regulations in determining fair market value, that would reduce the value of the company. You also have a discount for lack of control. If you're selling less than a majority shareholder position or ownership position, which would be 50% or less, then there's a discount that needs to be applied because the buyer does not have control of the cash.
 
The biggest reason why there will be a gap between perceived value and what we could call actual value, which would be the value that's derived from a business valuation engagement, is going to be the capitalization rate. A capitalization rate is going to be the inverse of a multiple. A lot of people are very familiar with the multiple. 
 
Let's say if I have a company that's grossing a million dollars a year in revenue, I want to use a multiple of three to sell the business, I would put just a wild guess in the air saying that the business is worth $3 million. Capitalization rates build up to an actual indicator on what to take, the quality of earnings, which is going to be your income after true business expenses. 
 
There are a lot of situations where you get higher than industry average officer compensation. And you may be paying family members through the business that don't actually work day-to-day in the business. Those are normalizing adjustments to arrive at a quality of earnings from the business operations. You apply that number to a capitalization rate. And that capitalization rate is going to be built up at different risk factors. For example, somebody was going to spend a million dollars either putting it into a CD or some safe investment vehicle, it's a much lower risk than going out and buying an operating business. 
 
So you have different risk factors that's going to be just the general risk of buying the equity of a stock. You've got the general risk of buying a small company and you've got the specific company risk, meaning the company that a potential buyer is looking at for the subject company, and when I say subject company, I mean the business that an individual is looking at buying. 
 
Or if an individual selling their business, what is the risk associated with selling that business? Are there key employees that really produce a lot of the income or create a lot of the customer loyalty, that if those key employees were not there it would seriously affect the revenue of the company?
 
When you look at these factors that create the gap between a business owner's perceived value, a lot of times you talk to a business owner and they've already got an idea in their head of what the value of the business is, whether that's through talking to competitors, or talking with peers in the industry for multiples, or reading industry periodicals that tell you this is what the business should be worth. There are no two businesses that are alike.
 
That can go either in the positive or the negative for the business owner. If I'm a business owner, and actually, Jeff, this is what got me into business valuation, is I had a client that was very profitable, had a very well-oiled machine in his business. And he was offered, I can't remember the exact number … let's say three times his revenue as a multiple to sell his business. 
 
My first question was why not five as a multiple, why not six? Who made the rule that it's got to be three, particularly in this kind of business because he didn't have to work the business. It was just a residual cash flow to this individual. 
 
So when you talk about multiples and how much of my business work based upon a multiple there may be two businesses in the same industry, whether they're competitors or not, it doesn't matter in this example. But one business may be worth two and three times as much as the other one because there may be systems in place, you may have a better management team. You may have a better financial structure. You may have better financial margins. You may have, whether it's longer contracts, the options are limitless of why one business in the same industry values differently than another business in the same industry.

I tell potential clients this almost every meeting. If you are a business owner that is relying upon your business for your retirement, if you had a retirement account with one of the large financial institutions, you would get a monthly if not an annual statement that shows the value of your retirement plan.

Jeff: I'll cut you off there because you've thrown... I'm putting myself in the place of a business owner who doesn't have a CFO or an accountant who can really help them understand the weight of what you're talking about, because there's a lot of the terminology here and some things that I think a lot of people probably may not have a very strong understanding of. 
 
But really, who is the person, who is the professional that I would talk to who would be able to help me, or help my accountant, or CFO, or whoever? Actually assign the multiple that we believe would provide us with an accurate valuation for how much our business could be worth if in fact we have designs on selling this or becoming involved in maybe an M&A deal of some kind in the next three to five years?
 
Matt: Jeff, I'm a little bit biased, but it would be best to use an individual that has a designation in business valuation.
 

Jeff: OK.
 
Matt: Because they're going to have industry data across the board. Not just a few industries but data across the board that not only do you arrive at a value independently but we also have access to databases of what we call a sanity check. 
 
If I arrive at a value, just an example, of a dental practice and come up with $2 million as a value, based upon cash flow and earnings, I have access to a database that says either I'm on base or I am way out of my league based upon transactions that have happened in the past.
 
Again, no two companies are alike, but that's what we call a sanity check, like a rule of thumb that says, "This is my valuation. It is well within an industry norm based upon the transaction that'll happen." Or if the company is strong enough, whether that would be your management team's financial history earnings, then can this company require a higher sales price because they're stronger than the industry or stronger than actual transactions that have taken place?
 

Jeff: What have you found to be probably the most common range of multiples that might suggest that a company has performed well and is selling at or better than market value?
 
Matt: Jeff, you're going to see capitalization. It's going to be anywhere from 20% to maybe even 50%. The lower the capitalization rate the higher the price. In terms of multiple, a capitalization rate of 20% would mean a multiple of five. That's how many times it could fit into a hundred. 
 
A capitalization rate of 20 equals a multiple of five. A capitalization rate of 50 equals the multiple of two. So it's going to depend on the business itself. Largely it does depend on the industry, because that's the track record that an industry specialist is going to go off of.
 
Matt: Anywhere from 20 to 50, which is going to be a multiple of two to five.
 

Jeff: OK. Have you ever seen anything higher than that?
 
Matt: Oh yeah. In certain industries you may have a multiple of 10. 
 

Jeff: OK. And that's a nice pay day right there.
 
Matt: Yes. It really is a nice pay day. There's a lot of factors that built up into that, but most of the factors are built around risk. What is the risk of purchasing that company?
 

Jeff: Matt, I'm going to take a short break, but when we get back what I'd like to do is I'd like to start to get into over the part of the conversation where we start to talk about the types of things that we might be able to do to, kind of, get that valuation moving in a better direction to kind of close that gap between what we assumed our business might have been worth and what a professional such as yourself is telling us our business is actually worth based on his calculations and going through.
 
I'm going to continue my conversation with Matt Turpin on valuations and how you can now close the gap or start thinking about ways to close that gap between what your expectations for your company's value was and what it could be when "Deal Talk" resumes right after this.
 
If you'd like to share your knowledge and expertise on any subject related to selling businesses or helping business owners improve the value of their companies, we'd like to talk with you about joining us as a guest on a future edition of "Deal Talk." Interested? Contact our host Jeff Allen directly. Just send a brief email with "I'd like to be a guest" in the subject line. In a brief message include your name, title, area of specialty and contact information, and send it to jeff@morganandwestfield.com, that's jeff@morganandwestfield.com.


Selling your business may be the most important business transaction you'll ever undertake, so don't go it alone. Work with an organization that has made it their business to sell businesses and that's all they do. Morgan & Westfield at 888-693-7834. At Morgan & Westfield we know that selling your company is not something you should take lightly. It can be a stressful, difficult, even emotional process. That's why it's important to work with a team whose one and only specialty is selling businesses throughout the United States. And Morgan & Westfield will help you every step of the way, from helping you plan your exit strategy, to preparing a comprehensive appraisal, and locating the right buyers. 
 
Without the right team behind you, you could be leaving money on the table. So don't leave your most important business transaction to chance. Call Morgan & Westfield for a free consultation at 888-693-7834, 888-693-7834, or visit morganandwestfield.com.


Are you a professional adviser, accountant, attorney or a wealth manager, or do you provide other professional services? Contact us today to see how our reliance program can help you increase your firm's revenues. Call Morgan & Westfield at 888-693-7834. That's 888-693-7834.
 
Jeff: You can listen to "Deal Talk" on Stitcher, Libsyn and iTunes. And we also have a fourth channel for you, morganandwestfield.com. That is the only place where you can listen to the show and get the complete show notes to go along with it. So of course you could read along with every word that you hear us talking about here on "Deal Talk" while you're on the morganandwestfield.com website. 
 
Or simply take and print hat PDF out, copy it to your machine, save it for later. You can come back later for easy reference. In that way you've got it all in writing. Some people think it's easier to take that writing with them depending on where they want to go or if they want to share certain key parts of our conversation with a friend or a colleague. 
 
Once again, that site is morganandwestfield.com for not only the podcast but the complete show notes. My name is Jeff Allen, joined once again today by Mr. Matt Turpin, and he's really an expert in the area of M&A but specifically having him on today to talk about valuations. 
 
We want to aspire, I think, really Matt, to reach a valuation that we're pleased with and one that would stand up during the sale of our business. So how do we start to bridge that gap and get from where we are, reality, to where we want to be, which is what we might consider ideal later on?
 
Matt: That's a great question, Jeff, and a question that we address quite often. Typically I suggest that business owners have a five-year plan to sell. Don't just decide that next year you're going to sell. Because there will be that shock of what the perceived value is and the price that the business could actually demand on the market. 
 
Of course this list is not all inclusive, but we've all heard the term “cash is king.” And that is true when it comes to most business valuations. You want to have the highest quality of earnings as possible that your business can earn. When Is say quality of earnings, meaning income minus your actual business expenses. If you've got a business that doesn't really require you to travel yet you've got some travel in there, of course that reduces your earnings. 
 
Taking a three-year, forward-looking approach on cutting expenses that can be cut without jeopardizing revenue and showing the highest earnings as possible. Of course, that's going to be the hardest thing to do but the easiest way to increase value. You could adjust officer compensation to industry standards. You can put a management team in place so that customers are not dependent upon one or two key employees. You can broaden your vendor base if that's applicable to your business. You can broaden your customer base. 
 
Nobody wants to buy a business that relies on one or two vendors, or one or two customers. Again, that goes all into the risk of buying the company. If I can cover it with an umbrella, the main objective in growing the business value would be to reduce the areas of risk in your business. Of course, that cannot be eliminated 100%, but reducing those risks of a potential buyer is going to be increasing the value of your business.
 

Jeff: I'm sure that you've probably gotten questions like this before. We're all human and some of us have some questions that quite frankly you might roll your eyes at from time-to-time after a while, Matt, someone in your position. 
 
When you have a chance to advise a company about maybe on plans that they have about moving forward with a sale or preparing their company for a sale and things have not been going well admittedly. The proof is in the numbers. And things have been tough the last couple of quarters, the last few quarters, and you've got someone, a CEO and his team have put in a lot of long hours into their business. 
 
Doesn't sweat equity account for something? When it comes to you going out and looking at this company and providing a comprehensive valuation. Is there any possibility that there's some kind of value that you can assign to effort? I don't know how else to put it.
 
Matt: That is a very popular item.
 

Jeff: I thought so.
 
Matt: When you talk about sweat equity, if that's what equity has generated, cash flow, yes, of course. But you're measuring the cash flow, you're not measuring the sweat equity, because that's when equity has turned into cash flow. If you look at sweat equity alone, somebody putting in long hours and is not producing any results, then there's no other answer than, no, the sweat equity does not generate value. But if that's what equity turns into, relationships, potential contacts, let's say a deeper vendor base, a wider potential customer base, another product, then, yes, that's when equity could be of value, and it could be of value to a specific buyer.
 
There is no flat line answer. No. Sweat equity does not generate and give value because sweat equity can’t generate value.
 

Jeff: I've got just a couple of moments left here, Matt, in the program today. What is wrong with the ideology that I can improve the value of my company by strictly going out and just working harder to generate greater revenue? If I go out and I increase my revenue by 25%-35%, doesn't that take and translate to something similar in terms of value later on?
 
Matt: It can. It depends on how much you've had to spend to generate that increase. If you've had to spend more on advertising, if you had to spend more in commissions. If the bottom line, so to say, is not increased, then there could be a situation where you're just spinning your wheels. If it does create a greater economy of scale, where an increase in revenue decreases the overall percentage of expenses or a certain expense classification, then absolutely it can help.
 

Jeff: Matt Turpin, I appreciate your time on the program today. No doubt there are business owners in your neighborhood, those listening to this program right now who might want to get in touch with you to talk about their particular situation, how can they reach you?

Typically I suggest that business owners have a five-year plan to sell. Don't just decide that next year you're going to sell. Because there will be that shock of what the perceived value is and the price that the business could actually demand on the market.

Matt: Sure. They can reach me through my email, which is mturpin@cricpa.com. They can reach me at 850-337-3241. They can also go to our website, cricpa.com, Carr, Riggs & Ingram. There are a number of ways. You can also find me through the National Association of Certified Valuation Analysts. I'm in their database there.
 

Jeff: And that means that you're pretty good, and we appreciate you, Matt, for making time for us in your schedule before you head on out for the day. It's been a pleasure, and we look forward to having you again on our program at some point in the future. Thank you.
 
Matt: Thank you, Jeff. I always enjoy talking with you.
 

Jeff: That's Matt Turpin, CPA, CVA and a certified mergers and acquisition adviser at Carr, Riggs & Ingram, LLC. 
 
Let us know how we're doing on "Deal Talk," won't you? We would love to hear more from you. Send us your comments, compliments and criticisms to dealtalk@morganandwestfield.com. Once again, that's dealtalk@morganandwestfield.com
 
"Deal Talk" is brought to you by Morgan & Westfield, a nationwide leader in business sales and appraisals. Learn more at morganandwestfield.com or by calling 888-693-7834. Again, 888-693-7834. I'm Jeff Allen, here's to your success.
 
While we take reasonable care to select recognized experts for our podcasts please note that each podcast presents the independent opinions of such experts only and not of Morgan & Westfield. We make no warranty, guarantee, or representation as to the accuracy or sufficiency of the information provided. Any reliance on the podcast information is at your own risk. The podcast is for general information only and cannot be considered professional advice.


Key Takeaways

  • Crowdfunding is a private security transaction that is targeted at retail investors.
  • Development around digital finance is causing the cost of capital acquisition to go down.
  • The digital finance market essentially is a complement to the existing financial market.
  • Crowdfunding is an alternate source of obtaining financing for small-business owners. When soliciting financing through crowdfunding, you need to understand who your company is being presented to and tailor your presentation accordingly.

Read Full Interview

Jeff: Crowdfunding is changing the way entrepreneurs fund their businesses. If you want to learn more about how the business financing landscape has changed and what the future holds, you've come to the right place.

From our studio in Southern California, with guest experts from across the country and around the world, this is "Deal Talk," brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.


Jeff: Hello, and welcome to the web's number one content source for small business owners committed to building a business for eventual sale. Here on "Deal Talk" it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.

The world has obviously changed a lot for us owners of small and mid-market businesses. And thanks to the explosive growth of all things digital, and I do mean all things, so has the way that people can fund or at least partially fund their startup businesses or the growth of their established businesses. What could that mean for any plans you may have for expanding your company and your quest to improve its overall value? We're going to try to get some answers from our guest on this edition of "Deal Talk." Markus Lampinen is the co-founder and CEO of Crowd Valley in San Francisco. Markus Lampinen, welcome to "Deal Talk," it's good to have you sir.

Markus: Thank you, Jeff. It's definitely a pleasure to be here.

I think it's good news for business owners in a couple of different ways. One is that the cost of capital acquisition is definitely going down. But the other one, very practically speaking, is that if investors can bring their cost of making a deal happen down that means that investors will be able to get into different types of asset classes and different positions in companies.

Jeff: Crowd Valley, familiarize our listeners about what you and your team do.

Markus: Like you said, we work with this changing landscape of online finance, or take essentially offline finance and how it's interacting with the online finance landscape. What we and the company at Crowd Valley do is really help these financiers, so lenders and investors, move their business processes into an online matter. What that means is essentially creating these types of online applications where a lender can essentially offer business loans through an online portal, or solicit essentially various different investors through an online portal, or essentially get these applications for financing, whether or not it's equity transactions or done through an online portal. 

So streamline the process for finding the sources of capital but also matching those sources of capital to the actual recipients of that capital, whether or not... It's like you said, early-stage company startups, growth state companies, but it is also other types of asset classes. Like, for example, we work a lot in real estate, but I think we can focus on the business side.  

But just myself as background, I'm born in Stockholm, I grew up in the Midwest in Kansas. Last eight years I've been working with this digital finance market starting out of Hong Kong, then London, then New York, and now here in San Francisco Bay Area for the last two years. So, definitely can expect me to have a little bit of an outlook on the market not just in terms of geography. I started in 2008, and I mean that's the fun times of finance. Everything was in a sense going downhill.



Jeff: That's right.

Markus: But that's really the emergence also for these markets, that a lot of the need for more efficient ways of essentially accessing capital and streamline the process, that's really where they emerge.



Jeff: How has crowdfunding, or the concepts of digital finance allowed business owners to grow their businesses? How advantageous has it been for them in terms of being able to procure capital?

Markus: You can think about it in very, very basic building blocks. What essentially this development around digital finance means is that the cost of capital acquisition is going down, which means that the process, and I'm talking time and money for actually getting access to the right investors. The right investors getting access to you as the business owner. That is getting shrunk essentially by a lot of these types of models. 

Practically speaking, what that means is for a business owner, actually looking for working capital or a debt solution, or a debt instrument. Then there are a lot of online options nowadays that are emerging. There are a lot of regional banks, a lot of institutions that are looking at alternative ways that maybe as a bank they can't offer you the loan that you're looking for, but they could have a community of various types of alternative lenders. That could then be private individuals, different types of maybe smaller funds, whatnot, that would essentially work through a non-conventional model where it's more of a peer-to-peer lending or a peer-to-business loans type of marketplace. 

I think the bottom line is that, obviously, the fundamentals of finance and financing, they're actually not changing. But it is the structure that by streamlining the process, by, for example, having a single point where you as a business you can go in into an online application, online marketplace, you can essentially submit your information there, you can get a quote back that this is the type of working capital solution that we could provide for you. Then that can speed up the process quite a bit. 

But I will say as a caveat that... Since 2008 I've kind of seen myself or heard myself say repeatedly each year that we are still very early on in the market. I still think that that's very, very true. If you look at the financing and the online finance space in the U.S., we're at a little bit under $10 billion a year, and certainly 10 billion is a huge number. But that being said, looking and comparing that to essentially small and medium-sized business financing from traditional institutions, which is in the hundreds of billions or trillions even depending on what you include in that, then it's still a very, very clear minority.

But I think as the education also develops, and as these institutions, lenders for example, or even the equity investors, they figure out how they can streamline their process. I think it's good news for business owners in a couple of different ways. One is that the cost of capital acquisition is definitely going down. But the other one, very practically speaking, is that if investors can bring their cost of making a deal happen down that means that investors will be able to get into different types of asset classes and different positions in companies. 

For example, maybe in the smaller deals or maybe in the sectors that have been hard to put structure around the deal. And that just opens up a few possibilities. But it is still very early in terms of looking at this market. And I think in the U.S., in particular, there's still a lot of opportunities on the table for both companies to push their lenders and investors to adopt more streamlined tools, but then also actually as an ecosystem to create more knowledge around what is digital finance, what is financial technology, how does it relate to the existing sector, how does it relate to business owners, and how you foster that entire communication.



Jeff: A part of the conversation has been that business owners are kind of limited to how much money they could actually obtain through these crowdfunding sources. Is that still true? Are the limitations such that it really only restricts a business owner to doing so much with these particular funds where they may not necessarily be able to obtain all that they need to start their business, if it's a brand-new startup, or capitalize an entire growth project. Tell me a little bit about the limits and how much money could actually be obtained through these online sources.

Markus: That's a good question, and it's also one that has various different dimensions to it. So let's just take a step back and look at the term crowdfunding. So typically crowdfunding will refer to essentially a private security transaction that is targeted at retail investors. And retail investors are the non-accredited investors. And in that world, there are certain limits, and there are also essentially, there's specific regulation, the Title III of the JOBS Act for you who are interested in looking at that. 

But just taking the basic concept to us, crowdfunding. There's a transparency, there is the efficiency, and then there is essentially the access that you're creating. So transparency in the process in terms of what's actually being done, the fees, efficiency in terms of time and capital that actually goes into this process, and then access in terms of access to new asset classes, access to new investment opportunities for different types of audiences. 

So taking that frame of mind that we are talking about something that is maybe a little bit more of a concept rather than anything set in stone at this point. And I often say there's various different types of crowdfunding. Like you can talk about crowdfunding with family office type of investors, investors that are qualified and accredited by a long stretch that are very sophisticated in their investment. But if you're able to approach not just three but for the cost of approaching three approach 30, for example. And that's the sort of crowdfunding in my head.

And then there's many different permutations for that. But if you look at the very, very basics. A lot of times for a growth company, then you will go into the venture capital space or the private equity space, and we work with some venture capital companies that are creating these types of online marketplaces where they will have their traditional investment model. Like their traditional venture capital financing structure, which they have a mandate for, which they have an LP that has given them money. 

But there are a lot of deals that they see that don't fit into that category. So it might be that they foster essentially a co-investment platform where people can sign up and they can essentially get access to these types of deals that are outside of the venture capital fund’s mandate. For example, in the private equity space we see that there are a lot of firms that are generating deal flow from online portals. 

So just to give you an example there that we work with a private equity firm that essentially raises capital from an online platform, or using an online platform that we power for essentially helping with the generational shifts in terms of small and medium-sized company. And they're not raising a million, they're raising typically between 10 and 30 million.

They will go into a healthy business, they will look at the business, the owner wants to retire. They want to foster essentially a continuity in the company. They will raise, let's say, $20 million for a company that's doing $20 million a year in terms of revenue. They will go and they will help with that generational shift, and they will just raise capital from the online finance, or online means. 

And this specific example that I'm giving, it's a company called Cobalt Funds out of the U.K., actually. And the reason that I'm giving it is I find that example was quite interesting in a way that you don't typically think about that as crowdfunding in terms of playing in that type of a niche. But that's what we see, that those types of applications, whether or not it's growth capital or startup capital, there is various different permutations of this model. It's about finding the right one.

And it also goes to this other point that if you are, for example, a company that has a solid business. You have revenues, you have recurring customers, you have good business, then there are different types of investments or different types of capital sources that might be more appropriate to you than the other sources. 

So just as an example for that is if you are a Silicon Valley startup. You probably want to raise equity capital because you probably don't have revenues and a loan isn't that attractive. But at the same time if you are a company that has revenues, a company that has an existing clientele in business, then equity capital might not make sense. And there's a couple of different reasons. 

Obviously, a loan might be cheaper for you, cheaper capital in terms of your cap table. But then also the other way around that aligning interests with somebody that expects their equity to grow but the company is structured in a different way that might be difficult. And I said at the start that these digital finance models, they don't necessarily change the dynamics of finance, and this very much goes back to that. That looking at the type of capital that you need for your company.

There are marketplaces that specialize in various different types of capital, I mean on the equity and debt side, but is also at various different stages of the capital ladder. If you're, for example, looking at raising equity capital, there are different platforms that focus on smaller equity injections, and those might be sourced from a network of credit investors or small funds. There's companies that look at essentially larger areas of capital financing. 

As with any business owner, it is all about the fit. Finding that fit in terms of what kind of capital you essentially take into your company, because taking the right capital can align your interests with essentially the capital source. It can be a great way for you to generate momentum for your company and essentially get a cost efficient source of capital that really aligns your interests with the investors. But then doing the other way around, not taking capital from the wrong source, then that can be a very detrimental idea. 

And again, it's nothing new, nothing revolutionary in that. And a lot of the time that we look at this market, then we encourage people to think about the digital finance market as essentially a complement to the existing financial market. So you're not necessarily seeing anything that hasn't been done before but it's the way that those services are being offered that hopefully they're more efficient, hopefully they're more transparent, and hopefully they are more accountable to all the parties in that life cycle. 



Jeff: We're talking with Markus Lampinen. He's the co-founder and CEO of Crowd Valley Incorporated at the San Francisco Bay Area, and we're really kind of diving in deeply here into this idea of crowdfunding and what the growth of this crowdfunding industry means for your company. And how easy it might make it for you to obtain perhaps capital that maybe you might not find someplace else, or at least it gives you the options out there that you might not have had maybe five, six, seven years ago, maybe even three years ago. But our conversation with Markus Lampinen will continue. 

We're going to talk about when we come back basically the process for obtaining funding through crowdfunding and kind of how that process works when "Deal Talk" resumes right after this.

If you'd like to share your knowledge and expertise on any subject related to selling businesses or helping business owners improve the value of their companies, we'd like to talk with you about joining us as a guest on a future edition of "Deal Talk." Interested? Contact our host Jeff Allen directly. Just send a brief email with "I'd like to be a guest" in the subject line. In a brief message include your name, title, area of specialty, and contact information, and send it to jeff@morganandwestfield.com, that's jeff@morganandwestfield.com. 
Selling your business may be the most important business transaction you'll ever undertake, so don't go it alone. Work with an organization that has made it their business to sell businesses and that's all they do. Morgan & Westfield at 888-693-7834. At Morgan & Westfield we know that selling your company is not something you should take lightly. It can be a stressful, difficult, even emotional process. That's why it's important to work with a team whose one and only specialty is selling businesses throughout the United States. And Morgan & Westfield will help you every step of the way, from helping you plan your exit strategy, to preparing a comprehensive appraisal, and locating the right buyers. 

Without the right team behind you, you could be leaving money on the table. So don't leave your most important business transaction to chance. Call Morgan & Westfield for a free consultation at 888-693-7834, 888-693-7834, or visit morganandwestfield.com.
Jeff: Welcome back to "Deal Talk," my name is Jeff Allen, and just to let you know, if you're listening to this program right now on iTunes, Stitcher or Libsyn, that's fantastic. That's exactly where we want you to be. However, as a bonus, on the morganandwestfield.com website you can also find the complete transcript to this program. In addition to finding the transcripts for all the programs that we have recorded to this point for you. 

Thanks very much once again for tuning in. Jeff Allen with Markus Lampinen, CEO of Crowd Valley Incorporated in the San Francisco Bay Area. We're talking about crowdfunding. Markus, real quick. I do want to talk about the process for obtaining crowdfunds, because many people already know how to go to a bank and fill out a loan application to contact the Small Business Administration or the representative there. Or any number of other sources, private equity firms, they may already be familiar with. 

But first of all, I did want to ask you about something you alluded to. This is something we've touched on very, very briefly in our previous edition of "Deal Talk," and that is the JOBS Act Title III. Can you please explain to us, once again, and for those people who may be listening for the first time, what that is?

Markus: Absolutely. The JOBS Act is a provision that was essentially put forth in 2012 and it's been implemented in various different stages. It has six titles to it, so six different specific components of the regulation. And they've been implemented at different stages of the process. Like Title II introduced the 506(c) offering, which essentially means that for a private security transaction, you can now conduct general solicitation, so market it freely. But at the same time you can only sell it to accredited investors which are then accredited by their net worth or their assets. 

But Title III, specifically, Title III is what's referred too often as a true crowdfunding provision in the JOBS Act. What that specifically means is that you could through these online portals that Crowd Valley work with, then you could through them essentially solicit investors publicly through an online portal and essentially raise up to a million dollars in finances from a retail investor crowd. 

Now, it doesn't have to be just a retail investor crowd, it can be accredited investors too. But for Title III of the JOBS Act, the retail, the non-accredited investor is the key component. This means that specifically for the first time in American history in a public financing market in private transactions you could actually invest in the startups without having pre-existing relationships.

There are some caveats, and we have great material on that on our Crowd Valley blog, for example, on the specifics of the actual regulation. But the key components are essentially for a non-accredited investor than the amount that you can actually invest in startups. It's then linked to essentially your income, and then for the companies, how much they can raise. It has different tiers. So for essentially being able to provide audited financials and you get a higher tier, and ultimately you can raise up to a million dollars.



Jeff: What you're saying is basically is much like the way that investors could invest in publicly traded companies today, private investors, those are non-accredited investors, folks like me, for example, would be able to invest in and perhaps somewhat limited depending on their income would be able to invest in private companies.
Markus: That's right. Hopefully in a secure and a very efficient process.

As with any business owner, it is all about the fit. Finding that fit in terms of what kind of capital you essentially take into your company, because taking the right capital can align your interests with essentially the capital source. It can be a great way for you to generate momentum for your company and essentially get a cost-efficient source of capital that really aligns your interests with the investors.

Jeff: Exciting times. And once more, just the number of opportunities that continue to grow out of this, just unbelievable. The process of obtaining crowdfunds, for those business owners who may be really interested in looking at this and researching this, and thinking about this as a possibility for obtaining capital to grow their companies, perhaps finish a construction project, add new equipment, whatever the case may be, tell us how it works. How do we get this money?

Markus: You mentioned the reference earlier that you know how you go to your bank you fill out the loan application, the SBA in that process. And the process I would argue is not that far removed from that. So you have to find essentially the portal or the platform which has its entry, the investors or the lenders that you're looking for. And you have to find one that actually fits your needs. And I'm not saying that once you see cash then you go all in, but rather research the portals, research the actors, research what they've been doing, what their diligence process is, how they handle the process, what fees they take, and kind of the process from there. 

But really, once you find a platform and you can just search on Google and you can find a lot of press around these portals and your specific niche for example. Let's say that you are working in agriculture, then just start by looking at agriculture innovation and online financing. And you can find probably various different platforms that are focused on that specific niche. But then you just read about them, you get familiar with their process. Typically it goes pretty much like essentially the banking process. 

You essentially have to present your company, of course. They have to do certain diligence on your company, make sure that everything is in check. The amount of diligence that they do, it does really depends on their model and essentially on who they are, but that should be explained to you by them quite clearly. And that's certainly important for you to understand because, that will have an impact on how your company is presented.

And then you need to understand also that who is your company being presented to. Is it going to be these types of investors that fall into this non-accredited crowd? And then your expectations should be in line with that, that you can't expect to raise $10 million if the restriction on the platform says that it's a million tops or even half a million based on different types of statements that you can provide. So understanding the platform and the party that will arrange the financing or broker the financing, that's incredibly important. Because that's essentially who will oversee the process end to end and that's who will also help you in that. 

Their success rate is also important for you to figure out, that, have they been able to help companies like yours before? Because there are specialists all around. But essentially you need to make sure that you have the basic things in place for your company in terms of how to present and create this narrative around your company. 

And it's a little bit different depending on who you talk to. For example, the bank loan application. And certainly if you're working with an online lender that has a similar process and it's going to be quite similar. But if you're talking to a group of ultimately private individuals, maybe some family offices, some wealth individuals that invest essentially into smaller or medium-sized companies for their own personal reasons or out of their own personal cash. 

And it's going to require you to tailor your presentation a little bit. The financials of the company are these types of things, they are what they are, so those are quite factual. But once you actually get to the presentation, and you probably want to emphasize certain things. Let's say that, for example, you are a mission-driven company that seeks to empower, for example, agriculture in certain states. Then that could be something that resonates very strongly with certain types of individuals. So it's all about kind of honing that value prop and that key massage that your company actually promotes.

Like, for example, if I take it back to Crowd Valley, then we are working on essentially this democratization of the financial market, and that's something that we as a company really believe in. And that's certainly something that some other people believe in as well. But finding those people out of these marketplaces, that's important. 

But oftentimes these marketplaces and these operators, these online platforms, they are quite often, meaning that you should be able to have a conversation with them, get information about their process, hopefully also already from their website or the representatives. But certainly you should be able to get somebody on the phone and just talk through these things. Because one of their key roles in this market is education, investor education, but certainly business owner education, and just market education in general. 

Because ultimately, if you're able to be smart about who you approach, and how, and through what process, then that's in their very selfish self-interest as well, which is a good thing. Because ultimately you want the same thing as them, and you want to make sure that those things are aligned as far as possible. That you find the right investors through a structured and efficient process for the right company.



Jeff: And so at the end of the day it really is about educating yourself, taking the time to see what's out there. Learn all about online financing as much as you can. And we know that folks are busy. There will always be probably resources online that people can connect with, and no doubt people that they can speak with, that they can actually call up and get their questions answered. And that's kind of where we've come to in this part of the program, Markus. 

I know that you're so fixed, right in the middle of all of these tremendous developments and certainly it’s grown beyond just a cottage industry anymore, crowdfunding has really become front and center. A true option for business owners to consider when it comes to deciding how they are going to finance their next move, whether that means to grow their company or to start up a brand-new venture. 

Markus, if we have folks in the audience who may be interested in reaching out to you, should they have any questions that were unanswered in this program today, how can they reach you?

Markus: Absolutely. And I'd be very, very glad to continue the discussion. You can find our website at crowdvalley.com. On our website you will find a lot of research that we published, white papers, different case studies, different tutorials, which is our commitment for essentially generating educational material in this market, but also providing statistics on some of the activity that we've got. My own details, you can reach me at markus@crowdvalley.com. It doesn't matter how you spell it, it will all reach me anyway. Or then just get in touch with our team at info@crowdvalley.com.

And really, a lot of the work that we do is fostering this discussion around how these online financing marketplaces, both equity and debt, and cross various different asset classes, how those are changing the very practical things that business owners, but also different types of investors and lenders, go through. So in that discussion, if there's anything that I can do to be of service or helpful in, then I'm very happy to have that conversation.



Jeff: We appreciate that, Markus, very much, that offer to do that. And I hope that I can have you back on the program soon because I know that there is a lot of information we have yet really to cover. And because of the developments in crowdfunding as a financial resource for so many business owners out there, regardless of your stage of business ownership, there are more and more developments coming along, practically on a regular basis now. And so I'd like to be able to have you back on the program again.

Markus: Thank you, Jeff, and I’d definitely love to be back here.

And I'm not saying that once you see cash then you go all in, but rather research the portals, research the actors, research what they've been doing, what their diligence process is, how they handle the process, what fees they take.


Jeff: Thank you, sir. That's Markus Lampinen, he is co-founder and CEO of Crowd Valley Incorporated in the San Francisco Bay Area. I hope that you enjoyed this program. I know that I did. And I hope that you tell a friend about "Deal Talk." In addition to morganandwestfield.com you can find us on iTunes, Stitcher and Libsyn. "Deal Talk" has been brought to you by Morgan & Westfield, the nationwide leader in business sales and appraisals. Learn more at morganandwestfield.com. My name is Jeff Allen, until next time. Thanks for listening.

While we take reasonable care to select recognized experts for our podcasts please note that each podcast presents the independent opinions of such experts only and not of Morgan & Westfield. We make no warranty, guarantee, or representation as to the accuracy or sufficiency of the information provided. Any reliance on the podcast information is at your own risk. The podcast is for general information only and cannot be considered professional advice.
 
 
Resources (All references mentioned in the show)

Key Takeaways

  • A company’s intangible assets are critical in the appraisal of startups or early-stage businesses. The most important intangible asset is the management. You can have the best idea in the world, but “without proper execution, you're absolutely nowhere.”
  • The most important value driver in a startup or early-stage business is traction – the momentum or progress your business has made.
  • When seeking business financing, entrepreneurs should consider private equity or venture capitalists more than banks.  Unlike private equities, banks don’t necessarily add value to your startup or early-stage business.   

Read Full Interview

Jeff: Evaluation may be the last thing on your mind if you've been in business for a short time. But my guest is here to explain why it's important even for the youngest companies. If you're the least bit curious about how a professional valuation might help your new business, you've come to the right place.

From our studio in Southern California, with guest experts from across the country and around the world, this is "Deal Talk," brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.



Jeff: Hello and welcome back to the web's number one content source for small business owners committed to building a business for eventual sale. Here on "Deal Talk" it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.

We know that many listeners to this program "Deal Talk" have their own businesses that are just getting off the ground or starting to show their first signs of their measurable growth. If that's you, congratulations. And since we're all about helping you raise the value of your company, we wanted to have someone join us who can talk about working with young businesses, startups or at least age ventures etc., to help them establish their values at an early stage. And to do this I'm happy to be joined by Mr. Pieter Stam, a professional business appraiser who specializes in valuations for newer companies. And he joins us from his office near Amsterdam in the Netherlands. Pieter Stam, welcome to "Deal Talk," sir, it's good to have you.

Pieter: Thank you very much. Thank you.



Jeff: Pieter, let's start by talking a little bit about you. There in the Netherlands we don't have a lot of contacts from the program. We've interviewed a couple of valuation consultants and also professionals in the M&A space from your country recently on the program, but let's learn a little bit more about you and what your area of specialty is, and the companies that you help as well.

Pieter: My background is basically I used to consult companies in turn around management and how to recover or restructure assets. After my masters I was basically headhunted to value companies in all stages of their life cycle. Particularly what I do is I try to simulate in a way the future. For that you need to have some of course … the normal … this kind of cash flow modeling. But also you have to put in strategic knowledge. Where do you think the company can be in a certain amount of time, and what is a normal horizon?

If you take a look at the whole value of a company, you subtract the debt and the assets, you're basically stuck with the intangibles.


Jeff: Why should the owner of a startup venture or an early stage business have their business appraised at such an early point in its existence?

Pieter: The most straightforward answer is probably to seek financing. But that is not nearly the most important thing. There are two things that I think that are really important. If you're at the very early stage, you have to make huge decisions. How will I enter the market, what is the market, who are my customers, etc. No valuation behind it. It will give you support with the strategic choices you have to make basically. 
And on the other hand, if you're still in the early stage but you already invested a lot of effort and resources, it's a way to value these efforts. And sometimes you want to take off shares from the other shareholders and you have to have a point in time to know what is it worth. And I think those things are really important because, for instance, what I tend to do is a majority of the time I do just discounted cash flow models. And sometimes enrich it with a Monte Carlo simulation.



Jeff: Tell us what that Monte Carlo simulation is. We've heard it discussed here before, but if you could provide us with some information as to why that's important.

Pieter: The Monte Carlo is a place in Monaco and they're famous for their big casinos, and that's where the name is coming from. It's like rolling the dice. If you have two dice in your hand the biggest chance that you throw is seven. But what happens if you throw a five or an eight? If you have a large cash flow model with a lot of uncertainties, you can simulate them.

So you can say, "Probably my market is growing with X rate, or my customers I will penetrate a new market so I expect." But what happens if those things aren't playing out? So you can say, "This is the bad case and this is the best case." So you know the bandwidth of the value of your decision making. And of course it's not like a hardcore science, but it gives you the idea and some know-how, which are good decisions and what's the impact of it.



Jeff: Pieter, can you tell me if the act of having a business valuation itself, the process of having a business valuation, that first one, is that something that can actually not just result in improved value but can that actually improve the value of a company itself if a company has taken the time to have their business appraised right from the start?

Pieter: Yes, definitely, because if you know the choices that you can make, all the possibilities, and you get consoled about those options in an early stage. And that's very difficult, because in that early stage businesses don't have money. But if they seek finance, and what we see here if you want finance you want to get finance from a bank, for instance, which I don't recommend for any early venture by the way. They want to have something more than just idea. The banks they need to have value. 

So in that whole process of putting a value on their intangible assets, in a way it's just an idea or it's just a group of people that are very intelligent. Even though they're probably very skilled, they still have to know what the result will be in a way from their decision making.



Jeff: So the intangible assets that really you're measuring in terms of value and providing that valuation to them, these are even more important aren't they when we're talking about appraising new, young, early stage businesses or startups. The intangible assets are probably more important in this particular case than they would be for an established company that has been in business for 10, 15, 25 years is that right?

Pieter: Yes, that's definitely right. When I appraise the business I tend to appraise the asset. I'm not interested in their depth structure or their... I tend to first take a look at, all right, what are just the assets worth, besides the whole structure having access to grapple the market or whatever. Because the assets itself and particularly the intangible assets, that is the real value of a company.



Jeff: We've been told that valuations are not necessarily just a measure of past performance and of the value of a company to the present date, but rather also forward looking as well, and can include potential... Is that true? Explain how that works.

Pieter: A lot of people that tend to look at a company, this is their track record. I expect the track record to be the same. And if the GDP is growing it will grow at the same rate. For instance, that's what you see with more mature companies, but with a startup or even an early stage venture you see that you have to anticipate on the future because you don't have that much history. And a majority of the time they're not making a profit. You can simulate what happened to see... For instance, we see when do they have enough mass to start making a profit. And you can use basically a multi-current simulation for that. 

Sometimes I have to tell people, "I don't think your idea's good enough. Or your business model is just broken. Maybe you should do something different. Be surprising. Enter the market in a different way." Sometimes I see businesses, they reinvent something but they don't do it better. They think they could do it better but the customer isn't thinking that way. So for me one of the most important factors is probably for early stage ventures that they have already traction, like the first customers. If it's a really early stage you can still tweak the product or the service. I think that is definitely important if you want to...



Jeff: Let me ask you this, Pieter Stam, what kind of reaction do you get from those individuals that you speak with, and you have to meet with these people and discuss what's driving their business, or discuss their product like you talked about or their service. And you tell them, "You know what, this isn't really working, or the potential here for failure certainly does exist if certain things aren't corrected." 

What kind of response do you get from them? Are people generally disappointed? Are they genuinely interested in hearing what you have to say? Just kind of give us some kind of indication of what reactions you've had to deal with in the past.

Pieter: Of course people are a bit disappointed, because they put a lot of effort in it and a majority of the time they're really passionate about the product. But if you report in such a fashion that they understand every step of a simulation of the valuation process you can point out the weaknesses. And of course they're not only weaknesses, sometimes the idea is great but the management team, for instance, is not good enough. There's always a way that they can stir it a bit. But sometimes they put in a lot of effort and it's worth basically nothing.

A good plan needs good execution. But along the way you find things that you have to change, or the market is changing, or you are changing. So you always have to keep in mind what is the dot on the horizon where I'm going.


Jeff: And it's what it is. And they continue to move forward with their original plans whether or not their plans would be able to result in anything tangible in terms of success. This is a great place to stop for just a moment because I want to take a break. And when we come back, Pieter, I want to be able to chat with you about value drivers and about these intangible assets in a little bit more detail to kind of get your take on some of the drivers and intangibles that you actually talk with these companies about and how they can start to make efforts to improve the value of their company and steer the ship in the right direction. My name is Jeff Allen, and I'll be back with Pieter Stam. He is a valuation professional based in the Amsterdam area in the Netherlands, and we'll continue our conversation when "Deal Talk" continues in just a moment.

If you'd like to share your knowledge and expertise on any subject related to selling businesses or helping business owners improve the value of their companies, we'd like to talk with you about joining us as a guest on the future edition of Deal Talk.

Interested? Contact our host Jeff Allen directly. Just send a brief email with "I'd like to be a guest" in the subject line. In a brief message include your name, title, area of specialty, and contact information, and send it to jeff@morganandwestfield.com, that's jeff@morganandwestfield.com. 

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And if you just want to provide us with some feedback to let us know how we're doing, if there's anything that we can do to make this show better for you. Just simply shoot us a quick email to dealtalk@morganandwestfield.com. Once again, that's dealtalk@morganandwestfield.com. And I'm looking forward to reading those emails and finding out what it is that we're doing right and some of the things that we need to improve upon. 



Jeff: My name is Jeff Allen with Pieter Stam. He's a professional valuation consultant coming to us from Amsterdam today. And we're talking about the importance of valuations, business appraisals for new, young companies. We talk about oftentimes valuations, the importance of value drivers and we're going to start this second segment of this program by talking about that right now. 

Pieter, you've mentioned that when you're called in to appraise these businesses you're going to visit with these clients and then you will sit down with them oftentimes and provide your feedback, and let them know about ways that they can approve some things that they need to do in order to gain the growth, to get on the path, the trajectory to growth in the future. Let's talk about some of these important value drivers right now for young companies. I know that all businesses are different, but are there some value drivers that you come back to again and again to discuss with these companies and things they really need to focus on in the beginning?

Pieter: Yeah, definitely. And it's not that special. The most important value driver I guess is traction. Do you have first customers, do you have first feedback on your product and services? The whole idea... Can you keep on improving what you're doing? The majority of them that's the most important thing. 
And of course you have things like patterns, you have maybe brand names, or like proper social media exposure. Those things are important to create a buzz around you. But the most important thing is probably traction. You just need to have your first customers and have your first starting up the whole business. Because you go from an idea to have them serving and resolving problems. That is probably the most important thing.



Jeff: One of your specialties is obviously it's appraising intangible assets and you explained why that is very, very clearly in the first segment of the program. What are some examples of intangible assets that you can describe for us?

Pieter: I think the most important intangible asset is probably the management. And it sounds really strange because you can have a great idea but without proper execution you have nothing, really have nothing. And there is a famous quote and it's called betting on the horse or the jockey. The horse is the starter basically and the jockey is management. You can have the best horse in the world, you have the best idea, but without proper execution you're absolutely nowhere. 

That's probably the most important intangible asset. But of course you have the whole process of R&D or the whole being able to attract new challenge. Those things are really things that you don't see on your balance sheets basically. If you take a look at the whole value of a company, you subtract the debt and the assets, you're basically stuck with the intangibles. And from there on you see that the whole things like the know-how, the good will, the brand name, the reputation. And when someone wants to buy a company or you want to have new shareholder, or getting equity financing, those things matter a lot.



Jeff: Let's go back to what you'd mentioned a short time ago about new companies and that they should not seek financing from a bank in the beginning. Can you tell us why that is?

Pieter: That's because banks they don't add any other value, and a majority of the time they're just money. And money by itself is not interesting at all. It's like if you have a venture capitalist, or private equity, or whatever, if they invest you can access their networks. Maybe they will be able to give you the first traction. It becomes easier to enter the market. And there's scientific evidence that companies that get funded by private equities they probably enter the market quicker, they are more successful. Because private equities, when they do their due diligence and they think, "We can make a profit out of it," that is by itself already a value a driver. Because if private equity doesn't want to invest in it, probably it's not a good company.



Jeff: This conversation with Pieter Stam has really been very interesting and very eye-opening indeed from someone who obviously, a former new startup business owner myself, it's been many years in the making now. But had I known then what I know now I probably would've been a much smarter individual from the beginning. Pieter, I want to wrap up this segment of "Deal Talk" by asking you if you can leave us with a few parting words, some final thoughts, recommendations that you have for new business owners, new entrepreneurs. Maybe they've just launched their companies, maybe they've been in business for a year or two. What can new businesses do now, young businesses do right now to work toward improving the value of their companies at the very early stages?

Pieter: The thing with the valuation of a company, in a sense it's very subjective because, like I mentioned before, if you get backed by private equity they provide more value than just money. They help you in other ways if they're the proper investor. 

That's a thing that probably you have to always keep in mind. So if someone gives you a value of your startup, or your early stage venture, or whatever, you always have to take a look at how they made the valuation. Because in my case I make a forecast. And if you take a look at the forecast you have to make a lot of assumptions. And if he or she is doing a good job the assumptions make sense, you can learn a lot from a valuation in such a fashion. 

If you do it at an early stage, which is quite funny if you're an early staged venture. You can still pull some strings to redirect your venture and do maybe some bit of difference to teaching decision making. And I just think that a good plan needs good execution. But along the way you find things that you have to change, or the market is changing, or you are changing. So you always have to keep in mind what is the dot on the horizon where I'm going. And I think that's probably the most important thing.



Jeff: Pieter Stam, this has been, like I said, an eye-opening conversation. We appreciate your time. We really enjoyed it. And hopefully in the near future we can have you back on the program again. Thank you so much once again for joining us today.

Pieter: Thank you.

If someone gives you a value of your startup, or your early stage venture, or whatever, you always have to take a look at how they made the valuation.


Jeff: Tell a friend about "Deal Talk," won't you? In addition to morganandwestfield.com you can find us on iTunes, Stitcher and Libsyn. "Deal Talk" has been brought to you by Morgan & Westfield, a nationwide leader in business sales and appraisals. Learn more at morganandwestfield.com. My name is Jeff Allen. Thank you so much for listening. We'll talk to you again soon.

While we take reasonable care to select recognized experts for our podcasts please note that each podcast presents the independent opinions of such experts only and not of Morgan & Westfield. We make no warranty, guarantee, or representation as to the accuracy or sufficiency of the information provided. Any reliance on the podcast information is at your own risk. The podcast is for general information only and cannot be considered professional advice.

Key Takeaways

  • Businesses can benefit greatly by taking a systematic and critical approach to negotiating their contracts.
  • It’s important to understand that the relationships that business owners have with their supply chain members are in fact partnerships, they go both ways.
  • When evaluating your supply chain, first look at the performance of your current suppliers then look at agreements with the suppliers.
  • Talk to other companies and find out who they're working with, what they liked about them and what's effective.

Read Full Interview

Jeff: Is your supply chain working for you or is it holding you back and costing you serious money? If you're looking for answers to help you fix potential supply chain issues, you've come to the right place.

From our studio in Southern California, with guest experts from across the country and around the world, this is "Deal Talk," brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.



Jeff: Welcome to the web's number one content source for small business owners committed to building a business for eventual sale. Here on "Deal Talk" it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.

Joining us back here on the program to talk all about supply chain management and how to heal those relationships, or if they're not broken at least improve them, is Mr. Tim Van Mieghem. He is a partner at the ProAction Group in Chicago, Illinois. Tim, good to have you back on the program, sir. How are you?

Tim: I'm doing well, Jeff. It's good to be here with you. Thank you.

When I negotiate every dollar of benefit that I negotiate for myself is a dollar out of your pocket and vice versa, there's no value created. When we're negotiating between two companies to provide a product, we can negotiate many items beyond price. … We can negotiate those issues and develop a contract where we actually create value.


Jeff: Thank you. Today we're talking about supply chain logistics. When we think of supply chain, many of us immediately consider manufacturers first and foremost. But might this discussion that we have today, Tim, also be helpful to other types of businesses and industries as well?

Tim: Yeah, absolutely, Jeff. And certainly when you think about cost of goods sold for a manufacturing company the cost of direct materials can be 60% to 80% of the cost of goods sold. So clearly for manufacturing companies negotiating good contracts with our suppliers is absolutely critical.

Distribution is the same. And one thing that I would add to it there's a complication with distribution companies. Oftentimes they're selling products that are branded and their customers are committed to buying a certain brand. And a lot of distributors we work with think that if their hands are tied because of that pull-through, and that perhaps their ability to negotiate a better deal is limited. 

Health care is another great example of a company that can benefit greatly by negotiating contracts. And to some degree as well it may not be the largest item on the income statement, but even professional services and service-based companies are still spending money every month that can be improved, sometimes dramatically, by taking a systematic approach and critical approach to negotiating their contracts. 



Jeff: So we're really talking about supply chain as far as... This is part of a company is doing business every single day. A portion of your supply chain is affected by what you do and your business is in turn affected a little bit by what they do, by the amount that they charge you by delays in service, by breakdowns. Whether any number of things that could influence the cost that you pay both in the short run and in the long-term because these costs that you end up paying, these expenses could really mount up, Tim, I think that you would agree.

Why is that, do you think, just kind of based on your travels and dealing with your clients, that so many business owners fail to take note of issues in their supply chain that could be holding them back from continuing to grow as an organization, and continuing to improve that value over the long run?

Tim: That's a great question, Jeff. And I think there's a couple of really important pieces here that prevent people from really evaluating it, knowing what's possible. The first one is I think it's the basic tendency that many of us have to look at price as the primary issue when negotiating with our suppliers and looking at our supply chain. And that is such a limiter. 

And actually one thing I will tell you that's kind of counterintuitive is that when we do an assessment and we talk to the people who negotiate purchasing contracts in a company, the more hardcore they are in terms of talking about getting the best price the more we find that we can help them dramatically improve the cost structure. 

And when we sit down and we work to become a good customer to a supplier, and we sit down and we have a rational, thoughtful conversation about who should do what to minimize the total cost of the supply chain, we can create a ton of value for our collective supply chain and how we serve our collective customers.


Jeff: Interesting.

Tim: Yes. When people talk about how they have a really hardcore negotiator it's often an indicator that they've been focusing on price and that there's great opportunities to improve. There's a second one too which is, it's that old comfort zone issue. 

And here's what I'm talking about here. Our biggest dollars when we're looking at what we buy in our supply chain are what I would call direct materials. It's the items that go into our product. So for a manufacturing company it's our raw materials, our ingredients, our purchased goods and services. If we're a distribution, it's the products that we sell to our customers. 

These are oftentimes they're strategic relationships. And what I found is that people get comfortable with their existing supplier and they do not like having a difficult conversation periodically that we're going to be putting it out to bid. And in fact they're concerned that they could disrupt their supply chain if they go down that path. And so there's a certain level of fear of change and of unknown that kind of prevents people from taking a deeper dive.



Jeff: And also, too, I think that there could be a comfort factor with the fact that you might believe that, "Hey, I've been with this guy for years. He's given me the best possible deal I could possibly get from anyone," when in fact that deal may be on price but there may be certain limitations that you don't understand that exist that maybe the guy down the road or someone across town may not necessarily be limited to providing you. And it may be better deliver time, shorter delivery times, maybe more trucks on the ground. It could be any number of things, right?

Tim: I'll give you an example. We just completed an assessment of a client spend for labels. It's a healthy spend, $2 million a year. And they've been buying from the same company for almost 20 years. And we put it out to bid and have looked at and received bids from alternative suppliers and here's what we found. There are suppliers who have different technology than the supplier we're using today. 

We also have different locations. You can serve in a different way the different plants and factories that our customer has. And in fact what we found is that the alternative suppliers that we're talking to can provide the same or higher quality product. And I'm talking about a 25% to 28% cost reduction. So this is something that occurred over time. We had a supplier that worked for us when we were a certain size, and a certain area, and a certain location. And over time they became less relevant and we never looked at it until very recently. And now when we look at it we find a tremendous opportunity, and you hit on a really important topic.

Back in the old days, it was the good old boys club. One of the primary methods that people use to select their suppliers was who they have a good relationship with. And then they then worked with that supplier and do the best they can. What we're doing today, it seems a little cold, but it's so much more effective, is you find the company with the right infrastructure that has the ability to serve you and your customers in the lowest cost and in the best, highest quality methodology possible. And then you build a relationship with that company. It's completely flipping the model on its head, and it works.



Jeff: And so really though, one of the keys I would think though is you've always got to have added value in mind, what is it that this next company over here can provide me that I'm not getting over here? Maybe it's for the same price, maybe it's for slightly more. But this is all business, this isn't personal here. We're trying to do things to help us get that ... 

I've got a plan to sell my company about 10-15 years and obviously I want to get as much for it as I can. But if I'm losing money here, and all of it seems to be invisible to me, I've got a guy, Jerry here has been great to me. He's fantastic. We've been working together for many years, that doesn't make any difference at the end of the day really because ...

Tim: Here's another quick story for you, Jeff, that tells this pretty well. We negotiated for a company a whole bunch of different things but including their outbound freight, their truckload shipping. And it wasn't a big spend. It was about half a million dollars a year, and the person who was doing it currently was a personal friend. And in fact their kids stood up at each other's weddings. And they had a long-term relationship. As it turned out we found an alternative that would save him $100,000 a year. And you know what the conversation was between the CEO of the two companies?



Jeff: What's that?

Tim: He said, "I love you, man, but I'm not going to write you a check for $100,000 a year."



Jeff: How did that go?

Tim: I'm sure it doesn't always end this well, but in this case the guy said, "That's the right choice. They're a different company, they're set up to serve you, and I understand." And it was truly the right decision. There are many times where companies decide to stay with the current supplier, but here's what I want it to be is a conscious choice with the facts on the table.



Jeff: Tim Van Mieghem is with us and he's been with us before here on “Deal Talk.” He's a partner at the ProAction Group, and we're talking about supply chain. We're talking about improving those relationships in your supply chain. And in fact Tim Van Mieghem is the author of a book, textbook, “Implementing Supplier Partnerships.” And this is really important because we don't tend to think of our partnerships and our relationships as partnerships with the suppliers and our vendors so much I think as much as we need to because really it's a two-way street, we're helping each other here, right, Tim?

And so you've got this book, “Implementing Supplier Partnerships.” Tell me, Tim, in your studies of kind of the improvements that are required, the relationship building that is necessary, in order to get the best value out of the partnerships that you should have with your suppliers and all of those vendors and people along the supply chain, what are two or three of the areas within that supply chain where businesses tend to lose the most money whether due to high cost or losses resulting from inefficiencies?

Tim: Sure. Another good question. Let me provide a little bit of a thought background on this, too, because we talked about price before. Here's the one big aha that really helps to paint a picture of why this is so effective. When we negotiate, for example, for a used car and it's a one-time deal it's a zero sum gain negotiation. 

When I negotiate every dollar of benefit that I negotiate for myself is a dollar out of your pocket and vice versa, there's no value created. When we're negotiating between two companies to provide a product we can negotiate many items beyond price. We can negotiate inventory programs, hedging programs, pricing terms, quality, new product development, when does title pass, how do we ship the product, and 20 other issues. Here's what's wonderful about it, is that we can negotiate those issues and develop a contract where we actually create value.

One of my favorite examples comes back to a tour I took of a forklift factory. One of the stories that came up was a supplier was coming through a factory that provided the wheels for the forklift company, the steel wheels. And they noticed that when they brought the wheels in the first thing that happened is they went over to a drilling station. And the representative from the supplier asked them, "What was going on here? Because once we receive your wheels we bring it over here and we've changed our drawings and we've added some things that we needed to put a couple of additional holes in these areas for this new application that we have." And the supplier said, "If you let me know, I can do that and I can actually design it into our computer, design our CNC machines and have it done automatically." 

This might seem like an obvious example, but, Jeff, I'll tell you, one, it happens all the time because people don't have time to review every process and have these kind of aha's. But what this exemplifies is that if you move a step to the right part of the supply chain you can dramatically change cost structure. And when we sit down and we work to become a good customer to a supplier, and we sit down and we have a rational, thoughtful conversation about who should do what to minimize the total cost of the supply chain, we can create a ton of value for our collective supply chain and how we serve our collective customers. 

And that's the first half of our negotiation. Our negotiation process is set up to understand that dynamic and to negotiate to provide the best cost structure and service to our collective customers. Then the second part of our negotiation is how do we divide up that value, and that's where we have the negotiation about things like price and what terms do we get and what do we give to the supplier. That process is where a lot of the value to the company can come from sourcing.



Jeff: This is a really important conversation we're having here, Tim, and I hope that our business owner audience, our listeners do take note of some of the things we're talking about because I think so much of it can't be taken for granted, particularly when you might think that you've already got some very, very strong relationships that are built on trust over the years. But there are always things you needed to do and take some time to re-evaluate particularly if you own a business where the supply chain plays such a vital role and such a vital part of your being able to satisfy your own clients.

My name is Jeff Allen. I'm going to be back with Tim Van Mieghem. He's partner at the ProAction Group in Chicago. We're talking about supply chain management or supply chain rather partnerships and your relationships with your supply chain members. And we're going to do more of this when we return on "Deal Talk" right after this.

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Jeff: I'm Jeff Allen with my guest Tim Van Mieghem, partner at the ProAction Group. We're talking about your supply chain and how you should work toward kind of bolstering those relationships with your supply chain partners. And really it's trying to have that mindset, maybe change the mindset that you might already have to understanding how these relationships that you have with your supply chain members are in fact partnerships, they go both ways, OK. But you need to really think first of all about your own business first. Are you really getting the value that you need to get from these partnerships, from these relationships to keep cost manageable while continuing to bring that value of your company up and delivering to your clients in an efficient way that helps them get what they want, you get what you want, your supply chain members they get what they want? Everybody is a winner across the board. I think, Tim, at the end of the day that's what we all want.



Jeff: I would like to ask you about the process. I'm a business owner and I am re-evaluating my supply chain from top to bottom. Walk us through the process. How do we start to take stock of things where a supply chain is concerned in order to start to make some improvements that are going to get us the results that really we're looking for?

Tim: Sure, good question. Here's what we do. If somebody asks us to look at their company, here's what we look for to find the smoke that tells us there's fire, the indicators that there's opportunities to perhaps get more value out of our supply chain.

The first place to start is to look at the performance of our current suppliers. Here, I'm going to start with things like inequality issues and returns. What kind of support are we getting from our suppliers for new product development? And I'm going to talk to the people in my company in each of the different departments and I'm going to ask them questions about which suppliers are your favorite, why are they your favorite, which suppliers make it more difficult for you to do your work, which ones would you prefer to not work with again, which ones would you like to work with more? 

It's amazing what you learn. It's like that old Yogi Berra quote, it's amazing what you see when you look. And by looking at this and asking questions we find out so much where there's pain that we may not have known about it before.

The second thing we like to do is actually look at our agreements with our suppliers. And this first assumes that there are documented agreements. If there are not documented agreements, then that is a meaningful sign that there's an opportunity. If we are not measuring something, then it's difficult to know that we're doing it well. So that would be the next piece. 

And here's a real important tip when we look at our agreements. There's two kinds of agreements that we consider to be technical and ineffective. One, our agreements that are less than a year where we're essentially negotiating each need as we go. And the other one is what I consider evergreen contracts which are ones that essentially just go on infinitum. Neither of those provide value. 

A supplier, what they want is commitment. They want to know that they're going to have your volume over a period of time. That is how they can evaluate their ability to invest in you as a customer. So if we're simply negotiating for the next order or for one year, that's a very short period of time that they are getting a return on any investment they make in you as a customer. 

If it's a very long term contract where it continues to just get renewed, then in a sense it's never being reviewed. And it becomes a cash cow for the supplier. It becomes something that they assume. What we want, what typically makes sense in many cases a 3-to-5-year contract that provides a real window for the supplier to get a return on their investments in us as a customer. And it gives us a real window to go back to the market and test our agreement, and see is this still the best supplier, is this still the hungriest supplier, is there someone out there who's better for us, and for our customers, and for our shareholders? And many times we end up staying with the incumbent and we simply improve our contract, and there are other times that we change.

Another step that we take is we talk to our suppliers. And we ask them how good are we as a customer to you, what could make us better, what are your best customers doing, and what do we have to do to be a better customer? What do we have to do to get the best deal that you offer? And it's amazing what we learn by asking these questions. 

Here's the basic premise, Jeff, on this line of thinking, is that if we want to get more value out of a supplier relationship, we want to be the customer that we can. We want to be easy to work with, we want to be dependable, we want them to be able to count on us and to have good transparency. And to be flexible in allowing them to solve our issues in the most efficient way possible. We could tell stories all day long about examples of this but having those conversations is a great place to start. 

And the final one I'll mention is talking to peers. Talk to other companies and find out who they're working with, what they liked about them, and what's effective.



Jeff: Tim, do you have any other maybe examples or stories for us of maybe some clients that you've worked with who had some what you might consider somewhat common or... I won't necessarily say every day, but maybe a situation with the members of their supply chain regardless of exactly what function that they perform where they had this issue. It was something that was longstanding, they couldn't see it, but they were able to make a small change, or maybe even just through conversations or something, able to turn their situation around and save them a lot of money.

Tim: Here's a great example. This is a food client that manufactured a retail item that people would consume and eat, and their negotiations with their packaging suppliers. So suppliers have provided labels and the cardboard packages with graphics, and the boxes that you use to ship. 

What was happening is that, and this is one of the examples of a client that had a really tough negotiator, negotiating with suppliers and prices all the time. And one of the things that ended up that they did to negotiate a good price is that they would commit to buying an entire season's worth of packaging at a time. 

So they would commit to... Let's say the next three months they would commit to a volume and they would have three months to take it over time. What ended up happening is we looked at their inventory, they had inventory left over from last year, very often. And here's the problem with that, is labeling requirements change every year. Products change every year.

So they're getting a good price. And actually in their income statement, based on what they actually sell, they're able to show a good profit margin. But for a company as a whole they've got this balance sheet with items on it that they can never use, that they're going to have to write off at some point, and it's going to hit their income statement anyway. But it doesn't hit the regular cost of goods for the items that they're selling. 

Here's the reality. Packaging suppliers today, many of them have gone through the lean manufacturing transformation. And they have improved their processes, they've changed over times, and now there are suppliers out there who offer the good pricing without requiring that you buy a whole year's worth of product at one time, or a whole season's worth at one time. 

Here's what we're able to negotiate. Their inventory levels went down by 80%. Every single week they would simply let the supplier know what they used, and that supplier would replenish that and send out a shipment every week. So their inventories fell through the floor. And their cost per unit was down by 20%. So we negotiated a 20% improvement and we eliminated this obsolescence issue and excess inventory issue that we were fighting with the whole time. 

This was a great example of stepping back and looking at the market to find a supplier who had the actual capabilities to supply what we needed.

And what I found is that people get comfortable with their existing supplier and they do not like having a difficult conversation periodically that we're going to be putting it out to bid. And in fact they're concerned that they could disrupt their supply chain if they go down that path. And so there's a certain level of fear of change and of unknown that kind of prevents people from taking a deeper dive.


Jeff: There are cases, Tim, where it's just not always really that obvious, right? You could be losing some money and you could be scratching your head thinking, "I'm not exactly sure where this is going or why this has become such a problem?" But it's true that you sometimes kind of have to step outside yourself and have a third party come in and kind of take a look at the environment, don't you?

Tim: I think that's a very good example. I always would start with our internal pain, what pains do we feel and let's make sure we address those. But the other piece of this that's so easy to forget is good companies can get to become great companies by challenging even the things where they're not obvious, where they don't have pain, and just by simply talking to their peers.

And of course I love the idea of bringing in external consultants who can help identify areas that may not have been obvious for other reasons.



Jeff: Tim, we've no doubt got people out there in the audience who will probably taking a look now at their own particular situations with regard to their supply chains trying to get on top of any issues that potentially they could be facing right now or determine whether or not that there any concerns they might have. But if someone wanted to kind of pick your brain and maybe potentially talk to you about their particular situation and having your company help them deal with issues that they might be having, how can they reach you?

Tim: Well, they can certainly go to our website, which is www.proactiongroup.com. They can send me an email at any time, which is tvm@proactiogroup.com, or call our company at 312-726-6111.



Jeff: Tim Van Mieghem, once again I appreciate your time and you taking just kind of a moment out of your schedule to chat with us a little bit about a very important topic indeed. And we hope that at some point we'll able to revisit with you one more time.

Tim: Thank you, Jeff. It was such a pleasure to be here with you today and I look forward to talking to you soon.



Jeff: There he goes, Tim Van Mieghem, partner at the ProAction Group has been my guest and we hope you enjoyed this discussion. 

Tell a friend about this show, won't you? You can always find us at morganandwestfield.com. Remember the name of the show, it's "Deal Talk," and if not morganandwestfield.com, iTunes and Stitcher also carry the program.

"Deal Talk" is presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. Learn more at morganandwestfield.com. My name is Jeff Allen. Thanks so much for listening and we'll talk to you again soon.

While we take reasonable care to select recognized experts for our podcasts please note that each podcast presents the independent opinions of such experts only and not of Morgan & Westfield. We make no warranty, guarantee, or representation as to the accuracy or sufficiency of the information provided. Any reliance on the podcast information is at your own risk. The podcast is for general information only and cannot be considered professional advice.

Key Takeaways

  • Increase customer diversification. You are decreasing the value of your company if your business depends entirely on certain contracts.  With a diversified customer base, you are able to lower the risk involved in buying your business. 
  • Develop recurring revenue streams. An appraiser will typically put higher value on a recurring revenue stream than on non-recurring.
  • Include assignment clauses on all key contracts. There should be an assignment clause in your key contracts specifying that in cases you sell the majority of your company’s assets, you can assign those contracts to the buyer.
  • Reduce discretionary earnings. Buyers expect a minimum amount of discretionary earnings in your business.
  • Increase profit margins. Profitability tends to be more important than revenue.
  • Get organized and stage the business. Just like when selling a home, it is essential that your business is organized and staged for the sale. As what Anja emphasized, “You never get a second chance for a first impression.”
  • Clean up pending lawsuits. Always consult an attorney whenever you make legal decisions because “every situation is unique.”
  • Be a big fish in a small pond. Position your company as a leader in any aspect of the business – you could be the best service provider or maybe the one with the best technology.
  • Spread know-how. When thinking of exiting your business, it’s important to spread the “know-how” to key empoyees. Potential buyers want to be assured that the business can continue to run without you at the helm.
  • Create golden handcuffs for key employees. You may structure the sale in a way that you allot a certain amount of the sale proceeds to your key employees.  That way, you get the support of key employees and at the same time, you “alleviate” the fear of the buyer about key people leaving when you walk out the door.

Read Full Interview

Jeff: They say the best things in life are free. So if you're interested in 10 free tips to help you increase the value of your business from a highly successful certified business appraiser, you've come to the right place.

From our studio in Southern California, with guest experts from across the country and around the world this is "Deal Talk," brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.

Jeff: Hello, and welcome back to the web's number one content source for small business owners committed to building a business for eventual sale. Here on "Deal Talk" it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.

Whether you have recently had your business appraised or not, you've picked a great show to listen to, because if you're like most of us, you want to know concrete ideas that would help you to lift the value of your business. On this edition of "Deal Talk" we have not one, not two, but 10 ways to increase the value of your company. And to explain what these ideas are, I'm joined by the certified business appraiser who put this list together, Ms. Anja Bernier, the managing director of Efficient Evolutions LLC in Boston. Anja Bernier, welcome to "Deal Talk," good to have you.

Anja: Thank you very much.

The idea here truly is that you try to build a customer base that's not specific to a particular industry, so that you have more of a cushion to any events that hit particular industries very hard. 


Jeff: You have written a document here called “10 Ways to Increase the Value of Your Company.” And I would like to go over that with you today and give our listeners a chance to understand what it is that they can do or what they need to be thinking about. Let's go ahead and we'll take these one by one if we could.

Anja: OK.



Jeff: Item number one in your list, increase customer diversification. Now, if I'm a business owner and I've had my business for many years, I may be happy with my customer base or kind of what I'm doing, but why is that important?

Anja: Customer diversification is really one of the factors that play a crucial role in the value of a business. And also when it comes to the perspective of a buyer on what the perspective is on how much risk is involved in buying your company. And obviously risk is a major factor in any valuation. The reason for that is that a high customer concentration typically obviously means that your business is entirely dependent on certain contracts. So as a buyer and an appraiser will have the same perspective, the question always is what happens if this contract goes away? 

And you have to keep in mind that as a buyer the perspective or the suspicion, I should say, will always be that a lot of these contracts that are focused on just one customer entail a very close personal relationship between this customer and you. And since you as part of the exit planning will be leaving the company, a potential buyer would be very concerned that that specific customer will leave because you are leaving, because they're really with you because of you. So that is the major factor, a major issue.

And the idea here is that the more customers you have the less likely it is that they're all going to leave at the same time. Think about it, what are the chances if you have 50 or 100 different customers that they all decide within the first 12 months of the acquisition to leave? However, if your business really mostly consists of two, three customers, chances of one or two of them making that decision, therefore in a sense ruining the business, are quite high, so that would significantly decrease the value of your company.



Jeff: I think it's a very, very important point to make, and one too that it goes beyond making every effort possible to keep your happy, satisfied customers, long-term customers with you, keep them in the fold. But you talk about increasing the diversification. Can you give us an example maybe to crystallize more the idea of diversified customers, what it exactly means as far as diversifying? We're talking about obtaining new customers through different industries or product offerings that you might have. Is this talking about maybe trying to work sales channels by increasing your customers maybe in a certain part of the country, for example?

Anja: Yeah, sure. The answer here really is all of the above. I use the example of 9/11 and what happened to companies that primarily sold to the airline industry. If you were a business at that time that was entirely focused on that industry, with the airline industry going into a tailspin after 9/11 you really had no option. A lot of them went out of business. So the idea here truly is that you try to build a customer base that's not specific to a particular industry so that you have more of a cushion to any events that hit particular industries very hard. 

The other ideas, today, it's a global world and few recessions hit worldwide with the same intensity. Sometimes it's even possible America might be in a recession and Europe might not be. Oftentimes, obviously, they coincide, but the severity is not necessarily the same. So there's another thing, if you have a product or service that can be sold worldwide it certainly would be a good idea to be looking at worldwide diversification.

And also, coming back to having high customer concentration, were the slow ones. Obviously some businesses will find themselves in this situation where that sort of just, it is the way it is. That is their business and it's very hard for them to change that with short notice.

That said, if you are in a situation where you do have high customer concentration, what you should try to do that you mitigate the risks associated with that, but at least tying these people to you either contractually or by certain services. I had a customer a few years ago, it was a printing company. And what they would do, they were offering their customers free printing plates in exchange for the customers to agreeing to a multi-year contract. Without that offer they would not have agreed to that. But by having them locked in into a multi-year contract that made them more attractive in a sales situation.

Or another customer developed an inventory management software that they sold to their clients at a very low price, essentially at break even. And just to make sure that by using this software the customer became more tied to them and make it more difficult for them to leave, because they would lose access to the inventory management software. And I should add, inventory management software was not the main business that this customer had. They just developed this as a tool to tie people to them. 

So there are many ideas out there that you can implement. You have to think about what industry are you in, what can you offer to your customers to entice them to either sign a multi-year contract with you, and or to tie them to you by other means with the example of the inventory management software. They simply can't leave because they really need access to that inventory software program.



Jeff: So really talking about value added services there to help in retaining those customers. We're talking about the 10 things that you can do, 10 ways to increase the value of your company as you are preparing to sell it, whether that be three years, five years down the line, whatever the case may be. And Anja Bernier is our guest today here on "Deal Talk." Number two, develop recurring revenue streams.

Anja: Sure. That's a perfect example. Buyers love recurring revenue streams. And when it comes to valuation, I can tell you an appraiser will put higher value on a recurring revenue stream typically than on non-recurring. Non-recurring meaning it's the type of revenue stream, it's generally one. And each year you sort of have to go out and win new customers again. Recurring revenue stream really means that you have an existing customer base that you can count on. 

Giving you an example. Hewlett-Packard sells you that printer for next to nothing, but by doing that they sort of know you're locked in and buying their ink. And where they're really making their money is the ink. So by knowing how many printers they've sold there's sort of a recurring revenue stream coming from the ink. Same is true with Gillette, with razor blades. Given the certain amount of razors being out there in the world, there's an expected revenue stream from the blades. 

For example, I had a client a few years ago in the home automation field. And at some point the owner of that company realized that it made more sense for him to install alarm systems at below or break even pricing, because that would allow him to then sign them up for alarm monitoring subscriptions. And that said, if you could think about it, installing an alarm system is a one-time thing when a house is built, and then there's no more revenue from it. It's a perfect example of having to go out again and find a new customer once you finished the installation. 

However, getting a subscription to allow monitoring means you have a recurring revenue stream. Every month you can build these customers. And in this case he was even able to then turn around and sell these contracts to some of the large national alarm monitoring companies who pay a lot of money for buying up these kind of contracts. That definitely increases the value of your company significantly if you can think of ways of creating recurring revenue stream. 

For example, if you have more on the manufacturing field, think about, for example, adding maintenance service plans to your portfolio. A good example is I recently bought a new QuickBooks subscription and they make you sign up for signing where you get support every month so they can bill you. Or maybe it's not QuickBooks. There are many examples like that where you can think of something where you really get access to a revenue stream that comes every month instead of just being a one-time deal. Buyers love that.



Jeff: That'll take us to number three. We were talking about contracts just a moment ago, so we'll segue into the next one: have assignment clauses on all key contracts. What do you mean by this exactly, Anja?

Anja: This is really crucial, particularly for smaller businesses. And with smaller business, I really mean businesses realistically that have a value in a sale of less than about $10 million. Because about 90% of these will be sold in so-called asset-based sales, meaning technically you're not selling the company, the legal sale, whatever it might be, an LLC or an S-Corp. What you're really selling is the assets of the company, your tangible and intangible property. It could be customer contacts, it could be actual machinery, whatever it is. But you retain the legal shell of the company.

This causes an issue, because if you have contracts with your customers, or any other material contracts that can be assigned, the buyer of the company has to go out and ask these customers to re-sign contracts, which many times they just simply probably won't do. However, if you have an assignment clause in all of your material contracts specifically say that in cases where you sell the majority of the assets of your company you can assign these contracts to the buyer, that'll make the process much easier, much smoother, and again, it will have an impact on the value of your company.



Jeff: That's huge. And just think about it again. Any time you can make the situation easier on the buyer, and there is less to do or less for them to worry about in this process, and they know that once the business transitions over it's going to, number one, of course, it's going to elevate the value of your company, but it is going to create for a much smoother process. There's going to be fewer headaches down the line, and less of a chance that's someone's going to come back to you later on and say, "Hey look, we need your help doing this. This is something we can't figure out."

I've got Anja Bernier on the line with me, president of Efficient Evolutions LLC. She's a certified business appraiser and CVA as well. You're listening to "Deal Talk." My name is Jeff Allen. We're talking about 10 ways to increase the value of your company, and this is really giving you some things to think about as you prepare to sell your business down the line. It doesn't matter whether that's going to be in three years or maybe even 23 years from now. Number four on your list of the top 10 things to do here: reduce discretionary earnings, Anja.

Anja: Yeah. That is, obviously, once again, one of the ones that apply to almost any company. And because we're obviously talking here about privately held companies. As we all know the typical privately held company has a certain amount of what I would call most people in the industry called discretionary earnings, which means it's the kind of expenses and thus earnings because they really create a benefit to you as the owner of the company that are maybe technically speaking are not 100% business-related. Let's just leave it at that euphemism. 

It could be travel expenses where you may or may not have gone to a conference and stayed a few more days. It might have been a meal that you may have spent with a client but you may have also taken out your wife, who knows. Those are just some of the examples. Or you may employ a family member who doesn't actually work there, or you're paying a family member above market rate. So those are the typical examples of discretionary earnings to an owner. 

And what it really means is if you have a lot of discretionary earnings, any buyer will sort of expect there is the minimum amount of discretionary earnings in there, and would probably during the sale process, the opening, sort of indicating this and that areas of expenses that would go away if you leave the company. However, if you really put that to an excess, especially if you have a cash-based business and you go even further that you don't record all the cash that comes in, something I certainly don't recommend to begin with. But if that's something or a practice that you have been using, think about it this way: 

If you're selling your company, on average you'd probably get about $3 to $5 for every dollar in earnings that you generate. That's a very rough ballpark. Of course, it could be more or less depending on the specifics, but let's just stay with three to five. So for every $3 to $5 you show on your tax return you then only have to pay, if you show it on your tax return for two years given the maximum tax rate being 40%, which means 40 cents on every dollar. So even if for two years on every dollar you pay suddenly 40 cents taxes, which is unlikely. Most companies don't even pay the maximum tax rate, you would end up paying 80 cents over two years for every dollar. But you get during the sales process between three and five for every dollar that you can prove exists. 

And those are just some numbers that are important to keep in mind. And this is actually where in many ways I have to say blows my mind on how difficult it is for a lot of business owners to just go ahead and do it. Put it in the tax return, prove that it exists, because again, it's 80 cents in expenses whether it's a potential gain of several dollars. It just really makes sense to do that. 

If, for whatever reason, you can't clean up legal issues before you put the company up for sale, at least be open and upfront about it. Disclose all these issues right away. Have the paperwork ready. Very few issues truly will derail a deal as long as you're open honest about them. 


Jeff: Ten ways to increase the value of your company. My name is Jeff Allen. I'm going to continue my conversation with Anja Bernier, President of Efficient Evolutions LLC when “Deal Talk” returns after this.

If you'd like to share your knowledge and expertise on any subject related to selling businesses or helping business owners improve the value of their companies, we'd like to talk with you about joining us as a guest on the future edition of Deal Talk.

Interested? Contact our host Jeff Allen directly. Just send a brief email with "I'd like to be a guest" in the subject line. In a brief message include your name, title, area of specialty, and contact information, and send it to jeff@morganandwestfield.com, that's jeff@morganandwestfield.com. 

Selling your business may be the most important business transaction you'll ever undertake so don't do it alone. Work with an organization that has made it their business to sell businesses and that's all they do. Morgan & Westfield at 888-693-7834.

At Morgan & Westfield we know that selling your company is not something you should take lightly. It can be a stressful, difficult, even emotional process.

That's why it's important to work with a team whose one and only specialty is selling businesses throughout the United States. Morgan & Westfield will help you every step of the way. From helping you plan your exit strategy, to preparing a comprehensive appraisal, and locating the right buyers.

Without the right team behind you, you could be leaving money on the table. So don't leave your most important business transaction to chance.
Call Morgan & Westfield for a free consultation at 888-693-7834, 888-693-7834, or visit morganandwestfield.com.

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We're also interested to know your thoughts about "Deal Talk," what you like, and your suggestions on how we can improve our program for you. And to do that all you have to do is send us a quick and easy email to dealtalk@morganandwestfield.com. Once again, dealtalk@morganandwestfield.com. 

Jeff: Jeff Allen with you today. Anja Bernier is my guest, and we're talking about the 10 things that you can do as a business owner to improve the value of your company. And that's kind of with your eye on selling your business, and all of us kind of look forward to doing that at some point one day. And Anja Bernier, we really appreciate you joining us today on this program.

This list is something that you came up with a few years ago, and we're kind of going by each one by one. And we've left off on number five. We still have a total of six steps to talk about too, six things here to talk about. Number five, increase profit margins. This sounds simple enough, and it sounds like something we should all be mindful of all the time.

Anja: Absolutely. It seems like a no-brainer, but the reality of the situation is that oftentimes what I see is that business owners lose sight of the fact that driving sales while at the same time recording decreasing profit margins will not do you any good. And that's really the sum of it all. Oftentimes what I see is that business owners will go after contracts just to record the additional revenue without really thinking through how profitable is this additional contract.

And what you should keep in mind is that from a buyer's perspective, profitability tends to be more important than revenue. Meaning that for a typical buyer, a company with $6 million in revenue and $1.2 million in profits, so 20% profit margin, is more attractive than a company with $7.5 million in revenue and $900,000 in profit, so 12% margin. So just because you increase revenue does not mean you're necessarily increasing the attractiveness of your company. 

So what you should really be doing is think very hard and long about how do you monitor additional revenue. You should also make sure that, for example, if you have a sales force, that you have incentives plans in place that reward your sales force for getting contracts with higher profit margins and vice versa. In a sense, penalize them for bringing in low margin revenue. So you shouldn't be basically instructing the sales force go out and sell, you should be really more specific about this and say, "Go out and try to get highly profitable business for us."



Jeff: This is something we've talked about on the program before, really apples and oranges when you get right down to it, revenue versus profit margins. Increase those profit margins and work at it. And I really like the idea, too, of incentivizing the sales force in order to help you accomplish that mission. 

Number six, get organized and stage the business. This sounds like something that many people might do in their own homes when they're getting ready to sell their home and put it on the market. You're going to stage that home. Is it the same thing with staging the business as well, Anja?

Anja: Absolutely. It really is always true, you never get a second chance for a first impression. And the point is I had walked into many businesses where the office of the owner literally looks like a bomb just exploded there. Or you walk into the cafeteria, it's kind of dirty, it's worn down. It just leaves a very poor first impression for any buyer to walk through. It feels like half the wire is hanging down from the ceiling, the floor hasn't been swept in a while. 

Another factor is please do make sure that you've posted all information required by the Department of Labor. Make sure there are no offensive posters, whether that's posters or screensavers. Because the one thing you have to keep in mind, it is the 21st century. Even though you in the past may have thought, "You know what, what's the big deal with having posters of half nude women hanging on the wall? The employees have that." That is unprofessional in today's world. 

First of all, it's illegal. It's considered a hostile work environment. But secondly you do have to keep in mind, and I'm not saying this because I'm a woman, because quite frankly when I represent the seller I don't have to work there. But what I can tell you that the buyers and even if they're male they'll look at it like saying you're not running a tight ship. You're allowing things to happen in your company that are illegal. And so do make sure that you pay attention to these kind of things.



Jeff: And it seems, again, like a no-brainer, but really it is true and I've been in these types of businesses before, Anja, as well. And you're absolutely correct; it is very surprising in this day and age when you walk into an environment that is unkempt that looks like it's quite frankly fallen into a state of disrepair regardless of what the numbers show.

Cleaning up the office and staging it or your workplace is not the only thing that really needs spritzing up. But you also need to clean up pending lawsuits. This seems to be a no-brainer, but it's possible that so many people can leave their dirty laundry behind. This is a real big problem that can really quite frankly pose a tremendous hurdle to a sale going through.

Anja: That is very true. Obviously there are many reasons why people may drag their feet on solving legal issues. It can be a lawsuit, it could be any other issue. And I should also say that before making any decisions about legal matters you should obviously always consult with the attorney because every situation is unique. 

But that said, in general broad terms buyers really do not like open litigation, open legal issues. It's going to be a major turnoff, it's going to decrease the value of your company. At minimum what it's going to do is drag out the due diligence period. And if any business intermediary like myself will tell you, dragging out the due diligence period is never a good thing. Time is the enemy of every deal. So you want to be hopefully in a position where you have resolved any major issues. 

That said, if for whatever reason it might be you can't clean up legal issues before you put the company up for sale, at least be open and upfront about it. Disclose all these issues right away. Have the paperwork ready. Very few issues truly will derail a deal as long as you're open honest about them. And also, if you can, present a path on how to resolve them. So do get your attorney involved. Be ready for this. And do not try to hide any issues like that.



Jeff: Talking about the top 10 things that you can do to improve the value of your company prior to sale. Number eight, be a big fish in a small pond. That's something that I feel comfortable doing. I don't know about you, Anja, but exactly what do you mean by this?

Anja: What I mean is that typically speaking when you're being acquired, the preference typically is that you find a strategic acquirer who would buy you out. Because strategic value is typically the highest value that you can achieve for you company. And what strategic usually do when they do so called roll-ups, meaning they look around and see the companies that we want to add to our portfolio. They usually go after the well-known entities first. So you do want to be a known entity, a big fish in your small pond.

The problem is if you get into a bigger pond, because if you're privately held, smaller abilities, smaller scale. It's very hard to be a noticeable entity. So do find yourself a pond in which you can get well-known, where you can build yourself a position where you are the known leader in something, the known expert, whether that's the best service provider, the best technology, whatever it might be. 

And, ideally, also build up a portfolio of proprietary know-how or intellectual property, whether that's patents or something like that. Because that will also be something that will make you more attractive. I give a very concrete example. You might be a manufacturer of ozone monitoring and then controlling equipment. That's a narrow field, so a small pond compared to the large pond of scientist and instrument manufacturing. 

Ideally you would become the known expert in manufacturing or zone manufacturing and controlling equipment. And then you try to expand your customer base, either geographical or industry diversification. So that would really be an ideal strategy where you address this point of being a big fish in a small pond. And also the very first point we've discussed today about that you should always try to broaden your customer diversification.



Jeff: And you can do that by virtue of being this go-to expert, someone in your field I think is very important indeed. We got two left here. Number nine, spread know-how.

Anja: That is something that also applies to most privately held businesses. The issue with the typical privately held company is that most of the know-how and expertise is concentrated in the owner. But think about it, you as the owner, you're trying to sell the company. So realistically you will be leaving the company soon. So the more of a concentration of customer contacts, then their contacts and know-how is on you, the more of an issue you're creating, and this, again, decreasing the value of the company because the buyer will perceive that as a risk. 

The way you may look at it is like, "Well, it's not a big deal. I'm willing to stay on for a certain amount of time to transfer all these contacts.” The buyer will look at it and say, "Well, what if I buy the company next month and the next day this guy gets hit by a bus? Or this person isn't cooperative during the transition process?” So a buyer isn't just going to look at it and say, "It's not a big deal; we'll just do that in the transition period." A buyer is going to look at you and say, "You know what, that's high risk. All of it is really concentrated into this one person.” So in the years leading up to the sale, do yourself a favor, start spreading know-how to your employees. 

It comes back to, again, like we were saying before, if you have 50-100 customers, it's unlikely they're all going to leave at the same time. The same is true with employees. Obviously, you don't need to spread your know-how to 50 different people. 

But let's say even if it's three to five, it's very unlikely from the perspective of a buyer that three to five employees will all leave within a few months after they take over the company. So that's much less risk than having all the know-how concentrated in one or two people. So you should definitely start spreading it and make sure that the company can literally run without you, even probably before you sell the company. 

The ideal company to be sold is one that if as of the day of the sale you would literally disappear, it would still more or less work the same way it did before. 



Jeff: And we've come down to the end of our list here, item number 10. We'll review the previous nine here, Anja, real quickly. Number one, increase customer diversification. Number two, develop recurring revenue streams. Number three, have assignment clauses in all three contracts. Number four, reduce discretionary earnings. Number five, increase profit margins. Six, get organized and stage the business. Number seven, clean up pending lawsuits. Number eight, be a big fish in a small pond. Number nine, spread know-how. And number 10, the last item here on our list that you can do as a business owner to increase the value of your company, create golden handcuffs for key employees.

Anja: Yes. This goes hand in hand with the topic we had just talked about about spreading know-how. Typically speaking it's always a good idea to structure a sale in a manner that you set aside a certain amount of the sale proceeds, whatever you feel is adequate. Again, that's very situation-specific. Let's say 5%-10% of the proceeds. And you basically give your key employees incentives, bonuses, that state that they are eligible to receive this share of the set aside amount if they're still with the company 12-18 months after the sale of the company. 

This will very much alleviate the fears of a buyer, of key people leaving. And will basically make sure also that these employees are committed to the sale of the company, say the right things at the right time because they have a vested financial interest in the acquisition going through. Just think about it. For employees a sale of a company and such, or we see acquisition by a new buyer, that's a time of change, a time of uncertainty. They might be afraid for their job. 

So this is a time where you can expect that they may actually try even to, whether it's subconsciously or consciously, sabotage the sale. Because for them it's really better if things stay the way they are. That's safety. That's what people like.

So you want to excite them about the sale. You want to have their commitment. You want to have their support. And by giving them an incentive like that you achieve two goals. First of all, they get a vested interest, like I said, in having the sale go through. And then secondly you alleviate the fears of the buyer that they may leave. So you're basically just achieving two things with one action.


Jeff: You're creating some assurances on both sides that there is going to be a tomorrow, and that there will be a reward essentially for those who stay on board, those among your employees. And at the same time you're providing some assurance to the new buyer that things are going to continue to operate normally with these world-class employees that you have on board.

Anja Bernier, I really enjoyed this discussion. We've run out of time. But what I'd like to do right now is give you an opportunity to just say a little something about your company and let people know how they can reach you. We've got business owner listeners to "Deal Talk" all across the country and in your particular neighborhood as well. How can they connect with you?

Anja: That's very easy. As you mentioned before we're actually located just outside of Boston, Massachusetts. Our company that is focused on buy and sell set representation and business valuation. Typically, the transactions that we handle have a value between $1 million and $20 million. That's our specialty across many industries.

The best way to reach us is either our website, which is efficientevolutions.com. And/or, obviously, by giving us a call, and the number would be 781-806-0880. But again, you know, all of the contact information is on the website, and that is efficientevolutions.com.



Jeff: There you have it. Anja Bernier, president of Efficient Evolutions LLC. Thank you so much for agreeing to join us. We enjoyed having you on this edition of Deal Talk.

Anja: You're very welcome. 

Buyers love recurring revenue streams. And when it comes to valuation, I can tell you an appraiser will put higher value on a recurring revenue stream typically than on non-recurring.


Jeff: Make sure you tell a friend about "Deal Talk." In addition to morganandwestfield.com, you can find us on iTunes, Stitcher and Libsyn. "Deal Talk" has been presented by Morgan & Westfield, the nationwide leader in business sales and appraisals. Learn more at morganandwestfield.com. My name is Jeff Allen. Thanks so much for listening. We'll talk to you again soon.

While we take reasonable care to select recognized experts for our podcasts please note that each podcast presents the independent opinions of such experts only and not of Morgan & Westfield. We make no warranty, guarantee, or representation as to the accuracy or sufficiency of the information provided. Any reliance on the podcast information is at your own risk. The podcast is for general information only and cannot be considered professional advice.

Key Takeaways

  • Selling your business is a process.  It requires specific steps that need to be taken in the right order over a period of time. It's not something you can do overnight or even in just a few months, in most cases.
  • There are four stages in the process of selling a business: The planning stage, the search stage, the deal-making-stage and the closing stage.
  • A broker does not immediately disclose business details to potential buyers. When a broker gets an inquiry from a buyer, he or she won’t divulge the business’s name, address or location. Instead, the broker will prepare a one-page executive summary full of general information, and won't share any more with the buyer until they sign a non-disclosure agreement.
  • It's important for the buyer and the seller to come together to test each other out and determine their level of comfort with each other.

Read Full Interview

Jeff: On each show we usually focus on a single facet, issue, or action item involved in either selling or planning the sale of your business. But on this segment we're putting it all together for a complete step-by-step explanation of how to sell your business, you've come to the right place.

From our studio in Southern California, with guest experts from across the country and around the world this is Deal Talk, brought to you by Morgan & Westfield, a nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.

Jeff: Hello and welcome back to the web's number one content source for small business owners committed to building a business for eventual sale. Here on Deal Talk it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.

We all know that selling your business is a process. It's a process that requires certain specific steps that you really need to take in the right order over a period of time. It's not something you can do overnight or even just a few months in most cases. Now, here to walk us through the entire process in less than 30 minutes for the sake of this program because that's the time we have is Mr. Andrew Rogerson, certified business broker and owner of Rogerson Business Services in Sacramento, California. With 26 years of experience and four books to his credit, among a number of other credits and attributes. This is his second appearance by the way on the program. Andrew Rogerson, welcome back to Deal Talk sir, it's good to have you.

Andrew: Jeff, thanks for allowing me to come back and talk with you.

Often the seller and the buyer may wish to do a deal in a certain way, but if the lender says, ‘I'm sorry, that's not happening, you've got to do it my way.’ Guess what? The lender wins out, because if the lender goes away, the deal goes away.

Jeff: That's okay. We don't allow just anyone back Andrew. We like to have guys on with Australian accents who have a lot of business savvy and experience. You have a lot of experience in your background. Also by the way I should say a business owner. In fact, I think you've owned five businesses if memory serves, is that correct?

Andrew: Memory serves well, that's correct.
 

Jeff: Very, very good. Listen Andrew, I appreciate once again you're joining us today. We've got these steps to take and we're going to go ahead and plunge right into it because we have such limited time. There are four stages, we just kind of talked about that. They are planning stage, the search stage, deal making stage, and closing stage. Within each of those stages there are several steps to take. So let's start with the first stage which is the planning part of the process, and plan for selling, which is step number one.

Andrew: That's a good introduction Jeff. I appreciate that, because there are different stages and they're equally important. And so it's important to stay upfront. Can you skip a step? Very hard to skip a step. So let's go through these things. The first item is plan for selling, and that's a really important step and here's why. Most business owners they live and breathe their business. And most business owners they're deciding to sell their business for a specific reason, whether they're tired, they're burnt out, it's time to retire, whatever their motivation, their decision is an important decision to them. One of the things I found, because I've been doing this for about 10 years now is that I really want to talk to a person that wants to sell their business to understand that reason. Because if they're tired and burnt out that can be solved by taking a vacation, which they've probably haven't done for a couple of years.
 

Jeff: Interesting point.

Andrew: So they really may not want to sell, they think want to sell, but when you get into the process and talk to them, maybe just taking a break and getting refreshed is a better option than actually going through the process to sell the business. So understanding what the motivation behind the selling is, and even with people heading to retirement I say to them, "What do you do if you sold the business?" "Oh, I'm going to spend some time with the grandkids. I'm going to play golf." I said, "You can do that now. You own the business. You have permission to go and play golf. You don't have to get permission from anybody. You are the owner of the business. And the grandkids, well, they're going to be around for a while so is this really what you want to do?" If there's a health issue, if there's a divorce, okay, now we're dealing with different situations and it's really important to understand all that.
 

Jeff: The next step in this stage is gather your data.

Andrew: Once I know the motivation of the seller is clear and it makes sense they want to continue I want to start putting together a valuation on the business because I really need to understand the business. It's intriguing what I do, and I'm being very blunt here, but a lot of small business owners don't have good financial records. And so that's a challenge to me as a third-party in the transaction because I'm there to represent the seller and bringing the best price I can. But if I can't support the price that makes the business salable because the financial statements are inaccurate. That's a task for me it's become too daunting. When I started out I was a young guy, a little bit of a novice. I took listings to sell businesses that I thought I could sell. But I've learned it's so hard to sell a business when the financial statements aren't accurate, or the businesses isn't what the seller expects. And so my step is to collect all the data from the seller, put together a business valuation so we can have a conversation about, "Okay, here's what it's worth." And I actually use that data to talk to lenders as well. Because typically the seller wants to sell the business and they want to get out. They don't want to become a band and get paid by the buyer. They want to get out. And so I'll talk to lenders who are third-party lenders like SBA lenders to see your finances and options. So I can then say to a buyer we have finance in place if you've got the right credit score, etc. This logic behind gathering the data and putting together a valuation.

And once I move into the process of collecting their data my next step is I recast the financial statements. This is America and most business owners just like everybody else, they hate paying taxes. And so one of the ways of bringing down their taxes is to put personal expenses through the business so it lowers the amount of tax they want to pay. That's a good thing to do if you're trying to reduce your taxes, it's a bad thing when you're trying to sell your business because you have hidden costs in there that when the buyer of the business buys they're not going to have to pay your golf country club fees, or your travel expenses, whatever you'd hidden in there. I want to pull those things out so I can reflect the true value of the business. So we call that recasting the financial statement which is looking at the tax returns, the balance sheet, and the PNL's. That's the reason for recasting the financial statements.
 

Jeff: And the next step of the process is either going to give people some headaches or it's going to make them really enthusiastic about the idea of selling their company maybe once and for all determining its value and the assets to be sold in the deal.

Andrew: And that's exactly right, because what we're doing is we're looking to finalize the valuation. But I'm also having the conversation with the seller about the tax. Again, we hate paying taxes which is perfectly fine. It makes perfect sense. But when you sell a business over the years you've been doing a thing called depreciating assets. But when you sold the business you're going to have to pay back some of that money in taxes because the governments encourage you to buy things and depreciate them. But when you sell the business you will have a tax liability that you need to be aware of. I want to make sure to a business seller that thinks they're selling their business for five million dollars, you don't get to keep five million dollars if you sell it. Uncle Sam wants his piece of it. So you need to be comfortable that you're not going to walk away with five million dollars. You're going to walk away with less than that.
 

Jeff: Yeah, you need to be reasonable. Now, the next step in the process of the planning stage is preparing an executive summary. Who does that Andrew?

Andrew: That's part of my role as the broker in the transaction. What the executive summary is, it's a one-page document I put together. I've got a template I've used and developed over the years. And it's the document I used because now the seller was saying to me, "Yeah, I'm good to go. I like the valuation. I'm ready to take this to market and let's see how many buyers we can find." I have my process to find buyers. When I get an inquiry from a buyer I don't want to tell them the name, the address, and the location of the business because that's confidential. I don't want a buyer walking into the business and saying to employees, "Hey, I'm Joe Below here. I'm planning to buy this business." The employees are going to say, "I didn't realize the boss was selling. Or I don't want customers finding out. Or I don't want the landlord to find out." The landlord's thinking, "Hang on. I'm about to lose a tenant here." The suppliers, the people who the business is buying their supplies from. They might want to cut their credit with the seller because they're not sure if they're going to get paid. And so I prepare a one-page executive summary full of just general information and I won't share any more with the buyer until they sign a non-disclosure agreement, or a confidentiality agreement.

This is the purpose of escrow. Let's get everything cleaned up, crystal clear for everybody so that the seller walks away cleanly, and the buyer's got everything to operate the business as the seller's been running. And that's the purpose of the escrow process. Get everything organized, i's dotted and t's crossed.

Jeff: Any by the way too, that leads us to speaking of confidence, preparing a confidential business review as well.

Andrew: That's the next step. Once I talk to a buyer and I want to interview a buyer, or I want to understand who they are, if they're qualified, and I put a capital "if" in there. If they are qualified, if they've got experience in the industry. They've got a good credit score. If they need to borrow money I want to have a conversation with the buyer to make sure they're qualified persons as oppose to the competitors down the road who's just checking things out, or somebody who's got a wishful thinking to buy their own business but really has no capacity to do it. I want to have that conversation with the buyer. So if I find somebody who's qualified I then have prepared, it could be a 20, 25, 30, 40, 50-page document full of much more detail that I will share with the buyer that gives the history of the business and a lot more confidential information. But I only want to share that with the right party. And so that's the purpose of the confidential business review to gather all that data. Because if I had three, or four, or five, or ten buyers, or I was selling a business last year where I had 55 buyer inquiries, I don't want to go back to the seller and have 55 buyers ask a bunch of questions. That's my responsibility. I need the seller focused on running business, and keeping things going, and keeping the business stable while I do my piece and accept the responsibility of what I've been hired to do.
 

Jeff: There you go. And that's the planning stage. You've got to be able to get that right and include all those steps in that stage. The next stage is the search stage. With the first step activate buyer search plan.

Andrew: That's exactly right. And what we've done here, the planning stage. We've put the foundations in place. We're all dressed up and ready to go to the ball, and now we're looking for prince charming. And so the search stage is, again, my responsibility as the broker, I'm looking to contact as many potential buyers of this business as I can because ideally I really want to create a competitive situation where I have two, or three, or four qualified buyers that have an interest in buying this business because this is an opportunity they can't let go. And if I can create some competition for the seller I can increase the amount that they may get from selling the business. So my plan starts to search for buyers and that includes posting the business for sale just in general terms on websites. I'll talk to the seller, understand if they have competitors. I'll have a conversation with the seller. "Mr. Seller are you okay if I talk to your competitors? And if so which ones are you okay with me talking to because I want to reach out to them if you're comfortable doing that." So that's the search plan, is to have that conversation with them. 
 

Jeff: And then that executive summary that you've prepared in the planning stage that is something that needs to be distributed at about this point. That's the next step in the process.

Andrew: That's exactly right. The executive summary is usually if I reach out and gets inquiries from buyers, one of my process may be to do with direct mail piece to some buyers. And so I'll do a cover letter and then I'll attach a copy of the executive summary. Again, I'm introducing myself as the broker, the seller isn't being annoyed by any of this, but I'm doing a direct mail piece to certain buyers. And the executive summary just gives some high level information that the buyer would find useful. And if they're interested it'll bring them into the process and keep them working through the process.
 

Jeff: And that's where step three comes in because once you have that buyer, those perspective buyers that really look good that's when you start to qualify.

Andrew: Absolutely. And the qualification is an important piece because, again, I can't stress how many times I get buyer inquiries from people who come from different places. I'm selling a business here in California where I'm located but they could be overseas, or they could be in New York, or Florida, or Texas, or in any other state. And so one of the conversation is do you plan to relocate to buy the business? No, I plan to run it and put a manager in place. They're like, "Okay, if that's what you plan to do, the numbers make sense for you. How do you plan to finance that? Getting through the process to make sure that I'm now only talking to qualified buyers that's part of that process and an important responsibility I have to the seller to make sure I'm isolating qualified buyers. 
 

Jeff: Followed by the next step where the buyer actually does sign the confidentiality non-disclosure agreement.

Andrew: And that's where we're getting an agreement from the buyer through my initial conversation within. Yes, I am qualified, and yes, I'm willing to sign a non-disclosure agreement. I had one buyer just recently that I approached to buy a business I had for sale. And one of the clauses in the confidentiality agreement says that once the business is disclosed to them they will not contact the employees to try to hire them. And the buyer said to me, "I'm not willing to do that. I may want to hire these people or I'm not willing to share the name of the business with you because I don't want you messing up this business by being identified. They're in the same industry as you are. And so I'm sorry, I can't disclose the name of the business to you because you could damage this business. And I've been hired by the seller to prevent that happening." That's just an example of why the confidentiality agreement is important.
 

Jeff: Now the next step in the search stage, determining buyer interest. Now, you've already kind of really interacted with these buyers a little bit. You've qualified them. The buyers already signed the confidentiality, non-disclosure agreement. But now you're determining their interest. Tell us a little bit about this.

Andrew: What's happened now is the buyers got the initial information. They feel comfortable. They've signed a non-disclosure agreement, they're being qualified. And now that the dynamic is changing a little bit because now the buyer knows the name of the business. They may know them as a competitor, or they've got more information. So now they're making decisions. "Okay. I know the business and I like the business or I don't like the business." And if they like the business, "Okay. I would like to meet with the owner and get a tour of the business. I want some more information." And so that's where the buyer has the opportunity once they've got the information to say, "Okay. This is of interest. Let me keep going," or, "I've got enough information. This isn't what I was expecting and I no longer have any interest."
 

Jeff: There you go. And the final step in the search stage of the business sales process, present confidential business review.

Andrew: And that complements the last thing we were just talking about with the buyer showing interest. We now present to the buyer because they've signed the non-disclosure agreement. We present the confidential business review we've put together, and that was that 20, 30, 40-page document I was mentioning before with lots of good information in there. Detailed financials of the last 4 years of the business, the number of employees, the hours the business operates, how many employees it has, all sorts of information that a buyer really wants to know so they can decide based on where they're coming from is it a good fit if they're buying at a competitor. Or if somebody's buying themselves, they've been working in corporate America and they're tired of doing that. They want to run their own business. They're now _________ and say, "Can I do what the seller's been doing? Can I take his place and run the business, and move from being an employee to an employer?" And so there's different buyers with different motivations for buying a business. And this confidential business view helps them work through that process.
 

Jeff: And so now that brings to a close the first two stages, the explanation of the steps within those stages, planning, and search stages. And now we've got two stages that is to cover, and those steps under those stages as well, deal making and closing. And we're going to do that here in just a moment when we come back from the break. And by the way, if you're trying to follow along you can always go back and listen to this program again. Or better yet hop on over to morganandwestfield.com if you're listening to the program on iTunes, or Stitcher, or Libsyn. Go to morganandwestfield.com. Underneath the podcast we've got a complete transcript of what you're hearing right now. That makes it easy doesn't it? I thought so. This is Jeff Allen, and I'm going to be back with my conversation with Andrew Rogerson on the steps to sell a business. We're going through this in the entire show. We're taking it step-by-step. The deal making stages coming up next. You're listening to Deal Talk.

If you'd like to share your knowledge and expertise on any subject related to selling businesses or helping business owners improve the value of their companies, we'd like to talk with you about joining us as a guest on the future edition of Deal Talk. Interested? Contact our host Jeff Allen directly. Just send a brief email with "I'd like to be a guest" in the subject line. In a brief message include your name, title, area of specialty, and contact information, and send it to jeff@morganandwestfield.com, that's jeff@morganandwestfield.com. 

Selling your business may be the most important business transaction you'll ever undertake so don't go it alone. Work with an organization that has made it their business to sell businesses and that's all they do. Morgan & Westfield at 888-693-7834. At Morgan & Westfield we know that selling your company is not something you should take lightly. It can be a stressful, difficult, even emotional process. That's why it's important to work with a team whose one and only specialty is selling businesses throughout the United States. And Morgan & Westfield will help you every step of the way. From helping you plan your exit strategy, to preparing a comprehensive appraisal, and locating the right buyers. Without the right team behind you, you could be leaving money on the table. So don't leave your most important business transaction to chance. Call Morgan & Westfield for a free consultation at 888-693-7834, 888-693-7834, or visit morganandwestfield.com.


You know, if you have any questions about any of the topics you hear us discuss here on Deal Talk all you need to do is ask us. We have an Ask Deal Talk info line set up just for at 888-693-7834 extension 350. Again, that number, 888-693-7834 extension 350. Leave your question and we'll try to furnish your question and our guest response on a future edition of Deal Talk. 
 

Jeff: I'm Jeff Allen, back with Andrew Rogerson of Rogerson Business Services now. We're talking about the four stages involved in selling your business, and we're going through every step of this four-stage process. So Andrew, I'd like to go ahead and start with the third stage here, and that stage is deal making. And the first step in that stage is buyer visit and first meeting.

Andrew: What we're doing here is that we've gone through the planning and the search stage, and we've come across one or two buyers that have an interest in buying the business. And now it's time to get into the weeds a little bit more. And so the buyer has reviewed all the information being presented to them. Their interest is piqued and they want to know a bit more. And that includes meeting with the seller. The capitalist system is built on trust. And so if you bring a buyer and seller together and the trust isn't there we aren't getting the deal done. And so it's important for the buyer and the seller to come together. They're testing out each other and deciding their level of comfort with each other. And that's the opportunity of coming together for the first time either to see the business or to meet the buyer and the seller, and check through things and decide their next steps from there. 
 

Jeff: That trust by the way, we all know takes time to develop. It's not just something that comes up after that first meeting as most people know. The next step in the process after that first buyer visit and meeting is actually the opportunity to tour the business.

Andrew: That's right, and that's if the business has got hard assets, the business to visit. We've moved now to the technology age where a lot of businesses are online. So if the business is online, looking at a website, that's the extent of the business. The buyer may like to come and see the back-end with the office where the business operates from and if there's employees that do certain tasks. They just want to get a feel for it. But touring the business is important because we're visual people. We like to see things and ask questions indirect. And so touring the business is an important part of the qualification process of the buyer and their level of comfort.
 

Jeff: And that too helps us get to stab the next step which is at that point after they've had a chance to tour the business they have a better idea of what they might be getting themselves into. And then you have to once again go in and establish buyer interest don't you?

Andrew: That's exactly right. The first two stages, we were doing the qualification process and the buyer had an interest and they've been looking at things from a theoretical perspective with all the documents and things they've been reading. We'll just take them and showing a tour of the business, so now they've got to combine the theoretical with the actual business itself. And they're saying to themselves, "Okay. I got to picture everything now. I've seen the financial statements. I've seen the business itself. Okay, what do I want to do now? Is this making sense to me to continue or maybe I should've drop out because there's something that come up that I'm not comfortable with. And if they’re uncomfortable that's part of my role because I'm talking with them, is it uncomfortable to the point that, "Hey, I'm out of here. I don't want to continue, or I'm feeling uncomfortable, can you get some more information for me, or can you answer these questions?" And so with me talking to the buyer to get their interest, that's an important step where we are right now.

As a broker, I'm not willing to present the thoughts of the buyer unless they're in writing. Because what's said in casual conversation, or whatever, it's got to be in writing, because that allows the seller to actually sit down, read it and then to go away and make their decisions on what's important.

Jeff: Your next move is to motivate the buyer to act in one way or the other.

Andrew: And that's a big step for the buyer because now they're moving from... I was thinking of buying a business to, oops, I could be buying a business here. This could go somewhere. And we're human, we're emotional. So their emotions are changing now because at this stage they could walk away and they don't need to hire any experts to help them through the buying process. But right now they've come to a fork on the road. It's either, "Okay, I'm doing this and I'm serious and I may start incurring some costs," Or, "Hey, I'm out of here. I don't feel comfortable doing this." And so the fork in the road is being defined and it's pretty simple. We need a yes when moving forward, or we need a no, we're not moving forward. If it's a maybe it's like, "Okay, why is there a maybe and we need to talk about that."
 

Jeff: And step number five at that point once you've made those determinations and the offer to purchase has been potentially extended facilitating the negotiations is next. That negotiation stage, very, very important. 

Andrew: And that's where the fun part starts, that's where the stress kicks in, because now you have a motivated buyer, and because we're in the market with the seller's business we had a motivated seller, and now from a business brokerage perspective I've done what the motivated seller wanted me to do, I found the motivated buyer. I haven't closed the deal yet but I've got two motivated parties and that's what you need to be able to get a deal done. And so it's like, okay, the buyer has an interest but he wants to negotiate things. He's just not going to write a check out for what the seller said he's looking for, then the negotiations start. And it is what it is. It's a bit of fun but it's also very, very stressful. And it can be a short period of time or it can drag on and on and on. It is what is. It goes where it goes. 
 

Jeff: The letter of intent or asset purchase agreement actually comes next after the negotiations.

Andrew: There's been conversations and things have been thrown out there and a whole bunch of words have been exchanged. But we really don't have things in writing. And for me as a broker I'm not willing to present the thoughts of the buyer unless they're in writing. Because what's said in casual conversation or whatever, it's got to be in writing because that allows the seller to actually sit down, read it, and then to go away and make their decisions on what's important to me, what do I want to go back and negotiate, or am I willing to accept what the buyers offer? Where's my head? And so having a written document, be it in the form of a letter of intent which the parties can walk away from, or it's in an asset purchase agreement. And the difference between a letter of intent... Letter of intent is high level, it has key details in it. An asset purchase agreement is a much more detailed document and different documents to use depending on the type of transaction. That's the deal making pieces we've just covered.
 

Jeff: There we go. We've identified and discussed the details of the first three stages and the final stage is the closing stage. And this should be the fun part really for everybody involved, open due diligence.

Andrew: You're exactly right Jeff. It's an important part. And the dynamics tend to change because previously the buyer and the seller had been adversarial to a certain extent because they're both working out what their level of comfort is with doing certain things. But now they've come to an agreement like the seller is made representations. And so the buyer says, "I've been accepting of the information you've been sharing with me but as Ronald Reagan says, show me and I'll trust you." Now, the buyer has the opportunity to bring in their CPA or their tax professional. I can talk with their attorney. They can bring in their experts to help them verify the representations of the seller. And that's the purpose of opening up due diligence. 
 

Jeff: Very, very good. The next step in that process, apply for financing if needed. Now the money is starting to come in at some point here, and we're getting deeper into that closing phase. 

Andrew: Exactly. And so the financing is an important piece because there would have been conversations previously. If the buyer needs to get finance, we want to have that conversation earlier than now. But this point now is actually formalizing the loan request. Because the lenders will give you verbal agreements or they'll give you pre-qualifications. We need to move from pre-qualification into pre-approval, which means the lenders are also doing their due diligence and they're doing their underwriting process to say, "Yes, we had an interest earlier, but now we definitely have an interest and we're willing to be part of the final closing process of making money available. And so dotting the i's and crossing the t's on the finance application, that's the piece we've just dealt with.
 

Jeff: And then the next step of course, obtaining those lender instructions from the bank.

Andrew: Yes, and the lenders do have rules, especially if it's for example an SBA loan. The SBA documents, it's a government program. They're about five phonebooks. They're incredibly detailed. And so often the seller and the buyer may wish to do a deal on a certain way, but if the lender says, "I'm sorry, that's not happening, you've got to do it my way." Guess what, the lender wins out because if the lender goes away the deal goes away." And so a buyer and a seller may think that they're in control of a situation but the lender has sometimes more say whether a deal gets done or not because of the loan underwriting requirements. 
 

Jeff: And the escrow is opened up then at step number four.

Andrew: This is where the buyer is paid the deposit to show they're serious in buying the business. And now we need to help with the third party which is an escrow company because their job is to represent nobody. Their job is to talk to the seller, talk to the buyer, talk to the lender, talk to the landlord, talk to the government agencies to get clearances. We're in California so in California there's sales tax, there's health department requirements. If you have a liquor license, there's the ABC. There's different government agencies. And so part of my role as the broker is to make sure the business transfers from the seller to the buyer, and everything's done correctly because I don't want the buyer buying the business and a step they missed that puts them into a financial disadvantage or a time disadvantage. This is the purpose of escrow. Let's get everything cleaned up, crystal clear for everybody so that the seller walks away cleanly, and the buyer's got everything to operate the business as the seller's been running. And that's the purpose of the escrow process. Get everything organized, i's dotted and t's crossed.
 

Jeff: By the way, we know Andrew that not all states do require escrow agents involved in the closing of business transaction. So this particular step, maybe a little bit different depending on where you're located in the country listening to this program right now. The next step in the closing stage, we're coming up toward the end now. Start the bulk sale process.

Andrew: If you're selling a business in California Jeff and I do appreciate your previous comment. You're exactly right, I am in California, I have a California real estate license to do what I do. So my comments here are California specific and your comment about being different outside California is very, very appropriate. In California when you're selling inventory there's a requirement to go through about sell process because the logic is the suppliers of the inventory to the seller, they may be owed money, they may have accounts receivable or accounts payable outstanding with the seller who has the inventory. And so to protect the sellers we have a bulk sale process which allows them to be notified that the business is changing hands from the seller to the buyer. And the supplies should look to the seller to get their money because the seller is the person that ordered and has the responsibility to pay for those goods.
 

Jeff: And really, the final step in the closing process is meeting at that all too important signing table, that whether it be Starbucks or no matter where you agree to meet, you've got a bunch of documents you're going to have to sign.

Andrew: Yeah. And we have probably polar opposite emotions. So the seller is absolutely exhausted by now because of the process they've gone through and they're so delighted to be sitting there and signing this documents and saying, "I'm done. This is exciting." And conversely the buyer is saying, "What the heck am I doing? Shall I be doing this?" And so that's the joys of the signing document process where total fear on behalf of the buyer, and the seller is just completely exhausted and relieved. They'd finally get this thing done and move on with their lives. 
 

Jeff: And Andrew, it's chapped like you who get to sit there and watch the emotions on both their faces and you just take it all in. And then you have a toast with your loved ones later on saying, "This was a good day." 

Andrew: It's a big drink too I can tell you, it's a big drink.
 

Jeff: We've gone through the four stages today and I certainly hope that you listening to the program no matter where you are got a lot out of this. We tried to cover each of the steps of the process, the planning stage, search stage, deal-making stage, and closing stage. Don't forget if by chance we lost you along the way, or you want to go back and you want to listen to the program again, you're welcome to obviously. You can also read the transcript at morganandwestfield.com right underneath the podcast media player that you're listening to this program on right now. Andrew Rogerson what a delight. As always my friend I enjoyed having you back on the program. If folks would like to give you a call too. Maybe they've got some simple questions, maybe they like to talk to you about the sales process, or maybe they'd like you to talk to them a little bit about their particular business, their situation, how can they reach you?

Andrew: I'm happy to talk to them and my phone number is 916-570-2674. And the good news is they get to talk to me, and they also get an Australian accent at no additional cost. So there's absolutely no downside to giving me a call.
 

Jeff: Thank goodness for that, and you'll even throw another shrimp on the barbie there for you at some point perhaps. It's Andrew Rogerson again, my friend, I appreciate the time. I really enjoyed talking with you and thank you again for joining us on Deal Talk.

Andrew: Thanks Jeff.
 

Jeff: That's Andrew Rogerson, certified business broker and a business consultant at Rogerson Business Services in Sacramento, California. Tell a friend about Deal Talk won't you? In addition to morganandwestfield.com you can find us on iTunes, Stitcher, and Libsyn, so make sure that you take us with you. We fit very portably into any personal or mobile device that you have.

Deal Talk has been brought to you Morgan & Westfield, a nationwide leader in business sales and appraisals. Learn more at morganandwestfield.com. My name is Jeff Allen. Until next time, thanks again.

While we take reasonable care to select recognized experts for our podcasts please note that each podcast presents the independent opinions of such experts only and not of Morgan & Westfield. We make no warranty, guarantee, or representation as to the accuracy or sufficiency of the information provided. Any reliance on the podcast information is at your own risk. The podcast is for general information only and cannot be considered professional advice.

Key Takeaways

  • Cash flow problems are mainly due to a company’s failure to plan -- whether it's planning to collect the receivables, to send the billings out on a timely basis, price its product, or just utilize its financial statements.
  • Business owners have the ‘ultimate responsibility’ in the company’s cash flow. They need to be involved on at least a weekly basis with what's going on from a cash flow standpoint.
  • Cash flow issues will have an impact on both the ability of the business owner to sell its company and the value of the company itself.
  • To maximize cash flow, business owners need to look at the following items, among other concerns:
    • Variables and fixed costs
    • Role of credit in the growth of business
    • Billing concerns
    • Handling of receivables
    • Product pricing
    • How debts could help grow the business
    • Financial statements that should be up-to-date
  • In handling receivables, if you’re not paid in 45 days, pick up the phone and ask why.  You can do that without putting your business relationship at risk. Help resolve potential billing problems, if any, or make terms.  Partial payment on a bill is a whole lot better than no payment on a bill.

Read Full Interview


Jeff: Is cash flow or the lack of it keeping you up at night? If you're looking for answers to your cash flow-related questions, you've come to the right place.

From our studio in Southern California, with guest experts from across the country and around the world, this is “Deal Talk,” brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.

Jeff: Welcome back to the web's number one content source for small business owners committed to building a business for eventual sale. Here on Deal Talk it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.

If your business is challenged by cash flow issues, you are in good company. And to help us get some ideas about the causes and what you may be able to do about it, I'm joined by one of the best numbers guys who ever push a pencil. His name is Scott Shields, CPA and founding partner Shields-Blice & Company CPA's in Fairlawn, Ohio. This is his second time joining us here on the program. Scott Shields, welcome back to Deal Talk my friend, it's good to have you.

Scott: Hey, thanks so much Jeff. I have looked forward for the last couple of weeks to be in back on the show.

“You need relevant, pertinent information, and it needs to be in real-time. If I don't have bank reconciliations done, or if my books aren't even closed for the month of January and here I am approaching the end of February, maybe I don't have the right person in that job supplying me with that crucial information, so I can make those business decisions.”

Jeff: Well, we appreciate that Scott in making yourself available. We know that you're a very busy guy so we're just glad to have you back. Scott, you know, cash flow it's a problem. It's a problem for many companies. If I put a list of 100 companies of all market caps, public and private, null industries in front of you right now, how many of those companies might you imagine based on your experience of course have had cash flow issues in the past, or are being challenged by cash flow problems right now?

Scott: Well, unless you're Google or Apple I think that in a 12-month cycle every single business does experience some form of cash flow crunch where they've got to go back to the financial, back to the numbers to determine how they're going to get through that little bit of business pain that they're experiencing with that cash flow problem.

 

Jeff: What are the most common reasons Scott that this is such a problem for so many small businesses really I'm talking about now if you want to think about a small to mid-cap businesses. For those companies that experience cash flow issues, what are some of the reasons, the most common problems?

Scott: Well, I guess from the basic standpoint it is a failure to plan Jeff. And whether it's planning to collect your receivables, to send your billings out on a timely basis, price your product, or just utilize your financial statements, I think there's a number of reasons that cause these cash flow problems. But I would have to say that it's just a failure to plan for these things.

 

Jeff: And that is incumbent really on the owner, him or herself, and maybe just a failure to understand the basic principles of accounting, is that it? Or is it they don't have someone who is there with them on the team who can handle that?

Scott: I think the answer is yes to both of those items. I think the ultimate responsibility always rests with the business owner. I've run into situations before Jeff where business owners say, "I've got my controller, or I've got my bookkeeper, or I've got my accounting manager." The bottom line is, just like Harry Truman said, "The buck stops here," and the buck is stopping with the business owner. And they need to be involved on at least a weekly basis with what's going on from a cash flow standpoint. And I'm not talking Jeff about looking at the bank balance to determine whether it's positive, negative, or two figures, or five figures. They need to be involved much more deeply in the planning process.

One of the things that we do on a regular basis with our customers and our clients is it's not just planning for the current year or up and coming year, it's also about talking about what historically has happened if your typical sales, or five, or 12, or 15 million dollars and your collection ratio is running 45, 48, 50 days, you got to take a look and see why is that and address the fundamental issues. And I think maybe business owners just fail to recognize what those issues are. They say, "My customers aren't paying me." My answer is why is that not happening? I think we got to get back to the basics.

 

Jeff: If I'm trying to sell my business right now Scott, and cash flow it's been a problem particularly of late, maybe the last six to twelve months it's been just kind of a real struggle. How much of an impact is that going to have not only my ability to sell my company but just really basically on the value of my company?

Scott: Well, I think it's going to impact both of those Jeff. Number one, is that if you're having cash flow issues, you're already adding negotiation disadvantage because you don't have the money to make the payroll, pay the bills, whatever the case may be, and now all of a sudden you may be dealing with an organization that you are hoping is going to be your white knight and bail you out when in fact part of that process may to be to use that poor cash flow against you to bring even more pressure to bear on you for potentially a lower price or for better terms for the buyer. So I think it has huge impact.

Also, as a buyer, when we're working with many of the organizations that retain us to assisting in the purchasing of companies, that is one of the things we look at. When you look at the financial statements or when you look at the tax return, just because there is profit on the tax return does not mean that money is necessarily being collected if they're on ___________ basis. And maybe, yeah they're profitable, but they can't even make their payroll that week or for whatever given period of time. So it does have impact. We analyze it, we determine it. I want to always make sure that the cash flow is adequate at a minimum to not only service the debt but also to service the general operating cycle of that business.

 

Jeff: Is there a rule of thumb Scott that you follow or that you apply with regard to maybe a percentage in reserves that a company needs to have at any given time to fall back on in order to ensure that they've got that cash on hand?

Scott: There's no real rule of thumb. I think that what our mothers taught us is kind of the golden rule in this situation which is I think you need to have the ability to access at least one minimum of one month operating cycle money. Now whether that's money in your bank account, or whether it's just a cash line of credit setup with your bank either one of those is good. One of the things that we do find out and we run into also Jeff is people who utilize their line of credit, and the line of credit should be one of those items that is to get you through some of those cash flow crunches or low cycle in your business cycle. But what people many times use it for is to support their business. The whole idea of a line of credit is you get the money, it helps you through that rough part, and then you pay it back. Most banks require that on lines of credit that it be zero for at least a 30-day period. Many banks have 60- or 90-day periods, it's just to get you through that tough part. I would say, at a minimum, no less than one-month access to either cash or low line of credit through your lending institution.

 

Jeff: You've kind of answered a question just a few moments ago I think Scott that I had planned to ask you. And you worked with so many companies over the years, but how often have you been witness to a situation where, and you kind of illustrated this a little bit ago, again, where you've gone in and the company showed all signs of a successful, healthy business, sales number's good, your earnings and revenues showed strong growth but the cash flow is just out of sync with the other numbers. How often does that occur?

Scott: It does happen and it happens many times on a regular basis. And we want to understand why there is that cash flow crunch. Maybe it is they've paid too much on their debt. I get asked all the time, "Hey, shall I pay my debt off?" Debt is not a bad thing as long as it's incurred for the right reasons and at a reasonable interest rate. Debt is very important to a business in order for that business to grow. But just because we have debt and we have a little extra cash one month doesn't necessarily mean the proper course of action is to pay that debt down. Now all of a sudden I got less debt but I don't have the cash flow if for some reason they do one, or two, or three big invoices that I send out in the up and coming month, or a little bit slow in getting paid. Now, once again, it puts me in that situation where I may have trouble making payroll, or making my other obligations for my business.

 

Jeff: That man right there is Scott Shields. He's a CPA and founding partner at Shields-Blice & Company CPA's in Fairlawn, Ohio. They actually have a couple of offices, don't you there Scott?

Scott: Yeah, we do. We've also got our office in North Canton, which is in the Southern part of our county but it is a tremendously growing area, very close to the Akron-Canton Airport which has been growing over the years and bringing us lots of opportunities down here in North Canton, Ohio.

“The time to get that line of credit, that revolving line that's always available to you is not when you are up against the wall and not able to make payroll. It’s during the fat season when you're flushed with cash, when you don't really need it... Get it in place right now.” 

Jeff: And we're going to tell you how you can get in touch with Scott and his team toward the end of the program so keep it here. This is “Deal Talk,” my name is Jeff Allen. Scott, when you go in and you meet with a client, maybe the first time, second time, third time, it doesn't matter how many times, and you start to get to the root cause of these issues and you start to put a plan in place to help the client dig out of this situation and maximize cash flow once again to get the train back on the rails. How many times will you say, we shouldn't even say how many times, but how common is it that a business owner as comfortable as those cash flow issues might be are really kind of uncomfortable with some of the changes that you might ask them to make? Is it true that sometimes some of these things that you might ask a client to do are things that may not necessarily feel very comfortable at first?

Scott: I think you're absolutely right, Jeff. One of the things that we absolutely don't have that a business owner has is I don't have the emotional attachment. So I'm able to look at things in a little bit different light. Just because an individual has been with you for a certain period of time doesn't necessarily mean that individual is still performing at a level they should. Just because you have had the same customers year after year after year, maybe you're finding an exodus of those customers because you're not keeping up with technology, or whatever the case may be. And I can walk into a business owner's office and I form my first opinion within about one and a half seconds of walking in his office. If I walk into an office that's got piles of paper everywhere, stacks on the floor, filing cabinets hanging out, and the guy's got an old flip phone on his hip, I already know that I got my work cut out for them.

 

Jeff: Used to like flip phones. I felt like I was a character on Star Trek walking around with one of those. And I like to remember the old Motorola Razr's, remember when they first came out they were nice and thin. Anyway, it's another story for another day. But what are maybe one or two things that some folks are most resistant to doing that you advise them to do that really can cause them maybe some short-term pain on the way to getting things corrected again with regard to cash flow?

Scott: I want to look at the whole vertical integration on their operation. I want to understand what it is that they do. And then we're going to look at the entire process, whether it's a manufacturing operation or a service operation, I want to look at everything. What is it they're holding out to the general public that generates them revenue? Is it something that is on the decline, is it a very stable industry, is it growing? I then want to take a look at how are they pricing it out? It's amazing to me Jeff. When I ask individuals what are their fixed cost and their variable cost I get the deer in the headlights. And they're not even sure what is the nut that they have to crack each and every month. And if let's say they're making widgets and that widget is being sold for 15 bucks, I'll ask, "What's your sub cost in that widget?" They don't know. I said, "How much are you making on that widget?" They don't know. So we got to get down to take a look at what is our margins on these things? Do I have an 11% margin, do I have a 1% margin? And then the next step is how frequently are we billing? Are we billing whenever we get time? Are we doing it religiously at a minimum of once a month? Are we doing the billing every time a project goes out? Whose responsibility is it then to follow-up with that customer based on the terms of our invoicing? Maybe we are 30 days, or 210 net 30, or something along those lines. Whose responsibility is it to make that phone call when that invoice is 45 days old and find out what's going on? Even on our whole organization we find problems that come up, and invoices and getting paid. And we call them up and we want to find out why. We're not being aggressive we're just saying, "Hey, did you get the invoice?" And many times they say, "No, we didn't." And we'll go back in because we're electronic and most of our invoices go out electronically. We'll find that there was a mistake putting an email address in, or the individual responsible for payable has changed and emails are going to the wrong person. Sometimes it's really that basic.

So we want to take a look at all those things, also making sure that that business owner is involved. If the business fails it's his responsibility. His employees are just going to go out and find other jobs. It may bankrupt him. He may lose his house. He may lose all kinds of things, so it's ultimately his responsibility to be involved and not to be delegating these various responsibilities to underlings unless he's overseeing the big picture.

 

Jeff: You kind of given us some initial I think feedback here in area where we're going to go into a little bit more depth after the break Scott. And we want to talk about the number of options that are available for increasing cash reserves. You talk a little bit about billing and receivables. We're going to talk about that maybe a little bit more on top of a number of other things. My name is Jeff Allen and we're talking with  Scott Shields, CPA and founding partner Shields-Blice & Company CPA's in Fairlawn, Ohio. Cash flow problems, how to deal with it and what you need to do as a business owner. Some thoughts about how you can get back on track to maximize cash flow. And we're going to continue or conversation with Scott when Deal Talk returns right after this.

If you'd like to share your knowledge and expertise on any subject related to selling businesses or helping business owners improve the value of their companies, we'd like to talk with you about joining us as a guest on the future edition of Deal Talk. Interested? Contact our host Jeff Allen directly. Just send a brief email with "I'd like to be a guest" in the subject line. In a brief message include your name, title, area of specialty, and contact information, and send it to jeff@morganandwestfield.com, that's jeff@morganandwestfield.com.


Selling your business may be the most important business transaction you'll ever undertake so don't go it alone. Work with an organization that has made it their business to sell businesses and that's all they do. Morgan & Westfield at 888-693-7834. At Morgan & Westfield we know that selling your company is not something you should take lightly. It can be a stressful, difficult, even emotional process. That's why it's important to work with a team whose one and only specialty is selling businesses throughout the United States. And Morgan & Westfield will help you every step of the way. From helping you plan your exit strategy, to preparing a comprehensive appraisal, and locating the right buyers. Without the right team behind you, you could be leaving money on the table. So don't leave your most important business transaction to chance. Call Morgan & Westfield for a free consultation at 888-693-7834, 888-693-7834, or visit morganandwestfield.com.


If you have any questions about any of the topics you've heard us discuss on Deal Talk all you have to do is ask because this is a show that is really driven by your interest as a small business owner. We're committed to bringing you answers and finding solutions because after all, we're small business owners ourselves. Simply call our Ask Deal Talk info line at 888-693-7834 extension 350. Follow the instructions to leave your question and we'll reach out to one of our guest experts so we can feature your question and their response on a future edition of Deal Talk. Ask Deal Talk at 888-693-7834 extension 350. That number is 24/7 by the way, okay?

We're also interested in knowing your thoughts about the program, what you like, your suggestions for how we can improve the show to make it even better for you. So send us an email to dealtalk@morganandwestfield.com. That's dealtalk@morganandwestfield.com.

 

Jeff: My name is Jeff Allen. I'm joined once again on the program by Mr. Scott Shields. He's been on this program before. And Scott is CPA and founding partner Shields-Blice & Company CPA's. We're talking about cash flow. You know the problem that you're having with cash flow right now. I hope you're not having a problem but so many business owners do. Scott, just to kind of pick up where we left off a little bit, we're now trying to get business owners in line with discovering how they can improve their own situation. They may be meeting with their own CPA, or maybe they might have an idea to contact you after this show is over so that you can give some ideas. But let's kind of get them jumpstarted. What really is the first step? We may be just stepping back just a little bit here and maybe asking you to kind of recap here. What is really the first step if someone feels like they've got an issue? Where's the first place that they should look and the first place that they should start in order to get themselves back on track?

Scott: I run into it a lot, Jeff. One of the first things I run into is denial. The business owner is in complete and total denial that he is having issues, whether it's cash flow issues or more severe than the cash flow issues that is potentially going to impact their survival in the business. I think number one is he's got to get with the numbers. We need to get the financials. I run into situations where we get brought in as a consultant and the financial statements haven't been done for two or three months. The bank reconciliations haven't been done for months. So I think number one is let's get the company books up to snuff, up to speed, up to date, and take a look and see what those things tell us. So the business owner should go there first. Perhaps he's got a bookkeeper, or controller, or CFO, or something along those lines, and you then have to question that individual. If those books aren't up-to-date the question is why. You need relevant, pertinent information, and it needs to be in real-time. If I don't have bank reconciliations done, or if my books aren't even closed for the month of January and here I am approaching the end of February, maybe I don't have the right person in that job supplying me with that crucial information, so I can make those business decisions.

 

Jeff: We've already talked a little bit about accounts payables and receivables and kind of taking a look at that. And that's one of the first places you're going to want to go, isn't that Scott?

Scott: It absolutely is. One of the first things is where is the hidden money at? And with most people that hidden money is tied up in their receivables. A good receivable report is going to give you that ageing, 30, 60, 90, and greater than 120. And we then want to take a look at what those old receivables are and what the processes are to collect those. Typically when somebody gets out there at a 120 days the chance of collection, unless there's specific circumstances goes way, way down. I typically tell my business owners, "Hey, if you're not paid in 45 days pick up the phone and find out why." It may be as simple as they didn't get the invoice. Maybe there is a dispute with the billing, what they received, what the cost is, whatever it is on there, but find out. Don't wait. Forty-five days, you've got to be asking the question, why isn't this paid? And you can do that in a real unaggressive way that doesn't put the relationship at risk. We do it all the time. We simply ask the business owners, "Hey, we sent an invoice out last week. Did you get it? Is there a problem with it?" And then be quiet, listen to what they say, and hear what those potential problems are so you can get them resolved, get a new invoice out there, or perhaps make terms. The one thing that we find is partial payment on a bill is a whole lot better than no payment on a bill.

 

Jeff: Boy, you got that straight.

Scott: And there's certainly no reason not to offer that to your customers.

“Being paid 98% of your bill in a week is a lot better than being paid 100% of your bill in 45 days.”

Jeff: Boy, you got that right. You know, nobody wants to endanger the relationship that they have with their clients. That's understandable. And particularly when times are tough we want to be fair with everybody and we don't want to endanger that valuable relationship that we have because in some cases that one client can be the difference between whether or not we stay in business. But at the same time you also have to take the very serious account of the fact that you have your own bills to pay, and those include the people who are working for you. So Scott, I appreciate spending a little extra time on that. Now, as far as credit standards are concerned, how can credit play a really vital role, or getting your arms around how this plays into your cash flow situation. Why is it important to look into this?

Scott: Well, there's two ways to look at it and a lot of business owners don't even recognize the fact that they're in the credit business. They are extending terms to their customers. They're selling something, whether it's a widget or a service, sending out an invoice in the promise of being paid in the future. So they're already in the credit business. So there's side to look at. The other side to look at is with your banker. One of the things I'm all about Jeff is I'm all about free. Give me some free services, I love that stuff. Almost all banks, all good quality banks have their business relationship managers, and these individuals out there are calling on small businesses, and of course these guys are sales guys. But they're also there to help with the other tools the bank has. And so very often the business owner doesn't go to that free resource and say, "Hey, I'm having issues. What do you have in your bag of products that can help me?" And it may be really basic stuff. It may be the business owner doesn't accept credit cards. We got to ask why. Being paid 98% of your bill in a week is a lot better than being paid 100% of your bill in 45 days. You get the money sooner. And a lot of people are afraid of credit cards because there's that processing fee. But very, very competitive out there with the banks right now, and you get a very, very reasonable fee.

There are also other products that the banks have. Whether it's setting up a lock box, assisting with collections, or a lot of other services they have. And some of these services do have cost associated with them, but other ones are just ideas. The business owners dealing with one business, his business. He may have some other friends that he knows that are also in business, whereas the banker may be dealing with 60, 80, or 100 businesses that are in his client base and they get a chance to see all these wonderful things that work and don't work. And they can provide that information to that business owner and maybe get them one or two thoughts whether it is establishing a credit line, using credit cards, whether it is factoring your receivables and selling them to somebody else, they all have those contacts that can help us.

 

Jeff: Here's one that may seem kind of obvious. If I'm making a widget, one of the things I know for a fact that my clients love about my widget is that they are the highest quality widgets available at the best possible prices available today. How much does price on my widgets affect cash flow and create this issue that I'm having right now. And is this something I need to look at, is how much I actually price the products I'm selling?

Scott: I think you should Jeff. I think that a good business owner, a good manager is going to know -- with every single widget he sells – “What is his profit margin on every widget?” If he's making a dollar on every single widget then he's got some potential wiggle room that he may be able to cut the price to another customer to gain additional business. If his product margin is too low, he doesn't have that option available to him at all. And then also looking at the variable and the fixed cost. We know that if you're paying rent on your facility, it's the same thing month after month after month, that portion of the cost of the widgets is going to stay fixed hence the name fixed cost, and there's going to be the variables. For example if I got to put more widgets out and I got to pay my guys time and a half because they're working more than 40 hours in a week, well that really drastically affects the cost on that widget, and i may find that, "Hey, I got the sale, I got the order." But now rather than making a dollar I'm only making 35 cents, or perhaps I'm even losing money on that. The business owner needs to know those costs so he knows when to say no and when to walk away from the deal.

 

Jeff: We're talking with Scott Shields and we're talking about cash flow and what you can do to improve your situation to help you maximize cash flow, some places that you need to look, some stones you need to turn over in order to help you kind of get resettled so to speak. And to help you get maybe hopefully a little bit more sleep tonight. But Scott we talked a little bit just a few moments ago about the importance of credit. How often will you go in to a client and actually suggest maybe the use of a loan to help maybe pad the reserves, or help them make their bills?

Scott: All the time Jeff, we work with that all the time. I am not that guy that thinks credit or borrowing is bad to grow a business, it's a necessary component. And one of the things also that we tell businesses, hey, the time to get that line of credit, that revolving line that's always available to you is not when you are up against the wall and not able to make payroll. It's during the fat season when you're flushed with cash, when you don't really need it. That way it'll be in place when perhaps you have a little bit of a downturn, maybe the company's not doing so well, maybe you're in a particular industry, whether it's the oil and gas industry that's having some difficult times. Get it in place right now. Also, in addition to the credit lines we also have those fixed loans. Whether it is to buy a new piece of manufacturing equipment and you're going to get that term loan for three, five, seven, fifteen years, whatever it might be. And use that to help grow your business.

Once again, the cash flow for that debt service has to be analyzed to make sure the return on the investment, the return on the money you're going to spend on that, maybe that new ___________ or that new person that's going to join your organization has got to be greater than the cost of the money itself. And it's called an ROI, a return on investment. It's a simple calculation to determine if I spend this money what's it do for me? What it's going to do for my bottom line? Is it going to generate me a 6% return or a 12% return? And we have to analyze that as well to make sure it's worth the time.

 

Jeff: Scott, we're starting to wind down now, so let's just go ahead and kind of do a quick wrap on things. Any final thoughts that you might have, an important key takeaway either from this discussion or maybe something we didn't necessarily talk about that you think might be helpful for business owners to remember when they're trying to deal with their own cash flow issues?

Scott: We did talk about getting into the numbers, number one. But I also want to caution the listeners, here's something I don't want them to do, ever. This is the kiss of death for a business, and that is if you've got a payroll and you decide not to make your payroll, tax payments, and to finance your business on that it's a disaster. Keep in mind that payroll money withheld out of paychecks it's not your money. It belongs to the employees and you're responsible for getting that to the federal state and local governments. The penalties are severe for not doing that. Also, it is a potential personal liability. Even if you go belly up you're not going to be protected from the government coming after you for that money that wasn't paid in. So be very, very careful and always pass on the temptation to make those payroll tax payments later or not at all because that will really create a problem, not only if you're trying to sell your business but if you're trying to finance your business, or if the government comes to look at you.

 

Jeff: Boy, indeed, that is for sure. And I hope that if nothing else that folks kind of go back and take a listen to what it is that you just talked about, because that one final point might be the best way that we possibly could have ended this particular discussion on cash flow today. Scott, if anyone would be interested perhaps in contacting you to discuss their own specific situation right now as it relates to cash flow or maybe any other issues that they might want to discuss with you, how can they reach out to you?

Scott: Hey, the best way is email. My email address is scott@shields-blice.com. Send me out an email, I'll get back to them right away.

 

Jeff: Scott, I enjoyed this program and we hope that at some point in the future we can have you back on again. I know that there are going to be some other great ways that you might be able to help our listeners, and once again I appreciate you joining us.

Scott: Hey, thanks very much for inviting me back Jeff, it's always enjoyable.

 

Jeff: Scott Shields, CPA and founding partner Shields-Blice & Company CPA's, Fairlawn, Ohio. Tell a friend about Deal Talk won't you? In addition to morganandwestfield.com you can find us on iTunes, Stitcher, and Libsyn, those four channels. Or you can find us someplace on the web. I'm absolutely positive of it. Deal Talk has been brought to you Morgan & Westfield, nationwide leader in business sales and appraisals. You can learn more at morganandwestfield.com. My name is Jeff Allen, thanks so much for listening. We hope to talk to you again soon.

While we take reasonable care to select recognized experts for our podcasts please note that each podcast presents the independent opinions of such experts only and not of Morgan & Westfield. We make no warranty, guarantee, or representation as to the accuracy or sufficiency of the information provided. Any reliance on the podcast information is at your own risk. The podcast is for general information only and cannot be considered professional advice.

Key Takeaways

  • When purchasing a property for the purpose of generating income by leasing it out, it is important to put a team of professionals together to help protect your investment, including a real estate agent, an attorney, a CPA and a mortgage broker.
  • When utilizing the 1031 exchange, it is important to have a qualified exchange intermediary help you execute the transfers and a tax professional to help assist with the transaction, as well as an attorney. 
  • If you are going to reinvest money earned from selling a commercial property and stay in the real estate market and continue a trade or business, there are some great tax vehicles out there to help defer taxes and put your capital to work.
  • Some of the tax rules on capitalization versus repair are more complicated than ever, and a good tax professional is very important to have on your side.

Read Full Interview

 

Jeff: Do you own the commercial property your business occupies or other commercial property and you're thinking about selling it? If you're interested in saving potentially a lot of money after you sell it, you've come to the right place.

From our studio in Southern California, with guest experts from across the country and around the world, this is “Deal Talk,” brought to you by Morgan & Westfield, a nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.

Jeff: Hello and welcome to the web's number one content source for small business owners committed to building a business for eventual sale. Here on “Deal Talk” it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.

If you own commercial property of any kind, whether it's where you do business or its property that you lease to others, this program is definitely for you. Our guest is Mr. Steven Oppenheim, a CPA, and partner at Gettry Marcus in New York. As a member of the firm's real estate group, he advises both commercial and residential owners and developers on matters that may impact their businesses. Steven Oppenheim, welcome to “Deal Talk.”

Steven: Thank you. Nice to speak to you, Jeff.

The good thing is, there is an exception to this general rule under internal revenue code section 1031, which if properly structured allows the taxpayer to sell real estate property, reinvest the proceeds in a replacement property and defer paying taxes on the gain.

Jeff: Steven, tell us a little bit about what you do over at Gettry Marcus.

Steven: Sure. I am a partner at Gettry Marcus where I am the partner in charge of the real estate group. I am a certified public accountant with 22 years of public accounting experience. Gettry Marcus is approximately an 80-person CPA firm in the New York metropolitan area. We are a top 200 firm nationally with offices in New York City and Woodbury, New York. Our firm provides accounting, tax and consulting services in various industries, which include real estate, healthcare, manufacturing, business valuation and forensic accounting. I specialize in the areas of real estate and high net worth individuals. Our real estate group provides a variety of accounting, tax and consulting services to owners, operators, developers and real estate managers. We also specialize in structuring transactions including 1031 tax deferred exchanges, and complex partnership entities.

 

Jeff: Very good, Steve. I appreciate that. What we want to do today is for those folks listening who are property owners or interested in owning property in generating income by leasing property out. This is kind of the show for you. And I'd like you to consider this a different kind of a “Deal Talk” experience here, more of a workshop. This is an opportunity for you to really learn from someone who specializes in this area, so let's get right down into it. Steve, just kind of setting up a scenario here, if I was looking to go into the real estate business as a landlord, it seems to me like this is probably … and it's just me talking here ... it seems that this is really an ideal time to be a commercial property owner. And I had designs on leasing this property out to other business owners. If I find a rental property that I'm interested in purchasing for the purpose of renting out, should I negotiate the deal for that property for myself, or would I be better off working with someone to help?

Steven: OK. I think it would be very important to put a team of professionals together to help protect your investment. Remember, you're investing a lot of money; you always want to protect that investment. This team should include a real estate agent. An agent is vital in educating you about a specific geographical market, and it could be a very good resource in helping you find a property that fits your situation. Obviously, there are all kinds of properties out there; you’ve got to find one that’s tailored to your situation and what you're trying to accomplish. They will also act as the liaison between you as a buyer and the seller, and will help you negotiate in getting the deal done. Obviously, it is important to work with a broker you trust and who is well experienced in that particular marketplace. Another team member I would add would a good attorney. It's very imperative to work with a knowledgeable attorney to help protect your investment. The attorney will assist you in drawing up all the contracts and work with the title companies that verify there are no issues with ownership and there are no restrictions that will affect your proposed use of the property. Another very important task would be for the attorney to review existing tenant leases, so you as the landlord know exactly what your obligations are for the remainder of the tenant leases. Another good person to add to that team would a CPA. And I think hiring a competent accountant can be extremely useful in helping you figure out how much you can afford to pay to acquire the real estate. They could assist you in the preparation of budgets, cash flow projections, expected return on investment and also perform tax projections taking into account the appreciation deductions. The accountant can also assist in structuring the transaction, including choosing the type of entity to use to acquire the property. And that will be tax efficient and minimize liability. 

I think one other recommendation I would have is to go speak to a mortgage broker or a bank directly to start the process of negotiating with the banks in advance of purchasing a property so you could weigh all your financing options. For example, what your borrowing restrictions are and how much cash you will need to come up with to acquire the prospective property. And maybe just some other professionals that you would want to hire as well would include an engineer and consultant to prepare environmental studies so you know exactly what you're getting into, because, again, it's going to be probably a large investment. It's a business you're going into and you just want to make sure that your investment is protected to the best extent possible.

 

Jeff: What a team indeed. We already talked about, essentially, there about five people: real estate agent working with an attorney, a CPA, banker perhaps, and an engineer possibly. And an engineer would really be handy particularly for those older properties I would think, or where you have special needs perhaps if you've got a manufacturing company. And you have an interest in leasing, too, perhaps, or maybe even your own manufacturing company for that matter, so there are a lot of things to think about. Steve, any thoughts that you might have about which one of those individuals you should probably be in touch with first? I'm probably thinking attorney for me, but I'm wondering if you have thoughts on that and if maybe it might be different for different folks.

Steven: It might be the real estate agent to start with, and just kind of seeing what's out there in terms of whether the business plan is feasible and there are properties out there that fit what your needs are. So I would say the real estate agent might be first. And then shortly thereafter would be contacting an attorney, because the attorney should be involved in the entire process.

Remember, you're investing a lot of money; you always want to protect that investment.

Jeff: Many times we see as we're driving by an industrial center for example, and there are a lot of those where I sit here in Southern California, a lot of distribution, warehouse facilities out here. Is it always necessary, do you think, Steve, to contact the people there on those signs in front of those buildings? Or if I've got a reliable source of information perhaps from a professional in my own network of professionals that know somebody in the commercial real estate business. Can somebody who may not necessarily be named on that sign help me out in negotiating the terms for that property, someone that I can hand-select, if you will?

Steven: That's a great question. And I'll tell you why. If you contact a person on that sign, their goal from the very start is to act as a representative on behalf of the seller and just get a deal done so they could get their commission. So I think it's very important. What you would be looking for is on the buyer side. There are real estate brokers you could hire independently to act as your representative as the buyer and not have a conflict of interest, so I think that's a great question and that's very important. Because, as I've stated, it's very important to find a broker that you trust and who's well-experienced in the marketplace and to avoid having that conflict of interest.

 

Jeff: You're talking about saving potentially not just thousands of dollars but perhaps tens or even hundreds of thousands of dollars perhaps in some of the larger cases. If I was looking to sell my property, maybe I’d like to reinvest the proceeds in new property someplace else across the country or any place else, are there any significant tax planning tools that I can use to help defer paying taxes so that I'd have more capital that I can invest in the acquisition of new rental property, for example?

Steven: The general rule is whenever you sell real estate property at a gain you generally need to pay taxes on the gain at the time of sale. If the landlord is looking to upgrade in properties or is looking to move to a different geographical location, then having to pay a big tax on a gain would reduce substantially the amount of capital you have available to reinvest in the new property. The good thing is there is an exception to this general rule under internal revenue code section 1031, which if properly structured, allows the taxpayer to sell real estate property, reinvest the proceeds in a replacement property, and defer paying taxes on the gain. The code states no gain or law shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind property. I'll just brief you on the 1031 rules. The general rules to qualify for a 1031 exchange are as follows. The form of transaction is a sale or an exchange. Both the property transferred and the property received are held either for productive use in a trade or business or for investment. And the property transferred and received is like-kind property. In this case, like-kind was intended to be interpreted broadly. For example, you can exchange commercial property for residential rental property. You could exchange residential rental property for industrial property. The rules there are very broad.

If you contact a person on that sign, their goal from the very start is to act as a representative on behalf of the seller and just get a deal done so they could get their commission.

Jeff: Who is the best person in that team that we talked about earlier to help me determine what truly is like-kind? If I know that that's what I have to look for and I'm out there on the prowl, I'm looking for my next investment to make in talking about like-kind property investment, who's going to be able to help me determine what like-kind actually is and what would qualify?

Steven: There is a team out there that you would need to put together because an exchange would have to be done through something called a “qualified exchange intermediary.” They must be used to execute the transfers of the buy and the sell of the property and ensure that all regulations are followed. It's also imperative that you use a well-experienced tax professional to assist you in the transaction. And between those two parties and the attorney as well, they would kind of lead you in the right way of what would be considered like-kind property. But as I said, the rules are very, very broad, and it's in the tax payer's favor in terms of going from one type of property to another and still being able to get a 1031 deal done.

Jeff: Talking with Steven Oppenheim. Steve is with Gettry Marcus. He's in the firm's real estate trust and estates group and a partner at the firm, and we're going to continue our conversation when “Deal Talk” resumes after this.

If you'd like to share your knowledge and expertise on any subject related to selling businesses or helping business owners improve the value of their companies, we'd like to talk with you about joining us as a guest on a future edition of “Deal Talk.” Interested? Contact our host Jeff Allen directly. Just send a brief email with "I'd like to be a guest" in the subject line. In a brief message include your name, title, an area of specialty and contact information, and send it to jeff@morganandwestfield.com, that's jeff@morganandwestfield.com.


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Jeff: Welcome back to “Deal Talk,” where we're becoming the Internet's go-to resource to help business owners understand what it takes to sell their company successfully. You can find a wealth of resources along with all “Deal Talk” episodes and their transcripts simply by visiting morganandwestfield.com. You can also listen to this show on iTunes. Just look for “Morgan & Westfield Deal Talk” in the search function. 

My name is Jeff Allen. I'm with Steven Oppenheim today. He's a CPA and a partner at Gettry Marcus in New York. Steve, we were talking a little bit about tax planning tools to help defer paying taxes so that it’d have more capital to invest in the acquisition of new rental property later on. And you were just starting to get into the actual ways or means by which we can, in fact, defer those taxes, what is needed. So let's go ahead and continue our conversation from that point.

Steven: OK, great. We've just spoke kind of about the general rules to qualify for a 1031 exchange, and now let's talk about … in order to obtain a deferral of the entire capital gain tax, the taxpayer must do the following: Purchase property of equal or greater value. Obtain equal or greater financing on the replacement property that was paid off on the relinquished property. All the net proceeds from the relinquished property need to be reinvested in the replacement property, and a taxpayer could receive nothing in exchange but like-kind property. So if the exempted taxpayer receives any cash from this transaction, that portion would be taxable. Also, there are two primary requirements in getting a 1031 exchange done. There's a 45-day rule and an 180-day rule. The 45-day rule is where the taxpayer must identify the replacement property within 45 days of when the relinquished property is transferred. And the 180-day rule is where the taxpayer must acquire the replacement property within 180 days of when the relinquished property is transferred. Or this must be done by the due date of the tax return, including extensions if that is sooner. So as you can see, although it's a great vehicle to use, there are complications and there are very stringent rules that need to be followed here. So it is very important to have a qualified exchange intermediary help you execute the transfers, and a tax professional to help assist with the transaction, as well as your attorney. 

 

Jeff: Boy, that's for sure.

Steven: Maybe just to bring all this home, I think I would like to use an example to kind of help the audience get a better understanding if that's OK?

You would defer paying a million dollars in tax and have the ability to use these funds as capital to fund the purchase of the replacement property.

Jeff: No, that's perfect. It'll really help to kind of highlight the key points and really, like you said, kind of drive the point home.

Steven: OK. Let's say the facts are as follows. You own a rental property with 10 tenants and you are looking to upgrade to a property with 30 tenants. The selling price of the building you currently own is $5 million, which has a mortgage of $2 million. Let's say there's a gain on the sale of the property of $3 million, and let's say the tax on that gain if you did not do a 1031 exchange would be $1 million dollars. And let's say the purchase price of the replacement property is $10 million and you will use net proceeds of $3 million from the sale of the existing property as a down payment and take out a mortgage of $7 million. This would be, in my opinion, a perfect fact pattern into entering to a 1031 exchange and defer paying any taxes until the replacement property is sold. Since in our fact pattern and you would be invested in the entire net proceeds from the sale of the property and like-kind property, and you are replacing debt on replacement property and excess of debt on relinquished property, you would defer paying a million dollars in tax and have the ability to use these funds as capital to fund the purchase of the replacement property. As you can see, this would be a great vehicle to use for someone looking to reinvest their proceeds in real estate. As stated earlier, I strongly recommend, though, you use a well-experienced, qualified exchange intermediary, a good attorney and a tax professional to assist in structuring this transaction.

 

Jeff: Steve, let me ask you really quick, and I don't want to sound like all of a sudden I stopped paying attention because I want to make that perfectly clear. There are a lot of details here in this discussion, and we talked about the importance of forming a team and using that intermediary you're talking about is going to be able to help fill in the blanks. But I want to make it clear, we started the top of the show, we were talking about if it is your business, if you are in the business of owning commercial property and leasing that property, that's where we started. Is this the kind of thing that a business owner of another type of business, maybe he is not a professional property per se. He's not a landlord but he owns his own property, or she owns her own property for their business. It could be for any kind of industry. Is this something that they would also be able to take advantage of, too, that they don't necessarily have to lease space out in their building to other tenants, but in fact they just use their building for their business only. Can they also take advantage of the 1031 exchange program?

Steven: Absolutely. And I think it's a very, very key tax planning tool because, let's just say, for example, you're a manufacturer and you own your own building. Normally the way it would be structured is the real estate would be held by one entity and the manufacturing operations would be set up under a different entity, but you're dealing with the same situation. Now you're in a situation where maybe you have to move to a bigger space, you outgrew your old space, and let's just say you bought the real estate a long time ago and you have very little basis in the real estate and you would wind up having to pay tax on a very large gain just because the market has increased dramatically over the years. This would be a perfect tool to use to reinvest those proceeds in a new and bigger space, and being able to defer paying taxes on the transaction.

 

Jeff: We're all about, Steve, helping business owners, regardless of what area of business they're in, save money, and improve the value of their companies in the process. And I think that that was a very important point we had to discuss on that. And something else that I think is really important, and this will kind of, I think, round out our discussion on this edition of “Deal Talk” today. 

Determining whether or not the improvement that one requires for their property, should they be capitalized or expensed? How do we determine which one of those we need to do and have there been any important updates in this area to help us determine where we're going to get the greatest savings for this? Let's talk about that.

Steven: Sure. This is an area of the tax law that has always been very subjective. But just recently after nearly 10 years in the works, the IRS finalized its tangible property regulations. And these regulations are effective for all years beginning on January 1, 2014. The new regulations for many taxpayers may result in increased deductions than the prior rules allowed. The regulations cover a lot of material and are very complex, so I'll just kind of touch on them here.

If you have a CPA, particularly one who has extensive knowledge of real estate property and all the tax regulations concerning improvements of those types of things, you're going to be ahead of the game and you're going to be serving yourself well.

Jeff: OK.

Steven: The facts and circumstances still play a very large role in determining whether expenditures are deductible or must be capitalized, but these rules were set up to help clarify what items should be capitalized versus what should be expensed. That was the purpose of the IRS coming out with these new regulations. The new concept described in the regulations is a concept of a unit of property, which is one of the most important revisions contained in the regulations. The unit of property as it relates to real estate is broken down into nine categories as follows. It's the building and structural components, the HVAC system, the plumbing system, the electrical system, escalators, elevators, fire protection and alarm systems, security system, and a gas distribution system. And it's important that I mention those because that's really what the IRS is looking to do, is really break down these expenditures into what the unit of property is. Under the new regulations, capitalization is required if the amount paid results in a betterment, adaptation or restoration of the unit or property. If the amounts paid do not meet these conditions, then it is deemed to be a repair and currently deductible. 

As these rules are very complicated, the best way to get an understanding of these new regulations is to discuss specific examples provided in the regulations. So let's take a roof, for example. I'm going to give you two different roof scenarios. And what the regulations are pushing taxpayers how to treat it. So you have the replacement of one membrane with a new membrane is not considered a betterment and is, therefore, a deductible. Basically, the roof is made up of different components. You've got the decking, you've got the membrane on top of the decking, and then you might have some finishes on top of that. Here they're talking about replacing the membrane would not be considered a betterment and is, therefore, a deductible. The reason being is that the replacement of the membrane is not a material edition to the unit of property, which is the building structure itself. As opposed to the replacement of an entire roof, which would include the decking, insulation, and asphalt. That would be considered a restoration because a new roof is a major component of the building structure that performs a discrete and critical function. And it is a substantial structural part of the unit or property.

One other example is the replacement of one elevator in an office building that has four total elevators. That was considered not a restoration since one of four elevators does not comprise a significant portion of the elevator system, which is a unit or property in this case. Just to kind of drill it home a little, because I know the rules are complicated, in the past if there were four elevators in a building and you did work on one and totally improve the entire cab of the elevator and really improved it. In the past, you would always have to capitalize, and now you have to look at its one of four and a unit of property is the elevator system as a whole. And therefore, since this is not a significant portion of an entire system, you now have the ability to expense it.

 

Jeff: Repairs essentially are deductible but improvements or restorations require capitalization or need to be capitalized, correct?

Steven: That's correct.

 

Jeff: OK, very good. And you really need to have a tax expert who is up to speed on these changes and help you to determine which one of those you're able to take advantage of or which one of those you need to be able to do whether you take the deduction on the repair or you have to capitalize an improvement or restoration, whatever the IRS might consider an improvement or restoration. And if you have a CPA, particularly one who has extensive knowledge of real estate property and all the tax regulations concerning improvements of those types of things, you're going to be ahead of the game and you're going to be serving yourself well. 

Steven Oppenheim, this has been a tremendous conversation and really something I consider more of a workshop when you get right down to it, with all of the important information that you've provided in  a very comprehensive way as well. Final takeaways here from our discussion if you could. If you were taking an elevator, maybe, in your city to the 50th floor and you are taking a meeting with someone but you had only maybe about 30 or 45 seconds to share some final thoughts before you jump off that elevator, and they were perhaps a landlord or looking at purchasing property, what would you tell them?

Steven: I think again, the keys are putting a team in place that will help you protect your investment. Although it might be more costly upfront, in the long run, it will help protect your investment. In addition to that, there're some great tax vehicles out there. If you are going to reinvest and stay in the real estate market, and continue a trade or business, as a property who's renting either commercial space or residential to tenants, there are vehicles out there to help defer taxes and put your capital to work. And the third item would be some of these rules in terms of capitalization versus repair are more complicated than ever and a good tax professional is very important to have on your side.

I think, again, the keys are putting a team in place that will help you protect your investment. Although it might be more costly upfront, in the long run it will help protect your investment.

Jeff: No doubt before you jump off that elevator they've already got their iPhone or their android out and they're getting ready to take your contact information. How can our listeners, Steve, reach out to you for questions with regard to their own particular situation should they like to perhaps sit down with you to take a meeting?

Steven: I would say the best way is you can go to our website to learn more about myself and the firm, and that's at www.gettrymarcus.com. And the best way to reach me is by email at soppenheim@gettrymarcus.com.

 

Jeff: Steve, I want to thank you so much for taking the time out of your schedule today to share your expertise.

Steven: Thank you.

 

Jeff: Steven Oppenheim, CPA, and partner at Gettry Marcus, has been my guest. We hope you enjoyed the discussion. I know that I did. To listen to more “Deal Talk,” visit morganandwestfield.com and click on the podcast link at the top of this site.

“Deal Talk” is presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. Find out how Morgan & Westfield can help you at morganandwestfield.com. For everyone at “Deal Talk,” I'm Jeff Allen. Thank you so much for listening. We'll talk to you again soon.

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