Inside a Miami Contractor Sale: Hidden Accounting Traps & Big Backlog

0:00Welcome back, everybody, to another episode of Acquisitions Anonymous, the Internet's number one podcast for small business M &A. Me, Bill, and Heather are joined today by Josh Tunneson from Tunneson Accounting Services. They do QAV work. And Josh brought a great perspective. We talked about a business today that was really interesting that had a ton of backlog and work in progress, a construction, specialty construction contractor in Miami-Dade with over a year's worth of backlog,$52 million worth of backlog. Amazing kind of sticker shock. But we dig into that, How valuable is it? The nature of these contracts, this business focuses on healthcare and aviation with recurring contracts.

0:41It kind of has a little bit of everything that you want to see in a business like this. Bill really likes it. He may be tempted to go and pursue this one if it wasn't down in Miami, but we have a great discussion about the SBA dynamics. So much to talk about here. Hope you enjoy the episode. Stick around after a quick word from our sponsor.

1:05Hello, another episode of Acquisitions Anonymous. We don't have 100 % beard anymore. I'm thumbs downing on just the plus inventory line. Hey, Michael here. This episode is brought to you by Toninson Accounting Services, the leading provider of quality of earnings reports for small and mid-sized business deals. Every year, their team reviews over$500 million in transactions, and the reports are trusted by buyers, bankers, sellers, and brokers nationwide. wide. What sets Toninson Accounting Services apart is premium quality work at an unmatched price, a full quality of earnings report for just$6 ,000.

1:38You'll get more depth and insight than firms who charge twice as much, which is why so many dealmakers turn to Toninson Accounting Services when accuracy and speed matter the most. There's a link to toninsonaccountingservices.com in the show notes or reach out to Josh Toninson on LinkedIn for a free consultation where he'll walk you through the process step-by-step and answer any questions that you have. Tell them that Acquisitions Anonymous sent you. Hello, everyone. Welcome back to Apposition Anonymous and happy Halloween. I'm the only one that got the memo that it was Halloween here. A bunch of Grinches.

2:08What's the Halloween version of Grinch? You guys all are Grinches. The question is, did you have this shirt already in your closet or did you go get it? This is my every Halloween shirt. You got to go and you don't know what I'm talking about unless you go on YouTube to see my Halloween shirt. You need to see it. Yeah. Every year. So it's my Halloween shirt. I'm on all my Zoom calls just after Halloween today. but we also have a special guest not only is Halloween we got Josh Tonneson here who is our quality of earnings expert and guest nice to have you here Josh thanks for having me so we were kind of chatting before the show and I wanted to pick a deal this week that had a lot of complicated accounting vagaries because we got Josh so we have an interesting one today so this is a specialty contractor with long-term contracts and a$52 million backlog.

3:04So I'll read the listing and then I want to see what you guys think about this one. This is in Miami, Florida, Miami-Dade County. It has gross revenue of$41 million, EBITDA of 4.7 million. It's been around since 2007 and they're asking$23 million for it. So what's 23 divided by 4.7? That's, they want 4.9 times, almost five times EBITDA. here. Here's the description. This offering presents a compelling opportunity to acquire a profitable and process-driven specialty general contractor serving institutional clients throughout South Florida. With consistent revenue of$45 million,$4.7 of EBITDA, and a robust$52 million contracted backlog, the company is well-positioned for scalable growth, either as a standalone platform or strategic bolt-on in infrastructure or facility services.

3:57So there's a few breadcrumbs here being dropped. It is a recurring revenue model with long-term contracts. Approximately 80 % to 85 % of revenue is derived from renewable three - to five-year contracts with government and institutional clients. These contracts have been repeatedly renewed, with customer relationships averaging eight plus years. This recurring structure offers downside protection and visibility while reducing reliance on open bids. It has a strategic sector focus on healthcare and aviation. They are both recession-resistant, capital-intensive verticals. These sectors involve complex regulatory environments and high compliance standards, where the company's certifications and technical expertise create significant competitive advantage.

4:40All projects fall under existing contractual agreements. It has a strong backlog of$52 million contracted and it underpins immediate post-close value and ongoing cash flow. This pipeline includes infrastructure upgrades at airports, healthcare campuses, and other county facilities with consistently high backlog to revenue conversion rates expected over the next 24 months. The leadership team averages over a decade of tenure. The managing director is capable of assuming a general manager role, enabling a seamless ownership transition. The organizational structure supports scalability and minimizes dependence on the owner.

5:15It says the growth opportunities include geographic expansion into neighboring areas, to formalize the business development process and build outbound sales to increase their RFP win rate, or to consolidate smaller niche contractors across Florida. So this is in Miami, Florida. It says they have$20 ,000, so almost no inventory, which is included in the asking price. They have$100 ,000 of furniture, fixtures, and equipment. I don't understand how they're doing this much business with no F, F, and E, but we can talk about that. They have 53 employees, and the reason for selling is retirement. What do you guys think about this business?

5:53Well, I thought it was a contractor until you said it only has$100 ,000 of equipment. Now I'm a little bit perplexed as to where it sits in the value chain of contracting. It feels like maybe it's more of a business services than an actual contractor. Could that be? Oh, it says infrastructure upgrades, right? Like repeatedly. It's also possible that they're just wrong and they don't know what FF &E means. That's true. That could be. I've also seen some that are just subcontractors too, where they don't own any of the materials or anything like that, and they're literally just subbing out the labor.

6:29So it could be that. Meaning they're the labor provider and they show up and drive all the machines? Someone else? Government contracts, yeah. Sometimes that's the case too. Well, that would be very interesting. I mean, a capital-wide business with this much backlog and EBITDA. And their margins are pretty good, 10 % EBITDA margins, almost exactly, right? And it's a one-year backlog. Yeah, so that's another way to think about it, right? $52 million of backlog and$45 million of sales. So they've got sort of the whole year or into the second year contracted up already. I mean, my first question is, how the heck do they win business?

7:07you know like it's just are they winning any new business at all or is just these renewable three to five-year contracts i i wonder if they have some kind of dbe status um in order to get health care and they say aviation contracts i see a lot of those because i mean we do we do those types of projects as a as a subcontractor um a lot of them end up going to uh either female-owned minority-owned, or service-disabled veterans because they're usually federally funded. And so when you follow the dollars, there's a lot of incentive for those owners, being the airport commission or whatever, to allocate dollars to set aside contracts.

7:53So I'd be curious if that's the case because it's not easily transferable unless you also meet those requirements. Yeah, the SBA has, like, recent headlines are they're going after abuses of that program. There are certain rules, and I don't know exactly, I believe it's something like if you have the status, you have to be doing 51 % of the work at least, and you could sub out the rest. So you have to be really careful that you're really doing it. Apparently, there are some companies like that that the SBA is going after in court because they're alleging that they did do not do the 51%. They're simply just sitting in between with the status and subbing out almost all of the work.

8:38So if that's the case, that would be an interesting thing to know because there's more scrutiny on that whole system these days. I've been to pre-bids at our federal VA hospital here in South Carolina, and you'll have these contractors who come who have DBE status. And it's for like a new build, like building a$40 million new building. And these guys will show up and they're like, hey, we want a bid from you as the general contractor. Like we will be the general contractor. We want you to give us a roofing number. And when you look them up, their specialty is like audio visual or just these weird quirky things.

9:19But they're like, how hard could it be? We'll get these contracts. So they are fairly competitive and, and you can get hosed, uh, fairly easily in this world because the contract requirements are very strict and very binding. And it's not like you can just go, you know, if you, if you were building a house for somebody and you mess up, you just go to the homeowner, like, sorry, like I've got to make this right. Like the army Corps of engineers doesn't work that way. You know, the, the airport commission, you know, probably doesn't work that way. yeah yeah yeah so if I had to guess I think it's so the so here a couple things are standing out of me 8 to 85 % of revenue derived from 3 to 5 year renewable contracts with government and institutional clients and they're repeatedly renewed and the relationships are 8 plus years it also says it's healthcare and aviation highly complex regulatory the company has certifications of technology expertise I think this has got to be some sort of maintenance some sort of upkeep, like capital upkeep, upkeep of the embedded capital.

10:24I don't know if it's cleaning or testing or some sort of maintenance, right? If they got no FF &E, maybe it's like light, tune up, swing a hammer, oil the machine, something like that. It's probably maybe like the HVAC units at these places are special to exhaust the airplane exhaust or the hospital stuff, and then it'd be tuned every three months. So it's got to be something like that. Keep in mind, the vast majority of general contractors don't self-perform hardly any work. So they have estimators, project managers, AR, AP, and business development. The vast majority of them are not actually employing general labor.

11:07Now, I think the best ones do. and there's a lot that we work with who are really good at handling general conditions themselves, but there's massive general contractors who do not have any field personnel other than maybe a superintendent, right? Who is going to man the job site trailer and check all the trades, but more and more general contractors are not self-performing any work. And it could be anything as like, Bill, I think you're right in that they may have some, you know, specialty that they focus on, like it could be renovations of these spaces, hospitals and airports are incredibly difficult.

11:44We've done roofing projects at airports. You have to get all of your employees badged by the like, you know, by the FAA and by TSA to go into secure areas. And we've had problems where like literally we may only have one guy who can get badged, But he has to remain in eyeshot of every other person on the crew at all times on the roof. We're not even in, but we're in a secured area. So the compliance and the process they talk about is actually really important here because you just have to be good at doing tons of paperwork. Yes, which is absolutely a competence that whole business, many big valuable businesses have been built on.

12:27Just high competence on filling out a whole bunch of regulatory paperwork. Yeah. um so josh i got a question for you so as part of like i'm getting a qv on this business right what am i going to find on the balance sheet of this thing because there's probably like a bunch of deferred revenue on all these contracts it's likely that you know they probably aren't accounting for that correctly you know when i get an income statement from this business as part of diligence what am i going to be looking at here yeah i'd say for this one i was looking at some other numbers when you guys were talking too.

13:03So their revenue that they have is at$41 million, but then they also have employees of 53, right? Again, assuming all this data is correct, it's just, it is a weird story because then that's about 780K in revenue per employee. So I think it might be some kind of GC sub out some of the work as well, just because of that high markup there. But then really the question is, okay, what are they actually doing? Then that could determine how they do their accounting for it. So if they do own these contracts for long periods of time and they actually are spending more material. So when I see like high revenue per employee, I'm thinking there's probably more materials and other things they are up charging for as well.

13:43So my original comment probably wasn't right then. But so what I would expect is if it's long, longer term contracts, a lot of times what they'll do is they'll bill out every maybe month or maybe milestones for their project. And then what they do is a percent complete analysis on that to make sure if they're over or under built. For a deal of this size with almost 5 million in EBITDA, I assume they have an okay accounting team that's probably doing all that. Although for smaller deals, I'll say it's like 50-50 depending on if they'll go to that level of detail or just strictly be on a cash basis.

14:17And would you expect, I mean, this is all contract of revenue, I have seen people asked to get paid for it. Like, hey, this is all money, you know, work you're definitely going to go get. You know, I want to get paid for this. And I go, well, okay. I still got to fulfill it though. You know, I've got to do all the work. I got all the costs. Like, I can't pay you for that up front. I've seen them want like some contingency too. Like if all this work materializes, I sold it. I want some pay out of it materializes. do you guys think that's bs or you think that's reasonable yeah so i'll say everything is very negotiable that's how i'll start that out everybody asks me like what's industry standard and i'll say it really depends so on smaller deals typically the bot it's more so with uh with the smaller deals it's less likely working capital will be left in the business um with larger deals and that's also why there's that multiple increase to raise because usually working capital is so So what is generally, the way I think about it is like there's certain accounts on the balance sheet that you'll compare to a peg.

15:20So it's like, what's your average 12 months for each of those balance sheet accounts, like accounts receivable, for example? You say, okay, on average, the business should have a million dollars of AR. And then you look at what's at closing, right? And if it's 800K, well, they're short 200K. So they're going to leave that for you at closing. that that's kind of similar to the web, not exactly, but that's the same mentality of, hey, the previous owner did the work. Why am I leaving the cash consideration for that for the new owner? Right. So with the larger deals, you're kind of buying a business with less transitionary noise needed for working capital.

15:55So I'd say for that, right, it's usually then for a deal of this size, I would say that the whip remains in there. So it's like historically, if you do$500 ,000 of work without invoicing or collecting from the customers, that stays with the business. If it doesn't stay with the business, which you run into is that the buyer will have to boot out that money to the seller at closing. If it's at 500K, then they need to bring an extra 500K to closing, or they'll pay it after 90 days or however it is, or just tag it onto their loan. And then this will have to bring 20 % of that and finance 80 % or whatever it is.

16:29The other big issue I see on these is retainage. So in the construction industry, and Josh, you can talk more about this. We have regular AR, but we also have this like long dated AR that everybody just kind of knows is out there. That's called retainage. That is usually somewhere between like five and 10 % of the total job. And those could be paid like a year later, depending on what you're doing. Yeah. A hundred percent. And I'd say that follows the same mentality of just whichever you're going to do for AR, right? Where it's like, well, if the company average is a hundred KM retainage, well, you're going to have that.

17:02And it's not, and that's where most this working capital discussion comes into like cash flow, right? Like what's the immediate cash need for the buyer to have their business like steady state going forward. So a lot of it is transitionary. But with the retainage, it's the same thing, except again, like you're saying a little more age, but also, and get me honest with that, but there's sometimes work you need to do, right? That's why they retain it because you have, you know, something, some punch list items you need to complete. So that I say a hundred percent, the retainage makes a lot more sense to keep in there because there could be additional costs for that.

17:35So the other thing with this, so I think at face value, 52 million looks like a lot of backlog. Heather made the point right away. I mean, you're basically at a year's revenue. If you're a general contractor and you don't have work booked a year out, you're dying. These are long lead time projects. They've got architects engaged. They've already procured funding. There is a long sales cycle. And so for every general contractor, there is a cliff. Usually you want to see it like 18 to 24 months out, depending on the nature of the work. But this backlog, like it's amazing sticker shock in a good way.

18:13But then when you dig, it's maybe not as good. I would also be really curious if this business has significant customer concentration because of the nature of these contracts. Yeah. Lumpy project work is what we lenders like to call it. So it's lumpy project work, but it's also contracted on three to five year contracts, right? So like it could be worse is what I'm saying. They're usually like task order contracts or multiple award task order contracts, MATOX, or IDIQ, indefinite delivery, indefinite quantity. So they may say, look, we don't want to have to go out to the general public and post bids every time we need a toilet partition replaced in the airport bathroom.

19:00But what we're going to do is we're going to do a request for proposals or a request for qualifications and pre-qualify a certain number of contractors. And we've got a pot of money that's, let's just say it's$10 million that we will award multiple task orders out underneath that, but you've got to get pre-qualified. You have to be on the list in order to receive those solicitations. So all of this just, I think, highlights the complexity of it. From a contract standpoint, the difficulty is these are probably not assignable in a very clean cut way. Most of these contracts, like we sign them as a subcontractor, they don't allow for assignment without mutual consent.

19:43And also they have change of control provisions to say, you can't just assume the ownership of that entity, like a stock purchase versus an asset purchase. But we want to know if there's any more than a 20 % change of ownership. Are you ready to take a leap into business ownership, but you don't know where to start? Well, look no further than Acquisition Lab, the premier resource for entrepreneurs seeking to buy their dream business. Founded by Harvard MBA and acquisition expert, Walker Deibel, the lab is your fast track to success in the search diligence and acquisition process. With hands-on support, world-class resources, and a community of like-minded entrepreneurs, Acquisition Lab gives you the tools and confidence to navigate every step of the journey.

20:23And we're proud to call Walker and Chelsea, the Lab's director, long-time friends of the podcast. They're passionate about helping entrepreneurs like you take the next big step. So don't wait to make your business ownership dream a reality. Visit AcquisitionLab.com today to learn more and schedule your free consultation. And when you do, be sure to tell them the Acquisitions Anonymous podcast sent you. There's timing considerations too when you're trying to buy a business like this in terms of like where are they in the process of these larger contracts. What I found, I have never funded a contractor this large, but smaller contractors, you ideally want to time at a time of the year like say around Christmas or the end of the year where the contracts would be at a low point.

21:06Things would have been wrapped up and you haven't really started new contracts. And maybe it's different in this location or, you know, the seasonality is a little bit different. But it's very tough to figure out what's the right time to close on a business like this if they've got large work in process going on. Absolutely. Right in the close, yeah. Is this financeable? You know, it's definitely not SBA. We'll start there because it's too big. But if we shrunk it down and we tried to go smaller, it's really challenging for banks to finance this kind of business. If they're going to do it at all, number one, they want the buyer to be experienced.

21:45You know, like sort of as teased here, a strategic buyer could maybe finance it. That's much easier. But a first-time buyer would have to have a lot of experience in this space, in the exact industry, have the licenses required that the seller probably has now. And then, even then, the bank will want to be pretty low leverage relative. like they'd go much higher leverage on other types of businesses this type of business they would want to stay safe if they're going to do it at all at like two turns or two and a half turns of EBITDA at the most yeah Josh do you feel like on businesses like this there's a really big gap between the stated EBITDA and the real cash flow um so I'll say a lot of times it depends on the broker.

22:30That's kind of how it goes, right? With how much detail they do into it. I'd say by far the bigger gap is the working capital with this, where it's just like the seller doesn't want to leave it, but the buyer can't front the cash to do it, right? Most of the engagements that we're on, I don't have the numbers up in front of me, but most of the time we find, I'll say, a variance greater than 5%, maybe like 50 % of the time or 60 % of the time, just historically. A lot of that comes down to judgments and also on the ad backs too, where it's like, okay, you're going to, I had a government contractor that I did, I think it was in July, where the guy added back a bunch of one-time contract expenses, but he had, all of his contracts were different, but he always had contracts, right?

23:13So it's not really one time, it's assigned to the revenue. So things like that could get kind of complicated for people in a way where they're trying to be very aggressive with their ad backs without seeing the sim. I can't really give a quick sniff test of it. Um, but a lot of, a lot of what I would recommend anyway, looking into due diligence around their P and L is looking at what's called to as their whip schedules. If again, if it's that longer term, right? So what you'll see is, okay, what's the total costs they estimate for the full project? What is the total cost they've incurred to date?

23:44And then what percent complete are they? And then they compare that to the percent that they've actually built. And then that's how you make sure on an accrual basis, you're okay. Um, the reason why I'd say that's the most important thing. And again, this is a larger deal. So I assume they have a good accounting team there that's looking at it. But if not, what we tend to find is that maybe they did their SIM on the cash basis tax returns. Right. So that's going to be a huge difference from the actual, you know, what was quote unquote earned by the business. Right. I did in another electrical contractor.

24:14I think we wrapped it up this month where they were advertising 400 K SDE, 800 K and then 1.8 million the next year, like huge growth. but it was because they were on that cash basis type accounting, right? As opposed to getting their WIP schedules and their actual accrual. So we saw it was about a million each with a decrease in$1.12 million. So that was a much different conversation, which the lender didn't really identify either. So it was a pretty bad potential issue for our clients. And so what Josh is talking about with this, like with WIP, work in progress, as the buyer, if you're not deep diving into every single one of those job costs, like the job codes and looking at what's been billed to date, the seller maybe intentionally or unintentionally could be aggressively billing those jobs.

25:02And then if, you know, in that true up, you would have, you would have a liability on your balance sheet that says, you know, billings in excess of cost, right. I think is the category code where you've got to make sure that if they've billed ahead, like if they build at 90%, but they've only completed 75 % of the work, you could be left holding the bag post-close where you're like, wait a second, I can't bill anymore on this job and I'm still behind. You said something really interesting to me because you said the lender didn't even pick it up and your QOV actually adjusted that million eight down to a million.

25:35I think that's really a selling point for lenders to get better at reading QOVs and interacting with the QOV vendor so that they do understand these things. Because I see that a lot. I do see that a lot where I think sometimes the buyer is getting a better understanding of the numbers from their QOV vendor and the lenders just sitting there staring at a tax return or whatever and not digging in. Yeah, sometimes it's a little awkward, I'll say, because in that deal, we did the QOV, we told our client, reported it all back, walked him through it all, and then we didn't hear from him for two weeks and he comes back to us because he said, the bank saw it and now they're having issues.

26:12And it's like, yeah, well, they obviously did their tax return analysis without considering the full thing. But obviously, we want to give the clients the best picture of the actual business, not necessarily what's fundable from a bank perspective. Which is important. When you get a QAV, who is the client? The client is the buyer. You're trying to be as truthful as possible. And it's not always the case that that QAV gets shared with the bank if the buyer is your client. Right, Josh? Well, 100%. So like on our, on our product, what we do is we document the risks that, you know, sometimes I write the financial documents were very messy.