200 - Crucial Red Flags to Know When Buying and Selling Businesses with Clint Fiore

0:00Business brokers have somewhat a well-earned, bad reputation. Every other broker treats the sellers like the customer and the buyers like nuisances. They take them for granted, but we want to flip that script and create the most buyer-friendly platform there is. Then we guarantee we'll get you an offer in 90 days or less for your company. And if we don't deliver, I'll give you$10 ,000.

0:25All right, Clint, I am super excited to talk to you. Let me give the listeners a quick rundown on your background and experience, which is extensive. You are the founder and CEO of Bison Business, which is a brokerage and M &A firm. You've also just founded, launched, raised money for Dealonomy, which is now a new deal platform, which we're going to get into, which I think is incredible. You've been a partner in a Texas-based 50-employee manufacturing company. You've sold and bought many businesses yourself. You've raised seven figures from angel investors. You've done over 500 deals. at least your company has more than a hundred million dollars in enterprise value.

0:58Probably if you wouldn't add it, all those up, you're probably close to the billion dollar mark, I'm assuming, but you're incredibly experienced in the business buying space. And the first question I want to ask you is what is the craziest deal you've ever seen? That's not, it's not a fair question. There's too many of them. You know, some of them, the craziest ones were just the normal deals that went crazy on us. And then we have kind of sub genres that would just be really weird, weird and wacky business models that you've never heard of. Let me introduce one to you that I thought was really interesting.

1:30It's a story that I read a while ago and it has always kind of stuck with me. I went back and found it as well. It was a story about a seller who was in his seventies and he was selling to these people who were forties or fifties. I can't remember, but they were well capitalized and the seller did everything possible to sort of self-sabotage and you massage the deal, massage the deal, got it closed. Is this ringing a bell? No. So you massage the deal, massage the deal to the point where the seller was like pissed off at you when it closed. Yeah. And you were sitting there looking like, dude, I just saved your retirement.

2:06These guys didn't need your business. And you're mad at me. It's like, I've had a few times like that with sellers in their seventies or so and big egos. And by the end of the deal, you know, I was sell side on them. So I'm representing them, but they keep doing things to try to change the deal at the last minute and just in generally make everyone's life miserable, push back on all the documents. You know, they'll eventually they say, whose side are you on here? You know, like, are you on my side or not? And I'm saying I am on your side by trying to actually get this deal to close and the behavior you're exhibiting here is going to kill your deal.

2:44And so me pushing back is me trying to help you because you're going to run this buyer off. You're going to run this bank off and, and you're going to have nothing to show for it. And then we're going to be dead in the water starting back over from zero. And you've told me you can't do this again, you know, and that's kind of happened over the years. I started pretty young in this business and a lot of my sellers were a lot older than me. And I'm, I feel like I click with the buyers a little bit more in general because they were like younger, ambitious, kind of playing offense in life. And I feel like a lot of the older sellers, especially we're kind of playing defense and I'm an offensive player by nature, which means I'm ambitious, growth minded and optimistic.

3:23And you have some of these people that have held on too long. And they're at this point, they're pessimistic, defensive, and, you know, kind of cantankerous in their personalities. And so, so eventually, you know, when we get into a deep into a deal, I'd end up being best friends with the buyers because they were just kind of like my kind of people, great people doing their best to get this deal done. And when the seller inevitably goes out with their golf buddies or their CPA or their attorney and starts getting somebody feeding them bad information in their ear who, you know, the peanut gallery will always tell these guys, you know, you're giving your company away.

3:59You shouldn't do any seller financing. What are you doing? You, you can get way more than that. And, you know, people will always say, tell them what they want to hear, but no one will actually write the check for more than what we have it under contract for. Yeah. If the wrong voice gets in their ear, all of a sudden they start second guessing the deal and pushing back. And then I've got to change my relationship from being their advocate to being their kind of referee and supervisor to keep them in line. There is like that healthy tension of, from the seller's perspective of like, I shouldn't even say healthy tension.

4:33I understand the skepticism from the seller's perspective of like, well, you just want this deal to close Clint so you can get paid. But what they don't take into account is because for many of them, this is probably the first deal or at least the biggest deal they've ever done. It's not like they're sitting, they aren't deal people for these SMBs. So they don't understand the natural flow of a deal. It's going to die two times. Everybody feels like they're giving up more than the other person. For them, it's so personal. And you've got to play like therapist, referee, advocate, mathematician, you know, all things kind of rolled into one.

5:05You definitely earn your money, I will say, as a broker. It's not an easy job. Yeah, people want to think it's about the dollars and cents, but it's the emotional side and the therapist side of this. And just dealing with those creeping doubts and the cold feet is a huge part of it. And I'd say it's almost the more important part of the deal making than the dollars and cents sometimes. All right, so here's what I want to cover today. I think it'd be really fun. I want to go through from a broker's perspective, what are the top five red or green flags, however we want to say it, that you look for when a seller comes to you and says, hey, I want to sell my business.

5:41And then what are the top five, let's say, red flags you look for when a buyer comes to you and says, hey, I'm looking for a business to buy or I'm interested in XYZ business. And then I want to ask you as a buyer, not as a broker, what would be the top five red flags you would look for in a business as you're looking to buy it since you have so much experience looking at tons of deals. If we get time, I want to know like the top five things that blow deals up as they go. And then I want to talk through how you've taken all this, you know, 20 years of brokerage experience and why you're launching a new platform, DeLonomy.

6:18I think anybody who's listening who has gone on Biz by Sell or any of these websites has had the thought in their head like, man, why isn't there a better place? Why isn't there a better marketplace for buyers and sellers to connect? You not only had that thought, but you've actually gone and raised money and launched a platform. And so I want to talk about like, what is that? How does that work? The why behind it? So does that sound fair? Is that? Sounds great. Yeah, it sounds great. Like a great way we can help people out to learn this, this space. It's a very cloak and dagger, smoky back room kind of industry that most people don't understand.

6:48They've never been on the inside of it. And I think that's why I took off on social media originally was like, I have no problems just kind of peeling back that curtain and saying, here's how it works. And I love teaching about it, explaining about it. And hopefully we can do some tips today that'll help the listeners. Okay. As a broker, when a seller comes to you and is like, Hey, I'm looking for, looking to sell my business. What are some of the red flags that you look for up front? the biggest thing I want to know immediately is why like why are you wanting to sell your business in the small business world so and I'm going to asterisk this most of what I'm going to be talking about on this show is going to be like the seven figure size deal which is like the premium main street mom and pop business that's going to be owned by you know privately held small bootstrapped owner that built it themselves.

7:44And like, that's what the typical deal we do is like that, that seven figure deal. Sometimes we do eight figure deals, but we work at kind of premium main street world, the economics of these deals until you get into the middle market, you know, into the eight, nine figure deals, the multiples aren't very big in our space. So you're talking two, three, four, five X multiples. That's a multiple of what that earn of what that owner benefits from owning the company each year. And when you tell this owner, I can get you three X or four X. Hey, I don't know if you remember this, but when we started this podcast, we entered into a social contract.

8:22I would spend time, energy, and money producing this podcast, interviewing these individuals and giving you insights into how to build, buy, start, grow your business. and you would like subscribe and leave me five-star review. Now out of that, we both get to talk to really cool people and hear really cool insights. We both get a ton of value, but I just want to help you keep your word. So would you do me a favor? We go leave a five-star review for me on Apple or Spotify. It would really help. And if you want, even share this with a friend. The natural thing is that sucks. Cause I could just not sell in, in three or four years, I make that much.

9:00And so why would I want to do that? And that's, I flipped back motion back on then. I'm like, yeah, why would you want to do that? You know, like you tell me, you came to me. Yeah. Yeah. Cause from your perspective, if you spend a ton of time and energy marketing and then they're just, they're not in the headspace for it, then that's kind of not a waste of time, but it's makes your job way harder. Yeah. And so I look for a big why, like if the biggest red flag for me is if the seller comes to me and they don't have they can't articulate a reason they want to sell their business that means there's something under the surface it means they're either like scared and burnt out but they're too proud to admit it or there's something wrong with the business that they're not sharing or there's something going you know like they're not being honest with me because I'll be honest with them and I'll let them know the economic reality.

9:55And, you know, nine times out of 10, it's not worth as much as they wish it was worth. And we have to kind of tactfully, gracefully pop that valuation bubble and let them know where these companies trade, which is not the same multiples as middle market or public companies. And so if I don't hear a really well articulated reason as to why I need or want to sell this business that makes total sense to me. That's my first big red flag. So I always look for most. Interesting. Can I ask a quick question on the multiples? Lots of times you'll see SDE, cashflow, EBITDA. And for these deals, many times it's interchangeable.

10:34What number do you look at? Are you like, I guess, let's define SDE first. And then for you, what number do you look at as you're setting that multiple in valuation. Yeah, those multiples I was describing aren't EBITDA multiples. Those are SDE multiples. And in the Main Street world, SDE is kind of king in our world. And that's how SBA lenders like to lend on as the SDE approach. But EBITDA is the most popular metric for kind of the middle market world. And that's earnings before interest, taxes, depreciation, and amortization. And you can compare companies side by side on a debt-free basis. So it kind of takes away their capital structure considerations.

11:12The problem with EBITDA and Mainstreet is it doesn't account for the owner's pay perks and benefits and their use of the business as kind of their personal piggy bank with their discretionary spending and things like that, which is much more prevalent on the smaller deals. And the owner's comp and perks and discretionary spending is usually a much bigger part of the earnings stream than on the middle market companies that have professional management managing the company and don't need as many of those adjustments. And so if you understand EBITDA as just a way you can look at companies on an apples to apples basis based on their earnings power, SDE just takes it a step further and it adds back that owner's benefit.

11:59So we start with net profit, then we do the EBITDA adjustments, and then we add back the owner's salary, the payroll taxes associated with the owner's salary, their benefits that they get through the company. And if there's any large, like one-time discretionary purchases that the company made that aren't going to be applicable to the buyer that we can document and defend, we'll add those back too. And basically what we're trying to get to is when we do that work, that's called a financial recast. You should be able to see as the buyer, okay, if you own this company and you didn't have any debt on it and you came in and you filled the owner's shoes and you were working full-time and you paid yourself zero dollars you were working full-time you had no debt and you only paid the necessary expenses for this company what's the maximum amount of earnings that was the profit that this thing could make on a normal year so like that's what SDE is that's a lot of adjustments to get there and it's a big earnings number and that makes it low multiples because we do so many adjustments to get there.

13:06But I think it's needed to really look at small businesses accurately is you have to get comfortable with that math because that number, that SDE is ultimately what you have to back out your salary. Because remember, we said SDE is paying yourself zero working full time. So what do you want to make? What do you want to pay yourself that has to come out of SDE? What's going to be your debt service that's going to come out of SDE. We build up that fire hose of income in SDE and then we back out of it the buyer's debt payments and their compensation. And then that tells us what the cash is going to be afterwards.

13:42Yeah. And part of the way that I look at it is like, like you're saying in the middle market, for the most part, those businesses are going to have a professional management. So a CEO that isn't necessarily the owner who's exiting for these businesses,$10 million and below the owner is the CEO. But on top of that, they're passing through a bunch of benefits that would not be normal in a middle market transaction. So there can be some haggling of like, well, I don't like the SDE number because I'm going to still have to put money big in for a CEO, blah, blah, blah. But there's usually still a lot of fat associated with, oh, the seller took their family to Hawaii, but there was a conference there.

14:18Oh, so they wrote it all off. That's not really, we can add that piece back in. Oh, and they've got three cars on the business. Yeah, we can add those pieces back in. So it makes sense to me. In your experience right now, what is a normal range of multiples for SDE in those businesses that are$10 million and below enterprise value? Is it the same as like an EBITDA multiple that people just use interchangeably? No, SDE multiples are lower. They're roughly about a turn less than an EBITDA. It's pretty common to see EBITDA multiples of like four to six and SDE multiples of like three to five. but I'd say most commonly it's around three, three or four, you know, the bigger the deal, the bigger the multiple, the more consistent the earnings, the bigger the multiple.

15:00And when you have a small deal and you have lumpy project-based revenue and things like that, then you end up getting the low end of that range versus the really dialed in business with recurring revenue that gets you the higher end of that range. In my experience, usually the higher multiples for those businesses that have a real moat, they have consistency, they have a professional management team in place. It's a more sure bet than the smaller businesses, which trade for lower multiples because they're just a little bit riskier than if you go upmarket. So that's the first red flag. Why the heck are they selling?

15:32I think that's a great one. What's number two? What's another red flag? If they haven't been running their business like they're thinking about selling it, that's usually reflected in their accounting. So it's best seen in their books. the typical like boomer owner that's been in business a long long time they become masters of proving to the irs they don't make any money yeah and they've got a million tricks of how to do that and and that can be very detrimental to trying to sell your business because we have to prove you do make money and the first things that banks and buyers want to see is your tax returns you're too good at that game.

16:17It really cuts deep on the valuation. And so I like the green flag for me is if you've run your business, especially in the last three to five years, knowing that you're going to sell it and that you need to have your books accurate, you're going to need to show profit and be able to prove everything up and not have a lot of shady, funny business going on. It's like the mindset of, are you viewing this business as an asset that you're going to be transferring to someone else and that you're going to have scrutiny on from banks and buyers? Or have you just been forever running it with the cat and mouse IRS game as your sole goal in life and with zero thought that anyone's going to actually look under the hood here?

17:00And we get a lot of those. And those can be extremely difficult to sell. There's kind of a right way and wrong way to do it because you can take a lot of legal deductions and have your cake and eat it too and still I have ad backs and still get I have something I want to show I have something I want to show you so video is cool but I have what scientists call a face for radio and so it's even cooler is long form audio via my podcast and my newsletter nickonomicspod.com go there for free subscribe to my newsletter it's one email per week super tactical and then go to my audio podcast I do three to five episodes a week depending on how curious I am and it's stuff like this.

17:37It's all free. No sleazy sales pitches. Nickonomicspod.com. A tweet of yours that I had up for this conversation. The CPA says, this business doesn't make any money, but the business buys the owner a new platinum F-350 every three years. The supplier takes business owner deep sea fishing in Cabo annually. The entire family is on payroll. There's a Vegas trip expensed for the industry conference and$30 ,000 a year in credit card rewards. It's like exactly what you're talking about. Yep. All those are pretty good ones. You know, like, like I can usually get you paid. I can usually get you paid on most of those.

18:12That's what I was saying. There's like a right way and a wrong way to play this game. This is not illegal. Just to be clear, this is not illegal. This is just what you were talking about. You don't want to pay taxes. And so you're running through as many expenses through the business as possible. And these all should be add backs to the business. Yeah. And when a financial nerd doesn't have, you know, a street smart entrepreneurial business broker running point on like what these ad backs are and why they're legit and why every business owner does this and why these expenses aren't necessary business expenses that are going to ding the buyer because you don't have to do that you know that family is not going to be on the payroll the college kid of the owner that's the social media manager that's making 40 grand a year posting a few times like you're not going to pay them 40 grand a year to post a few times like no any of those things that don't apply so you have to make sure you're able to explain every ad back and explain it in a way that's believable and it's defensible and that would survive irs scrutiny but there's a wrong way to do it and that's the part that sucks is when i get people like i literally had a call last week and and it was a cold lead like he didn't know me from anybody within five minutes of talking he's admitting to probably a million dollars of tax fraud like oh no I mean and this is stuff that like I can't get you paid on that is yeah black hat stuff and it was like yeah my books say I'm making a million a year or my tax returns I'm paying taxes on a million a year but I'm really making about two million a year because and he starts rattling off all the things he's doing and it was things like yeah I've got a lake house and we just we spent 250 ,000 rebuilding the dock I expensed all that through the company but it was like his personal vacation home oh no i don't want to know about that and i don't want to like you're never going to admit that to to like the banks and people get too cozy with that because they've gotten away with it and i don't want to hear about that kind of stuff and i tell people you can only steal it once this is my line for that so if you're stealing from the irs that's your you don't get to steal it from the buyer too like you don't get to get paid on that closing.

20:29And it's actually really foolish too, because not only is it just wrong and illegal, but it's stepping over dollars to pick up dimes. Let me give you an example. The$100 ,000, let's just use for easy numbers. You, you expense the$100 ,000 house remodel. Maybe you have like a, a construction company that does construction remodeling other people's houses, remodeling, you remodeled your vacation home and you used your cruise and you know so like the payroll for all that the expenses for all that were all expensed in your business but you didn't pay yours you didn't actually claim that as a income on your yeah exactly so maybe that adds a hundred thousand dollars of expense with zero dollars of revenue tied to it so that what does that do that reduces is your bottom line by a hundred grand and you think you're smart because you're, you save a hundred, a hundred thousand dollars of taxable income.

21:27And if you're, let's say your real tax rate is like 25 % or 28%, something like that. You think you're a genius because you just saved $25 ,000 in taxes by pulling that shenanigan off. But when we go to sell your business, if we're running at a four X multiple, you just sacrifice$400 ,000 of business value to save$25 ,000 of taxes? What would you rather have? $400 ,000, Mr. Jones or$25 ,000? That's why I say you step over dollars to pick up dimes when you're pulling that BS, especially in your last few years of ownership. It's a completely false choice that you're not doing the right thing. It's funny because as a buyer, I've had multiple of those occasions.

22:09I actually like those because number one, it makes the bank the bad guy. Cause I'm like, Oh, Mr. Jones, I'd love to pay that price, but the bank won't underwrite that because it's not taxable income. And then it puts you as a buyer, like in a better position. Cause you're like, okay, well, I know that's coming, right? Because he was treating things the wrong way. So I can get to the higher end of a justifiable, you know, bank underwritten valuation and feel comfortable with that because I know they've been playing some games. So as a buyer, sometimes I'm like excited about it. Obviously there can be downsides.

22:43I bought a business once. I'll try not to get too in detail about it. They had some fraud that I didn't know about. And the IRS came in and because it's a healthcare company, the healthcare number is tied to the entity, even though we did an asset sale, they garnished our bank. Like they, they froze our bank accounts and they took what was owed to them from the seller out of our bank accounts. It was a couple million dollars and it almost crushed us. It was terrible. So anyways, you may think that you're getting away with it in the short term, but in the long run, somebody's got to pay the price.

23:15And many times, like you said, the buyer shouldn't be paying the price for that. Yeah. And a lot of that does work out in the buyer's favor. They're being too aggressive on their tax mitigation or tax avoidance strategy. You may find there's more money there than you thought. I have found as I've gotten older that I think that people over index on taxes where they're like playing this game of like okay well they're going to optimize the taxes in the most efficient and best way possible and like there's a space for that but there does come a point where you're just over engineering and you're kind of wasting mental capacity my parents my mom and uncle who owned our family business our nursery garden center in texas were the exhibit a on that like they every time so the nursery business is very seasonal and it's also feast or famine based on the weather and all kinds of things is you have good years and bad years.

24:07And, you know, they're always borrowing money to pay for the inventory buildup before, because they make all their money in the spring and they have to borrow money to fill up the greenhouses with inventory. And then they hope that at the end of spring, they pay off all the revolving debt and have enough to survive through the negative cashflow months of the hot summer months when nobody's buying plants and get to the Christmas sales and then to the next spring. And so you're always riding that cash cycle and you're paying the banks tons of interest on revolving credit to support your inventory, breathing in and out at the nursery.

24:46And I was like, man, why don't y 'all ever just save some money and not have to borrow for him? Like have to keep borrowing. But what they would end up doing is anytime they had a good year where they could have gotten out of that revolving debt once and for all and just become their own bank for their own inventory they'd always just go buy a bunch of crap because they they knew about schedule 179 accelerated depreciation right they would literally have this conversation with their cpas in november december every year and if they're like all right are we gonna owe taxes yeah you had a good year it looks like you're gonna owe taxes okay let's go down to the car dealership and they just go they go buy brand new trucks suvs equipment and their whole goal was just to not have to pay taxes but what ends up happening over time is your balance sheet gets bloated with all this crap that you bought but you never actually have cash and you never have and you always are paying the banks tons of interest and i'm like guys you are making banks all the money because you're paying they're getting loans on the cars they're getting loans for the inventory they're paying all this interest on all these things and i'm like guys you got to get on the other side of this debt power curve you're on the wrong side of this and this is why you never have money is because you're paying the banks all this money every year but it was because they're letting the tax tail wag the dog is what i would call that is they're so worried about if they show a few hundred grand of profit and they leave hundreds of thousands of dollars in the bank so they have like more money and could be their own bank they'd have to pay taxes and That's their worst nightmare.

26:22So guys, if you're listening to this and you're a business owner, there's worse freaking things than paying taxes. Paying taxes means you're doing something right. It means you're making money. And yes, be smart about it. Like take all the write-offs you can, but don't do it at the expense of never getting ahead in life because you're so afraid of paying taxes. All right. Those are two red flags, which I like. Let's flip to the buyer side. So as you are going to market, you've listed this business. what are like the biggest red flags you see or you look for when a buyer approaches you and says, Hey, Clint, I'd like to see your SIM.

26:58Yeah. Yeah. You know, most brokers like really heavily index and we do too, to an extent on just, do you have any money? Why is that important? I can't overemphasize the, how much brokers like it when you have money, when you show up to a deal. That's usually the first thing is most people are borrowing to buy a business on main street deals, but you have to have a down payment. And so like the first thing most brokers try to do is screen you with, they're going to ask you for your net worth, your liquidity or personal financial statement, or some indication that you're financially qualified for this deal.

27:42Because we all have lots and lots of buyers coming at us and the hardest buyers to get across the finish line are ones that just are so thin on their financial firepower that they're you know scraping the couch cushions to try to get the down payment and trying to raise friends and family money after the fact after the LOI which adds time and deal risk and so I would say being cagey about that answer is a red flag so when I hear buyers we'll ask you a lot of times first conversation of let's role play I'll ask you so Clint do you have enough money to put down to buy this business I can get it

28:24that's the worst answer stuff like that that's the right answer are you alone shark oh my gosh people say that I can get it yeah they say you know good deals good deals have no problem getting capital and there's people that teach that and it's it's to an extent it's true but not if you're a loser that's never done it before like i've raised money i know it can be done i've raised seven figures for pre-revenue startups from angel investors three times so if anybody knows money can be raised it's me I know that's a thing that happens but for a small business transaction the especially if you're going to go the SBA route they've got to see seasoned funds you know they're like they've been sitting in an account they know where they came from and if you don't have that lined up personally you better know who your financial partner is and introduce them right away and I'm and show us the down payment you ask me the question now and I'm going to be someone who doesn't have the money and you tell me if this is the right answer.