Summary

Patrick O'Connell, a quality of earnings specialist, discusses the importance of analyzing the true earnings potential of a business before buying or selling. He highlights five red flags to watch out for in a potential deal: pending lawsuits, high employee turnover, inconsistent financials, declining market share, and key dependence on a few customers. Patrick emphasizes the need for thorough due diligence and understanding the story behind the numbers. He also provides insights into evaluating two specific deals, a tech wholesaler and a medical tech blog.

Takeaways

Quality of earnings analysis is crucial to understand the true earnings potential of a business before buying or selling.
Red flags to watch out for in a potential deal include pending lawsuits, high employee turnover, inconsistent financials, declining market share, and key dependence on a few customers.
Thorough due diligence is necessary to uncover the story behind the numbers and assess the risks and opportunities of a deal.
Understanding the secret sauce and unique value proposition of a business is essential for future success as a new owner.
Valuations and deal structures depend on various factors, including industry dynamics, profitability, growth potential, and buyer-seller dynamics.

 

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Transcript 

Jon (00:00.827)
Welcome to Top &A Entrepreneurs. Today my guest is Patrick O 'Connell. Patrick runs a quality of earnings business. He's been in the private equity world 10, 15 plus years, kind of went out on his own. And he goes by the name SMB Deal Guy on X. Welcome to the show, Patrick.

Patrick O'Connell (00:20.962)
Thanks for having me, John. Let's get into it.

Jon (00:23.087)
Yeah, I want to talk to you about a number of things here, a little bit about what quality of earnings, what you did, how many people you saved with the quality of earnings report. And you got a video on your site about the five business buying red flags. So that, and I have a couple tests for you. I got a couple deals we are looking at, and then I want to get your score on those. So let's talk about that. Tell me a little bit about quality of earnings, what it means, know, what kind of...

Patrick O'Connell (00:47.97)
Let's do it.

Jon (00:52.793)
what it means to the buyer, what it means to the seller.

Patrick O'Connell (00:55.778)
Yeah, absolutely. I'll give you listeners just a quick overview of who I am and the people I serve. So I help people buy, sell, and operate enduringly profitable businesses. Started the bulk of my career in private equity, supporting equity groups, portfolio companies, and investment banks in quality of earnings analysis and a few transaction advisory firms.

To date and most recently, I am the managing director of O 'Connell Advisory Group. We are Q of E specialists in Main Street and lower middle market deals, helping entrepreneurs, small capital groups, and independent sponsors buy and sell businesses.

Jon (01:40.335)
Yeah. Now, that any, is that SBA, Paripassu, or is it just middle market? You've got capital from a fund or private equity.

Patrick O'Connell (01:49.026)
Yeah, great question. So we do a mixture of both, you know, SBA loans as well as traditional independent sponsors.

Jon (01:56.123)
Great. So what does the quality of earnings guy, your skills do for somebody? you know, we know what it says. The moniker is quality of earnings, right? What is the quality of earnings? How do you

Patrick O'Connell (02:12.982)
Yeah, so the quality of earnings, it really is an analysis and over the course of three to four weeks to really identify and understand the true earnings potential of a business. How do we unpack that? Over a historical period, typically the last three years, three to five years, we analyze the income statement and balance sheets of the company, hold several management meetings to understand

the intricacies of the business, and what is a normalized earnings the new buyer should expect on a go -forward basis.

Jon (02:50.363)
Here's the question, if the guy, the buyer signs an LOI, you do a quality of earnings and that could be higher or lower or spot on to the valuation, how does that change your offer?

Patrick O'Connell (03:04.46)
Yeah, it's a good question. So typically a buyer will submit an LOI based on marketing materials in a SIM that the owner and the broker present. The quality of earnings is essentially a verification process to confirm that the numbers presented in the SIM and marketing materials actually reflect what's reported in their QuickBooks or financial system.

Jon (03:32.699)
Okay, and if it's lower, how do they make adjustments to the valuation?

Patrick O'Connell (03:39.5)
Yeah, so based on the conclusion of our findings, if there are discrepancies in reported net incomes, the valuation and the purchase price may be adjusted higher or lower. In the business and industry, this is often referred to as a retrade. Now, I'm not saying I come on here and I encourage retrades because those sometimes can hinder deal optics, but...

Jon (04:06.565)
Yeah.

Patrick O'Connell (04:07.658)
Ultimately, that is the quality of earnings. It confirms the numbers and the financial data which you submitted a bid on in that LOI phase.

Jon (04:16.601)
Right. Yeah. Is it more often than not lower in quality of earnings versus higher and go, geez, you're actually earning more money than you thought.

Patrick O'Connell (04:27.828)
Yeah, it's typically there are some shortfalls where the marketing materials may have presented the business in a more profitable state compared to the actuality. There are intricacies such as if we unpack the net income, we also look on a balance sheet standpoint from a networking capital basis. What does that look like? Because that's a key negotiating point as well.

We could probably do a whole podcast just on how to negotiate working capital in terms of where it fits into this deal picture, but that is essentially the procedures we're performing.

Jon (05:07.419)
Yeah, I'm to go off on a tangent on the networking capital because a lot of the SMB people below five million bucks, they believe that the networking capital, anything in the balance sheet or AR or in the cash in the bank, they believe that's theirs. But if you move up and if this is true, there's a little more education about the seller going, you need to leave networking capital in there depending on what the turns of the business are.

Patrick O'Connell (05:36.3)
Right, yes, there's a lot of schools of thought. It depends on the deal optics and size. Typically smaller deals, you may leave out working capital. So essentially at the time of close, the seller will keep any receivables and he'll just make sure there's debt paid off. It really depends on how you wanna structure the deals and what both parties think makes sense at the time of closing.

Jon (05:56.261)
Yeah.

Jon (06:03.738)
Yeah.

Yeah, here's the challenge with this is I've done an analysis. So if the guy took out all of the working capital and it was $500 ,000, if they were to borrow that and pay it off in 10 years, it equates to almost $900 ,000 at the current interest rate. So that is not ideal.

Patrick O'Connell (06:27.566)
Yeah, so that's never ideal. And that's why that piece, the networking capital is often where experts such as myself add the most value. Because if you were to go on your own and do a DIY quality of earnings, you may in the short term save money. But if we go back to that example, you actually have lost $400 ,000 if you had to draw on a line of credit for 500 ,000, which turns into nine.

Jon (06:37.239)
Right.

Patrick O'Connell (06:57.678)
Whereas this is what my recommendation would be if The seller wasn't he wasn't interested in doing working capital you could do something whereas he leaves 400 ,000 of cash in the bank Compared to receivables and that stickiness like that could be a quick way to fix this

Jon (07:17.851)
Yeah, quick way. And there's a little education on your part. Do you ever get involved in educating the seller? It goes like, you need to leave $400 ,000 in the, whereas the buyer does that with the broker.

Patrick O'Connell (07:29.61)
No, I certainly lead these conversations because the role that I take as the third party, independent, non -equity partner in this is I explain the concepts, weigh the pros and cons, and then we come to an agreement of what makes sense. If I try to tell the seller what to do, that's never going to work. He needs to understand

why we want to do this, why it'll benefit the buyer, and if he doesn't want to do this, what are the implications? These need to be open dialogues. So those working capital conversations will typically take place in the last week of the core of our engagement.

Jon (08:06.937)
Right.

Jon (08:16.727)
Right. All right. So I got a good understanding of this and now you have a pretty interesting video on your site, the five business buying red flags. Let's go through these one at a time. Number one.

Patrick O'Connell (08:29.838)
Pending lawsuits. Pending lawsuits are a big deal point. So I'll give you an example and I shared this in my video. If the company has ongoing lawsuits that may be subject to a certain number of liabilities in terms of dollars, buyers, they need to think about this. For example, if they had three open lawsuits for $100 ,000 each, the buyer could be subject to $300 ,000 of a liability.

Jon (08:31.929)
Right.

Patrick O'Connell (08:59.368)
After the transaction closes, they assume the roles of the new owner, but these issues were from the old owner. So they need to think about.

Jon (09:08.271)
Yeah, and you adjust for those in the, if they're still open and unresolved, non -settled, you adjust for those in the asset purchase agreement, right?

Patrick O'Connell (09:17.646)
Correct. So there's two ways you typically could do it. You can either directly reduce the purchase price by these pending lawsuits if it's likely that they're going to resolve in $300 ,000 of payments, or you could hold them in escrow with a third party attorney. And as these fees come up, if they do, they're quickly paid outside of this escrow fees.

Jon (09:43.109)
Yeah. Does that include lawsuits from the IRS or is that just a malpractice or something? mean, know, lawsuits from an individual or from stock or an employee.

Patrick O'Connell (09:58.55)
Yeah, unfortunately, pending lawsuits is a vague term. They could look like things such as employee conflicts. An employee that was terminated may have sued their old boss. It could be customers who have had damages to their goods delivered or just competitor liabilities. There's a lot of different scenarios where these lawsuits could occur.

Jon (10:28.091)
Yeah, let me give you an example. Over the weekend, I saw a teenager die in a traffic accident. A device, 50 pound device, metal device fell right off a truck and killed her instantly. That is a large lawsuit that will be, even if he tried to sell, it wouldn't be settled for probably three to five years.

Patrick O'Connell (10:46.466)
Yeah, and I've spent a lot of time reviewing lawsuits and these things take time. And at the same time, these businesses may be great, but these lawsuits drag out. So they do have implications and deals. And these things likely might not be on the books. So you need to fact find through conversations with management and owners, because that's how you learn about these findings.

Jon (10:56.751)
Yeah.

Jon (11:09.979)
Do they, if the lawsuit's unsettled and it looks like it's gonna be three or five years, do they still keep that in escrow or hold back?

Patrick O'Connell (11:20.768)
Yeah, so it's a tricky one. It depends on a deal by deal. I think an escrow would be something that's foreseeable within one year. You would likely have to make some concessions between buyer and seller if there's a pending lawsuit. Likely, maybe a small reduction in purchase price.

Jon (11:44.389)
Yeah. Let me ask you if yet to be filed. They like, for instance, this accident that I'm referring to, the attorneys haven't filed it yet, but they're already in mid a process of selling the business. And you know, there's going to be a liability suit on this. Huge.

Patrick O'Connell (12:04.428)
Yeah. So I would say your example is very, it's very material because it's in the news, it's public knowledge and there will be a lawsuit. fortunately I've not come across an issue like that because that is serious. You would likely have to conduct probably a separate engagement just to analyze the potential, you know, outcomes for that.

Jon (12:11.216)
Yeah.

Jon (12:15.867)
Yes.

Jon (12:29.474)
Yeah.

Patrick O'Connell (12:32.056)
Typically, these are filed lawsuits with a pending litigation of X dollars. So they're a little bit simpler.

Jon (12:38.939)
There's a cap on that. So it's like maybe, you know, whatever your insurance is, five million bucks. yeah. Right. All right. Number two. No, let me go back to this before we go to this. And you find this through UCC filings, right? Anything else?

Patrick O'Connell (12:52.494)
Correct. I often find them through management discussions with the owners. I typically have one to three calls, which can be several hours of just fact finding conducted by myself with buyer and seller on the

Jon (13:08.483)
Interesting. All right, number two, let's go to that.

Patrick O'Connell (13:10.786)
Yeah. So number two is going to be high employee turnover. So through these conversations with management, if you learn they've had three general managers in the past three years, that's a red flag that speaks to there may be an operational issue with the business. Is the owner maybe does not treat the employees well? Is there not much loyalty with the business? Because if there is a change of hands in ownership,

Jon (13:15.397)
Yeah.

Patrick O'Connell (13:41.439)
and there's a negative bias around the old owner, it could be a risk that all the employees leave following closing.

Jon (13:48.217)
Yeah. How do you place evaluation on?

Patrick O'Connell (13:52.194)
So that likely cannot be valued in terms of dollars. That is a deal optic the new buyer needs to assess from a risk standpoint. Hey, worst case scenario, I lose key employees. Is this business still equipped to run itself? And am I the guy who can quickly find the great operators to keep this business moving forward?

Jon (14:07.471)
Yeah.

Jon (14:13.659)
Yeah. I have an example. We looked at a software company, two or three years ago in Texas. It was a, a device in the O and G industry. They were doing $6 million. It looked like pretty profitable bottom line earnings, 2 million, two and a half. However, when we did a little bit more due diligence and looked at the org chart, the guy leaving was related to by DNA or by marriage to six other people in the org chart.

We passed on the deal because we thought like, you know, if he leaves and they have a party, who do think they're talking about? You.

Patrick O'Connell (14:52.194)
Yeah, yeah, so that is an unusual circumstance with that many family members. But if we think about it, take a step back, these Main Street small businesses, they're family run businesses. Typically what I see is the owner, the husband and wife combination, the wife is the bookkeeper and sort of that general manager.

Jon (15:06.382)
Yeah, yeah.

Patrick O'Connell (15:20.204)
while as the husband is the sales pipeline and may manage the job sites and project sites. Going forward, it's always best practice to assume that family members at some point will move on from the business following a transaction. The dynamics around it are often too much to overcome when a new owner steps in.

Jon (15:26.522)
Yeah.

Jon (15:42.255)
Yeah. And how, so to me, that sounds difficult to place a value, a dollar value on. So more of it's about a risk. Do I understand the risk? Can I make adjustments to the risk?

Patrick O'Connell (15:56.918)
Right, yeah. And if you're comfortable with moving on from the family members following close, how much is it gonna cost you to find new people to take on those roles? How much is a bookkeeper gonna cost you? Do you need to hire a general manager? How much does that cost? Those are real dollars you can approximate today.

Jon (16:09.689)
Right.

Jon (16:20.015)
Yeah. Cool. All right. Three, number three.

Patrick O'Connell (16:24.322)
Number three is inconsistent financials. So if we go back to the original example of what is the quality of earnings, it is comparing and verifying the financial reported information from the marketing materials to the reported numbers in QuickBooks. And if there are discrepancies and variances, that's a red flag.

Jon (16:47.109)
Yeah. So a lot of SMBs and manufacturing or any other thing are just never clean books. They're either start out with the Excel spreadsheets or they're quick books and they're not balanced. What are you asking to do? Are you coming in and look forensic audit or what?

Patrick O'Connell (17:08.524)
Yeah, so typically what I'll do is gain direct access to the company's QuickBooks files and begin to run the reports of the financial system, income statement, balance sheet, revenue by customer list, general ledger. And ultimately we're analyzing and reviewing the data to make sure does reported revenues tie to the amounts in the marketing materials and SIEM.

Is it run on an accrual or cash basis? And then if we double click to a more granular level, if I review what the revenue is, does that all look like valid customer revenue? Or are there items that could be possibly removed? Are there transfers, et cetera?

Jon (17:56.507)
Let me ask you about cash or cruel. It's got inventory. IRS says you should be doing a cruel if you have inventory, but it's got inventory and it's using cash. What does that mean to you when you see this? Like, we got to find out how sales are generated, one, the, et cetera.

Patrick O'Connell (18:16.62)
Yeah, so more often than not, these smaller businesses are run on a cash basis. And there's a few reasons why. A cruel basis is a more challenging concept. And often if they don't have a CFO or a controller in place, it's much easier to record transactions when cash comes in and cash leaves. Additionally,

Jon (18:22.692)
Yeah.

Patrick O'Connell (18:42.26)
Most small businesses are filed on a tax basis on a cash tax basis. So if their tax preparer also does their book cleanup, they will ensure that the cash basis financials match the cash basis tax returns.

Jon (19:00.635)
The 1120 looks the same as the, okay, I got it, I got it.

Patrick O'Connell (19:02.86)
Right. In reality, without overwhelming and getting too accounting, it should be on an accrual basis. But I feel like that's another conversation.

Jon (19:14.703)
Yeah. Let me ask you about the balance books. Many of the times, you know, if a student comes to me and goes, hey, this is an income statement, looks great, right? But I tell them the profit on the income statement is a theory. You have to check the balance sheet. What if they're not balanced? What does that tell you? And they're consistently not balanced.

Patrick O'Connell (19:35.896)
So things, elementary items such as an unbalanced balance sheet begins to create the narrative of I don't, the integrity of the recorded statements. If you can't get a proper balance of the books, I may have to do a completely deeper dive to really verify that information because I don't.

It's hard to trust what I'm seeing as accurate.

Jon (20:08.185)
Right. So you're skeptical about it. And let's take example of all three or four of the things about the veracity of the books. What do I do to the asset purchase agreement and say, is going to X amount of dollars is going to be held in escrow or the valuation of the business goes down depending on what or, up depending on what I find.

Patrick O'Connell (20:11.649)
Yes.

Patrick O'Connell (20:35.51)
Yeah, so the whole procedure of due diligence is to, you want to get a narrative behind the business. What is the integrity of the books? What is the integrity of the seller? You know, I often say that transactions are human more than financial elements in nature. Like you need to have a level of trust and verification before you make this multi -million dollar investment.

Jon (21:01.829)
Exactly. All right, number four. Let's go on to the next one.

Patrick O'Connell (21:06.03)
Number four is declining market share. So when you're doing your analysis, if the business is beginning to lose customers to market competitors in the most recent 12 months, that's a red flag.

Jon (21:20.431)
Yeah. How it's a red flag unless what were the only scenarios where you would say, this is a red flag and I'm telling you it's a red flag. It's decreasing market share. Why are you buying it? Because they have what skills. Yeah.

Patrick O'Connell (21:41.132)
Yeah, so I'll give you an example of when it would come up and it wouldn't be a material issue. If they're losing market share to a wide variety of small dollar customers, that's not an issue. If they have, you know, heavy customer concentration and they've lost two of those to a competitor, you need to know why is the

Jon (21:55.589)
Okay.

Jon (22:06.203)
What do you consider heavy? 25, 50 what? Percent?

Patrick O'Connell (22:10.83)
Any customer over 25 % is significant.

Jon (22:13.732)
Okay.

Jon (22:17.443)
And people that do go ahead with this reducing market share, they usually have a bigger balance sheet. They're in the industry or something's going on, right? They have some kind of strategic advantage to make up for those red flags. Yeah. You wouldn't do it on a financial buyer anyway, cause they're like, nobody's going to underwrite them. Yeah.

Patrick O'Connell (22:34.444)
Right. Yeah.

Patrick O'Connell (22:41.88)
Correct. Yeah, and a lot of times people in industry have the confidence to maybe win back those customers that may have left or they have other strategic industry specific expertise. They are going to apply as new owners.

Jon (22:57.179)
Cool, understand. Number five.

Patrick O'Connell (22:59.47)
Number five is key dependent on a few customers. So going back to that customer concentration, if the business has a few customers, which comprise 25 % of total revenue, that's a red flag.

Jon (23:13.211)
Yeah. So two scenarios, you're in the O and G industry or your defense contracting GovCon. Have you done either one of those businesses quality? Cause those always have 90 % concentration one customer.

Patrick O'Connell (23:29.294)
Correct, so being close to the Washington DC area, have a lot of experience in the government contracting space. Those specific deals are, they require an analysis over the contract. What does that look like and what are the terms going forward and are there red flags within those contracts?

Jon (23:49.627)
Yeah. But if I was to buy a business that had to do with putting oil on top of pipes in the O and G industry, they have one customer at Shell or Texas, somebody in the Permian Basin, you go, okay, that's okay because they have a lot of money and you're going to be around for another 30 years, a hundred years.

Patrick O'Connell (24:09.356)
Yeah, of course. And after analyzing how long of a relationship they've had, what does that look like through, you you can learn these information through fact finding with the owner. You can gain comfort that they're going to stay on even with a new owner in place.

Jon (24:24.623)
Yeah. Initially red flag, but if it's got a narrative been around, it's you can, it's the risk is mitigated some. Yeah. Yeah.

Patrick O'Connell (24:34.658)
Certainly. it really the process is understanding what could be potential red flags, noting them when they do come up, ask fact finding questions to make sure that, hey, is this an actual risk or is it verified because of X?

Jon (24:51.919)
Right. And you would talk to the owner and just curious, what was if he wasn't really transparent enough? He wasn't giving you the answers that you need to hear. I mean, let's say you're a private detective. You're trying to find out who killed somebody. Like how means motive method, what?

Patrick O'Connell (25:08.066)
Right.

Patrick O'Connell (25:11.51)
So this goes back to, know, these deals are human more than financial in nature. You need to know how to ask the same question three to five times to get one answer. And the only way you do that is by being in industry and doing this for long as I have. Every personality is different with owners. I'd like to say I've seen it all. But if you approach it as a relationship

Both buyer and seller need to be on the same page to a collective goal of a deal close. Most owners come around.

Jon (25:50.619)
Yeah. Gotcha. All right. So we are in the second part and I, we've been looking at a couple of deals, this little Patriot growth capital fund we're looking at. the first deal is a tech wholesaler and I'll give you the revenue from 2021. It's from the SIM, like you said. So 2021 was 15 .79 million in revenue.

955 ,000 in net, 2022 was 5 .5 million in revenue and 831 ,000 in net. 2023 is 13 .8 million in revenue and 1 .7 million in net. I don't have trailing 12 months or last six, seven months.

Patrick O'Connell (26:48.974)
Okay.

Jon (26:48.987)
And they are asking 5 .9. It's a tech wholesaler. How would you look at that with all hundred deals that you've done and you there's pretty much you can write, start writing a profile for this. What, what am I looking at? What's the story and narrative around this?

Patrick O'Connell (26:54.072)
tech wholesale.

Patrick O'Connell (27:07.278)
So I'm glad you brought up an actual example. The real question is, what is the story behind 2022? We saw a significant revenue decline from 15 to 5 million. Is that correct?

Jon (27:17.434)
Yeah.

Jon (27:24.699)
Yeah, that's correct. A $10 million drop, but only a $80 ,000 net drop.

Patrick O'Connell (27:27.662)
$10 million drop.

Patrick O'Connell (27:34.166)
Right, so that's even, that's almost a two -pronged question. And I, would probably want to start at the gross margin level. Profitability has effectively almost gone unchanged, but your top line revenues has decreased significantly. What's the story? And see what they say.

Jon (27:41.872)
Yeah.

Jon (27:52.379)
Yeah. Let's say, let's say speculate what actually happened here. And I'm, I'll give you my thesis here is that it's a wholesaler. So they had a couple large deals, let's say one or two, you know, one deal was 5 million. The other deal was at 5 million and they, get their tech wholesaling from China and they got a contract, but they lost the contract. But it was a lot of work to generate $10 million and only

$831 ,000 a net. I mean, that's my guess here.

Patrick O'Connell (28:28.14)
Yeah, certainly. And it could be that they're selling an item that's virtually they're breaking even on. So you want to unpack who it is, what is the nature of it. And it might be an opportunity for an operational improvement on as a go forward basis for the new owner. Maybe you don't want to do that revenue line anymore or work with that customer because you're virtually making no money on it.

Jon (28:37.017)
Yeah.

Jon (28:55.663)
Right, I gave jobs to a lot of people. That's nice thing to do, but that's not why we're in business.

Patrick O'Connell (29:07.072)
Ultimately, small businesses need to make money or they're not going to be around for much longer. If you're serving a customer based on a relationship, but you're not making money, what are we doing here? You need to think about this and especially as a new buyer with the interest rate environment we are currently in, this debt servicing is not cheap. You need to work as efficient as possible to really get your...

Jon (29:13.04)
Yeah.

Patrick O'Connell (29:35.104)
Self in a position for success early on.

Jon (29:37.691)
Yeah. So the next year went up $8 million and net went up. But if I did a three year average of that net, it's like 1 .1, 1 .2. And they're asking 5 .9. Is that in the ballpark? That's a five X even though it's over 1 million average three years.

Patrick O'Connell (30:01.294)
Yeah, that's a good question. Valuations and what is offered and ultimately transacted on is dependent on who's buying the business, what is the market and economic conditions when they're go to sale and go to market. Based on what you've described, I think the business is more in a trading range of around four to 4 .2 times earnings. It seems like it's a little high.

for my risk appetite based on what I've seen in deals that are actually closed. Assuming we got comfortable over the narrative of the 2022 revenue declines and the profitability, there could be a case for a bid that's close, but I don't think we're there.

Jon (30:50.235)
Yeah. So I'm going to say we're financial buyers and we passed them on. It just didn't make sense because if we debt any debt on it, like even if it was 50 % debt, it would drop the profitability down to an uncomfortable earnings level. What's the scenario for who would buy this? The larger wholesaler would just like the customer base.

Patrick O'Connell (31:13.55)
Yeah, so I think for this one specifically, it would have to be a strategic buyer who understands there may be a shortfall in the first year or 24 months as the new owners, but they have a longer term vision. They can increase profitability through synergies given their industry experience.

Jon (31:36.251)
Gotcha. So your analysis on this, it should be trading maybe a 3 .5, 4X, and it should go to a strategic buy.

Patrick O'Connell (31:48.95)
I think that's the only thing that fits this business in terms of the buyer.

Jon (31:52.155)
That scenario, right? I agree with that. So let's go on to this next one. Cause this is what's really interesting. This is a tech medical tech blog and it gets 50 million, 50 million visitors per year. And however, so they did about 3 .5 million top line and 2 .5 million earnings. It's very profitable.

they're selling it for 12 .5. And here's the challenge with this. this is all 100 % of the revenue is generated through a content ad network like Mediavine. And I've been on the site, I refreshed and I refreshed and I refreshed and there's no specific ad there. It could be political candidates looking for money.

It could be insurance, could be car insurance, it's anything. It's nothing that I could key on on. That's one thing. The second thing is they do have medical products on their site, but they're linked back to Amazon to purchase. And they're only generating like less than a thousand dollars a month on this. So my...

pushback on this is that it's going to be difficult for us to raise money because I don't have any clear path to increase the revenue for the first year. Not at all. Maybe I can spend 12 months trying to figure it out, but affiliates don't work. I don't have any control over SEO. Heck, I could hit by a new Google update and it drops 50%. How would you, quality of earnings guy, 100 deals, millions and millions of dollars.

Look at this.

Patrick O'Connell (33:50.062)
This is an interesting one. It makes sense they're trading at a six times earnings given 2 .5 million in profit on only three and a half million of top line. The key to this, and if it makes sense on purchasing, is learning the secret sauce behind what they're doing. After you sign an exclusivity agreement and move into formal due diligence, you need to clearly understand and they need to articulate.

what they're doing right in order to drive the top line revenue and ultimately what do their costs look like because there's virtually it's very few.

Jon (34:28.879)
very lean and they're taking a very big salary and it's okay. It's their business. They own a hundred percent. and there's not really a lot of GNA involved.

Patrick O'Connell (34:42.86)
Right. So they seem the buyer who comes in and purchases a business like this, you need to likely either find someone with that expertise to have a minority stake alongside you to run this business, or you as yourself need to understand the technicals behind what they're doing right in this space.

Jon (35:06.159)
Yeah. Having said, laid out the facts as I see them. Have you ever had a conversation with an investor that's willing to wait one, two years if they help us put down the down payment? Say, okay, I'll give you one to two years. It's throwing off a lot of cash. I want participating for Fird and some kind of, you know, stop up and all kinds of like that. Wait around patient enough to say, okay, yeah, go, go do the deal.

I'll give you 2 .5 to help you buy it.

Patrick O'Connell (35:39.35)
Yeah, so capital raise is a tricky subject. really kind of depends on who are the parties involved. Any kind of capital raise, regardless of terms, you need to clearly articulate the growth path, why the business investment makes sense, and how is the investor going to make a significant return in these private markets.

Jon (36:01.913)
Yeah. How's that going to do? So what do you, what do you score this out as far as a potential trade?

Patrick O'Connell (36:10.166)
Yeah, a couple knocks. Given the very little affiliate marketing, it seems like they have a singular revenue stream. It's spread thin. Yeah.

Jon (36:23.611)
100 % is from a content ad network, yeah. Well, let's say it's 99 .9.

Patrick O'Connell (36:28.098)
the content app network.

Right. So that is a wider market, but I would be, it would, get a higher grade if it had some affiliate marketing. I would probably score this as a B given they're doing something right in terms of a profitability standpoint. The high six times earnings multiple is a lot to digest. You would need to understand how long has this company been in business? What are the owners look like? Who are the owners?

And really getting back to that first point, what's their secret sauce? What are they doing right? And what can you do what they're doing right going forward as new owners?

Jon (37:05.05)
Yeah.

Jon (37:11.131)
Yeah, I can answer some of those. It's been around for 10 years. However, it didn't really start growing in the size it has until the COVID hit because everybody sat home and looked at blogs all day. Medical blogs, yeah. Are they motivated sellers? Like, no, I think they put in enough systems in place where it's all outsourced. It's delicate.

Patrick O'Connell (37:24.685)
Right.

Yeah.

Patrick O'Connell (37:35.49)
Right, and a deal like that, mean, that's a great business for the current owners. They're in a, they're in a advantageous position where they don't have to sell. They listed as six times earnings. You could probably make a case for five times.

Jon (37:46.297)
Yeah.

Jon (37:51.621)
Five, yeah.

Patrick O'Connell (37:55.276)
maybe five and a half. I've hardly ever seen a list price that's like too low. There's always some wiggle room. But if they don't get the offer they're looking for, they're happy to just keep running this on autopilot.

Jon (38:08.919)
Exactly. It's mailbox money, essentially. Yeah. Well, cool. Patrick, thank you so much for spending time with me to understand a little bit more about quality earnings and how you score these deals. I really appreciate it.

Patrick O'Connell (38:25.89)
Yeah, pleasure to be here, John. Thank you for what you do for entrepreneurs. I love listening to your show. for your listeners, feel free to connect with me on Twitter, SMB Deal Guy, LinkedIn. I love connecting and meeting people who want to buy businesses and entrepreneurs. And thanks for having me.

Jon (38:43.963)
Thank you. Here we go. All right.