Summary

In this conversation, John Martinka discusses the seven biggest mistakes business buyers make. He emphasizes the importance of making contacts and building relationships in the search for a business to buy. He advises against looking for perfect businesses and falling in love with the product instead of focusing on the business model and value proposition. He also highlights the significance of understanding free cash flow and recognizing the leap of faith involved in buying a business. In this conversation, John Martinka shares insights and advice on buying businesses. He discusses the importance of customer communication and the potential consequences of not being able to talk to customers during the due diligence process. He also highlights the impact of customer concentration and vendor relationships on a business's value. The conversation delves into the role of due diligence and the concept of quality of earnings. The significance of being an inspirational leader and the importance of the 'secret sauce' in a business are also explored. The conversation concludes with a discussion on confidentiality and employee communication, as well as the benefits of multiple acquisitions for business growth.

Takeaways

Making contacts and building relationships is crucial in the search for a business to buy.
Buyers should focus on the business model and value proposition rather than falling in love with the product.
Understanding free cash flow is essential for evaluating the financial health of a business.
Buyers need to recognize that buying a business involves taking a leap of faith. Maintaining open communication with customers during the due diligence process is crucial to avoid potential issues and misunderstandings.
Customer concentration and vendor relationships can significantly impact a business's value and should be carefully considered during the acquisition process.
Consequences of losing a key customer can lead to immediate revenue drops and potential legal issues.
Due diligence is essential in understanding a business's financials and operations, and the role of CPAs or CFOs in this process can be valuable.
Being an inspirational leader can positively impact employee morale and productivity.
The 'secret sauce' of a business, such as unique competitive advantages, should be carefully evaluated during the acquisition process.
Maintaining confidentiality during the acquisition process is crucial to avoid potential disruptions and employee concerns.
Multiple acquisitions can be a strategy for business growth and expansion.

 

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Transcript:

Jon Stoddard (00:02.86)
Today, my guest is John Martinka. In this video, we're going to talk about the seven biggest mistakes business buyers make. My guest is John Martinka. He's helped over 100 clients with the BizBuySell transactions. He's been in the M&A advisory business for over 20 years, and he's also author of five books, which I have two right here, and they're available on Amazon. Welcome to the show, John.

John (00:30.294)
Yeah, thanks for having me.

Jon Stoddard (00:31.844)
Yeah, so let's jump into this. But I want to get a little your origin story. How did you get started in this M&A world?

John (00:42.078)
Serendipity, how's that for an answer? Yeah, you know, I, my background is I guess I got the entrepreneurial spirit in college because my friend and I set up a business painting houses. We were both pretty handy kind and my dad was extremely handy. I learned a lot and did that through college and then grad school and even during a recession for a while. And then you know, did some

Jon Stoddard (00:43.964)
That's great! Serendipity's always a great-

John (01:10.79)
other small business things. Actually, my first real job out of college was in the concert business with a concert promoter in Milwaukee where I grew up. And then we moved to Seattle. I did some sales things. And then I was back to back president of a rotary club in Kirkland, Washington with Ted Leverett, who you know. And one day after a meeting, as we had become friends, Ted said something like I've always thought you'd be good in this business. And one thing led to another.

And here we are.

Jon Stoddard (01:41.976)
Yeah. And what did that, what was the business like, Hey, Ted said you should help companies buy other companies and grow by acquisitions or what did that start as an evolved to?

John (01:53.342)
Well, it really started as we were building a network of people around the country to

Learn from Ted and what to do to help people buying a business and other things, whether it's evaluating a franchise opportunity or just getting the business ready for sale, things like that. And then I really like what I do helping buyers. And we do some work on the sales side. I say, we, my daughter is part of the business now. And it's variety. Every day is different. Every hour is different.

There are challenges, there are rewards. And one of the taglines we use is changing lives via business transitions. And that's what we're doing. It's often the biggest thing most people would do is whether it's buying a business or selling a business. Biggest risk, the biggest financial, all of that.

Jon Stoddard (02:57.2)
Let me kind of get something clear on the table. What kind of business buyer do you help? There's a whole bunch of coaches out there that'll say, hey, buy this distressed business, turn around. There's people that are out there saying, hey, buy this business with no money down. What kind of business buying advice do you give and what do you look for?

John (03:19.198)
Okay, so I'm a big believer in the 80-20 rule, you know, and 80% of the, yeah, like the old 80% of your business will come from 20% of your customers or whatever else. What you're talking about is the 20%, the fringe stuff. Most people can't buy a business with no money. Not a mature, profitable business. Because if you're a seller, and you got a business that's cranking out a million bucks a year.

Why would you sell it to someone who has no money to put into the deal when there are scores and scores of good buyers out there who do have the money and the credit worthiness?

Jon Stoddard (04:00.5)
logical question. Yeah.

John (04:01.738)
Yeah. Uh, you know, our clients, you know, we tell them what to focus on again. It's a mature profitable business, a fairly priced business. Don't go, don't go chasing things that, you know, don't go chasing dreams. I've been doing this since the nineties. I've had, out of all the clients we've had four by a distressed company, every one of them knew it was distressed, why it was distressed.

what to do and they did it. But for the most part if you want to come in with no money down you're buying a fixture.

Jon Stoddard (04:39.084)
Yeah. So what's your ideal profile client? Is it a millennial gen Xer or baby boomer in different stages just that wanting to buy a business?

John (04:51.306)
Well, you know that 80% are typically people from 35, 40 to 60 years old.

You know, and I know the market is flooded with a lot of young buyers now, but, but if you get to be 35, 40, the chances are you've, and you want to own a business, chances are you've built up some experience. You've managed people, you've managed processes, you've managed money. And I like to add, you know, as an owner, you need to manage enthusiasm.

Jon Stoddard (05:22.36)
Oh, interesting. Yeah, I love that.

And are you, when you qualify these buyers to help them, are you looking at their balance sheet? What are you looking for? Are you looking for somebody with, you know, 250,000 in balance sheet cash assets or 500,000 or a million or what?

John (05:43.49)
But before we get to the money, the other two legs of the three-legged stool are the right skills, just as we just talked about, having managed and led and done something, and a good personality.

Jon Stoddard (05:57.892)
Yeah, I call that experienced operators. You've got to have, you know, if, if you do happen to go after investors, you got to be an experienced operator to, you know, you're not going to put alignment in a quarterback role.

John (06:01.719)
Yeah.

John (06:08.822)
Right, you're right.

Mm-hmm. You're right. And the, you know, then the good personality is you gotta, you gotta be a nice person. You gotta, you gotta be able to convince a seller that you're going to take care of their baby. That, that, you know, that they're going to come back by in five or 10 years and see, see the name on the door still until their grandkids, Hey, that was my business. Look how good it's doing. And then we get to the money and then again, the money has to be appropriate to what they want to do. Uh, what size.

business, the salary they want and need. And you as you know, banks will look at a buyer and their profile and you know if a buyer comes in and says I have $250,000 and I need a business that will pay me 250 a year, it's probably not gonna happen and the bank is gonna say well look you need 250 a year you're gonna have to buy a larger company and you can buy with a quarter million dollars.

because the last thing a bank wants is the buyer to go in personal debt.

Jon Stoddard (07:15.249)
Yeah.

John (07:16.582)
And it's the same thing, you know, buyer comes in and the opposite and says, well, I'm willing to take a really low salary. Well, that doesn't matter to a business appraiser, a business appraiser will look at it and say, what's the fair market salary for running this company. And that goes into the expenses to calculate the value. Then the buyer can take less if they want.

Jon Stoddard (07:39.076)
Yeah.

Jon Stoddard (07:43.06)
So you got these, of course, a good deal, and you got an experienced operator, and you got the money, the three-legged stool. Let's talk about the buyers when they start this journey and the seven biggest mistakes that they make. Warren Buffett usually called this, I just avoid the dragons. It saves me a lot of time and money and heartache, yeah.

John (08:07.212)
Yeah.

John (08:11.814)
OK, so we got to narrow it down to seven, huh? No, seven's a catchy number, isn't it? So in no particular order. And but this one does really come near the top. Realizing that searching for a business is a contact sport. The more contacts you make, the better off your search is going to be. Yeah, it's sales.

Jon Stoddard (08:15.592)
So, well, if you got more, let's hear it.

Jon Stoddard (08:20.913)
Yeah.

Jon Stoddard (08:36.496)
Contact Sport, I like that, yeah.

John (08:40.778)
It's a sales effort. You can't sit back and wait for the phone to ring. You have to do things. And tied to that, when you find one you like, you don't quit prospecting. There's a lot that can happen between I met the owner, I liked the business, and getting it closed. What else?

Jon Stoddard (08:53.67)
Right.

Jon Stoddard (09:03.305)
Is this off market or on market or both? Yeah.

John (09:07.042)
Both. You know, if all you're going to do is peruse biz buy sell, you're going to see a lot of junk. And you're going to be, if it is a good one, you're going to be in competition with other buyers.

Jon Stoddard (09:24.036)
A lot of other buyers, because that's the most trafficked site for buying and selling businesses.

John (09:25.442)
A lot of other buyer's issues.

John (09:29.682)
Yeah, you know, it's recognizing that there's a lot of talk out there. I know you had Richard Parker on a while back and Richard and I are good friends. And I know he, in his materials, he has always said 90% of people who say they're going to buy a business never do. And I, I actually think it might even be a little higher these days, you know, with all these people taking classes on buying a business.

Jon Stoddard (09:49.884)
Yeah.

John (09:57.75)
you know, entrepreneurship through acquisition. And, you know, it's a challenging process. It takes a year, two years.

Jon Stoddard (10:06.948)
What do you think the numbers should look like? Just setting expectations with somebody. Should they look at a thousand businesses? And here's why I had this searcher from an ETA search funder group. And it was a younger kid and he said, I asked him how many businesses he looked at and he goes, 4,000. I go, 4,000? You couldn't find one business in 4,000?

John (10:29.378)
Well, there is the crux of the issue, is that when everyone says, Richard's materials came out 30 some years ago, and others have say the same thing on that 90% or more, is that there's a lot of people like that person you're talking about who look at a lot, but never pulled the trigger. You could put the perfect business with a great deal in front of them, and they're gonna find a reason not to do it.

You know, they're not in it for the kill, they're in it for the excitement of the hunt.

Jon Stoddard (11:06.34)
Yeah. And I don't think he's probably the right person to buy a company. He's no, he's telling us that. Yeah. All right. So number two, no, in no particular order.

John (11:16.182)
So, okay, so what else? Another mistake. Yeah, you know, I like to make an analogy to the chess game at chess. And, you know, in chess, the, you know, the king and the queen and, you know, in businesses cash and cash flow is king, but the queen is the most important piece in the game and the queen in this case is relationships. Not recognizing that.

Jon Stoddard (11:41.864)
Queen is relationships.

John (11:45.07)
The buyers want, the sellers want to sell to somebody they like, they trust, they respect to take care of their business. And I've seen buyers, you know, they've said, oh, I just sent over this IOI, I just sent over this LOI. And they just pulled a number out of the air, they never met the, never met or talked with the seller. It's just, oh, the broker, the intermediary, banker said, you know, we're taking, we need an IOI by such and such a date. Oh, here's an IOI.

And, you know, talk to a.

Jon Stoddard (12:16.552)
that's just clicking the buttons, right? There's no relationship or backbiting.

John (12:20.914)
I talked to an owner the other day that I know and have known for 20 years and they're selling and there was a particular buyer I mentioned and he said, everyone else asks good questions. He didn't even ask for a call with us.

Jon Stoddard (12:34.668)
Yeah. Well, I got a good story on that. I interviewed a guy quite a while back. He bought some foundries and he bought a fencing foundry for a million dollars less than three other bidders because he drove five hours to meet the seller and had spent like two to three hours with them.

John (12:57.375)
I've had a few situations like that, one in particular my client Mike, there were three offers on the business, his was the lowest and he got it because the seller said, you're the guy to take over my company.

Jon Stoddard (13:09.896)
So it's peers selling to peers or would there happen to be unbalanced to that possibly just because that you could make up with a relationship?

John (13:23.054)
Well, I think you can make up with a relationship that if a seller says, you're the one I want to sell to, they're going to, you know, you got to be reasonable on your offer.

Jon Stoddard (13:33.264)
Yeah, now you're working together to get all the asset purchase agreement and moving forward. Yeah.

John (13:35.039)
Yeah.

John (13:38.738)
Yeah, let me give you a great story on that. It goes back quite a few years. And my client, his name is Ted. He bought a company that does, they design the product, have it manufactured by contract manufacturing, and then they distribute it. And we're in due diligence, so we know the sales are going down. Pipeline doesn't look that good. And the seller said, well, yeah, the reason is.

And the reason he was selling, he'd been in the business for 40 some years, having started at like age 13 when his dad owned it. And he started another company and he started playing with the other company. And he says, I know what to do. And he says, give me some time. I'll get it. I'll get things back on track. A month later, he calls Ted and says, come on in. And he hires him on what I considered a very lucrative consulting engagement to do nothing but be his buyer.

wait till he got it back on track and learned a business before closing. Because he said, you're my guy. I don't want you going out and finding another company.

Jon Stoddard (14:43.8)
Yeah. Oh, that's a great story. I like that. Was that kind of like a lease to own? You come in, you work for me, and then I'll start selling this to you, seller financing, or was it just to... Yeah.

John (14:45.57)
That's a relationship.

John (14:55.158)
Nope, it wasn't even that. He was just learning the business. He was tying the die up at a nice fee per month, so he wouldn't go find another company.

Jon Stoddard (15:06.892)
Yeah, there you go. That's a strategic move, wasn't it? Yeah. All right, number three. Yeah.

John (15:10.558)
Yeah. So.

Another one, you just talked about the guy who's lifted 4,000 deals, not recognizing there are no perfect businesses and no perfect deals. You won't find it. Don't look for it. Look for something where there's opportunity. And what I'm seeing is that there's a lot of opportunities.

Jon Stoddard (15:24.837)
Right.

Jon Stoddard (15:32.79)
Unpack that for me. Opportunity because you see the arbitration or...

John (15:39.086)
So the buyer sees what they can do with the business. And there are a good buy, let's say you take a good buyer, they're 40 years old, they've got some ops experience, they're completely comfortable with technology, and they buy what we call a legacy business, making something, distributing something, and they bring in productivity enhancing tools.

Jon Stoddard (16:02.628)
Yeah. Could be technology, could be software. It could be just new processes. Yeah.

John (16:07.494)
Yes, and documenting processes and everything else. That's opportunity. And a buyer should be looking for something not with works, but with opportunity.

Jon Stoddard (16:22.184)
with opportunity. And have you ever seen somebody, one of your buyers come in with too much enthusiasm for opportunity?

John (16:31.178)
Yeah, and that's part of our job to temper that. I like to say that, half of what we do with our clients is quasi-therapist work. Sometimes it's bringing them down because they're so excited, and other times it's getting them out of analysis paralysis. And that brings me to another mistake, and I like to say the...

Jon Stoddard (16:44.68)
Quasi-third.

Jon Stoddard (16:53.488)
Yeah.

John (17:01.358)
The bigger the spreadsheet, the less chance of a deal because you're going to get analysis paralysis. You know, the private equity firms can do the massive spreadsheets. The buyers, you know, we're talking about the corporate executive wanting a business, the small business owner wanting another business, you know, stuff in that SBA range and maybe up to 10 million or so. You don't need the massive spreadsheets. You need to build a relationship.

Jon Stoddard (17:06.481)
Yeah.

John (17:30.722)
find out what's going on and look for the opportunity. And it's like you mentioned Warren Buffett before, and I know he says things on like diligence. I don't worry about the lease yet. There's gonna be a problem with the lease. I wanna know how is this business gonna be in the upcoming economic forecast?

Jon Stoddard (17:50.34)
Yeah. Has it weathered through ups and downs in the rollercoaster? So I have another story. I interviewed a guy from a private equity company that bought a landscaping in Georgia. And he did what he learned how to do, which was put everything in a spreadsheet and go. And then he had these conversations with the seller who was just a guy, a blue collar worker, just like, hey, man, I cut lots.

I don't know what you're asking me. He goes, I threw everything out and then went just like, I just went with my gut and bought the business. And it's doing real well. Yeah.

John (18:31.722)
Yeah. Oh, let's see. What could number four be? Again, it's tied to what we just talked about a little bit. But don't fall in love with the product. Fall in love with the product.

Jon Stoddard (18:32.12)
So number four.

Jon Stoddard (18:42.192)
Yeah. The product being the company or the product being the product that the company makes? Yeah.

John (18:45.622)
The product that, you know, they make this wonderful widget. That widget is so cool. I wish I had 10 of them in my house. I want to buy this company. Fall in love with the business model and the value proposition and what you bring to enhance that value proposition. In other words, you want a business with a defensible competitive advantage.

Jon Stoddard (19:13.22)
Yeah. Let me ask you a question. If all three check mark, for instance, I got another story. I got a partner looking at a business in California. He's a pilot and this company makes props, which is very exciting. The business otherwise is very profitable, definitely has a defensive competitive advantage, but it's also a really cool product because the seller also buys and

John (19:42.668)
Yeah.

Jon Stoddard (19:42.952)
And he goes, look, if you buy the company, I'll give you a ride in it. Yeah. Which is a nice sweetener, but it's, you're starting building these sand castles going, you have a tendency to overlook the crates blind spots.

John (19:58.262)
Yeah. Yeah, you're right. That's exactly it.

Jon Stoddard (20:03.384)
Yeah. All right, so number five. And we could keep going with these. I like these. Yeah.

John (20:09.186)
We can keep going, yeah. Don't get greedy.

Jon Stoddard (20:14.268)
Don't get grady.

John (20:15.202)
buyers will get greedy. You know, I've seen buyers that would spend a lot of time negotiating an eighth of a point on the bank loan. It's like, get the darn deal done.

Jon Stoddard (20:25.542)
Yeah.

John (20:26.026)
Yeah, you know, you know, I'll say to somebody that, you know, say, I don't know, I don't want to pay more than 3.6 million for this company. And I said, so if you, if you paid 3.7 and the business does what you think you can do, do you think you'll be looking back in two years laughing about it?

Jon Stoddard (20:44.6)
Yeah, I read that story when Warren Buffett bought Seize Candy. He says like, I wasn't going to pay over $27 million or something like that. And this has turned out to be a billion dollar business cash flowing for 40 years for him. Yeah. And I regret trying to be greedy, trying to like putting a, you know, a line on this price. Is there a, is there a...

John (21:10.628)
Mm-hmm.

Jon Stoddard (21:13.976)
A stop where you say, you know, 2.7 versus 2.2, where you just like, you're, yeah.

John (21:21.694)
Yeah, that's a big gap. That's a 20% gap. But if it's close, get the deal done.

Jon Stoddard (21:30.085)
Yeah.

Because, and I'm gonna make this point is, if you're bringing your skills as an operator and you see opportunity there, you're gonna be able to make up that one point. Yeah.

John (21:48.342)
Yeah. Right.

Jon Stoddard (21:51.216)
Right. Very nice. All right, number six.

John (21:57.158)
Let's go with not understanding what free cash flow is.

Jon Stoddard (22:01.519)
Okay.

John (22:03.042)
You know, we hear the term EBITDA all the time. Now look, if you have a company that has a bunch of people in the office doing stuff on computers, your depreciation is next to nothing, but you talk about your guy with the foundry, they may be, you know, they're spending a lot of money on equipment, et cetera. You know, a classic example, you know, makes a point very easily is, they say, well, the...

EBITDA for this distribution company is $2 million. But they have, I'll just use easily divisible numbers. They have 21 trucks. A truck's life is seven years. That means they're buying three new trucks a year. Every year. They're buying three new trucks to stay in the same place. Those trucks, they may, whether they're 50 or 100,000, that's 150 to 300,000 a year. It's cash out the door.

Jon Stoddard (22:46.724)
Every year. Yeah.

Jon Stoddard (23:00.528)
Yeah, and depreciation is important. Yeah.

John (23:03.222)
Yeah, it is important. And I hear this line all the time from, it goes back to the old days, depreciation is not a cash expense. Well, the payments to the bank with a principal after tax is a cash expense.

Jon Stoddard (23:18.8)
Right, especially if you have having to replace three new trucks every year. Yes. Yeah.

John (23:23.37)
Right. And you look like we worked with a client who's become a friend who owns a concrete cutting business. For him to get a new truck, it's over $100,000 with all the equipment on it and everything else. He wants to expand, $100,000. You know, you look at retail businesses that may have five locations. How do you grow it? You put in a sixth. What does it cost to put in a sixth? Half a million bucks? That's real money.

Jon Stoddard (23:50.584)
Yeah, the incremental cost is, you know, this is a funny question because it's not funny. It's just what you brought up. The guy that we're looking at, that this, my partner's looking at to purchase the propeller company, he got a very large catalog company that sells other props to ask him, can you build these for us? And he goes, well, I'm at 80% capacity with my Masec CNC machines right now. I can't handle it.

John (24:18.615)
Yeah.

Jon Stoddard (24:21.244)
Like if he were to take the business, he'd have to open up a completely new location and possibly buy two new, at least two new, basic machines. Yeah, which didn't make sense to him, to his lifestyle and what he wanted to do. I don't want to work 100 hours a week. Right. Yeah. That's a good one. Number, free cashflow. Can you unpack that a little bit more about the free cashflow? Because of, yeah.

John (24:30.188)
Yeah.

John (24:47.638)
Yeah, let's talk about that. That's a really interesting subject I can get going on. So what do you see when you're out there looking for a business? You see EBITDA and EBIT and seller's discretionary earnings, net income. To me, seller's discretionary earnings is a very misleading term. In fact, it's quasi-fraudulent.

Jon Stoddard (24:52.633)
Yeah, that's...

Jon Stoddard (25:03.844)
Net income, yeah.

John (25:15.298)
to put out a business and say, well, this SDE is $500,000 because the, you know, the owner's comp needs to be 150 to meet your net income is really only 350. But they advertise that. And what are the, I have never seen a bank do their calculations and not put in a salary for running someone running the company, whether it's a buyer or a CEO. I have never had a business appraiser say, oh yeah, there's no.

Jon Stoddard (25:28.749)
Yeah.

Jon Stoddard (25:39.752)
Absolutely, right?

John (25:45.294)
Whoever's running the company is not going to get paid. That's an expense. So I mean, if you look at free cash, yeah. So add-backs are another thing that we can get to. If you look at companies' financial statements, here's what I like to do. You calculate the EBITDA. And you add back.

Jon Stoddard (25:49.639)
Yes.

That's not in a legitimate ad back.

John (26:14.646)
the owner's comp, and then you subtract out fair market owner's comp and anticipated capex. And if the company's been using a line of credit, that operating interest is probably going to continue, so you subtract out operating interest, not acquisition interest, operating interest. And that should be your free cash flow. And that's what you have to pay for the business, grow the business, pay taxes.

Et cetera.

Jon Stoddard (26:46.672)
What cushion margin of safety should be in there?

John (26:56.057)
Depending on the size of a deal, I think the debt coverage ratio, which is simply principal and interest payments to free cash flow, you should have at least a 1.5 to 1 coverage. I know there are things that will go down to 1.1, 1.15.

Jon Stoddard (27:14.96)
Yeah, yeah.

Yeah, I've seen SBA is like 1.25, but some of SBA banks will go, it needs to be 1.5. But anything above that is great, better.

John (27:24.287)
You know, at least one of my friends. Yeah, and look, if you're buying a million dollar company, you want it to be two to one, because the absolute number isn't that high.

That's your money to grow the business.

Jon Stoddard (27:36.476)
Right, right. Because I can see what you're doing. Because I've been in this situation before, it's like you just don't have any cash to do anything. You don't have any cash to grow, you don't have any cash to put in more marketing, blah, all of it.

John (27:45.196)
Yeah.

John (27:50.942)
Right. So if we look at the last couple years, last year and a half with what's happened with interest rates, think of all the buyers who got a variable loan, 5.5%, and now, most SBA loans are around 10 to 11. Yeah.

Jon Stoddard (28:08.712)
It's 11.25 plus three to 5% for closing cost.

John (28:14.226)
But just say you're no, let's just go back. You got the business two years ago five and a half percent interest rate now the bank has raised the interest rate to Maybe not to what a new borrower get but say nine ten percent Say ten percent. That's almost double your Interest and on in the early years of a loan just like your mortgage interest is the high is higher than the principal

Jon Stoddard (28:18.278)
Yeah.

Jon Stoddard (28:38.82)
Yeah, yeah, that sounds like the GDP. Okay. Yeah. Current US government, right?

John (28:44.106)
and the banks that...

John (28:48.306)
You know, the banks that were out there with low debt coverage ratios just to make loans, I think are feeling the pinch of borrowers who are having trouble. And if they were so strapped that they didn't have that cushion to grow it for a couple years, it's not pretty.

Jon Stoddard (29:00.401)
Right.

Jon Stoddard (29:10.268)
So what would you do? You see these, this is I'm trying to, opportunity presents itself when other challenges come up. If you go to a business and it looks like it's pretty good cashflow, let's say it's marginal, but then you're qualified for SBA bank and you go, wow, 11.25, then three to 5% for closing costs, this is gonna be too tight. Is there anywhere else they can go to purchase or do to purchase this kind of business?

and it's a motivated seller.

John (29:41.829)
Yeah, they get an equity investor, a minority investor who's going to be under the 20% that they don't have to sign on the bank loan.

John (29:55.374)
And well, here's the other thing. I'm seeing more seller notes and I'm seeing larger seller notes because the seller interest rate is gonna be less than the bank interest rate. And that gives the buyer a little blended rate that is lower.

Jon Stoddard (30:10.488)
Yeah. And the benefit to the seller for a seller note is, of course, he gets to sell the business, right? That transaction happens. Is there tax benefits to the seller?

John (30:22.474)
Well, they're going to get the price that they want that. I don't know. That's not a tax benefit, but it's an overall benefit. Yeah, so if somebody says, I'll give you $4 million for your business, you'll finance X amount at 6%. When the bank's at 11, they can pay a little more.

Jon Stoddard (30:28.145)
They're going to get it over time. Right.

John (30:45.822)
And again, you know, if it's the right buyer, they're going to, they're going to want to do it. Or they should want to do it because it is having an effect on valuation. It is, it is starting to kick in a bit. Buyers are a lot more conservative. It's taken them about a year to catch up with all the interest rate stuff going on, but seeing lower offers and lower multiples. Not, not draft drastic. I mean, not talking a multiple going from five to three.

Jon Stoddard (30:50.148)
Right. And what do you see in...

Jon Stoddard (31:03.493)
Yeah.

John (31:14.914)
But if you go from five to four and a half.

Jon Stoddard (31:19.524)
Right.

This is something that it's a completely different than the real estate industry. You can see those price interest rate pressures pushing down real estate quite rapidly. We see it because so many are people into it, but businesses, you don't see this immediate effect. It's just there's a business over here, it's HVAC in Arizona, there's one in Florida, and they're not affected by each other based upon valuations.

It's just who comes to buy it.

John (31:54.054)
Right. Yeah. And it's taken a while versus, you know, real estate where it's, like you said, it's pretty instantaneous. It took, it's taken a while for buyers to recognize that. It's, I think it's taken a while for sellers and their advisors to say, yeah, this is what's going on. Your interest rates are a lot higher. It's going to cost them more to finance it. Prices come down, finance more. A buyer can get the equity if they want to give up some equity. There's, it seems like there's developing a whole industry.

Jon Stoddard (32:12.101)
Yeah.

John (32:24.202)
of people who arrange minority positions on these deals.

Jon Stoddard (32:31.364)
I see it, I don't see a big effort succeeding just yet. I mean, if I look at, for instance, like the startup industry where they have angel list, that's a hundred thousand investors willing to put 10,000 to 50,000 to a hundred thousand or more in anything that comes on the market. Like there's no group of those types of individuals, somebody put them together just yet. I could be wrong.

If I'm wrong, please let me know down in the comments.

John (33:03.142)
There are some groups out there, and people I know that do that. I'm not giving a plug, but Search Investment Group in Texas does that. They've got a roster of investors and they cut deals. Nice guys. But if we go back to the banking thing, there's about 2,000 lenders in this country.

And a lot of them do SBA loans. And there are some that will lend on anything to anyone just to get the loan.

Jon Stoddard (33:39.8)
numbers. Yeah.

John (33:41.346)
And a buyer should want a good bank, a good banker. They want the bank to do as good a job on underwriting and bank due diligence as they're going to do on their due diligence.

They don't, it should want that.

Jon Stoddard (34:01.26)
Absolutely. It's like a second point of view that you missed. Like, I need this to be peer reviewed.

John (34:05.58)
Yeah.

John (34:08.992)
Right.

Jon Stoddard (34:11.204)
Like I see a lot of people, you know, uh, buying a business that are not, uh, they don't understand the language of business, which is accounting. And if they get a rubber stamp on underwriting, like that's it, you know, that's the gold standard for them. And they move forward.

John (34:22.288)
Mm-hmm.

Jon Stoddard (34:36.464)
But I think they should always go back and learn a little bit more about accounting. So you can tell about trends and make the changes.

John (34:36.482)
So.

John (34:41.826)
Well, yeah. And as an owner, especially if you're not a numbers person, and there's a lot of great owners who are not numbers person, is to hire the right people around you. And a couple of things that I've recommended lately, more than ever, to buyers and owners is, first of all, get an outsourced HR firm involved.

Jon Stoddard (34:51.592)
Great.

John (35:11.47)
The HR is just a field of landmines. I mean, there's little things that can trip up a company and get them fined if they don't do some of the things the right way. It's not just having a five-year-old policies and procedures manual. Laws keep exploding in number on HR. The other thing is a CFO controller, whether it's the owner or the buyer.

Jon Stoddard (35:32.912)
Yeah.

John (35:40.226)
A lot of times the accounting department is like, you know, I call it the weak, little redheaded stepsister off in the corner. I love working with the product. I love the customers. Yeah. Go take care of what everything, everything over the ride, you know, and give me a statement every month, but get someone who really knows what they're doing and can give, give management reports that can show trends, can show your KPIs that you need.

Jon Stoddard (36:06.588)
Yeah, I'm going to reference this same business out of California we're looking at. Run by husband and wife, wife does is runs the accounting. She's not an accountant. She's not a CPA. She's not a bookkeeper. And she sent the income statement and I said that chart of accounts are off. You don't have your manufacturing company and you don't have the cost of goods in the right section. It's somewhere down here.

in GNA and expenses, and I can't really tell how much you're spending on.

But there's no way to fix that because she can't fix it. Ha ha ha.

John (36:44.158)
Yeah, well, I'll give you a good one, too. I was talking to a business broker. I looked at one of I looked at one of his memorandums and I end the financial statements and I called him up and I know the guy well and I said, how confident are you in the financial statements for this company? And he's oh, 100 percent. And I said, then why are there balance sheet items on the income statement?

John (37:12.214)
You think before you take a business to market and you send financial statements out, you would at least review them for basic stuff like.

Jon Stoddard (37:22.224)
Yeah. Let me ask you about that. I think they're all important documents, the financial report cards, the balance sheet, income statement, and cashflow statement. But most of the time you're just going to see the income statement from these small businesses. I think the balance sheet is more important. It tells the story about the money they used and the debt that they're using, the cashflow.

John (37:30.839)
Yeah.

Jon Stoddard (37:49.7)
everything else. To me, it tells a story. I look at them all together, but if I look at the income statement, I said, hey, that net income or EBITDA, that's a theory. That doesn't really tell me how much is in the cash account or how productive they are turning assets to cash flow.

John (38:08.862)
I agree, I usually look at the balance sheet first, if it's there, and then go compare them. And I like to first look and say, is the net income on the P&L the same as the net income showing year to date on the balance sheet? Sometimes it isn't. But yeah, right, the balance sheet tells you, are they, what are they doing with assets, and are they bleeding the company? You know, there's, you know, we're doing.

Jon Stoddard (38:23.117)
And if it's not...

John (38:37.118)
8 million a year in sales or 18, it doesn't matter. And cash account is low and working capital looks normal, but owner distributions are off the chart.

Jon Stoddard (38:48.304)
Yeah, so why do you have a couple Maseratis? Yes.

Jon Stoddard (38:55.59)
Exactly.

All right, number seven, I think we're on. We talked about cashflow a lot, thank you. That is actually looks just the lifeblood of the business. So yeah.

John (38:59.446)
Yeah, let's go to it, you know. Yeah, oh, we could talk, we could. It is, it is, cash is king, as I said before, cash flow is king. So let's just go, a big mistake is big on the big picture side is not recognizing you're going to make a leap of faith. And, you know, in the preface to my book that's aimed at the individual buyer.

It says, you're going to make a leap of faith. You want to make it off a chair, not the roof. And that ties into both not being too defensive, because again, we talked about there's no perfect businesses, but not getting buyer fever.

You're making a leap off the faith off the roof when you get buyer fever.

Jon Stoddard (39:54.244)
Yeah, I like that analogy. It's, I might evolve it a little bit to say it, if you're going to jump into, headfirst into a pool, probably should wade into it and see if it's deep enough.

John (40:07.294)
Yeah.

Jon Stoddard (40:10.52)
Yeah. Do you have stories about that? Specifically anecdotal stories? That cautionary?

John (40:22.37)
Yeah. And I'll tell you when you get by your fever and you really like something, I'll tell you, I won't use the guy's name because this is not a pretty story. So, offers in, it was a nice size company. I mean, we're not talking about a small business. This is a nice, you know, multimillion dollar deal. And it comes time at the end to do the final due diligence. And to me, final due diligence is talking to employees, management.

and customers. You know, generally, you know, there's a requirement, hey, we'll at least sign the purchase and sale agreement with a contingency for that. So we get time that it's talking to the customers. And a husband and wife owned it, and she's the one who just said, no, can't have you talk to the customers. This industry is very tight. Word will get out, something's going on. I told him, you need to put this deal on hold. His attorney, who's a little stronger, said, kill the deal.

He said, no, I trust her. I understand completely. It'll be OK. Comes to find out, and this one did have customer concentration, which was handled in the valuation of 20%, 25%. That top customer, while we're in due diligence, was doing due diligence. We called a test kitchen of all the competitors, products, and services, and didn't invite their current vendor.

Jon Stoddard (41:21.733)
Yeah.

Jon Stoddard (41:49.833)
Ooh, okay.

John (41:50.154)
company he was buying because they were so sick of them nickel and diming them over the year. This is some product, a service where you make a big investment in it and then there's you know upgrades and maintenance and they just felt you know they're just taking advantage of us because you know we can't go out and replace what they have every other year. This has got like an eight or ten year life before new equipment and they were just sick of them and they didn't even invite them to bid.

Jon Stoddard (42:19.62)
Yeah. Did the buyer buy the business?

John (42:22.986)
Holy oh this came up after. Yeah.

Jon Stoddard (42:24.94)
Oh, it came after and did the customer drop them and 25% drop in revenue immediately? Was there any attempts to win them back and say, we're not going to do that again? New owner.

John (42:29.525)
Oh yeah!

Yeah, yeah, never.

John (42:38.642)
Of course there was, but they were, excuse my language, they were pissed off.

Jon Stoddard (42:43.844)
Yeah, yeah, yeah.

John (42:45.402)
and the lawyers got involved and there was a settlement and all of that, but it was, you know, there's a self-inflicted wound. Cause the lawyer and I both said, you know, don't proceed on these terms. That's buyer fever.

Jon Stoddard (42:58.548)
What, yeah, what are your, what's your, yeah, the buyer fever, um, you know, in the human body, they used to, the doctors used to try to minimize the fever, but the fever was the whole process of correcting or healing the body. It's, it should happen. Uh, do you think about due diligence, outsource it or do it yourself? And the reason I brought that up is, is I just had a conversation with a, another

I call a mentor. He's, he's holding a little holding company. He's 84 years old, but he goes like, John, we, we do, we do all the due diligence ourselves, we get in there and do everything. We're the financials. We go to the customers. We go to the suppliers. We do it all ourselves. Cause I'll know more about that business in the first three months than the guy selling it did.

John (43:50.626)
What size companies does he buy?

Jon Stoddard (43:53.365)
Uh, anywhere from one to $10 million in Roman. Yeah.

John (43:55.954)
Okay, yeah. So in the smaller deals, I think most of it should be done by the by the buyer. I mean, obviously, they can't do any legal due diligence. And if they're not financially astute, they should have a CFO or an accountant be helping them on the financial side. You know, the buzzword these days, and you know, I hear this all the time, what should I get a Q of E on the quality of earnings on this company? It's like

This isn't that big a deal. You know, this is like an SBA deal. You know, why do you need a quality of earnings? And I will give the CPA profession credit for creating a great marketing term, quality of earnings. You know what we used to call it? Mini audit. Mini audit is not sexy.

Jon Stoddard (44:27.024)
Yeah, you got $30,000? Yeah.

Jon Stoddard (44:42.94)
Mini audit, yeah.

John (44:47.33)
Quality of earnings sounds sexy.

Jon Stoddard (44:50.084)
Oh my god, that sounds official.

John (44:52.202)
Yeah, but you know, you know, if you're in the P.E. world, you have to get it done because your investors, if anything happens, they're going to say, why didn't you do a quality of earnings?

Jon Stoddard (45:02.256)
Yeah, that would never happen because they go like, we're putting a multiple on this business based upon we think these customers are going to be ordering from us for the next five years. Okay. Great. I don't think you can do that with small businesses. Yeah.

John (45:18.87)
No, but you can go in and tear apart the financials. And, you know, I mean, what are they doing? They're seeing, is the cash flow really the cash flow?

Jon Stoddard (45:29.072)
Yeah. Would you sick a, if you saw, for instance, going back to my example, like the chart of accounts is messed up. They don't have the cost of goods in the right place. Would you sick a CPA on this?

John (45:43.415)
I would suggest a CPA or a CFO type. What is your true cost of goods sold? Now, let's also face it, if you say a company's doing, just say five million in sales and making a million bucks, are you gonna worry that much about it versus, hey, I got a company doing five million making 200,000?

Jon Stoddard (45:46.739)
Mm-hmm.

John (46:09.014)
you know, then you're gonna dive in a lot more and say what the heck is going on at your margins are so horrible.

Jon Stoddard (46:14.864)
Yeah, yeah, well, it's not financeable. I mean, I can't borrow money to buy that. Yeah.

John (46:19.91)
Yeah. Well, I mean, you can't borrow money to pay the same price. But yeah, if you're making 200 grand and you're going to pay 6, 800, it's all relative. I'll tell you something I learned great term. There's a guy who was the president of one of the divisions at Expedia. And his line was,

Jon Stoddard (46:31.845)
Right.

John (46:46.99)
growth hides a lot of operational warts. And he also said those warts tend to work their way out.

Jon Stoddard (46:50.725)
Yes.

Jon Stoddard (46:55.813)
Yes.

John (46:59.543)
And whether it's, well, our cost of goods sold could go down by 2%. Well, get in there and do it. Don't obsess over it.

you know, grow the company so that you're buying materials at a lower rate.

Jon Stoddard (47:17.208)
Yeah. Can I, can I rewind a little bit? Because when you were talking about people and being a nice person and the question has to do with like, if I come in and I'm a numbers guy and I run the business on numbers, but businesses are run by people, do I have to, should I be an inspirational person to help people want to come into work and then come back tomorrow?

John (47:42.778)
I would think so. I mean, there's a lot of numbers people who have good personalities. I mean, it's stereotypical, you know, the old green visor and lamp of an accountant in the corner or like in Christmas Carol, just writing numbers or entering numbers now. I mean, you got, you know, there's a lot of numbers people who can motivate.

Jon Stoddard (48:02.228)
Yeah, that's Charles Dickens. It's not going to work.

John (48:12.293)
But you can't sit in the office and just analyze spreadsheets like you were talking about with your guy in Georgia.

John (48:20.062)
And be as successful as you would be if you're out there with the employees. I just read, I think it was in the Wall Street Journal today, that there's some disconnect, dissatisfaction at Starbucks and the new CEO is getting out and meeting the rank and file workers and going and getting to know them. Not all of them, obviously, thousands, but he's making an effort to do that.

to see and asking them what they would like to see happen.

Jon Stoddard (48:54.648)
Yeah. What's the danger in that? Like if you start talking to baristas and they say, Hey, we need more Starbucks with pink cups. I don't know. You know, like

John (49:05.598)
Yeah, well probably what they're gonna, I would think more than that they're gonna say something like, you know, the equipment gets kept around too long and it gets difficult to use.

Jon Stoddard (49:15.54)
You have to filter through that, right? Yeah.

John (49:17.606)
Yeah. What's, you know, what, and it isn't just like, what would you want to see, but what could we do to make your job better and experience for the customers better? And they're not going to say we need multicolored cups, but they're going to say, you know, these machines, you know, we've got to do maintenance on them every other day. It should be every other month, you know.

Jon Stoddard (49:39.3)
Right, serious filtered suggestions. Yeah. All right, so number eight, is there a number eight? Do you have a number eight?

John (49:42.046)
Yeah.

John (49:48.458)
Oh, there could always be a number eight. Oh, I mean, it's just so many things that go on in, you know, in buying a business. Uh, yeah, you know, that's just, uh, you know, that the, I think the mistake that, you know, and the mistake that a lot of buyers make is they want to secret sauce upfront. They don't, they don't recognize.

Jon Stoddard (49:51.464)
What do you got, like 8 to 20?

John (50:14.814)
You know, you got to put an offer together and get it accepted before you get in to see the secret sauce. The secret sauce could be the name of the customers or, you know, the exact name of the employees or.

Jon Stoddard (50:28.592)
So tell me a little bit about that. What do you mean like the secret sauce of the business? Are you referring to like what really makes the bell ring in the business and that the buyer can't see or just not visible to them?

John (50:28.662)
Yeah.

John (50:37.494)
Well.

No, I'm talking about the things that, you know, like I'll just, you know, see, I like to use the term secret sauce is, you know, sort of the stuff that the owner, you know, the business has that gives them a competitive advantage. And some of it's perfectly explainable. We make the best product out there. But you know, we've got a really loyal, we've got really loyal customers. Okay, show me well, customers A through Z, you know, look at them over the years.

Jon Stoddard (50:57.112)
Yeah. Yeah, but why do you make the best product?

John (51:11.163)
They've been with us for 10 years and here's their percent of sales to those top 26 customers, to each one of them and notice how it bounces around. But at that point, you don't get the customer name.

But when you sign an offer, you get due diligence, you get the customer name.

Jon Stoddard (51:30.9)
This is a leap of faith, right?

John (51:33.374)
Yeah, I mean, if you were selling a business, would you show your list of customers with how much they do to everyone that came in the door saying I might want to buy it?

Jon Stoddard (51:45.316)
Not everyone. Probably some individuals that were serious had the money and looked like they're qualified buyers. Maybe when it was down to two or three, probably. Yeah.

John (51:53.79)
Right, or I like the thing that I see mostly in the process, whether it's the customers or access to employees or some other things, it's after an LOI is signed. And then you're in due diligence.

Jon Stoddard (52:06.521)
Yeah, yeah.

Yeah. What's your, what's your thought about that? You sign this LLOY, you go due diligence and, uh, you know, it's time to talk to the employees. It is, you know, Hey, why are you talking to me by the way I'm selling, you know, and the first thing that comes to mind and he was like, Oh, are you shutting the company down or should I expect to get fired or what's going to happen or I'm going to get a reduction salary?

John (52:26.99)
Uh, you should get-

John (52:35.702)
That's why confidentiality is the most, a breach of confidentiality is the most dreaded term to a business seller.

Jon Stoddard (52:43.836)
Yeah.

John (52:44.914)
And generally, it would be the senior people in the company. I mean, you wouldn't go out if you got a factory with 40 people, you're not going to hold a meeting and say, hey, this guy's buying the company. But before you close on the deal, you're going to meet the four people who are, you know, sales manager, the ops manager, the financial manager, et cetera. And look, a smart seller will bring them in. And they say, look what I'm doing.

Jon Stoddard (52:51.556)
Yeah, you're not gonna go out to the-

John (53:12.25)
I'm not the age. I need to retire. I need to do something else. And a really smart seller will say, and when we get this close, here's your, here's a retention bonus. If you stick around with the buyer for a year or whatever, here's some, here's money. They'll go in an account for you.

Jon Stoddard (53:29.008)
Yeah, in some kind of as-gro.

John (53:31.978)
Yeah. You know, if you're selling a million dollar business, that's probably not enough. But if you're selling, I've seen it done, you know, business selling three, five, seven million that they do that. Cause people are what make the business also. Right. Yeah.

Jon Stoddard (53:46.224)
Well, number that was number eight and number we got time for one more number nine. Yeah

John (53:50.534)
One more. Hmm.

Oh, what can we talk about, John? There's so many, I'm trying to think of some good stories.

John (54:04.862)
Here's one I think you'll like. It's don't think that when you buy a business, that's first of all that it's, you gotta fall in love like you're getting married to it. Think that, hey, this is a business and I may not be in it longer than say five or 10 years, but at the same time, don't think it's the only acquisition you need to make. I've had many clients, as you know my book on company growth by acquisition, many clients.

Jon Stoddard (54:32.016)
Yes, right. By the way...

John (54:33.762)
who have bought multiple companies. And yeah, it doesn't mean, and it doesn't, so that means don't think you have to buy the biggest possible thing right off the bat. Cause you can always buy a smaller one and buy another one and another one. And it is really true that I'd say there's a darn good chance after a while, someone in your industry is gonna say, hey, it's time for us to exit. We noticed you're, you buy and the people like, like working for you.

I just had one, what, two years ago, that's it. The largest, that guy made four acquisitions, the largest one was the last one, bigger than his other three combined on sales volume, and they came to him and said, we've seen you buy three companies in our industry. Would you be interested in buying us? And he did.

Jon Stoddard (55:19.728)
Yep. I've seen that too. Yeah. Well, I actually saw it in the franchise business, but you know, they go to a trade show and everybody's walking around going, Hey, I understand you buy, you know, you buy businesses like, yep, we'll do it.

John (55:22.782)
Yes. Yeah.

John (55:40.982)
Okay, it's been a pleasure.

Jon Stoddard (55:42.084)
Yeah. John, thank you so much. By the way, John Martinka, he's been doing this for over 100 businesses, 20, 30 years now. Got five books on Amazon. I've got two. John, thanks for being on my show.

John (55:56.13)
Yeah, it's a pleasure. I think we could have gone on for hours.

Jon Stoddard (55:59.576)
Uh, I love pure knowledge.

stop this and give it a