Summary:

This conversation discusses how to analyze deals like an M&A professional and identify bad deals in five minutes. I want to emphasize the importance of quickly disqualifying bad deals to save time and effort. Jon discusses the financial report cards to ask for, including income statements, balance sheets, and cash flow statements. The speaker explains the difference between cash accounting and accrual accounting and highlights the importance of balanced books and financial integrity. They also provide examples of red flags to look for in income statements, balance sheets, and cash flow statements. The conversation concludes with a Q&A session.

Takeaways:

▪️ Quickly disqualify bad deals to save time and effort
▪️ Ask for financial report cards, including income statements, balance sheets, and cash flow statements
▪️ Pay attention to red flags in financial statements, such as unbalanced books and negative profitability
▪️ Understand the difference between cash accounting and accrual accounting
▪️ Evaluate the risk and reward of acquisitions

Chapters:

00:00 Identifying Bad Deals Quickly
10:05 Understanding Financial Report Cards
20:00 Analyzing Income Statements and Cash Flow
30:03 Red Flags in Business Acquisition
39:55 Q&A and Insights on Deal Making

Transcript:

Jon Stoddard (00:00.558)
Thank you everybody for joining me. I know your time is valuable and choosing this to learn a little bit about how to analyze deals like an &A pro and identifying bad deals in five minutes flat. If you identify bad deals in five minutes of flat, this is how you're sifting through deals. So we are going to talk about what financial report cards to ask for and why, what red flags to look for, income statements, balance sheet, cash flow statements, what formulas to use to score the business and how to spot trends and

improving, declining. So let's get into this. All right. Why are you here? You spend too much time on bad deals, deals that cannot be financed. And every single one of my students that bought my course, that's been on the phone with me, they will get these SIMs from the broker or they're reaching out on an off market deal and they spend too much time looking at bad deals.

You don't have to be a genius to spot good deals, but you must know how to disqualify bad deals fast. So here's my story. I bought Century Urine Aids, I don't know, seven, eight years ago, and it had an ugly balance sheet. I spent countless hours, heartache and money to fix this thing. I ultimately did. I just wouldn't wish it on you. And here's what Warren Buffett actually said about this.

After 25 years of buying and supervising a great variety of businesses, Charlie Munger and I have learned not to solve difficult business problems. What we have learned is how to avoid them. So if you know how to spot a bad deal, you move on real fast. And when I say five minutes flat, I mean, you're not going to tell if it's a good deal or bad deal by the SIM because it's a marketing document. Sometimes they lie.

but you will be able to tell in five minutes flat after getting the financial report cards that we'll talk about. Here's the first thing I look for when reviewing a business. Do they use accounting software? Yes or no. The second thing is financial report cards. Which financial report cards to ask for? Do they use accrual accounting or cash accounting? Are their books balanced? And what are the red flags in these books?

Jon Stoddard (02:26.57)
And are they making money, reasonable debt, cash in the bank? I look for all of these things in order because I want to see integrity in the business and their financial reporting before I see they're making money, reasonable debt, cash in the bank. And we're going to go through each one of these. A lot of the times you're going to go to a broker, these on market deals and bill out the NDA, get the SIM, and they're going to send you these financial report cards and Excel spreadsheet.

I would raise the red flag on this because it's so easy, manipulatable. The best thing to do is make sure that they're on QuickBooks, FreshBooks, Xero or some other accounting packages. That gives you some kind of a surety that they're using financial integrity to do their books. According to GAP accounting, which is general administrative accounting principles. Here's what we asked for from broker dealer. I always ask for

three to five years of income statements. I always ask for balance sheets, two balance sheets, same date. Usually it'll be at the close of the year and it's always going to be 12 months apart. And the reason we asked for two is the balance sheets, like a snapshot of at that given moment of the equity and assets in your business. And the only way you can tell what's going on in this business is if

You have context. You have to look at their position. Has it changed for better or worse in that 12 months? Cashflow statements, that's cash in, cash out. Same thing. It's a snapshot of the business, how cash is moving in, how cash is moving out. Same dates. It's usually like 12, 31, 2023. And then I asked for 12, 31, 2022, 12 months apart.

And here's a, here's a letter from Warren Buffett when he was buying private businesses in 1967. He asked for balance sheets, plural, dated December 31st and January 31st and income statements. So I am not alone in asking for these documents. It's done by these guys. Let's get a little bit into the cash accounting that you want to ask and what the red flags are versus a Crowe County.

Jon Stoddard (04:51.926)
So cash accounting, it only records those transaction which cash changes hands. There's not a lot of businesses like that. Cash accounting actually ignores the transaction until the cash is deposited. There's no receivables, no payables, no inventory. And I think the only real cash accounting business is a cocaine dealer. So that's, you wanna make sure, you wanna ask the broker dealer, does this business use cash or accrual?

Accrual asks, did you earn it or do you owe it? And did you use that asset? Accrual accounting says that it's important to match the cost of the generating the sale with the actual sale in that same time period. That's what an income statement shows you. Not with the receipt of the cash payment. And actually the IRS requires you to do accrual accounting if you have inventory. And that's a lot of types of businesses.

I also ask the broker dealer if their books are balanced. A lot of the times you'll see these small businesses, their books are done by the wife or a bookkeeper. That doesn't mean the books are balanced. And when I say books balanced, I'm talking about the equity equals the assets minus the liabilities. And that essentially means it's the net worth of the company.

Balance books means those two equations equal mean that the business has diligent recorded financial transactions. There's financial integrity in the business. you know, when I look for these three documents, I look for the income statement, I look for the balance sheet, like cashflow. And you can identify if the books are balanced. If you look on the income statement, if the company has earned a hundred dollars in net income, and then you go to the balance sheet,

And then under the equity, you could see is the net income $100. If those two don't match, the books aren't balanced. So it's kind of a red flag for financial integrity. And a second check on that is the cash flow statement. If the ending cash $75 matches the cash on the balance sheet, then the books are balanced. There's financial integrity in the business. If it's not, it's a red flag.

Jon Stoddard (07:15.862)
And I, when I say red flag, I don't mean that, geez, throw the target out completely. Go on to the next one. Because if you're an expert in the industry and you can go in there, you know, you've been in manufacturing for 30 years, you run manufacturing companies. This is like your fifth manufacturing company and you know, you know, this company, what they're doing, how much it costs to run it, how much probably they're making, how much the prices, you know, you can say, I can fix this. I'm not saying it.

completely eliminates the business, but it's a red flag. I just wanted to show you gaining confidence in a business and just stay on this a little bit. There's three ways you can get a little bit of financial integrity and confidence. There's reviewed books, which mean it's by a bookkeeper. They're not CPAs. They're audited. That's by a CPA. And then you do a quality of earnings report. Earnings report is really depth in value of the inventory.

where the cash is going, customers, know, how far they're ordering out. And there's costs associated with that. So if they say their books are reviewed, you are probably going to have to have a CPA look at it. If they're audited, a CPA has reviewed it. So there's a level of attorney there. If they've done a quality of earnings, you can actually use that quality of earnings report to help you raise capital for the business.

Is that helpful right there? That's, I didn't want to stay a long time on that, but here we go. All right. In every business, the goal of the business is to turn the assets into sales, into profits, into free cashflow. And we measure that how effective is that small business at acquiring the assets? How efficient are they at converting those assets?

and how productive at converting those earnings to cashflow. This, every business is going to be different, right? Because every business brings their own management, their own culture, their level of efficiency and effectiveness. The best thing to do in these kinds of industries is look at a lot of different businesses at what their, you know, net income is. If you're looking at a manufacturing company, you got a good sense that manufacturing companies do.

Jon Stoddard (09:35.982)
10, 15 % in net income right around there. If it's below that, that's concerning. Then you got to look at, know, what are they buying their inventory at? How many people they have in a general administrative, you know, work in the business and the payroll. How are they doing at turning those assets into cashflow? And by the way, if revenue exceeds those expenses, you're making money. The balance sheet, just a little other explanation on this. All right. So the balance sheet, what is the balance sheet?

you're going to, when you ask for this, it compares assets and liabilities of a business. It's things and stuff or assets, and it includes liabilities. That's what you owe. and what you owe, which is the assets of the business. As you could see, here's the equity equals the assets minus the liabilities. The reason you have two columns here is you don't

How many contacts, if you only had one come, you don't know if they've done well, you don't have to done worse. Like here's for instance, cash in the accounts from 2020 decreased $30,000. That could be concerning. Accounts receivable increased. They haven't collected their, you know, the jobs that were coming or accounts payable. That's increased there. you know, they're not, they don't have enough money to send. owe people.

to pay bills, either it's their employees or it could be subcontractors, something like that. That's the balance sheet. So here's some red flags, like low, insufficient cash. Always check for that. And the only way you could do that is if you have contacts. That's why you need 12 months apart. That's why Warren Buffett does that. He asked for two. Mounting receivables. That's a red flag. If accounts receivables are moving up,

Something's going on with could be macro or micro level, right? If the industry is going bad and customers that owe you money have not paid you, you got to find out what's going on there. Now, if you're looking at a business and it's a big receivables, you have to ask for the agent report. And that agent report is going to tell you how long it's taken your customers to pay you. If that agent report shows that

Jon Stoddard (12:00.75)
good percentage of those receivables are 90 days out, that's going to be a challenge to collect because something's going on with the business, your customer, that they're not getting paid and they don't have money. Low current ratio, what's the current ratio? That's current assets to current liabilities. Now, if you had a current ratio of 140,000 over 50,000, that's a 2.8. This is a number that every SBA lender is going to run.

in underwriting, if you have a one or something that means your current assets are the same as your current liabilities. They are not going to lend to you. It should be as high as possible. The higher the possible, if you see something like four or five, that's fantastic. Lots of assets there. But if it's low, that's a red flag. Loans in and out of the business from shareholders. This is kind of concerning, but you know, a lot of these business owners use, actually you use low interest loans

to buy their houses, their boats and everything. You know, if you're going to go buy a business, you got to make sure when you do an asset purchase agreement that you're not buying any of this debt here. All right. Large debt obligations. This is, could be a big problem. This is $500,000 in this bank loan and they had to buy, borrow a lot of money to, you know, basically buy assets of the business. could be equipment, it could be inventory, it could be any of those.

But if it's a huge loan, that means you're going to have a low current ratio, which means you probably won't get any lender to help you buy the business. Because this money is being used to fund the business. Negative retained earnings. If you see this on net income, you should see this. If the books are balanced, remember what I said, you're going to see negative earnings net income on the income statement. That's a red flag. Income state analysis. Everybody's seen these. They know what they are.

But this records sales activity of business along with the expenses curve. Here's a dirty little secret that I don't think a lot of people know. The profits on this bottom line here, the net income, have nothing to do with cash in your account. Profits are a theory of whether those sales did or did not exceed the acquisition targets expenses. They're just the theory. You may see these businesses like, you know, throwing off 3 million top line.

Jon Stoddard (14:25.926)
and it looks like a 20 % bottom line, maybe 600,000 in net income, does it? And then you look at the balance sheet and they only got $30,000 in there. That's a problem, right? Because they're spending their money somewhere else, like to pay off debt or they're just taken out of the business or, you know, I should say this.

When you're an SMB and you're an owner and you own a hundred percent of the business, it's your prerogative to do whatever you want with that cashflow. But if you're taking a lot out of the business, it makes it difficult for you to value the business if you're going to try to buy it. All right. Cash on the other hand is, is a fact. And that's where you see in the cashflow statement. That's where you saw it on the balance sheet. You can't spend these earnings at the bottom line, the net income. You can only spend cash.

Whether that's to acquire more inventory, hire new people, et cetera. All right. Declining revenue. We all know what that means. I'm not going to spend a lot of time on it. company has experienced three or more years of declining revenue. It's not a good business, but it's not going to get to underwriting. Nobody's going to lend you money on a declining business. If you want to buy the business, this is where it's going and it's going on revenue. This is a creative financing offer. right. High number of other expenses. This always needs to be checked. If you see in the income statement.

There's a whole bunch of expenses in other. Most of these expenses need to be reclassified. If they are assets used to turn into sales, to turn into cashflow, they need to be classified in the right operating expenses category. They could be coming under advertising, computer internet, whatever they are. If you see something with other and it's a big number, you got to check that. A lot of non-opening income.

Non-need operating income is from the sale of fixed assets, like you sold a truck or you sold a building. It's a one-time large sale or it's a sell of an investment. Say you had a small division that wasn't really doing well, wasn't fit within your business and it was a two-man operation and you sold that. That's non-recurring. That's a sale of an investment. right. Inventory manipulation. It's a red flag when you see when a business

Jon Stoddard (16:47.168)
can buy a lot of inventory and not record the full expense of the purchase or record the purchase at all. Or companies can also exaggerate the vendor discounts to reduce costs or not write the inventory off like it's out of date. I've seen a lot of businesses that have come to me and say, hey, they want me to value and buy the inventory. Well, normally if you're buying a stock versus an asset purchase, you're gonna buy the inventory comes with it and it's valued in there.

but you have to check the value of that inventory. lot of businesses, the inventory changed because their business model and their products changed. Some of that inventory, you could see up to 50%. It doesn't have any value to the business and cashflow at all. This is one of the things that you can only check if you're like an expert in the industry and you know the inventory, you go do a site visit face to face, or you have a quality of earnings report.

But you got to got a good hand of what that inventory, how valuable it is to the cash flow of the business. Kind of another scheme with inventory is over accounting, under accounting inventory to present a nice pretty picture or phantom inventory. Negative profitability. Now, if you see a negative net income, even SDE, which is, you know, an owner's trying to sell it and they has all these ad backs like depreciation, amortization, phone.

insurance, 401, things like this. That's not going to fix a business because when you put pencil it into an underwriter to lend you money, it's not going to work. They're not going to lend you. There's no excess cashflow to be able to pay the debt service on that business. If you see a business with increasing costs, that is also a red flag and you got to find out why.

You know, everybody's been through COVID and they know that it costs more for gas. It costs more to have inventory shipped over here. A lot of costs increased. Maybe the guy wants to sell the business because he can't charge more. There's a couple of ways you can fix that. You could either buy in bulk or you're to have to raise your prices. Those are two simple answers.

Jon Stoddard (19:01.952)
This also mean at the end, it's a, can't scale the operations to remain viable. Let's go into the cashflow statement. Here's a picture of a cashflow statement side by side, 12 months apart. And you could see the increase and decrease the Delta. It's also going to show you the net increase, the cash from the operating activities, the cash from investing activities and the cash from financing activities. That's the cashflow statement. The red flags here, large.

Negative balances may signify that the seller is spending too much on an initiative that doesn't generate an ROI. Every small business is out there going, okay, how do I bring in new customers? And they're going to try this marketing. They're going to try pay-per-click. They're going to try direct mail. They're going to try social media marketing. They're going to hire a digital agency. Some of that stuff doesn't work out. Negative or limited cash flows from financing. This is if they're borrowing money and they borrowed too

because we're going to play a little game on these. We call, I have weekly meetings every Monday at 11 a.m. group meetings and talk about, we look at businesses to review, deal review. Do we pass or pursue? A little game for business buying experts. All right, here we go. All right, here's a business we looked at, my and my student recently. The business broker said that it was doing 4 million top line, 1.5 million and

We asked for the financial report cards, three years income statements, two balance sheets. And this is what he said of the combined properties. It's losing $270,000. Like that's not financeable. We couldn't even buy the real estate. We'd have to tear the car washes down and put something up that actually made money and have a very, very long-term lease on this. It's just not financeable. So five minutes or less,

Pass or pursue? We passed. All right. Here's a business that we recently looked at. It's doing $6 million and there was about four of five locations and the adjusted EBITDA, if you could see this, is 10%. It's like a service-based business. Like something was going on there and we just asked for the balance sheets. If everybody could see this.

Jon Stoddard (21:28.856)
It was taking a lot of loans from the shareholders. shareholders, owners were injecting cash into the business to save it. And remember when I, little earlier, this is one of the red flags, loans outside from people to run the business. Its own cashflow could not support the activities of the business. It was taking loans from investors. Passed on that. All right.

Here's, looked at a battery manufacturer that supplied batteries and we'd have to order a lot of inventory. We looked at this and we didn't have to really go on any farther because you look at these years and months and it was, you know, 50,000 lost here, lost 33,000 here, lost 163,000 here, 51,000 here. This was a cashflow nightmare.

We each in the margins work good enough. just passed on this one. Here's a business we looked at and I had the broker send me something and they had some bunch of gross profit. And you could see that the Inibita was higher than the gross profit. Like what's going on here? There's no financial integrity in this at all. Of course he added these ad backs, which is depreciation and amortization, but depreciation and amortization are not cash.

They don't add to cash. They're non-cash events that help you in taxes. It doesn't add to cash flow. So we could not borrow money on this. So this was also a We looked at this business. It was a medical equipment supplier out of Las Vegas. And we looked at the cash in the bank was $63,000. They were doing about $3 million and the cash reserves were low. That was a red flag. And then we looked at the discounts receivable.

which was almost a million dollars where, and then we ask, my God, what's the agent report on that? And a lot of that, some of that debt, I think almost 50 % of the debt was over a year old. That means it's not going to be collected. This is not an asset anymore. We have to write that off. They didn't have a lot of liabilities. That's great, but this did not work for us. We passed on that one. Here's a business where

Jon Stoddard (23:49.452)
Cost of goods sold, we look at this and if you could take a look at this where in 2020, they're selling the same products. They've sold same products for 10 years. Cost of goods sold went from $1.6 million to $964,000 to $500,000. We said, how are you reducing your cost of goods three times?

So we called the broker, the broker checked with the seller and the seller said, hey, we made a mistake on our accounting. We just changed accountants and they have to reclassify that and redo the books. No financial integrity in that. As you can imagine, we passed. Here is the balance sheet on this cash and accounts. Had cash on hand, $198,000, a lot of negative. They had a lot of accounts here, which was kind of interesting. They were.

I'm not sure why that was like that. Today, that's not really a bad thing. And today, if you have Stripe, Stripe has a reputation of shutting some people's accounts down. It's a good idea to split that up to mitigate some of the risk. Tons of accounts receivable. Look at this accounts receivable. $2.262 million. That was another red flag. Be like, where is this? Why haven't you collected the money?

So this was a no. said pass or pursue. Passed on this.

This was kind of a funny one. The broker sent us first thing. The problem red flag was it's in an Excel spreadsheet. The next thing problem was we looked through this and look the income statement go, what the heck is non-essential salaries and expenses, mistress and family. Yeah. The guy was being ethical about being unethical, having a mistress on staff. And we said, Hey, if he's going to lie about this to his wife, kids.

Jon Stoddard (25:54.186)
Whatever we are going to pass on this. This is a company we looked at in California. It was a security company. They were lost a lot of money. Every month they would look like they lost the money. And basically our security company is just somebody that, you know, supplies guards, physical man guards to, you know, malls and events, stuff like that. And for some reason he was losing a lot of, a lot of money here.

This was un-writeup from a bank. had 20,000 in cash, except they were doing, this is a small number, right? $1.4 million in total and a lot of cash generated, but they only have $20,000 in cash. They're either not charging enough or they're taking a lot of money out of the business. Shareholder distribution, they definitely took some money out of the business and the books weren't even balanced. So we passed on that one. That's a red flag. So here's a business. They rebuilt transmissions in California.

They did $6 million in 2022 according to their taxes. And then the broker said, why don't I just take the 12 months and make it look great? That's not what they're, they didn't do $10 million. It's, they only did 6 million something in 2023. So we said, look, this is just fluff. And if you go down here, we're here right here in the top, like they do all these ad backs now.

They only made $219,000 in 2022 tax. Now the trailing 12 months, they took the best of the months to kind of make it look, that's a broker. You know, they're trying to put a big, great big cherry on the top, make it look better than it is. Now appreciation, amortization, those are legitimate ad backs, but they're non-cash events. They don't add to cashflow. In fact, SBA lenders, willing to count, don't like that in underwriting. Salary to the owner.

You know, $334,000. He definitely took some money out, but businesses like this don't run by themselves. So that is not a legitimate ad back. Life insurance premium. Well, if you get an SBA loan, you're going to have life insurance too. So it may be different than that, but that's going to be an expense on there. It went from 873,000 to a million back down to 160,000 to 619,000 to 219,000.

Jon Stoddard (28:11.532)
There was something's going wrong with this business where he's not turning those assets into cashflow. He's got to do a better job. There's got to be more margin on this. Unfortunately, we couldn't take this to underwriter. They're not going to loan on this. So this was a pass. This is a business we looked at closely. It was out of the, Southeast. And you could see they're doing 6 million top line, but they're only doing 616,000 bottom line. They definitely.

have some assets on the business, $1.6 million in cash. Counts receivable is huge, almost a million dollars. We don't know if that's normal or not, because you need to, like I said earlier, you need two of them for context to see if that's an increase or decrease. They're fixed assets, we're a building they own, but it wasn't worth much, couldn't finance. They didn't really have any big liabilities according to that.

Their ratio was great, right? Net assets to liabilities, the ratio was fantastic. Unfortunately, we'd have to look at the accounts receivable. Now this is two things here on the red flag. The net income's a little small. It's like less than 10%. It's nine something. And they have a lot of accounts receivable. We'd have to know a lot more about what's going on in the business and how effective, efficient, and productive they are turning assets into cashflow.

There's a lot of these we look at and we have to eliminate them as fast as possible. I just want to give you an example here. One of my students called Tom Diamond, he, we looked at probably a hundred businesses, 10 of them. He's got a hundred Sims. said, nah, that's ugly. That's ugly, ugly, ugly, ugly. You got that financial report cards, all three of the documents. And then he found one that was really profitable, had a lot of cash on the balance sheet. I said, this is what you go for. Say no fast.

Five minutes or less, so you can focus all your energy on a good business. If you guys want to join me, this is how to buy a million dollar business. I'm going to open it up for Q and a now. I'm going to ask everybody stop share and open it up. Does anybody have any questions? Scott Jose, Alex, Paul, Chris Larson, Chris Larson. What's going on, man?

Jon Stoddard (30:35.83)
He's my holo Marine. It's Nappin and Chief, how are you? Good, Who said that? Who's the other guy? Jose. Yeah. Two Marines. Yeah.

Yeah. Anybody have any questions on this? got to, this is the point. You know, I read this book. Does anybody know who the guys are on the all in podcast? Yeah. There's four guys, Chris Calacanis. And he said, look, I see thousands of PowerPoints from startup founders. And I had to become real fast at looking at the crap.

to find the good stuff. And that's the point is like, you got to look at, able to see those red flags really fast. And then all of a sudden, you know, like you inverted, I know what ugly looks like. And then when a great one comes on your desk, it's like glowing gold.

That's what you spend your energy on. That's what you go. That's when you call up, John, I can get a loan on this, but I need help raising capital. And I'll look at it go, you're right. Let's go. Let's go get it. And you just go as fast as possible because money loves momentum.

Jon Stoddard (32:03.486)
All right, guys, anybody with any questions that is basically my kind of presentations. The red flags looked out. Yes, this is recorded. and you can see it back on my, YouTube channel in a couple of days. So Scott got any questions, Chris questions, Paul. Alex, do have one for you just because, know, obviously I've known you for a little while. You guys tend to focus on the service industries or service businesses and stuff. mean.

Most of them in the price points that we're talking about, despite revenues, have a lot of warts in them and they stink some of them quite frankly. As you prioritize what red flags are within the realm of possibility, do you guys find either for yourself or your clients, those that are based on expertise, so you've got real insight so you can quote unquote fix that red flag or?

As you're looking at it, mean, obviously, some of them are an immediate no go for obvious reasons. Fraud, something that is clearly just completely unacceptable and is a dumpster fire. But I do sometimes, you know, wonder what are the criteria, if you have some, as to prioritize those that are maybe with qualifiers and flags and those that, you again, are you ultimately get to the deal that looks, you know, looks amazing. So.

What are for you just more areas for inquiry and then others that are not necessarily a red flag in your particular view, if you just want to answer it for you personally, because I know you try to acquire businesses as well. Yeah. So the whole point is, is you're buying cashflow. Right. And that cashflow has to be there and then you got to prove it. And that's it right there. That's the priority, right? I buy cashflow. It's going to be at some kind of multiple because of the time I spend in or the costs.

is that are used to generate it, but I'm buying cashflow 2X, 3X, 5X multiple, whatever that is. Now the industry is kind of separate, right? And I don't know how to fix all industries, but you can go look at the comps in the industry and go, well, what is it normally? What's the cost of goods for the industry? What's my gross margin should be? Is it should be 40 % or is it should be 70 %?

Jon Stoddard (34:29.93)
And some people are saying, or some people say 40 % is fine, right? Because it's a longer sale and it's a bigger margin sale or it's a bigger, you know, price tag.

So that requires industry specific knowledge. Did that answer your question? Yeah, I just think of sometimes, I for example, I focus, it's not different, it's the same around SaaS companies, et cetera. And while the valuations are very high, again, I tend to look at efficiency. I tend to look at some other.

criteria, if you will, beyond the obvious things, are, you know, no-goes, which, whether again, it's fraud, I happen to agree that, you know, having audited financials is huge, but the quality of earnings cost is usually quite high and most, certainly most sellers don't want to pay for it. Buyers don't want to pay for it either, whether that's 100K or whatever the number ends up being for that Q of S. But for me, I tend to think of, because of SaaS, there are specific metrics, which are different.

from say manufacturing or service-based businesses and so forth were that that sales cycle could be longer. So was just curious as to what you if you if you saw beyond the numbers just you know those other again as a set of criteria but it's it's close enough so. Yeah let me let me for like the SaaS industry let me give you an example. I was a co-founder of a business a long time ago like 15 years ago called TurboSquid. It was a marketplace right

You know, we sold 3D assets to 3D artists. And at that time there was no KPIs for marketplaces. We didn't know what there were. And it didn't really grow until the creative artists were creating stuff and selling to these guys until there was organic growth and buying. Those KPIs were created. So if you're not in the industry and marketplaces, you don't know what those will look for. Right?

Jon Stoddard (36:38.124)
At that point, you say, you know, I got to bring in somebody that can look at this and say, look, are they doing an effective, efficient, and productive job of turning assets into cashflow? Or can I improve it? Or can it be saved? Yeah. Yeah. Yeah. I agree on the quality of earnings. Quality of earnings are usually only good for companies, 2 million EBITDA above, because it's going to be $30,000 to $60,000, depending on what they're trying to do.

Yeah. And how much work they have to go through in order to actually, you know, get that, you know, Q of S, which is pretty thorough. So, yeah, it's thorough. I mean, QL quality of earnings is, know, they're going to audit the books or they're going to check all everybody's accounts to make sure, you know, all expenses are accounted for all debts accounted for all UCC filings and UCC is doing a background checks. Do you the IRS anything or their, leans on the business, all kinds of other stuff like, and morality clauses too.

all kinds of stuff. Yeah. I just think it's really inspiring when somebody pulls the trigger on that. But again, it's, it's going be a difficult thing to do with, you know, the cost and the time and the commitment and everything too. Yeah. And I will say some of these, but if you're moving forward in this, getting your first deal done is critically important. And I'm not saying you say no to a thousand opportunities. I'm saying you got to get one down and there's going to be warts on it.

And you just got to understand those risks. The worst thing is you look under the hood and you didn't look under the hood before you bought the car or you didn't drive it before you bought the car. Right? There's no motor. Yeah. And there's no motor. Right. I love it. Well, it That's pretty. Yeah. It looks pretty. Is that a 76 Ferrari? Yeah. You buy the car without the motor.

Yeah, that's a fair statement. I do think it's very much about risk tolerance and management and what strengths you bring to the table or a team does. Obviously why your students bring you in on the deals is because you've seen a thousand pieces of absolute stink and can either save them an enormous amount of time and stress or green light something where there might be, yeah, that's a flag, but

Jon Stoddard (38:59.648)
Here are the five other opportunities that with these four tweaks, we could shift the game in six months or less. Exactly. In every business, there's what they call, and if you've been in bigger businesses, it's called unit level economics. Understanding what it required to make certain cash flows. If you want a million dollars, you say this HVAC business, you need five trucks.

They're each producing X amount, like say $200,000 per truck. And that's how you get to a million dollars. Which means if I want to do another million dollars, I need five trucks, another five trucks. Yeah. And you understand the scale, the scaling challenge at that point and where the bottlenecks are as a talent, is it the acquisition materials, time to time to offer stuff like that. And you could fix the price, right? You can say, I'm stepping this up. I understand the risk.

I'm buying a business that needs a little bit of fixing. Like I'm going to start painting the truck, show a little quality. I'm going to pay my guys, people a lot more. And I'm going charge more. Cause it's 115 degrees here in Tucson, Arizona in the summer. And you want me to get on your roof and fix your roof? It's going to be $200. You value. Yeah, indeed. So cool. All right. Appreciate it.

All right. Anybody else? Jose Silva. Alan. Yes. You asked the question. Thank you. Usually great person. How do I attain a recording this? I will have it on my YouTube channel, is YouTube at John Stoddard or top MNA entrepreneur. Chris Larson risk to reward ratio. Exactly. I will tell you this though, just kind of set your expectations. There's always, there's this stupidity tax that you will pay. buying a business, just something you.

overlooked. It happens. Like I bought a business and like, there was a lot of bad reviews on those sites where it cost me $10,000 to get the reviews off. I didn't see it. And they were affecting everything with my organic search level.

Jon Stoddard (41:12.704)
I didn't see it. I had to fix it afterwards by creating a ton of content to push that down. If I would have known about that, I may have reflected that in the price I pay.

Jon Stoddard (41:32.074)
And also there's, there's this little theory called the J curve, which means as soon as you take over the business, you pay that stupidity tax and then you get, you have the energy and the know-how to move it up. So, Alan, can we play pass or pursue with you on Mondays? Yeah. Just look at the only admission price is buying one of my products over on my site. Okay. I got like three of them. Get on the call. Okay.

Yeah. All right. Any other questions? Michael, Michael, Mortiza. I thought he left. Israel, Shane, Paul, Richard. Any other questions? Look, you guys know where to reach out to me on LinkedIn. You got my emails. Or just ping me. Happy to answer the questions. new question here.

Jon Stoddard (42:31.872)
Hey, Shane Collins, great question. The cash in the business, do we keep when acquiring it, add it to the purchase price, have for cash for working capital? It's a great question. And I will tell you kind of a weird way this happens. If you are buying larger businesses, lower middle market, middle market business, the cash stays with the business. It's very customary. It's what happens. Smaller.

acquisitions, the owner always seems to believe that that's their money. And in a sense, they did earn it. They could take it out. But if they take too much out, that is like taking blood out of the system. That is the working capital. So they can either take it out and then have SBA replace it, which they will. They'll say, what's the working capital requirements? That needs to go in the loan.

Jon Stoddard (43:32.812)
Or I had a, or you reflected on your price. We were looking at a plumbing company in Sacramento, California, pretty doing great. $15 million stop line, 3.4 bottom line. And they pegged the working capital at AR minus AP accounts receivable minus accounts payable, which was only $900,000. And I said, well,

shows your total working capital, the formula for that is total current assets minus total current liabilities for a given year period. That is your working capital. And that was $2.4 million. There was 3.5 million in the bank. And I saw in the income statement that it takes about $3 million to run that business per year. said, I can't make you an offer.

He can't take the cash out of the business. There's only 3.4 million in there. So we came to an impasse and had to pass on the business because they wanted to take the cash out. And then he wanted more for the business, the cash and...

I hope this video has inspired you. If you need help buying your first building or business, make sure you visit me at www.tittleflow.net. If you like this video, make sure you subscribe down below. Comment on it, share it, everyone about it. And thanks for watching.

Jon Stoddard (45:14.518)
So did that answer about the working capital? Shane?

Jon Stoddard (45:25.164)
Perfect. Thanks. Look, if they take the cash out of the business, SMB, and you get a loan on the business, you got to put it back in. If they take it out and you're not doing a loan, that is taking blood out of the body. And you take eight, what is it, eight liters out of the body, you're, going to, you know, kill the patient.

Jon Stoddard (45:47.926)
Chris? What's going on?

How you doing sir? Yeah, Well guys, that's it. If you have any more questions, let me know how I can help. You guys know where to reach me. Alan, I'll see you Monday, 11 a.m. We play pass or pursue on our group meeting. Just bring some deals, whatever you're looking at. You know, get out there, with a broker dealer, get the SIM. Let's take a look at it. If it's a business that looks like it's making money based on what the SIM says.

ask for the financial report cards. And you can really, you know, identify bad deals in five minutes or less only after you look at the financial report cards, because those guys lie. Yeah. All right. Mortiza. All right, guys. You guys know how to reach me. Thanks, Scott. Thanks, Chris. That is the end of this presentation. Appreciate it. Thank you. Thanks. Thanks, John.

 

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