[00:00:00] Speaker A: Welcome to the Independence by Design podcast where we discuss what it means to be a business owner and ways to get unstuck from the day to day so we can design a business that gives us a life of independence.
There's a question that keeps coming up in my community and in my coaching clients, and that's if, if I'm sitting in the boardroom and I'm keeping my company, I'm collecting distributions and I'm allocating capital, you know, I want to focus on the big picture, focus on the strategy, focus on M and A. But what happens if something happens to me? What do we do with the operations? And then how does that actually unfold? And I couldn't think about any other better place to go ask this question to than Jim Carlile, who is a ex business partner of mine in a previous consulting firm that we had years ago. And Jim is an M and A attorney and he has done hundreds of transactions and he has a specific way and approach of handling. How do you have continuity of the, the staff, how do you continuity of the actual asset? And what are different decision trees you could go down whether you keep the company and you put it in the estate or whether you actually have a process to actually get rid of the business. When I say actually get rid of it, you sell it for fair market value, not at a discount. And the reason that I think that this is so damn important is because I've actually had multiple clients who have passed away while working with them and it has been nothing short of a chaotic nightmare. And it didn't need to be because, you know, yes, you can get all the financials in place, you can have your goals in place and you can have all this stuff in place, but what happens and who's following what directions if something were to happen to you? And so it's about protecting your legacy and protecting the wealth and the company that you've had and that you've built. And so Jim and I have a great conversation about capital allocation. What does it mean to think about valuations and the marketplace as well as as capital allocator and owner of that business? And what are the different ways to protect the operations? What are the process that you can go through? I know you're going to love this, love this conversation. Jim and I talk about this new resource I just launched, which is my newsletter and I've got a series of articles out there about the three lenses of business valuations that I think you'll get a lot out of. There is very detailed overview on the three lenses of how to think about the value of the company that I think you'd enjoy. Go check it
[email protected] otherwise, enjoy the conversation with Jim. So, Jim, this is, as I was just telling you before we hit the on button, I'm very excited to, to reconnect. It's been a minute, and I was just saying to you that I'm very grateful of the relationship that we. And how we were having.
We had the ability to hook up for. I don't know if it's like 18 months or it seemed. Seemed longer at the time, but in our shared passion to help business owners. And you have a wildly different skill set than me. Than me. And I'm very grateful for what I learned from you, which was a lot. And I've got a list of a couple of things that I'm excited to unpack with you. But I appreciate you spending the time.
[00:02:49] Speaker B: Well, thank you for having me and I'm a big fan and I'm very proud and happy for your success.
I've always felt that you're one of the most authentic and genuine people that I've met that's actually out there really just trying to help people.
And I love the content that you regularly share. It's very, very valuable to business owners. I've turned a lot of my clients on to watch and to listen and to learn.
And I, I mentioned you the recent one about your life, God and money, one that was really something that took it over the top to me, because you're speaking of issues people don't often do and aren't comfortable with. And you went head on at it. And that takes somebody who's brave and put themselves out there. And I thought that was really, really thought provoking. So I really applied that well.
[00:03:38] Speaker A: And then as we were saying, you know, it's like, you know, we could sit here and we could talk about the technical stuff, which I know we're going to get into. But, like, you know, the reason I put that out there, Jim, is I had people, I put it on YouTube, like last year, and it got a lot of it got some traction. I was like, heck with it. Like, this is the why I'm doing all this. Like, I have two questions that I answer ask all the time. Why are we here? What's the point? Because, like, I just, like, I'm a context guy. Like, why are we doing this? Like, if we're going to rip through a legal document about, you know, partnership agreements or, you know, the estate or a Deal like, why are we doing this? What's the why behind it? And I do think that that's one of the things that you brought to the table and why I enjoyed getting to know you and your intellect years ago, and so I appreciate that. And I got so many questions because it's been a minute since we caught up. So why don't, why don't you give the listeners who aren't familiar with what your practice is, maybe the why behind why we met and what you're up to today, and then we can take the conversation in a couple different directions.
[00:04:34] Speaker B: Well, I think leading into you talked about what drives you. I have a couple base beliefs. I believe time's the most valuable currency.
I think that you need purpose and you need the ability to have impact.
And I think that relationships have to be prioritized. So I try to structure my personal and business activities around those principles.
And so I've been practicing law now 34 years and I do general corporate work. I do growth and exit planning, succession work, and I do ESOP work. I'm chair of Dinsmoor's National Growth and Exit Planning Group, and I'm also chair of Dinsmore's ESOP Transactional Services Group. So I do a lot of transactions. I also do general corporate work with my clients and I help them deal with whatever it is that's on their mind.
And I try to do it from a perspective of knowledge. So when I first start with the client, I try to get educated about them as human beings and then about their business because I think you have to earn the right to have an opinion about all of that.
[00:05:41] Speaker A: I was, I always like that about you. It's like if I'm going to have an opinion, I need to earn it. It's, it's a great statement.
[00:05:48] Speaker B: And at Dinsmore, you know, Dinsmore is a great firm. So we have about 850 lawyers, 37 offices growing across the country. But what it does for me, for my clients is I've got this amazing team that if I need them, I've got world class professionals that I can draw upon. But I see myself as like my clients concierge to Dinsm.
So my loyalties to my client, when my client needs something, I go find what they need in house because we have a lot of great people. I manage that work for them and I make sure that it goes smoothly. So it's a good relationship with me and Dinsmore and it lets me very effectively service my clients.
[00:06:29] Speaker A: You still got that sports facility.
[00:06:31] Speaker B: I do, yeah.
[00:06:33] Speaker A: So you were like, I remember you were, I think you were just doing that. He said, you're also an entrepreneur. You're getting in the, you're in the weeds with other stuff too. I will never forget.
Wasn't it like there was something to do with, like, this is a long time ago, but like they were putting in the floors and you're like, I, we were on a trip together and you're like the whole, there was a whole catastrophe going on with the gym floor. So welcome to business ownership.
[00:06:53] Speaker B: Right? Well, over, over my whole career, I've always been entrepreneurial, so I've always had business activities that relate to my interest outside of my practice of law. So it's been real estate, residential, commercial. It's been active businesses and recently it's been sports facilities. Because I, I was the coach for my son's basketball team, soccer team. I got into sports and when I was in it, I was really immersed in that community and I saw some shortages in practice facilities. So we ended up buying a, the, a local tennis and country club facility that we turned into a sports complex. And then I got into a few others. So you just kind of follow the trail.
[00:07:36] Speaker A: That's awesome.
[00:07:36] Speaker B: But what I love is I've taken the bumps and bruises just like my clients have being a business owner. So I can really relate to their pain when issues pop up.
[00:07:45] Speaker A: I just started coaching my daughters a soccer, so I'm now in it too. Thank God for GPT because I had that GPT helped me build out the entire curriculum.
So one of the. I'll just kind of frame it up and we're going to, you know, juke and jazz throughout the conversation. But there was a post on LinkedIn that I put out there and it was about like, maybe, maybe it's not about selling. It's about building something that lasts and designing the company around you. Because you and I over the years have, you know that that word exit, it doesn't have to be about the transaction. You can also run it from the boardroom. And one of the things that I always knew that you had a lot of good ideas around was what do you do if you actually want to keep the business and run it from the boardroom? Preparing for a potential option of an out of the blue offer or whatever. But you know, one of the things that I saw as a, as a challenge recently, in the last couple years, I've had a couple clients that actually passed away while they owned the company. And yes, their financials were good. They had good operations. But then the aftermath of that was a total disaster. Like, what do you do with the operations?
And then there's the estate, you know, and there's all that, you know, that noise all over the place. That's one thing that I want to unpack. And then we can talk about ESOPs in the marketplace and stuff like that. But what, what was, you know, what, what, what's a good place to start with that topic?
[00:09:02] Speaker B: Well, I think there's a couple points. I start out with my loyalty to my client, the business owner.
So you represent a client, they're a business owner, they get older, they hit a certain age, and then everybody starts telling them that they should retire, they should sell their business, they should move to a different lifestyle. And meanwhile, you might have somebody that's done something for 40 or 50 years. That's their passion and impact.
And you're urging them to leave all that to go retire. They don't know what retirement looks like. They've been a business owner for a long time. So then some of these people take that cue. They sell, they move on without purpose and impact, and then they wither and then they die and they're not happy. So, you know, that's, that's not great.
[00:09:50] Speaker A: That's so appealing. What a great pitch.
[00:09:52] Speaker B: I know, like, that's not great. So I go to the business owner and I say, what do you want? I mean, forget the noise. What do you want? And maybe they say, yeah, I'm getting older, I'm getting tired of the grind. So maybe it would be great if I became supplemental and not essential to the business. So I can still be involved. I can be chairman, I can go to meetings, I can manage relationships, I can maybe do some extraordinary sales. But if I go away for three months, nobody's going to notice because I have a great team in place to run it.
So that might be a better balance. And if they become succession ready, where the value isn't going to plummet, if they die, then they can hold it till they die if they want, and then the business can still sell at full value because the preparatory work's been done in advance. But I really worry about people being pushed into things that aren't consistent with their personal identity and their happiness. So I try to tell them, look, I'm the coach on your side. You tell me what you want and, and your objective becomes my objective.
[00:10:55] Speaker A: I love it, Jim. And, you know, since I think back to like GEXP when we were working together on, on some stuff 2017, 20, 18, whatever it was. And since then, what I've learned over those years, Jim, as I, as I dove deep into the fine finance world, is once someone gets a actual financial model put together where they can forecast out their free cash flow from ownership distributions, that becomes no longer a hope, but an actual reality. Because it's like you might not be able to collect your 50k a month today, but maybe in 24 months you can. And then they're willing to grind away so they can actually see that path forward.
So what I, what I love is that over the last seven or eight years, I found out the way to actually make that tangible and what needs to be put. Put into place to actually make that a reality.
And so the, you tell. Back in the day, you used to tell this story about, and I can't remember the, the specifics, but it was like a gentleman that died that you work with and then his wife and then family and estate had to come in and had to like, do the fire sale and like, I think, you know, kind of frame this up. Like once, once the financials are put together in the management team, let's say they kind of build out the professional organization like a private equity firm would, but they keep it. And they're sitting in the boardroom, there's still kind of like two buckets of what I see as, like, things that need to be handled that I think we can unpack. One is like, there's the estate plan, right? Like, there's the estate and how are you dealing with transferring that wealth to children or to whoever, charities, whatever, and the different, you know, different trusts and the different things of the estate, but that estate will have the ein number and the company inside of it. And then there. And like, how to handle all that. But then there's this other bucket which is if something, something should happen, like some of the people that, that story and you can tell the story or the people that I went through is like, operationally what should be put into place so someone is disabled or, you know, they're still alive, or they can't actually make decisions who runs the company, should you sell, should you not sell? So there's the whole kind of like, narrative around what, how to handle those operations separate from the estate.
Any way you want to reword what I'm saying or like, any thoughts on how I'm framing that up?
[00:13:10] Speaker B: Yeah, I, I call the second part business continuity. You know, so when an event pops up, how do you keep the internal operations running smoothly that you've done the right preparatory work with the internal staff so that they won't meet the miss a beat in the event of a catastrophe because you have the backup plan set up. And I agree on the estate planning, that's a separate component, and that needs to be dealt with early because there's things you can do where most wealthy, sophisticated business owners, they're not paying estate tax. Estate tax is 40%. You know, if you don't figure out a way to deal with that in advance, 40% is a hefty amount. The exemption just went up. But even so, if somebody has a net worth that exceeds the exemption, if you plan, you can ensure that you're not going to pay much, if any, estate tax if you get ahead of it. So planning early is really important.
And like the situation that you refer to, that's a true story of a situation that came to me some years ago. And it was. I went into a conference room and my assistant had arranged a meeting with a new client that was referred to me. And I go into the meeting and a woman's in there, and she tells me that her husband died in his mid-40s suddenly, a few weeks before, she was referred to me, and she needed my help. And she said, I need your help because I have to try to get out of the lease that we have in our office building.
I want to figure out how to properly terminate my employees, and I want to liquidate the business.
And she told me the name of the business, and it was this big engineering firm in the region that I knew of instantly. I said, well, wait a minute. Why are those the things that you want from me?
How did you come to that? And she said, right after he died, people came to me and said, don't worry, we understand. We're staying. The employee, the key employee, said, we're staying. We got your back. We're here. And the client said, don't worry. We're going to be patient. But as the weeks went by, employees started to leave. And what they realized was the person who died was the rainmaker in the business. They didn't have a co rainmaker. He was the person bringing in all the big accounts. And they thought it, we're going to have to go take the best jobs before our colleagues do. So they started to hop.
So then more every day, she got new notices of people hopping. And then clients started to say, we're losing our delivery team. We're going to need to transition to other firms, part or all. And so all of that downward spiral just started to fade. And she said, I feel like I'm trying to hold sand in my hands and it's falling through and I can't keep up. And meanwhile, I've got three young kids, inadequate life insurance, inadequate educational funding. I got my hands full, and I'm dealing with the trauma of just having lost my husband. I just want this resolved.
So, you know, we went. We ended up figuring out how to get stay bonuses in place with some of the employees. And we got a deal closed within about a month with a party. But it sold for about 60% of what it would have sold for had the person not died. And we saw that as a win at the time above a liquidation. But that really highlighted to me then that if you plan, you can ensure that if a catastrophe happens, 100% of the value can be protected and saved by planning. If you don't, you might be looking to sell office furniture and get out of leases. Like, the goodwill value of the business can plummet almost to zero if you don't plan. So that was a very. That story hit me hard and helped me to guide my clients to make. Help them avoid that same situation.
[00:16:55] Speaker A: Oh, it's.
[00:16:56] Speaker B: It's.
[00:16:57] Speaker A: It's a story like what I experienced since you used to tell that story when we would do some workshops together.
It's a story until it's something in front of you. And like, I've had two to three clients that actually went through that same thing over the years. And one of them, it was like, it wobbled a bunch, but it was kind of okay. The other one, the key executive, held the wife hostage.
And like, this huge company that was. Had value. Like, it ended up, like, huge lawsuit. And then the key executive had. It was holding the people hostage. It was like, it was so gross that you're like, there's no way that someone out there could take advantage of someone in that situation like that. So, like, how do we want to unpack, like, what that kind of planning looks like? Because the way that I think about it, when I'm thinking about the owner's playbook that I was explaining to you, and so someone builds out the financials, they get the executive team. So let's say they're doing all the value, growth, operational stuff to get it all tightened up. But then there's. The question is, what happens?
So then there's that business continuity versus the estate.
So, like, how do you.
Does that make sense?
[00:18:08] Speaker B: It does. And what I like to do is I start by charting everything out. You probably remember all that. I'm A big chart guy. Because before you start getting mired down deep in documents, it's good to know that everybody's on the same page. So I'll take the status quo, chart it out perfectly exactly with the affiliated entities and who owns what and what's the organizational structure chart look like? What are people compensated at? What are their roles and responsibilities? So then I get everybody to approve this is the current status quo. Then I start to stress test it. So I say, what happens if Barbara dies? What's going to happen? So you're telling me she's responsible for these five key relationships. What if she didn't come in tomorrow morning? How would you deal with that? Who steps up? And if they say, oh yeah, that's John, he's got it covered, great, let's work around that. Let's make sure that we lock John down with the right base incentive comp and maybe stay bonuses so that we have him locked in. But maybe they don't have a John, in which case we have to figure out how to hire and how to build. So in that case, and then stress tested every way, what if this person dies, becomes disabled, leaves to take a different job, is terminated for cause, files for bankruptcy, all these different triggers, what happens? So you stress test it, then you build the model for what would happen.
And some of that is just identifying the holes and the gaps. And then a lot of it is the hard work to build the backup structure so that it will actually work in the future. And that might take years to do. You identify the needs and you start chipping away. And then at some point you think you're there and then some change happens and you have to chip away at a new problem. But getting to a state of succession, readiness or readiness for the after the outcome of a triggering event is critical.
[00:20:00] Speaker A: I like it because I think what, let me, let me know if you think this is on track where, like what that solves is you have a void of a decision maker that's holding everything together.
And then it's like, well, how do we make these decisions? Is it a good use of cash to keep Johnny on? You know what I mean? Like, so then it's like trying to figure out how to allocate those dollars in a, in a high stress environment.
Eliminates all the decision fatigue where there's the money grab and everybody's coming at you, so you're just laying out like, should this all happen, how do these resources get allocated and who's allocating those resources?
[00:20:35] Speaker B: That's right.
And I Think another way. Another way another client did it was that they developed a really robust fiduciary board.
So when we first talked about the board, they thought, I don't really want to report to a board. I don't want to even take the time to build it or to meet with them. I'm running this just fine. And then we went through the what ifs and they didn't really have senior contingent decision makers that were ready. They had younger generations coming into form, but not yet ready. So what we decided was let's get a fiduciary board in place. Let's have them get educated about everything that's going on. And if you're not there, they'll step up. So one of the people from the younger generation can be promoted into the spot, but they can have the support of the board. And we worked out procedures for how the board would become hyperactive in the event of a transition or a triggering event. And then they would groom the person live. But the backup of the board would help to fill that gap in that situation.
[00:21:36] Speaker A: Is, do you have, is there any situations where like you have.
Because if there's people listening, I mean, there's maybe a little bit more of a, the visceral or allergic reaction to a fiduciary board. But if there's more like, could there be a situation where you have a hit team that is like a. Because like in what I'm involved in is like my, one of my clients calls it the wonky board. Or like, hey, you know what? We're bill, we're building that level of professionalism. But I don't want it to be a fiduciary yet. Do you, could you have it where like you're building this all up and then in the event of certain things, this is the team that comes in. Here's how the decisions are made. So there's almost like an on call situation. So that way you're not having to have who's going to take over the, the decision making.
[00:22:16] Speaker B: Well, sometimes business owners don't want a fiduciary board because they don't want to empower them. Even though they realize they have ultimate power with the equity to replace the board, they don't want the threat of a fiduciary board holding them up. So a good interim step is to set up an advisory board that isn't fiduciary. They talk about the same things, they can help in the same ways. They just don't vote. And then maybe that could be activated. Like you Just said, Ryan, if there's a triggering event, maybe the, the advisory board becomes a fiduciary board and so they're ready to step up and in if needed. Or you get the same meaningful impact from an advisory board. But I think most business owner decision makers will want the comfort that they have someone to step in. And if they don't have a someone, they might take comfort in that board stepping in if they don't exist.
[00:23:08] Speaker A: So you would be having to address the leadership operational like, like you said, you're charting things out who's doing what, who's going to be running the operations, what are your, what are some of your thoughts or guidance or exercise you go through. But like, do you sell? Do you not sell? Does the estate keep it? You know, is there someone in the estate sitting on a new fiduciary board that's looking at distributions like how do you align the estate, the equity, the liquidity and all that stuff is something happens.
[00:23:36] Speaker B: Well, one thing I love that you bring up through your podcast is the fact that a business owner that's seeking independence doesn't have to sell to get it. So they can operate their business in a way that they can get the independence that they want but still own it. That's true. Another principle is that a person may say they very much want to have a family business and they almost, it's almost sacrilegious to suggest that the family business be sold. But I try to break that down to challenge that the opposite way to say you want a family business, it doesn't have to be this business.
So if you have a family business and you can get above market price for it today, and if your children or next level of management aren't ready to lead it, the question is, would it be smart to sell it and to take that money and transfer that into family office type family businesses or real estate and leave that as your legacy rather than this business. Because maybe future generations or the next tier level management aren't able to operate it the same way that you did. So you'd be doing them a favor by liquidating it while you're in control. And then you have something that's easier for them to manage as the next family business.
So selling the family business doesn't mean you're out of business. It could just mean you're in a different business.
[00:25:00] Speaker A: I like it. And that, that ties to when I, when I say capital allocator, like when someone truly gets out of their operator role and then they're like, okay, I'M a capital allocator. Like, well, what does that actually mean? It's like, well, I sit on a board of my company to say if we have a couple million dollars in cash this year after working capital debt, taxes and reinvestment, what's the best way to deploy that? Is it in this business and we want to then go do an acquisition, do we want to hire out the next, you know, another location or whatever it is, or do we look at other assets? So like, and I think the stepping stone in between there could be, Jim, is that when they're sit and they're having that they're starting to get used to that level of thinking on their own advisory board of capital allocation, thinking about the reinvestment versus, you know, because reinvestment you should be able to get to equity growth. And if you can't sit see that you're guessing. But if, then like, if we can see that, then we can weigh the, the opportunity cost of other, other assets. But they're starting to think like that. And then you could apply it to outside investments and, or that company. To your point and like, what I, what I found, Jim, over the last seven years is the, the sheer lack of understanding of valuations is, I think, a root problem of a lot of this stuff. Because of like the balance sheet valuations from CPAs or whatever the hell it is, like all these different noises from the private equity firms or strategics. I've come up with this like, lens of three valuation lenses. The first one is what I call the owner's utility lens, which is like, what does it mean to you? And it should be the discounted cash flow of the free cash flow of ownership distributions.
So it's like, okay, well, and that, because that, that really is how all finance and investments work. But like that takes into the whole corporate structure all the nuances of that current state.
The next level, Jim, of what I've described is this. I call it the market valuation, regardless of the seller, or I'm sorry, regardless of the buyer. So normalized EBITDA times a multiple net debt and then normalized working capital. So you go, okay, regardless of whether it's an ESOP private equity sale management buyout, at least if I'm tracking these numbers, I have an idea on the outside and to use your words, I would know if there's a premium price right now because of my industry, the trends, economic issues, to see if I should harvest that premium or not. And then the last one on top of the Triangle Gym is what I call Strategic transaction value, where it's specific buyer specific deal structure and specific net proceeds that then you're weighing all three of those lenses against the goals. But that is what's allowing someone to then do what you're saying, which is, where should I put my money, my time?
We have like a lens of ideas.
[00:27:38] Speaker B: That is so good. That really is so good.
So someone could decide, I'm owning the business now because I have it built and wrapped around my lifestyle.
What is the cost of me owning this business for the next five years? So you're still making money from it, but if the opportunity cost is that you could be making more money if you liquidated it and repurposed that money, then that's actually a drain on your overall enterprise investment model because you're not doing as well as you could if you liquidated it. And again, business owner, I respect what their goals and objectives are. If they understand that fully and they want to do it, I'm right there with them. But most don't understand that. So they're just toiling along and they might make a different choice if they were educated about those valuation principles you just went through.
[00:28:29] Speaker A: Agreed. And you know, to the the point of goal setting, which is super fascinating. This is like where I've gotten really geeky over the years of the way to figure this out. So if we looked at someone's net worth and said, okay, I want my net worth to be 10 million bucks in 2030 equity, not enterprise wide, but like the equity of all my assets is 10 million bucks.
What we can do, Jim, is we can actually back into today that whole financial model to see the discounted cash flow of those ownership distributions from that date. And then what we can actually. So the weighted average cost of capital, which is the inverse of the multiple. So we say, okay, if it's 25%, my WAC is 25%.
What's happening, you know, in the private equity world, they call it the hurdle rate, right? So they're saying, well, the PE firm needs to give Ohio's Teachers Pension Fund a 20% IRR. Well, the owner, as you and I know, generally doesn't come up with that goal. So we actually mathematically can't come up with the discounted cash flow. So, like, what we're doing is we're saying your hurdle rate is your wealth target.
And then we can then actually have another lens to say, okay, well, the return is not actually going to get me to my $10 million target. Is that okay? Not okay. So it's interesting Like I just want to throw that over to you because like I got super geeky. Like I said, we're like, that's mechanically what we have to do. But that's how important it is for someone to say what their goal is. Because there's no way to model this out unless they come up with their goal.
[00:29:57] Speaker B: Agreed? Yes. And along these lines, I had this client on the west coast manufacturing company and they were large company, very successful, but they saw that there was international competition emerging. So when we looked at the trending, we saw we have aging senior leadership, we have increasing international competition. When we look ahead five years from now, it's likely that the value is going to plummet because of those facts, we don't have the next generation. There's going to be a transition period and we don't have time to transition this fully because senior leadership had been in place for decades. So they really knew what they were doing. So we ended up finding a strategic value for the business and they had to try to consider did they want to sell this family business or do they want to maintain and hold. And they ended up selling. And it ended up being the right thing at the right time because as predicted, international competition took a lot of the market. And unfortunately some of the members of the senior leadership team came down with health ailments after and we saw some pre indicators of that. No one wanted to hit that necessarily head on, but it was kind of taken into account. And so they ended up having a family office with advisors supporting it. And those liquid assets were much easier to manage until they got deployed into other businesses and real estate ventures.
[00:31:25] Speaker A: In what I heard out of that and you, I always knew that this is your way of thinking is like you were able to take the emotion of the identity of that business and compartmentalize it, not, not ignore it, but at least quantify what's the cost of lying to ourselves if this is not happening. Right. So then like in the true capital allocation and like looking at investments, you would be looking at economic issues. I mean like Jim, like this morning I woke up like today chat GPT5 is out. Sam Altman has the video explaining it.
Software on demand. I mean Jim, do you think a lot of software companies are mispriced right now? When you have a freaking tool that you can explain how to build your next productivity tool and they'll do it for you. So like you might like or I just think like looking at these trends, we have to be if we want, if that goal is a certain dollar amount or a certain lifestyle, being real with ourselves of like, there are real risks out there and like, what's the trade off of lying to ourselves versus actually addressing these risks?
[00:32:34] Speaker B: Yes. And I think that idea of reverse engineering outcomes is critical that you start to, you start to take all the right steps to make yourself succession ready or sale ready or market ready, whatever your goal is. You start to take the steps to make yourself look like the company that you want to sell with, with the same type of valuation methodologies applied to you. And that takes hard work. You know, like you. The way I approach it is we start with a virtual data room. I approach it like I was a buyer, I get all the documents, I study the documents, you come up with recommendations, you do those recommendations, then you catch your breath and say, what's next? And then you come up with a new list of recommendations. And you're constantly making the company a more valuable company, but even more so, you're making it succession ready. So when it comes time, Ripcord, when it comes time to pull that rip cord, as we always used to say, the client is ready. And even if they don't pull it, the fact that they have the peace of mind, having it there on their chest that they could pull it makes a whole difference in their life because they have that. I think they enjoy the rest of their days more knowing that they are ready.
[00:33:48] Speaker A: Totally. And I think what on top of the mechanical parts of being ready. So this is like, I've got a couple examples, Jim, that it's that peace of mind. But what I think is I see that ad says the peace of mind of the understanding, like the understanding of what's this worth actually to us? What's it worth to the marketplace? Where are my points of leverage and negotiation? So I can understand like how to like run through the deal structure, run through the different executive, you know, however, like, like run through everything. So. Because what I think is really fascinating, and you've always been a big proponent of good decision making, is having that knowledge.
Because I was doing this Vistage workshop recently and they were like, so tell me, what would you do if you got an out of the blue offer? I'm like, you know exactly what I'd do if we had this all built the right way. And it's all about speed to decision making so we don't waste time and money. And so it's like, okay, well, if we have a three statement forecast, we understand our goals, we understand what the valuation of the company is. We sign an NDA, send over the financials, we. If they have a virtual data room, you send that over and you say $20 million minimum, $15 million cash, not doing an earn out. And then you say on track or off track? If you're interested, I'll have another conversation. If not, go away.
And like just to be able to say that and then. But I think it's a difference between saying it and knowing it and knowing why. And then the financial piece, but then also that data room, because it's the, it's the erosion of trust of these buyers that is what destroys the value, even though the value might be there. It's the, the lack of the ability to prove it or articulate it is what I've seen. Any thoughts on, like when you've seen people with out of the blue offers, how they've, how they've handled it?
[00:35:27] Speaker B: Well, I like the thought that you want to be ready to analyze the offer in a meaningful way. And that should be part of getting to a state of readiness for our investment banker friends. I'll give them some credit towards how the process can increase the strategic value.
So with what you just said, I always say if you go through, if you have one buyer, you don't really have a buyer because you have no strategic pressure or tension that's added to the process.
An investment banker will take an unsolicited and then they'll add to it a mix of others and they'll start to push it so that a buyer will pay at a minimum what it's worth. But at a maximum, they'll pay what it's worth to them, not what it's worth. Because if there's competitive pressures, they'll be pushed to say, if there's a strategic fit, if I have that company, I can do extraordinary things with it. So it's worth more to me than it is where it is now. And if I have other bidders, I've got to bid some component of that. So then the seller gets a special price, something more than it's worth, because competitive pressure has been applied. And that's the value that investment bankers bring.
[00:36:39] Speaker A: Totally. And I actually have a recent example of that where so they get, they got an audible offer for $20 million or something like that for someone where I was like, whoa, this is awesome, right? I mean, like, yes.
And I was like, well, is it real? Like, they haven't done any due diligence. Like, I'm a opportunistic at heart, but like, knowing what I do over, over the last 10 years, it's like, is that actually real? Well, went through, interviewed three investment bankers pick. And then they were talking about the different values. One was 30 million bucks.
They said range of 60 to 80 million bucks.
Like, holy.
Well. And they knew the industry. And so there's all to your. That's to your exact point where like, even if that, like, even if that buyer wanted to be involved, they can, we can now just say there's a formal process going on and like the deal structure and the terms become something that I have over the years, I've tried to become better at articulating to owners who aren't familiar with Y and I's, you know, level of understanding of this space, the terms and conditions and leverage and deal structure.
Like, people can say, I got 10 million bucks, but they have no idea what could have been available.
You want to speak to like gotchas in like the deal structure. And I like. So that's one component and then Jim, this other one of like, so you know, the deal structure and the kind of legal issues around the deal structure, because it's not just the dollar amount, right? That's not what they're getting in cash most often. And I did a whole podcast, Jim, that I can link in for everybody on six components of deal structure with cash earns, all that kind of stuff. So you can just assume that we're kind of coming into it with that understanding. But then there's this other bucket that I think you would have some interesting ideas on of like, it's that legacy stuff that people haven't articulated. Like, I want Sally and Johnny to maintain their jobs. We want to keep it in this community.
I want to make sure my customers get the same level of service. So it's all these intangibles. Have you, have you ever gone through a way of sucking that out of people? So that way, when you're in that deal, you are explaining outside of the financials and deal structure, what's it the soul of the company?
[00:38:49] Speaker B: Well, that starts in getting to know the business owner for me that I talk about.
What are your objectives? And one of the questions is, do you want to get the maximum price? And that might seem like, obvious. Of course I do. Well, not necessarily. Like, some of these people care more about their community, about their clients, about their employees, and so they'll take a lower price to maybe do an ESOP transaction where the employees own or to do a transaction where senior leadership will stay and the company can stay in the community.
And for some of these people that reach a Certain age, they don't want to sell for some big number. And then the facilities moved and they can't even go to the grocery store with their former employees seeing them and looking down on them for betraying the town. So it's not necessarily an obvious answer that is getting the best price what you want. So those intangibles need to be worked into the fray of the whole, of all the issues and again what the client's objectives are or what my objectives are. So if they say it really, really matters that we structure a deal this way, that's how we'll do it. And I had a financial advisory firm was approached by a New York City firm wanting to buy their, their company for a premium price. And the client looked at it and came back and said no. And the reason was their motto is that they have farmers and not hunters. So they have great client service people. Their, their client service people have been with them for years. They work nine to five. They don't go out capturing all kinds of new business, but they grow the accounts they have and it's a very stable performing business. If this firm had bought them, they would have added in hunters, destroyed the, the culture and the whole company would have changed. And he said not on my watch. And he ended up doing an ESOP and employee zone protected the culture, didn't do the deal that would give him the best price. And now I think he would tell you that's the cornerstone of his legacy. He got enough.
[00:40:45] Speaker A: Oh, that's cool.
[00:40:46] Speaker B: And he's happy.
[00:40:46] Speaker A: Yeah.
So let's. Because this might be a good bridge to esaps too is I like because I'm picturing like the, the deal, like the deal calls where like you have the investment bank or the buyer, maybe a seller there but. And you're having these conversations and we're fixated on the 20 million bucks and two thirds is cash and there's gonna be some roll equity. So there's that whole fixation on the deal structure. But you as the representative of the owner's goals, how are these conversations being, how are they taking place with the investment bankers who have incentives to get high purchase price buyers who are all over the place and swimming all around.
And where and how do those conversations take place of like here's what I want for my customers, here's our culture. Like because at the end of the day it is just a conversation because you made that decision.
But somehow that like some of that has to be taken place. And I think so many of those advisors around the deal table aren't doing that. And so that is what becomes missed. And that's where a lot of that regret comes from.
[00:41:52] Speaker B: Well, like you mentioned, you interview investment bankers. So do I, as part of my practice. And so when a client decides that they want to explore engaging an investment banker, I'll go through a process to find the right ones for them. And it's not just, you know, the three that I work with all the time, it's what are the right ones for them in their business, in their geographical region, whatever factors I can think of that might be the best for them. And then I talk to the whole team about it and then we come up with a list. So these are the four investment bankers we're going to interview. I go in with a summary of the business that talks about, here's the business, here's the key elements and here's the owner's objectives. And if part of that is culture, community, clients, senior leadership, etc. That's made very clear up front. And then when they propose and they come back with engagements, I remind them of those ingredients and then when they come forward with their first letter of intent that isn't consistent with those, I pull out that same document and remind them again.
So yeah, you might be all excited about this number because your percentages what it is on a bigger number, but it's not consistent with the requirements. So we've got to restructure what's being offered.
[00:43:06] Speaker A: How do you make sure that people.
[00:43:08] Speaker B: Aren'T lying, buyers aren't lying?
[00:43:11] Speaker A: Yeah, like, like as in like, okay, what are we actually going to do with this after we buy this? And how do you make sure that the promises are actually followed through with or whether they're lying or not?
[00:43:21] Speaker B: Well, if the owner cares so much, if that's a super high priority, they're going to do a transaction that's consistent with that. So it's going to be an ESOP or it's going to be an owner financed sale to senior leadership team members. So they can keep control of that at financial risk, but they can keep control of it. If they're going to do a third party sale and they're going to rely on future events. I always tell them, you only have so much control. So we can document what we can document.
It's going to burn off and then they can say change the circumstances, we had to do something different.
Or they can just have different leadership themselves that change it or they can change their mind. So I, I, I'm realistic about how much Control you can have post sale.
[00:44:05] Speaker A: I think what you just said is probably one of the valuable takeaways is you have to make a commitment based on how much control you want after that transaction and there will be trade offs of that. You know one, one cool thing that I, I've seen Jim that have, that has been done where and it takes more time but it's like show me the future strategic plan.
Show me the future org chart with my employees in it. You know it just takes more due diligence then at the end of the day you still don't have the control if it's a third party buyer and they're taking controlling share. But you could do maybe a little bit more on the like what show me what the plan is because I don't know about you. And like most of these buyers have not a very sophisticated plan.
So like realizing the fact that the buyers have figured out how to find debt and find equity and then they hope that they get the growth that they want. There is some people with sophisticated thoughts and you know, strategies but it's not a lot of. We're going to take this org chart, roll it into here. Here's how we're going to like. It's a lot more loose than I think maybe most sellers would would think.
[00:45:12] Speaker B: Well, I think you can, what you can control is you can get employment agreements in place as a condition to closing with your key employees that give them severance.
It gives them the right base and incentive comp and severance if they're terminated without cause or if they leave for good reason. They're all defined legal terms but that's some protection. And then to the extent that you have earn outs you can stipulate that they can't change the ordinary course of the business during the earn out period because that's how you measure whether you're going to get it. So you'd know for the earn out period you're good.
But most clients that really value that stuff are going to choose a different structure.
[00:45:50] Speaker A: So let's use that as a jumping off point to ESOPs. So one thought that I have because you had mentioned a lower price and I think that is an accurate statement. I'm curious if whether you agree or disagree on this, if you took a company to market, depending if it's a seller's market or a buyer's market. I mean there's a lot of caveats behind this but let's say it's a seller's market and there's a lot of you Know, there's a frenzy over your company to, you know, get that tension to push up the purchase price. Let's say intrinsic cash flow value is 10 million, but maybe a third party buyer is willing to pay 15.
I had a call Jim, two days ago with this guy. He's got a $35 million business. They're looking to potentially go through this whole process.
And I, so here's my belief is like hey, you might have a, call it a 30% premium on the purchase price.
However, if we ran over for five years what the net proceeds would be for you as the owner if you had five to seven years to realize the cash up front, the seller's note on pre tax dollars for the ESOP plus the warrants plus 1042 exchange with the C Corp plus irrevocable warrants into a trust.
I would probably put up the net proceeds of an esop over that 30% premium.
Potentially.
[00:47:13] Speaker B: Yeah. So I, an ESOP will be sold at full fair market value, not discounted. It's full fair market value. I find that on the pure number alone, strategic value of a third party sale might, in a, in a very, very desired value business enterprise will exceed that number. But when you have all the additions to it, the fact that the owner doesn't pay tax on the purchase price in a 1042 structured transaction, that's unbelievable. Like it's easy to say, but no tax on the, on the purchase price, that's an amazing development. So how much more does a third party sale price have to be to make up to taxable versus not taxable? That's a big thing.
Then secondly, you have the owner's note which is now subordinated behind the bank note so it can command a higher rate of interest then you have on pre tax dollars.
[00:48:11] Speaker A: Pre tax dollars, right. You're not, you're not getting 11%. You know, again, 11% is a combination of the interest plus the warrants. But you're getting that on the pre tax note, not the sale. And then I mean it's.
[00:48:23] Speaker B: And then you get a warrant that you can put the warrant into your estate plan at low to no value and let it grow to some big number that's outside of your estate, which is awesome as well.
And then as if to make it a little more comfortable, the company after the closing doesn't pay tax. So when you're wondering, can they replicate the results? Well, they can take the tax savings to pay the note and then after they pay off the note now the company can grow like crazy and Like, I have a number of mature ESOP companies now that their main problem is that they're stockpiling cash.
So they're wondering, they can do acquisitions, what do I do? So first they start by paying themselves more. So they increase everybody's comp to the upper end of what the IRS would say is reasonable compensation.
Done. Then they do acquisitions. Done. Then they diversify. Done. And then at some point they're like, we're not motivated to do anything more than that. And they might sell.
So if you look at the ESOP levels, a lot of ESOPs are done every year. But the number of ESOPs is growing, but not by a ton because it's somewhat stable because companies grow, mature and sell and then more companies come in. So it's a flow in and out of ESOP status.
[00:49:36] Speaker A: It's interesting and I think one of the factors that could be part of this, and I do not have the data to support this, Jim, but a lot of private equity firms, because there's too much money that was raised to too few companies that are worth the leverage buyouts and putting the debt on and being able to like, because private equity firms don't want the job like they want the asset. So there's like, everybody's kind of pushed down to that 2 million in normalized ZO. We're like, you have to get your hands dirty after that. And so I watched some conversations that I, I, I, I feel like is a true, it feel like it could be true is private equity firms have been, have been targeting EOBs because, you know, it's a good company.
Like, you, like, you just have this inherent, like, well, it should be. By the way, I, I've seen plenty that are not as in like, like, I don't know how they got it done because there's not good clean financials, there's not a good structure they somehow converted into an esop. But I think there's not only the ESOP sell, but there's, there's a desire for private equity firm to find a good company because then they can know they can put the debt on it and actually run with it. That's what happened with my old partner Pat's firm. Like three years after they did the esop, they sold to a PE firm for a lot of money because they're like, well, we want you. So the, the other thing I was going to say, which I, I think is an important call out, is it's why this word exit.
Over the years I've become, I've had a very dysfunctional relationship with, to say the least. Because in that ex. That ESOP situation, it's an ownership sale, right? So then that whole situation, you're selling the equity of your business, partial or all, but you could keep your job.
So like it's like when people go like. So like I've literally been saying like Jim, like the, the story I've been saying over the years is like everyone's arguing about, you know, for this word exit, whether the spoon in the matrix is gold or silver. I'm like, there is no freaking spoon. It's either like you're either talking about your succession of your job or capital allocation with your asset. And with the esop you can actually design whatever you like. I mean that's, it's the ownership third party. You might have both, but I think we conflate these two. And my, my last point to this and I want to hear your thoughts is I had an ESOP that I was on the board of.
They, the owners did the ESOP with this perception of progress.
They were tired and they actually wanted out of their job and they were lying to themselves that they would if they did the csap. Magically, all of a sudden someone's gonna have my job and it's like, hello, you still need to hire people and you still need to do this stuff that is going to get you out of the operation. So they did the esop but they were still stuck in their job.
[00:52:15] Speaker B: Totally agree.
Whenever I have a client that has third party offer and I'm urging them just to become educated on ESOP so they can make an informed decision. The high points that I have to lead them into that discussion. For a proper ESOP analysis, you might not have to pay tax on the purchase price. If you do, 1042 right company will be tax free after the closing. You'll end up likely with a much higher net after the fact. You decide how much control and involvement that you want. So if you want to keep running the company as you did before, you can, if you want to change your scale or whatever, you can, you have control of that. It's under the trustee's purview. But unless there's a problem, the trustee is going to defer and let you run the company.
So that is all powerful.
[00:53:05] Speaker A: The downside doesn't have any opera. The trustee doesn't have any operational oversight right there. It's kind of like a 401k trustee. They're making sure you're not going and taking the money and putting it Into I mean it's like the, the big ideas of like make sure you don't completely blow this whole thing up. Right. But they're not coming in there and going, well you should put in netsuite versus you know, salesforce. They're not getting into the operational decision making like that.
[00:53:27] Speaker B: If a company started to financially struggle, the trustee would probably get more active. If the company wanted to do a major acquisition, the trustee would approve it, things like that. But day to day they would leave it to the person to decide that has been deciding or has been put into place to decide as long as everything's going smoothly. The one downside with an ESOP versus a third party sale is that they don't get all of their money upfront. They might get two to three times EBITDA and the rest of it will come in the notes. So they have to wait for it. And if they're willing to do that, they'll end up with a higher net I suggest in most cases.
So that's the equation when you stack a third party sale against it.
[00:54:05] Speaker A: Right. And that's where that cash flow versus equity in the time Venn diagram that I talk a lot about where like I mean I was talking to someone recently again, if you're bullish on the company, if you have a good company and you're like okay with this, it's like dude, your seller financing on just the interest. So like you get call it a third to a half up front which is now you could diversify but that interest only could be hundreds of thousands of dollars per year which is your lifestyle anyways while you're sitting on the board. So it's it like it's not as painful I think as some people would think. And I don't know, I just think it's so fascinating because if your company is intrinsically worth that you shouldn't be concerned about it. So what I say to Jim is people is like well I don't know if my company's worth this. My in an esop you would have your investment banker, you would have the senior lender, the trustee, the other investment banker. You would have like five parties all agreeing that the cash flow can service this debt because otherwise it wouldn't be done.
[00:55:01] Speaker B: That's right. Department of Labor.
[00:55:03] Speaker A: So you get confidence.
[00:55:04] Speaker B: Yes. Department of labor standards as rolled through company council, trustees, council, bank counsel, valuation experts all around the ESOP feasibility study company and implementation firm. Many, many people are looking through this and they are likely to spot they won't be approved at evaluation that the cash flow won't support.
[00:55:26] Speaker A: And I think that's where it's, what, what I'm, what I've been experiencing is with talking about this ownership playbook, Jim, I'm catching people when they're not super tired because this, it's a message that suggests I would like to run it from the board and have more options and then like 50% of the time, like, yeah, it would be awesome to do eventual ESAP because the company has time to grow to that versus like when, you know, if someone wants out in huge quotations and they come to us and they say, well I want out. And I'm like, well it's all reliant on you. You're super tired and in order to do these things to get all those intrinsic other nuances that you want, you'd have to reinvest all your distributions, spend five years, hire an executive team, put in an ERP system and like I just told you I was tired, Ryan. It's like, well that's where I think the ESAP community unfortunately is, is not getting the benefit because like we're meeting people when they're tired and the actual cash FL is not where it needs to be and then the exhaustion comes into play.
[00:56:25] Speaker B: Yes, no, that's, that's great that you're getting people earlier stage to consider these things when they have more gas in the tank to stomach the complexity.
[00:56:36] Speaker A: So, and then they get, and they can learn over time too without having to be like stressed out about this stuff because it, you know, you lay the groundwork, you know, stone by stone and it's a lot easier to digest. So I, I, I have noticed and I'm curious if you have noticed this in the advisory community, Jim.
You know, everybody talks about the inflation of eggs and the housing market and even multiples of companies. You know, if we've seen the inflation and the debasement of the dollar hitting a lot of this. What I'm starting to see is the inflation hitting on advisory fees.
So like what used to be like, oh, you're a $2 million million dollar. Two million dollar normalized EBITDA company. Five multiple. Yeah, we'll do an ESOP now it's like $5 million normalized. EBITDA is the minimum to even be interested.
And so I'm, and this is where I'm thinking Dan Zugel and I'm curious like if you've different figured out different ways. But like when I think about the pure numbers of like how many companies are over 5 million in normalized EBITDA. And it is like 1% single digit. And like, and it's not the norm. What I like my clientele and the people that are most likely listening to this, I mean, you're talking close to a million dollars in normalized ebitda up to 5. And I've got a couple a little bit over that. But like, it's, I call it the backbone of America. And like, they're struggling attracting good advisors because the good advisors are moving upstream.
And then like the sheer ability for people to screw stuff up for significant, what I would call a significant dollar money. You're talking 5, 10 million bucks, 20 million bucks. That's a lot of money.
Yet you're dealing with very inadequate pools of advisors.
[00:58:16] Speaker B: That's why, you know, one point for your listeners is like, how do you get the most out of your professionals?
And I think you have to develop relationships with them.
So that's true. With your lawyer, with your accountant, with your business coach, with your insurance advisors. You need real relationships. And that's not what typically happens in the real world. So most clients engage with their lawyer that they have a need. They call their lawyer, the lawyer picks up the phone and they become an order taker. So they say, ABC Company, what is it that you needed? Okay, you want to do a phantom stock plan for who and how? And let me ask you this, they take all the details of the order, they hang up the phone, they draft that document, they send it, it's refined, finally finalized, put into place, and then that client's file was put away by the lawyer. And they don't think about them again until the next order comes in to be taken.
So it's very much a commodity. It's in exchange money for the project.
And there's not a lot of continuity or relationship there. What I like to do, and I think the best relationships with professionals are that you've got regular touch points and contacts.
So when a client calls me, they call and say, I have a need. Like, I'm struggling to keep my best employees. What do you think I should do? And then I might say, well, maybe a new incentive compensation plan might make sense. It could be a phantom plan, it could be whatever, we'll talk it through together. But I bring something to the table because I understand them, I understand their business, and now we can have a real conversation about the point. And then I don't hang up and put away their foul.
I schedule the next meeting with them. And it might be that we don't even have anything on the agenda to talk about. But in a couple months we're talking again about how are things going, how did your numbers turn in? What's the. And then we preview the issue so we have a relationship. So in that way you have professionals that are invested in you, so when it comes time they understand you and they're willing to go the extra mile for you because you've had a regular relationship. It's not commodity oriented. And like with an accountant, it's like having your accountant, end of the year, you go dump all your receipts on their desk and your, and your tax returns and Your W, your 1099 and you ask them to be a scorekeeper and just do the return. Or are you engineering the tax outcome by working with them all through the year? You want to have engaged professionals on your side and then they'll be there when you need them.
[01:00:52] Speaker A: I, I think that is a very fair point. And you, like you said, in the real world, it doesn't happen that often. And I, on the CPAs, I, I mean honestly, the people that even ask for help, I mean like that whole industry is suck and win for like employees and like, I don't know, like, I know there's good people, good CPAs out there, but I'm not hearing a lot of great referral ideas. It's like, even if I want tax planning or I want this and it's just like there's a lack. There's, I think the billing model and the, and the, the employee are becoming issues in all of these advisory services of the demographic cliff is here. And I think then, but to add to your point, and I just want to. For the listeners too, I've always struggled with like none of this is an absolute. Like there are really good people in all these different places. And I think what I, you know, but like what I heard, Jim, here was this one stat of like 95% of the people hire the first realtor that they meet.
Doesn't shock me. And it's like, well, I also believe 95% of realtors are probably idiots. So like, like you're, that's not a good odd of you randomly stumbling into your soulmate for, you know, a real estate agent. Like, so I think it the same thing applies to the advisors where there's a lot of people out there that are subpar.
However, when the owner doesn't know the technical expertise, they don't know how to judge these people so that it's fatigue and they just hire the right person. So where I' with this and to enhance the, to enhance the ability to do what you just said, what I have watched personally with the, the people I've been coaching with, by building out and treating your company like a PE firm in a family office, you're taking ownership over your own. It's like, okay, I have to do this stuff. And then what happens is we actually disproportionately attract the good people. So it's like, wait a second. Like, like, can you imagine, Jim? Like, hey, here's a three statement forecast. Here's our strategic plan. Here's, you know, here's where we're going. Here's, we've got some comp plans built out. Now you're up to speed, way faster.
But then there's not this catastrophe, like always reactive. And I watched it happen with recently with a couple investment bankers. Like, this is insane, like how prepared they are. Now. We're, we've attracted investment bankers that normally have a threshold of 5 million in normalized EBITDA and they're totally comfortable going down to 3 because it's like, I think it's, I think it's this arbitrary threshold to just filter out all the people that they don't want to waste their time with.
Well, and then you're kind of meeting it in the middle.
[01:03:24] Speaker B: And there's different firms for different situations. You know, like on the ESOP side, there's firms that are really, really good at $100 million plus ESOPs. And then there's firms that, if you've got a $20 million company, they can find a way to get it done.
So, you know, there's ways.
[01:03:40] Speaker A: Do you have anybody that, you know for like the, the, the like 2 million dollar ish normalized EBITDA for ESOPs.
[01:03:47] Speaker B: That'S at the, that's at the, you know, the edge of possible, you know, or, or appropriate.
[01:03:52] Speaker A: So it sucks so bad because Jim, like I remember when we started doing this, 2016, 2017, it's like million dollars normalized E. But the $5 million valuation, that's kind of the par. It's going to be 250, 300 grand in fees and like that is doubled.
[01:04:07] Speaker B: Yeah.
[01:04:07] Speaker A: That's why I said inflation has really come.
[01:04:10] Speaker B: I agree with you. And I would want to take those. Probably what I do with those companies now is to try to figure out how to grow them. So I'd try to say, okay, you want to do an ESOP, let's take the next two or three years and let's get you up to a 4 or 5 million dollar EBITDA company, and then you can do it comfortably.
[01:04:28] Speaker A: Amen. And that's where, like, I'm just trying to stress to people, like, and like, which is like, it's okay. I know I'm. I'm looping around, but all this stuff is really. Like, my wife just got done. She's. She. She had a hair council yesterday. And my wife gets one haircut a year. She is like, not the one that gets it every six weeks. And like, her mom used to cut her hair. And so, like, total scrappy, like, on the budget. And she's like, what the f. How much money are you gonna charge me to cut my hair? And she's like. And I just watched her and I let her process, and I was just like, it's everything, Megan.
Like, it's $300 before the tip. And like, how much dye you put in? It's another 80 bucks. And I'm just like. So I think there's this swallowing of the gulf of reality of the, like, we printed $5 trillion. We've debased the money. This is what's going on. Sorry. And so to your point, like, the, the faster we can recognize reality, we can just move on. And then just like, we have to grow. So, like, like, but like a $2 million normalized EBITDA on a 5 multiple, you're like, that's a $10 million company, which is a lot of money, and most advisors won't touch it.
And you just go, isn't that crazy? And like, that's a bummer because you have really good companies with like 50, 70 employees. You know, you've got a real thing there. It's not like, I guess why I'm so passionate about this. It's not a freaking job with someone that's got 15 employees. Like, that's a real company. And then you go, son of a bitch. Like, so the only option is to sell to a third party. And like, even a private equity firm is not as interested. The investment bankers aren't as interested. And there's just this, the chasm of that middle market. Jim, I just see it's. It's unfortunate. I don't know what else to say about it.
[01:06:11] Speaker B: But that's why I think they need help to grow. To grow, to hit the bottom level.
Because with all those great tax advantages that we were discussing for ESOPs, they apply to any company. But if you can't get a job, if you can't get a deal done because you're too small, you're in essence boxed out of those tax advantages. So you gotta grow to a level where you can get that deal done.
[01:06:32] Speaker A: So, okay, this is super fun. So now we're like an idea ideation mode. So, okay, I have I believe, you know, like let's, you know, hit the I believe button. My friend and client Kyle says hit the I believe button for a second, right? And I'm like, okay, fine. So let's say they have a three statement model with a financial forecast and they actually have a very coherent plan.
And like they're in the 1 to 2 million in normalized EBITDA.
I think because even the SBA loan tops off at 5 million bucks. And by the way, Jim, I've been watching lower deals on like a million dollars normalized ebitda. And then people like, well, I want a five. Like there's no a million dollars in normalized EBITDA does not mean free cash flow. You're probably sitting at 500 grand in free cash flow after taxes and working capital. So you're sitting there going like whatever has been going on is complete insanity because the margin of error is like zero and there's a lot of headwinds coming. So the SBA loan boxes a lot of people out or they have to find someone that will mortgage their whole life to actually take the SBA loan to get the cash at closing. So there's a lot of unicorn or like stars that have to line on the call it $5 million SBA loan type of deal. And then the million to $2 million in normalized EBITDA. If you can't do an ESOP.
Like I think that there are structures of like, okay as a seller's note, like if we can actually make that seller's note, or maybe a partial liquidity. So you say, okay, like maybe a third where you get conventional banking that doesn't suffocate the cash flow. Maybe a partial SBA loan to take a deep breath, maybe take a couple million bucks off the table. But you still have control and you're doing a lot of stuff that we're talking about here. That seller's note becomes less scary because they've got like control mechanisms on the financials, the board level cadence to actually be okay, where like it might be your only option if you don't want to gut the company.
[01:08:28] Speaker B: Yes, I agree with that.
[01:08:31] Speaker A: How do you feel about.
[01:08:32] Speaker B: No, I, I think, I think creativity has to bridge the gap in those situations where maybe they won't qualify for an esop, but you've got to just find a way through structure and, but sometimes seller can't finance it or that's a big part of their retirement plan. So they need to have the certainty and they don't want to lose.
[01:08:53] Speaker A: Well, that's where the certainty. Sorry to interrupt but like the certainty. I see. So I'll just use my dad as an example. Like he wanted like roughly call it 50 grand. This is 11 years ago. 50 grand after tax free cash flow, making sure that I didn't F up his entire life.
Like he didn't need a lump sum necessarily. He wanted the certainty that I wasn't gonna F it up. And through planning, forecasting and like, and maybe you can speak to the legal structure of like how you can protect yourself on this. But like let's assume they've got the financials and they got the mechanisms to sit on a board meeting go. Okay, here's what you know, budget to actual. We got this much in cash. So like we have. Because I've got clients that are literally swiping out distributions into their personal checking account every month because it's that level of clarity.
But then there's the, to your point of like reducing the, the fear and increasing the certainty. Because again if people only need call it and I don't mean only like 250 to 500 unless you're getting planes and stuff like that. I mean it's a, it's a comfortable retirement in some sort of seller's note that they can see what, what are, what are potential risks or potential things people could do to take some of the fear away that what happens if this whole thing, what happens?
What could happen in that situation? How could we reduce that fear?
[01:10:12] Speaker B: Well, I think it's getting to the succession readiness. So if you're going to apply the creativity and leave this to senior leadership team members, you need to have them, have trained them to have them be so capable that you feel like they can manage as your replacement to replicate the results.
And if you're worried about replicating the results, you got to stay on. And then if you got to stay on, you might as well keep owning it, you know. So then the question is you got to get the good senior leadership team members below you that are actually capable.
[01:10:43] Speaker A: It's, it's funny how you say that like that because you and like that's why I've always liked your, your, your mind because like you and I will do this like you ping pong and then you're back to square one, right? It's like and, and I, and I say that because there's no way get of getting out of the hard work.
And I think that's like the moment that we can go, we can swallow that pill and go, okay, like if I'm gonna lose weight, I have to just go to the freaking gym, right? So like it's the denial phase that's painful. And like to do the hard work of getting the people in place, put the financials in order, put the controls in place. Otherwise you're most like, if you're gonna be in the range of 500 grand to a couple million in normalized zipita, you're probably gonna have to sell to a third party and then you're gonna have to capitulate on a lot of that shit that's really important to you. And I think that that's one of the things that you just can't get out of the hard work.
[01:11:35] Speaker B: Well, and a lot of clients will do hard work, but they won't do the smart work. So they'll grind away in the day to day business, but they see it as a waste or less valuable to do the strategic work. But the strategic work is so much more valuable, but they don't see it that way. They might have been the original producer, founder of the company and they're used to doing the essence of the business, so they stay mired in that and don't do the smart work. So I think the earlier that clients can shift out of the grind and do the smart work, they'll, they'll get their independence by doing that.
[01:12:13] Speaker A: Well said. I like that. And I think the normalized EBITDA concept, even though normalized EBITDA is not free cash flow and not distributions, but just thinking like that, like, hey, if I spend money on these advisors or these projects or an executive recruiter, it's net income is lower, but normalized Z could be same if not higher. And I'm de risking it. So it's just this mindset shift. Knowing you're an attorney and knowing that our calendar is off and we're done with our meeting in three minutes. I want to respect your time.
Anything else that we didn't cover. Man, this has been a, this has been a blast.
[01:12:46] Speaker B: You know, earlier you talked about, you know, deal structure, gotchas and things that pop up in transactions. And I would just say to your listeners that when you're in the throes of transaction and doing the documentation to just make sure that you really, really focus on the reps and warranties, the disclosure Schedules to make them as complete as possible.
Get rep and warranty insurance if you can get.
[01:13:14] Speaker A: Talk about it. I, I don't have hard cutoffs, so if you want to keep going, we can, we can follow through this. I just was. What? I was making sure that you were.
[01:13:22] Speaker B: No, no, I, I can just finish that thought if that's okay with you.
[01:13:25] Speaker A: Yeah, yeah, yeah.
[01:13:26] Speaker B: So, you know, when I, when I approach a transaction, I tell clients selling, you're about to make 25 to 30 promises about the, the business.
And you've got to read those reps and warranties very carefully to make sure that they're accurate. And you got to own it. You have to read it. Your top people have to read it and tell me where you have concerns or where it's not accurate. If it's not accurate, disclosure schedules get to be completed. When you fill out the disclosure schedules, they're your get out of jail free cards. If you put all. If you disclose what's actually happening that are exceptions to those promises later on, you won't be held responsible because you're telling the buyer about that. So we got to spend a lot of time on the disclosure schedules. Then if you can do it, get the buyer to buy rep and warranty insurance coverage. If they won't buy it, offer to split it with them. But try to.
[01:14:20] Speaker A: Can you explain what that is real quick? Because I think it's pretty cool.
[01:14:23] Speaker B: Yeah. So if there is a breach of a rep and a warranty, the buyer will get insurance coverage that they can go to the rep and warranty insurance company that has underwritten insurance for that purpose and they can get paid from them instead of from the seller. So it takes the risk off of the seller. It's expensive and it's an underwriting process, but it's insurance and it's helpful to have.
Then to the extent you either can't get rep and warranty insurance or it's things that fall outside of it, you've got to negotiate what's your cap on liability, what's the deductible for a meaningful claim, and then what's the survival period? Because again, we talked earlier about what's the net purchase price. I also want to know what might I have to give back. So in the worst case scenario, what's the cap, what's the deductible? And then when can I breathe out a deep breath of relief and know the survival period's over and no longer can I be pursued? Because some of these buyers, some of these institutional buyers, they approach the post closing period as a sport. So they're going to go through the agreement and they're going to say where can we get them? So we're going to study every rep, we're going to have claims, we're going to look to get part of the purchase price back. So you want to approach all of that with great intensity and that's what lawyers at that stage should do for you. But you got to own that process by digging into the reps and warranties and schedules yourself.
[01:15:48] Speaker A: Very good advice. Last question for you. So if you were to go back to yourself, call it 10 years ago, 10, 20, whatever date you want to pick and say, hey, this is what is going to be important for me as I'm working with business owners, what would you have said to yourself?
[01:16:06] Speaker B: I think when I first started practicing I felt like I knew a lot and I was looking to find people that would let me tell them how much I knew.
And after a time came I realized they don't care to hear that. What they care about is how can I impact their situation.
So my meetings with business owner clients are a lot more about listening than talking because I'm trying to identify what their need is and then how I can help. So I think it's critical to know your client, know the business. I like to go on site, I like to tour the business. I like to get into the weeds about the business owner's family and understand what matters to them and then I can be of maximum impact. So that's how I train the people on my team at Dinsmoor is I tell them the soft stuff is the hard stuff. You got to get into the intangibles with the business owner to really know what makes them tick. And if you can solve that, you'll have a client for life.
[01:17:04] Speaker A: Jim, this has been a blast. Where can people find you?
[01:17:08] Speaker B: So I'm@jim carlislensmoor.com or you can reach me at 412 855-4333 and those will.
[01:17:21] Speaker A: Be in the show notes. Thanks so much for spending the time, man. This has been an absolute blast catching up.
[01:17:25] Speaker B: I really enjoyed it. Ryan, thank you very much.
