REAL ESTATE

Everything You Need to Know Before You Buy a Business

17


Buying a business? Maybe you’ve thought about it before. You could own a laundromat, self-storage facility, plumbing business, or landscaping service. It doesn’t sound glamorous, but these types of businesses can make you millions of dollars and lead you to financial freedom. And, with so many baby boomers retiring, tons of small businesses with built-in customer bases are for sale, just waiting for YOU to come and make money from them. But before you buy, there are some things you should know.

Elliott Holland, an expert in acquiring small and medium-sized businesses, helps aspiring business buyers uncover whether a business is worth the price. Elliot’s team specializes in business due diligence, making sure that YOU don’t buy a business that’s worth less than what the owner/broker told you it was. Trust him; he’s saved many new entrepreneurs from making million-dollar mistakes.

So, before you buy a business, listen to this episode. In it, Elliot walks through exactly how a business is valued, which loans you can use to buy a business, why you CAN’T trust the financials from the current business owner, questions to ask before you buy, and who should even be buying a business in the first place. Do this right, and you could be sitting on lifetime financial freedom, but take a wrong turn, and you could lose millions (we’ll share that story, too!).

Mindy:
On today’s episode, we talk to Elliot Holland, founder of Guardian Due Diligence. Elliot has spent two decades helping people acquire small to medium businesses and walking them through the nuanced due diligence process.

Scott:
And there are two different types of due diligence, right? There’s the soft work of going, maybe looking at a business, viewing it, touring the operations, asking the right questions, those types of things. And then there’s the accounting due diligence piece of verifying the financials and that the numbers are what the seller presents them to be. Today we’re going to discuss both of those with a true expert who has deep experience and has built a business over decades doing this kind of due diligence over and over and over again for clients looking at those types of properties. Hello, hello, hello, and welcome to the BiggerPockets Money podcast. I’m Scott Trench, and with me as always is my diligent co-host, Mindy Jensen.

Mindy:
Thanks ebitda.

Scott:
Alright, we’re here to make financial independence less scary, less just for somebody else to introduce you to every money story because we truly believe financial freedom is attainable for everyone, no matter when or where you’re starting.

Mindy:
Elliot Holland, welcome to the BiggerPockets Money podcast. I’m so excited to talk to you today.

Elliott:
Excited to be here. I’m glad you guys have me.

Mindy:
Elliot, you have a long history in acquisitions and the general due diligence process. I’d love to start off with a hypothetical situation. Say I’ve heard of a boring business, this is the term popularized by Cody Sanchez and I decide I want to do it and I go on a website like biz buy sell.com. When I’m browsing through businesses, what should I be looking for right off the Bat?

Elliott:
Right off the bat, you should be looking for in a due diligence sense, revenues and profits that don’t make sense. But I will admit to you, when you’re looking at biz by sell, the amount of data you have relative to what you need to know is so small. You have to sort of have the ability to deal in between the lines interpolate and give everybody a bit of grace on that.

Scott:
Maybe it’s also helpful to just zoom out and think about why someone would be interested in buying a small business, right? We’re buying a small business. I think that a lot of folks are thinking about buying small businesses because they believe that there’s inefficiencies, old practices, lots of things to change that they can use to then drive growth. And so the historical financial profile of a business is important, but also the correctable issues are what I think a lot of folks are looking for when they’re buying one of these businesses. How does one approach due diligence from that context? I’m not doing due diligence to try to find all the things that I’m trying to do, due diligence to find the things that are wrong with the business, but I’m not necessarily changing the valuation of the business based on those things. Those might even get me more excited. So with that framing in mind, how do I think about the process of due diligence and driving value for me as someone looking for an opportunity in this space?

Elliott:
So let me answer the two questions that I heard. First off, why would you buy a business? And second off, how do you look at the historical financials to continue to evaluate and perform due diligence on the business? So first, if you think about, so you continue working your job or owning your small business, it’s kind of the stay steady option. You can start a business or you can buy a business. Let’s just say those are the only three things you have in front of you, right? Well, continuing on with your job or the business you’re running the same revenue profits, cash flow that you got last year is probably coming this year, plus or minus. So you don’t have a huge chance to sort of explode this into something bigger, start a business. Yes, it could be the next Airbnb or Amazon, but 90 something percent of these things fail.
So you’re taking on a 95% bet of losing as opposed to in buying a business, particularly those done by individuals every day using SBA seven A loan. Those deals 96% of the time work. And so whether you want to bet on a 96% failure or a 96% success, that’s the opportunity between starting and buying a business. Now, how do you look at historical financials from a due diligence perspective to think about how to make good decisions? Well, the thing is, think about a business with a hundred points and you go through due diligence and you find 20 points that stink and 80 points that are great. Well, here’s the reality. If you’re good, you can fix some of the 20 points to stink and then that’s probably the business for you. If you look at it and out of a hundred points, 60 points stink and you’re not good at fixing any of them, then there’s not a business you should look at. And so yes, there’s sort of what’s there that’s not up to par. And then as a percentage of that, how much of that do you think you can fix based on your experience, your energy? And that’s what propels people to get into businesses and fix things to improve your return because it’s the money podcast. We’re here for a return. Yes,

Mindy:
We are. You mentioned and did you say SBA seven loan

Elliott:
Seven A. And so not to bore folks, I don’t want to put anybody to sleep, but it’s a government backed loan so any American citizen can get a loan up to $5 million, 75 to 95% backed by the US government at your local bank. So circle a mile around your house. The banks that are there, they all do SBA seven A loans, they all do acquisition loans. So it’s a loan for the everyday person to get in this game, which is why I like this so much. It’s not just for the fancy credentialed folks. Anybody can get into this.

Scott:
I think that this tool, this SBA seven A loan is really important because I talked to a friend the other day and they are a little bit bemused or seem a little bit skeptical of this industry because they feel like at the end of the day, after all this due diligence and everything is said and done, a huge percentage of transactions just end up being at essentially max leverage for these SBA A seven loans or whatever the lender is willing to give on the purchase price of an asset. Does that have any truth to it in your experience?

Elliott:
It does, but I don’t think that matters one bit. So if I’m a real estate investor, the real estate market is the same way. If the bank will loan X on it, then the market price for it is going to be a function of how likely the bank is to finance it. That doesn’t mean you need to buy it, and it doesn’t mean you need to buy it at that price. And so even though the bank will finance a deal, that does not mean that you need to do that deal. And people complain all the time and say, oh, the whole market’s messed up because it’s just whatever the banks will finance. Well, that’s every market that everybody, anybody has ever made money in. Part of the whole thing here is using discretion, using due diligence, using your own skills, getting smart in this so that out of a hundred deals, there may only be 10 that you’ll like and maybe only half of those 10 or five you might like at the price that they’re fetching in the market. And then that’s what being an investor is versus a speculator.

Scott:
Love it. I think that’s a wonderful framing. Totally respect that answer here, but I think that is also important here to just do one more layer of depth into the SBA A seven loan because this is in practice how a lot of businesses seem to be valued at the end of the day, right? So can you tell us what max leverage is on an SBA seven A loan and how that works when someone’s starting to buy a business? Sure.

Elliott:
So for 95% of the companies that are being bought under this loan, the price of those businesses is three to four times ebitda. We probably all heard of EBITDA interest before or earnings before interest tax depreciation and amortization a a profit or cashflow. So here’s the thing, the bank will likely loan about three times EBITDA on a business they like and a lot less on a deal that they don’t like. And so the sort of bid ask, if you think about it, is three times leverage. If the business is sort of solid, less than that, if the business isn’t, and you shouldn’t be paying over three, three and a half, four times EBITDA for any business. If so, you’re being silly. These businesses have some amounts of risk that you should be cognizant of.

Mindy:
We are taking a quick break when we’re back. Elliot Holland will let us in on some of the questions you should be asking with the small business seller. Welcome back to the BiggerPockets Money podcast. Okay, Elliot, once I have decided on a business that I’m interested in learning more about what usually happens next and what should I be looking out for in this stage, because I don’t want to go down some month long journey to discover that I could have learned something at the very beginning that said, this is not a deal.

Elliott:
So once you find a deal that you like, let me just walk you through the process to closing it. So you will likely set up a call with the seller. So you’ll email the broker and say, Hey, I’m interested in this business. I want to talk to the seller. So then you’ll get on a call with the seller, typically 30 minute call. And what you’re going to want to do is two things. You’re going to want to ask the questions you want to know about the business, but you’re also going to try to present yourself as the best buyer for the business. So both things have to happen in that half hour. Then if you still like the business, you’re going to put an offer on the business. Well, offers in the land of small business acquisition are called letters of intent, or Lois, I have a sample on my website.
There’s samples on the internet. You can have your lawyer write one up, but you send in your offer, which is a letter of intent. Now you’re not the only one sending in an offer. So other people send in offers. The broker has a conversation, Hey, you need to come up a little bit. Hey, you need to change this. And then the broker picks, or the seller picks the best offer. Now you have a signed letter of intent, and now you’re in what’s called due diligence. And this is where you have 60 to 120 days to evaluate the business, to finalize the funding, to close the deal, and to do the purchase agreement with your lawyers. And so successfully, you would’ve had a call, you would have had the broker do his thing. You would’ve sent in a letter of intent, it would’ve been accepted, you would’ve had 60 to 120 days for due diligence. You would’ve done a quality of earnings in that process. You would’ve done a purchase agreement in that process, a few other things. And after you complete that, you actually closed the business. Now, I skipped over a couple of steps here, but I wanted to keep it high level. That’s how it gets done.

Mindy:
Okay, that’s great. No, I like the high level. I’m sure there’s more steps than that. Regarding the first meeting with the seller, you mentioned that I should be asking questions while also trying to present myself as the best buyer. What kind of questions am I asking? I’ve never bought a business before, so I’m not sure what I should even be looking at.

Elliott:
Yeah, so let’s use the plumbing example. So some good questions would be sort of why does somebody choose your plumbing company over the competition? Why have you stayed just in plumbing and not expanded into other home services like maybe doing bathroom remodels or doing roofing or hvac? You’re already in the house. Why have you chosen not to do that? How do you keep your plumbing labor longer than your competition to have less disruption and less cost in your business? So what you want to do is take that small half page right up on Biz Buy, sell the McDonald’s of business listing sites, and you want to add in questions that are going to actually help you understand how sustainable this business is, how good it is relative to its competitors, and also in that process getting to know the seller. Now, what you don’t want to do, don’t bring a clipboard with a whole bunch of questions saying, Hey, question one is this.
Let me write down the answer. Question two is this, let no, no, no, no, no, because of the second thing I told you you need to do in that half hour conversation, which is impress the seller that you’re the best buyer for this business. Now part of that is you just have more cash than the rest of the folks, but I don’t know anybody that goes in and says, Hey, my money bag’s bigger than everybody else. Choose me. What you’re really trying to figure out and what the seller’s trying to figure out is in a seven business acquisition, the seller is going to have some transition period where they’re teaching you how to run the business after you’ve bought it. And what they’re trying to figure out is how easy would you be to work with and if there’s any seller financing in the deal, how likely are you going to be to deliver my check on my seller financing? And so that’s the other part, which is why it needs to be conversational, sort of like this podcast and not like an interrogation room like on first 48, who

Scott:
Is the right buyer in your opinion for that plumbing business?

Elliott:
The hungriest son of a gun in the marketplace is one answer I can give you. Why is that Elliot just being hungry is no, it does because this process has enough ups and downs that a hungry person that’s willing to sort of run through challenges is likely to win this race. Who’s the other one? Somebody who already runs a plumbing business or an adjacent business or has domain expertise. Their parents were plumbers or they’ve been working for a plumbing company. So somebody who has domain expertise is another great buyer for this business. Third would be somebody who’s related to or local to the owner. So if you’re in Spokane, Washington and this business is there and you have interest out there, you would be a better buyer than somebody in Atlanta like me buying that same asset in Spokane, Washington. And then the fourth one I’ll give you, and this is part of why I like the deal world so much, the luckiest person in the process, sometimes you’re not the hungriest, you don’t have the industry expertise, you’re not local, you just got lucky and you played your cards and it worked out. And so the best buyer can vary because at the end of the day, the seller will have a limited amount of options, typically three to five that they have to choose from. And so sometimes it’s like that private equity company, they were pain in the butt, I don’t want to deal with them that family office, they’re kind of sly, I don’t want to be working for professional money. And so now we have three, what I call s and b small business acquisition buyers, and I’m picking one of the three. And off we go. So

Scott:
I guess my question here is it seems to me that in our fictional plumbing business, the best qualified person is the owner’s second in command that’s already existing in the business in many cases. Is that a frequent occurrence or is that relatively rare?

Elliott:
It’s relatively rare. And this took me a long time in my career to understand I’m 40 people who are entrepreneurial have tried something entrepreneurial by now. So that 55-year-old, number two in that plumbing business that for 25 years never decided to go start their own company, they’re not likely to start becoming entrepreneurial. Now they don’t like risks, they don’t like debt, they don’t like personal guarantees, they don’t like running everything. They don’t like managing talent. And so although they may seem to be the most qualified, they may not be risk neutral enough to do it, which is why this transfer of wealth, people call it the silver tsunami, is so favorable for younger hungry professionals because somebody has to take on the entrepreneurial risk to get the debt oftentimes personal guaranteed debt to do this. And oftentimes somebody who’s been sitting in number two has had 10, 15 years to do that already. They’re not likely your competition. Does that make sense?

Scott:
So the SBA seven A loan is a personal guaranteed debt.

Elliott:
Now like I said, the default rate is less than 4%, so I don’t want to scare anybody, but it is personally guaranteed. And for my real estate investors, you’re used to that when you get started, a lot of the debt that you’re going to have is personally guaranteed. Now, when you get to be Warren Buffet size, those personal guarantees go away.

Scott:
This letter of intent seems like a really critical piece of the puzzle here, and it sounds like I got to submit the letter of intent before I can really parse out and believe the financials here. So what can I do before I get to expensive due diligence work to suss out any red flags and get confident in a letter of intent? So

Elliott:
The first thing you can do is go visit the business and look at what we call key man risk analysis, right? So what does that mean? If a lot of businesses first time the founder is still the owner, 80% of what’s happening in that business is related to the owner who you’re buying the business from and then kicking out. And so if they’re doing sales operations dispatch, if they’re the plumbing specialist for weird situations, then they’re probably doing three or four jobs and you’re actually not buying a business with $500,000 of profit because it’s going to take you four employees to do what the owners doing. Currently it’s probably a breakeven business. So key man risk is one thing you can just look at, but it is not something you can sort of Google the answer to. You got to typically show up and spend some time with the person.
Something else you can look at is how solid are the financial systems? So you might not speak accounting speak, but you can say, okay, do they have a single financial system? Is the bookkeeper competent? Is the CPA that does their taxes competent? Is this a system I think in a group of people who I think I can get accurate answers from? So that’s a second thing. A third thing can be a huge piece of this. You don’t get to EBITDA without getting to revenue. So how consistent are these plumbing customers? Do they have customers from 10 years ago, five years ago, three years ago as opposed to if 80% of their customers have only been with them for 12 months, that’s a very different plumbing business and one you’d be far less interested in buying. So those are three things you can look at before you do any financial diligence to kick tires on a business.

Scott:
So educate me here on this. If I’m looking at this plumbing business and I ask a question, how many jobs did you do last year and what was your profit per job? Can you give me three examples of very profitable jobs and three examples of unprofitable jobs? Would that tell me a large amount about that company’s financial systems? I

Elliott:
Get what you’re asking. So I would call that a clipboard question, Scott. So in my Harvard Business School days, if I’m talking to a hundred million dollars business owner, I would start with something like that. But remember, I’m trying to make this person like me. So what I’d probably say is talk me through the average profit margin on the job. And what I’d be looking for is do they have a number? Is it typically based on anything? Is it consistent throughout their business? And then could I see those same numbers that they’re telling me qualitatively in the financials? And then do they even record profitability per job? I would tell you probably over half of the plumbing businesses I look at don’t record it in their financials, that does not make them terrible businesses to buy. It just means that that question that I asked, let’s talk about the average profitability may be the most advanced and specific answer you’re going to get.
Does that make sense? And then the next question now you’re going to ask me is like, well, how do you tell if the business is super reliant on the owner? I think you were going to go there if that’s the case. So part of that is your visit. So a lot of times in this digital world, people want to show up for a half hour asking questions and fly back home doesn’t work here because if the business owner’s doing four or five jobs, it might take you a half day or a day of spending time with them to understand all the things that they do in the business. And so if you’re so time pressed to get out of there, you’re curtailing your ability to do the diligence you need to do. So it’s a million dollar acquisition that’s very sensitive to cashflow. I would encourage people to spend the time necessary to get the information they need to do a good deal, not a bad one. Now

Scott:
Let’s complicate this even further. I’m buying a business for three to four times EBITDA with $500,000 in ebitda, so 1.5 to 2 million purchase price, but the business also comes with a paid off office space that is attached to the business as part of it. How does that work and factor into the SBA seven A loan and the overall purchasing calculation?

Elliott:
Two ways. First off, when you are valuing a business, you’re valuing everything that it uses to operate and everything that it has in its sort of ownership. And so there will be people that will disagree with this, but generally that paid off office space, if it’s part of the business and the business is no longer paying rent to anyone because it’s paid off, then that actually paid off office needs to come with the business. Otherwise you’d have to adjust the profit for a market-based rent that you’d have to pay somebody even if it is yourself if you didn’t buy the real estate along with it. The second piece is when it comes to an SBA seven A loan, the business portion of the loan is a 10 year term, but the real estate portion can be 25 or 30 years. And if you buy real estate plus a business, you get a blended term. So now instead of having to pay in 10 years, maybe you have to pay in 15 or 20 on a blended basis, and so you get the benefit of the real estate being involved in it because the bank will actually give you a longer term, which means a lower payment.

Scott:
Okay, and how about real estate is still challenging, but relatively easy to value perhaps hopefully for folks that have been listening to BiggerPockets for a long time especially. But what about other types of stuff like specialty equipment in a plumbing business or a asphalt paving business or something like that? How do I think about valuing those types of items and financing them again using this seven a loan?

Elliott:
So it takes a little bit of a different approach, Scott, and then let me step back and then answer your question directly. So real estate people are used to kind of stacking value. So this is in there, there’s marble countertops, there’s a brand new roof, so we stack all that value and then the value of the asset is like all these things stacked businesses are valued at three to four times cashflow. And so everything that you do in the business like that specialized equipment, I’m assuming you wouldn’t have bought it unless you could have gotten more cashflow because why would you buy it if it wouldn’t have gotten in working with cashflow? Now, how can equipment get more cashflow, Elliot? Well, you’d only get it if it actually allowed you to do things quicker so you could do more of them. It was a better quality so you could compete against your other folks in the plumbing market, for instance, and get more business or there were some long-term benefits.
So my plumbing jobs last 25 years where the other guys last 10. And so what we look at in businesses is that the value of all of the assets used to create the revenue and the profits are all included in the sale because all of them are necessary to create the cash flow that we’re then making a multiple of to come to the valuation price. So now to your plumbing question, if I’m looking at two businesses, one has specialized equipment and one doesn’t, and let’s say they have the same profit, same profit margin, then what I’m saying is actually the one without the specialized equipment is doing a better job of producing cashflow for its asset base. And so I may choose to buy that one instead. Alternatively, if there’s two plumbing businesses and this one has advanced assets, I would expect it to have better cashflow in some capacity, and so therefore I’d probably be willing to pay more because the cashflow would be more, was I able to answer that, Scott?

Scott:
Yeah, absolutely. I think I’ve just perused and seen sometimes businesses that seem to be trading for just the value of their PP and their property plant and equipment and maybe one times cashflow on top of that and and that’s how they’re advertised at least. So maybe I’m getting fooled by this stuff because I’m a novice. No,

Elliott:
No, no, you’re right. So let’s drop into that. So just because some crazy broker says that the value should be this crazy funky asset and one times revenue, that doesn’t mean you should pay that. So Scott, you’re right. There’s all kinds of wonky stuff on Biz By Sell and all these business marketplaces that would suggest you pay all kinds of crazy rationales for these businesses. Don’t be a fool. Elliot told you three to four times ebitda, that’s the market price for 90% of these deals. Now if you go do something else, don’t call me and say it didn’t work, right? Because a broker will try to sell you, because think about this. So if I’m running a limo company and the market price for a limo ride is a hundred bucks and I have a Maserati, but you have a Cadillac, right? But everybody’s paying a hundred bucks. Why should I pay this Elliot guy more for a Maserati if he’s only getting a hundred bucks per fair so that these special assets, if they don’t do anything to create better cashflow, they’re fool’s gold and there’s a lot of fools gold out there. In fact, a lot of what my business does is help people find fool’s gold, which is probably why I’m so emphatic about don’t be fool, pay a market multiple and really check to make sure that the profits the business says are there, are actually there.

Scott:
Okay, that’s a wonderful answer. Thank you for educating me. I’m learning a lot here. You can tell I don’t know what I don’t know and I appreciate learning from the master or we’ll call you the EBITDA here. Oh, we need a T-shirt for that. How much can I trust the EBITDA and the financials that are presented on by Biz Sell? When I’m looking at these types of businesses and even if I get further along, how much can I trust the financials?

Elliott:
As much as you can trust the person at the used car lot a, k, A, not at all. And so the reality of businesses is just like the used car lot. First off, the broker is trying to maximize value for the seller and there’s no recourse. You can’t take it back. So once they convince you that asset is worth 5 million and it was really worth nothing, it did not create any cashflow. You can’t go back and say, Hey broker, I want to give it back. Where’s the return line? Is this like Walmart? Nobody that’s yours, just like the used car lot. And so what I’m seeing is a huge portion, 20 to 30% of these deals have what I call fraudulent EBITDA or bogus ebitda. And part of the game is making sure either you personally or your team has the ability to dig through messy small business accounting to get to the true profits because you can’t do a successful deal without getting that number right. Alright,

Scott:
This is super helpful and I’m sure we could go for 45 minutes on additional things you could do before we get to this, but let’s talk about, I now have an LOI and I now I’m doing formal diligence. What is a quality of earnings going to cost? What is a quality of earnings and what’s it going to cost me to get that done? Why do I need it? So

Elliott:
A quality of earnings is nothing more complicated than a mini audit. The reason you need a mini audit is because there is no standard of performance for small business financials. Nobody checks how they report. And so you might get 10 plumbing companies that report 10 different ways and you would not know it if you had not gone through the analysis of standardizing their financials through this many audit called the quality of earnings. So that’s what it is. What does it cost?

Scott:
So if I’m looking at 10 plumbing companies, one might say I got revenue because my customer whose job I’m going to do in January paid me a check of $10,000 for that job in December. So 2023 revenue is great, 2024 revenue is going to look worse. Another company will say, I got the cash in December, but I did the job in January, so I’m going to declare the revenue in January. It’s those types of problems from the accounting perspective that you’re talking about here, right?

Elliott:
Yes. And then to double click, one company will take inventory and put it on the balance sheet the way a bigger company would do. Another company would take inventory and expense it through the profit and loss statement right away. And those two companies financials would look totally different even though they matter the same revenue and the same cashflow. And so what you’re trying to do is normalize the way that these companies present. The revenue one’s a great example. There’s cost ones, there’s a bunch of things you need to sort of be cognizant of. What does this thing cost typically less than 1% of your deal. So my average deal is about $3 million. So my cost is around 25 to $30,000 for a quality of earnings, which is about 1%. You can go a little bit less and you can probably get something for 10 or 15 grand. The question I would ask you is, do you get your bulletproof vest from Walmart? Or if the other side of risk is catastrophic, do you actually pay for something that’s going to protect you? So there’s, you kind of get what you pay for, but about 1% of the transaction value is probably fair across the whole spectrum of deal sizes.

Scott:
I believe that there is quite often that the Q of E 80% of the time produces a lower buy-side interpretation of EBITDA than what the sellers are presenting. What do you think the ratio is? Is there a good number of cases where it’s actually higher in your estimation?

Elliott:
No, 80 20 is probably accurate. 80% of the time it’s less 20% more, plus or minus. So the

Scott:
Q of E in most cases saves the buyer much more money than its cost because that purchase price is negotiated down as a multiple of the EBITDA presented in the LOI.

Elliott:
Yes, absolutely. So we often pay for ourselves. Some of it is in lower negotiated purchase price. Scott, other parts are because we’re an advisory firm on top of just an accounting firm, if I help you figure out that that plumbing owner was doing four jobs and that $500,000 of EBITDA is really closer to 200,000 by the time you hire four people to do the jobs of the seller, then all of a sudden not only do you get to reduce the purchase price, but you may walk away from, and so I saved you 1.5 million of silliness in probably five years of your life. And so if you look on my website, there’s a section of testimonials, not from folks that closed great deals, but folks that are happy that they avoided terrible million dollar transaction that would’ve ruined their financial setup. I

Mindy:
Think that’s really important to note that you’re not just going through this to make sure the deal goes through, you’re going through this to make sure that the numbers are what the seller is presenting. I really like what you said, trust but verify. I’m going to go a step further, not being your business and say verify. Don’t trust until you verify.

Elliott:
You know what, Mindy, I like you already. I’m

Mindy:
Pretty awesome. You can like me, I’ll allow it. But yeah, you have to verify because this is somebody who’s trying to sell their business. They’re not going to be like, Hey, my business is kind of a dumpy business. Do you want it? They’re going to be like, Ooh, look at all of this amazing stuff. Don’t look at this stuff over here. And how much of a shortage is there of buyers who don’t know what they’re doing? I mean, I’m a real estate agent. There’s no shortage of buyers in real estate who don’t know what they’re doing. So this is a business, it’s even bigger than real estate.

Elliott:
Even bigger, the valuation of the businesses are more volatile in real estate. It’s purchases close to that type of asset in that area, doesn’t fluctuate all that much. 10, 15% cashflow can fluctuate 40, 80, a hundred percent in a year. And so really dialing in on this is super important because the value of a business that did $500,000 of cashflow last year and $100,000 this year is 1.5 million versus 300,000. Same business, same employee, same location, same name. You bought yourself a crater. The other thing I like what you said, Mindy, is verify. I don’t even like the word trust too much. Not in this game. Why? Because owners are getting three to four times any profit dollar they can convince you is there whether it’s there or not. So they convince you that those season tickets to the Dallas Cowboys have nothing to do with the business and you should add back that 50 or a hundred grand and then multiply at times three. And you don’t realize that the only people they take to the Cowboys games are all their customers and their vendors. Then you overpay for that asset. And once you do it, you can’t go back to the Walmart line and say, Hey, can I give this business

Scott:
Back? Stay with us after the break, Elliot Holland will tell us some success stories and some stories where the outcome wasn’t so great. And we’re back. We’re talking to Elliot Holland about how to do due diligence when buying a small business. Let’s talk about some stories here. Can you tell us about somebody who got their bulletproof vest at Walmart and regretted it in the due diligence process?

Elliott:
Yes. I had a person that came to me. He wanted a quality of earnings and was debating the do it yourself method, and we went back and forth for three or four weeks. He decided to do it himself. It was a $3 million transaction. It was actually a real estate related business. They helped people find places to live. And so this person went through the process. They were able to get the SBA to finance their deal. To your earlier point, Scott, the SBA will finance a lot of stuff. That doesn’t mean you should do everything. And there were probably 12 things that were missed. I have a case study on my website, we’ll probably linked to it in the notes that goes through 12 things that he missed in due diligence. And so that meant that he overly paid for the business. It probably was worth 800,000, maybe something in that realm, but $3 million were paid. And so that person struggled through it for a year, tried to do everything they could to put the pieces back together and eventually lost the business. So they could have paid me 25 grand and saved a $3 million loss. And now they’re sitting on a personally guaranteed note of over $2 million, and I’m sure they’re not thinking about that $25,000 they saved a year and a half ago. So that’s one story of the bulletproof vest from Walmart.

Mindy:
Is there any recourse for a buyer who pays $3 million for an $800,000 business? It almost sounds fraudulent at that big of a gap.

Elliott:
So there’s not workable recourse. It’s very similar to the used car lot, which is why I use that as the analogy. If you go buy a car from the used car lot and you don’t realize the transmission’s blown and they didn’t guarantee the transmission, you can say, Hey, use car a lot. You knew the transmission was blown, you overcharged me for the car. But by the time you go through the legal system and the way the legal system is set up, the buyer is supposed to be smarter than the seller of assets like this. And so the courts don’t favor the people who were showing up as BiggerPockets but weren’t bigger diligence solution providers. And so what ends up happening is can you actually go to court and say somebody committed fraud and defrauded you? Yes, but small business acquisitions are so fluid that the likelihood that you’ll win a case is very low and the likelihood you’ll get any money from that case is even lower.
And so really it’s verified before you buy. It’s just like the used car lot. Now, I’m not trying to scare people. What I’m saying is a hundred percent of the effort that you are going to do in diligence on this acquisition should be done before you buy it. Don’t leave things up to chance. Don’t be pushed off of a question you need to understand because of time pressure because of some broker, because of some seller, because of some urge to be a million dollar business owner. Just think about going off the used car lot with the car with a bad transmission and the engine and what your recourse is there. You don’t have much. Alright, so let’s

Scott:
Go to the other extreme now and we’re interested in the subject. I’m assuming if you’re listening to this part in the episode, because you’re hoping for the opposite outcome, you’re hoping to buy this plumbing business at a $500,000 EBITDA for 1.5 million and then balloon EBITDA to one two 3 million if you can over the next couple of years and sell it not just for a three to four multiple, but for a 5, 6, 7, 8, multiple. Do you have any clients that have had that kind of outcome and made the millions or tens of millions of dollars on these types of transactions?

Elliott:
There’s over 75 clients I’ve worked with that have done just that, bought a million dollar business and now it’s worth three to five times that whether they’ve sold it or not. There’s a whole testimonial page. I have 10 clients. You can actually see their testimonials about businesses they bought leveraging my services to go on to million dollar success in mass proportions. Let me tell you my story of my favorite one. So one of my buddies bought a business and I call ’em that because we work really one-on-One during this process, he was a former technology guy, did some marketing work, he was married, two kids, wanted to buy a business, came to me for due diligence. We went through the process. We found that the broker had overstated ebitda, so we slowed the process down two or three weeks to work through a new purchase price work through some of that, and we were able to get to a place where the EBITDA matched the price that he had said earlier.
So he made the acquisition, this acquisition freed him up to leave his job, his wife left her job, they moved to an island off the coast of Belize. They took their kids out there and were sending their kids to a local private school and living the absolute dream. I mean location, autonomy, wealth, running your own business, having the reins of a million dollar plus company, all of the trappings of this. And that whole process took that person less than six months. And so there’s dozens of stories, many of them on my website about the successful stuff. And keep in mind folks, the reason this is so interesting and so tantalizing and why folks like Cody and Ozzi and Walker get such an attention is that you can be a six figure earner and walk into seven figure million dollar upside if you do this right? That’s why we play this game. That’s why the investment is interesting, and that’s why even if you hold real estate, a lot of my customers are real estate investors that are looking to get higher returns. That’s why you play this game,

Mindy:
Elliot, that was awesome. I can’t even talk. You’ve made me speechless, which nobody has ever done before because I can talk forever. Where can people find more about

Elliott:
You? So go to Google type in Elliot Holland or Guardian Due Diligence. If you get any anywhere close, my SEO will get you to the right website. My socials are Twitter, so Elliot e Holland on Twitter, and you can also find me on YouTube at Guardian Due Diligence for YouTube. Any of those places you can find great free content. I have one of the largest libraries of free content around small business acquisition and my contact information’s at the bottom of my website. We also offer free letter of intent reviews. Remember the offer letter I told you that you send to buyers to acquire a business? If you go to offer from elliot.com, you can submit your letter of intent for a free review. So that’s another benefit I can give to listeners.

Scott:
Awesome. Elliot, this was really information packed. Thank you very much for sharing that.

Elliott:
Thanks so much for having me. I really enjoyed it.

Mindy:
Thank you, Elliot, and we will talk to you soon.

Elliott:
Talk soon.

Mindy:
Holy cow, Scott, that was Elliot Holland and that was fan flipping tastic. I absolutely love talking to him and I learned so much just in this one hour.

Scott:
Yeah, absolutely. I mean, this is another one of those guests that we’ve had where you’re just like, wow, this is a true master in his area of expertise. He’s also a salesman, right? This is a product that he sells and this is how he makes his living. But I was happy to learn from someone who makes a living in this particular space. As a reminder, BiggerPockets has no financial affiliation or no prior relationship with Elliot. He applied to come on the show and we were thrilled to have him. And boy did I learn a lot. I just got schooled by somebody who really knows what they’re doing in this space, and I have a deep curiosity. I thought I was going to be able to ask good questions in the show, and he was very polite in saying, no, that’s a bad question. Frame it this way, including a few times where we edited it out actually on the show.
So wonderful, wonderful guest. I hope people learned as much as I did, and I’m sold on the value of this kind of due diligence and lining up a quality of earnings in the due diligence process there. So really learned a lot today and how that can add a lot of value for someone on the buy side. I’ll just leave us on this particular point. If I was starting over or if I was not CEO of BiggerPockets, this is where I would be spending my time and energy looking to build a career. I think it’s a wonderful, wonderful opportunity. I think a lot of people are going to do very well here, and I think there’s a great, great core thesis that folks like Cody Sanchez and Alex Hormoze talk about, and I think people like Elliot are the kinds of folks that people who want to execute on this are going to need in their court, in addition to some BiggerPockets couple hundred K, most likely in cash. Well, Mindy, should we get out of here?

Mindy:
Yes, we should. Scott, that wraps up this episode of the BiggerPockets Money Podcast with Elliot Holland, who is so amazing. He is Scott Trench, and I am Mindy Jensen saying bye for now. Sweet cacao.

Scott:
If you enjoyed today’s episode, please give us a five star review on Spotify or Apple. And if you’re looking for even more money content, feel free to visit our YouTube channel at youtube.com/biggerpockets money.

Mindy:
BiggerPockets money was created by Mindy Jensen and Scott Trench, produced by Kaylin Bennett, editing by Exodus Media Copywriting by Nate Weintraub. Lastly, a big thank you to the BiggerPockets team for making this show possible.

 

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.



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