Ever wondered how to reduce the amount of taxes you need to pay when selling your business? Or if it’s possible to eliminate taxes altogether? Here’s the guy who shows who how to do it. Dr. Bart Basi is the nation’s leading tax attorney and one of its best estate planning experts. He talks about ways to reduce your tax liabilities that no one else can touch, detailing how this depends on which state you are in and what kind of company you have. Dr. Basi also explains the best approach when coming up with succession plans, the role of brokers in this undertaking, as well as the right way to deal with double taxations. Listen. Take notes. Save thousands. Or millions.
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Get Uncle Sam Off Your Back When Selling Your Business With Dr. Bart Basi
How To Reduce, Even Eliminate, Your Tax Hit
We’re talking about getting deals done for folks looking to buy and sell outstanding businesses. After working with entrepreneurs and business owners all these years, one thing I’ve noticed is how many of them don’t have a good sense of the numbers when we’re talking about selling their business and what their walkaway numbers might be. Their accountants often give them general advice and thoughts about what the tax hit could be if they sell and take the profits.
Until someone like me gives them a real evaluation and estimates of what the sale price of the business might be, and then they take that to their accountant, what you get is that ‘Oh my God’ moment. That moment is not only terrible for these business owners who think, “I can’t afford to sell my business,” but it’s also a lousy moment for me, the business broker, who’s now getting told, “Sorry. We can’t sell your business right now.” It’s important to know how long-term capital gains and other tax issues will shape your plans for the future.
We thought, what better way to take a deep dive than with one of the best tax and legal minds in the country? Dr. Bart Basi is amazing. He’s a national speaker at dozens of conferences and events over the years simply because he is so good at it. He’s both a CPA and a tax attorney. He has a Bachelor’s and an MBA from Syracuse University. He took his Law degree from the University of Louisville, then a Doctorate in Economics and Accounting from Indiana University, and topped that off with post-graduate work at Stanford. He’s the author of five books and has won many awards over the years. He writes The Tax Report, which is a publication about tax and estate issues.
[bctt tweet=”Double taxation exists with publicly held companies and not with private companies. ” via=”no”]
He’s the Founder of The Center for Financial, Legal & Tax Planning in Illinois. You can go to his website at TaxPlanning.com and check them out. He talks to us about ways to reduce or even eliminate your taxes to Uncle Sam. He also tells us things you don’t hear anywhere else about new ways to sidestep taxes altogether, which is amazing. He also gets into structured installment sales, a great way to reduce and even eliminate the amounts you’ll pay to Uncle Sam, which is extremely relevant to a lot of business owners. Anyone who’s looking to sell in the next few years and doesn’t want to get killed on taxes needs to learn from Dr. Bart Basi. I hope you enjoy it.
Bart, I’m glad to have you here. I appreciate you taking the time. As a business broker, this topic is so important and it’s not understood even by some of your fellow accountants. They’re not able to keep up on a day-to-day basis as to what’s going on with tax law, tax changes and how to serve their clients best. We’ll get into some of that. Thanks for coming. I appreciate it.
My pleasure. I’m glad to be here and glad to help you and some of your readers.
We should start with a quick overview of how taxes work for the typical business seller and the owner who’s been working at this for years. I built my construction company from scratch. Let’s say I built it 25 years ago and I’ve got a buyer who’s offering me $1 million to buy my business. I’ve got eight employees, equipment and vehicles. My wife works part-time in the business in the accounting and bookkeeping function. Can you give us a little bit on the basics of how the IRS and the state will tax my business when that guy gives me $1 million?
When the buyer gives the seller $1 million, if the money goes directly to the seller, that creates one problem. If it goes through the business, that creates another problem. The method of operation or the entity structure is critical. In some cases, some of these people have never even incorporated. You mentioned a construction company. I spoke with an owner of a construction company in the State of Illinois and he likes his accountant so much. He’s selling his business and he’s retiring. It’s similar to your situation here, although his wife does not work in the business. Would you believe he’s never incorporated?
He’s got a $10 million to $12 million business, not just $1 million, and everything is on his personal income tax return, including all the real estate that he personally owns. He’s going to pay 40% type of taxes and when you include the state taxes depending on the state. He’s in Illinois. If you’re in California, it’s a totally different situation. By the way, I don’t know if you’re aware, but some states have no state tax. Tennessee’s legislature voted to eliminate their state income tax.
West Virginia is going to be doing the same thing soon.
It’s an overtime period with West Virginia. It’s amazing what’s going on in this country. To answer your question, it depends on how the structure is legally written. In Connecticut, a gentleman sold his business. He sued and went to court because he had to pay all these taxes. The judge says, “I know what you wanted to do. I understand what your intention was, but the legal documents do not say that. Therefore, you have to pay taxes because your thoughts and your objectives were not properly drafted in the legal documents. The legal document is drafted properly, but not from a tax standpoint.” To answer your question, it depends on how the company is structured, how the payment of $1 million is made, the entity itself, and the way in which the legal documents are drafted.
One of the 30,000-foot level pieces of advice I give to my clients when they ask the question, “How is this going to be taxed for me?” I typically tell them that you can guarantee that Uncle Sam wants some money if you put dollars in your pocket. If you defer that or you somehow don’t put dollars in your pocket, then they’re not going to ask for money right off the bat. Is that a fair statement, do you think?
Eliminate Taxes: If the money goes directly to the seller, that creates one problem. If it goes through the business, that creates another problem.
To a great extent. One of the first things my firm does whenever we get involved with a client is we do what’s called a tax minimization analysis. We look at different scenarios like selling your stock, selling your assets, whether it’s a C corporation, Subchapter S, partnership, or incorporated. We take a view to say, “If this is the way the deal is structured, the deferred tax is your after-tax cash.” You mentioned deferral. Yes, there are some tax laws that you can defer taxes. There are also a couple of tax laws where no Federal taxes have to be paid at all.
Having said that, we also have to deal with state taxes, and the state revenue departments are looking at things totally different from the Federal Internal Revenue Service. Depending upon the state that you live in, where the business is located, it makes a big difference. I’m going to give you one quick example. A gentleman in North Carolina is selling his company and the buyers want to buy assets in that stock because they’re concerned about potential liability issues. Long story short, he has moved to the State of Florida. By moving to the State of Florida before he sells the company, the money he receives will escape all state income tax. We have this happening a lot. In California, they move over to a state that has no taxes. Nevada is a big state that we work with a lot in. A large publicly-held corporation moved its headquarters from California to Texas because Texas has no state income tax. Be aware that state income tax is totally a different approach than Federal income tax is.
I get a lot of clients who come to me and they’ve done their Google searches and they’re trying to educate themselves. They will tell me, “From what I read, there are three categories of capital gains rates. You can be either 0% or 15% or 20%. When that guy gives me $1 million for my business, should I plan on having to pay Uncle Sam 20% as a capital gain?”
While you’re correct, you’re not correct. Depending upon the income reported and the personal income tax return to the seller, the tax rate can be 18.8%, not 15%, and it can be 23.8%, not 20% because there is a 3.8% Medicare tax that’s added on top of all revenue generated from investments. If the income reported on the tax return, whether a single head of household, married, joint family and so forth, reaches a certain level, that level is not much. For married couples, it’s like $250,000 to $300,000. We’re not talking much. When you talk about 10%, 15% or 20%, be aware it could be 18.8% or 23.8%. In some cases, it’s even higher than that. That’s only Federal taxes that you and I are talking about.
On the state level, what does that picture look like? Take California, for instance. A lot of my clients are in California.
California has a high-income tax rate and it does not recognize capital gains. They’re taxed as regular income. In one large company in Southern California that we handled, in order to smooth out and lower the taxes, the buyer agreed to take over the company under a management agreement and pay a fee to the seller over a period of years so that the state taxes would be lowered and smooth it out instead of being hit all at once. There are several different ways and that worked extremely well. We’ve used that concept in other situations.
That’s a great one to know. Walk me through that scenario. It’s the same example. I’m a construction guy. If I don’t have a general manager, a family member or anyone I can hand the business to and an investor comes along and says, “I’ll buy your business,” what does that look like? I talked to this potential buyer as not buying my business, but what does that look like for him?
Let me explain. You got to be careful and I apologize. Terminology is extremely critical to me and it’s critical when you get into a court of law. You used the word investor. When these investors come in to buy companies, they usually do not want to run it on a day-to-day basis. The buyer has to have a good operating structure and people in place for investors to be interested in paying premium dollars for it. That’s important. Management agreements may or may not work in that case. They may if the internal operating structure is properly drafted prior to the sale because then they can use that as a management structure and operate it for 5 years, 7 years, 10 years or whatever the case may be. The seller can get a steady stream of income.
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Let me give you an example of how this works in one case when it wasn’t an investor. It was someone who knew the business. The person said, “I know the business and I know the operation so I’ll make sure I have my people in place.” They took over as a management company. What they’re doing is their fee for managing it is they will keep all the profits of the company. However, they will pay the owners a fee of let’s say $50,000, you can add as many zeros as you want, on a quarterly basis to the owners, which by the way, is then tax-deductible to the company. At the end of the year, the company shows no profit because the profit is transferred to the managers’ third-party company.
The people who own it, their accountant continues to file their tax return. They pay no income taxes because on their tax return for their company, it shows no profit, doesn’t it? In that particular case, over a ten-year time period, for a nominal amount, that entire company will be transferred to the management company. In the meantime, the management company is buying equipment to run the company and they get a full 100% deduction every year they buy the equipment. That will give you an example of how we use those management agreements.
Let’s review that. Under that scenario, the outgoing seller, the man who wanted to sell his business is taking income year after year, but at such a level that he’s not going to incur the same level of taxation that he would have if he took it as a lump sum. In that scenario, what does the change of ownership look like? Is that a change of ownership or is the outgoing seller retains ownership? What does that look like?
The outgoing seller retains ownership and the management company comes in. My company might be let’s say, Bart’s Construction Company. You come in and operate it. We say, “Ken’s Construction Company operating as Bart’s Construction Company.” We have both names there so that the people know. Gradually, you’re creating your own goodwill so that when the actual transfer has taken place in 5, 7, 10 or 12 years, it’s a smooth and seamless transaction. That’s not the only way of doing it. There are other ways of doing it. This is something that I ask all the time. When I get involved in a job, I sit down with the seller and we ask them, “What are you going to do with the money?” There are a couple of laws that affect them. Have you heard of the term Opportunity Zones?
Eliminate Taxes: There can be no constructive receipt by the seller.
That term has been extended in time periods so that if people want to sell their business and they can invest in an Opportunity Zone, there’s a possibility that they not only defer taxes but profits can be completely eliminated depending upon the time period involved. It’s a technical array. Opportunity Zones are something your people should look at. Another area that they should look at would be what we call a Structured Sale. I did one in the Washington DC area where the buyer wanted to pay X number of dollars and the seller wanted to receive Y number of dollars and they couldn’t seem to get together. The broker called me and said, “Bart, can you help?” I said, “Let’s see what we can do.” I talked to the buyer, “What are you going to do with the money?” He said, “I’m going to retire. I don’t want to work. I’m sensitive about my investments.” I said, “Would you be interested in investing in an insurance company and getting a return and annuity?” He said, “That would be fantastic.”
We worked out how much the seller wanted on a regular basis for 10 or 20 years or whatever the case may be. I then went to the buyer and I said, “How much do you want to pay for this company?” Once I found out how much cash the buyer was willing to pay, we then contacted an insurance company. I have no relationships with any insurance company so you understand how I work. I get agents calling me saying, “Bart, what commission do I owe you?” I said, “Nothing. The guy needed it and we did it.” In that case, we took the buyer’s money and found out that if we could buy an annuity policy, that would give the seller the amount of money he wanted or she wanted each year for X number of years.
Would you believe we could buy an annuity policy that the buyer paid for with the money that the buyer was willing to pay, which was less than the seller wanted, but then we could give the seller an income that he wanted over a period of years that he was comfortable with? We were able to solve the problem. In one case I did, we had a woman who owned a company and she wanted to transfer it. I said, “What do you want?” She’s like, “I just want some money. I want $50,000 a year.” We divide the $50,000 by twelve. We set up a program where she gets it and the buyer is happy because it’s costing him less than he thought it would cost him.
Would you believe she wants that income every month for twenty years? Here’s the key. Your readers have got to be careful. There can be no constructive receipt by the seller. That’s the key terms, constructive receipt. That means if the seller makes the decision to invest the money with let’s say an insurance company, the entire thing is taxable in one year. It’s got to be the buyer that buys the policy where the beneficiary of the annuity is going to be the seller.
The buyer must buy the policy and the seller is going to be the beneficiary.
Correct. I had one in New York State with a veterinarian who takes care of the dogs. The attorney that was working to try and sell his company did not understand the concept. I said, “You can’t do it because if you do it, you’re going to have a major problem on your hands because you represent the seller.” We hired another attorney that worked for the buyer. They became the intermediary, and the funds were transferred to this other second attorney representing the buyer and getting paid by the buyer. They invested the money and the veterinarian was able to get a steady stream of income for the rest of his life.
I do want to spend a little bit more time on this installment sale thing because it is something that comes up a lot in my conversations with folks and they are intrigued by it. Let’s use super simple numbers as we have been. Instead of taking $1 million as a check from somebody who’s going to buy your business, you come to an agreement where the buyer and seller are agreeing that the price is going to be $1 million for the sale. Instead of handing over any money at the time of sale, I’m going to take $100,000 for ten years from you in the form of an annuity. This is an annuity that the entire activity is such that it is now money that is being held by an insurance company. Like you, Bart, I have no stake in the game but I do know that these types of instruments, MetLife and Independent Life are the two big players in this game.
A lot of people also use US Treasury bonds. I had one guy in California who sold his business and he wanted a steady stream of income. I asked him casually, “Where would you invest your money?” He said, “There’s a stock brokerage firm in Miami, Florida.” I said, “You’re in California.” He says, “Yeah, but I like this guy and he knows how to invest money, so we talked to the buyer.” The buyer invested the money with the stock brokerage firm in Miami, Florida, and the seller got his money on a regular basis. You can use insurance companies, stockbrokers, treasury bonds with banks. There are all kinds of things. There are all types of installment basis, but it’s not an installment decision of the seller. It’s the installment decision of the buyer.
That’s an important distinction.
I can explain because the IRS or the state, especially if they find that the seller was involved in the decision process and the seller controls whoever is handling the funds, the entire amount is taxed immediately.
Let’s talk about that. I’m the broker for the seller and I come across a buyer who might be interested in this scenario. You’re going to have to advise me. Are there things I should be saying and not saying to guide them towards understanding how this process works, what steps they should take, and what I, as the broker, or what my client, as the seller, should or should not say? This has come up a couple of times in my life where the seller wanted this to take place, but they couldn’t convince the buyer to take the necessary action to get the ball rolling. It’s a tricky scenario where the buyer has to do a self-education process. Isn’t that the way it has to go?
Yeah, to a certain extent. The broker has got to be careful because they’re being paid by the seller, typically. In some states, they call themselves transactional brokers, which bothers a lot of people. It’s like real estate agents, “We don’t represent the seller and we don’t represent the buyer.” You signed a contract with the seller and you’re getting paid by the seller. You better say you represent the seller. Otherwise, you’re going to be held responsible. It’s a touchy issue of brokers. My firm does not do litigation, but we get involved in court cases as expert witnesses. I’m sorry to say that there’s been a couple of court cases where we’ve been asked to testify against business brokers.
[bctt tweet=”If you’re talking to the buyer, make sure to use the word ‘suggestion’ and not ‘recommendation.’ ” via=”no”]
They got involved in the transaction from a financing standpoint where they’re not supposed to. You can talk to the buyer, but the buyers got to have their own counsel, or you’ve got to hire an independent third–party who advises the buyer on how the structure should be. You got to keep the buyer happy. Otherwise, they’ll walk away from the deal. You’ve got to make sure that the seller is happy or they are scared to sell. Keep this in mind. If you have a bank account and the bank account gives you interest on your account, at the end of the year, you receive a 1099 interest statement from the bank saying, “You earn $50 on your savings account.” You may not take that money out, but you could take it out if you wanted to.
Therefore, you have to pay taxes on that money even though it’s not in your pocket. That’s called Constructive Receipt. If the seller or the broker works with the insurance company, the state and the Federal Government could come back and say, “You’ve got a connection,” therefore, the decision not to receive the money. You’ve got to be sensitive to your position. I don’t want to say the brokers can’t participate, but I’m saying that it’s got to be careful. The buyers got to be educated. “If you want to buy this company, here’s what you have to do. Here’s where you have to pay the money. Talk to an insurance company.” You can suggest. There’s a difference between suggesting insurance companies or banks as opposed to recommending. You never want to recommend. That puts you at risk. You got to use the words, “I can suggest you can talk to this company, this guy and that guy.” If you can set up an annuity program, the seller will probably accept it.
Because you are so good at accounting issues and legal issues, is the dividing line that would keep me safe as a broker and my seller safe as an owner is if the buyer going through this installment sale process has his own representation and attorney? Is that a good enough divider?
It’s probably a good idea to not go far down the road with the buyer until he has some form of representation for that.
If you’re talking to the buyer, you want to make suggestions and make sure you use the word suggestion and not a recommendation. A suggestion says, “I can suggest anything I want.” People call me and say, “Bart, where should I invest in?” I’m not a registered investment advisor according to the United States government, but I can suggest what I do. I can suggest what I think might be good. It’s a suggestion. I’m not going to say, “You should do this. You should do A, B, C. You should invest in this real estate down the street.” That puts me at risk.
Let’s do a quick review. We’ve gone over two big bullet point strategic methods where someone cannot take all the cash in a transaction and get the money paid to them over time. One of them is a structured sale. The other one that you mentioned was the management agreement. What would you call that category? Does it have a term? I just call it a management agreement.
There are other ways. Keep in mind, if the client has formed a C corporation, there’s a special law in the United States that says, “The law in effect at the time you create the company, not when you sell it, will control the taxes you pay on the transaction.” Let’s assume you have a company that’s thinking of selling but they’re not sure they’re ready yet. They might be ready in 3 or 4 years or something, and they’re not a C corporation. You might suggest, and if they’re your client, you can recommend that they form a C corporation and keep the ownership for a minimum of five years. The Federal Law says, “If you create a C corporation in 2021 and you operate it for at least five years before you sell it, you will pay no income taxes on the profits at the time you sell it. If you’re married, the maximum amount of excluded profits being taxed is $10 million. If you’re not married at the time you sell it, the maximum amount is $5 million.”
If I’m an S Corp or an LLC and I transitioned this minute to a C corp, and I hold the business for five more years, and I want to sell it for $2 million in five years, I’m not going to pay a dime in taxes up to those amounts.
Let’s mix a couple of things. Let’s say that somebody comes along in two years and they want to buy your business. How can you sell your business in two years and still take advantage of not paying taxes on the profits? Let me tell you, I’m an old professor. We discussed the management agreement, didn’t we?
Eliminate Taxes: The time when you create a C Corporation, not when you sell it, will control the taxes you pay on the transaction.
Suppose in 2 or 3 years, somebody comes along. You’re a business broker and your job is to sell companies and buy companies. You help the guy structure his entity properly. You keep marketing it if you can and someone comes along and they want to buy it. You say, “We can’t close the transaction until five years and one day, but we’ll give you a management agreement to run the companies if you’ll keep all the profits on it. You’ll pay the seller a few dollars each year, but we will sell you the company at the end of five years.” You see, I can mix apples and oranges.
It gets back to trust. The seller at that point says, “Can I trust a total stranger to commit to this kind of arrangement and last for five years?” It then becomes a trust issue.
Not just that, but you’ve got to also realize, typically in these situations, the seller is going to have some involvement in the company. The way we draft management agreements is that the buyer has not a tightrope. They’ve got the flexibility to change and increase the company and all this type of stuff, but it works because you’ve got the business sold and it could be 2 years, 1 year or 4 years. The idea is that under the income tax laws of the Federal Government now, it is advisable that people close down their Sub-S or partnership or whatever it could be and create a new C corporation.
There have been studies done on this since the law has been changed. There have been articles in the newspapers and magazines and Journal of Accountancy. There have been seminars given even by the different bar associations. I know I’ve done several programs myself for associations and for companies about it. It’s not just a Bart Basi idea. I don’t want to mislead you. A lot of people are concerned about double taxation. I wrote a report and it’s amazing. Double taxation exists with publicly held companies. It does not exist with private companies. It’s important for people to know.
I even educate accountants and they say, “Bart, there’s double taxation. We can’t do that.” I say, “Tell me something. Would you rather pay 37.5% taxes every year or would you rather pay 21% taxes every year?” A publicly held corporation like General Motors makes a profit. You are an investor, but you’re not an active investor. You’re a passive investor and you have nothing to do with running the company. You simply own stock. At the end of the year, General Motors makes a profit and they pay income taxes. It’s basic. You’re an investor and you live in California, and you want some dividends, so General Motors issued you some dividends. You have nothing to do with General Motors other than the fact that you bought some stock in the stock market. You will pay income taxes on the dividends, will you not? People call that double taxation.
Let’s switch gears. You have a private corporation, a construction company, and you want to operate it. I recommend that you operate it as a C corporation. You’re going to pay 21% tax and you’re not going to have the income transferred to your personal income tax return. You’re not going to be subject to personal audit with anything that happens with the company because there’s no relationship between you and the company other than the fact that you own the company and you work there. If the company makes a profit, it will pay taxes at 21%. That’s the tax rate that General Motors pays. You say, “Bart, how do I get money in the company?” You own the company, don’t you? You run the company. If you want to take money out, take it out as a bonus. The company gets a tax deduction. You saved 21% on your bonus. Your bonus is taxed on your personal return the same as if it was a Subchapter S corporation, but you’re not paying 35% or 37%. You’re paying a maximum of 14% because the company got a tax deduction of 21%. If you were a Subchapter S corporation, there’s no tax deduction.
In addition, capital gains do not apply to C corporations. The 3.8% capital gains do not apply to C corporations or medical expenses. The Subchapter S corporation and partnership are transferred to your personal income tax return. The corporation pays everything and nothing is transferred anywhere. You have Social Security taxes and you’re paying your salary. It’s paid by the company and it’s not shown on your personal income tax return where you can deduct 50%. You can’t deduct the other 50%. There are many benefits. I would not ever recommend anything to you or any of your clients or any brokers that come to me and help me if I don’t do it. As you introduced me, I am the Founder and the Senior Adviser to The Center for Financial, Legal & Tax Planning. Inc. in the United States. If I practice what I preach, the corporation is what kind of corporation?
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You are going to be a C corp man.
I have been a C corporation since 1978. I was interviewed by a movie producer for a movie. I’m not going into the details. By the time we ended, he said, “Are you telling me I’m not operating my business right?” I said, “You may not be.” I wonder how I get clients.
You look on the internet and you get advice and you even talk to your own accountant. You’ll always get the same thing, “That’s double taxation. You don’t want to be a C corp. You want to be an S corp or you want to be an LLC.” It’s like a mantra that’s out there that is not founded in reality.
If you’ve got a private company and your aunts, uncles, cousins and nephews own stock in your company and they have nothing to do with your company, and they want money and you give them a dividend, let them pay taxes. You’re operating as a public company. That’s not true. I can show you how you can get two tax deductions also with a C corporation. Let me use myself as an example. If you are a C corporation in your business and you own equipment. Your business has heavy equipment. Let’s say you’re a contracting firm. You’ve got trucks, backhoes or whatever the case may be. You got to even have a building. All that equipment should be in an LLC, a limited liability company, that should be a partnership or a Subchapter S corporation, not a C corporation. Here’s why. The operating company is a C corporation. The operating company needs to use the trucks and the equipment in the real estate, so it rents it from the LLC. Therefore, the C corporation gets a tax deduction for the rental expense.
In addition, item number two, money is taken out of the C corporation and put into the LLC, Subchapter S company, let’s say. No taxes are paid for transferring the money because the money being transferred is payment for the ability of the C corporation to take a tax deduction for its rental expense, renting the building or equipment. Item number three, the LLC must now report the cash they received as income, but the LLC owns the trucks and owns the real estate. Therefore, they get a second deduction because they can now take depreciation on all that stuff against the income and not pay taxes. There are two tax deeds. You can’t do that with a Sub S or a partnership. You can only do it with a C corporation if the equipment in real estate is owned by an LLC.
I’ve done a lot of deals with equipment-heavy businesses and I don’t know that I’ve ever seen somebody arrange it like that. Why haven’t more people done that?
Like my wife says, “If people know what to do, they wouldn’t need me.” I practice what I preach. It’s just some key things.
It does create more accounting complications. You’re now having multiple entities rather than one. I would presume that if you were taking 179 deductions on brand new purchase stuff, you’re still able to take that in that scenario.
If all this stuff is owned by the C corporation, you get one deduction, but you can’t transfer money out because of that deduction either. I’m showing you how you get an income tax deduction in the C corporation. You get an income tax deduction in the LLC for the same piece of equipment and you’re taking money out of the C corporation free of taxes. Just to let you know something, and we might be able to conclude on this point. It’s important to understand that not only am I a subcontractor with the IRS, but my son and I teach classes for the Internal Revenue Service for tax return preparers throughout the entire United States.
We wrote an examination that everyone was taking. In other words, if you want to file taxes in the United States and you want to be registered with the Internal Revenue Service, it’s a volunteer program. There’s no requirement that every tax return preparer for money has to be registered. Congress won’t require that. There are over 146,000 people all over the country. To be registered, you have to take eighteen hours of continuing education every year because the Tax Law changes and you have to pass an examination.
For example, during 2021, you have to take eighteen hours of continuing education, pass an examination in 2021, and then in 2022, you’re registered with the IRS to file tax returns for 2021. Roman and I teach those eighteen hours and we write an exam for the IRS. We’ve got to know the tax laws. As a result, we have been approved and the IRS audits our programs. They even audit me. I’ve got to be honest with you, the last two times I was audited, I was audited by former students of mine who worked for the IRS. Can you imagine?
Eliminate Taxes: Succession plans are a team effort, which can be done with family members, employees, investors, and even competitors.
I’m very careful. I will never tell you something that’s unethical or illegal. I’ve got too many licenses to lose and too much of a reputation in the United States, so I’m very careful about what to take. I’m telling you three things. Let’s review quickly. One, when a person wants to sell the company and someone values that company and tells them, “This is what you want. This is what you can get.” That’s step one. Step two is you got to do a tax minimization analysis to find out what you are going to keep after taxes. Step three, what are you going to do with the money? How are you going to invest in it? Do you want to turn around and invest in an annuity yourself or is there someone else, so we can save some taxes by doing it?
Installment sales are good. You’ve got to jump through hoops. Number four, are you set up properly to help you operate your business in the next few years if you don’t sell it right away? Number five, what are you going to do? Do you have a succession plan in your own structure or in your own family? Brokers can help so much in all of these areas, but these are five key areas that deal with that. As we talked about here, these are the basics. I refer to them as basics.
Before we let you go, I do want to let you talk about succession plans. People hear a succession plan and their eyes glaze over and they think, “How am I going to take time to do this? What does that look like?” All this kind of thing. They’re running day-to-day businesses and they’re putting out fires. They can’t sit down and write a succession plan. That’s going to be some 50-page god-awful thing.
It’s not that bad. Some of the largest corporations in the world have to spend time. I’ll give you two examples. You’re located in California. Toyota Corporation in the United States used to be headquartered in California. They’re now headquartered in Texas because Texas has no state income tax. That’s another matter. Stop and think of the dealers in Toyota Corporation around the United States. If they don’t have succession plans, a dealer dies. Who takes over the dealership? What is the succession plan? I work with Toyota Corporation. I said, “You got attorneys.” “Bart, they put up brushfires. They’re handling legal suits. They’re litigators.” We worked with 3M Corporation.” The same thing, they’ve got distributors all over the company. Purell Corporation, distributors all over the country. Insurance companies like American General Life Insurance Company. They’ve got insurance agents all over the country. If those agents or those distributors die and they don’t have a proper succession plan, these manufacturing firms and these large insurance companies lose market share. It is critical that every private company has it now.
What is the succession plan? It is called an executory contract, a contract that goes in-effect in the future. If I die, when I become 65 and I want to retire, not just want to retire, but it’s got to be a specific time or date in the future that occurs, a contingency plan. If I’m not able to run the company. There are three things. Do you have someone that you can prime to take over the situation or take over the business? It’s got to be in writing? Do you have other stockholders, buy-sell agreement? Do you have a friendly competitor that you work with that you could be a potential takeover for his company and he could be a potential takeover of your company? Is there a merger that the business broker should get involved in so that they can help someone? That’s a succession plan, a merger.
I’ll give you one quick example. There are so many I’ve gone through. John Deere Corporation in the State of Washington had individual dealers all over the state. Why? Years ago, they were farmers and they needed equipment. They started buying equipment and they were able to sell it to other farmers and they became a distributor. They hired me to consolidate a whole bunch of dealers. By consolidating them, we wrote up a nice couple of documents. We had to value each operation and write up a couple of documents so that each person who is running a dealership now is part of a large organization. They could sell their stock back to the dealership over a three-year time period and eventually, phase out and retire. It’s a fantastic succession plan.
Succession plans can be done with family members, employees, competitors or investors. It doesn’t have to be something that’s implemented now. It’s implemented in the future. It consists of valuing the business and setting up a format. It consists of watching how the stock is going to be transferred. It’s a team effort. It’s not done by one person. It’s done by working together with the owner and the owner’s family. I’m going up to see a dealer and I’m going to work with him and his wife and his family. He’s got four children and he’s getting ready to retire. We’re going to sit down across the table probably for 2 to 3 hours. We’re going to talk about what he plans to do when he retires and how he plans that. Does he have a team in place to take over the operation of the company? Does he need to sell it? What does he need to do to prepare it for sale? Does his spouse have a steady stream of income that may not be dependent on him?
I’ve done my own succession plan. Succession plans should be reviewed every three years and succession plans are also part of an estate plan. My wife and I have our own operation. We have set up our own succession plan. I recommend in this particular gentleman’s case once we finish everything that we sit down with his family. His children who are adults now understand that if something happens to dad or something happens to mom, what’s going to happen? If mom and dad want to retire, here’s what they’re going to do. They might travel. My wife has a philosophy that we should travel to California and Italy for two months. God bless her.
I say the same thing and it never happens.
My wife did go to Florence for an entire month with a friend of hers and went to school. It’s one of the best things. Don’t get me wrong. I was home working. She said next time, I’m going with her. I said, “I’ll take the time and come.” Be aware. Succession plan also deals with retirement programming and setting up funding for that. The brokers can find a fantastic operation there. That’s not done on a percentage basis. That’s done on a flat fee basis. It can generate substantial income to brokers that work let’s say with my firm or any other firm that it gets involved in. We do valuations and we’re authorized by the Labor Department, which is very important.
We do valuations with private companies. We do mergers and acquisitions. We work with brokers side by side. We’ve got some brokers that will call us on different items just for a second opinion and we provide that. We have a staff that works with setting it up. I’ve got a complete book with eighteen pages, and I’m not selling it, so don’t mislead me. It’s a series of questions that I’ve asked over the years when my staff says, “Dr. Basi, we got to put this in writing.” One of my attorneys has said, “If I can keep working for ten years, they can retire.” It’s a situation like that.
I talked to a gentleman who’s retired. He worked with the Federal Government. He says, “Bart, you don’t have to retire.” I said, “I retired twice, but I like what I’m doing.” He said, “Yours is more intelligence, brain-wise. Mine was physical work. I can’t lift 40 or 50 pounds anymore.” Depending upon the type of business, depending upon the type of involvement, every broker in the United States can assist in developing a succession estate plan that a business can continue. If you do it right, you’ve got a continuing client because every 3 to 5 years, typically businesses are resold.
This has been so great. I don’t see any reason why all the S corp and LLC and partnership ownership out there don’t go and become C corp. Is there any reason not to become a C corp?
There’s some reason. If a person’s making under $100,000 in profit and they need it to live on, then just stay as a Sub-S Corporation. It’s not worth transferring. Another thing is when people start up a business, a lot of times, there are losses because it’s the beginning business. The law says, “You can start up as a Subchapter S corporation, and then as you grow, you can convert to a C corporation.” Some small businesses do start a startup as Sub-S or partnerships. Remember what I said, if there’s equipment in real estate, that should not be in a C corporation. C corporation should be reserved for operating entities.
Those are investment vehicles that we do use partnerships and we use Subchapter S. My family has a lot of real estate in the United States. We have a partnership. It’s not mine. It’s been transferred to my wife, children, and grandchildren. Everyone participates in that, which is a good long-term passive investment. There’s one other subject we haven’t talked about and we’ll leave it for another blog or something, and that’s the use of a trust. It’s important both in transferring a business, buying a business, selling a business, preparing it for sale, and also succession planning and estate planning.
That is a different subject. You could spend an entire show just on that. They are important instruments. They are not recorded instruments, so they’re private documents. You’ve covered so much ground in however much time we’ve done this. Bart, I appreciate this.
Eliminate Taxes: If a person’s making under $100,000 in profit and needs it to live on, they should stay as an S corporation and don’t transfer to C Corporation.
I hope I’ve been of some help, not just to you but to all of your readers. If I can conclude by saying they can go to our website, www.TaxPlanning.com. It’s not just about our company, but we have blogs on there and we have articles we’ve written. They’re all free. You and your members can go there and take a look at them, read them, and download them if you want if they can help you. Our job is to help private companies in the United States be successful and be able to pass on to the next generation, which my father was unable to do.
It’s so important. You found your niche in life. You have done a great job. I was going to conclude by saying TaxPlanning.com is Bart’s site, as well as we want to drop your email address. It’s B-Basi@TaxPlanning.com in case anybody wants to reach out. Bart, I can’t thank you enough. We could do twenty of these and people would be learning a lot.
Keep in mind, let your people know that tax laws are changing, so they’ve got to stay current. They can’t use this three years from now. Possibly maybe not even six months from now. I wish you the best of luck. Thank you for taking your time to work with me to be able to assist not only you but all your readers. Good luck.
Thank you, Bart. Take care.
About Dr. Bart Basi
Dr. Bart Basi is quite amazing. He’s been a national speaker at dozens of conferences and events over the years, simply because he’s so good at it. He is both a CPA and a tax attorney.
He has a bachelor’s and MBA from Syracuse University…. took his law degree from the University of Louisville… then a Doctorate in Economics and Accounting from Indiana University… and topped that off with post-graduate work at Stanford.
He’s the author of five books. Won many awards over the years. He writes “The Tax Report”, a publication about tax and estate issues.
When buyers make the wrong move or ask the wrong questions, they end up missing out on great opportunities. What are the biggest mistakes buyers make during acquisitions and how can you keep yourself from committing them? Peter Siegel witnessed firsthand every common trap that business buyers fall into – twenty times over. Peter is the founder of Bizben, a dedicated online portal where small businesses are sold and bought. In this conversation with Brian Loring, Peter explains how you should settle your financial qualifications and study the deal structure when browsing through your potential buy listings. If you want to have a better, more secure experience of business ownership, tune in!
Listen to the podcast here:
The Biggest Mistakes Buyers Make In Business Acquisitions With Peter Siegel
Don’t Commit These Errors When Searching For Deals
We talk about getting deals done for folks looking to buy and sell outstanding businesses. A lot of people lump business brokers into the same bin as real estate agents after all, we both provide a service where we get paid with a commission check once a deal gets done. The reality is that these are very different practices. It’s apples and oranges in comparison. It’s so different that in fact, many residential and commercial real estate brokerage firms, including a couple where I used to work, they expressly forbid their agents from doing business transactions, even though the broker’s license used in real estate and business brokerage is the same.
One of the biggest differences I have found over the years is how buyers are treated in the marketplace. Often, we get calls from folks who want to leave their day jobs behind, buy their own business, may be out of work or looking to buy a new future, even strategic buyers who are wanting to strap on another business to their existing company. All these buyers generally have one thing in common. They are pretty much on their own in their search. For the most part, we business brokers only work with buyers when we get a listing and we go hunting for those buyers out there once we get that listing. We don’t represent buyers. A real estate agent works with someone where they show one property after another. Few business brokers are in that relationship. What I’ve found is enormous amounts of frustration out there. Many buyers feel like they flail around month after month without getting anywhere. A lot of them give up after a while.
Our guest has seen this frustration firsthand for many years, very close up, and we’re going to spend some time on how to make progress while you’re on the hunt and not get too frustrated. Peter Siegel is an MBA and Founder of BizBen. If you’re not familiar, BizBen is an online business community that provides a lot of different services in business sales, it’s been a fixture here in California since 1994. First and foremost, it’s a platform where sellers and their brokers can list businesses for sale and buyers can ask to see the businesses that they’d like to buy. For those who have used it for years, BizBen is an amazing resource. The site is packed with all great information articles, blog posts, webinars, podcasts.
Peter heads up BizBen’s ProBuy and ProSell Programs. These are programs for people who are seriously pursuing a deal and want to find something. He also has a financing arm that helps buyers get a deal done through a variety of loan programs. Also, Peter has some very big news to share with us about the future of BizBen, which for years has been focused solely on California businesses. Peter talks about the mistakes he sees buyers making all the time, and he also shares a couple of tips on how to succeed in your search. It’s a great episode and I hope you enjoy it.
Peter, thanks for joining us. I appreciate it. I know that you have a lot going on with BizBen and some amazing stuff that’s going to be coming shortly to BizBen. I appreciate you coming on. Thank you.
Thanks, Brian, for having me. I appreciate you having me on the show.
You and I have talked numerous times about this particular subject and why it’s near and dear to our hearts. It is a very hot topic among the business brokerage community and how buyers go about securing deals, finding deals, figuring out the information, dealing with brokers, and dealing with owners. It’s a very difficult process. I find it annoying from the standpoint of we brokers treat the buyer in the process as chattel, as secondary citizens, and it shouldn’t be that way. Do you get people who are frustrated and come to you and say, “How do I do this better, because I’m not doing it very well?” Do you feel that sense out there?
Mistakes Buyers Make: When people don’t feel secure in a process, they get amped up or go negative.
All the time and I feel your frustration as well, too. At BizBen, I talk to a lot of buyers every day and there was this dynamic shift in our industry. When I say industry, the business brokerage industry, whereas years ago, I remember business brokers, including myself, I was a business broker at one time many years ago, but we would invite buyers into our office for a sit-down. You didn’t get information about a listing unless you came into the office or a phone call and spent about fifteen minutes with us. Ten minutes of it were an educational process and talked about the protocol and everything. In retrospect, that was helpful to buyers, that was one. The second one was the actual representation of buyers as well too. In those days, a lot more brokers cooperated with each other. I’m sure we’ll talk about it in this show, but that’s another problem too and a lot of buyers don’t understand that process.
Do you find that a lot of buyers struggle with the very first process of search? Your BizBen site is a fantastic resource and a fantastic tool. Do you get the sense that people begin the search on the wrong foot or are doing it wrong in how they search for something?
They do. I always tell buyers in our ProBuy Program on BizBen, “You’ve got to look at this as a methodical process, and it’s like finding a job.” For example, when you go to find a job, if you’re an engineer, you don’t look in the line cook section online. You focus and direct your search and you find what types of categories or businesses that are interesting to you. To narrow it down, if you need financing, getting pre-qualified for financing, make sure that you meet the requirements. Buyers have an extremely difficult time, especially at the very beginning of trying to find a business, but tools like BizBen can help you narrow that. When you’re searching, it’s best if you can search by category or by type of business as well as a full-on search.
Lack In Financial Qualifications
I wanted to get a little bit into some advice about how buyers can be fully prepared. What I find is that there are so many people out there who haven’t taken the first 2 or 3 steps to come off as being prepared because they haven’t taken those steps. Getting pre-qualified with either an SBA or a local bank is a big first step. Can you talk a little bit about how we as professionals and brokers determine whether somebody is earnest and prepared to buy rather than somebody who’s talking the talk?
First of all, let me give you statistics because BizBen reaches out and talks to a lot of buyers every day, but also does a lot of surveys. In our estimate, 80% of all buyers who say, “I’m thinking about buying a business,” never ended up doing so. That’s a huge number. My feeling is when they go to buy a business, number one, they should be pre-qualified for financing if they want to leverage their money and buy a bigger business. That not only means SBA financing. It could be a commercial, bridge, and there’s a lot of financial tools the buyers can use to leverage their money.
The other thing that they may want to do is have a personal financial statement ready because they’ll always want to have that going back with a nondisclosure agreement back to the broker or the owner that’s involved. That shows a level of professionalism on the buyer’s aspect. They will want to have what I call a buyer’s resume. It’s a lot like a resume, but it lists what type of business you’re looking for, geographically, where you’re looking for work experience that may relate to the industry, or the categories that you’re looking for, all of those factors. What that does is that tells the business broker, “This person is serious.” Surprisingly, Brian, only 10% of business buyers take those steps.
I noticed that I will talk to some buyers and they call up and they give broad criteria and try to drill down and get more specific about what they’re looking for. Start with what price range you’re looking for in a business and when you hear somebody says, “Whatever. It can be between $200,000 and $5 million.” It’s like, “No, give me some specifics. You need to be targeted.” I feel like a lot of buyers haven’t envisioned what this is going to look like if they did find something that would hit their mark.
Mistakes Buyers Make: Aggressiveness never pays off.
When I was a business broker, I usually didn’t work with buyers who said that. That was a delineating point for me. When a buyer said to me, “It doesn’t make any difference. I can buy anything. Don’t you worry about it?” When a buyer told me that, I knew they didn’t know what they were doing. I would be polite, but I wouldn’t work with them. Business brokers now tell me it’s the same way. If buyers are belligerent or if they think they can do something and they demonstrate they can’t, that’s it. It’s the end of the line. They’re not going to get deal flow.
One of the things I must admit that I’m guilty of as a broker who takes listings and represents sellers is that instantly I will want to find out about a buyer’s past, what industries they have been working in, and whether that industry correlates to the listing that I’m holding. I have been guilty of discounting somebody or eliminating somebody who has been in a completely different industry. Yet, there are qualified buyers out there who do buy in something that they haven’t done before. Do you find that’s unusual or uncommon? What are your thoughts on going out of an industry when you’re doing your search?
Two angles on that. I find lots of times buyers who think they know what they want to buy, and they target certain things, usually end up buying something completely different. I can give you numerous examples of that, but all the time they usually end up saying, “I want to buy a liquor store.” They start looking at liquor stores and the financials aren’t that tight and the tax returns aren’t reliable. They spin and buy a feed store or something retail-related but a little bit more on line for, “I have some competence in the tax returns and the financials.” There’s that aspect.
The other aspect is the financing portion because, especially SBA 700 financing, work experience is huge. There are about fifteen different parameters that SBA loans have with buyers, and work experience is important. You got to have some related experience to the business you’re buying. Do I agree with that typically? No, because most of the time, if you’re coming out of Corporate America or working in a job, you have a skillset that could easily run that business, but bankers being bankers, they’re going to look at those things.
Not Looking At The Deal Structure
Do you find that people know how much they can afford?
They don’t. That’s the other thing that we do when we pre-qualify buyers is you need to take them through that process of what they can afford and why they can afford it. There are two factors I feel that you need to look at. You need to not only look at the price of a business but also the deal structure because there are so many ways you can structure a deal. I typically tell people for financing on a good deal with provable income tax returns, etc., you go to the right person, the right lender, you can put down anywhere from 10% to 25%. You can leverage your money. You can work backwards and see how much you’re going to need for a down payment.
[bctt tweet=”Be polite even if you disagree. ” username=””]
Ignoring The Protocols
I wish I had a dollar for every time somebody called our office and saying that, “Here’s the business I want. Here’s the location I want. Here’s how much I can spend. Can you go find it for me?” They expect business brokers to operate like a real estate agent and show them houses. It takes a little while for people to understand it’s never going to work that way. However, there are cases, like my case in particular with ManageVisors because we are a specialty brokerage and we narrowly focus on a couple of different industries. We do approach that level of specificity when it comes to working with a buyer. There’s so much frustration when it comes to the time and amount of energy that’s required in looking at the financials and getting in front of somebody. Talk a little bit about the energy and the amount of time and effort it takes to get a deal done. It isn’t small, is it?
It’s not small and it’s a process because there are protocols in place. I go over that with buyers as well. Protocols are important.
What do you mean by protocols?
The stages of buying a business, everything about identifying, searching, where to look for a business, how to even deal with brokers and agents. For example, most buyers don’t even realize 70% of all business brokers don’t cooperate with each other. That’s not like residential real estate and commercial real estate. What most buyers do is they go reach out to one broker and say, “Will you work with me?” The brokers say, “Sure, I’ll work with you.” They’re not going to have access to over 70% of all deals.
I didn’t know it was that high. I’m a big believer in cooperation because the biggest obstacle we have as brokers is deals that don’t sell. We all have had deals that we thought should sell and don’t sell. The idea of not cooperating, it’s shooting yourself in the foot and you’d rather have 50% of something than 100% of nothing.
Not only is it unprofessional, professional to me is if their seller client knew that they weren’t cooperating and the ramifications of that, it’s horrible. I’m with you. Our association of business brokers should take that up and have some mediation process or something but have the system in place where brokers felt more comfortable about cooperating with each other. That only makes a more efficient marketplace.
Failure To Make Proper Analysis
California is about the worst state there for this particular subject. Florida and Texas and a few other places are much better at it than here in California. That’s a separate subject. In terms of how a buyer goes about finding a deal that is worth their time and effort, I’ve always given one tip and I don’t know what you think about this. I always instruct people to disregard the price at the very beginning. Don’t worry about the price. Look at the deal, location, business. Look at all the factors that go into it other than the price, because the reality is every buyer will tell you that it seems like everything is overpriced and that on its own can lead to a bunch of frustrated candidates.
Mistakes Buyers Make: Don’t just worry about the price. Look at all of the other factors that go into a deal.
I tell buyers the same thing. I say, “Here’s a couple of things. Number one, do your analysis. Do what we call level one of due diligence, and then make an offer and have a reason for that offer. No matter what the price is, have a reason for it and let them know the reason why I’m making this offer of XYZ is because of ABC.” I tell buyers, “You wear the pants in the transaction.” Realize what’s fair and then offer it. If they don’t accept it, then walk away. It’s easy.
Make a fair offer based on information that you think you can trust and see where you’re at, at that point. A lot of buyers are not aware of it because so many buyers come to it from a real estate ethos and most people have bought a house or commercial property or whatever. A lot of people do not understand that some businesses come down a huge amount in price because of circumstance. Years ago, I put on the market a business that was listed for $1.2 million and the business wind up having to take $300,000 as sale price. They took it and you don’t find that price drop in real estate. It doesn’t happen. That leads me back to the same point. That is, don’t fixate on price. I see so many buyers looking at the multiples and say, “That’s 4.2 times earnings or something, and I’m not going to go for that.” Eliminate that from your thinking and get to a point where you understand what the deal is about.
Brian, I have an interesting story about that. Before I was a business broker and started BizBen many years ago, I owned several businesses. One of the businesses I owned was fairly large and a business broker was helping me. He said, “The way these works is if somebody makes you an offer, listen to it.” Somebody came in and they made me an offer and it was lower, but they had a great reason why they were offering me what they were. Being the business owner, I was like most business owners. They usually overprice, thinking that they’re going to come down in price. It was helpful. I was stunned. I was like, “This makes sense.” I took him up on his offer because it made sense, but also the deal structure he put in place too made sense for me where I was at in my life. I’ve had numerous buyers call me back after I’ve given this advice and saying, “That worked,” because what I find is most buyers are gun shy. They will not make an offer on a deal. They get this paralysis and I tell them, “Don’t do it. Find out what you feel is a fair price and go for it. You’ll be surprised.”
Do you think that’s because of fear that they don’t trust what’s being told to them, or they don’t trust the numbers?
The psychology on this, it’s two reasons. Number one, they’re not sure because they may not have professional guidance, but number two is they don’t want to insult the seller.
Not Staying On Top Of Communications
I get that all the time. People saying, “I’d like to make an offer, but I don’t want to be insulting because the business that you’re asking $2 million for, I don’t even think is worth $1 million or something.” That is the case. That does happen. There is a certain amount of give and take that you have to work past and make a fair offer, get it out there. Why do you think the failure rate is so high among business sellers? Is it about overpricing or are they not treating buyers properly? You see the same stats I do. People estimate that 70% to 80% of the listings out there don’t ultimately sell for the seller. Do you think part of it has to do with how buyers get treated or how buyers approach it? Why do you think the failure is so high?
There so many factors to contribute to this, but the first is pricing and deal structure. It doesn’t make sense. Also, control over the process. The deal and communications are very important. Unfortunately, if an owner hires a broker or an agent that isn’t on top of it, or they have too many listings or they don’t get back to people, that breaks it down because these buyers are looking at multiple deals. If a broker doesn’t get back to somebody in time, they’re going to move on. There’s a myriad of reasons why deals don’t go through. The longer a deal goes on, the higher chance it’s going to fall out.
That leads me to one of my questions and that is, I do sense that a lot of buyers want to sit and let the listing sit there for 6, 9 or 12 months. Do you think that’s a good strategy to wait around and let something sit there for a while in the hopes that you make an offer and in a year from now or something?
I’ve never thought of that, but I typically think that if a listing sits there for 6, 12 months, it’s not a very good listing because with the exposure that you get on platforms like BizBen, if it doesn’t sell in 6 to 12 months, something is inherently wrong. Sometimes buyers tell me, “It’s been sitting there for 2 months, 3 months. It must not be very good.” That’s not the case because lots of times, when a listing comes on the market, it’ll go into escrow quickly, but the due diligence process and the closing process will be 45 days and 50% of all deals fall out for one reason or another. That typically happens.
There’s a big difference between the three-month mark and the twelve-month mark. I wanted to get back to a couple of common mistakes that you and I wanted to talk about that we see. Another one that I come across a lot, not only about being fixated on overpricing, but also is about the idea of a buyer’s going into the process with a wrong attitude or a chip on their shoulder. They feel like they have to exert power and be dominant in any negotiation or discussion process. They’ll get on a phone call initially with a broker or even with an owner and be argumentative about the price or disputing facts and figures. I always have to tell people, “A business deal is a win-win scenario. You have to go into it in a cooperative mindset.” Have you found the same thing I have that some buyers go in with a negative or antagonistic approach that doesn’t work?
I do. It’s not a good strategy. In lots of those cases, they don’t feel very secure in the process. Lots of times, when people don’t feel secure in a process, they get amped up or go negative because they don’t feel secure. Like what I was alluding to when the buyer would come to me and say, “Don’t worry about this. Don’t worry about that. I can do that. I’ve done this.” That’s the worst thing you want to do. It’s a two-way street. You’ve got to let things work their way out. If it doesn’t, it doesn’t, but don’t be aggressive. It doesn’t pay off.
In your shoes, somebody who is the head of BizBen, one of the most amazing resources out there, you see things that I don’t. Are there other common mistakes that you see that buyers are making that they should be aware of in the whole process?
They’re not prepared. They have very unrealistic expectations about the size of the business that they can buy. They think SBA financing is easy. What they don’t realize is with SBA financing, they want to leverage their money, is all lenders are different. They have different portfolios and underwriting criteria. There are so many factors. They think that the SBA is all the same. It’s not. Between that to contacting 1 or 2 brokers and let them do the search instead of doing the outreach and then spending enough time on the search. This is a lot like finding a job. You got to spend time looking because if things come on the market, if it’s a good deal, you’re competing with a lot of other buyers. It’s going to go and contract in an escrow quickly if it’s an approvable good deal.
You’ve seen 2020. How has COVID impacted BizBen and the marketplace in terms of how buyers approach this? Has there been a dramatic change at all?
I don’t think it’s been dramatic, but there’s been a drop, I would say 30% overall. As far as certain industries have gotten hit harder than others.
[bctt tweet=”The idea of not cooperating is like shooting yourself in the foot.” username=””]
What is 30%?
Reduction in overall deal flow. On BizBen, we keep stats of California sales, small business sales, and were watching the number of sales go down and it’s about a 30% to 40% drop in the California marketplace.
Is that a 30%, 40% drop in the number of listings that you post?
A number of listings had been sold. There has been a drop. Also, it’s correlated to different industries as well. Restaurants have been decimated, retail sector, etc. A lot of service businesses have ramped up a little bit. We’ve seen a lot of cleaning companies in high demand, a lot of real estate staging companies that are high in demand. You see some drops in certain industries, but pick up in others.
Is there a way to know what industries are doing better than others? It’s mostly anecdotal. Everybody knows that restaurants are struggling and other recurring revenue businesses and a lot of them are doing well. Is there any research to be able to identify that for a buyer out there? I don’t know exactly how you would approach that if you wanted to do that.
I think doing a Google search and then also talking to some knowledgeable business brokers like yourself, they usually have a good fix of what’s selling, what’s not selling, what’s hot, and why. You can’t help but pick up a general article about COVID and then they talk about various sectors about what’s getting hit hard and what’s not.
Let’s talk a little bit about BizBen itself. You have some great things coming up and I don’t want to steal your thunder. Why don’t you tell a little bit about what’s going on your end?
We’ve been reflecting a lot during this downtime in COVID and a lot of people over the years. We’ve been online many years and a lot of people have told us, “We love your platform, but it’s California. Can you expand nationwide?” We had a lot of business brokers and agents ask us to do so over the years. While we were down, I was doing some repairs and some maintenance on the site, and I gave it a long look of, “Why not do this.” There’s a lot of features I’ve always wanted to put on BizBen. We incorporated a lot of new features, a lot of online tools, and then also the ability to search nationwide.
The other thing that we have on BizBen too that I’m proud of and excited about for the future is business wanted to buy postings. That’s a huge factor. The internet in the future is going to go more on the demand side versus the supply side. It makes so much sense where buyers can post what they’re looking for and they can get really detailed after they talk to a broker like yourself or broker can even post and say, “I have a buyer who’s looking for liquor stores in this price range and close to this particular geographic area.” It would make our marketplace so much more efficient. That’s what’s missing. That’s going to be a huge component on BizBen. We have something called the TruMatch, which will match buyers and sellers right online.
What’s that about? Talk a little about that.
Sellers who go online, when they post something, they can see buyers who’ve posted wanted postings and vice versa. You can make matches a lot quicker. The whole purpose of BizBen is to make the market efficiency a lot better for buying and selling small businesses. With this process and this tool, we feel that we’re going to be able to do so. It can take anywhere from 3 months to 12 months to sell a business. Our whole goal with the new platform is to get the process down into 3 to 4 months from start to finish.
Let’s keep going on TruMatch. I’m looking for a landscaping company in San Diego County. I put that in as a wanted and then what happens after that?
What happens if there are any postings on the flip side, on the for sale side, it automatically matches. When you go to your listing, you say, “See buyers for my listing,” it will give you the TruMatch link, and it brings up all the potential sellers on that side. It does the complete opposite. We’re doing a beta test on this. I knew it would be successful. We did this beta test and I was telling a broker about this in San Diego and he goes, “I’d like to check this out. I have a buyer who’s doing a roll-up or looking for other businesses in his industry.” It happened to be a garage door business. I love those businesses because they’re usually successful, consistent cashflow, etc.
He said, “He’s looking for up in Northern California. I’m in San Diego. I don’t have the outreach to that marketplace.” I said, “Let’s do an experiment. Let’s put on a wanted posting on BizBen and let’s let it roll.” Two weeks later, an owner got on BizBen from Marin County, which is Northern California, saw this wanted posting. He contacted the broker and a deal was made within three weeks. The broker made a $70,000 commission. I tell buyers and sellers, “It works if you use the tools, it works.”
In the beginning, we brokers tend to pooh-pooh the buyers. We tend to treat them as second-class citizens sometimes, and it should not be that way, should it?
Absolutely not. A trend that I see coming up is a lot of brokers who are representing buyers. It’s like going old school. They’ll charge a fee to the buyer, but they’ll be a buyer’s representative. They’ll act on behalf of a buyer in their best interest and do the searches, but also get a success fee if they find something.
It’s usually a success fee-based. It’s not like a monthly fee-based thing.
People are experimenting with this right now because it’s a newer concept, a lot of them are doing a combination of both. Sometimes it’s a success fee. It depends too if on the sales side if the broker is cooperating or not.
We do it on a success fee basis. I have found after doing this for years, that is very difficult to get buyers to commit to any ongoing or regular monthly type of fee for a buy-side engagement or search because they don’t know that you’re going to be able to get anywhere with it. In terms of putting a bow on this, a couple of things that struck me is that you are doing something actively to make life better for buyers. I have to applaud you for that because you mentioned that you think in ten years, our industry is going to be significantly different when it comes to buyers.
I think the marketplace will become a lot more efficient. Brokers and agents will become more facilitators in our industry, assisting both sides and making sure that transaction gets done instead of a one-off mentality. I have high hopes for the future in our industry.
The reality is that buyers have the potential to be multiple customers a lot better than sellers do. We tend to forget that.
Another thing too is I’ve had buyers for over 15 or 25 years. What I find is it’s a transgression where the buyer will end up buying a smaller business, say for $200,000, an entry-level business, they’ll sell it in 3 or 4 years because they get bored or what have you. They leverage up and buy a bigger business. I have a lot of clients now who have million-dollar businesses who started buying businesses on BizBen 15, 20 years ago. You’re absolutely right. This happens or they buy multiple businesses.
[bctt tweet=”Always make a fair offer. ” username=””]
What’s the timing on the new and improved BizBen?
We’ll make the switch online to the new and improved BizBen version four. We’ll be making tweaks as we go and everything. I like to listen to more users and see what they would like to see. A lot of the new tools online came from users. We’re rolling it out and it’s going to be great.
Peter, you’ve been great, very helpful. I appreciate it. I hope the buyers out there take heed and maybe you get a little bit farther down the road in their search skills and their ability to get a deal done. I appreciate it. Thank you so much for joining us.
Thanks, Brian. I appreciate your time.
About Peter Siegel
Peter Siegel is an MBA and founder of BizBen, an online business community providing many services to buyers and sellers of Main Street businesses. BizBen has been a fixture here in California since 1994.
First and foremost, it’s a platform where sellers and their brokers can list businesses for sale, and buyers can ask to see the businesses they’d like to buy. BizBen is also an amazing resource. The site is packed with great information in the form on articles, blog posts, webinars and podcasts.
Peter heads up BizBen’s ProBuy and ProSell programs for people who are seriously pursuing a deal. He also has a financing arm that helps buyers get a deal done through a variety of loan programs.
When we think of selling a business, we rarely think of the online landscape. But now that almost everyone is on the Internet and businesses need to adapt to this shift, we can now see that online businesses also need to plan their exit. Gary Nealon, a serial entrepreneur and the founder of Nealon Solutions, did more than just exit; he quadrupled his company’s purchase price while at it. In this episode, he joins host Brian Loring to share how he did it. He takes us across his journey from establishing his e-commerce business to making a couple of acquisitions, highlighting the importance of vision and core values to growing a business and finding the right buyers for it. Don’t miss this conversation to learn how to get the most of your business while also understanding the strategies to acquire your next.
Listen to the podcast here:
How To Quadruple An E-Commerce Business’ Purchase Price With Gary Nealon
Gary, I appreciate you coming on. Thanks for joining us. I loved the discussion you had with John Warrillow at Value Builder. I’d like to go back if we could to the moment when you decided, I guess it was around 2017, when you said, “It’s time to sell my business. It’s time to move on.” Can you talk to us a little bit about how you proceeded from that point in your mind? Did you know that you wanted to hire somebody to sell it? Did you give the thought of trying to go out there and trying to sell it on your own? One of the reasons I ask is because in our property management space, our businesses are all owned by licensed real estate brokers and contractors. A lot of times they say, “Why should I go out and get a broker? I can do this myself.” Did you give any thought? Did that cross your mind to try to sell the business at that time on your own?
No. I knew it wasn’t my skillset. If somebody may be a little more familiar with that process, it might be easier for them to do. I knew that my business was a little more complex than a traditional eCommerce business or like an Amazon business or anything like that, where it would be a pretty easy transaction. I knew I was going to need some support on that and getting everything organized several years of financials. It never crossed my mind to do it myself. It’s more of I want to bring in a professional that I thought could do the process for me or help guide me through that process.
Did you approach other people in your industry before you put it on the market? Did you say, “I know a couple of guys out there who might be interested in this?”
The interesting thing about the industry or that segment of the industry is it was one of the first times I’d ever experienced even competitors not wanting to associate with each other. It was very adversarial versus some other niches or industries where it’s more of information sharing and it’s a friendly environment. I knew that if I had approached anybody ahead of time or even told them that I have this for sale, it probably would have caused some ripples. I avoided doing that before I got a broker involved.
What was that process like then? Did you interview brokers or did you pick one you knew? How did that work?
I didn’t go about the smart way to start. I asked around to a couple of people I knew that had sold businesses before, I asked their experiences. My first go round, I went with the one that I had heard multiple people referenced. In hindsight, I have done more of an interview because it is a lengthy process. It’s something real estate agents or whatever should interview multiple versus picking one that somebody tells you about.
Was there something there that if you had asked a few more questions, you would have found out that maybe would have turned you in a different direction?
It was understanding the process. It was the first time I was selling a business. There are two different ways to go about selling a business, which is what I found out. There’s more of the real estate transaction type where they come in, they give you an estimate of what the business is worth. They set a price and then they left it in the market and say, “Here’s a business that’s worth X.” There’s the mergers and acquisitions approach to it where they take more of a holistic approach. They put together a forecast and position the company a little bit better. They go to the market and say, “What would this be worth if you were interested in buying it?” It’s a different conversation to have.
Was it exhausting and difficult to try to get the business ready in terms of all the financial reporting, the operational information, and all the stuff that needs to go into the process? Talk a little bit about how difficult that was.
As I alluded to, there are two different types of processes. I went through both of them. The first one, they set a price, you sign an LOI and then they start asking you for due diligence, documents and everything. That was almost like a full-time job because I didn’t know what I needed to have prepared ahead of time. They would ask for documents here, documents there. I was constantly chasing things. The second process when I ended up pulling off the market and going back with a mergers and acquisition company, they took about 3 or 4 months to compile everything ahead of time. It was more streamlined. We had a database of all this information. It was less a burden on me and it was more their responsibility to find that information. If they have it already, then they’ll come to me. It’s two completely different processes that I went through. It was interesting to experience both.
[bctt tweet=”Look for people that are not relying on the revenue as their income. They’re thinking strategically and long-term on it.” username=””]
I should say that advisors and your better business brokers, they will operate in more of a manner that you’re describing for the M&A. As business brokers, we should have you prepared emotionally and financially to have everything uploaded already into a data room before we put the business on the market. All the financials that we know that everybody will ask for, a lot of the material that is the preliminary due diligence materials, that should already be uploaded and ready to go for anybody even before you get on the market. You weren’t quite as adequately prepared as you should have been. You didn’t know what you didn’t know at the time, so it’s not your fault. You get to a point where you get on the market. Did you have initially an offer or a couple offers right away? What was the timeframe and what was that process like?
The first time we went to the market when we set up price, we ended up getting a couple initial offers. I was concerned both with price and how they were going to handle the business. If we were going to a private equity firm where they’re trying to merge it in with other companies, they may get rid of the warehouse and the staff. I was looking for a mix of that, of ensuring the employees were going to be okay, getting the right price, and the combination of how much was it in cash, how much was equity. We came up with a couple offers on the first round. The first experience though was I came across a lot of tire kickers. People that would go into due diligence to get some financial information and poke around, but they weren’t as serious as they were once we went with the M&A firm.
When you got the initial offers under LOI, did you pick one of them and go under an exclusive arrangement so that you had to pull it off the market for a while, while they went through due diligence?
Because of the complexity, it was very hard for us to do it without exclusivity. Imagine with a high growth company, it might be a little bit easier to get somebody to do it. For our industry, they wanted at least 60 to 90 days locked down so that nobody else can be going through the process at the same time.
That’s common. You get through their due diligence and then you had a couple of cases where those LOIs didn’t go anywhere, and they backed out after due diligence was completed. Is that what happened?
Some of them backed out during due diligence, some would wait until the last day. It was a very frustrating process at first. It was two different processes I went through, but the first process, they didn’t do a lot of screening on the buyers. I didn’t know what I didn’t know to ask the questions to scrutinize them. On the second go-round, I figured that out. There were some questions that I would ask to ensure that they were vetted properly and everything else before we went into due diligence.
This was an online business. As such, were you able to meet the buyer in person or was this all Zoom calls and phone calls?
A lot of times it was in-person. One of the unique things about the business was that we did have a warehouse. We had 35,000 square-feet outside Philadelphia, which had a showroom. There was a brick-and-mortar component to it. It wasn’t just a true eCommerce. In a lot of cases, before we signed the LOI, we’d have some Zoom call or conference call online. I’d like to at least meet them face-to-face as well to get a feel for who they were. It’s a lot easier to see facial expressions and everything. They needed to get a better feel for people.
Did they try to grind down on the price after they got through due diligence, or did they give up entirely?
It’s two different processes. When we set the price and we went to market with the first go-round, that was a lot of looking for holes and trying to figure out how to beat down the price. When we started working with the mergers and acquisitions firm, the interesting thing was that the buyer was setting the price. When they came to due diligence, they would go through the numbers, the financials and they weren’t looking for holes. They’re looking for reasons to justify why they set that price. It was an interesting dynamic. They were no longer saying like, “This number is off by X number of dollars and we’re going to deduct that.” It was more like, “We can live with that because we see what the forecast is going to be.” It was interesting to see those two different dynamics of buyers and how they operate.
E-Commerce Business: A strategic buyer will more likely pull the trigger than somebody who’s looking at the business to have the cash flow as their income.
The M&A deals live in the investment banking community and a lot of their deals are for companies that are going to sell north of $25 million, $30 million or $40 million. They have a very different approach. They have a very different staff and structure.
One of the things is that they could see the future. They’re looking at when we buy it and we merge it with these companies, we’re going to have exponential growth over here. They’re not just looking at it strictly from the EBITDA of the business itself. They need to make money there. They’re looking at other opportunities that they may have in their portfolio.
How much time separation was there between when you gave up with the business brokerage world and you went with the M&A advisor, was that 6 months or 1 year?
We took it off the market for about six months. That was data collection and then building out a forecast, a five-year model of if we were to implement certain strategies, what would that look like in five years? Using a professional accounting firm and making sure all the numbers made sense, and we weren’t just pulling them out of the air.
That was one of the things I wanted to drill down and hit home on this particular conversation. That five-year forecast that you did, it’s such an important part of trying to get a successful transaction especially for a company like yours was at that point doing $40 million in revenue. That’s the business that you do that with. Talk to us a little bit about how that five-year forecast got put together. Did you get a third-party auditing firm into the mix or did you try to do it internally?
The M&A firm had a team that came in. It was almost like a brainstorming session, picking our brains like, “If you were to keep the business for another five years, what were you planning on implementing?” We would take those ideas, we’d put them on paper and assign realistic values to it. They would backtrack of, “How much revenue would this bring in? How much could we feasibly get in terms of traffic?” They brought in a third-party, an independent accounting firm to say, “Assuming these numbers here now fill in the gaps so that we can go to somebody with realistic numbers. If you were to implement this within these variables, you would estimate this much revenue coming through and this much overhead.” We use a third-party accounting firm for that. The numbers were documented versus us just saying, “If you do this, you could have $40 million more in revenue,” or something like that.
At the end, what was the final product? Did they have a report that was presentable to a potential buyer or what was the end product?
The end product ended up being a report that would show a forecasting model for each year, for five years. It would give a full marketing strategy saying, “These were the plans that we had in place. Here’s what you would need in terms of expenditures to implement them.” It was almost like a roadmap to say, “If you take this now, here’s the exact roadmap that as long as you follow it, you can be at this number within five years.”
That is very commonly done in the M&A world. Were you scaling significantly at the time? Was your year-to-year very different from the previous year or were you mostly flat?
Surprisingly enough for that industry, we were able to maintain anywhere from 15% to 25% growth every year. We were still on an upward trajectory. That was one of my thought processes in the back of my head. When I was going to sell, I wanted to make sure that it was on a growth trajectory so that if I handed it off, I felt good about the fact that somebody would be able to continue to keep that growth instead of plateauing or worst-case scenario dropping. That was one of my motivations. It was like, “We’ve done this now for several years when we’ve had at least, 20%, 25% growth. Now might be the time to pass this on to somebody else that can take it to the next level.”
[bctt tweet=”Just because you think there’s value in the business doesn’t mean that the buyer thinks there is.” username=””]
Now that you have that forecast done, you go out to the market now with an M&A firm behind you. I got to imagine that the asking price was substantially higher.
They are significantly higher. The way our business operated, we couldn’t use a standard platform like a Shopify or Magento or any of these other things that are built for eCommerce. We built a lot of custom technology, everything from our shopping cart solution to how we handled shipping. We made a couple of different apps plugged into our system. While we were doing that brainstorming session, one of the things that came up was they’re like, “You guys have so much technology, you can be a technology company that happens to sell physical products.” That was one of the angles that we took. We repositioned the company to say, “We have all this underlying technology that you can take any physical product and plug it into. You don’t have to go out and build it anymore. It’s scalable. Everything’s manageable internally. There’s no more expense.” The selling feature was the fact that either private equity firm or a small business can come in, buy it and they could scale it by adding new products to it.
One of the things that a forecast like that is valuable for is the line of work that we are in, which is to field inquiries from buyers. What do buyers do? They’re trying to find a deal that’s appropriate for their needs. Pushback on price is the most common thing we deal with. When you have a five-year forecast in your hands like that, where you can show where this company is going to go, that pushback becomes a lot different story and a lot different negotiation, doesn’t it?
It does. You’re giving them a vision of where it could be versus where it is now. At least in my mind, that’s the difference in the conversation. They’re focusing on the future.
I found that with a lot of business owners, the idea of spending time on a forecast is a very difficult prospect. They’re trying to get through the day of life. You can’t see sitting down and spending three months trying to prepare that. At the end of the day, it’s valuable. Let’s talk a little bit about working with some of these buyers. You mentioned when you were with the business broker, you had a lot of tire kickers, a lot of people who wound up being not terribly serious even though they portrayed themselves as being serious. Do you have any tips on how to determine who’s a tire kicker and who’s real? Did you determine anything through that whole process?
The thing I would say is get a full background on what their business acumen is. I tried to avoid direct competitors coming in because I knew that they were looking more for the financials than the bias. With the M&A firm, we ended up doing a reach out to strategic buyers, which was the key. A strategic buyer is going to be more likely to pull the trigger than somebody that’s looking at the business, at least in our case, to have the cashflow as their income. If I look at some of the commonalities, the previous buyers that fell through, they were trying to figure out how they squeeze out every penny to keep that as their income versus scaling it or merging it in with another business, or looking at it from a growth strategy. I’d say that’s the biggest takeaway is looking for people that are not relying on the revenue as their income. They’re thinking strategic and long-term on it.
That’s an interesting point you’re making here because after having done many deals, a lot of times, we business advisors and even owners of businesses, we will tend to want to discount or discredit a buyer who maybe is not in the industry for which this business is being sold. A lot of times, we’ll look at their lack of that industry experience and say, “This guy is not real.” It sounds like from your experience, you had better luck with people who are not necessarily your direct competitors and not necessarily in your exact line of a business. Is that a fair assessment?
Yes. It gives you some context as to why I picked the one that we ended up going with. They didn’t have the highest price. It was a combination of they had the same customer base that we did. They were buying it for the customer interaction and other things that they could sell to their customers whereas some of the other people were not. I also knew that they were going to keep the actual company where it was and protect all the employees. Those were my deciding factors on it even though they weren’t directly in the cabinet business or the kitchen industry as we were.
Did you feel like you made a bunch of mistakes that you wouldn’t make again when it was all said and done?
I always say I don’t live with any regrets. I came out with a number that I was happy with, which is great. I’d say if there was one thing that I would do over in the whole process, there was a bunch of technology that we lumped into it, and I thought that I was creating a much of value by giving it to them. At the end of the day after we closed, they didn’t even want that technology. It was something that I could have kept and done something else with. I got a number that I was happy with, I’m not going to complain. The takeaway that I had from that was that just because I think there’s value in it, it doesn’t mean that the buyer thinks there is. I would’ve kept some of that and leased it if they wanted it versus lumping it all into the business.
E-Commerce Business: If you’re selling, make sure that the business is on a growth trajectory so that somebody would be able to continue to keep that growth instead of plateauing or, worst-case scenario, actually dropping.
Most business advisors are representing the sellers of companies. As management advisors because we’re a specific to one industry, property management and property related businesses, we do work directly with buyers trying to find deals for buyers, which most business brokers and advisors don’t do. I know that you are now doing some counseling and some business advice work, aren’t you?
After I sold the company, I got a lot of inquiries from other eCommerce companies saying, “Can you help us?” Some of the strategies that we use were pretty unique. I’ve been doing business coaching for eCommerce companies for the last few years. The last few months, I got back into the eCommerce space and started buying up companies again.
If you put your buyer hat on, do you have any thoughts about some of the things that you think buyers commonly make mistakes for or commonly don’t do correctly when they’re trying to pursue an acquisition? I’ll give you one if you want a moment to think. One of the things I always tell buyers is in the business sales universe, don’t get overly preoccupied with the asking price. Almost everything out there is going to be overpriced by a good 20%, 30% to 40%. It’s a given in the marketplace. My advice to buyers is don’t get preoccupied with the fact that this is a seller who is asking too much. Chances are hopefully very good that they know they’re asking too much. You know after you’ve looked at some financials and some historicals that they’re asking too much, but get past the price is my advice. Don’t get too hyper-focused on that because this may be a good fit other than for that.
Sometimes people skip over it because they think that some business owner is going to be not reasonable when you bring them a good offer. The reality is the price is just a component of the whole deal. Terms is a big part of it. Personality and fit are a huge part of it. I can’t tell you how many deals I’ve had where the buyer and seller wound up getting to like each other, and where the seller saw that the buyer would be a good fit. Maybe that buyer wasn’t at the highest price. Maybe that buyer wasn’t even at the best terms. Things happen when you get people together.
Two things popped in as you were saying that. One is understanding the seller’s motivation and that plays into the terms and everything that you’re talking about. Do they need the cash right away? Are they looking to retain some equity and grow with you? What is their motivation and that helps with structuring the deal? Some of the companies that we’ve bought, we’ve gotten to the point where those zero cash down. We brought so much to the table that the seller was willing to forgo their upfront cash to be able to have a higher backend component.
The other thing that I’d say that a lot of buyers tend to make the mistake on is they sit back and they wait for deals to come to them instead of proactively looking for them. One thing that we did was we found all the big brokers that were specific to the industry that we were focusing on. We proactively reached out to them and said, “Here’s the type of company we’re looking for. If anything comes across your desk, please keep us in mind.” We were able to get to look at a couple of companies before they hit the market. That’s the big thing that has been helping us is that we’re getting access to potential companies for sale before everybody else gets a chance to look at it.
You said in the last couple of years, you’ve made a couple business acquisitions. Did you do all that groundwork and legwork on your own? Did you find the deals and did all the due diligence yourself or did you hire a broker to help you with that? What did that look like?
It’s a combination. We looked at what was already on the market and went through whoever the broker that was handling it. We also did a scrape on that particular industry. It was very specific. It’s eCommerce and pet brands that were doing anywhere from $200,000 up to $10 million. We looked at the players in the industry that have traditionally sold those types of companies and proactively reached out to them and said, “Here’s who we are, here’s our experience.” They got comfortable with the fact that if they brought us a deal, we had the potential to scale it. We let them know that we were out there versus where a business hits the market, then you have to wait for people to find it online or within your mailing list or whatever.
One of the things that also I applaud you for is realizing how important in the business sale process the whole idea of your technology, your systems, your SOPs. All of that plays a tremendous role in investors and individual buyers coming in and realizing that they can take this and run with it. You understood that at a granular level. I applaud you for that.
In fact, one of the businesses we bought was underperforming, it was losing money. The organization and processes that he had in place, it made sense for us because then we can apply it to every other brand that we were buying. It was more of a strategic buy even though the company was losing money. That’s why it’s also important to not just focus on the EBITDA if there are other opportunities within the company to do something with it.
[bctt tweet=”In the business sales universe, don’t get overly preoccupied with the asking price.” username=””]
You mentioned trying to approach business owners directly or independently, most investors out there find it daunting and an impossible idea to go out, canvas, physically get phone numbers and get email addresses for hundreds upon hundreds of different prospective businesses out there. Is that an impossible task? Could somebody go out and look for property management companies in the Western US and find 5,000 names and start calling? How would you approach something like that?
Ours was a little more strategic. For something like that, you’d have to go geographically. We took the approach of we want to become either an affiliate partner or something along those lines where we have an inroad association with them, so they can get to know us a little bit better before we go down that road. After 1 or 2 months, it would be like, “We’re doing so well with this. Have you ever considered selling?” Just have those genuine open conversations. That’s where people get a little too salesy. They’ll send the generic email out to a bunch of companies to see if they’re interested instead of taking that ground approach, and genuinely starting some relationship with them first before you try to approach them about selling.
We brokers get those constantly. They send a very formulaic emails saying, “Here’s our criteria and here’s what we’re looking for.” It doesn’t prompt a lot of action to be honest. I applaud you. You learned the hard way and you got through it by advancing to a more sophisticated level of company and advisor. It was a bit of a gulp. M&A companies asked for pre-substantial fee upfront and monthly retainers in a way that business brokers don’t usually ask for. Some business brokers don’t ask for any money upfront. I’m sure that was a bit of a gulp to put that money where you wanted to make it work, but it sounded like it was worth it.
It could have been just the experience I had with the first business broker. I know not all of them operate the same way. Through the M&A firm, I had developed a relationship with a guy over the course of 6 or 7 years. I had some trust factor there that I knew if I was going to have to put out that money that you would make sure that I got it back.
We’re not here to try to bash whatever business broker you had hired. I don’t even know who it is. We have all had companies that we were unsuccessful in selling. It happens. Unfortunately, the failure rate in our industry is significant. It does happen.
To their defense, as I look back at it, even though they had sold businesses before for people that I had known, the profile of the businesses they had sold were different than mine, with the brick and mortar and eCommerce. It was a little bit different than just a straight eCommerce sale. Their process works well for simple businesses, whereas mine was a little more complex than I should have understood when I was going into the relationship with them.
What’s challenging you now? Are you actively looking for new businesses in the pet eCommerce space? What are you doing now?
We’re closing on another one. We’re looking on an average of anywhere from 15 to 20 per month. We have a pretty strict criteria in terms of what we’re looking for. We’re not just entertaining every opportunity that’s out there. The most challenging part that I’ve never experienced before was trying to merge multiple companies together. That’s something that’s challenging and something that we’re learning as we go. There are nuances to that like everything else. It makes it a little more difficult when you have different platforms, vendors, all these different things coming together and trying to merge them under one umbrella.
That is a separate conversation right there. When a business buyer comes in and has the seller exit within a couple of months, that is one thing. When you have to spend 1 or 2 years merging systems and integrations, that is a whole different discussion. Gary, I appreciate you taking the time with us. Thank you so much for doing this. It’s a great story. I applaud your success and your entrepreneurial spirit. You’ve been great. I appreciate it.
Thanks for having me on.
Thank you. Take care.
About Gary Nealon
Gary Nealon is a serial entrepreneur and founder of Nealon Solutions, offering strategic marketing help to owners of e-commerce businesses. Among his recent successes was the completed sale of RTA Cabinet Store, an online cabinet wholesaler.
It’s one of the biggest worries business owners have when they attempt to sell their company – what if a buyer wants to steal my sensitive information and use it against me? It’s happened. Today’s guest, Myron Von Raesfeld, executed his privacy strategy perfectly during due diligence with his buyer. He also managed to sell his company for three times annual revenues, which is quite an accomplishment. Myron joins Brian Loring to share some great tips for getting a deal across the finish line without endangering your confidential information.
Listen to the podcast here:
How To Protect Your Client List When Selling Your Business With Myron Von Raesfeld
This PM Owner Made Sure His Info Stayed Private – Til the Deal Was Done
Welcome to the debut episode of the show, where we talk about deals done for folks looking to buy or sell property management companies, as well as landscape maintenance, cleaning companies, property-related businesses in general, excellent recurring revenue companies. We’re truly unique in the US, the only sales business firm dedicated exclusively to selling these types of companies. That’s why we call ourselves The Property Management Business Marketplace. We bring together buyers and sellers who realize that these recurring revenue businesses can be great to own and often very challenging to run and even more difficult to purchase.
We have a terrific episode for you. We have a guest who has some insights into how to structure a deal when it’s time to sell your property management company. Myron Von Raesfeld owned Realsource Property Management in Santa Clara, California for many years. He started RealSource back in 1998. He managed a few properties for himself and his friends. As time passed, the business started to grow. The company managed single-family properties in the South Bay portion of the Bay Area if you’re familiar. It went from Morgan Hill in the south up through the San Jose area into Los Altos and Palo Alto, stopping short of the San Mateo-Santa Clara County line.
Over the years, he brought in his wife, Pam, who handled accounting and management tasks. He also brought in his oldest son, Jason, who works in the maintenance side of the business while also handling advertising, marketing and leasing tasks. The business got to about 110 doors under management when Myron decided to sell. That was in early 2020. One of his strongest selling points was that a vast majority of the units they were managing at that time were concentrated around Santa Clara University. That’s where demand is high, vacancy is low, and the students and the parents who need housing in that area can usually afford full market rents.
Myron wound up getting a terrific deal, close the transaction at nearly three times his annual gross revenue and more than five times earnings, which is pretty stout. Being centered around Santa Clara University was a huge draw for buyers who were mostly nearby competitors who saw a strategic advantage in buying the company. He had interested buyers wanting his business but he also needed to make sure that the deal was structured properly.
Like all management company owners, he was especially concerned about disclosing his relationships. It’s a very important key point when it’s selling a company. He wanted to make sure that the competitors around him wouldn’t take advantage of them by getting hold of his enormously valuable information and possibly using it against him. That’s one of several interesting aspects of his deal that we discussed in this episode. It’s a helpful episode for owners who are curious about how to structure a deal when it’s time. I hope you enjoy my talk with Myron.
Myron, thanks for joining us. I appreciate you being here.
Thank you. Thanks for asking me.
First off, congratulations on getting your company sold. How long has it been since the closing and how long did it take?
We closed on November 1st, 2020.
[bctt tweet=”When you’re selling a company, try to find the guys that have the most to gain by working a deal with you.” via=”no”]
How long did it take to go from beginning to end and the deal time?
It was about 5.5 to 6 months from start to finish.
Anytime you can do it in less than six months, in our world, that’s considered a fast deal.
I could have done it sooner, except I was trying to find and make sure I was getting the guy who was paying the most or wanted to pay me the most values. In a little about two months if I had not done anything else, but it worked out fine.
You’re about weeks into the transition. How has that gone so far? Is the first month been okay?
It’s been good. You have that overlap of tenants still paying rent to the old company while we sent it to the new. You’ll deal with that for about 1 to 3 months. We deal with a lot of younger kids that aren’t necessarily on top of things because they pay. Getting them to change their auto payments and stuff, that’s a little bit of work on that, but it’s all coming together. Our agreement is whatever comes in, we forward it directly over to the new management company. It’s working fine.
I want to take a step back and go back in time to the months previous when you had begun this process, and you were starting to entertain offers. You told us at one point that you had five offers that you were considering. Three of those were in the form of actual LOIs that had been presented to you, and then two of them were verbal expressions of interest. People were hovering. What was the purchase price at that point, the biggest consideration at that time? Did you feel like the other deal points were more important? How did you weigh those?
We have a personal relationship with all of our clients. Finding the right person who could take good care of our clients with their special needs and dealing with student rentals. It is a little bit different than dealing with non-student rentals. Having somebody that had the infrastructure in place to deal with all of those issues, dealing with students was very important to us so that our clients wouldn’t be thrust upon somebody else who now has a year of a learning curve trying to figure out how to deal with all these massive amounts of students, all the issues, and problems that students bring to a management portfolio.
One of the aspects of the deal that I wanted to get into detail was how you structured the deal and specifically a couple of the deal points you made sure that were in your transaction. One of which was how the dissemination of information and the release of information was going to be structured in the deal specifically about how you would release the client information, the client contact information, and the list of properties that you had under management. This is always a bugaboo and a very sensitive point with a lot of the property managers that I talked to in the early process when they’re concerned and anxious about the potential for competitors or for people who don’t have the best of intentions to possibly get their information and use it against them. In your deal, you had structured it in a not creative way, it’s a way that a lot of owners do structure it, but it worked out to your benefit. I was going to have you explain that a little bit.
I truly believe that the real value to a management company is your goodwill and your clients. Without those, you’re just another real estate broker out there trying to do something to make a little money here or there. Especially to me, it was critical because two of the potential buyers that I was dealing with work direct competitors to us. The last thing I wanted to do would be to give my competitors a freebie look and contact information for all of my clients, in which they would then go and say, “We’ll do this and we’ll do it for this much less or whatever.” In which case, it would do two things. It would hurt my company drastically and would hurt the value. In the negotiation process, we did all the P&Ls and the general stuff.
Selling Your Business: Have a personal relationship with all of our clients. Take good care of them and their special needs.
I was confident because everything we gave them was 100% accurate about what my company was doing and how we’ve been performing. I had no concerns that they’re ever going to come back and say, “We didn’t know that this was an expense or whatever.” I was never worried that a buyer was going to back out on me because my information wasn’t accurate. However, I was a little concerned that a buyer could back out for some other reason. After they have my list of clients, they could certainly run their own direction with that, then I’d have a huge problem with the units people calling. Let’s face it, I’ve been in real estate for many years, and most realtors are good realtors. They’re good brokers, honest and good, but there are some people out there that make you shake your head sometimes. Not that I felt I was dealing with anybody, but you never know.
It was important to put a provision in there where they wanted a non-compete with me so that when they buy my company, I’m not going to compete with them for the next five years. That’s fair and reasonable because I’m giving them my company. The last thing they want to see happen is me go back out, get back into business, and take all my clients back after I get a bunch of money. I said, “That’s fine. I’ll agree to that, but you have to agree that if we get past your due diligence, when you look at the generalness of my company,” and you say, “We want this, we’re going to move forward with this.” It gets to me disclosing who my clients are, then the money has to be non-refundable and hard. In other words, it’s released to me, which it was.
When we got to that point, they literally wrote the check and gave me the check. It was substantial and it needed to be substantial because the last thing I want to get involved in is a bunch of lawsuits, suing people and all that kind of stuff. It’s like, “If you’re going to take something from me, then at least I got a significant amount of money, and we can deal with lawsuits or whatever later, but hopefully we never have to go anywhere like that.” I felt one of the best ways to do that was to make it substantial. In my case, they paid a $250,000 non-refundable release of the deposit of their earnest money. It was released to me upon me, giving them our client lists.
You said it was a check that was literally handed to you. They didn’t even submit it to escrow. There was no escrow involved with that.
In my case, I did it without an escrow. It was fairly simple. I’m not a huge company. We didn’t sell any of our equipment. Nothing was sold other than he bought my clients and my goodwill. He also bought us being around for the next six months to help him in the transition of things, which anybody who sells is going to want to do that. You want to make the transition as smooth as possible for all of your clients, so they stay with the guy that’s buying your business so they don’t come back to you later and say, “I don’t have these clients and you didn’t give me this business. I want to reduce the price and take some money off of the deal.”
In terms of the mechanics there, he hands you a check, you deposit the check and you wait for the check to clear before any of the information is disseminated. Is that how it works?
We could have, but I didn’t. It turns out he uses the same bank I use. I took it from his account, and put it into my account. It was seamless. The guy is an honest guy that purchased my company. I wasn’t worried about him putting a stop payment on it. If he did, and if that were the case if something like that would have happened after I gave him, then there would have been a lawsuit, and I don’t think they would have won with the documentation that we had by any stretch of any means. It would have been detrimental to them and to us. The guy that we sold to is the right guy. He would not have done that. I gave him the list and he gave me the check. We went through the list and gave him a rundown of all the particulars about the clients, what they are and their history. They have a good data point for them when they’re working with our clients that are now transferring over to be his.
At that point, by the time he hands you that check, he’s already gone through due diligence, which I presume was several weeks to more than a month. I don’t know how long that period was.
In his case, it took him a little less than two weeks. We were very forthcoming with all of our data.
At that point, he had reviewed all of your financials and corporate tax returns. He had reviewed any receivables or payables and notes that you had. He had a broad brush keystroke for your financials. He didn’t have the specifics of your client, customers and property.
[bctt tweet=”Many real estate brokers are not necessarily the smartest guys on Wall Street, but they are good, hardworking people.” via=”no”]
He had all the end results, but he didn’t have the keys to the locks, so to speak. Not your clients, emails, contact information and all that stuff.
Was there any other information besides those specific clients and contacts that were held back as part of this or was that it?
We were forthcoming as far as I know. Anything that he asked about our company that he wanted, we gave him information or supporting documentation if he wanted that. Like our tax returns, he looked at that. I’m not just giving him a P&L that says, “We’re making all this money here. Isn’t it great?” We showed them the tax returns, “This is what we’re doing. How many tax returns do you want to go back on?” In this case, he only wants to look at two years. It wouldn’t have bothered me if he asked her four. It wouldn’t have mattered to me because it is what it is. I was confident in the value of our company and what it does for his company. Another side point I would say is that when you’re selling a company, try to find the guys that have the most to gain by working a deal with you. If you can find those people, you’re going to get the best value, I believe, rather than finding just anybody.
That’s one of the points that we tell all of our clients and that is you should always put all the buyer pool out there into two different buckets. One is the strategic buyers and one is the financial buyers. The strategic buyers are the ones to seek out because they inevitably will find more value and more reasons to move forward with the transaction. Most of the time, they’ll wind up paying more and be more equipped to get the deal done. It won’t be nickel and diming you as much during the course of the transaction.
That is great advice. I agree with that 100%. It is exactly what I see happening. I had both people. I had the strategic buyers and I had the financial buyers. There was a significant difference in the offerings between the financial guys and the strategic guys.
At that point, you’ve gone over all the contacts. Since he’s in the area and he knew some of your customers and some of your properties by the time you reveal that, was there still some nervousness on your part now that he knows all that stuff or by virtue of the fact that you’ve got all that money, you’re presuming that he’s going to get a deal done no matter what?
I looked at it from the perspective that if he’s willing to put up that much money, non-refundable, he’s not looking to hurt me. If he was, he wouldn’t put up the money. $250,000 is enough for me to hire an attorney to take anything and tie everything up for a whole long time. I’d be using his money while I’m doing it. I figure if they’re willing to do that, that’s like the golden ticket. You get the ride. Let’s go, we’re in this together at that point. I’m committed to him and he’s committed to me. I feel very comfortable. Even when we came to the agreement that when we get to the point where we’re going to release the confidential information and they’re willing to go non-refundable, I was comfortable working with them from that point on. I’m like, “Nobody is going to agree to do that if they’re looking to try to find a way to hose you.” I felt good, the transaction went very smooth, and it’s still running smooth to this point.
The $250,000 at that point is in the ballpark of 20% to 25% of the total transaction. That’s a hefty amount.
That’s how I felt. I go, “If they’re willing to do that, then they are good people to work with.” They didn’t balk at it. Between you and I, I figured they go, “We’ll give you $125,000 or something.” I told them what I wanted. They said, “That sounds good. We’ll do that.”
You mentioned that it was a five-year non-compete, which means that within a given geography, you’re not going to do any property management within a certain radius that would compete with them. You said that it also went the other way and it protected you from him not competing against you in the event that the deal went south. Is that right?
Selling Your Business: The real value to a management company is your goodwill and your clients. Without those, you’re just another real estate broker trying to make a little money here or there.
Yes. It was bilateral non-compete. In other words, I wouldn’t compete with him and he won’t compete with me because once he gets the name of my clients, it becomes very easy for someone to send out notices or whatever emails, all kinds of things you can send to people and work around all the other ethics and things in some people’s minds. I would never do it, but people could. I don’t think this guy would have done that, but I didn’t know at that time. When you’re in the early stages of negotiation, I’m looking for ways to protect myself and my company and its value as well as protecting him because I know this. I never will have any intention of competing with him in any way whatsoever. I’m selling my company, I’m done. I’m out. Also in the event he didn’t do it, I didn’t want him to start coming in and whittling off any of our clients through any offerings or anything that would hurt my ability to sell it to somebody else for the greatest possible value.
That makes total sense. That was very astute of you and your attorney because that is the way you should do it. You mentioned the word whittling there. One of the things that I know that you had in your transaction was a clawback provision. Those who might not be familiar with that, that’s a provision that’s put into contracts and transactions that allows the buyer of the level of security in the event that clients and customer relationships don’t get maintained after the sale is complete. They’re able to take some of the money off the table, I presume held in escrow in your case. In your case, from what it sounds, the clawback provision hasn’t had to be invoked because everything’s going fine.
I structured my deal for tax reasons. I didn’t want my entire payment all in this year. There are tax reasons why, so I have a large payment coming in February 2021 so we get past the first of the year and then they’ll make the next big payment. They were fine with paying it all off. I said, “Why don’t we stretch it out? I’ll take another payment in 2022.” I structured mine so that I have two large payments coming in two more installments. In the meantime, they’re paying me 100% of what my gross revenue was on a monthly basis. That all applies to the purchase price.
You hit on a couple of topics there. One was that you’re deferring taxes in an installment sale transaction. That spreads out your tax liabilities and makes the tax hit a lot less because you’re not taking it all in one lump sum. That’s always a smart thing if you can do that if somebody can accommodate that. For argument’s sake and better understand the people who are reading about the clawback, let’s say that for whatever reason, the company did struggle with retaining clients, and the new buyer coming in and started losing clients left and right. What did the clawback provision exactly give him as a protection? How did it work?
I’ll use a dollar amount. If he lost $10,000 in revenue, then that would reduce the value that he’s paying me by $8,000. There’s still some value to it other than that. If $10,000 went away through clients leaving or whatnot, we would give him back or reduce what he would have to pay by that amount of money, whatever that calculation would end up working out to be fit upon.
In terms of the mechanics, it’s not as though anything was held back in escrow or put into some third-party fund of some kind. You simply were going to have to write him a check if that happened.
In this case, because I’m doing it on an installment with some payments, we would end up reducing what the final payment would be. We won’t reduce unless many people left that it would affect the next large payment or whatever. It won’t affect that and it won’t affect the monthly payments. It will affect the final payment if in the event somebody ends up leaving. In my case, the clients that I transfer, if they switch over to him now, which all of them are, but if they don’t switch, then that’s when the clawback provision takes effect. If they leave in a year from now, that’s not my problem, that’s his problem.
The clawback has a six-month window on it.
It’s the transition. If somebody does not transition over, then there’s a reduction, but if everybody transitions over and then January 30th, they all change and want to go somewhere else that’s not me as long as I’m not competing with him, then that’s the risk he takes in doing that. I don’t think any of my clients will be leaving. There’s always 1 or 2 that might say, “This isn’t a good time. We’re going to take care of our property ourselves.” It’s small things here or there. I don’t even know if he would even trigger it for 1 or 2 tiny things at all. He would even say, “It’s fine. We’re good. Let’s move forward.”
It is almost inevitable especially as we’re dealing with a pandemic. There are going to be life circumstances and changes that will prompt somebody to make a couple of decisions.
[bctt tweet=”If you manage and take care of your clients, that has great value to a lot of people.” via=”no”]
The other interesting part was in my case and with my company, from the time we use the specific date from our rent roll. We had a rent roll as of September 30th, 2020. We use that as the value. Since September 30th, we have added four more clients to our portfolio in that period of time. We have a buffer. I could lose 2 or 3 people and still be fine. It won’t affect me because I added some people to it. What I should have done is I should have put a closet in there and says, “That’s fine. We’re going to use September 30th. If we add anybody, the price of the company goes up by that amount.” I didn’t do that but maybe I should have done that in hindsight.
You mentioned that the transition is going well. Talk a little bit about your role as a seller, how you have done calls, done introductions, and made the transition on his behalf. Do you sit in on all those calls? Is it a bunch of Zoom video calls? What does that look like?
We’re doing Zoom because of COVID. We also have clients that are even out of the country, so Zoom is the only way to do that. What I did initially was I called all of my clients. I spoke to every one of them personally, without him, just me personally saying, “Here’s what’s going on in our lives. This is what we’re doing. We brought on a new guy.” I explained to them the whole situation. I said, “What I’d like to do is set up a time where we can do a Zoom or a conference call with the new guy.” Most of my clients were so great. They were like, “We wish you well and you’ve been the best ever. Have him call us, you don’t need to be involved. You take care of your things and go do your stuff. We’re here. If we ever need you, we’ll call you. Thanks a lot.”
We’ll do a few Zoom calls with some of the clients that we have done them already. Certainly, not all of my clients want to do Zoom calls. Many of them do a Zoom call with him at some point or whatever, but most of my clients have been with me for a long time. We’ve established a relationship for many years, it’s almost like family to some extent, and we’ve done a great job for them. When we told them this is the best thing that we can do, it’s going to be good for them and good for us, they were all on board with it. That was the best feeling and the best thing to have when you’re talking to your clients and telling them you’re not going to be there anymore, but they are so supportive of you. It’s a wonderful feeling.
That goes to your credibility, Myron. For somebody who’s been doing this for so long, when you tell them finally that you’re going to be going, but you’re not going to be going just yet, and you’re going to help coordinate a transition, that speaks a lot to your credibility. You should take some kudos for that.
I did tell them I’m still selling real estate. If they want to sell, they can always come back to me.
Good for you. You’re a capitalist.
We still got to eat.
The other thing you touched on, and I appreciate you doing this, we’re close to the end here, is the fact that you did have a lot of counsel from your accountant about how to defer payments, spread out the taxes and not make the tax hit. When I talked to many owners out there about the prospect of selling their business, a lot of them don’t realize how much of a burden it’s going to be. In your case, you started the business in ’98, so your basis would have been low. I’m sure you had your first initial discussions with your accountant, and you had a holy crap moment at some point I would imagine.
That’s why I chose the installment side of things to spread it out a little bit, so I don’t pay a big bunch all at one time. In hindsight, with the way the election worked, this is all pre-election, keep in mind. Now, the elections happened, and they’re talking about rolling back all these taxes. Maybe I should have taken the whole hit this year, but it’s the way it goes.
Selling Your Business: Most realtors are honest and good brokers, but there are some people out there that make you shake your head sometimes.
You don’t know how it’s going to play out, but that could be that way. You had also mentioned to me that it’s your opinion that a lot of these property management companies in the marketplace that we’re in are highly undervalued. Owners sometimes don’t appreciate the value of their customer relationships and their client relationships that they developed all these years, and how that is an enormously valuable commodity that some of them don’t quite understand themselves, even though they’ve done it. I thought that was a very interesting point you made with me.
I would agree with that. Many of us are real estate brokers and we’re not necessarily the smartest guys on Wall Street, but we are good, hardworking people. It’s very easy to get wrapped up in your daily grind of doing all the stuff you do and then not grasp what value you’ve created. I sell properties to people and we sold the apartment buildings, duplexes and fourplexes, and the people are buying them. I sold one at a 1.7% cap rate and I’m like, “Who on earth?” I was happy that they bought it. It was fine and I was a listing agent and they’re going to pay over exorbitant prices.
As a listing agent, I’m cool with it but on the other side, I’m looking and shaking my head, “I can’t believe this is selling this for this.” I look at the management company the same way. It’s a revenue-producing asset that you have. If you manage and take care of your clients, that has great value to a lot of people. Unfortunately, there are a lot of people out there because they’ve been doing it for a long time or what. Maybe I’m wrong on the values but I don’t think so because I did well with mine. When people ask me why I’m asking so much, I explained it to them and they’re like, “We didn’t think of it that way.” I go, “I’m thinking of it that way because if I’m going to give my company away, then what’s the point in doing that? I’ll close up shop and let people go find it wherever they want. I don’t need to give somebody else a windfall where there’s nothing in it for me.”
I thought it had to be reasonable and fair. That falls back on what you had talked about earlier which is finding those people that are the strategic buyers for you. If you do your homework and you find those people, they’re the ones that will see the real value in your company and your clients much more so than somebody that’s looking, “We want to expand and want to do this or whatever.” I had those people too. I had nice conversations with them and I said, “Save yourself some time. Don’t waste your time. I don’t want to waste mine. I’m good.” If that was my company’s value what some of those people were talking about offering me, I wouldn’t sell it. If there’s nothing in it for the seller, what the heck is there? I don’t need to do that.
Until you get to larger deals where the companies are doing a maximum north of $10 million in revenue or something, you will get out of town buyers. For the most part, you can draw about a 20-mile ring around wherever you’re located for smaller companies. Your buyer is more than likely going to be in that ring somewhere. Even though it is appealing with the recurring revenues and the management structures that these have, the reality is they are local businesses. People want to build outgoing from wherever they’re at to build a larger, more profitable base by going outward. They’re going to be local. Myron, you’ve been helpful. I appreciate it. It’s been a great discussion. I wanted to double-check and I know that you retired your old Realsource website. Do you have a new website that we should go to or do you want me to plug that at all?
I’m a Keller Williams broker and I’m in the business. We take care of all my existing and past clients. I’m not necessarily looking to grow my business a lot more, although I do have a whole team as well on the East Coast. I’m licensed in both California and North Carolina. I found that there’s a real niche right now in people taking their money from California and going to other states, North Carolina is one of them. That Research Triangle area is an amazing place. If there’s any of your audience interested in knowing more about going from one place to another, I’d be a good resource to help them give them some good information on that.
That certainly is a trend we’ve seen for many years here in Southern California. People are taking their money and going to Texas, Florida, Arkansas, Missouri or something.
I’ll tell you my personal sense on Texas is that the waves already hit there, and the tide is already high. You’ve got to go where the tide hasn’t risen yet. That places are Nashville, Tennessee, Idaho and the Boise area. That’s starting to rise quickly right now, but the Raleigh Durham Chapel Hill area, I believe it’s an area that’s going to be like Silicon Valley years from now.
That’s good to know. Myron, I appreciate it. Thank you so much for doing this. You’ve been great.
Thank you. Have a great day.
About Myron Von Raesfeld
Within a year of graduating High School from Bellarmine College Prep, Myron was hired by the Oakland Fire Department where he quickly began to move up the ranks within the Fire Department. Shortly after being promoted to Engineer, Myron was forced to retire as a result of an on the job injury. It did not take Myron very long to find his stride in his next career, Real Estate Sales. Myron has continued to excel in the Real Estate industry and year over year and has been a top producing Broker in the Santa Clara County area. In 1992 Myron was recruited to the position of Sr. Vice President for Prudential California Realty to manage their Cupertino office.
Within 2 years under Myron’s management, the Cupertino office was recognized for becoming one of the top producing offices in the Prudential Realty Network nationwide in its size category. In 1996 Myron left Prudential to begin work on a new concept for the real estate industry. In 1998 with his Business partner Rick Smith they started RealSource. In 2002 they incorporated the name of ClickHome and began offering the Clickhome employee benefits program to medium and large-sized companies. Currently, ClickHome represents over 80 companies in the SanFrancisco Bay area and they are continuing to grow.
Specialties: ClickHome is a Real Estate Brokerage of in which Real Estate services are marketed to larger companies as an employee benefit. This company was founded in 1997 by Myron Von Raesfeld and Rick Smith.
They currently provide this Real Estate Benefit to over 80 companies located in the San Francisco Bay area. In addition, Myron owns and operates RealSource Property Management Inc. RealSource is a full-service property management company that specializes in student rentals surrounding the University of Santa Clara. In addition, RealSource Property Management manages residential and commercial properties from Morgan Hill to Fremont.
It is undoubtedly challenging for owners to sell their businesses to entirely new management. But on the other hand, the buyers of such assets also undergo a complicated company transition, which could be messy if things are not handled properly. More often than not, the difficulties lie with the people involved. Brian Loring sits down with Matt Walker of Walker & Associates Property Management to share his experiences in closing two handshake real estate deals in the smoothest way possible. He explains how he created a strong initial connection with the clients, tenants, vendors, and employees of the companies he has inherited by making phone calls and how this affected his entire management system.
Listen to the podcast here:
How To Successfully Transition Your Company To A New Owner With Matt Walker
We have a great guest for you with some key insights about buying a property management company specifically about creating a successful transition, retaining the clients after the sale. This gentleman has bought two portfolios in his management career. He’s Matt Walker of Walker & Associates Property Management. Their office is in Santa Maria, California. You can find them at WalkerRentals.net. Matt and his wife, Marlena, had built a terrific single-family and multifamily management business on the Central California Coast. I used to live in Santa Maria and San Luis Obispo. Those areas are the primary markets for Matt and Marlena’s business.
I wanted to talk to Matt about his experiences buying these two residential portfolios and how he managed the process of keeping the books of business that he had intact after the sale. It can sometimes get a little dicey when a new owner comes in and takes over the operation. It’s sometimes not easy keeping your property owners and your clients happy, and keeping your tenants satisfied at the same time with your service, and keeping your employees in place. All of that can be very difficult. When you do all those things right though, you’re going to succeed when you buy a property management company. Sometimes it’s a lot easier said than done. It’s a great conversation we had with Matt. I hope you enjoy it.
Matt, thanks for joining us. I appreciate it. I wanted to start by having you briefly describe the two portfolios that you bought in your business past, how big they were, what type of properties were in the portfolio? Give us a little sense of why the sellers were leaving in each of these two cases and what the background was?
Thank you for having me, Brian. Both portfolios I bought were very similar in the sense that both were people who had been in the business for decades. They were looking to get out. One was due to a serious medical condition. They had to get out in a hurry, but they were both similar sizes. I believe one was about 25 units and the other is 35. They are not large units by any stretch of the imagination, but very quality units. It’s all single-family from both of these portfolios. What I found interesting was that both of them were interviewing me as much as anything about how I was going to treat their clients once I took over the accounts. They were very concerned.
It’s a commonly big issue. They want to make sure that it’s getting handed off to somebody with the proper skillset and the proper mindset.
One of them was offered more money from somebody else, but decided to go with me because they believed that I would be better for their clients.
[bctt tweet=”Most people don’t like change very much.” via=”no”]
Were both of these something that was being marketed actively in public or were these private deals?
They were private deals. I was approached by their family member from both of them. My wife and I have been in this town 3rd and 4th generation respectively. They came to us thinking that we would be a good fit.
You approached them with an offer. What did that look like? Did they submit financials to you? Were they reluctant to share information? How did that process go?
The financial information we were given was very basic. We have this many units. The average rent is this amount. We’re getting 7% to 8% management fees. It gave a roundabout figure but fairly accurate of the monthly revenue.
How did you get comfortable with knowing that it was a deal that you wanted? Was it strictly in the financials you were looking at? How did you get comfortable?
When you look at property management numbers and what you want to pay for them, it makes a lot of sense quickly. If I’m going to give somebody a year’s worth of revenue, let’s say, that means in twelve short months, I’m in the black. How many investments can you make? That would be the case. That was it. I looked at them and thought these are a no-brainer for me as a newcomer to the business. One of them, I was only in the business for a couple of years. The other one was about 4 or 5 years. It was a very fast way for me to grow my own portfolio and to increase my revenue significantly.
What was the situation with the outgoing sellers? Did they both just want to be completely done with the business? Did they want to have an existing role post-sale? What did that look like?
Company Transition: When text and email are not going to work, pick up the phone and make a personal human connection with somebody.
One of them didn’t have a choice. Unfortunately, she had had a stroke and her family was the one that I was talking to. They needed someone to come in right away and take over everything. The other person was retiring but also didn’t want anything to do with it. They wanted to be able to hand it over to someone who would take it over and they could go to Fiji.
Did you work through a broker or accountants? Were there third-party people involved? Was it simply you and the owners in both of these deals?
Because they were so small, it was a handshake deal on both of them. We all felt very comfortable with each other. We didn’t have a third-party involved.
How did you originally find out about these deals? Had you known them through the community? How did it come about?
I had known both of these managers through being in real estate since 2001, when I first got my real estate license. I always knew these people and they knew me. Their families approached me and one other property manager about taking over their accounts.
You had mentioned that in both cases, both of these owners were very sensitive to who was going to be buying the business, and how they were going to treat it, and what changes they were going to make. Did you have to convince them of things that you were going to do differently or were they overly concerned with how you might change the business?
[bctt tweet=”If you can keep your mouth closed and your ears open, it’s amazing what you can find out.” via=”no”]
The biggest thing that they were concerned about and they had a hard time wrapping their heads around was as you know, we’re a 21st-Century company. They had done everything very hands-on. They would deliver checks to people. They’d pick up rent from some of their tenants in person. When I told them the type of company that we are, that was their only apprehension. They knew that as far as handling their clients and their tenants, and taking care of things, that would be fine. They were a little apprehensive as to how someone was going to be able to do what they did without being so hands-on.
One of the reasons I wanted to invite you onto the show and talk a little bit about your deals and your experience is not so much what happened before the transaction closed but after, specifically about retention of the relationships with the owners, tenants and vendors. The most important is the property-owning clients. Did you know going in that it was going to take a good amount of time to massage that process of getting to know these people and letting them get comfortable with you? What was that strategy like?
I knew that many of the clients that these people had, they had been with them for decades, for years and years. Most people don’t like change very much. I had to approach it especially considering the age of these two folks and the age of their average client. I had to think about the best way to approach them. It’s a lost art these days but I picked up the phone. I called their phone number and talk to them personally. It’s something that I’ve carried throughout several years now of doing business. It’s knowing when text is not going to work and email is not going to work, you’re going to have to pick up the phone and make a personal human connection with somebody. That’s what I did with each one of them.
Was there any resistance on most of their parts? Did you get a lot of pushback? Did you get people saying, “I might not want to keep going with the company?” What was the reactions?
I’ve got to give a lot of credit to the previous managers. They had made it where I was almost making a warm call. They had to let them know that they needed to exit the business, and that they were going to be selling their portfolios to a property manager who was going to take care of them. I was able to call them with them already having a little bit of an idea about who I was. I needed them to hear that I was someone that was going to be there like Mary was and the other person was. I was going to be there, answer the phone and be able to speak to them if they had an issue. I was going to take care of things like they had been before.
What I tried to emphasize is that I was hoping that they would not only experience the level of customer service they had before, but some enhancements to their experience, ease of communication, being able to always reach me no matter what time of day it is. It doesn’t mean I’m going to return an email at midnight, but if they woke up and they had a question, they could send one. The next morning when I get in, they’re going to get an email response. That was something that improved their experience. They didn’t have that before. It was all old-school phone calls.
Would you recommend to anybody in that situation to make that initial phone call with the owner, with the outgoing seller on the line? Do you think that was necessary?
Company Transition: The biggest thing that a new owner can do is paint as positive a light on the previous manager.
The outgoing seller wasn’t on the line.
You didn’t utilize that, but to others out there, do you think that would be valuable for them in that situation?
It could be. I want to make my own phone call. I would like the seller to call them first. Number one, you get many phone calls now that you’re not sure about. It’s nice to be expecting a phone call from a specific person. That part of it is good. As far as calling them with the seller on the line as well, I would go that far. I could see how maybe someone else would.
How did it go then with the existing employees that you are now inheriting? Did that go pretty smoothly? Was there any resistance there?
The first portfolio I bought was a husband and wife situation. They were both retiring at the same time. I quickly figured out after taking over their portfolio, they had kept their favorite clients and their favorite properties. I bought a very high-quality client list because it was very obvious to me very quickly why they kept these folks around so long. They were very easy to deal with. They took care of their properties. The other person was retiring and was a one-man show, so no employees to deal with.
How about on the tenant side? Did you get any resistance or did the tenants seem to bristle in any way?
[bctt tweet=”There are not too many things more rewarding than owning your own business.” via=”no”]
I felt that it was important to reach out to the tenants. We first sent them a letter letting them know of a change. I also called them. I let them know especially that they would be receiving a lot more service and the way of options to pay rent, to submit work order requests. The tenant’s response was very positive. I felt like they were a little relieved that they would have someone that was a little more dynamic as their manager.
Dynamic is a good word like active. There are a lot of good terms you could put to that. You get through this process and come out at the other end. You had told me in a previous call that you learned a couple of things, some tips and tricks in terms of some of the language and some of the positioning to speak to an owner, and some things to say and not say when you first approach your client owners. Did you find some things that were not the right things to say to them initially?
The biggest thing is that you always want to paint as positive a light on the previous manager. It’s one of these things where you want to tell them that you’re going to enhance their experience while at the same time, not saying you’re better than the previous manager. That’s the only thing I would say is that you want to make sure they know, “I’m going to be here. I’m going to handle everything the way the previous manager did.” You have to also consider when you’re saying that, what if there were things about the previous manager that they liked or didn’t like? Those were questions I straight asked like, “Were there things that they did that you would prefer were done differently? Are there things that you would like to stay the same?” I let an owner lead the conversation with questions to where I could know what they had expected from the previous manager, but what maybe they would like to have in a new manager.
You don’t necessarily force the conversation. Let them drive it, sit back, listen and learn. That’s a good way to go.
It’s like what I tell my kids, “If you can keep your mouth closed and your ears open, it’s amazing what you can find out.”
Your deals did not have any earnouts or clawbacks or any deferred payments based on performance of any kind?
No, I could see why they would on a larger transaction, but because these were so small and such handshake deals, there was not any of those provisions in those. Plus, the way that the sellers had spoken to the owners and the warm phone call into it, everyone was going into it knowing who was staying and who was going. There were a couple of people who bailed right away before I even made the phone call when they were saying they were selling, they went and found somebody else. It was one of those things where it was so small, it didn’t need that.
Company Transition: People assign too much risk to the idea of buying a business, and so they purchase real estate that barely has any cash flow.
At ManageVisors, we get a lot of existing property management owners who have built their own company. They come to us and say, “I would love to buy another one or another couple of more companies.” They get somewhat frustrated in the process of either not knowing how to approach someone on the outside or a total stranger who they don’t know, or how to even find those persons who might be wanting to sell a business. Did you come out with any particular experience or thoughts about how to approach somebody out of the blue in striking up a conversation about the possibility of selling their business? I know you’d love to find another one to purchase.
I did come out of it with a lot of thought about how I would approach someone about selling their company. I have sent out some unsolicited letters. I start them very non-confrontational.
It’s open-ended and very friendly.
It’s more of an introduction of, “I’m a guy who him and his wife and they’re few employees run this company. We’ve built a company the right way based on customer service and all that good stuff.” I let them know, “If you’re ever considering exiting the business or retiring, I don’t know what your situation is, but keep me in mind if you decide to sell.” That’s not quite as eloquent as I put it in the letter but it’s the gist of it.
Talk about some of the good stuff. The fact that in both of these cases in your portfolio, you were profitable quickly. That is one of the advantages and one of the points of being an aphrodisiac for these recurring revenue businesses. They do perform generally well, don’t they?
They’re incredible investments. Within a year of purchasing both of them, I also do real estate sales. I had one real estate sale for me, which paid back a whole chunk of what I bought them for. Moving forward, because I did so well for them managing their properties, I got referrals from these people. Most of them are still with me. I believe one of the purchases was eight years ago and other one was six. Most of these clients are still with me. The only ones I believe that have left have been the ones who use me to sell the property. I’ve never done the numbers. I guess I should because they’re meant.
[bctt tweet=”Once you get entrepreneurship in your blood, you’d never go back to being an employee.” via=”no”]
One of the articles I wrote was headlined, Why buy a four-cap building when you can buy a 40-cap business? In many ways, that is almost the case. They assign too much risk to the idea of buying a business. They go buy real estate that barely has any cashflow. Here in California with prices and what they are, it’s almost impossible to buy great cashflow right off the bat.
What you’re saying is what I say all the time. I know my business is selling people homes, but would you rather buy a $400,000 home that has a revenue of $2,000 a month, or $400,000 business that may have a revenue of $15,000, $20,000 a month?
Matt, this has been great. I appreciate it. One of the things that we try to get across to people is that the risk is out there. There is a risk that you have to weigh, but don’t let that sway you. Go after the deals. They’re out there. A lot of people sit back and they worry. They fret and they don’t want to take a chance. I know you took a chance and it paid off nicely.
There is a lot of risk in owning and running your own business, but like being a parent, there are not too many things more rewarding than owning your own business. It’s not for everyone. Once you get it in your blood, you’d never go back to being an employee. I can tell you that.
Thank you so much. We’ve been speaking with Matt Walker of Walker & Associates Property Management. Matt and his wife, Marlena, have a great business. I appreciate you spending some time with us. Thank you, Matt.
You’re welcome, Brian. Thank you for having me.
About Matt Walker
Matt Walker is co-founder and president of Walker & Associates in Santa Maria, CA.
With more than two decades of experience in property management and real estate, Matt and his wife Marlena build a customized Individual Management Plan (IMP) based on the unique needs of their property owner/clients.