How To Achieve a Higher Valuation And Sell Your Business Smartly

You know, I think the smaller businesses are just shocked, you know, when people start picking apart all the addbacks that they've done, you know, it's like, you know, it's just a nightmare when you get in there. There's a guy selling a coin-operated laundry and he's trying to figure out how big of a note he's got to take back because the bank will only do what I mean, there's so many other problems that are solved by the size of the deal, but there's a lot more riding on it. I think they have a hard time understanding like why people are going so deep into the operations of the company when, you know, they have a tax return that shows that they, you know, had two million in EBITDA. I mean, I'm all for employing people and having a personal income, but the amount of energy, stress, sleepless nights that are applied, like, I don't feel like there's a day that people shouldn't be worrying about what is the valuation that I want for this business and how am I working toward that right now? Welcome to M&A Talk, the number one podcast that's selling a business brought to by Morgan and Westfield, a boutique M&A firm specializing in the sale of small to midsize companies. I'm your host and president of Morgan and Westfield, Jacob Orals. If you're considering selling your business and you'd like to work with me throughout the process, you can schedule a free consultation at MorganandWestfield.com, or if you'd like my team and I to perform a valuation of your company for one-time fee of $1,500, visit MorganandWestfield.com or see the link in the show notes, now onto today's show. Today, we're going to talk with Chip Higgins, he's the author of the BizX Way and he's been an investment banker for over 40 years and we're going to talk about the differences between the lower, the middle, and the upper middle markets and Chip, welcome to the show. Glad to be here, Jacob, really excited. He has lots of experience as a banker here and we're going to talk about something we actually haven't talked about before, maybe little nibbles here and there, but the difference between the lower, the middle, and the upper markets, first of all, how would you define each the lower the middle on the upper? The lower, probably, the dominant characteristic is the lack of professional financial management. How would you define in terms of revenue or EBITDA or employees? I'd say the revenue could probably be up to 5 million in revenue, but there's usually a tipping point where the account isn't good enough and they need in-house financial management and I think that's usually where it changes. What about the middle and upper market? Where would you define those boundaries? I would define middle is probably the five or 10 million up to about 100 million and usually a pretty big team of financial people driving that, reporting wise and everything's elevated externally with audits and just more de-diligence on the company. Which meant team, strong accounting and stuff like that. Just generally more professionalized. The upper market is 100 million plus. Yeah, I'd say 100 million plus and that's probably where I've had the least experience, but I had kind of a unique experience with kinkos that gave me some flavor for that because they ended up on a path. They thought they were going to do an IPO and it ended up being better to be acquired by a strategic partner in FedEx, so that was kind of an interesting dynamic there. Did you interact with the CEO directly? No, he had partners all over the country, so I was primarily working with TJ Kinkos, which is the Tennessee operator. I think they had about 25 locations in Tennessee. I know he's dyslexic, which is phenomenally, you can run a company that. Yeah. Well, he's an amazing guy. I never got to meet him in person, but I was dealing with some real estate developers here that were building these locations and they used to tell me the stories that he's really a wonderful person, very interesting man to talk to you. Now, these sizes, the lower the middle market, the upper market, some call it the lower middle market, the middle market, the upper middle market. So we're generally referring to the middle market, which has kind of three sub-signants here. Those definitions, I know, are highly subjective. Different people are going to have different definitions, so don't hold us to that. But why do you think it's necessary to segment those markets? I just think the behaviors are so different. That smaller market, it's so much of a personal decision about what they're doing. And there are still family owned, privately owned, some of these middle market companies still have somewhat of that flavor. But I think the smaller end, it's not as crisp of a financial valuation decision about what they want when they're selling or even buying. I think there are things that they feel like they want to own and they go and buy it. I think when you get in the middle market, it's just, there's just so much more discipline with the team you have around you about the return on the capital you're deploying to make the acquisition or the return on the capital you've invested. And there's a lot more discipline and there's just, there's a lot more experience on the other side of the table that it's not always a company that's buying you. I mean, there's P groups and people that are buying middle market companies and roll ups and things like that all the time. So you have to be more disciplined, there's more expertise in that. Again, I'd say on the large corporate, you're dealing with pretty high-powered investment advisors. I feel like if I have one perspective on corporate outside of Kinko, it's just the fact that I was in an industry that consolidated by 75% during the time that I was in. There's just a constant M&A landscape in the banking industry, just being in the middle of that is a very interesting experience. The lower middle market is probably more defined qualitatively than with an absolute number. Wouldn't you agree? Because you could have a wholesale company that's doing 20 million in revenue, but it could very much look just like a small mom and pop business. Yeah. I had one company. I think they're still independent. But if you looked at the top line, it looked like they were 100 million, but we really picked the business apart. It was about a $10 million business who's kind of commodity-related. They were making money off the transport more than the commodity. All these companies have their unique styles and you can't assume anything when you walk in. You're going to find out all kinds of things about how they even got there and built a business model. That always comes into play with the valuations. I think there is this transition with the smaller businesses that they really kind of believe that top line is the driver of what they're going to get for the company. The further up you go, it's just like, what's the cash flow? How durable is it? Is it growing? I think the smaller businesses are just shocked when people start picking apart all the addbacks that they've done. It's just a nightmare when you get in there. It's just like, well, I paid myself this and this is my cousin that works here. He doesn't need to work here anymore. Then it's like, what's the credibility of the cash flow? I think they just have a mindset to how big it is and not necessarily the cash flow part of it and what that means to a buyer and investor. What might the difference be in multiples between the small, mid and upper markets within the same industry? How different can those be? That obviously changes by industry. There are some industries that I've found top line as all they want. People are just interested in revenue. I would say it could be double or even triple. You think it's pretty linear? Going from the small to the mid to the upper market or is there a big jump at some point? I think there's just a little bit of a hockey stick when you're demonstrating something that's durable. It's not just the earnings, but to your point earlier about an management team, stated strategies, competencies that have developed into really valuable competencies that companies want to acquire. It becomes a cash flow plus to me. It's like people have worked for 20 years to figure out how to do something. They do it better than anybody else. It's even beyond the cash flow. It's like that competency can be leveraged up across a lot of different businesses that somebody might own. Again, I feel like I observed M&A as a banker and unfortunately, he hated losing a customer and they got bought by somebody in California or somewhere. I feel like my literacy around this really came from just wanting to be intentional about dealing with the capital markets people with the banks that I worked with and attending the customer conversations with them about, "Are you really prepared to sell and getting into some of these conversations about multiples?" We started dealing with industry research probably in banking probably 20 years ago. It used to be something people only dealt with in corporate banking in the underwriting process, but first research and that vertical IQ, there's a lot of information available. You can share with your customers and that's where I look at it and how those multiples can change is based on what they're providing. It's like I don't have my own data set like you would working in the space of all the deals you've done and what they add it up to, but you can kind of see that inflection point with sales that sales quality of earnings, many things will lead to a higher valuation. It brings up a good point because a lot of times you look at EBITDA multiples and you say, "Okay, if EBITDA is a million, the multiples five, if EBITDA is five million, it might be an eight. How tied to that is the EBITDA versus the characteristics that a business of that typical size would have like professional management, audited financials and so forth. How scientific is that?" Or is the EBITDA just a proxy for those other qualitative factors that business might have such as a strong management tool? That's what I've found mostly is that you need a metric to communicate all these factors and it ends up being what's a common denominator across all businesses, so it becomes EBITDA. I think that EBITDA is a starting point that the acquisition is going to be relevant to be accretive to whatever cash flow the investor wants, but the reality is, I mean, that multiple is a reflection of where's the industry going? What's their strategy? Is it compatible? Is there a management team that's going to continue to. Customer concentration. The one customer had that happen recently and he was so disappointed, but he had I think 90% of his business dealing with UPS stores and he was really kind of shocked when he got down to it. He was selling it to some employees and there are multiple factors that hit that. There's just multiple things that hit. Did that deal close? The last time I heard, no, it hadn't, his employees couldn't pull it together and he had a great kind of family environment and he's not. At that point, he wants to bail out and go to the beach or whatever. It seemed like a good timing thing and I think it just kind of opened his eyes and there's a lot of things that I need to work on. His service can be applied to many industries and I think that was probably the single biggest wake-up call. He can't have that much exposure in one industry with one firm. You think it's true that most companies that do have, say, a $5 million EBITDA to get there, you have to have professional management. You're probably going to have an in-house CFO. Wouldn't you say that a business that generates 5 million EBITDA is a general rule is going to have most of those characteristics. Most of those businesses are going to have pretty similar characteristics from an investment attraction standpoint. Yes. I think, to me, at that point, all things being equal, they have audited statements. They have a good management team. I mean, there's a lot of reliability and the outcomes. The valuation difference is just like to me, it's like the stock market at large. What is the growth story and the segment that they're operating in and how much is it growing and how relevant is their strategy to it? I think it becomes very strategic. The higher the EBITDAs, have we capped out or is there a lot of life left in this is untapped? What do you see in terms of efficiency? Do you see that the upper market is more efficient than the lower middle markets in the M&A world? Yes. I mean, to me, you go from this lower end where you're dealing with the business broker, then you get to the middle. You probably have a team of advisors and then at the very upper end of the market, I think about pinnacle banks and Ovis merging recently. You've got investment bankers, you've got every specialist you know is all coalescing around that for they're getting paid well, but they deserve it. It's a big deal. Millions of dollars in fees, a team of dozens of people, but you think about that being announced on August 1st or whatever, it's a $7 or $8 billion transaction that's going to close in March. That's efficiency to me. I just feel like there's a lot of people working to get that deal done and just how many times we've seen a deal drag on and on and the company valuation starts getting hammered, you know, just kind of the uncertainty. The deal with first horizon and TD that didn't happen is dragged on and on. How much harder is it to sell a company with say $10 million in EBITDA than a company with a million in EBITDA? I think it's easier. I think the hard part is the partner, you know, I think that's happening a lot in banking landscape right now is a big EBITDA number, but who's the partner that it makes sense for, you know, it's like it could be a small amount to a huge bank that there's no interest in the deal because it's not very accretive and it's a lot of hassle. You're saying ultimately with the buyers, that's going to affect how hard selling your company is. Yeah. Why is that? I think there are multiple points in that Jacob. I mean, I think the first one would be how much is at stake. You're going to be a lot more cautious with $20 or $30 million and $2 million, you know. I mean, that's just stewardship. But I think there, because of that and the responsibility you have to that investment, let's get a lot trickier with management teams and synergies and integrations of companies that you have to be so cautious about how it all fits together that finding the right partner could be really difficult. Having the money available is not that difficult because I think it will attract a lot of interest at that deal size, but, you know, everything has to be vetted and it takes a lot longer to find the right partner. I think once a deal is identified, I think, you know, things come together pretty quickly compared to, you know, there's a guy selling a coin-operated laundry and he's trying to figure out how big of a note he's got to take back because the bank will only do what it. I mean, there's so many other problems that are solved by the size of the deal, but there's a lot more writing on it. I mean, think about, you know, the one merger that stands out in my mind that I was personally involved in in banking was the first American deposit guarantee merger in the late 90s and everything went wrong on that deal. You know, the due diligence didn't happen at the level to warrant like two five to ten billion dollar banks coming together, and that bank was sold pretty much within a year afterwards because it's a lot of hard work. Interesting. Let's take a quick break and we'll be right back. If you're a regular listener of M&A Talk, you know the secret to successfully selling your business as preparation. Whether you want to sell your business now or sometime in the future, my team and I can help ensure you're as prepared as possible. We can perform an assessment of your company, which includes a valuation of your business, a review of how easy your business will be to sell, a summary of deal killers that can derail your sale, a list of things you can do to maximize value and insight into how buyers will perceive your business in the actual marketplace. The assessment has a one time fee of $1,500 with no commitments and a 10-day turnaround time. To get started, visit morganandwestfield.com or see the link in the show notes. Now back to today's show. Welcome back to M&A Talk with Chip Higgins. Chip, I think one of the fundamental differences between a small company that is lower metal market and a mid-size company that is middle market is who the buyers are because with the smaller companies you have predominantly individuals, maybe some search funds as well, whereas once you get to a certain size, call it in my opinion, it depends on the industry obviously, maybe a half a million to a million in EBITDA, then you start attracting professional investors. To me, those sale processes are totally different, selling to an individual and maybe that individual spouse and they're going to buy it and operate it as their own kind of lifestyle business. That's a totally different M&A process than, say, selling a company with 2 million in EBITDA to a PE firm, how are those processes different and why is that important? I think it's really the size and experience of the team that comes around the deal. For instance, I look at what's happening, dental service right now, it used to be that there would be a dental practitioner, he'd bring in a younger practitioner, there'd be a promise made and then ultimately they work at a deal and they buy it. It's all like one-on-one, I like the person, you're a good fit for my clients and all that type of thing. Most recent bank I was at, at a specialty in DSO, roll-up financing and it's a completely different experience. There are seasoned professionals that are testing earnings, they're testing a lot of different things about the company besides, can this guy put a crown on like I do? Geographic fit, there are just the whole dynamic in the customer base, how long they've been there. I think it's just a lot more, I want to use the word clinical but it's much more of a standalone entity analysis than the person and what they're trying to do for their customers. I think it's just, I don't say colder but I mean it's just a lot more of like, does this fit the portfolio based on the five-year trajectory that we have to do a roll-up game and my Lord I mean how many roll-up industries that we've seen over the years from Collision Center? Think about what Collision Center used to be, it was very much a family owned business and that's a whole different game now too. It's just a level of professionalism and kind of clinical treatment of that transaction that makes it entirely different than the mom and pop. What size EBITDA do you see in your opinion that it starts to attract professional investors? It's funny that number keeps going further down, I have a few friends that operated in the mom and pop space as business brokers and it was a nice lifestyle and pretty good income for them and even they are saying like I'm up against the PE firm, I'm up against it's going further and further downstream. What size EBITDA? Under a million dollars. I mean he said deals under a million dollars. We've done deals four or five hundred thousand, sold those to PE firms. Yeah. I don't see them going too much below that because if you have a business with say three four hundred thousand in discretionary earnings which usually includes the owner salary by the time they hire a manager for a hundred two hundred K there's not much left so yeah it starts evaporating. Yeah, maybe about five hundred K and like you said there's PE firms that are just getting started then they have a fifty hundred million dollar fund and that's a sweet spot. It's capacity. Yeah. Well there's a lot of improvements you can make and if you can take that company from five hundred K and EBITDA to two million you're going to drastically increase the value of that company. What's multiple expansion for those that don't know? I believe that's what we were talking about earlier that the higher the EBITDA, the higher the multiple you're going to get and I mean I've always not having worked at a PE firm. I just feel like that's part of the game and what the value is that they're bringing is not only top line growth of consolidation but also enhancement of all the EBITDA that goes with it. Durable processes that are leveraged across a lot more customers. I've noticed a very big jump in sophistication of the buyers when you go from that small mom and pop business into dealing with private equity firm, strategic family offices and so forth. What I haven't noticed a big jump is say when you go from like a million in EBITDA to ten million in EBITDA, I haven't noticed a very significant jump in sophistication because it's still the same to me it's the same parties and a lot of these buyers, if you have a family office looking at a business generating a million in EBITDA, they're probably also buying companies that are generating ten million in EBITDA. To me, those selling a business for five million versus selling one for 50 to 100 million, I don't think that process is that different. What do you think about that? I agree with that. I think that it's really shocking to smaller business owners when they're used to dealing with the bank, the general annual questions that they get about renewing a line of credit and they decide to sell and let's say they have a million to two million in EBITDA. The rigor around their company is absolutely shocking to them. I think they have a hard time understanding why people are going so deep into the operations of the company when they have a tax return that shows that they had two million in EBITDA. I think it's a real eye opener and unfortunately I've seen situations where they weren't really prepared for it. They kind of felt like the time was right, but the EBITDA, the multiple, all of it seemed right. There's a lot of work that goes into preparing your company for a sale and it could be overwhelming. When you hit a real M&A professional, you're going to ask the questions that need to be asked and to get the right answers for them. What do you think about that paradigm if you want to call it that, where to get past a certain stage of growth, you really have to have a shift in skills in your perspective as an entrepreneur because a lot of entrepreneurs get stuck and I tend to see it in numbers of people because maybe it can effectively manage 5 or 10 people. A lot of entrepreneurs get stuck there and then they get stuck, multiply that by about 5 to 7 and they get stuck there again. These different stages of growth, entrepreneurs get stuck. What has your experience been in seeing how entrepreneurs try to work their way through those? How many different issues in that validate that 100% it's true and I think we call them scaling events and you see all the different texts that are out there, the attractions and what's required to kind of scale into the operating model. But I think first and foremost, you've got to have some leadership development by the individual that they actually know how to lead people and I've seen many businesses just kind of give up at the idea that they're going to even manage 5 or 10 people. They just, they enjoyed that thrill of starting up and getting something going. They're birthing a new idea and they want to take it that far and that's as far as they can get and then I think there's a next stage which is realizing that even if you accept the leadership challenge that the people that you brought on are not the heavyweights you need and it's like how do you start replacing family members with qualified people? Not to say that all family members aren't qualified, but how do you get the qualified team? Well, if we pause there for a moment, that's a lot of private equity firms swoop in and they help that business scale by professionalizing the management team. Yeah, that's a big benefit to them and then this is my personal belief is that it takes years to perfect and document processes that are scalable even with some of that's accepted the leadership challenge and has assembled a better solid team knowing the scalable process that will provide them that next level of growth is extremely challenging for people. So I think I've seen different texts, you know, my, my book is really geared toward people that are probably at three to five employees and trying to figure out how to get to 20. What's your name of your book? Let's plug your book. It's called The Physics White and it's about, it's just applies the momentum equation to business like how you build and sustain momentum over time, but I've seen it at all levels, you know, I think even solo perners could probably take their businesses further than they do at the daunting idea that they're going to have one employee, which is too much for. How would you sum up your book in a nutshell? I would sum it up by saying that, you know, momentum is a universal principle that is talked about a lot in business, but it is not really the formula, the proven formula for momentum is not always present and followed by business owners, and that's the magic of the book is that it's all applicable. I mean, it's mass times velocity and you've got to have energy to have velocity. So you put all that together. It's like, do you have the energy to do, solve the problem that you're attempting to solve? And do you have a strategic direction for the company and are you aware of the, you know, the counterforces? But a lot of this conversation that we're having right now, Jacob is, but what I say is the mass and businesses, is it a heavyweight company? And you know, that goes to the value proposition. It goes to your strength and experience as the founder or leader, but, you know, all the people that you hire, that essentially is what's at the very core of every business. And, you know, one week person can ruin everything for you. You know, I mean, you find out the books weren't kept or Bill, was it really making sales calls? You know, it's like he enjoyed the T and E expense, you know, but he wasn't the heavy hitter that you needed. And it's a, I don't care what industry you're in, it's incredibly competitive. And you've got to be aware of these things or you're going to get bumped out of the way. I mean, it's, you know, I think that's why we have so many physical terms around business about, you know, momentum and heavy lifts and all this type of thing is because it is that way. I mean, it's, you know, every person for themselves, so. What pattern have you seen in dealing with entrepreneurs for 40 years? Many of them get stuck. And I think many of those end up selling their company because they feel like they're stuck and they can't get that to the next stage in their business. I think there are two things that stand out to me is there's a principle in the book when I talk about energy part of the background of the book is that I had a long conversation with a friend of mine. He's a legitimate physicist. He's like a Caltech physicist and, you know, we started talking about energy and speed and he said, you know, that speed and energy have an interesting relationship. It's a direct relationship, but it's also a squared relationship. And if you want to go twice as fast, you need four times the energy. If you want to go three times as fast, you nine times the energy. And I think that is a big limiting factor for entrepreneurs as a plateau is they've either lost the energy that they originally had for the company or they really haven't built a culture that delivers energy across the organization consistently. And people are excited about doing the work that they've been asked to do like they don't totally get it. And, you know, just finding energy and people that are totally bought into the vision and the mission and having all the energy you can have to move forward. I think they kind of run out of energy, but I think the other part that I stress in the book that you can't start this scene enough is the annual planning process of discovering new ideas, products, services, markets. And you're constantly intentional about how you're going to add that next layer of growth onto the company. I think there's a complacency that you had the one big idea and it worked and you don't really believe you have any other ideas, but there are people working in the company that probably see multiple opportunities that are never really fleshed out because they don't feel like they're a part of that planning process. And so, you know, there's a lot of trust that develops of being inclusive with everybody that works at the company of where do we go next and what's in the next plateau, I don't want to stop. You know, I mean, I started this up, but we need to always have something that we're tinkering with. It's the next big idea. And I don't know, people get complacent and forget that. And it's kind of like, well, how many widgets are we going to sell next year? You know, like, I don't, you know, we did 40 million this year. I wanted to do 45 next year. We need to sell more, but is it really like a true, you know, discipline process of exploring opportunities that provide the same level of energy that it did when the company started? You know, it's that entrepreneurial energy of doing new and different things and helping people in different ways. That's my perspective on it. And Chip, what's the takeaway point here as we wrap up the show? I think my biggest takeaway and my interest in being on the show, Jacob is just this whole idea of every business being constantly vigilant about their value. And I think sometimes companies get locked into the day to day. We're going to hit our goals kind of thing, but I don't know, I mean, I'm all for employing people and having a personal income, but the amount of energy, stress, sleepless nights that are applied, like, I don't feel like there's a day that people shouldn't be worrying about what is the valuation that I want for this business and how am I working toward that right now? And that can happen at multiple levels. And I think that's, it's an asset. It looks like cash flow, but it's an asset. So that's probably my biggest takeaway. And to be aware of momentum, I mean, I think momentum is a big part of that in the valuation game is how predictable are ongoing EBITDA gains based on the model that you build. Well, priceless advice is always, let's plug your book, what's the name of your book? It's called The Physics Way, and that's what it does. It's a path to momentum and consistent business practices that will produce that. And while I wrote it for smaller businesses, I really believe it applies to every business. You can't forget it. It's a universal principle that applies to everything that we do. We're fortunate that we see it in action more than we think about it in the context of our business. We want it. Everybody wants it. But, you know, what the book does is pick it apart and tell you exactly how to get that done in your business. So it's easy to read 200 pages and you know, there's a lot of wisdom and case studies of things that I experience in my banking career that I think I'd value to it. I love that perspective, that physics perspective, because businesses like you mentioned, there's definitely an element of physics there and mass times velocity. I think that's a very useful perspective to look at it from. And that's Chip Higgins and Chip, thanks again for joining us on the show. Well, thank you. And thank you for having me on. Wonderful talk and team. 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