Big Deal Small Business: Live Deal Process Update (12/2)
December 2, 2021 | Issue #53
ICYMI, I went under LOI about 2 weeks ago. As we progress through diligence, I thought I’d provide ongoing updates and learnings.
As a general update, I’ve been pleasantly surprised at the pace of due diligence so far. The Sellers have been super responsive and easy to work with. They’ve only pushed back on a couple asks, but with sound rationale and with workarounds suggested.
Deal Killers
The “potential deal-killer” workstreams at the moment are quality of earnings and vehicle inspections.
When I say deal-killers, I mean they may require a re-cutting of the deal, which is always emotional and difficult to do. In general, they increase the odds of LOI breakage by a lot.
I’ve seen some conflicting thoughts in SMB Twitter about whether you even need to do a QoE (versus doing it yourself). My personal view is 1) you should 100% be doing a QoE and 2) you need to be highly involved in the QoE process.
The QoE providers have seen way more deals than you, so they can pattern match more effectively. They’re also trained CPAs, which improves their ability to spot discrepancies or issues.
That said, you can’t outsource thinking - that’s a hill I’ll die on. The QoE provider, no matter how good, will never care about the deal as much as you do.
Every file they are reviewing, you should be reviewing. Every analysis they run, you should be checking in detail or running yourself.
Given that approach, I’m cautiously optimistic that the QoE will be okay - I’ve reviewed a number of key files that give me confidence that the reported numbers will be borne out (helped by the fact that there are basically no Seller-proposed addbacks in EBITDA).
Vehicle inspections have been a bit more complicated as most mechanic shops are only open M-F during normal business hours and the vehicles need to be working in the field during those times.
It would have been easier to use an appraiser firm on the weekend, but their physical inspections are not very detailed; they are more focused on valuing the equipment & vehicles, which is less important as I’m not getting an asset-backed loan.
As a compromise, the Seller recommended a mobile mechanic with deep expertise in the specific trucks & equipment this business uses. It makes me a bit uncomfortable to use the Seller’s recommendation, but at the same time, it’s the ideal type of mechanic both logistically and in terms of experience.
Hopefully, we’ll get those lined up for next week, in which case the big deal-killers could be in the rear-view mirror by the end of next week.
This Post’s Sponsor: SMBash
If you want to spend 3 days talking SMB buying, operating, and investing, you need to be in Orlando this February.
The first annual SMBash is 2/3-2/6 and is chock full of small group socializing, events, and panels.
It’s a long weekend of hanging out with smart people with a healthy dose of happy hour thrown in.
If that sounds like fun, check out the tentative agenda or sign up here!
____________________________________________________________
QuickBooks Access
When you kick off due diligence, one of the first things you'll ask for is a number of QuickBooks accounting exports.
Monthly P&Ls & balance sheets, YTD P&Ls, comparisons year-over-year, etc.
It's all pretty straightforward, but kind of annoying for a seller who isn't used to looking at those reports very often.
As an alternative, consider asking your seller if they'd be willing to share their QuickBooks backup file.
I'm not sure if most sellers would be willing to do this (I've never asked), but my sellers actually suggested it - it had never occurred to me before that.
Basically, they create a local backup copy, which they can send to you as a .QBB file. Then you call up QuickBooks and get yourself a 30-day free trial of QuickBooks.
Make sure to ask the sellers for their customer license number - that allows the QuickBooks salesperson to verify what version of QuickBooks they are running and send you a trial for the exact same version.
Load up the file into the trial, and boom, you've got all their financial records. Now you can run every monthly P&L report you want, at your leisure.
The financial analyst in me is like a kid in a candy store...I have to limit myself from just running every report I possibly can just out of curiosity. I've also never used QuickBooks before, so it's good to get on the learning curve ahead of closing.
One note - make sure you guide your seller to send you a "backup copy", which will be a .QBB file ending. Otherwise, they may send an "accountant's copy", which will be a .QBX file ending. The only way to open that file type is to have the accountant's version of QuickBooks, which doesn't have a free trial option.
Seller Relationship
Different deals will have different levels of seller involvement post-closing. But in all SMB deals, the seller relationship is crucial as there is always some kind of transition period required.
Further, signing on the dotted line will require a leap of faith that your seller is being reasonably honest & transparent with you in the due diligence process.
Of course, you'll have protection against misrepresentations in your purchase agreement, but legal protection is a fallback, not your first line of defense.
I had a different deal die on the 1-yard line earlier in my search - one of my learnings from that deal as it relates to sellers was to "Invest in the personal relationship, not just the working relationship."
I'm trying to learn from that experience by spending more casual, unstructured time with the Sellers. Naturally, you're going to talk about the business during these unstructured sessions, but it gives you a chance to dig into the personal context of the business.
Small, family businesses are intensely personal endeavors. I love learning the "founding story" of these businesses. They're downright interesting stories, but they also tell you a lot about the Sellers' personalities and the culture they foster at the company (the two are usually intertwined).
Casual meals & ride-alongs are my go-tos on this front. Ride-alongs are amazing because it creates unstructured time in between actual diligence. Driving around in their truck is the perfect time to get to know each other and build that personal relationship.
On my last ride-along, the Seller asked me about my parents, my upbringing, my girlfriend, and more. We got greasy burgers for lunch at a local institution that we've both been going to all our lives.
It's hard to recreate that during a "diligence session" or worse, Zoom calls.
Conclusion
All in all, shockingly smooth diligence process so far! I'm sure there will be bumps in the near future, but for now, I'm enjoying learning more about the business.
If you have specific questions about the due diligence process or want me to chronicle different elements of the deal process, let me know! You can hit reply to this email or find me on Twitter.
Thanks,
Guesswork Investing
P.S. I’d always appreciate introductions to potential acquisition targets or brokers (primarily targeting $750K-$1.5M+ of SDE or EBITDA, located in Seattle or the Bay Area).