Ever wondered how to structure your business to protect your personal assets and boost financial health? Join Kelly Patterson and Ryan Hudson on HVAC-ology as they chat with Dan D'Alberto, managing director of Purpose Equity. Dan's unique career path from political science to private equity offers a treasure trove of insights for entrepreneurs. Learn why forming a proper legal entity like an LLC is essential and discover practical tips for operational preparation.
Managing your business finances might seem overwhelming, but Dan breaks down the complexities into digestible pieces. Learn the critical stages of cash creation, from Work in Progress to Accounts Receivable, and the importance of regular invoicing to maintain cash flow. Our discussion also sheds light on effective bookkeeping practices, the impact of different accounting methods, and the substantial costs businesses incur due to poor working capital management.
Curious about how to value your business accurately? This episode covers everything from understanding EBITDA to the factors influencing business valuation and sales, such as company size and recurring revenue. We also delve into transitioning from hands-on operator to strategic leader, offering guidance on acquiring a business using SBA loans and 401k funds. Plus, hear a compelling story about a partner buyout facilitated by Purpose Equity, showcasing the complexities and solutions in navigating business sales amidst personal conflicts. Don't miss these invaluable insights from Dan D'Alberto. Follow HVACology for more industry-leading discussions!
Please be sure to subscribe to our podcast and share with anyone who might be interested!
Ever wondered how to structure your business to protect your personal assets and boost financial health? Join Kelly Patterson and Ryan Hudson on HVAC-ology as they chat with Dan D'Alberto, managing director of Purpose Equity. Dan's unique career path from political science to private equity offers a treasure trove of insights for entrepreneurs. Learn why forming a proper legal entity like an LLC is essential and discover practical tips for operational preparation.
Managing your business finances might seem overwhelming, but Dan breaks down the complexities into digestible pieces. Learn the critical stages of cash creation, from Work in Progress to Accounts Receivable, and the importance of regular invoicing to maintain cash flow. Our discussion also sheds light on effective bookkeeping practices, the impact of different accounting methods, and the substantial costs businesses incur due to poor working capital management.
Curious about how to value your business accurately? This episode covers everything from understanding EBITDA to the factors influencing business valuation and sales, such as company size and recurring revenue. We also delve into transitioning from hands-on operator to strategic leader, offering guidance on acquiring a business using SBA loans and 401k funds. Plus, hear a compelling story about a partner buyout facilitated by Purpose Equity, showcasing the complexities and solutions in navigating business sales amidst personal conflicts. Don't miss these invaluable insights from Dan D'Alberto. Follow HVACology for more industry-leading discussions!
Please be sure to subscribe to our podcast and share with anyone who might be interested!
Welcome to the HVACology experience, where we talk about all things HVAC industry topics that are so hot, they are cool.
Speaker 2:Okay, we are in episode number six for HVACology. Hello, Kelly Patterson.
Speaker 3:Hello Ryan Hudson, Happy Friday to you.
Speaker 2:Happy Friday to you too. Do you have big plans this weekend?
Speaker 3:I'm going to shovel mulch into my flower garden, so, so excited about that.
Speaker 2:Is it weird that I like the smell of mulch?
Speaker 3:I do too. It smells like the earth is doing wonderful things to me.
Speaker 2:Do you know, sometimes they put like deer carcasses in mulch.
Speaker 3:Don't tell me that Now I'm going to be looking for a little Bambi hooves. That's not a good thing to think about.
Speaker 2:Sorry, Kelly. So a big thing that I have been working on is I am trying to get in decent shape this summer. And do you know what drives me crazy, Kelly?
Speaker 3:I really want you to tell me, Ryan.
Speaker 2:It's 2024 and you cannot get a straight answer on what kind of food you should be eating. You have your vegetarian conversation and you have your carnivore conversation, and both of them are positive. That if you go down this road for I don't know three weeks, you're going to die oh, 100%, that it's got to be, that the narrative is profiting someone as the reason why society, all of humanity, has not figured out yet what you should put in your body.
Speaker 3:Well, you know, here's the thing, ryan, like I believe that moderation is the key for all things. I mean, that's my philosophy, right? And also, someone once said to me I'm here for a good time, not a long time, right? So I feel like you should enjoy your life, and if you want to eat a little carnivore pleasure and have a little vegetable pleasure, I don't know, unless you just want to be a bodybuilder, do you want to, like, get in Supreme Arnold shape? Is that what you're looking for?
Speaker 2:Well, if I'm going to be fully transparent, there's these guys that I work with.
Speaker 3:Oh heck.
Speaker 2:And they're both jacked and I'm like man, I'm older than one of them and I just want to get to where I'm close to them In the event that we yeah, yeah, because you never know, you could be in the office and all of a sudden shirts go off and you want to make sure that you're, that you're able to be in the uh, in the competition I mean you do what you need to do, listen I love it. Uh, kelly, what is it that we're supposed to say at the very beginning?
Speaker 3:Be sure to like and follow and subscribe our podcast, HVACology.
Speaker 2:Yes, yes.
Speaker 3:Yay.
Speaker 2:I'm hoping this has been entertaining for you out there. So today our guest is Dan D'Alberto. You have to make sure, whenever you say a last name like that, that you have a lot of character in it, dan welcome.
Speaker 4:Hey guys, you have to hold your hand like this too.
Speaker 3:Oh, yeah, did he pronounce it correctly Dan?
Speaker 4:Di Alberto, di Alberto, that's right. I don't do it with the flourish typically.
Speaker 2:So Dan is a long, long time friend of mine, kelly, and he has been extremely helpful to me in my past with starting a company and being a part of a purchase and being part of a sell of a company, and one of the things that I love about Dan is he is very gifted at taking very complex things and making it very common sense. So I'm excited to talk to him today about what it looks like to start a business, what it looks like to sell a business, what it looks like to buy a business. Happy to be here, I'm pretty excited about that.
Speaker 2:Mm, hmm. So, dan, kind of one of the things that we like to do is is start us off. How did you get?
Speaker 4:from high school to this guy that is the guru of all things buying, selling, merging businesses. Well, that's that. We don't have a four hour podcast, so I'll make it very brief. But I graduated from high school in upstate New York and came to South Carolina to college and was a political science major. And of course when you're a political science major it means you have to go to law school.
Speaker 4:But I did five years off after undergrad, then went to law school, went to a large law firm where I worked with mainly private equity owned businesses. So I was kind of outside general counsel for those private equity owned businesses. So I got to see the inner workings of private equity, kind of from the legal side. And then after that experience I went out on my own and started helping people buy and sell businesses. And that's what I do today. And so that's the very brief version. But having gone through undergrad here in South Carolina with a political science major, going to law school and then ending up working on a mergers and acquisitions team, it kind of made sense to do what I'm doing now and I actually really enjoy the business side of things more than I like the legal side.
Speaker 3:Interesting.
Speaker 2:That is interesting. So, dan, take me from. If somebody is just got the entrepreneurial itch and they want to start a business, but they don't know left from right, but they have some skill set and something that the world needs, or the local your, your local community needs what, what do they need to do to get started?
Speaker 4:yeah, great question. We deal with clients all the time that actually are in that phase of life where it's hey, I've just rolled out from my employer and I want to start my own business, or I've got an investor involved, potentially already. What does it look like to put together the startup? And so you know there's a lot of legal work that has to be done to make sure you do it right, but then there's also kind of a lot of operational prep work that needs to be done as well. On the legal side, it's very important to actually form your entity right. You don't ever want to be a DBA, a doing business as meaning you don't want to perform work where you might have liability under your own name. So you want to form your LLC with the Secretary of State's office and that's very easy. It's $110 with the Secretary of State, and then you also want to get a federal employee ID number with the IRS. And those are kind of the two main things, the basic, what I would refer to as blocking and tackling.
Speaker 4:As far as starting a business literally starting an LLC to start your business One of the things that we see that many clients often leave out is actually having an operating agreement in place, and so a lot of people say, well, it's just me, or it's just me and a partner, we don't really want to pay an attorney to do an operating agreement, we don't need an operating agreement.
Speaker 4:But you really ought to have one in place from the beginning because really, what we call the four D's decision making, death, disability and divorce and so those things need to be taken care of in writing before your business really gets going, especially if you have a partner, because if you ever get into an argument, the document is going to control, and if you don't have a document that controls, then everything's up in the air and there can be significant arguments that result and so that's kind of the legal side is start your LLC at the Secretary of State's office, get your federal employee ID number and then have your operating agreement in place. On the operational side, there's a lot of basic stuff that a lot of people don't do and they kind of do things fly by night. But if you're going to want to grow your business, very basic things like getting QuickBooks and running all your financials through QuickBooks from day one you'd be surprised how many people just wing it or do it on an Excel spreadsheet, right.
Speaker 2:Or set up a separate bank account.
Speaker 4:Oh my gosh, Amazing Setting up a separate bank account.
Speaker 2:Yeah, they're like I Setting up a separate bank account. Yeah, they're like I set up a separate bank account. I'll just put everything with the business in there, don't worry.
Speaker 4:Right, it'll be fine.
Speaker 4:Right, there is a significant difference.
Speaker 4:You know, we we deal with clients all the time and see people all the time that um have high school degrees and are extremely smart and extremely capable in either HVAC or some other trade.
Speaker 4:And the guys that do things right from the beginning meaning separate bank accounts, quickbooks, all those sorts of things are able to grow more quickly and hire more people under them because they have things set up right, whereas if you just want to run it on your own and use your own personal bank account as your business piggy bank, it's way more difficult to grow when you don't have everything set up. There's no difference in intelligence. All these guys are extremely smart and are very capable with their hands, but the guys that have that extra business sense can go from a million dollars a year in revenue to 5 million to 10 million and on up. We've dealt with several business owners who have high school degrees, never went to college and have sold their businesses for 12 million, 15 million, 20 million dollars because they had that extra little bit of business sense that made them set their businesses up to grow.
Speaker 3:Mm-hmm, and did they see an attorney from the get get go like? Here's what I want to do. Tell me how to do it, or did they not? Did they just do it on their own?
Speaker 4:Yeah, they all did. You know the guys that knew they needed an attorney, they knew they needed an operating agreement. That's just kind of part of that. Hey, I need to do it right from the beginning. Mindset. You know, you know the operating agreement, the QuickBooks, the bank account, all that stuff. You just have to have the common sense to say I know these are very boring operational things and they are going to be a pain in my butt because I'm not going to be doing a change out or something like that. This doesn't make me any money.
Speaker 2:But it actually sets me up to make way more money in the future money, but it actually sets me up to make way more money in the future. So if I could go back a little bit. Dan, you said a lot there and that was all good stuff, but whenever you're setting up something to where it is separate from a DBA, can you kind of elaborate on that? Why that's so important as far as from lawsuit standpoint? Elaborate on that. Why that's so important as far as from lawsuit standpoint losing you know what you have of value for your personal, what you have personally, versus the business.
Speaker 4:Can you kind of dive into that just a second? Yeah, sure, so when we set up new companies for folks, we set them up as LLCs, that's a limited liability company, and it's called that for a reason, you know it's in the name. You want to limit your personal liability from anything that goes wrong, and so when you have a business that works on people's houses or in industrial or commercial settings, there's always, of course, things that could go wrong. You know there could be a leak of some sort, whether it's gas or water or whatever it is, and you want to make sure that you limit your personal liability from the wrongdoing of yourself or others as it relates to negligence on the job. And the way to do that is to have an LLC, literally a limited liability company that limits your personal liability, literally a limited liability company that limits your personal liability. And so when you set up the company, there's referred to as what's called a corporate veil, and I know we're getting into the weeds now, but this is really important.
Speaker 4:When you have a company and it's owned even by one person, that company is considered separate and apart from that one person, and that gives you that corporate liability protection that you would not have otherwise. So if you're just using your personal bank account and just doing work on the side and just running it through your bank account and getting paid cash, that's fine, it's not illegal. But you have no liability protection associated with that. And then when you add, of course, the added sophistication of having separate insurance for the company, which you have to have when you're licensed and bonded, then now we're talking about extra layers of liability protection with that insurance. That's just a mature way to start and continue to be able to grow your business by adding that liability protection.
Speaker 3:So, for example, if I started the company and I didn't have that LLC, I used my own personal name and just did it myself. If somebody sued me, I could potentially lose my house. Is that what?
Speaker 4:you're saying that's exactly right and that's a perfect example. So hopefully that never happens, right? But yes, if you do something wrong and you screw up somebody's house and they see you for $5,000 or $50,000 or $250,000, you are personally liable, without that LLC, in effect. And so that's the reason you're exactly right, kelly.
Speaker 2:So, with setting up the articles for your business, tell me the difference between, if you're in a partnership, what it looks like, if you are a 50-50 partner, or if you just have 1%, 51-49%. What's the difference between those two?
Speaker 4:Well, we oftentimes see folks who want to start with a 50-50 partnership. So it's two folks, they want to start a business. They say we're going to be equal partners and this is going to be great and we're going to make every decision together, and 50-50 partnerships are actually okay. But to your point, ryan, somebody has to be the decision maker. And so even if you want to split the financial results 50-50, somebody needs to be able to be the deciders quote, unquote. And so sometimes that results in hey, I'm going to be 51 and you're going to be 49. And so we split the ownership differently in order to achieve that decision-making capability.
Speaker 4:But sometimes we would say, you know what, we want to stay 50-50. But, ryan, if you and I started a business, we would say, ryan, because you're the expert in this field and I'm just the investor, we're going to give you the decision-making power on the day-to-day stuff and we're going to give me the decision-making power on the investing side. By way of example, alternatively and we've had some clients do this before they say listen, we want to be 50-50. We want to be 50-50 on finances, meaning we want to split everything 50-50. And we want to be 50-50 on decision-making, meaning we want to make every decision together, but if we get into an argument we want to have a third party, help us break the tie.
Speaker 3:That's great.
Speaker 2:And that can look to like you each have 49 percent, and then there's a two percent ownership for somebody that's maybe crucial to the business, that has the ability to be a tiebreaker in any situation. Have you seen that before?
Speaker 4:We've seen that, yes, when where it's an actual owner of the business, that comes in at 1% or 2% to kind of break that tie. We've also seen it where people pick their CPA and say you know what? You just be the decision maker. If we have to break a tie here, you're not an owner of the business, but we both trust you to make a wise business decision for us, and so you break the tie. Hopefully, what we tell people is, when you do that operating agreement and you're a 50-50 partnership, hopefully when you do that operating agreement you put it in the drawer and you never have to look at it again Because you have to look at it. They pick the right partner at the beginning, they pick the right investor or whatever it is and they put that thing away and never have to look at it again. And that's the best case scenario.
Speaker 2:So, when you said something very crucial there and you brought up horrible nightmares for me the word CPA, nightmares for me, the word CPA. So one of the things that I learned with starting my first business was, uh, you can go to five different, five different people who are CPAs and they will all have different answers and the end result will result in either you having some money left over, having no money left over, having too much money left over, and so uh, kind of uh. What I learned is is that, as you tried to do all of these things, a very good lesson that I learned is is find a good CPA and become very, very good friends with them.
Speaker 4:I actually completely agree with that. Not to be too terribly funny about it, but I actually think about, like, business owners need to know enough about accounting and taxes to. I refer to accounting as the dark arts, 100% Like from Harry Potter defense against the dark arts. You have to know enough about it to understand it in order to defend yourself against what various CPAs may tell you. And Ryan, you're exactly right Five different CPAs will tell you five different things.
Speaker 4:The way I think about it is that there's CPAs that are very black and white, and some of them are all the way in the black, meaning they're going to stay way far away from the line, and some are all the way toward the line and take chances on taxes, and some are in the middle.
Speaker 4:But if you don't know where the line is, you have no idea what they're telling you or how they're advising you.
Speaker 4:And so, especially in trades businesses where you know there's bonding issues involved and you know you have significant AR and you have WIP and all these accounting issues come up at the end of the year. You're exactly right Finding a CPA that has experience in the trades, and preferably even in the trade that you are in, yes, and typically that means finding a CPA that's probably not a one-off or a two-off, meaning somebody that's at a little bit of a bigger firm, who has a little bit of a specialization, maybe in the construction industry, at least that understands how your business works. You think to yourself oh, I don't know if I can afford these guys because they're at a 50-person firm instead of a five-person firm. That firm's probably going to get you better advice and you're going to get a longstanding relationship with them that gives you better thoughtfulness as it relates to your taxes. But you can't just ignore it. You have to teach yourself some of that and make sure that they explain it to you so you understand those dark arts.
Speaker 3:I want to clarify a couple of things you said in there. You're whipping around those dark arts terms like WIP and AR. Tell me what those are.
Speaker 4:Yeah, and so we run into this all the time when we help people sell their businesses. So when you sell your business, ar and WIP are very important Not that they're not important as you're running your business. But AR is accounts receivable, meaning what do people owe you and when do they owe it to you and for what reason do they owe it to you. And WIP is work in progress, so it's not necessarily it's work that you've done that you have not yet billed for is kind of the way to think about it. So before AR accounts rece receivable becomes accounts receivable, it was whip right before that work that was done, work in progress, that was done but not billed, and then once it's billed, it turns into AR. And then once AR gets paid, once you receive that check, it's called revenue. And so it's kind of the three stages of cash creation. I guess you would say in a business WIP, ar and then revenue. And those are crucial. Revenue is what you make every year, ar is what you've billed for and WIP is what you've done that you haven't billed for.
Speaker 4:And the reason we need to pay special attention to that is because in accounting terminology there's all kinds of different ways to handle AR and WIP depending on how you report your taxes and depending on how you report your financials. Some financials are done on a cash basis. Some are done on an accrual basis and that means cash means whenever I get that cash in, I'm going to recognize that cash as revenue. Accrual means whenever I send the bill, I'm going to recognize it as revenue. So it's two different ways to handle your accounting. Fortunately, quickbooks is very easy. There's a little button you press at the bottom that says do you want to do this cash or accrual? But that's a very important thing for people to understand the difference between cash and accrual and the difference between revenue, ar and WIP.
Speaker 2:Yeah, you hit on something there with the QuickBooks.
Speaker 2:One of the things that I found with starting a business and then also being a part of a larger business is those QuickBooks.
Speaker 2:You've got to reconcile those daily Because the difference between the company that, whether you're a residential or commercial HVAC business or electrician or whatever the companies that have the ability to invoice and capture that payment are the ones that have the ability to not just survive but thrive. Where I've also done business with companies that do not do a good job with their books and you receive an invoice you did something work from a commercial standpoint in September and all of a sudden in June of the following year you're getting an invoice and your likelihood of getting paid for that stuff is low, especially if it's a uh, another B, a B2B situation where you're doing business with someone else, their, their books might have shifted over and if that was a million dollar project or a quarter million dollar project or whatever they're like dude, that money was for last year and you get this whole argument and all of a sudden now you're not getting paid, or you're getting paid but it's way later and there's a cost to all of that.
Speaker 4:Ryan, what you're hitting on is kind of the lifeblood of small business. So you're talking about the practical applications of managing working capital, and that's really a crucial thing in small business. If you do not bill with regularity and don't get paid with regularity, you're going to have a working capital problem eventually.
Speaker 4:So let me tell you kind of what that means practically speaking. Working capital has a very easy definition. It's accounts payable excuse me, accounts receivable minus accounts payable as current liabilities. So if you have a long-term accounts receivable or long-term payable, that's not included in it, but short-term accounts receivable minus short-term accounts payable okay, that's the technical definition of it and every website and their brother will tell you that that's what that means. But the practical application of that is vast in small business.
Speaker 4:Think about it this way you do a $100,000 job. Maybe you have $60,000 of costs in that job between labor and equipment that you have to buy and that you have to pay your guys to do that work. If you wait three months to bill it and you don't get paid for another month after that, the time between when you put out that $60,000 and when you get paid that $100,000 is four months. In that case that means you are letting that client borrow that money from you for four months and there's a significant cost associated with that. And so making sure that you invoice on time and with regularity and try to keep your AR paid within around 30 days, which I know is tough in the trades but if you can reduce it to around 30 days.
Speaker 4:That is a typical very good AR capture schedule, working capital schedule that you want to be on. That gets you paid quickly. Lets you not fund somebody else's business by letting it run out too long. Working capital. For every business owner who have ever experienced a cash crunch, it's usually because of working capital have ever experienced a cash crunch, it's usually because of working capital, Yep.
Speaker 2:And so I've seen it to where there are companies that will zero out at the end of every year and whenever they basically zero out their account for tax reasons or however they want to run their business, what they find is that they're having to borrow money to make payroll and all of these things.
Speaker 2:Well, and to your example, if you do that a hundred thousand dollar job, but you're the kind of large commercial business where you're going to do that same job 10 times, well, now, all of a sudden, you are deep into a line of credit, deep into the six figures. Well, there's interest that you have to pay, that you're not accounting for as a business, and I've I've talked with people and they'll once they kind of realize that they were what they were doing. These larger companies. They're spending $300,000 and just interest, and that $300,000 could have done a lot of things. I could have bought new trucks, I could have bought uh, you know, gantry, that you needed they could have bought. You know, gantry, that you needed it could have bought. You know all kinds of things that you needed for your business, but instead you were paying interest on it because you don't invoice. That's exactly right.
Speaker 4:That's exactly right. That's why it's imperative. You know we've you may have heard the phrase before you can grow your business into bankruptcy, and that's the reason you just described is because you can. You can go get a. You can be a five million dollar uh, you know, commercial hvac company that does. You know a hundred thousand dollar, two hundred thousand dollar jobs. And then you can go land. You can. You can go land a two million dollar commercial job. It's your first over a million dollar job ever, but you've got to put out $800,000 of equipment for that job. Well, where are you going to get the cash to be able to do that? And so that's the working capital trouble. And even if you go find the cash, if they don't pay you soon, you owe the equipment manufacturer or wherever you bought the equipment from, and you already paid your guys to do the work. That lag time could put you out of business if you don't have a line of credit. And if you don't have a line of credit, that can fluctuate with your business.
Speaker 2:Yep Cash is king.
Speaker 3:And Dan, you mentioned something I think that is really important is when you do bill, you have net 30 on your invoices. What happens when somebody doesn't pay you in net 30? What can you do?
Speaker 4:Well, our policy is, as it relates to advising clients on that is, making sure that on day 31, there's a follow-up email.
Speaker 3:Okay.
Speaker 4:And on day 45, there's a follow-up phone call.
Speaker 4:You know it's. People understand that. You know they need to get paid. Now, if you've got a vendor that's got an issue that has a financial crunch on their own, that's nothing you can do about that. But sometimes things just fall through the cracks and sometimes people appreciate some follow-up, and so don't be afraid to do the follow-up. You don't want to lose the client because you're being too aggressive with the follow-up, but be thoughtful. Like you said, Kelly, putting net 30 on your invoice is something simple that you can do, and so as your bookkeeper processes your checks, they go oh, this one's due on this day and I'm going to process it 29 days later, so that they get it in the mail 30 days later. Hopefully you never get into a situation where you have to result to collections, which is a big problem, and you're probably not going to get paid everything you're owed at that point but just doing little things like email reminders, which QuickBooks can do automatically, for instance, phone calls if you have to, and then, in the worst case scenario, collections.
Speaker 2:All right. Yeah, I think to add to what Dan said as well you need to be very careful with how you handle that and be thoughtful with that. And the reason why is is because, if you're the person that is quick to take somebody to collections, that's going to get around and you also want to make sure that, uh, you've exhausted everything else before you take it to that point, because it could be a situation to where you know the person that normally does it, they've been out on maternity leave and it just slipped through the cracks. So you want to make sure that you exhaust everything before you go down the road of legal action.
Speaker 3:Remember the human element to all of it.
Speaker 2:That's right. So, dan, if I could transition a little bit so you've started this business, you've grown it, you've put your 10 years, 15, 30 years into this business you have. This is your child, okay, and now it's time to sell it or pass it on to the next generation. Uh, and I kind of want to go down those two different roads. Which one would you like to start with?
Speaker 4:We can start with the sell in it, since that's what you said first.
Speaker 2:Okay, so you want to sell your business. You think that it's worth $20 million, and then you come back and you crunch some numbers and then you say, uh, your, your company and you say it's only actually worth $8 million. Why in the world did I think it was 20? All right, and then why in the world did you find out that it was eight? How do you figure out the value of a company?
Speaker 4:Yeah, great question. Well, in the scenario that you painted, you know, everybody thinks that their baby is the prettiest baby of all time Right.
Speaker 4:And so there's that part of the psychology of owning a business right. And then, on top of that, there is always rumor out there well, so-and-so sold this, their business, for x, and so mine must be worth y, because so-and-so sold his business for x, even though you don't really have any idea of what his underlying numbers were. And so, realistically, you know what. What you need to do is get somebody who knows what they're talking about to give you an estimate of value for your business before you decide to sell it. So typically in the trades, you know, depending on the size of the business, if we start with the commercial sides of things, those businesses trade for four to six times EBITDA, anywhere between kind of half a million dollars of EBITDA up to, let's say, $3 million of EBITDA, kind of that lower middle market, and that would be produced by a company that maybe has between $15 and $20 million of revenue, that top number, that $3 million EBITDA number. So let me give you an example.
Speaker 2:Hold on you can't go on yet.
Speaker 4:You got to tell everybody what's EBITDA mean? Great, yes, good question. It's funny you say that because most of our clients don't know what it means and they actually don't care and never had to care until they sell their business, and that's completely fine. Ebitda is earnings before interest, taxes, depreciation and amortization.
Speaker 2:Okay, and you're going to have to explain what those mean.
Speaker 4:Yes. So you can sort of ignore the ITDA part, really, because here's what it really means. Here's what it's boiled down to Earnings is your net income before any other financing activities. That's what the ITDA is. Interest taxes, depreciation and amortization are financing activities of the business, meaning you're not paying guys, you're not buying equipment, you're not paying your bookkeeper, you're not doing all the things that run the business. All these other pieces are financing related. And so when you scrub out the financing impact of interest, taxes, depreciation and amortization, that gets you your earnings number, your true net income. That is referred to as EBITDA for operating businesses.
Speaker 2:So net income is the number, is the money that basically you have left over after A lot of people think that net income is okay. I've done this job and I've paid for the crane, I've paid for the rooftop unit, the curb adapter, the electrician and my guys to install it, and that's the money I have left over. That's not correct. That's actually gross profit or gross margin, right, that's correct. And then you have to take into account all the little things the lights inside of your building, the fuel for your vehicles, the rags that you used, everything down to the last penny. And then, after all that's paid, then that is the net income, and then the owner is going to be paying themselves. So that's not even a part of it as well. The net income is even after that as well.
Speaker 4:That's correct. Yeah, think about it. All the rent, you know, all the trucks, every, you know your copier machine, everything that goes into the running of the business comes out before you get to net income, including the owner's salary, if the owner is in fact paying themselves a salary.
Speaker 2:Yes, Okay, sorry, so I took you down a rabbit trail. Ebitda has now been explained. Do you remember the example you're about to give? If not, that's okay.
Speaker 4:Yes. So we had a client one time. He was an $18 million revenue company and this was a perfect example of a guy by the way, high school degree just learned how to turn wrenches. Basically, when he was in high school, started his own company and grew it from nothing to $18 million of revenue over 16 years. Phenomenal guy, phenomenal story.
Speaker 4:Well, he had around $900,000 of net income when we got to him and we thought, well, for this size company, $18 million of revenue, $900,000 of net income, that's kind of low. Actually, the margins, the profit margins or the EBITDA margin, if you want to look at it that way probably need to be between 15 and 20% in that business. And so he was spending money somewhere that we didn't quite get. And so we took his net income and we realized we added back. He was running $1.1 million of personal expenses through the business every year. And so you also, when you get to EBITDA, you add back any personal expenses. So if your company is paying for your family's phone, your daughter's vehicle, you know, your beach house even I mean people run crazy stuff through the business Any personal expenses that you're running through the business get added back to EBITDA. So you start with your net income. If we're going to build back to EBITDA, so you start with your net income. If we're going to build back to EBITDA from net income, you start with your net income, which is what everybody refers to as your bottom line. Right, that's literally the bottom line of your profit and loss statement. That's why they call it that. Then you add back all of your personal expenses on top of that.
Speaker 4:So in this guy's case he went from $900,000 of net income to $2 million of adjusted EBITDA excuse me, adjusted net income. Okay, so it's net income on your P&L plus your personal expenses. He got the 2 million. Now we do the EBITDA adjustments. So we take that net income number, that adjusted net income that got up to $2 million. Now we do the EBITDA adjustments. So we take that net income number, that adjusted net income that got up to $2 million, and we add back interest, taxes, depreciation and amortization and in his case he had $700,000 of those three things, most of which was in depreciation. So we got from $900,000 of net income to 2 million of adjusted net income, to 2.7 million of EBITDA. Now think about the difference in the value of the company If we're talking about a six times multiple. Six times 900,000 is a lot less than six times 2.7 million, right?
Speaker 2:Just by doing that calculation seven million right just by doing that calculation. That's interesting. So, uh, with taking that business that you are trying to sell, you've you've talked about this multiplier of eboda. How do you evaluate that the company x should be three times eboda and how do you evaluate that another company should be three times EBITDA and how do you evaluate that another company should be eight times, just for example, of EBITDA? How do you justify the multiplier?
Speaker 4:Yeah, great question. So people ask that actually all the time, and so there are really two main factors. Don't get me wrong. There are actually dozens of factors, of course, right, but really the two main factors are the size of the company, meaning the size of your revenue and the size of the EBITDA, and then the percentage of recurring revenue. So the bigger the company, meaning the higher the revenue and the bigger the EBITDA, the higher the multiple is going to be. So let's say all things are equal. Otherwise, and you have a $20 million revenue company with $4 million of EBITDA and a $1 million company with $200,000 of EBITDA the $20 million revenue company with $4 million of EBITDA, that might be worth seven or eight times depending on how much recurring revenue they have. So that company might be worth seven or eight times, depending on how much recurring revenue they have. So that company might be worth as much as $32 million or even more, depending on where it's located, because geography plays into that as well. But the million-dollar revenue company with $200,000?
Speaker 3:of EBITDA, you're probably looking at $600,000, maybe $800,000 of value in that company, at best, just based on the size difference. And so why would say I'm looking to buy a business, why would I be interested in that recurring revenue piece of it?
Speaker 4:So the recurring revenue piece is the other main factor in what drives a value of your business.
Speaker 4:So if you think about it this way, if you have recurring revenue, that means you can count on that revenue recurring year over year, meaning it's steadier, meaning you are more likely to be able to get financing to fund the purchase of that business and therefore you are more likely to be able to pay more because the bank will see the recurring revenue.
Speaker 4:However, on the other side of the coin, there's a lot of businesses in HVAC and kind of the trades that we talk about that are project based and don't do any recurring revenue.
Speaker 4:They don't do any service or anything else and they just do projects, and those projects are always going to be one off.
Speaker 4:You know, once you build a building, you're done building that building and unless somebody you know builds another building the following year, that revenue is gone and so you're always having to fund new projects and because you're funding new projects annually, that revenue is worth less than the recurring revenue because it's less sure and so you can't borrow as much money against it to buy that company and therefore the purchase price is always going to be lower, and so the higher the percentage of recurring revenue and then the higher the revenue itself, the higher multiple you're going to get. And then the higher the revenue itself, the higher multiple you're going to get. So, by way of example again, if you're talking about a $20 million EBITDA excuse me, a $20 million revenue company with $4 million of EBITDA, and it's all project-based you'd be lucky to get four to five times for that business, probably. Again, depending on where it is and who the leadership is, and all these different little factors.
Speaker 4:But if it's a hundred percent recurring revenue, oh my gosh, people will be falling all over themselves to buy that business. I mean, we're talking about 10 or 12 times. If it's 100 recurring revenue now we're talking about a, you know, 40 or 48 million dollar business.
Speaker 2:At that point, so we've talked about large or mid-sized companies right in the grand scheme of things, but as far as the average person, those would be like really big numbers. So if I'm a million dollar company, $800,000 revenue company, and it's me and a nephew and my next door neighbor and we're running this business, but I'm the owner of it and I've decided that I want to sell it because I've done everything I can in this business and I'm ready to hang my hat up and retire, how and I come to you, dan, and how would you instruct me to make the company as valuable as possible?
Speaker 4:Yeah, that's a great question. So kind of along the lines of what we just talked about. It's really those service contracts, that recurring revenue service contract work, that's going to get you the highest value. So even at the size that you're talking about, Ryan, you know, maybe you're doing a million of revenue, maybe you're doing two million of revenue not a particularly large company. Maybe you're doing a million of revenue, maybe you're doing two million of revenue, not a particularly large company.
Speaker 4:But if you have your uh sticker on the side of uh, you know the guy's refrigerator and when something goes wrong they know they've got to call you. That's worth something, right. So that phone number connection is worth something. That client list is worth something. Even more valuable than that is the service contract, the actual contract that you have that says for the next five years we're going to come and replace your filter and we're going to do some adjustments for you, and so the more service contracts you have, the more value you create. So even if you're a small company or you're doing a small amount of revenue, if you can focus on getting those service contracts, you will increase the value of your company exponentially.
Speaker 2:So what if the company lives and dies by me? In other words, I am the company. How in the world do you sell that and what should you do? How do you sell that? And then, what should you do, maybe to make it to where the company passes the bus test? And you know what the bus test is is. We're basically if OK, kelly. So the bus test is, if something were to happen to the owner they get hit by a bus today Would the company survive tomorrow? And that's that's kind of the question that I've always asked is, when people are talking to me about businesses, is you know, will it pass the bus test?
Speaker 4:Yeah, yeah, I'm very aware of the bus tests, so the way to think about it is is kind of along the lines as I just described, right? So there are lots of buyers out there these days for small businesses, even the size of businesses that you're talking about, ryan right so a million to two million dollar range.
Speaker 4:and even if the business itself would not pass the bus test meaning if it didn't sell, it would just kind of fall apart when the owner got hit by the bus that doesn't mean it's not sellable while the owner is still alive because of those service contracts and that recurring revenue. So you can sell your business if there's a higher percentage of recurring revenue. But if, for instance, if you're just doing a million dollars and you're only ever doing new construction and you have that one relationship or that two key relationships with home builders for instance, and you don't have any service contracts after you install the system, then you have a very business that is not particularly valuable because you cannot pass the bus test.
Speaker 4:in that scenario, but, again, it's the service contracts and the phone numbers that are valuable.
Speaker 2:Mm hmm, and not just that, dan, but you can start to get to where you are no longer a treadmill operator is a term that Dave Ramsey uses in his Entree Leadership podcast and books that he has to a trailblazer, and what that means is is to where you're basically pulling yourself out of the weeds and you're making it to where the company has the ability to operate.
Speaker 2:In the event that you decide that you want to take a vacation for a week, uh, and that that's one of the ways that you can find out if your company's running well, is is if you step away from it, does it continue to operate? And what I find, especially in blue collar businesses, uh, is that, um, is that the uh owner operator is in the weeds every single day and they can't pull themselves out of it or won't allow themselves to pull out of it. So, uh, dan, what if, uh, you don't want to sell the company, that you want this company to be a legacy for your uh, the next generation and the generation after that and the generation after that? And your hope is that, when you are long and gone, that somebody, somewhere, is celebrating the hundred-year celebration of this company being owned by your family. How do you set that up as a legacy to next generations?
Speaker 4:Yeah, great question. So I think the question there. Really, there are a number of legal mechanisms you can use to do that, but from my perspective, the most important thing is really setting it up from a psychological perspective. That's really the key. To start with, the tax structure and the legal structure follow the psychological portion of it. Here's what I mean by that. So if you're 65 years old and your son is 30 and you want him to take over the business from you at some point, you have to make sure that he's going to be ready to run the business, and so there are a number of things there right? So if you run an HVAC business, he ready to run the business.
Speaker 4:And so there are a number of things there, right? So if you, if you run an HVAC business, he needs to understand the nuts and bolts literally of everything that you're doing, because he's probably, if you're, of a smaller size still, he's going to need to be able to understand how the guys in the field work and make sure that he can handle, you know, questions and comments and thoughts and problems and subbing in if he needs to, if people are out sick and all those sorts of things. So prepping your son or your daughter in that case to make sure that they can handle the day-to-day of the business is key. But then there's the overarching, like the business training that I was talking about earlier. Just like when you start a business, just because you know how to turn the wrenches doesn't mean you're good on the business side, and so making sure that the son or the daughter that's going to take over the business understands the business side, the HR, the finance, the accounting, the QuickBooks, all those pieces and parts is critical.
Speaker 4:The best advice I ever heard there is for those business owners who really want their child to take over their business and really dig in and do a good job if that child has an interest in it. You should send them out of state to someone who's in your business and have them go work for somebody else you trust for a year or two years or three years and then, until they've learned that business, they can't come back. That's great advice. That's the biggest piece is do they have the maturity? Because some people don't.
Speaker 4:We've seen it repeatedly where, hey, I'm 65. I want to hand it over to my 30 year old. The 30 year old just sees this thing as a cash cow. He likes spending the money, but he doesn't like doing the work or he doesn't understand the work. That's a worst case scenario, because your team will not respect that guy because he's not rolled up his sleeves and figured out how to do this business. Yep, you send them away to somebody else who doesn't care whose son it is, and if they do a really good job for that guy and then come back, they will have earned the respect and that's really the key. The legal mechanisms will follow the respect that the son or the daughter can earn, that they gain by doing a good job in somebody else's business.
Speaker 2:Good information. So to transition now from selling and I've always had this entrepreneurial itch I have zero desire to start up a business. What in the world do I do if I want to buy a business?
Speaker 4:Yeah, good question. So, because of what, the baby boomer generation is in retirement mode and more are heading that way every day there are lots of businesses for sale. My recommendations for folks who are looking for businesses are to prepare yourself to be able to do that. And so if you want to buy a business and you have a little bit of money saved up to where you can put down a down payment of some sort, go talk. The first thing I would do is go talk to an SBA lender, small business administration lender okay, the SBA funds small business acquisition loans to the tune of hundreds of millions of dollars every week around the United States.
Speaker 4:And going and speaking with an SBA lender in your community, or just some of the largest in the country. For instance, Live Oak Bank is one we send people to all the time. Live Oak is, I think, the second largest SBA lender in the nation and they will lend you the money to go buy a business with only 10% down. And so if you buy a business that's worth $3 million, you only have to have $300,000. In some cases and the scenarios differ you may only have to have 5%. So if you buy a business that's worth $300,000, you may only have to have $150,000.
Speaker 2:And here's a trick that I actually learned recently is that you can actually take your 401k money and you can have it to where you turn the business you want to buy I think into an S-corp I can't remember if it's an S-corp or a C-corp and basically you're buying the stocks of that company with your 401k money and you have to make sure you have the right people involved in that, because it is a very tricky thing, but if you can get it now, there's a lot of rules that are associated with it, but that is a route that you actually can take that's exactly right.
Speaker 4:We have a client who actually did that um and bought the company for three million, and now it's worth 15.
Speaker 3:awesome there you go, so his 401k looks great.
Speaker 2:His 401k is rich, not necessarily him. So in buying a business, let me ask you this what if you are willing to work your face off and you have all the desire in the world, but you have no money? Is there any way possible for you to be able to buy a business?
Speaker 4:Yes. So if you're in that scenario but you are gung-ho, got a ton of energy, know kind of the ins and outs of your particular business that you're in, let's say you've been in whatever trade you've been in for 10 years and you're 32 years old and you just have that entrepreneurial spirit but you haven't saved up any money. You can partner with an investor to go buy a business and the investor can provide that down payment. But they don't have to have any involvement in the day-to-day business. And so, for instance, in that scenario that I painted earlier, let's say there's a business out there that's worth $3 million and you need $300,000 for that 10% down payment. That investor can provide that $300,000. You don't have to provide a dime and you can still go get an SBA loan to buy that business.
Speaker 4:The SBA doesn't have a problem with that and that gives you the opportunity to get started with an active business with active revenue that can cash flow the debt payments on the SBA loan. And then the only nuance to that is you of course have to figure out your deal with the investor. Does the investor get paid back first? Does he get an interest rate? What's the split of cash flow that you have with that person, so it's a little bit more complicated. But the nice thing is is you got to come to the table with zero and the investor brings all the cash.
Speaker 2:So what if you befriend a person who owns a company? Is there a way that you can buy out that company over time from that from the person who owns the company? Like, basically, your net income can go towards buying the company out.
Speaker 4:Yes, and we structure deals like that all the time. So let's say there's somebody in town who has a $10 million business and he really likes you and you really like him and he doesn't have a son or daughter that he wants to transition it to, but he also just doesn't want to sell it to the highest bidder because he wants his people taken care of. In that scenario, what you can do is set up a long-term purchase where you agree on a purchase price, but that purchase price is paid over seven years, 10 years. We're setting one up right now where it's going to be paid over seven years, 10 years. We're setting one up right now where it's going to be paid over 15 years and it's just paid little by little over time and the seller gets his annual or quarterly payments and the buyer slowly buys in over time and the business transitions over time.
Speaker 4:And you look up one day and the seller is very happy because they got what they wanted. Their guys are taken care of, nobody got fired, the business is humming, it's still locally owned and they've got their money in their bank. And now you've changed the life of this young entrepreneur who didn't have any money but they made sure that they treated the employees well. They ran the business, they grew the business and they've paid that person off over time. So you've changed the life of the person that exited and you changed the life of the person that came in and bought the business.
Speaker 2:I tell you you hit on something there that the employees are happy. You know, the people that I've seen that do the best job with growing businesses and transitioning businesses are the ones that are humble and they have a servant's heart. If they have those two things, it's incredible, uh, what they can do with those businesses and have a transition with those businesses, because they're doing what's best. They're doing what's best for their clients, they're doing what their customer base, they're doing what's best for their employees and and it's a beautiful thing when it works out that way- Well, you just hit the nail on the head, ryan.
Speaker 4:I didn't say this earlier, but the name of our company is Purpose Equity, where we help people buy and sell businesses, and so the purpose is really the key, right?
Speaker 4:The people that only want to sell.
Speaker 4:When we work with people and they say the only thing we care about is selling for the highest number, that's a red flag for us, because selling for the highest number typically means something bad is going to happen after the sale.
Speaker 4:I can't tell you what it's going to be, but usually the highest number results in, you know, financing issues or they got to fire people to make sure that they can make the debt payments or whatever. And so making sure that your people are taken care of, having a heart, a servant's heart, for the future of your business, is really the key. That's frankly why we call purpose equity purpose equities, because most business owners if it really, if you really boil down they care about the future of their business, they care about the legacy, they care about their people and they want their people to be taken care of. They need to sell their business to retire Don't get me wrong. They've got to monetize it, but it's really about the people, and so we can find that balance between the right purchase price and the taking care of the people. That's really the best scenario.
Speaker 2:Very good. So we are getting close to running out of time and I want to make sure I'm mindful of your time. But before we get off, could you tell us a quick story about how maybe a merger or a purchase or a sell just went completely wild?
Speaker 4:Yeah, it's actually the most recent one we did. This one is particularly interesting. So it was two guys. They owned a company in the trades together and they were 50-50 partners and they owned the company and grew it very quickly over the course of six years, but over that course of the six years they actually grew apart to the point where they weren't speaking to each other at all, and so they were 50-50 owners and they did not talk for the last six months of the transaction.
Speaker 4:Wow, wow, yes, that's not ideal. And so the scenario was how do we get them to sign the same letter of intent to sell the business and then to sign the documents to actually go through with the sale of the business, when they're at odds with each other and they might not agree on terms or price or valuation or any of the pieces and parts? So what we did in that scenario is we made sure that the guy who was leaving got what he wanted. The guy that was staying was taken care of with a new partner. The guy that was staying was taken care of with a new partner. So let me paint the picture with a little bit more specificity. This was a business that was for sale through us, through Purpose Equity, they ended up getting around six times three-year average of EBITDA. So they were kind of a mid-sized business between two and three million of EBITDA and so they got a great purchase price.
Speaker 4:But the best case scenario actually happened there because these guys were at odds with each other, right?
Speaker 4:So they were going to. That friction between the two partners was going to limit the growth of the business and not only limit the growth but, frankly, probably depress the growth of the business to the point where it was going to fall off and die. So instead of wasting that value right, that would be a waste of all the time and effort associated with growing to the business to the point they grew it we found the right partner to come in and take out the guy that wanted to leave, subbed in the right partner, which was a private equity group out of Austin. That guy is a great partner for businesses in the trades and he has given the guy who stayed much more vim, vigor, access to capital, financing, back office help, refreshing QuickBooks, refreshing marketing, all the different pieces and parts. And so we went from a terrible scenario where those two people were those two guys, those two owners were going to drive the business into the ground because their relationship was deteriorating, to refreshing the business. And now everything feels fun and new and they are growing like crazy.
Speaker 2:I tell you, dan, I could talk to you for another hour about this stuff. There's, there, there is, there is other things that I didn't even get a chance to hit on, so maybe we'll have to get you back on. But, dan, if folks are interested in buying or selling a business, how in the world do they get in touch with you? Great, question.
Speaker 4:So again, my name is Dan DiAlberto. You can find us at purposeequitycom. That's our website. Our phone number's on there and you can even email me at danatpurposeequitycom as well.
Speaker 2:Very good.
Speaker 3:I love it.
Speaker 2:Man, I really appreciated this. Kelly, did you learn a lot today?
Speaker 3:I did learn so much, I feel like I should buy a business right now.
Speaker 2:Go do it, I dare you.
Speaker 3:I'm going to call Dan right after this. Come on let's go.
Speaker 2:Oh, that's funny. Well, thank y'all so much for listening in today. And, kelly, what should folks do?
Speaker 3:They should like. Follow and subscribe to HVACology.
Speaker 2:Excelente and for those of you who don't know Spanish, that's excellent and I am grateful to have you guys out there and thank y'all. That's another one for HVACology, goodbye.
Speaker 3:Bye-bye.
Speaker 1:Bye-bye. Took a rocket past Saturn. Things don't seem to matter much to me anymore. Got lost inside a daydream, get sick of all schemes they play on their machines. Lost so many words as I got older. You would have thought I was a storm in a mind of love. I accidentally wrote these words down, thought all the best of me faded in an empty sea. But you always bring me back. It's in blue eyes. Twenty years of staring at that freckle On your left shoulder. Who would have thought all I needed Was to think of you To bring back the words inside? But you always bring me back. It's your blue eyes. 20 years of staring at that freckle On your left shoulder. Who would have thought all I needed was to think of you to bring back the words inside of me? I drove an hour to see you. Things just seemed to matter more to me anyway. Got lost in reality. No answers to cancer. We never got to talk. Lost so many friends as I got older. Wish I had the strength to hold you a little bit longer.
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