Host: There are many, many businesses for sale out there, but the majority of them probably do not actually make good acquisitions for the loan acquisition. Entrepreneur Ryan Doyle understands this well. Ryan is himself a searcher in the trenches right now, looking at listing after listing, trying to find the right business. Heather Andresen is a lender who specializes in SBA loans for searchers and has been closely involved in countless search acquisitions. The both of them Ryan as Searcher and Heather as Lender Join me today to share a list of criteria you should use to quickly dismiss a business that would not make for a good acquisition. Quickly being the operative word. It's easy to waste weeks and even months of your life on a potential acquisition that a more experienced person could have told you, hey, this is a problem with this business that you should have seen at the outset and moved on. Here are Ryan Doyle and Heather Andresen to explain what some of these problems can be. Welcome to Acquiring Minds, a podcast about buying businesses. My name is Will Smith. Acquiring an existing business is an awesome opportunity for many entrepreneurs and on this podcast I talk to the people who do it. August Felker is a two time successful searcher, first with a traditional search fund. The second time around he did a self fund. Today August runs Oberle Risk Strategies, an insurance firm with a dedicated practice group for searchers and acquisition entrepreneurs like you. If you've got a business under loi, Oberle will provide complimentary due diligence on that business's insurance and benefits program. A great no risk way to get to know August and team. They love helping searchers. They've worked with hundreds. Oberle is a specialty insurance brokerage for searchers by a former searcher. Check out oberle-risk.com O B E R L E- risk.com link in the show notes. Ryan Doyle and Heather Andresen. Thank you both for joining me today on Acquiring Minds.

Guest 2: Thanks for having us.

Guest 3: Thanks for having us.

Host: Ryan, you are a searcher. You're actively out there in the trenches looking for a business to buy. Heather, you're director of the search lending practice at Live Oak Bank. So so you are working week in week out to help searchers get loans, usually SBA loans to buy businesses. What we're gonna talk about today is time killers in search and how to avoid them. So time is so precious in search, particularly for full time searchers like you Ryan, because full time searchers are often not earning income as they search, not to mention spending money on deals which is expensive. So you've got your life burn rate plus deal costs and it adds up very quickly. So anything that we can do to become more efficient as searchers is extremely valuable. And one of the biggest areas to become more efficient is learning when to pursue the deal you're working on or to discard it and move on to the next. Understanding the time killers that we're going to cover today will help you do just that. Ryan, you are the original author of this list of time killers, but start us off with a quick bio on you. Elaborate a little bit on what I've already said, and then tell us about the genesis of this list of time killers.

[3:40] Guest 2: Sure. And thanks again, Will, for having me on. So I'm a little bit of a finance journeyman. I spent about 15 years on Wall street across variety of different roles. Started in pe, moved over to a boutique investment bank, and then from there I spent some time at a rating agency while I went to business school on Saturdays. And then after graduation is where I really shifted to a more traditional investment banking track. I'd say the one common thread. It's definitely not a linear path here, but I basically focused almost entirely on financial institutions. And so that's kind of where it created a lot of opportunity for me through, through all these different firms. Gained a lot of interesting roles and responsibilities through that process.

Host: Okay, and what led you to search?

Guest 2: So I've always kind of been, I guess, interested in entrepreneurship. I'm from a family of small business owners, have fond memories of spending time at my dad's office and warehouse, going to conferences, and had flirted with the idea of doing something more entrepreneurial in business school. Tried to kick around a few different ideas with some classmates, but nothing really took off and just always felt the need for more capital, really get something going on my own. And then after I graduated, I basically financed my business school degree and I had this really specific industry expertise that I really wanted to leverage. And so I really just went to work from there and focused on that entirely for seven years or so until it's kind of cliche. But essentially I was flying back to New York. I was traveling still through Covid, and I had the Buy then build book everyone talks about. Had this bad habit of really this kind of a banker move I could imagine. But I just bought lots of books on Kindle that I never read. And then this one somehow made its way into my library and I just had read it and I was like, wow, this is. It's interesting because I'd spent my entire career working with banks, spent a lot of time in credit lending Obviously knew the sba, but I didn't know that you could finance an acquisition with an SBA loan. And the capital that's required to do that was kind of within my reach. So there's this kind of light bulb moment. And so did a little bit of networking with folks that had done it from my business school class. Vaguely remembered a few people talking about it at the time. It wasn't that big back then. And then. Yeah. Then after that year's kind of bonus cycle, I decided to kind of pursue this full time, 100%.

[6:25] Host: So none of the folks that you'd learned that you'd met in your career post business school ever talked about this? This wasn't in the air at any of the financial firms that you worked in?

Guest 2: No, no. And there weren't any classes when I was in school about it. I do remember people talking about it at lunch one time, like vaguely. But then there's one person that I knew well, actually that I got along with really well that was doing it and I just didn't know what it was called. And he was, he was basically rolling up landscapers out in California for since graduation. So I touched base with him and, you know, got a little bit of a lay of the land.

Host: Heather, I want to get you in here as well. I think 99% of the people listening to this will already know you and Live Oak, but, but indulge me anyway and just give me a quick tell the people who you are, please, for that 1% who doesn't know.

Guest 3: Absolutely. This is Heather Anderson. I'm co director of sponsor finance for search fund lending for Live Oak Bank. We have a vertical in the bank that specializes in providing both SBA loans and conventional loans for self funded searchers and traditionally funded searchers to buy a small business to become the CEO of Great.

Host: And Live Oat bank is just a huge name in the space. They're really kind of top of the list for many searchers and they put out a lot of content and in fact, hey, Heather and Ryan worked. Ryan originated this list and we're gonna hear about that in just a second from you, Ryan. And then Heather and Live Oak worked with Ryan to actually publish this as a formal piece of content. And we'll of course link in the show notes and all that. Ryan, so I wanna hear about your search, but just, I don't wanna bury the lead here. So tell me about the origination of this. Where'd you come up with this list of time killers and then take us

Guest 2: into your search yeah, sure. So actually I was working on a deal that just had died and this is a little bit part of my morning process where I'll go through really just mostly my email box and just kind of fill out a database that I keep of deals that I've looked at. And one of the data fields is why I killed it. And I just started noticing these patterns where I was just like this is kind of crazy how much garbage is out there. And so I kind of put it out there in Twitter just to see if other folks were thinking the same or come across the same. And then also just curious if there's others that I hadn't been identifying as key time killers that people can contribute.

Host: So this list is actually 15 items long. We're not going to get to all 15 today, but we're going to get about halfway through the list. So what you found in your spreadsheet of deals that were, that were dying or that you were moving beyond, do they just some of the same, same reasons jumped out again and again. And is the, is the list ranked like, is number one the most common time killer on down?

[9:20] Guest 2: Maybe, probably. I, yeah, I think I kind of, I wrote it more to flow. I think there's some things that dovetail so. But I would definitely say just, I mean looking at the list, we're going to talk about valuation first. That would probably be number one. Yeah, sure.

Host: Great. Okay. And just before we get into the meat of this list, just tell us a little bit about your search. When did you start? How long have you been doing it? Size, industry, any geographic constraints, all the top, top line points about it.

Guest 2: Yeah, sure. I would characterize myself as really a non traditional self funded searcher. I'm more geographic focused. So coastal Southeast Dallas, Houston markets and then I like to say Mountain west, but that's really been passive. I actually haven't really been actively searching in there, but it's essentially places that my wife and I would like to live. And in terms of industry, it's a little bit of the cliche positive characteristics that you expect with searchers to look for. So evergreen stable growth, stable margins, low capex requirements, you know, recurring revenue or repeat business, sticky diversified customer bases, fragmented markets. But ultimately I'm looking for like GARP types of investments, so or opportunities so growth at a reasonable price. And then that really has led me to probably some of the more popular search sectors. Services businesses within residential, residential services, light manufacturing, some commercial services, and then have looked at a few kind of niche industrial types of services and how Long

Host: have you been at it?

Guest 2: About a year. A little over a year now.

Host: Okay, and how would you say it's going? How are you feeling? Let me take your pulse here.

Guest 2: I'm not gonna lie, it's as advertised. Search is tough. It's not easy. It's definitely finding a needle in a haystack. Numbers game, a bit of a grind, but with lots of ups and downs. It's really, you know, it was one thing I think I anticipated going in, obviously working on deals I had understanding that a lot of it's very challenging to get a deal across the finish line even in corporate world. But I think it's even harder in this part of the market. So, you know, it's. And it's difficult not to get emotionally invested in a deal that you're excited about. But other than that, I mean, I'm really trying to enjoy the process and it's really been great meeting new people, learning new business models. Especially someone that's been so hyper focused on one industry for so long. It's just refreshing to dig into other types of models. And I've gotten close on a few things that's given me hope, a couple things currently in the hopper. So cautiously optimistic. But it's always one of those things that searchers are always thinking about, how do I fold the top of the funnel? So that's something that's always top of mind for me. Never could really relax.

[12:27] Host: You say it's as advertised, it being difficult. Is anything more or less difficult than you expected or is it pretty much the lonely slog that you thought it would be?

Guest 2: Yeah, I'd say one thing that I guess is a little bit more difficult than I anticipated was really just getting a deal to, you know, to get under loi. Really this negotiation process has been especially for proprietary outreach deals where there's just a huge amount of, there's just a lot of education into the seller. You know, there's not a lot of sophistication, not surprisingly, but you know, you just find yourself spending a lot of time explaining really basic concepts and then it's. And you're also trying to sell yourself for them to think of you as a steward for their business. And you know, that's, that's something that I kind of anticipated but not didn't fully appreciate until until now.

Host: Yeah. And. But you're still feeling the proprietary is worth your time? Because I just, I feel like I've talked to so many self funded who try it and then ultimately are like, you know, it was just the response rate was so low. You know, if I had just invested all the time I was doing in proprietary into, you know, in my broker relationships and filling my, filling my funnel through broker, broker deals, but just kind of enhancing my brokered outreach, I might have been more successful. But how are you thinking about this in this moment in time?

Guest 2: Yeah, at this point I'd say in terms of deals that excite me or interest me, it's probably 2/3, 1/3 proprietary source versus broker. And I'd say I think you have to kind of do both because the proprietary outreach is just such a slow burn that there's going to be times where, you know, you, you send out 25 letters or 25, whatever your process is for reach out or outreach. There's just going to be downtime where you might as well be looking at deals. And then there are, there are occasional deals that come from brokers that are interesting. You just have to move quick and it's going to be competitive.

Host: Yeah, okay. Thank you for all that, Ryan. It's really, it's so many all, essentially all of my guests are people who have already completed their search. So it's great to have somebody on who's, who's in the thick of it. Let's get into this list. So again, these are time killers in search. And if we can figure out, we as searchers can figure out how to, to really reduce the time that we spend on, on a bad deal, we'll be ahead of the game. Number one you have is, as you said, Ryan, is valuation. So what do you mean by that? How is, how can valuation be a time killer?

[15:10] Guest 2: So I mean, I think everyone goes into this search, reading the books and what you read on Twitter and there's kind of this bogey of 2 to 4 times SDE or even EBITDA. And the reality is most of these deals that go to market are rarely priced at that. And it's just a highly inefficient market. Pricing's all over the place. And we're also in a really unique time with COVID And so earnings are very lumpy. And so where you have a business that might be listed off of a headline EBITDA number that, you know, four times it might be up 100% year over year pre Covid. And it's really an eight or nine times business if you try to think about, if you look past or through the cycle or what it looks like on a normalized basis. And I've just, it was also, that's another thing that I found pretty surprising is you could have that conversation with a broker and they'll just be very emphatic about the valuation being, you know, completely competitive and there's a market for it, but then you'll see it sit for six months. And I think that's also. I think a lot of these challenges in these time killers is sort of related to this inefficiency of the broker model. There's some obviously proprietary challenges that you'll face, but brokers are generally happy. And by the way, not all brokers are created equal. So some great brokers on Twitter that I've met and a couple that I've interacted with through this process, but they're content, kind of keeping a diversified portfolio of listings and letting it sit and basically fishing expedition. So as a searcher, you got to have a little bit of discipline and then you might want to be tempted to reach out, which I actually don't think it's a bad idea to reach out and kind of submit some level of interest and hang around the hoop because I do think opportunities come from that. But really don't spend your time spinning, doing a sort of analysis on it in the meantime.

Host: And so essentially just write off a business whose valuation is outside of that 2 to 4 or that's where you save time and. Or make sure you look at the, you know, when you're looking at the revenues, if there was a Covid effect, a positive Covid effect, quickly look for that so that you can kind of normalize revenue and then see what the valuation is in normal times and make sure again that it's worth your time and it's at a fair valuation. Is that the opportunity to save time here?

Guest 2: Yeah, I'd say that's fair. Yeah. I typically won't even reach out to a broker if it's five or six times sde, because I know it's only going to get worse once you start digging into it. But, yeah, I think what you said makes a lot of sense.

Host: Heather, do you see valuation being a time waster for any of your searcher clients?

Guest 3: Definitely. I totally agree with Ryan that sometimes you just need to let a deal sit. They may be on a spot fishing expedition. So we'll often, as bankers, see that same deal, you know, 912 months after the first time we saw it. So that tells us something too. It was on the market for a long time. Maybe the second time we see it, the valuation has come down. But ultimately, yeah, it's a 2-4x market and anything priced above that that's a small company is probably going to be a waste of your time. And I think the normalization of EBITDA is also really important point. We're going to size debt to normalized ebitda and so we're not really going to tell you what you should pay for it. But given there's, if there's a big delta between normalized EBITDA that we size debt to and what you're paying for the company, that's all paid for with equity. And then you need to plug that into your return on equity or invested capital model and decide if that's worth it to you. And I think that's usually a, maybe a fast way to get to a. No.

[18:57] Host: Yeah, yeah. I mean one of the things about valuation, if you're, if you're planning to do kind of a standard structure of 10% down or 15% down and then 10 or 15% seller note and the rest in SBA loan, I mean there is an, there's an anchoring effect that the loan for you guys, for the loan to pencil that means that you just, no matter what the seller is saying, you just can't go higher than that, than that range. Is that, do I have that right, Heather?

Guest 3: Well, you can, but you're going to be paying for it all with equity and that is going to, that's going to impact your model quite a bit. And that may be the easiest way for you to figure out that you really don't want to do that.

Host: Do you ever find that searchers are able to use that point as, as a pushback on the, on the, on the valuation negotiation? Like look, you know, Live Oak does these loans week in and week out and their range is this. And you know, the standard, the standard structure is 10, 1080. And asking me to do something that would cause me to put in a lot more equity than is standard. Therefore, you know, you're kind of, you're overvaluing your business based on this, this big data set that Live Oak sees all, you know and is working with.

Guest 3: That works definitely. I mean there a lot of times you can use the bank as the bad guy. That certainly works in a lot of different situations. I think even more importantly, it's the bank decided that normalized EBITDA is X even though broker is trying to push non normalized EBITDA or much higher number. I think you can maybe sometimes use the bank's reasoning as to why we think that as part of your discussion or your negotiation.

Host: Great. Okay. Stupid margins. Ryan was Deal killer number two, what are stupid margins? What do you mean by that?

Guest 2: Yeah, I mean it's crazy to see. I mean it's actually a very high percentage of deals that are listed that will have 50 plus percent margins. And so they'll advertise as a million dollar EBITDA business. And I mean usually you'll see kind of in the summary blurb that there might be only 2 million of revenue. And I've spent some time out of curiosity looking into some of these businesses and really usually what it means is the, it shouldn't be surprising, but the owners is either wearing a lot of different hats, driving a lot of the business, there's very little infrastructure in place, so there's no operating expenses. So it just introduces a lot of key man risk. Again, you see this in contracting businesses or professional services businesses sometimes. And so I think it also applies to kind of just trends in general, trends in the financials in general, where you should kind of have a good sense of what the industry should be doing, you know, either from other deals you've looked at or publicly traded comps, hopefully where you know, they're not going to do, you know, landscaping business is not going to have a much better margin than brightview. Right. If not, there's something, if so there's something, there's something there. And then yeah, I mean, for example here I had a broker that convinced me to meet with a lighting business. I drove five hours to meet with this guy for a million dollar EBITDA business. Realized quickly there was 2 million of revenue. It was husband, wife, working out of home. He was really a good sales guy. He'd already kind of built this business up and sold it in the past and now this was more of a hobby project. And it was, you know, just quickly, you know, it's a buying a job, a sales job, which you're not going to do better than the seller, you know, that's already doing it. So you know, you have to really think through the value that you're buying or the value that you're paying for these businesses is a lot to do with the infrastructure around it, the people and the assets and the brand. And these stupid margin businesses, they're generally kind of one or two men, operations sometimes out of their home

[23:01] Host: and that scares you off as opposed to okay, well this seller doesn't understand that. In fact the way I'm going to approach this business is I'm going to need to replace them. And so therefore the SDE is going to immediately the day I Take ownership or the day I put in a general manager is going to immediately compress and we should really be talking valuation based on that future, you know, that future sde, is that not, are those not conversations you even go down the path with because your experience tells you that they just won't see it that way. Where's the opportunity to save time? Because by itself, even though I'm not going to take their margin, that stupidly high margin at face value, it's still, it still tells me something. And not in something maybe not, not, not necessarily a deal breaker. I don't necessarily interpret that as a deal breaker. So what elaborate on that for me.

Guest 2: Yeah, I mean, look, I think if it's, if it's a, you know, it might be unique to the individual searcher, if it's something that they maybe have operating history in and that's one thing. But again, as a first time searcher, not, you know, looking at sectors that are relatively new to me, it would scare me because you're really facing more than just a potential revenue headwind of losing that key employee that's driving probably a lot of the top line. But then it's really hard to get a handle of what the expenses or really the capex you need to put into this business to scale it. So yeah, it'd be really tricky, especially again if it's, I mean also like if you think about just the simple math of taking a business from 50% EBITDA margin to what is like a normal industry, even on margin, you know, I don't think any valuation, that's a huge, that's a huge gap to bridge.

[24:51] Host: Yeah. Heather, any thoughts on that one?

Guest 3: Yeah, I mean I think I sum that up as the way the banker will see that is you are buying a job and as Ryan said, you will probably not be able to do as good a job as the seller. So there's that right there that even if you were trying to replace him, your EBITDA might go down a bit right there because you're not as good seller owns the relationships. That's always really risky. And even if you were to replace the seller with an employee, is the employee going to be able to do as good a job? I mean that's a big risk too. So it really just buy a job is just not a good financing scenario for a bank. And stupid margins really say it really is a sign, it's a really good sign that you're probably buying a job.

Host: Yeah, I mean what we're saying here is basically the Stupid margins is kind of a proxy for the business being too reliant on the seller essentially. And so Heather, what's the ideal? I mean, I assume the ideal is like a management layer and you know, the seller is absentee. I mean it actually is a really high functioning business and the seller is never there. Like that's the ideal ideal. But we don't, we probably don't see that very often. What, what is the, what is a happy, happy medium between that ideal and this in this, you know, kind of worst case stupid margin case that that kind of is, is functional. And you see more commonly, well, just

Guest 3: normalized margins and, and an org chart that shows that the seller is not wearing all the hats, that he's got some key people in place that will continue on with the business after, after transition. That's really what we're doing looking for in general.

Host: Great, okay.

Guest 2: Or you could be a tech business with recurring revenue and it's, you know, just by, you know, just by virtue of business model. It's actually a high margin business. But. Right, those aren't the ones I'm looking at.

Host: Right, right. And the valuations on those probably won't be very friendly to an SBA loan size. Ryan is, is time killer number three.

[27:01] Guest 2: Yeah, this one's an interesting one because when I network with a lot of different searchers, I feel like we've had this conversation, I've had a conversation with all of them. We're at some point tempted to go down market. You see a listing and there are a lot more of them at the smaller size call like the 150k of EBITDA, 200k or STE and you're like, okay, well that's enough to live on. And you have a lot of confidence in your ability to grow the business. But end of day it's, it's, it actually will and you know, maybe there's less capital you have to put into the business up front and so you kind of view it as lower risk. But reality is the smaller the business, especially that that size is, you're introducing a lot more risk. I mean we're already kind of in a, in a really, you know, it. Small business is inherently risky and then when you go down market to that size, these are pretty fragile businesses. And then on top of that, if you're going to try to grow it again, you're going to end up putting in more capital down the road. So I'd rather do a deal that requires 500k to a million of equity and be able to fund the growth with cash flow versus putting 50k in. And then every time you're trying to make a hire, buy a truck or increase marketing spend, it's not coming out of your pocket. And I think the other thought here too is there's really a sweet spot here for economics researchers where your cost of capital is kind of lowest at the largest size deal you can fund. So I mean that both from like an SBA standpoint because you can get the maximum amount of leverage assuming you're doing it on a business that can cover it, cover the cash flow conservatively, but you get the max amount of leverage from the sba. But then also too, if you're going to equity investors, you know they're going to be more interested in larger deals just again because of going back to that risk point I made earlier. So it's tempting I think for a lot of folks and I also like the idea too of it's easier when you have an asset, right. That you can go find out other assets and bolt on. But I would anticipate putting in a lot more capital after you've made that purchase.

Host: So what range of EBITDA is the sweet spot And I assume whatever you're going to say is where you're looking.

Guest 2: Yeah, I mean look, I think, I think you know, a lot of the self funded searchers will kind of push it towards about a million in EBITDA is like a good bogey. I, I'm kind of, you know, 750 to one one and a quarter. I can go as low as 500k I think and get comfortable depending on the business. But yeah, Nothing sub of 500k. I won't even, I won't look at it anymore.

Host: Mm, Heather, you're nodding your head.

Guest 3: Oh yes, totally agree with this one. Our minimum enterprise value to lend on is a million and even then I don't really feel great about it. And I think what Ryan said is really interesting way of looking at it. The cost of capital does go down the further up market you go. And the beauty of having this great search fund investor network is that you don't need to buy too small of a company. You have access to capital both in terms of debt and equity. And so you know, it is within reach for most searchers if they find a good deal to go a little bit upmarket. And we really dislike small deals. They are fragile companies and it is very tough to put leverage on them.

[30:28] Host: Heather, there are, I have three follow up questions to what you just said. First, so when you said you guys won't land on an, on a, on a deal where the enterprise value is less than a million. So just backing out that, assuming a 3x as an average. So that's basically 350 STE. If we're, if we're thinking about things in terms of how much money, how much cash it generates. So 350, 400 is kind of the, is kind of the floor of businesses. Okay. When you say the cost, you both have said the cost of capital goes down as the purchase price goes up. Can you spell that out for me?

Guest 2: Well, I guess if you think about it from just the equity perspective, right. If you were to go out to investors and you were, you know, say the deal needed 50k of equity and you were going to go out and raise capital around that, hey, I don't even think anyone touch it. But maybe, maybe you are taking capital, the terms are not going to be as favorable as some of the stuff that you're seeing out of these self funded searcher investment groups where it's pretty attractive economics. It can be. So where you're taking money in, you might be taking in $10 of cash, but really giving up $3 of ownership and you're not going to get that in these smaller deals. I mean you may not even get that 500k EBITDA or 750. That's kind of where it starts.

Guest 3: I agree. As a debt provider, it's risk reward and an equity provider is going to be the same thing. So if we're going to see small deals as higher risk, we want to get paid more if we're going to lend or provide equity into those spaces. So it is definitely more expensive capital the smaller you, you go.

Host: Yeah, yeah. So, so in fact you're actually being punished in a word, as the searcher if you bring a smaller deal because the source of your capital, be it debt or be it equity, perceives that as a riskier, a riskier investment.

Guest 3: That's right.

Host: Heather, you said, lastly, you said, you know, you can find that capital. You know, if I'm just somebody who's kind of new to search, listening to this conversation and I don't have connections, I don't know anybody. I've just kind of found this on the, this concept of search on the Internet and I keep hearing people talk about how you know all these investors, this investor community, how easy it is if you have a good deal to get an investor. Where, where do I start?

Guest 3: Well, that's a good question. So first you need to Sort of get to know the investor network. So just classic networking. You need to get to know some other searchers, maybe attend a conference, look around online. There are several resources online that actually list the names of some of the investors. But just like raising debt, you've got to go meet them, you've got to impress them with yourself first of all, and your thesis, what you're looking for and try to find the investors whose appetite for risk matches your thesis so that you can sort of cultivate a group of at least a few investors that you know, if you find a deal that meets their criteria that, that they would probably be interested. But it's classic networking really is the best way.

[33:37] Host: Yeah. Yeah, great. Okay. This size of acquisition time killer leads in naturally to the fourth one, bolt on versus platform. What did you mean by that, Ryan?

Guest 2: Yeah, so yeah, it overlaps with size also even the margin point. I think that could potentially be a good bolt on. But yeah, you'll see a lot of deals. I mean that's the broker's job. They're going to market it as a platform the best they can. They're going to take whatever the seller provides them and put together a SIEM that shows that they do have a management team in place, they do have systems and processes. But reality is it won't take long when digging in in preliminary due diligence to find that this business is really at best a bolt on and that's what it'll eventually trade as. And you know, just I guess for an example, I met with a, you know, landscaping business and the seller told me straight up outright that mean they operate out of a parking lot, don't really have an office, you know, no systems, no process, no crew leads. He leads the whole team. And he'd worked at a landscaper six years ago, saw the opportunity, grew this, you know, went on his own, grew it to a decent sized business. But for me it doesn't, it's not a good fit. Right. Because I need, I can't immediately be focused on building everything from scratch. I need some semblance of a team in place or you know, some type of systems in process to work from. Otherwise I think you'll get kind of caught into that, you know, working in the business versus on the business from day one. And it can be tempting because it's again, once you have that asset, maybe you can make it into a platform. But I think it's going to be hard enough to find a good platform at attractive value to build from. So I'd avoid Anything that smells like a bolt on

Host: anything to add there. Heather?

Guest 3: Yeah, I would say this one's interesting because I think most lenders wouldn't be able to detect this as well as the actual searcher. So this is one where we might not be really your safety net. It's really dependent on you doing your diligence and asking those questions and kind of having this in mind when you do that because to a banker it's a little harder to detect this and a lot of bankers won't ask these types of questions to figure this out.

[36:05] Host: Great industries with private equity interest. This is going to be an interesting one. This was your number five time killer, Ryan. Take me through it.

Guest 2: Yeah, so look, I'll preface it by saying I'm curious. I mean I'm interested in private equity or businesses that private equity is interested in. Right. There's proof of concept there, there's comfort around terminal value. There's potential opportunity for multiple arbitrage. I like those types of businesses going back to my PE roll up days. But it's the challenge there is that you're if you're going into, or you're going into a competitive process with a private equity buyer and by the way that also includes private equity spot you know, backed platforms which are also trickier to find, you know, trickier to be aware of. It's, it's going to be tough so they have greater access to resources. They will get under loi quickly. They have no problem with, with, with getting under loi. It's a lot of sellers like you know the high limited, like the low amount of execution risk involved with those types of deals. But so I guess my advice on this and I hate giving advice as a searcher that hasn't actually executed a deal yet. But my, my thought is, is if you're going to do it just be kind of quick and nimble about it. So you'll see a deal, you know, be quick to, you know, quickly underwrite it and, and, and, and try to submit an LOI so you can be competitive but don't spend time again creating analysis around it. If you know there's a potential that there's in market PE interest because I've had that where for example I had a broker that I thought had a really good relationship and this happened two or three times where I asked him I want to see deals in this sector. I will be quick, I have all of the capital lined up, it shouldn't be an issue and submit my LOI go dark for a few days. And then they're under contract with somebody else. The brokers are again overgeneralization. But many brokers will be happy to feed a PE sponsored or PE backed platform because that's better. They'll feed them on a recurring basis and it's also kind of lower execution risk. So be mindful that also your bid will be potentially shopped to those guys as well. So look, I think there's, there's opportunity in that space. The pre pe, you know, sectors that, you know, just under their radar or maybe they're just below the scale that gets them interested. And that's actually kind of where I spend a lot of my time. But you know, I wouldn't get too excited about a deal where it might be pretty competitive and.

Host: But Ryan, why what you just said there at the tail end was going to be my question. Why is that not a great strategy? So if pe, let's say arbitrarily or kind of roughly, they stop looking at $1 million EBITDA and below. So why isn't it an awesome opportunity to buy the 6,800ebitda business in an industry where there's a lot of private equity interest with the expectation that, you know, you have, you have these ready buyers once you grow the business a little bit? That seems like a great playbook.

[39:23] Guest 2: I agree. I mean, I like that thesis. I guess I would also say though, you have to be cognizant where there's, you know, strategics again that are PE backed that will go down a little bit below that. I mean, there's competition regardless. But yeah, I think that size, anything above a million is really where I think it starts to get more competitive. A million in ebitda and I'd say too also though, searchers, we do, I think have a little bit of an advantage depending on what the seller's true goal is in the sale process. You know, the sellers that I like the most are the ones that care about their employees. They care about their brand, they care about their legacy. And, and you know, a lot of them have seen PE come through town, maybe they've acquired a competitor. You know, they have a shorter investment horizon, you know, where if you can go in and convince them that you're, or her that you're, you're buying it. To own an operator over the long term, take care of their employees, take care of their customers, preserve the brand, be a steward for, for the business that they've built. I do think that goes a long way with, with the right sellers. But sometimes, you know, Sellers are looking for, you know, they're burnt out. And I just want to, you know, just think about after tax proceeds, you know.

Host: Yeah, yeah. And, you know, you hear people say that, you know, kind of appealing to the sellers, kind of like their emotional attachment to the business and interest in seeing it live on after them. But that is. I just, Just want to echo what you said. I mean, that's a very real thing. And, you know, you hear it even more in traditional search, where traditional searchers are looking for larger businesses and so they're having to compete almost certainly with, you know, bigger capital, bigger, deeper pockets, private equity and so on. So the only thing that they can really say is like, I'll be, you know, a responsible steward of your business. I'm a human. Meet me, and so on. It's really the only differentiator or one of the only differentiators they have or competitive advantages. Maybe I should. I should call it. Heather, what are your thoughts on this private equity concept?

Guest 3: Yeah, very interesting in the last few years, how much smaller a company private equity can. Is interested in these days. I think the multiples are certainly attracting them, and there are certain industries where they'll sort of heat things up and they will. It would be very tough for a searcher to win a deal against them if they find something that they like. So definitely not something to. To waste your time on. And, and definitely to be careful about the brokers who might just be using your offer to shop around. It definitely happens. Fortunately, there are so many niche industries out there that I don't think PE would ever really be that interested in. They're too different and they don't really fit on a platform. So I think, you know, you tend to find searchers looking in those spaces where they know they will. They will not have that kind of competition.

[42:13] Host: Let's move on to number six, where we probably got. We got time for probably just a few more. So number six was market. Ryan, what did you mean by market?

Guest 2: Yeah, so I've kind of fallen into this trap where I'll look at a business, take a deep, deeper dive on it with the hope that I will get so enamored with the business that I will overlook the market that it's in and magically convince my wife and I to completely relocate our lives into, you know, a place that doesn't necessarily fit our preference. So, you know, I think, and I kind of joke, I think there's really a. And then separate from that, there's. There's a lot of market considerations as it relates to the deal. Right. In terms of opportunity as well as valuation. So, you know, I will spend less time again on these, on these markets. You know, for example, I looked at a cut and sew manufacturer that made a product that I actually really like. It was a great size, it was a little expensive, but it was in a market that was prohibitively expensive for us to live in, especially when it factored in the price of the business and our economics. After considering, my wife would have to leave her job, most likely. And so you have to kind of balance all these when you think about where you're actually going to be. And I think when you think traditional search model, a lot of the investors will make sure that you're, you know, completely geographically agnostic. I think that that's easier said than done. And I think if you really kind of boil it down, people are, you know, they're obviously they're going to, there's going to be natural preference to certain areas in certain states, certain cities. And, you know, I wouldn't, I wouldn't ignore that.

Host: Heather, do you have any thoughts on market?

Guest 3: Yeah, I mean, I, I agree with Ryan. Most people just are going to have their preferences. And that's why if you, if you do find a deal in a place where maybe a lot of people don't want to live, you might actually get a pretty good valuation. So there's the other side of that. If you really are truly willing to do it, there is going to be a limited number of buyers and therefore probably a better price. But, you know, but I still don't see that many deals transacted in places like that either.

Host: Yeah, Ryan, at the start you said where you were looking and it was a pretty wide swath, but is that narrowed by. You just want to live in a metropolitan market. So really it's actually a handful of five to ten cities.

Guest 2: Well, I'm actually kind of looking in, I'd probably classify as like tier 2, tier 3, metro markets because again, I'm actually getting the most traction too. So again, on the proprietary outreach, like, you know, there's some markets that are, you know, call it 150,000 populations, definitely small cities that, that, you know, the sellers haven't been pestered by searchers or pe, and, you know, they're actually open to taking your call. And if you have a actual, you know, inroad for being there, you know, we're now in the Southeast, so it's a little bit easier to have a conversation. I think it goes a long way. Whereas you Know, if you're reaching out to businesses in Miami, it's. It's going to be pretty tough. It's. It's just inherently more competitive. But not saying it's impossible. I'm just getting a lot more traction in a market like Sarasota.

[45:30] Host: Sure. You have a couple of examples listed here. Getting outbid in Charlotte, Charleston, remote beach town. Any stories behind these examples?

Guest 2: Yeah, so, yeah, I told you about the manufacturer that was in Washington. Couldn't get comfortable with living there after doing a decent amount of work on it. Then, yeah, when I was looking, you know, spending a lot of time in Charleston, Charlotte, driving all over, it was. It was kind of crazy for a while. I think things are kind of hopefully settling down a little bit. But late last year, I mean, businesses in those markets were on fire. So, I mean, they were listing for, you know, businesses. For example, I looked at a business that almost was almost identical in Sarasota, that traded at four times and then four weeks later, a business listed in Charleston, almost identical in terms of characteristics and traded for seven times. So, yeah, it's huge disparity.

Host: Ryan, you say that you will look at other deal, you'll look at deals in other markets just to continue to educate yourself. What do you do there?

Guest 2: Yeah, so if I see a listing in another market that I know that I, I wouldn't necessarily pursue, I might look at it just to get a sense for, you know, like I was telling you before about KPIs, what are, what are reasonable margins? What are, what are they doing best practices, you know, if there are any good diligence questions that come out of that. But again, I won't. I won't do actual work or spend too much time on it beyond that. And then, yeah, I guess the other downside to it we're missing, going back to the other point on terms of valuation, is that there's.

Guest 3: There's.

Guest 2: There's a. There's more. There's another reason besides the fact that it's a great place to live. And it's also, there's a lot more growth opportunities, you know, in some larger markets. And so, you know, there's one business that I really liked. Everything about it, other than the fact that it was in a remote beach town where I think it would just be really challenging to grow that business. There's limited amount of competition, which is good. But at the same time, if I was looking to grow, you know, I like fragmented markets looking for opportunities to grow, be acquisition down the road or even attracting talent. It can get really challenging, I think in some of those places.

Host: Yeah, yeah. Heather, how, how much do you, when you're doing a loan, do you look at the growth? Like how do you think about the growth potential for a business a searcher's looking at.

Guest 3: That's a great question because a lot of folks don't realize that as a lender that's one of the lesser important criteria for us. So a lender always looks at sort of the worst case scenario of historical cash flow. So we're going to adjust it and then we're going to think worst case, if we lost a customer or we hit a down cycle or whatever it might be, could this loan still be repaid? And almost all of our decision is really centered around that, that thought process. Now we then will look at the growth more from a risk perspective. Are you going to try to grow too fast? Are you going to have to spe too much money to grow? Is the type of growth you want to engage in going to introduce risk? Because we're all about protecting that sort of historical nest egg that we have rather than the growth. And the whole simple answer, the reason why is a lender does not have upside. All we have is downside. We're going to either get paid back with at a particular interest rate that's already been set and determined or we're going to lose money. So we're all about not losing money. And so growth is great and we're certainly excited to see it happen and we understand that that's what searchers are here to do. But when we underwrite, we really only think of the growth in terms of what might go wrong and how it might hurt what we do have. And we want to make sure that that doesn't happen.

[49:26] Host: Great. Such a valuable point. Got time for two more here. Ryan, did you have something you wanted to add?

Guest 2: I actually do want to add something on that. So there lenders though, that will stay away from certain markets. It goes back to kind of the point where maybe they were burned there in the past. So for example, I had a lender that didn't want to touch a deal in South Florida. They just. And I think that might become more and more common as we kind of get later cycle or if we're in a recession now, who knows. But I think a lot of banks might pull away from states that are regions that, you know, what we saw kind of during the great financial crisis was sand states got crushed. And I think a lot of banks may shy away from those types of deals. If there's an over concentration or they start pulling back credit, I will add

Guest 3: to that just that bankers have scars and they might be a geographic, they could be all kinds of different scars but when something looks similar to a bad deal that we've had or experienced, it really is a quick turn off and you'll see that a lot if banks have had a bad experience and to Ryan's point, if the recession sort of causes more stress on credit in banks, then those are all going to be new scars and whatever the lessons learned from those are going to tighten up credit in those ways. And so that is sort of how the cycle works.

Host: Heather, do you have any searcher scars that you can be public about or give us an example of?

[51:01] Guest 3: Oh gosh, you know, sure there are certain industries we've learned I won't go into specifics but I'll say that we've learned in certain industries that there's the ethics are not very good. What you know, what a seller thinks is perfectly fine and the way they've represented things we found later was effectively misrepresentation but they had no problem with it. And we sort of saw that similar pattern in other businesses of the same industry and sort of formed a, an idea around that. So sometimes we develop opinions that way. Another one that I can think of is an example where a searcher relied on a gap. You know they converted cash accounting to GAAP on their own and based their that was their EBITDA that they were buying and they didn't do it correctly. They did not get equality of earnings. And so I think you know that's another scar is you know any anything that's got to be heavily adjusted should absolutely have a quality of earnings. A third party, you know, look at that a deep dive on the forensic accounting. So I think those are two just ethics in certain industries and make sure you get a Q of E if everything's not completely straightforward in your numbers.

Host: Heather, I so want to know what this crooked industry is.

Guest 3: There's more than one but I've just give you one example but there, there are more than one and that to really be careful about and that that's

Host: something that would you be if a searcher took you a particular deal that you would, you'd be able to say to them privately this is an industry. Yes, definitely crooked industries that's going to be the subject of an upcoming POD Red Flags Ryan is, is your next time killer.

Guest 2: Sure. So look I think a lot of the opportunity that exists in the SMB space is kind of offset by a lot of risk. Right. So it's really the Wild west. And it doesn't cease to surprise me. Some of the things that I've been seeing and I'm, I think a little bit more risk averse. But if there's one or two red flags, depending on what they are, I will usually kind of go pencils down pretty quickly. So, you know, red flags are pretty obvious. But you know, unreported income, that's something I see a lot in the Twitter sphere. Some brokers have mentioned it. They'll try to, you know, they'll try to price a deal on it. It's crazy aggressive ad backs, it's more obvious. That's a more common one. Although I don't think that would in itself be a deal killer, but something you definitely would want to be skeptical of lawsuits. That's something I've noticed. Kind of just I'll do some Google research on, on senior management or the partnership and then you'll be surprised that they might have had a falling out where a previous partner sued existing partner that you're buying from. And I don't know, usually maybe there's ways to kind of immunize yourself from that risk down the road. But to me, I think when you take multiple red flags on, usually there's a much larger. There's potential issues unknown to you down the road. And I had this kind of, it was this simple concept. I was just networking with another searcher who just recently recapped his business. So he kind of basically was treading water for the last five years. And he attributed it almost entirely to the fact that he bought his business from, excuse my French, an asshole. And he didn't know it until, you know, they closed the deal. And then day one, he lost like a couple of key employees. And then the, the rest of the employees basically demanded huge raises because they were very disgruntled and they knew they had some leverage. And he went from being excited to grow this business to just completely putting out fires. And that was leading into once I think he gotten everything stabilized and Covid hit. So I mean, it's something that you always want to be mindful of and there's enough out there in the public domain nowadays where you could definitely find just from a Google search, you don't even need to be doing background checks to find bad reviews or employees complaining on employment websites. So things like that. Usually for me, I might go pencils down pretty quickly depending on the flag.

[55:31] Host: And so the way to save time Here is, as you said, just to kind of put your pencil down, stop working on the deal, rather than maybe the temptation of a searcher might be, especially as a searcher gets desperate. You know, it's been months. They're looking for a deal to rationalize how they can overcome the bad reviews on whatever on Google or they can correct the toxic relationship that the seller has with his employees. It's like. No, just, just skip it.

Guest 2: I think bad reviews, well, it depends

Host: how bad I was choosing those arbitrarily.

Guest 2: Yeah. As examples.

Host: Yeah.

Guest 2: Right. I mean, I don't think they're all created equal. But if, again, if somebody's trying to sell a business on unreported income, you just have to think about all the ripple effects that that person probably had on that business. So what is the culture really like are people or are they potentially stealing from customers? And then there's obviously all those liabilities associated with that down the road that you could potentially, obviously you could try to immunize yourself that from a legal perspective. But then there's just operational risk of losing employees, losing customers. Again, going back to I think a point I made earlier is you're buying a large part the brand employees, the ability to grow this business. And again, if you're turnaround situations based off of poor ethics are really, I think really difficult to execute on.

[57:06] Host: Heather, what do you think?

Guest 3: Totally agree. I mean it's a non starter for us if someone, you know, shows us that the seller's not reporting something or doing something, you know, wrong on purpose for some, you know, quote unquote tax advantage. You know, the gray area with that is, is the add backs where, you know, they're running personal expenses through the business and they're selling the business saying, hey, these are personal. They weren't really business even. We accept some of those. But I even have a hard time with that to be quite honest, because where's the line? You know, and there's many of those that we'll just kind of throw out. But I think anytime you're looking at buying a business from someone who's putting out there right up front that they're not doing things properly, that's a red flag. You need to really dig deeper.

Host: The ad backs one is so gray though, because I mean, you know, any accountant will talk about how small business ownership, one of the great advantages of small business ownership is that you can run your personal life through the business. So I mean, in some ways some of that behavior is practically encouraged by your accountant. Heather, I think you said that some things were, were within this, the pool of potential add backs and there are some add backs that are deal breakers that if they're trying to add back, if they're expensing something that they shouldn't. Can you give me an example of one that's just like crosses the line?

Guest 3: I've seen many that cross the line very, very far. They'll run a hobby. You know, I had one who was into car racing and his mechanic and everything to do with that hobby was in all kinds of parts of the profit and loss statement. It was crazy. I've seen people run food like including their groceries for their entire family. It gets out of control and we don't. It's not only do I not want to add back the number, but I really want to think twice about whether I want to lend to anybody in that business at all.

Host: Great, Very clear. Okay, let's do one more. Ryan. And just again, this is a list of 15 and you can download that list of 15 with the link in the show notes. But let's do. We're on number eight here. So wrap us up with number eight. Ryan.

Guest 2: Yeah. So needs to pencil effectively, needs to support leverage. So again, what I'm trying to do here is essentially a micro lbo. Right. So these businesses should be.

Host: Please.

Guest 2: Lbo Leveraged buyout. Right.

Host: Micro leveraged buyout. Go ahead.

Guest 2: What is that? Micro leverage buyout. Yeah. So we're effectively. There's a component of financial engineering here that improves returns responsibly. So you think about buying a business at 4 times 0 growth, that kind of translates to a 25% IRR. But once you start introducing debt, you can really improve the returns of the business and growth and all that good stuff. But the business should be able to support that debt. I like to think of it through the cycle. I kind of underwrite it to a downside case of what a recession would be and whether or not that could support, you know, the debt service and you know, and then expected capital expenditures and my salary. Right. Because you do hear, I've heard from few searchers that have had kind of the nightmare scenario of buying a business and business goes away and then all of a sudden you're contributing capital to the business, you're not taking salary anymore. And so I guess you should always. I always think about deals in terms of the max amount of debt it could take on. So and a rule of thumb that I think about in terms of valuation for that is about four and a half times. Really, if you wanted to max out SBA debt, you're going to be pushing it. If you're paying over four and a half times. And then to Heather's point earlier, above that, it's fine, you can do deals above that, you're just going to contribute more equity, which means that you'll probably, you'd have to have a stronger case for growth and especially if you're raising that equity. Then again, you better have a pretty good story behind why you think that you can grow that business. But I don't know. I think. Yeah. And then I guess beyond just valuation. Right. A lot of banks will look at really the business characteristics. Some things are not financeable. So again, to all those kind of attractive characteristics we described earlier, but evergreen businesses, stable cash flow, recurring revenue, all those types of things are attractive to lenders. And guess what, they're attractive to me as well. And so usually if it's a business that I know that I'm going to really struggle to get debt put onto it and be worried about being able to service that debt down the road, then I will either negotiate on the valuation or walk away.

[1:02:25] Host: So getting kind of lender endorsement of the industry before you spend too much time looking at a deal in that industry.

Guest 2: Go ahead, Heather. I'm sorry.

Guest 3: Yeah, I was just thinking of an example today. I have a deal that we spent a lot of time on. There's a lot of noise in the numbers. Definitely there's a good company in there, but very hard to figure out, normalized ebitda. Long story short, we declined it and another bank has approved it. And that searcher is coming back to me and he might walk away from the deal just because of our input on declining it. So I think the story there is as a searcher, the bank is another set of eyes. And to the extent that we dug in deep and asked a lot of questions, that helps, I think, whether it's a yes or a no. So maybe even the no helps you think if the bank doesn't want to do it, maybe there's a point there, maybe I shouldn't do it.

[1:03:23] Host: Absolutely. Yeah.

Guest 3: But we're not always right.

Host: We don't know, as I've learned more and more about search and come to appreciate particularly with like a live oak or banks that really know search and are really active in a lot of search deals. And you use the phrase earlier, Heather, that the safety net that you act as sort of a safety net or a second pair of eyes. And in fact, I did an interview just a couple weeks ago hasn't aired yet with somebody who worked with your partner, Lisa Forrest on a deal and really was singing her praises about how she really kind of helped, helped kind of coach them through the deal. Get through the deal. Like what to look at. I don't know if that's common in other industries and other applications of debt, but it certainly seems like it's valuable that searchers have as a resource the lenders in the space that they do. Let's call it there. Why don't we just Ryan, please tell folks your Twitter handle and I'll just endorse. I've seen you around on Twitter. Didn't know it was you. So this is. You have an anonymous handle but now people are going to know who you are. You're a great follow. Obviously this one piece of content got Heather's attention, got my attention. But it's not the only great piece of content you put out there. So I encourage people to follow YouMBQuest,

Guest 2: a great creative name. Clearly I did not put much thought into making that name and yeah. But yeah, feel free to give me a follow. DMs are open for searchers that want to compare notes, self funded investors open to having conversations and then any brokers that have deals within the criteria that I've outlined. Happy to connect.

Host: It is a quest, I think search. So maybe it's a pretty apt name for a Twitter handle. And Heather, how can people get in touch with you or connect with what Live Oak is doing and find this piece of content? Is it going to be just right on Live Oak's website? Tell me where people should go.

Guest 3: Yes, so, so come to our website, Live Oak Bank Search fund lending. You'll find our landing page. We've got all of our resources there, recordings of podcasts, all kinds of great stuff. But look for the Time Killers slide and you can download it. It's a, it's a two page PDF and it's got a little bit of a detail on each of these, these 15 time killers. But I think it's just a great piece of content so for searchers to think about as they're deciding how to spend their valuable time.

Host: And as I've said there will be a link in the show notes, but go to the Live Oak page directly anyway because there's a lot of other great content there that people can find. And Heather, what's your Twitter handle?

[1:06:02] Guest 3: It's Andersen, Heather, but Henderson's hard to spell so but you should be able to find me pretty easily.

Host: Great Ryan. Heather, this was a fascinating conversation. Thank you, but both very much for coming on.

Guest 2: Thanks for having us, Paul. Thank you.