About the Host

Ryan is an entrepreneur, podcast host of the show Life After Business and the co-owner of Solidity Financial. Having personally experienced the hazards of selling a business, he joined up with his friend Brandon Wood to educate others on the process. Through their business (Solidity Financial), they provide a platform for entrepreneurs called Growth and Exit Planning that helps in exit planning, value building and financial management.

About the Guest

Dave Kauppi is the editor of The Exit Strategist Newsletter and Author of Selling Your Software Company - An Insider's Guide to Achieving Strategic Value Dave is a Merger and Acquisition Advisor and President with MidMarket Capital, Inc. MMC is a private investment banking, merger & acquisition firm specializing in providing M&A sell side representation to entrepreneurs and middle market corporate clients in information technology, software, high tech, and a variety of industries. Dave began his Merger and Acquisition practice after a twenty-year career within the information technology industry.His varied background includes positions in hardware sales, IT Services (IBM's Service Bureau Corp. and Comdisco Disaster Recovery), Software Sales, computer leasing, datacom, and Internet. The firm counsels clients in the areas of merger and acquisition and divestitures, letter of intent consulting, achieving strategic value, deal structure and terms, competitive negotiations, and “smart equity” capital raises. Dave is a Certified Business Intermediary (CBI), is a registered financial services advisor representative and securities agent with a Series 63 license. Dave graduated with a degree in finance from the Wharton School of Business, University of Pennsylvania.

If you listen, you will learn:

  • Dave’scareer background.
  • WhoMidMarket Capital serves.
  • Howthe tech industryhas changed overthe years.
  • Thepros and consof the recurringrevenue model.
  • Howto convert yourcompany to arecurring model.
  • Companiesthat are accidentalsoftware providers.
  • Howthe market dictatesthe value ofa software company.
  • Commoncontingents that areincluded in techcompany sale deals.
  • Dave’sKindle book.
  • Dave’stips for negotiatingwith experienced buyers.
  • Dave’sparting words forthe audience.

Full Transcript

Dave Kauppi: In terms of the business buyer, it's all about risk reduction, so the the, you know, number one, fear is I buy your company and the day I take over, your customers start walking out the door, so with, with contracts in place, the greater the percentage of your revenue that's on a contractual basis, the not only the higher the value you're going to get for your company, but also your cash at closing will be higher.

Announcer: Welcome to Life After Business, the podcast where your host, Ryan Tansom, brings you all the information you need to exit your company and explore what life can be like on the other side.

Ryan Tansom: Hey everybody. Welcome back to the Life After Business podcast. This is episode 120. Appreciate you tuning back in. Today's guest name is Dave Kauppi and he is an investment banker and has been doing this for 18 years in the tech and software space and the show today was a lot of fun because we went back and forth on what buyers are looking for for value and how to build reoccurring revenue. Whether you're a main street business or a software business. What is the reoccurring revenue being valued as compared to a time and material and projects? We talked a lot about what is a strategic buyer looking for and how a business owner, like yourself or any seller, should be thinking about the M&A landscape. Thinking about how their product and service could fit into a bigger picture of the marketplace even if you don't want to sell.

Ryan Tansom: And I think if there's a big takeaway for this episode as it is just really knowing and working on the right things that build enterprise value in line with any potential way that you want to sell the business so you can make the most amount of money and essentially dictate your terms and conditions. It just gives you more options. Whether you want to sell it internally to a third party to private equity, but you're leveling up your game and you're playing field so that way you're in control. And Dave and I have talked a bunch about how to do the business models change and how a business model is also valued. Not necessarily just the software, but just about thinking about how to deliver your services differently and really talked a wide variety of the LOI to deal negotiation, what the buyers are looking for and how they're actually making their decision.

Ryan Tansom: So overall just a super fun and educational episode and I think I've mentioned it in some previous episodes, but a GEXP Collaborative and my team has put a ton of work into writing some ultimate guides. So there's one on our website called the ultimate guide on how to value your business. So it's everything about how to value the business, how did the different valuation types, how to understand how much money you need pre and post closing. And then there's a couple other exit option guides. So there's one on all the different internal exit options that you have and the pros and cons of those and another ultimate guide and all the external exit options and the pros and cons of those. So we're trying to give as much content as possible for you to level up your knowledge. How to put yourself in the driver's seat of this entire negotiation process and building the business that you want. So without further ado, here's my episode with Dave Kauppi.

Announcer: This episode of Life After Business is sponsored by GEXP Collaborative. Their proven process gives you clarity on all of your exit options and how those options impact your financial success, timing and future happiness. Sell your company on your timeframe to the buyer of your choice at the price you want.

Ryan Tansom: Good morning, Dave, how you doin?

Dave Kauppi: Hi Ryan. Good. How about yourself?

Ryan Tansom: Doing good, so we got introduced by a mutual connection and I started looking at some of your stuff and you started looking at what we were doing and we're going to have a fun. I think we see the world the same way as far as your own insulin companies. All good. It sounds like you've got some bruises and stories to share to us, but you know, for those not familiar with your background, give us a rundown of like, well, how did you get into the industry? How did you get to where you are today?

Dave Kauppi: Well, my first sales job was with IBM and I kinda got the high tech sales bug and uh, went to another company and um did well and really decided that yet the solid for technology companies was gonna be my by career. Unfortunately in technology as you know, that it's very unstable because, you know, technologies come and go. And so after my fifth either company buy out or, or bankruptcy, uh, I decided to try and find something that I thought would be a little more stable. So I hired on with a small M&A firm in my, in my hometown and trained with him and decided I wanted to represent tech companies and he wanted to represent more ah, wha you'd callbrick and mortar or mainstream type businesses. So I spun off. That was the start of mid market capital.

Ryan Tansom: And when was that?

Dave Kauppi: That was, gosh, about a 18 years ago.

Ryan Tansom: How many, how many companies have you bought and sold over the of almost two decades.

Dave Kauppi: We averaged about one and a half a year. We're a small firm. And uh, you know, they, they take a six to nine months to go through the whole process. So it's a, it's a labor-intensive time consuming process.

Ryan Tansom: And what we're going to be diving into today. People call and say I'd like to sell my business tomorrow. That's not how it works. There are so many people that have these big huge shops. I don't think these owners, some people understand that it doesn't mean you're going to have high volume. That doesn't mean that you're getting the good expertise anyways. I mean there's, there's a lot of people that get thrown in front of analysts that don't actually know what they're doing too. And so there's a lot of questions that they need to ask in order to hire the right investment banker.

Dave Kauppi: Right.

Ryan Tansom: So, you know, what, what, what kind of tech companies are you representing? Because I know for the kind of the agenda of the conversation is... We can dive into the recurring revenue and you've got a lot of, a lot of expertise on like what people are valuing and why and what, what are, what is your definition of technology and what have you seen over the last few years?

Dave Kauppi: Well, mostly because of my background, we mostly represent information technology companies and software companies or healthcare, uh, information technology companies, generally companies with a high level of intellectual property as a component to their business value. So it's not unusual for us to hear from our clients, well, we want more than a multiple of cash flow. We want strategic value. Uh, you know, we've seen a, just an incredible move toward the recurring revenue or subscription model. Uh, you know, the very high profile ones are like salesforce.com really off the, the subscription model. They never had a licensed model. It was always subscription. Microsoft, uh, within, you know, since Sasha Nadela came on board, has converted to that model and they went through that, the growing pains of that, but now they are hitting on all cylinders.

Dave Kauppi: Uh, adobe, I mean, you name it, every major software company is converted to that. And then in the information technology world, it used to be, you know, 10, 15 years ago they had these folks that were project-based consultants and what they call VARs or value-added resellers. So what they would do is they would represent the, you know, Microsoft and Hewlett Packard and IBM and they would be hired by a company and put together a solution for them. They'd sell the hardware, take a markup on that, sell the software, take a mark up on that and do project-based consulting. Almost all of those firms are converting to what they now call a managed services provider, which basically says, Hey, we'll be or outsourced data processing department will, we'll do hardware as a service, will, uh, we'll do help desk, will do, you know, major projects. What they are looking for is this monthly recurring revenue. And that along with EBITDA or cash flow are really the two major driving valuation metrics that are... that we see today.

Ryan Tansom: You're hitting on my old world here. It's gonna be, it's gonna be fun because, you know, we were, we had with the copier business, we're built out the managed it services and that like, there's so many. So there's a couple of ways that I went on on this day was because one is that you got some good information and you've got a book that I want you to mention as well, but like you know, why, why is the reoccurring revenue so important from, from the owner's perspective, but also the buyer's perspective? But then also maybe the second part of that was backed into his, how to start doing that because I think there's a lot of businesses that are just really challenged with how do I actually go about doing it? So maybe let's start from, from the sellers and the buyers perspective, you know, why is reoccurring revenue so important and how are all those different categories of revenue that you just mentioned? How were they valued differently in the eyes of a buyer?

Dave Kauppi: Right. Ryan, that's a great point. The reoccurring revenue model is in terms of a business buyer, it's all about risk reduction. So the, you know, number one, fear is I buy your company and the day I take over your customers, start walking out the door. So with, with contracts in place, the greater the percentage of your revenue that's on a contractual basis, the not only the higher the value you're going to get for your company, but also your cash at closing will be higher. So a lot of people don't realize that very few companies in the lower end of the market, you know, small, medium businesses, yes. Lot completely one hundred percent cash at close are completely 100 percent stock. There usually is a, either an earnout, or a seller note or some other contingent factor based on reducing the, the buyer's risk and reducing their amount of cash that they have to put down at closing. So for a seller, yeah, the greater your percentage of recurring, you know, contractually recurring revenue that reduces the risk to the buyer. And therefore one, you'll get a lot more interest out in the market. So you'll have more competition for your deal, which drives up the price. As I said, you'll get a higher valuation and you'll get a more favorable terms. So for example, if you say, I want to stay on with the business for two or three years, if you have no recurring revenue, they're gonna want to lock you up for four or five and, and make an earnout four or five years or six years long. So it gives you a lot more freedom.

Dave Kauppi: In terms of turning your business into a recurring revenue model. Obviously I touched on the uh, software and the um, it services. Let's say you're a florist for example, and you saw flowers. Well way to do it would be to go contact small companies in your area and maybe have a monthly plant exchange service where you come in and manage their plants. Uh, I had a doctor friend who did a concierge model, so he, he cut down the number of patients and was just a very high touch. A scenario for a fixed annual fee for a patient, you know, any time and materials, all kinds of things that you use currently do, try and figure out a way to turn those into a, you know, a monthly or an annual contract. Like an HVAC, you know, have your winter checkup and summer checkup as part of a contract. Uh, we even had a, uh, a company that did pool maintenance, bought a pool maintenance software company so they would go out and sell the software to other pool maintenance company. So, you know, it's, each business is unique, but, but you really need to try and figure out if you're contemplating selling your business or even if you're not, it's a better business model, you know, on January first when you turn on the lights, you want to know where your revenue is coming from.

Ryan Tansom: It's just as stressful for you as would-be, potential buyers.

Dave Kauppi: We, we actually, we actually had a, uh, a company that was buying one of our clients that was a managed services provider and they gave us a formula. They actually spelled it out. They said your, your hardware and software var type sales are worth ten cents on the dollar. You're a break fix is worth sixty three cents on the dollar and your managed services contracts are worth a dollar 27 on the dollar. So it really defined in my mind exactly how these buyers are looking at it. They, you know, a hardware and software sale or a sales pipeline or projected sales that is not very solid if you're a buyer, but having contracts that you know, kind of two years or three years remaining, that's a really, really important as a risk reduction strategy.

Ryan Tansom: Well and I literally went through that. Because that was our old industry. We had a huge pipeline, a lot of transactions. And then literally they were like, "Well, what are your contracts." They skipped over all that stuff. What's actually guaranteed? I totally agree. There's very few people that would disagree with how important strategy is. And it comes down to okay, what the heck can I do as an owner? Whatever industry it is. I'm not in the tech space. How can I start doing this? And I think it's a big challenge whether it's followed some of your own clients or potential clients where we went watched it and it was actually with a client yesterday trying to go to the brake fixed and it is a son of a bitch because you have your reliance on the big hits for cash flow. But if you take that big yet, let's say you're making $100,000 per project or per time and material and for whatever it is that you're doing and you need that gross profit and the cash flow to all of a sudden throw it onto 36 months and you're making two grand a month, it just like blows up your entire financial model.

Dave Kauppi: So I'm curious like what, what are some creative things that you've seen people doing as they're going through that early? It's either the shale, it really does in the short term as you correctly state Ryan, that it kind of blows up your cash flow scenario. It's a tough transition, but you know, at the end of year two it then shifts over. And so you can see by just, you know, Microsoft's performance for about eight years. It was that money if you were an investor. And when Sasha Nadela came in and converted them to subscription model, it took a couple years. But now it's all positive because it builds on itself and it's basically they, they used to rely on, you know, I bought my PC and I would get, you know, Windows seven and I'd used that for 10 years. Right now it's now Microsoft is supplying my email at $5 per person per month and all that goes on and on and on and on. And at a certain point, you know, the, the cashflow turns much more positive than your old, you know, sell one thing at a time model.

Ryan Tansom: Dave, have you seen.... It's beautiful. When it starts to happen, it's just very scary because you have to make sure that you're pricing it right, that you're selling it correctly and then you get into the right contracts and making sure that see written those correctly. Is there anything that you've seen, like you know in the life cycle of would someone like if someone were to back into, okay, I'm going to want to sell my business at this date, where in that cycle turning into the reoccurring revenue. Would you see them? Because they don't want to do it when it's dead money because there is no evil and they don't have the tax returns a shoe, what's going on in curious in that life cycle of where they should kind of start calibrating.

Dave Kauppi: Yeah. I think that, uh, you know, just kind of a rough guesstimate is somewhere between, you know, in terms of a pricing model, if you've got a license or even people are doing hardware as a service now our infrastructure as a service where it's like a rolling lease, but what I've seen is kind of the 28 to 38 month sort of full pay out for that. If it were a lump sum, turning it into the recurring model. So you basically have a, um, you know, your, your purchase price, let's say it's a million dollars. You would consider the payoff over, let's say 36 months and that would be your monthly rate for that million dollar lump sum. And then the good part about that is if the technology stays or if that piece of equipment stays, uh, you know, you continue to roll that over and they're continuing to pay you that fee. So that's pure profit. After that.

Ryan Tansom: A total side note is there was a client of mine called BEI that is trying to really change the copier model. Where instead of using these things called Idaas. Devices as a service. It's all copiers and printers that are just released them anymore. It's just a rental. It's everything on the entire network is just on monthly payments.

Dave Kauppi: Are they, are they doing it by the usage per, per copy or?

Ryan Tansom: Well, they just, they're trying to eliminate the cost per copy because they've got all the data to say, okay, here's how much it runs here's the usage and the labor. Here's this piece of equipment should be 200 bucks a month. And it's all included, all of the service, everything.

Dave Kauppi: I think that's a great idea.

Ryan Tansom: I think when we look at you know companies not in the tech space because you're going a lot of exposure to this - when you and I were going back and forth prior to the show, you've got some examples of all your people getting into it. Are there ideas of building outside forward, acquiring software companies that might be worth it? And how do the numbers numbers change if someone were to go down that road?

Dave Kauppi: Well, it's funny because we, over the years we've represented what I would call a number of an accidental software company and what I mean by that is it's either a, you know, a functional type business where they have subject matter-expertise and they go, gee, the software for our industry is terrible. I'm just going to write my own. And so they end up writing a really nice piece of software because you know, they're the subject matter experts and then they try and convert their business models to, I'm now going to, instead of being a car dealer, I'm going to go out and sell car dealership software. That's a tough transition to make. You know, they're, they're completely changing their business model. The ones that do it well oftentimes go, wow, I'm glad I'm in this business now as opposed to the original because that's a lot more profitable. So we've seen that. In fact, that we have one right now who's in due diligence and that's exactly what they did. They were a car dealer guys and they support our document management systems are terrible and we don't see anything out there that we like and the big dealer management systems don't work. Why don't we develop our own. They found their software business to be much more profitable than the dealership.

Ryan Tansom: Have you seen... buyer beware is going into risky. Yeah, like in the main street or brick and mortar, end up buying your clients in order to get into that space and to increase the value of their business or efficiencies?

Dave Kauppi: That's a tough one because... The sort of the multiples in the brick and mortar space are pretty well defined and, and overly generous. Whereas if you're talking about a software company, those multiples can get to be pretty, uh, pretty high because of the leverage of technology and the, the tremendous profitability, you know, the next, the, the incremental cost for your next copy of Microsoft Office is, is almost zero. The Programming has been done. Whereas if you're manufacturing a widget, the incremental cost is basically the marginal cost of labor and the marginal cost of capital and the marginal cost of, of resources and inputs. So, uh, it, it's a little bit of a different model. So we've found that, that, you know, short of the traditional brick and mortar folks that may want to buy a software company. It just, it's sort of, it doesn't fit with their valuation models. So they're, so they're not, they're not winning those deals, let's say. Now they can, if they decide they want to play in the, the multiple game where software companies are being sold, but that's a tough transition.

Ryan Tansom: What are you seeing for the valuations? And how are they getting valued?

Dave Kauppi: Well, it's, you know, there are all kinds of different categories, you know, and the, the high profile ones, you know, the, the ones that are doing ai or, or gaming or mobility, uh, you know, those kind of are off the charts and it's, it's basically a, what the market will bear. Uh, then you've got other models which are, you know, what I might call legacy cash flowing software companies that are vertical industry software. Like, you know, I do the, uh, the internal accounting for architectural firms, right. So those are, yeah, more humble and, and are closer to sort of other businesses. They're not that, you know, off the charts, they might be a five or six times EBITDA whereas, you know, you get some of these new rapidly growing technology, AH, companies and it might be eight times revenue or 10 times revenue. So it just depends. It's very market-driven.

Ryan Tansom: One of the themes I want to come back to which is um, because I think there's some interesting things that they can do if they're playing their cards right, to increase their value and depending on what their multiple or exit options or thoughts are. We'll come back to that. But taking what your train of thought was further is. Who did SAP buy this week? Was it like atext or something like that. Um, did you see that?

Dave Kauppi: I did not see that. No.

Ryan Tansom: I was looking at the numbers and Dave, I just laughed. I'm like, my gosh, it's so crazy. So, uh, this company was go public and SAP swoops in. The company was doing 200 million in revenue, 2 million in EBITDA, barely making any money, and they got $1.8 million.

Dave Kauppi: Yep and a bricks and mortar business, that would be five times or a $10,000,000 purchase. Yeah, I remember, I remember years ago, Ryan, I was, I was looking at a, uh, an acquisition that Johnson and Johnson made. And I remember writing in my blog, I go, I can't justify this purchase. So they bought this company. I had $40 million in revenue and were barely profitable and they paid $400, million dollars for. So of course I wrote before researching. So I said I can't justify this purchase price. And then I went and researched and I go, oh, so this company did time-release medication. So they had the technology for, you know, making drugs release over time. Well, what Johnson and Johnson figured out is they could extend the patent life of their blockbuster drugs by putting a time release component on it. It made the $400 million dollars seemed like a bargain. So that was a really interesting strategic, strategic value kind of play.

Ryan Tansom: This is going to go into the conversation we were bouncing back and forth with our notes and there was a very interesting customer yesterday that I was working with and is in the software space and, you know, with these owners, I think you kind of have to do a couple things. One is, you know, you can always fall back on the. If you're doing, if you're making a profitable business, you will always be able to sell it and doing things. Certainly certain things right on a multiple of EBITDA, but a lot of baby boomers, they don't think about the exit. I'm not going to think about the exit, like it's just so, so ridiculous in my opinion because then they're not looking at the landscape of the mergers and acquisitions and why someone would buy their company. So there's like this whole like have a foot in like, yeah, make a profitable business but also build something that someone's going to want to buy and you're solving a problem because then you can line it up with a Johnson and Johnson's customers or something like that. So I don't know what. What is your thoughts on balancing the combination of EBITDA and strategic sales and building and actually the sale versus just kind of putting your head in the sand?

Dave Kauppi: Yeah, no, there's a lot of factors that go into, you know, I have a lot of, a lot of our clients come and say, Hey, I want you to sell me for strategic value and you know, a lot of that is, you know, strategic technology, but some of it can be a business model that's superior to the norm in the business. So for example, we had one company and they used Upwork. I don't know if you know what Upwork is, it's a, it's a, a freelance network. They used Upwork as their appointment workers and that was an incredibly successful business model for them. And that turned out to be of strategic value for the buyers of their company. A blue chip account, like for example, if you've penetrated the federal government, right? You're a vendor to the federal government. That's a very hard process, so some companies will buy somebody that's gotten their foot into that, you know, that maze and figured out how to, how to get those clients. You know, one time we, we said, Gee, what's your cost of customer acquisition? In other words, if you're a sales guy, you know, if you're a sales guy at quota for a year, made $125,000 and sold five new accounts. Theoretically or sure cost of acquisition is his annual cost divided by the number of accounts he sells. Well, if you can buy another company with installed accounts at less than that number, that could be a strategic acquisition. Uh, you know, one of the things that we were able to do, again, this is not GaaP accounting mind you, but um, on one of them we had a small company that had a, a great product. Uh, they were very comparable to a similar product offered by the big company, but the, the buyers of the small company's product go, hey, you know, you're small.

Dave Kauppi: You could be gone tomorrow. I'm going to need a discount for your, for, for us buying your product as compared to the big company. Well, what we did is we sold them to another big company and said, hey, by the way, look at what their income statement would look like with your pricing power. In other words, if they were owned by you, a big company, they wouldn't have to discount this anymore on paper. We were able to double the performance of the company now that the buying company didn't pass the full amount for that, but they certainly gave some strategic value there. So what you're trying to do is you're trying to, you know, gather these things that could be leveraged by the buying company and that's how you position yourself when you're, when you're selling your company.

Ryan Tansom: What I find is... think about those people that call you and say this is I want you to do, they would have done that five years in advance and started to engineer their way towards that. How different it could potentially be. Some consumer question is having a balance between, okay, well we have to make money, but then I'm also positioning this to make a huge windfall. And like I don't know if there's a balance that you see people doing or you're thinking about selling your worst case scenario. You're still making money, you've got a good product or company do you have any insights?

Dave Kauppi: Well, I, you know, I think what you want to do is you want to create as much value along the way as long as you're building your business. So, you know, somebody said work is heard on yourself is to do on your business. Well, I think you need to work on sort of improving the value of your business besides just, you know, increasing sales. So, so for example, um, you want to build content. So if you're a, if you're a, a, a, a plumbing company, you know, why not create a bunch of videos or a bunch of content for people that want to go out and look at it. And they go, okay, I recognize these guys really know what they're doing and they're experts and yeah, they showed me how to do it, but I'm not gonna do that. I'm going to go hire them to do that. You know, to, to establish yourself within the industry as a, as a subject matter expert, to go to the conferences and be a speaker to, you know, do the little things that give you a little, uh, you know, a halo of value beyond just, you know, the dollars and cents of selling product.

Ryan Tansom: And I think If you're doing that, they're thinking about value and where they are in the marketplace instead of just collecting their 200 grand a year, just going off and just cheering in the marketplace and what's going on and I think that will also beneift them when they sit down with these potential buyers and I know you and I want even this, I don't know how you worded it, but when a business owner's sitting down ready to sell their business and what these potential buyers are like... what did you say it was?

Dave Kauppi: If you're coming in and selling your business and you're representing yourself and the guy sitting across the table from you has bought 36 companies. Yeah, that's, they're bare knuckles brawlers. And you don't stand a chance. The way I like to look at is, I don't know if Ryan, you remember your, you know, coming out and getting your first apartment lease and you get handed the document and I'm sure you're a bright guy and you looked at it and go, oh my God, why would anyone sign this? And guess what? They, they have the experience and they have the power and so they write the document to give them every advantage. That's kind of what, what business buyers do, you know, they're experienced, they've been through the wars they want to take every, you know, eventuality protect themselves and quite frankly, they write terms that are, can be interpreted in their favor, late into due diligence and, and you know, you ended up getting taken a $200,000 haircut without even realizing it.

Ryan Tansom: What are some of the things you've seen slipped into the terms and conditions? Because I think there's that, that point can't be hammered into listeners'heads... Yeah, sure I'll nuy your company for 200 million bucks. I'm going to pay you over 200 years, and this is the terms and conditions.

Dave Kauppi: Well, the simplest one that I see at almost every, a letter of intent is no, uh, and you will, at closing you will turn over to us and net working capital surplus that's consistent with industry norms. Well that's just like, okay, that's, you've just given me a license to steal a couple of hundred thousand dollars to be off the market into geologists for 90 days and then have there big five accounting firm come back to you and go, oh by the way, you need to turn over $600,000 in net working capital. Well where'd you get that number? Well, that's what our experts told us. So you have two choices, neither cave in or you blow up the deal and both of those are expensive. So one of the things you do is you want to define what the net working capital is. So you know, current assets minus current liabilities and it will be 200,000. And so you tell them how you're gonna measure it and you tell them what the level will be. It's all a negotiation. We get other ones where they have an earnout and the earnout is a what, what I would call an all or nothing. So they go, okay, it's $5 million cash at close and then here's an earn out over four years and you have to grow your revenue by 15 percent and if you don't grow your revenue by 15 percent, you don't get any of the or earnout. No.You don't do that, you do a percentage of revenue to a formula. Another one that happens is they do multiple targets in order to earn your earn out. So you have to hit this revenue and profitability. No, that doesn't work either because you've got somebody else that's driving that rather than the car. They have the keys. Uh, what if your corporate overhead allocation is a million dollars a year? All of a sudden all of your profits have gone away. You didn't control that and you don't make your earnout. You know, there are all kinds of things that. But what I would say is an intelligently worded earnout your, your buyer is gonna want you to make that.

Ryan Tansom: You just don't know what happened until after the fact. ...Forcing people into making really terrible decisions or forced, even though they didn't want to. Buddy, he just closed on this deal and he got all of this. I don't think I've ever seen a sweeter deal like this and hopefully they'll be able to two and a half times future revenue. I know. And if he acquires companies and gets one times or something. So like literally like the company was just like, dude, like go sell. But he had gotten all of his money, other money up front and so there was a bunch of other things but so earnouts aren't all bad if you negotiate them the way you want to. So what can a business owner do? What have you seen people do that have very successful terms like that when they're sitting down with sophisticated buyers like this because you can't just go in blind.

Dave Kauppi: Well, let me, let me give you my 30 second negotiation class. Okay. I'm talking to my, my wife the other day and she says, Oh our, our son, uh, you know, he uh, you got an offer on the house you saw in his house and she said, and they asked for a $10,000 concession and they asked for this to be fixed this to be fixed, this to be fixed and this to be fixed. And he said no on all of them. And they took the deal and man, my chest was puffed out. I'm going, man, that's my boy. He can really negotiate. And then she says, yeah, she but had four other offers. So there's like, there's my 30 second negotiating class. If you have offers, you are a much better negotiater. So for example, we had this company that was well in demand from the buying community and we provided, you know, we had like eight bidders down at the end. We provided counterproposals and counterproposals. We're pretty rich. In other words, they offered $8,000,000 and we came back and said it's 11 and a half million. So the guys going 11 and a half million. I said, well, I'm either a hell of a poker player, or we got a lot of competition out there and you know that that's the key is, is you know, the problem with being a business owner and processing your own sale is, I'll use another term, it's a bare knuckles brawler I say, but if you're doing that and you're going against a private equity group that is bought $200 companies over their lifetime, it's like facing Nolan Ryan with a wiffle ball bat, you're probably not going to do very well. So the other thing with, with, you know, a owner selling it himself is that's a full-time job and he already has a full time job and because of that he's going to process his offers serially. In other words, she's going to do one at a time and he'll follow that one through and then if that doesn't work out, we'll then start processing another one and he'll follow that one through. But you have no competition and no way to to sort of leverage the, the buyer. I mean when was the last time you walked into a car dealership and, and you look at the sticker price, she grabbed the salesman, go, okay, write it up. That's just doesn't happen. Right?

Ryan Tansom: Right. You pull up Google and you show them seven other offers.

Dave Kauppi: Now that, that's way easier for car than a business because businesses are so unique. Cars and houses are pretty, pretty easy to value. Okay. There's a number of bedrooms. Here's the neighborhood, here's the school district. Yeah, here's the age of the roof, et Cetera, et Cetera, et cetera. It's all pretty, uh, pretty standard. And you get pretty close, right? You know, as you said, with your deal where they got two times future revenue. Wow. Where'd they come up with that one?

Ryan Tansom: I agree with you. You and I and a lot of people in this industry are trying to do is trying to make it fairly consistent you and I were talking about John Warrillow and the value builder system. And there are certain things that are coming out there these days and say like, no matter what business or what industry, you have to do these things to have repeatable cash flow. And so I'm curious, I'm like, these people that you're getting eight times, eight different people, what is the competition of, what are the, what are all these people drooling over for these businesses?

Dave Kauppi: Um, well, you know, as, as we talked about a great deal here, the first primary, the thing that they liked is that, you know, this last one, almost 100 percent of their revenue was contractually recurring, right? Have the corporate credit card every month, it just gets automatically charged. And uh, that's right. A very consistent, consistent business. The other thing that we, we saw was the ability to take a company it's in one vertical and move them to multiple verticals. That's really key is, is you know, you get, you get a small company and they have limited capital. You know, you ran a family business, you know, you pretty much stick to your knitting unless you get a capital infusion, right? You know, you get bought by a big company and let's say, uh, you're doing document management for car dealers. Well, you bring in a private equity group that's got all this capital and all these connections. And they go, yeah, we want to do it for car dealerships, but then we want to expand to a home healthcare and then we want to expand to medical claims processing and then we'll, you know, and so you take a business that goes to one vertical and then you, you add additional verticals. You know, another thing they can do is expand geography. So if you're, if you're in the New York City area, uh, why wouldn't that business model work in Chicago, Washington DC, Cleveland, Ohio, et Cetera. So if you've got a strong business model, it can be duplicated and all you need is additional capital and resources. Those are, you know, again, strategic value can be, you know, you've got a really cool technology. The strategic value can be, hey, I've got a business process. That's awesome. I've got a sales process. That's awesome, right? I've had companies buy smaller companies because they go, wow, you run your salesforce so much more efficiently than I do mine, the value in your company to me is you've got a better sales process. I'm going to implement your sales process on my big salesforce improve the, the performance of that and I've just paid for your entire company just with the improvement of my performance and my salesforce.

Ryan Tansom: And I think you hit in some good points there. A couple things and this is why business owners need to think about where the value all the time and then how it relates to the market and where they're going because otherwise the. If that person knocked on the door and that person knows why they're buying them, but this person has no idea why they're going to be purchased and they get this random number, they don't know that they could have potentially got three times more for their business because they didn't do enough due diligence. Understanding why that person is actually even interested and I see that all the time. Then they're like, holy crap, I, I could have. It wouldn't have been a multiple of EBITDA if I had been paying attention. You know? Also it is. I mean going back to when I was saying earlier on, no, but when you're talking about the strategic verticals or expanding or whatever is like, if you think about maybe like, you know, mainstream business that doesn't have no reoccurring revenue or a software or whatever.

Ryan Tansom: I mean, I think that there's a huge argument that if someone is willing to pay the value and sees it and potentially is driving towards an exit or growth, depending on where they're coming from, is if they have, they have a big customer base or different industries or different verticals. If they bought a software company, they could immediately deploy that to their customer base as well and cross pollinate and then the whole machine instead of getting a three or four times x, I mean they can get significant value if they're looking at doing all that on a private equity or something like that. So I do think that there's a way that. Because otherwise they'd have to do it themselves, which is just a big pain in the butt.

Dave Kauppi: Well you know a lot of people might not think a restaurant would be a subscription model. Okay. So there's a restaurant that was started in the Chicago area and we love it because it's a restaurant that has a wine club. Right. And you sign up for two or three bottles a month and then of course you probably go there to pick up your bottles and then they have wine tastings where, you know, you go there and then they serve dinner and you can have your wine that you bought at retail served to you at dinner. So instead of paying, you know, $65 for a nice bottle of wine at dinner, you're paying $22, plus you've got the wine club membership. I mean I thought it was a brilliant business model and they've been able to expand to, you know, eight or nine other cities. So okay. Again, they didn't have brilliant technology. They just had a great business model idea.

Ryan Tansom: That is awesome, sign me up. think if someone has customers that are paying them for something, there's a way for them. If they just think differently and it's, you know, it's definitely cognitive work and slash or potentially, you know, others Australia was worked to, to build it all up. But it's so worth it because you have people paying you money. Just think about how to deliver different things differently. And the return on your thoughts can be huge.

Dave Kauppi: I completely agree. See, there's, there's brilliance in business model. So you know, you think back to a, you know, like the Golden Arches, right? Mcdonald's. Well, they figured out how to do hamburgers quickly and cheaply and quality control and that turned out to be a dominant franchise for our lifetime. You know, if you, if you've got main street business and you have excellence written all over it, by your systems, your business model, your approach, you know, procurement, process, whatever it is that somebody could, you know, with more capital could, could leverage, you know, those are elements for getting strategic value for your company. And you actually, Ryan earlier you mentioned is guys try and figure out a way to articulate what that, you know, research who the buyer is and articulate what the fit of your company is to that buyer and how they could leverage your assets. No, your business sale is, is the most important sale you'll make. You know, if you're a good salesman, sell your company that way.

Ryan Tansom: Yes. You wrote a book recently and give us a little overview of the book, the buyin.

Dave Kauppi: Well, I'm, I'd like to share, this is kind of, you know, I'm kind of an old dog and learning new tricks, but over the years I've written about a hundred articles and they're really taken right from deals, right? You know, here's what happened on this deal. Here was a letter of intent that we got that had all these hidden things. Here was an earn out. All of these were elements of, you know, our business and we would put them in the blog and, and at a certain point I go, wow, I've got a lot of content here. Uh, I think I'm going to write a book. So I used a editor, an illustrator, right? I went to Upwork and uh, hired a guy to, to edit it and uh, and do the graphics and then put it on Amazon kindle. And then one of my guys in the industry and M&A guy calls me up, he says, Hey, I see you've got a, a book on kindle. Get a paper back. And I said, why would I do that? He says, it's the best thing I ever did for my business. I said, what do you mean? He says, I go give talks at these industry events and I hand out my book and when they're going to sell their company, guess who they come to? You know, in the old days you publish a book, you'd have to go find a publisher and then they have a minimum run, you know, so you're looking at 10 or 20,000 bucks. Well, Amazon bought this company that's publish-on-demand. So in other words, every time somebody orders a paperback, they actually print it out and send it. Now they take the lion's share of the fee. But you know, my objective of the book is to help business owners. And secondly is if, if they want to hire somebody, they're going to hire the guy that wrote the book on it.

Dave Kauppi: So the, the book is called the Selling Your Software Company: An Insider's Guide to Achieving Strategic Value. Quite a mouthful. But yes, it really applies to, to any company I just happened to, you know, that's. I specialize in software and it, you know, it's about positioning your company for strategic value, you know, find those, those nuggets that will appeal to a larger company with a bigger capital structure and more resources. The other part, you know, probably a third of the book is how to defend your value when you're going through due diligence. You know, it's, there's a on my soapbox a little bit here, but there's sort of a, a perverse view out there, uh, in, in the private equity group that says anything we can do to win. That's fair. And so the modus operandi is they come in with a, with the high bid, a letter of intent and the letters of intent are qualified, meaning they are nonbinding. They're just a statement of, you know, if we're going to commit resources to doing due diligence. Here's what we're going to pay for your company. And then they spend the next three months hacking away at that value. They hire accounting firms and they do a, what they call a quality of earnings report. My, my view on a quality of earnings report is how can we attack the value of your company and bring in our experts to justify it? And you know, so it's you, you went through that. I'm pretty sure in your business sale.

Ryan Tansom: I've told our listeners and owners. They do that ahead of time and everything that you can do to pretty much switched the power dynamics and you should be telling the PE firms what to do is my opinion.

Dave Kauppi: Well they, you know, what you do is, is during the process, you know before you sign a letter of intent or dual sign, a letter of intent. That's where you do your negotiations. You do your heavy negotiating before you take yourself off the market. You want them to define what the networking capital is. You want them to define exactly how the earnout is calculated. You want them to define this and that and this. And so if you do a very tight letter of intent with a and it's really important to communicate just how much in demand you are. Meaning, Hey, there are other buyers out here and if you misbehave we're pulling it off the market and taking it to them. That's really your only leverage and so you know, the key is one is is getting that value sort of thing at the beginning of the letter of intent process but, but really a lot of the hard work is, is during that three months of your value being under attack, how do you maintain and translate what you got in the letter of intent and have that actually translated with the same terms and conditions in the purchase group? I don't. I think that's. I think that's the biggest surprise that business owners find out.

Ryan Tansom: If you take everything that you just said and you mentioned something in the emails going back and forth before we got on the show is, is if an owner is thinking, okay, I'm going to be doing this over the next few years. Like I learned this stuff. I kinda liked the level of my game and I understand what everyone, what the processing look like. Like there are 6,000 private equity firms in the US right now. And there's so many people that want to buy businesses that if they've even done half of a decent job building a decent business, you should be able to dictate the terms and conditions and have a bunch of buyers. And what did you, what did you like? I'll give it to you, but... I get the same thing where I have private equity firms and buyers call me all the time. Like do you have any customers? Wouldn't give the analogy that you gave in the notes.

Dave Kauppi: Okay.

Dave Kauppi: All the time by private equity groups. And they go, okay, I want a fragmented business. I want to cash flow positive, I want to eat, but that at least $2 million. I want it to be defensible. I want it, you know, like a Warren Buffett description. And I go, yeah, you and 5,000 other pe groups. I said that's like going to go into, you know, draft a quarterback. And I say, well I want somebody who looks like Peyton manning. Even even if I ran that football team, it'd be pretty hard for me to screw that up if Peyton manning was like word. So.

Ryan Tansom: there's a couple of takeaways. One is that the listener can do these things because you will literally be the Peyton Mannings because no one else is doing the hard work and there's that many people out there that want,

Dave Kauppi: you know, buyers don't want commodity-type businesses. They don't wanna, they don't wanna have to grind in the dirt to capture business by taking another penny off the price of their product. I mean they, they want something. There's a book written. I thought it was very cool. It was called the Blue Ocean Strategy and they talked about, I don't no fight in that, you know, don't scrub around in the dirt for those nickels, reinvent the business model. And the, one of the ones that, that I remember they used as an example of the Cirque de Solei and you on the circus was dying and it was, you know, had all these negative things where the animal activists that didn't like the way they're treating the elephants or the lions. And he had all the stars that you're trying to. And Cirque du Solei just completely rewrote it, the book. And they had no competition and the pricing was off the charts, you know, so, so what's attractive to buyers is things that have moats around things that are difficult for somebody else to duplicate, you know, and again, you need to find those things out about your business that you do. And if, if for example, getting blue chip accounts, you know, it's a, you know, growing up in the Chicago area and selling, uh, it's not easy to penetrate a caterpillar tractor or a John Deere, right? Every vendor in the world is after that. Well, if you've got a, if you've got a foothold in those, those accounts, you're going to be valuable to a large company buyer because it's way easier to sell additional product into an existing account than it is to open a new account. So those blue chip accounts, if that's your strength, you know, that's what you ought to be selling to the buyers of your business

Ryan Tansom: And make them sign contracts. A client of mine, she spen two years, because they just had a ton of blue chip accounts. She got a three year contract sign the company. So she'd been a couple years doing really hard to negotiate with these people. But then it was just amazing when she ended up doing with the business name is we're kind of wrapping up, is there something and we talked about a lot of different things. Something that you want to highlight or if there's maybe something that we didn't touch on that we want to leave with the listeners

Dave Kauppi: You know it's, it's very interesting, you know, since we published our book and by the way that strategy work, so any business owner out there, if you have the content and want to publish a book that the barriers to be at a published author or had been completely democratized. It is so easy. I was blown away. So if you have content and you like to write a, that certainly is a, is a good strategy. But one of the things that has happened is our, our inbound traffic, because of that book has gone up three fold or four fold. The most amazing thing that I found was we would get calls from these guys and they go, hey, I got a letter of intent from a buyer. I need your help. And for my first 14 years in business, I'd go, yeah, well the best way I can help you is we'll do a full M&A engagement all throw them into the mix. We'll leverage them against people. We'll do a soft option and we'll sell your company for a ton of money. And they'd go, nope, I just want to see how this one plays out. And it was tremendously frustrating to me because in my mind I knew they were going against this gauntlet you know because the bed is going to be a low ball, the bed is going to have all the contract, like your apartment lease in favor of the buyer. They're going to attack your value during due diligence and you're either going to blow up the deal or take a big haircut.

Dave Kauppi: So that was my sort of view of. And so I said, well, I can't, I can't help you then. So then what I would do is say, okay, I'll give you a carve out. So if the, if the, uh, unsolicited buyer is the one that buys you after we throw them into a regular M&A deal, we'll give you a huge discount on our success fees and that met with a little bit of success, but not really. What I did recently is I said, okay, you can hire us on an hourly basis to do letter of, of intent consulting and that is exactly what they wanted. We got, we launched the service while I was on vacation actually in March of this year. We've got seven new engagements of guys that had letter of intent and they wanted help processing that one letter of intent. And remember I talked about the importance of competition? Well, what we do is we sell a company, so the buyer, when we get involved, they don't know if we've got other buyers. We're just, we're trying to provide that backstop. And so a lot of times these are just low ball offers and you know, they hire us for four or five hours and the guy goes away when he finds out it's going to be competitive. Sometimes the deals go through and we help them save money on net working capital adjustments or earnouts or or whatever, but at least we're providing a service that the market wants, so. Okay. That's been a big learning over the last couple of years for us in a very positive one.

Ryan Tansom: That's fantastic. So if the listeners want to get in touch with you, what's the best way?

Dave Kauppi: Well, our website is www dot mid mark cap that come am I d e m a R K, c a p.com. Email address is d a v e k a u PPI at midmark cap dot Com. Or they can pick up the phone and occasionally I answered two, six, nine, two, three. One five slash seven slash 72. I have a book on Amazon called Selling Your Software Company: An Insider's Guide to Achieving Strategic Value. And again it's for software companies because that's our main focus, but you know 80 percent of the lessons in there apply to anyone selling their business.

Ryan Tansom: It's definitely worth the read and we'll have all these links in the show notes and it was an absolute blast.

Dave Kauppi: Thanks for having me, Ryan.

Takeaways

Ryan Tansom: I hope you liked that episode. I had a blast tack on with Dave. I think if there's a couple of big takeaways for the listeners and for you to really just be paying attention about what is it that you're doing, if you're waking up every single day and understanding how to drive enterprise value and how to understand what the value of your businesses strategically in the marketplace, there's nothing better that you can be doing so if you're waking up, if you're fixing things, if you're

Ryan Tansom: in the day-to-day, you need to get out of that. You need to invest in people and process to get you out of that, to pay attention to the big picture because one, you'll create a business that doesn't rely on you and you'll be able to actually collect the distributions without having to work, but b, you're going to understand that you're doing the right things to maximize the company's value. Understand what's going on in the marketplace so that way when the time is right, you could potentially sell to a strategic competitor and slash or you can start the transition internally or get the exit option that you want. I just really believe that you have to be paying attention to this stuff all the time, and if you, as you heard Dave say, it's a brutal, brutal, bare knuckle brawl when you're out there and if you're planning on doing this and not paying attention and not educating yourself, you're going to be taken advantage of and you're not going to be maximizing your outcomes.

Ryan Tansom: Whatever those ideal variables of success are for you. So please go on our website, research on the ultimate guides. Look, dive into those listening to some of these other podcasts, call me, call my team any questions that you have, we can point you in the right direction. And just as a little note, we're going to be doing some live group workshops, educational sessions starting in 2019. So just be aware that those are coming down the pipeline. So if you enjoyed the podcast, go on Itunes, give me a rating. Otherwise I will see you next week.