Podcast: Preventative Valuations: How Doing a Valuation Early Impacts Your Sale Price, an Interview with John Carvalho

By Ryan Tansom
Published: July 26, 2017 | Last updated: March 29, 2024
Key Takeaways

John Carvalho, President of Stone Oak Capital, a mid-market advisory firm, talks about the importance of an accurate and realistic valuation before you position your business for sale.



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 The Value Advantage™ that helps in exit planning, value building and financial management.

About the Guest

John Carvalho, president and founder of the middle market M&A advisory firm, Stone Oak Capital, as well as co-founder of Divestopedia, talks about the importance of starting to plan for your exit early so you can have time to get the valuation to where it needs to be. If a change in objectives or change in business is needed, you can back into that if not selling for another few years. The more time you have, the more able you will be to achieve the goals you want when selling your company.


Do you have a realistic valuation of your company? A lot of business owners never actually know what their company is worth until they go to sell their business. It is important to know this earlier to be able to figure out what exit option makes the most sense.

In today’s episode you’ll learn:

  • How to structure your company sale
  • Who to find as a likely buyer
  • How to architect the financing behind the deal
  • How to reverse back into what you want out of your exit
  • Making a healthier business before sale

Full Transcript

Ryan Tansom: Welcome to Life After Business, the podcast, where I bring you all the information you need to exit your company and explore what life can be like on the other side. This is Ryan Tansom your host, and I hope you enjoy this episode.



[00:01:00]Welcome back to the Life After Business podcast. This is Ryan Tansom here. Today's guest's name is John Carvalho. John is the founder of Stone Oak Capital, which is an M&A investment banking firm. He's out of Canada. He's also the co-founder of Divestopedia, which is an amazing online resource website for everything to do with buying, selling a business, exit planning, value-building. John has done a great job aggregating information in Divestopedia, applying it to his clients at Stone Oak Capital.


[00:01:30]John and I have a great conversation because of our new formed partnership with Divestopedia and having this podcast on their site. But we also wanted to bring you, the listeners, all the information that we've been gathering on how to go about this as a business owner. John and I talk about how to structure your deals, who to find as a likely buyer, how to architect the financing behind that, and how to reverse back into it. John talks about one of his clients where they're working on a 1000 day plan and how they are making a better business by going about doing things correctly to eventually sell. Even if they don't, they'll have one really, really healthy business because of their efforts. So, I really hope you enjoy this podcast episode because John and I cover a lot of different topics from both of our experience with working with our clients and has his vast knowledge from Divestopedia.

Without further ado, I hope you enjoy this interview with John.

[00:02:00]This episode of Life After Business is sponsored by The Value Advantage. The Value Advantage is a platform delivered via peer groups and/or one-on-one to help you build a valuable company that can thrive without you, while putting an exit plan in place so you have the options to sell when you want to who you want for how much you want. You're able to manage the business by the numbers, working the business as much or as little as you want, and you fully understand how the business impacts your personal financials. If you want to know more, check out the show notes or the website.

John, how are you doing today?


John Carvalho:

I'm fantastic. Thanks. How are you doing?

Ryan Tansom:I'm doing good. I'm excited for our call today because we got in touch because you guys have a really cool website and a lot of good resources that our listeners probably have come across. I'm excited to go through your experiences and some of the things that you see in M&A industry, and the trends that are going out there.

For our listeners sakes, can you just go back and tell us a little bit about how you got into the whole mergers and acquisitions space?


John Carvalho:

Sure, yeah. I can definitely do that. So, I guess it was 15 years ago where I was doing accounting and auditing. I became a CPA when I first came out of university. Quickly after auditing and doing verification on different clients' books, I realized that, that's not what I wanted to do. Really I was interested in business valuations and corporate finance mergers and acquisitions.


[00:04:00]So, quickly changed gears and went over to a large Big 4 accounting firm with their corporate finance group, and worked there for about eight years. After those eight years, I learned a lot and made number of great contacts with colleagues and prospective clients, and felt that my skills were at a point where I can just go on my own and start my own firm. So, I did that with Stone Oak Capital and that's kind of what I'm doing right now, and keep on doing it. Helping business owners monetize their life work is how I view the work that I do.

Ryan Tansom:Yeah. I mean, that right there is a pretty solid mission and I obviously love it. You've got a platform that you're utilizing that is outside of Stone Oak Capital called Divestopedia. Can you just give us a little rundown on where did that come from, where did the baby and the brain, or the idea, come from? How did you execute and what's the mission?


John Carvalho:


Yeah. Maybe like most things in life, I got lucky and fell into it a little bit. I was working away helping business owners sell their business and a lot of times I'd come up with the business owners that just didn't know what they didn't know when it came to this topic. I felt like there needed to be a lot more information out there in the public to help these entrepreneurs, again, monetize their life work. I did some research, looked online, didn't really see much that I thought was fine enough quality in terms of this topic. So, I started writing a few blogs around topics in [inaudible 00:05:13] in selling a business that I thought were important.


[00:06:00]As luck would have it, I ran into an individual. His name's Cory Janssen. He was the founder of Investopedia, which is a massive financial education website. Told him that I was writing blogs around selling a business. The luck of the story was that he just sold his business, Investopedia, so he thought that the topic area was really interesting. Away we went from there to being partners on creating Divestopedia, which is an educational platform to provide business owners and entrepreneurs with information that's needed for everything from valuing a business to maximizing value to actually selling a business and the processes involved in that.

[00:06:30]It's kind of a long story there, but really, it was lucky that I came across a guy that had the capacity and technological wherewithal and knowledge to help me share all of the ideas and topics that are in my head around middle market M&A to a wider audience.

Ryan Tansom:

[00:07:00]And I think it's absolutely amazing what you're doing because that's how you and I ended up connecting. When I was researching or Googling and just trying to find information about this topic … When we sold our business, so it was probably about late 2013 and early 2014 when I was just scouring the internet for information, trying to find holistic resources that's not just one blog about a specific trust and you have no idea how to put that into context. So, I think you guys are filling a really, really needed void and the information that you guys are accumulating is fantastic. I'm really, really excited for some of the stuff that we've got going on.

[00:07:30]As we shift gears, I want to … For our listeners, I think there's a lot of the stuff that's going on out there about where do you turn. There's all these things that, like you said, the seller doesn't necessarily know what they don't know, so that's what I kind of want to dive into. With your decades of experience in this space, what are some of the common things that you see that pop up over and over, that are the most unknown from the sellers?

John Carvalho:


[00:08:30]No, that's a fantastic question. To be frank, I mean, I'm still learning myself each and every day as I get into a new deal. As you can imagine, I think about this a lot. It kind of consumes my thoughts. One of the things that I find over and over again, from business owners, is just valuation. The starting point on what a realistic valuation is. I think that's always something that business owners don't think about often enough. I think that they get it wrong at the end of the day.

Ryan Tansom:So, where do you see that they find … I think most business owners have an idea and usually it's either way wrong or it's very close to the accurate. I guess couple of questions. Why do you think that is the case that they don't know? And then, what are the things that they have wrong usually?


John Carvalho:

I mean, it's a complex area. You just can't … They might have a general idea of ranges of where their business might end up on valuation, but until you talk to a professional, you don't know for sure, right? They might be floating with this idea that's totally unrealistic or they might have an idea that's kind of reasonable, but you never really know until you want to sell your business. So, having that information early I think is important.



[00:10:30]A couple areas where I think they go wrong is really having a realistic expectation of what an exit looks like. I talk to business owners and they think, "When I want to sell, this massive competitor that's overseas or in a different country, he's going to come up. I'm such a great company that they're just gonna write a massive check for me." Unless you have a proprietary product or you have double or triple digit growth, that's not the most likely exit for you, right? So, you have to look at what is a realistic exit option because a lot of times that drives valuations. If your management team is the most likely exit, they're likely not going to have a massive bank account to write a huge check for a business owner that's exiting. On top of that, they're usually gonna want to pay you out over a certain amount of time.

I think a couple of places where business owners fall down on valuation is, again, just not knowing what's realistic in terms of a range and then also not knowing what's realistic in terms of the actual buyer that might be most likely to come to the table in a transaction.

Ryan Tansom:

[00:11:00]I think you're spot on because it's just all the unknowns of that whole situation. When you are talking to business owners and they're deer in the headlights on these subjects, what is the process that you see that's the most … The ones that successfully go through their process, what are some of the things that they do?

John Carvalho:


[00:12:00]Starting early is one, for sure. When I say start early, it's like eif you want to exit … You got to pick a timeframe that's three years out and then work backwards from there. That's really been where I have seen the most success is where guys say, "Hey, listen, I'm not going to be in this business forever, so I need to start thinking about it now and I need to have enough time that if the valuation isn't where I need it to be, I can actually pull a couple of leverage to increase value. I can also have a lot of time to find that ideal buyer. I can have enough time to switch gears if I need to." So, starting early, I would say is … It's kind of a cliche, right? You got to start your exit planning early, but it really is I think the number one factor that will translate into the most successful exits that I've seen.

Ryan Tansom:

[00:12:30]You hit on two things that I really, really liked, which is the benefits of finding out early is you actually understand your numbers and can actually work towards a specific exit. What is it like for you, and I don't know what the percentages of the owners that want to sell, when they see the numbers and where they're at, just the distraught look on their face of, "Okay, now what?"

John Carvalho:


[00:13:30]I don't know if it's distraught. Sometimes the good guys just say, "Okay. It is what it is right now. This is where I would like it to be. Now what do I need to put in place to get there?" That's like any planning. That's Planning 101. Where do you want to be and then work backwards from that point to say, "Okay, what do I need to put in place to get there?" Some guys truthfully might not believe what I have to say. Maybe they go get a second opinion and think that someone else might tell them what they want to hear. But really, I'm not in the business of telling people what they want to hear. I'm in the business of being realistic on what exit options are and what valuations are.

I come across pretty blunt sometimes and I think clients either really like that or they really don't like it.

Ryan Tansom:Come down to passive-aggressive Minnesota, man. You'll get a lot, "Hey, just call it what it is. Just tell me, man. I can deal with that faster than anything else."


John Carvalho:

Yeah and it doesn't help anybody to give somebody an expectation that they can't or I can't achieve. Again, with the benefit of having more time, if it's a number you don't like, let's put a plan in place and let's figure out how you get there. Really, time gives everybody a lot of power to be able to achieve what they need to.


Ryan Tansom:


As far as the two different categories, like the valuation and the numbers and then the exit options, what are some of the things that you see with … Like, let's take exit options. What are the most common exit options that you see? I think that there's a range that a lot of people don't know about. I just got off one of my calls with Richard Wilson, which … family office, people don't know about that. When you're sitting down with sellers, what is it that they're looking for and then how do you match up the exit option with what they're trying to do? What do you see on that front?

John Carvalho:


[00:16:00]I try to understand what the objectives of the owner are. Usually, it comes down to, "Do you want to get out entirely or do you still want to stay involved?" So, you want to get out entirely, you're trying to find some sort of strategic buyer. Even when I talk about strategic buyers, I mean, there's the local or regional competitor that's looking for a return on their investment, looking for a business that they can add on and create some synergies with. Or there's the multinational, large conglomerate that's willing to pay a little bit more because you have a product that they can really plug into their operations and just take it from a local regional company to something that's more global, right? And that doesn't happen. That's very rare for a middle market business to have that type of interest. So, that's one exit idea or something that you have to consider depending on the objective, if the owner really wants to pull out and not have any involvement going forward.

[00:16:30]Then of course, as you mentioned, there's family offices and private equity firms for those business owners that are really just looking for some sort of capital partner to bring to the table. That's a different breed of business owner altogether. I guess, just as a framework, I really try to understand what the objectives of the business owner are and try to see what's realistic based on their business characteristics to see if those objectives are reasonable. If they're not what they aren't, let's go back to the drawing board, let's figure out. Maybe you got to change your objectives. If you don't want to change your objectives, maybe you have to change your business. Again, the more time you have, the better the ability that you can actually transform that to achieve those goals.


Ryan Tansom:

What are some of the objectives that you see that the owners are trying to accomplish?

John Carvalho:

[00:17:30]Some guys just want the biggest check that they can get. That's totally understandable, right? They want to take this liquid assets and turn it into cash. I'm all for that. That's, I feel, one of my objectives too is to help an owner maximize the dollar amount that they walk away with. So, definitely one objective. Other objectives, there could be family situations. So, maybe they want to get their children involved in the family and give them some ownership and help them really profit from the upsides. In some cases, people want to make sure that their legacy is preserved. Other guys want their management team to be intact and to have some ownership going forward. So, ton of different objectives.

[00:18:00]Step one is determining what those objectives are. A lot of time business owners haven't thought about them, but it's really not that difficult to sit back for an afternoon and jot down on a piece of paper what would you like to see and what's important to you when you sell your business or exit your business.

Ryan Tansom:

[00:18:30]I think one of the biggest personal experiences when we sold our business is the unintended consequences of not knowing your objectives. I think I've mentioned to you, but when you sell to a strategic competitor, you do a sweep with a lot of the employees and stuff like that, which sacrifices some culture and the legacy of your employees and the relationships. So, how do you match up the owner's objectives with the exit options? That's a bigger Rubik's cube a lot of those objectives you talk about. How do you walk the owner through the different variations and how the different things affect what they're looking for?


John Carvalho:


I think it comes back to what I mentioned earlier. There either is a fit. So, if your objective is to, let's say, make sure that your employees are taken care of and you don't want anybody to get cut, then selling to a strategic, where some of those employees might become redundant might not be the best exit option, right? So, it's just saying, "Okay, with a strategic buyer, these are what they're looking for. Now let's sit down. Let's really map out what your objectives and let's just do a matching game. Are your objectives consistent with what's really going to happen if we pick this exit transfer channel? If it's not, let's revisit either the exit channel or let's revisit the objectives. One or the other."


Ryan Tansom:


I'm sure you have experienced something like, "I want all my money right now and I want to sell it to my managers." Well, okay. Or "I want to make sure that I maximize my dollar amount by selling to a competitor and make sure no one gets cut." It's just like, okay, there's give and takes. Everybody wants to make the most amount of money, but then you start to … I don't know. It's probably up to every owner how you assess how much those objectives you're willing to sacrifice monetarily in order to make sure that they're accomplished.

John Carvalho:

[00:21:00]Yeah. Yeah. I think you're right. There definitely has to be some trade-off, right? Again, I go back to either rethink the objectives or rethink the plan or rethink the exit option, one of those three. When you do that, that's really what improves the success rate and success factors of the ultimate exit, right?

Ryan Tansom:And then, switching to go back to the valuation. What are the common forms of valuations that you see? How do you go about applying that? I think there are even these softwares that are popping up these days that can value. You've got a lot of different methods. What is a kind of a nice rule of thumb that you can share with us?

John Carvalho:



[00:22:30]Okay, I can't share rule of thumb because there is no rule of thumb. Anybody that says there is, is just not understanding valuation very well. But one valuation that I've kind of landed on that I really like is … And it goes back to these exit options. So, really understanding what exit option is most likely, and then from a buyer's perspective, how would a buyer actually facilitate that transaction, right? So, a buyer is going to have to get financing. A buyer is going to be looking for a certain rate of return. And different buyers look for different rates of return. So, if you understand what a deal structure looks like and you also understand who the likely buyer is and the amount of financing that they can get, either through their own equity or through a party financing, like a bank, then you can work backwards to say a different valuation level is the equity that that buyer have to put into the deal, does that give them an adequate return on capital?


[00:23:30]It's kind of like a leverage buyout analysis, I think, if we're talking valuation methodologies, but that's one that I've landed on that I think I like the best just because it's a real world … It analyzes what's happening in the marketplace around the ability to get financing for a particular deal. On top of that, it also really illustrates how a deal is going to be structured for a business owner whereas a lot of traditional valuations will just give you a number and the business owner thinks that's all cash. So, the value of the business is 10 million bucks. Well, great, I sell it tomorrow, I'm going to get a $10 million check and I'm going to [inaudible 00:23:25] for me, right? But really, it's not a $10 million check in most cases. It's 5 million in cash, a certain amount in vendor takeback. Maybe there's an earnout tied to that.

Giving a business owner an idea of not only valuation, but also deal structure is something that I feel is missing in the valuation community.

Ryan Tansom:

[00:24:00]I'm going to actually add, a 100% agree with what everything you've just said. And then, you go one step further, which is how that deal structures puts net proceeds int your pocket because that is actually what matters.

John Carvalho:

[00:24:30]Yeah, exactly. The tax guys are going to take their cut too. So, I'm beating a dead horse here with the planning, but that's where the planning comes into play, right? Get tax planning involved too, so now you not only know the valuation, but you also know the deal structure. If you have an efficient tax structure, you know exactly how much cash you're going to walk away with after you pay cash. All of that combined … The owner doesn't care about valuation. They care about exactly what you said. How much money is in their pocket after they sell their business?

Ryan Tansom:And what time frame and over how long and what kind of risk because if you're going to do an earnout in an industry that's selling floppy disk, it might not be a solid idea.

John Carvalho:Exactly. 100%.


Ryan Tansom:

I'm curious because I love how you articulated that whole situation. Do you have with all of the years of experience one really cool structure or way that you're versed in that you can walk through start to finish of how you take someone's objectives, form an exit option and then what kind of structure and financing you put behind it? I know that's a lot and we don't have to go into some crazy details, but I'm just thinking, even if you don't know names or anything like that, just a way that you would walk us through how that would look.


John Carvalho:

So, I'm actually working with a business right now as we speak. I can't take credit for the plan that we've called it, but we called it the 1000 day plan. I guess the reason we've called it that because a three year plan just seemed like it was too far out, right? Too nebulous.

Ryan Tansom:Throw in the days.

John Carvalho:

[00:26:00]Yeah, so we can actually count down the days, right? It really started with looking at the market and saying when do we think the market is going to be at a peak for the sale of this business in this particular industry that they're in. So, we pick that date and now we work backwards. Just put in place all of the things that we need to do to get ready for that ultimate exit.


[00:27:00]We initially thought one exit option was most realistic, which was a sale to a strategic buyer. But putting the plan in place and the forecast, we actually think that we might be able to get to a specific size where another exit option is more lucrative. Really there's appetite for it. Even with my experience and my knowledge of the industry and exit options, still the conversations with others within the industry helped us all realize that there was another better exit option that can create more value for this business owner.

Ryan Tansom:Sorry to interrupt, but what I love about just even that specific part of the process is your everything over the next 1000 days is going to be different depending on the different ways that your margin, depending on the people you hire, the systems and softwares you put into place, and the competition structures, all that stuff.


John Carvalho:


Exactly. For sure. The other beautiful thing about it is at the end of the 1000 days, if it doesn't happen, this business and this client that I'm working with is a 100 times better business than it would have been otherwise. We've also, exactly like you said, we've filled in the gaps where we needed to from an organizational perspective, from an outside consultant perspective. We're looking at putting an independent board of directors in place. So, there's that third party oversight and mentorship for the business owner.

[00:28:30]It just gives you such a laser focus on building a great business and creating value. And again, if it happens, this business owner is going to hit it over the park. If it doesn't happen, he's still going to have a great business that is miles ahead of where it is today.

Ryan Tansom:Yeah. What's the worst case scenario, your EBITDA's 10 times more than it was before?

John Carvalho:Exactly.

Ryan Tansom:Like, darn I don't work as much and I'm making 10 times more money.

John Carvalho:Yeah. That's exactly it. There is no negatives from putting a plan like this in place.

Ryan Tansom:

[00:29:00]I'm just curious because my firm, we focus on the value building system from John Warrillow. There's a million different ways you can call it. But it's the value drivers. It's all those things that you've talked about, some of them get really technical, some of them are strategic, but have you noticed that when people are looking like that, you have a foot in the short term cash flow, but then you also have a foot in the multiplier of your EBITDA. So, you can sacrifice some cash flow today because you understand what you're going to get out of it. I mean, how do you have those conversations? What are some of the cool examples you might have seen?


John Carvalho:


I think that's a good way to paraphrase it in terms of value appreciation. Look, you have to spend some money today to create value tomorrow, right? And there might be a little bit of an impact on cash flow and EBITDA in the short term, but you see what the long term goal is and what the long term objective is. I think prospective buyers can wrap their heads around that too. They recognize that you have to make investment in the business to get it to another level.

Ryan Tansom:Well, if a prospective buyer's going to invest a bunch of money into the business right away anyways, they're going to knock off the price of the acquisition anyways. So, you're going to end up paying for it regardless.

John Carvalho:Yeah. I agree with you there for sure.

Ryan Tansom:

[00:30:30]So, after you pick a couple of likely potential buyers, you put a value creation and the plan in place, all the technical stuff that's got to get it done. Let's kind of dive into the financing a little bit because we haven't really touched on that too much in the show. I think there's a lot of perceptions that you got bank financing, seller financing, all these different types. But what kind of creative financing options do you have that are available and how does that affect getting the deal done?

John Carvalho:I think [crosstalk 00:30:54].

Ryan Tansom:

[00:31:00][crosstalk 00:30:55]. Oops sorry. More like a leverage buyout analysis. I don't know if there's something, like how you've seen something unique get done that you didn't think was possible.

John Carvalho:

[00:31:30]Yeah. I guess doing a lot of middle market deals, I kind of see that there is a need for buyers to have great advisors just as much as there's a need for the sellers to have great advisors. A lot of blame gets put on the sellers when deals don't close. I'm sure you've heard the daunting statistics of one in ten deals actually gets consummated or gets completed. But some of that responsibility has to fall on the buyers too where they just don't know how to structure a deal, they don't know how to find the sources of capital, they don't know how to put a letter of intent together to make an offer.


[00:32:30]There is so many sources of capital now out there. There is the typical senior debt. There's the mezzanine capital or that middle layer of capital. There are party equity groups. There's the vendor financing like you said or some sort of contingency payment like an earnout. I guess I can't really specifically say one that is more creative or unique than others, but there are just so many ways to find money and it really is just how risky is that money. That's what it comes down to is if it's backed by a lot of assets and security, it's not so risky. If it's more based on something that's future and a little bit more nebulous, then that's definitely risky and it deserves a higher rate of return.

[00:33:00]I think just understanding the layers of capital and where to search for those can help get more deals done and help buyers execute more deals.

Ryan Tansom:


[00:34:00]Getting the buyers and the sellers on the same page too. I think the things that I've seen is there's just this huge either lack of awareness or this misperception that you either get the check or the buyer's got all the cash and they're just going to write the check. Or the bank's going to finance it. Or the complete opposite of the spectrum that the sellers just got to take a long drawn out payment. But, I mean, all these things that you just referred to, there's so many ways to get the deal done, that you can structure a lot of those different things together and combine them based on different terms and conditions that I think … If you have two people, the buyer and the seller, that are actually on the same page of trying to get the deal done, you can find a way to reverse back into that financial engineering to make sure that the net proceeds, which is what the seller cares about, and that the deal terms for the buyer are actually aligned if you've got the right people at the table, I think.

John Carvalho:

[00:34:30]I think it all comes down, or should come down to … I say this as a pretty rational guy. I think of myself as a – I don't know if you're a Star Trek fan or not – but I think of myself as like a Spock, right? Everything should be very logical for me and it comes down, from a buyer's perspective, to return on equity. If I'm writing a $10 million check and I think the risk of the business is I should be earning a 25% return, then the metrics have to weigh that out, right?

Ryan Tansom:Mm-hmm (affirmative).

John Carvalho:

[00:35:00]From a buyer, you either have to tell me why you think a 25% return is maybe too high for the business or how you think that a buyer can actually achieve those returns. So, there's that balance there of return on equity.

Ryan Tansom:Do you find it hard to get sellers to think in the buyer's perspective?

John Carvalho:

[00:35:30]Again, going back to the leverage buyout analysis, I think the way that it's presented where it's a "This is the value. This is what your deal looks like. This is the equity check that a buyer is going to write based on a forecast that you've given me, business owner, this is their return." It's pretty straightforward. It's math. I'm not inventing any sort of new crazy math here. This is what the numbers say, so prove to me where I'm wrong because I know that this is a likely deal structure that we can get involved with this.

Ryan Tansom:

[00:36:00]Yeah, it is interesting because, from my exposure and even from our own business, even if you're in the middle market where tens of millions of dollars, lot of business owners look at the cash flow and the distributions, but never looking at their whole business as one asset that should provide a return on equity.

John Carvalho:Yeah.

Ryan Tansom:And that's the challenge where all of a sudden instead of 120k plus 200 in distribution. No, it's literally how much is your rate of return total.


John Carvalho:


Yeah, exactly. I've thought a lot about this and I think business owners look at the perks of ownership and tie that all into lifestyle. They can set their own hours, maybe they're tieing in their owner salaries into their return on equity, which I think are two separate things. Maybe a conversation for another time. But you're right. Nobody sits down and does that kind of math. Like, "What kind of return on equity am I earning as a business owner?"

One guy that I really like who talks extensively about this is Rob where he says that 90% of businesses out there in the middle market are not earning an efficient return on equity to compensate the risk that these business owners are taking on.

Ryan Tansom:I agree. That I have not seen it, but I can only imagine it's got to be pretty damn close.


John Carvalho:


Yeah. You think of a risk of a business and especially a business kind of sub-$25 million of revenue, there's a ton of comeptition out there. A lot of things can happen in terms of financing and loss of customers and loss of employees. You got to be thinking that on your equity you want to be earning at least a 25% return, but a lot of guys, a) aren't thinking like that, and b) aren't even close to earning that type of return in their business.

Ryan Tansom:


[00:39:00]Yeah. I would agree with that because I mean I don't even remember who in our advisor or expertise circle of influence would have been able to provide us with that information. It was just a challenge making sure all of the payables were geocoded correctly, let alone good heavens someone coming and showing us that kind of information. A really cool exercise that I think helps this situation is to have … When someone's looking at a house, to buy a house. They go on Zillow. I don't know if up in Canada you got Zillow [inaudible 00:38:41] or any kind of real estate website where you look at all the deals and you start to understand what the market bears. Is to then do the same thing in your world is go look at all these companies and look at what they're asking for, the pretext and the multiple, and then go, "Would you want to buy that?" And actually, put the buyers head and go "Holy cow." Now, you're looking at it like an asset instead of, "I don't want to go weld all day long. I want to actually have a piece of asset that kicks out cash."

John Carvalho:


[00:40:00]Yeah, I know exactly. That's exactly right. One thing I think that's just very time-specific right now is the return that people are looking for on their capital is so low that it really is an amazing time to sell a business. When I perceive the risk on equity of these smaller businesses to be 25% plus, there's just so much capital looking for a place to earn a return that a lot of buyers are looking at return on equity that are lower and that translates to higher multiples on business valuation. If timing the market is something that business owners really think about, which I think it should be, now is an amazing time to get your business in order to hit the market.

Ryan Tansom:That's interesting that you said that because, yeah, I mean I agree with that. There's everybody, every investment banker, business broker I've talked to has said there's five to ten times buyers to every seller because they can't find something that's healthy enough that they want.


John Carvalho:


Yeah. That's why unfortunately a terrible business will never sell. Well, I can't will never sell. Anything will sell at the right price, but it's still difficult to sell a business that doesn't have really high quality earnings or high quality characteristics in the marketplace. But a business that is above average will sell at a significant premium just because there is that inequality between the number of buyers versus the number of sellers, especially high quality sellers.

Ryan Tansom:Yeah. Because we were talking about some of the macro things right now, what are some of the common trends that you're seeing in the marketplace because of the exposure that you got from information Divestopedia and the deals that you're seeing? What are some of the key characteristics of trends that are popping up that you're seeing?


John Carvalho:



A couple of trends that are interesting. Outside just valuation multiples being at a level that frankly I can't understand. But another trend that I'm seeing a lot of is a minority equity investment. So, private equity firms, typically they always wanted a majority, they wanted to be able to control their investment, they wanted to be able to control the direction of their investment. But now we're seeing a lot more bigger firms, bigger private equity firms looking at minority investments, which I think is actually what a private equity firm should be selling, right? They should be wanting to partner with business owners that still want to have control, that still want to be involved, that still want to take their business to another level. So, I think there's probably more synergies and just more fit between the objectives of the owner that wants to grow the business versus a private equity that wants to make an investment. So, the minority investment is kind of an interesting trend that I'm seeing more and more of here.

Ryan Tansom:That's interesting. I mean, it makes sense both ways. Obviously, if you're a PE firm, you want to go buy in, make sure that you got control over the asset that you're responsible for. But at the same time, why wouldn't you want to get a higher rate of return and give some guidance and let someone else do all the work?


John Carvalho:

Exactly. I'm sure they still have other mechanisms and other ways of controlling, like board seats and maybe a different class of shares. But the minority interest is new. I'd say probably over the last year and more firms are definitely moving in that direction.

Ryan Tansom:Interesting, yeah. How are the valuations … Usually, the minority shares, that's an easy way to discount the value of the company and gift it to kids or managers or something like that. How does that affect the valuations?


John Carvalho:


That's a good question. I haven't actually worked on a minority interest deal. But from a theoretical perspective, the minority interest discount is there, but I don't think it's there from a practical perspective. Again, I think that these private equity firms are astute enough and have done enough deals that they're going to find other ways other than just pure share ownership where they can control the direction of the firm. I'm sure the shareholder agreement is going to have very specific buyout clauses and triggers there. I don't think that the minority discount in the real world is actually something that happens in a deal.

Ryan Tansom:Mm-hmm (affirmative). Yeah, because it's used for tax purposes for the most part.

John Carvalho:Yeah.


Ryan Tansom:

I want to go back because you mentioned something about the multiples that you don't fully understand. Is that because the multiples are so low right now?

John Carvalho:No. So high.

Ryan Tansom:So high.

John Carvalho:Yeah, I can't wrap my head around how high these valuation multiples are.

Ryan Tansom:And what size companies and what size EBITDA are you referring to? I'm just curious.

John Carvalho:

[00:45:00]I guess I talk to a lot of private equity firms, just through my relationship with Divestopedia there. I don't even want to put valuation multiples out there in the public realm because I think it gives owners unrealistic expectations.

Ryan Tansom:

[00:45:30]Yeah. I was a speaker at a local event and there was a panel of business owners that have sold. They were telling their stories. There was two family transitions and two that have sold. This one gentleman, awesome guy, sold his family business out 17 years ago over a cocktail, at a trade event. He got 11 times. He sits there and tells that in front of 250 current business owners and I'm like, "Aw crap."

John Carvalho:


[00:46:30]Yeah. I know. Again, I'm not putting those valuation multiples out there because I do think it's very company-specific. As much as some people want to give that rule of thumb or paint an industry multiple on different industries, I'm not that guy, right? I look at a business as each individual business on their own island. Obviously, you want to look at what's happening in the marketplace. If they're one of my clients, I want to get them the highest value that I possibly think I can get. But I think what's happening is that the private equity firms, typically they'd always talk about return on their money of that 25% as their hurdle. Now it's more like 16-18%, right?

Ryan Tansom:

[00:47:00]So, I got a question for you. I'm just totally shooting from my own random thoughts and experience. I like to follow money and then figure out where all the motivations come from. Think about these PE firms, they're borrowing money or taking money from big pension funds or big private investors that are also trying to hit a rate of return because interest rates are nothing, so no one's getting their rate of return that they need. So, all these pensions are drying up, so you just start to see all this. Are you seeing that because they're just trying to scramble to get the return for the people that they report to? I mean, I just … I agree. I have no idea what's going on in that front.


John Carvalho:


Look, I agree with private equity firms. If you get somebody a 16% return, in this interest rate environment, people are super happy about that, which they should be. That's an awesome return for people, but the thing that just doesn't click in my head is the … I guess because I've been involved with so many small business as clients and also having investment in small businesses, I just see the risk in the equity of these small businesses. I don't think it's that sub- 25%. You're putting money out there, looking for that 16-18% return. But you're investing it in instruments that are really at 25% plus return. So, that's where the disconnect is for me.

[00:48:30]I understand where the private equity firm, they need to place the money, they need to earn a return for their investors. But the assets that they're putting that money into, I think, at least in my perspective are riskier than the return they're looking for.

Ryan Tansom:

[00:49:00]Yeah. There's a disconnect in what they perceive to the risk of what they're putting with their funds in. I mean, yeah, I agree. That's interesting. To your valuation point, I agree. I think it's a good idea not to talk about specific valuations because, again, I think to your point earlier, that if you specifically figure out who you think your potential buyers might be, you can reverse back into there and hopefully calculate the value and get to the value that you want regardless of some general number and multiplier.

John Carvalho:


[00:50:00]Yeah. Exactly. Again, let's say you had a company that had an incredible brand. This company sold a product. It was super successful. It had a regional focus and a large multinational distributor's coming to buy you. They can take that brand and product and now put it through all of their distribution channels and multiply that company by X times. What's the valuation that one of those guys are willing to pay and the cost of capital for one of those multinationals is more like the 10-12%, right? So, their return on equity is a lot lower. So, you're going to base, taking all of those assumptions, into this leverage buyout analysis, you're going to get a much higher valuation because the cash flow's going to be higher with this business now with all of the distribution channels that you can send this product through and their cost of capital is way lower.

[00:50:30]That's why it's not a one size fits all. You got to look at what's likely for the business in terms of a potential buyer and then how is that buyer going to view that transaction, and you work backwards from there and figure out, "Okay, this is a price that I think I can negotiate to."

Ryan Tansom:

[00:51:00]Yeah. It's just absolutely spot on advice to be able to reverse back into it because like you said then you got a very specific target there going towards. It's laser focused. If you got specific strategic buyers that you're trying to sell to, and you're making yourself that much better, if that doesn't happen, then you've got the worldwide area of private equity or financial buyers that will just take a healthy company and apply a really good multiplier to it.

John Carvalho:

[00:51:30]Yeah. Exactly. I've thought about this value creation thing lots. It comes down to couple of areas. So, the first one is just increasing cash flow. When you increase cash flow, you're going to increase the value of the business. It's a simple concept. Now there's a lot of things you can do operationally to increase your cash flow, and you just got to figure that out for each specific business on how to do that.


[00:52:30]The second thing is reducing risks. So, if you can reduce even the perception of risk to be able to generate that cash flow, that's going to increase value. Again, that's more of an operational thing. But the third piece to increasing value – and this is where I come in, so being a little biased here – but a great M&A advisor increases value from that timeframe when you start to market the business to the timeframe where you close the deal. Let's say, that's a year period. That period is so important to maximizing value in terms of the preparation, the negotiation skills, the ability with your legal team to be able to really set terms that are maybe more favorable to the seller. I think thinking about that one year period when you're actually executing your sale, a ton of value can be driven in just that process.

Ryan Tansom:

[00:53:00]Yes. I think you've checked all the boxes. One of people on that panel I was referring to, they said during one of their processes – because they're all buying companies – they said, "We found that there's a humongous difference between good advisors and excellent advisors and the expertise that they bring."

John Carvalho:

[00:53:30]Yeah. I'm still working to get to that excellent advisor role because I have a lot of people that I look up to and respect that I feel are in that echelon, but really, it's just a mastery of the craft, right, in a lot of things that go into trying to get to that becoming an excellent advisor. I do have a number of thoughts on what differentiates a good advisor from an excellent advisor, but it takes time and experience I think to get there.

Ryan Tansom:Well, right. And you'll always tell on the battlefield. It's always the results usually speak for themselves.

John Carvalho:

[00:54:00]Yeah 100%. That's something that most business owners should look for. Go get those references, go look at what the track record of the advisor is. What's their batting average? The funny thing about batting average is that great advisors will typically pick the winners, right? They're not going to pick the losers, so their batting average is not only good because they're good, but also because the companies that they pick are good.

Ryan Tansom:Yeah. Everybody wants to sell the house that is the million dollar house that's perfect and is super marketable.

John Carvalho:

[00:54:30]Yeah. Exactly. But I guess going back on that, is typically the great advisors that get those listings too. Looking at batting averages is important to see how many businesses does the M&A advisor actually work on and what's their [inaudible 00:54:42] percentage.

Ryan Tansom:

[00:55:00]And then, also how do they apply all those things that you just talked about. How can they take the average and make it the great house or the great business that's really marketable. I think there's not as much work as a lot of people think and being able to get the right guidance to be able to put it into place, so that way they can execute. That is super important.

John Carvalho:Yeah. And there is a little bit of a different skill set though, I think Ryan, between the value creation piece where there's operational stuff, there's corporate structuring stuff. I think that takes a team to really put that value creation in place. And it also takes a team to execute that sale. I do think they're different skill sets.


Ryan Tansom:

Yeah. 100% I agree with that. So, what is the best way for our listeners to get in touch with you?

John Carvalho:A lot of ways. I'm pretty accessible and pretty easy to find online. If they want to get in touch with me through Divestopedia, it's pretty simple email address. Just [email protected]. That's probably the best way to get hold of me.

Ryan Tansom:Well, I had a blast. Thank you very much for coming on the show.

John Carvalho:Hey, appreciate it. Always like talking to you, Ryan.

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Written by Ryan Tansom

Ryan Tansom

Ryan runs industry-specific podcasts on his website which pertain to mergers and acquisitions, and all the life lessons he wish he had known then. He strives to bring this knowledge to his listeners in a way that is effective and engaging by providing new material each week from industry experts.

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