Mike Harvath  00:04Hello, and welcome to this week's Shoot the Moon podcast here, broadcasting live and direct from revenue rocket world headquarters in Bloomington, Minnesota. As a reminder, revenue rocket focuses on helping IT services companies grow through facilitating m&a transactions and helping with optimizing growth strategies. Today, I've got my partner, Brian Barnett, on the call with me, Ryan, welcome. Ryan Barnett  00:31Hey, Mike, it's good to be recording a little podcast here. And I have a couple of ideas for you today. One of them to start with just trends that we're seeing in the market. And then what we've seen in the last couple of weeks in have been negotiating deal is that working capital and working capital calculations have been one of the big things that have cropped up as discussion points. So want to do a bit of education and understanding around working capital and where it matters in a deal. But Mike, just want to start out seems like in the second half of the year, things have changed a little bit on people willing to take a call when it comes to selling their business. As our listeners may know, we provide both buy side services to our clients, which means that we're helping companies acquire other companies and finding the right strategic cultural and financial fit for them, as well as helping companies sell, sell their companies. And we've seen a little bit of an uptick in people actually answering their phones, and, you know, typically says, hey, you're about the third or fourth person I've talked to this week. But once this conversation going, there seems to be people willing to consider selling their firm. And, Mike, I'm just kind of curious if you've seen the same and why you think that is. Mike Harvath  01:57Well, I you know, I do I have seen it, I think people are, you know, hopefully the dust has settled for much. For the most part due to the COVID pandemic. I think a lot of people had their business kind of up ended during the pandemic. And it took them a while to get it re established and reestablished in a way that was consistent and predictable. So I you know, I attributed some of that just the distraction of focusing internally on the business and then ultimately, getting back to, you know, more, little more breathing room, their ability to field calls. Certainly they focused on. It's not not that businesses have been necessarily seen a material downturn in the pandemic, although some did, and the kind of IT services space. But certainly what we're seeing and based on conversations lately 2021 has been a banner year, for most, most of our clients and our targets and, and folks that we've been talking to, on behalf of our clients. And there's certainly a lot more conversations going on about, you know, the merits of putting together a deal strategically and culturally. And people are more open to exploring those things right now. Ryan Barnett  03:29Yeah, you know, in general, I think we have seen these rising valuations. And in general, if you see that long enough, you finally say, hey, maybe this is the right time. Mike Harvath  03:41Yeah, I agree with that. Ryan. I think that's been fascinating. Certainly, I think the market will continue to consolidate through 21 and 22. and beyond. We certainly don't see an end in sight to the market. You know, the, the rather frothy market, which has driven valuations. And, you know, I think the more and more people have conversations about combinations, they realize sort of where the real market is for their business. And maybe they're open to having conversations that are somewhat more realistic for value now. And not just based on kind of what they feel the business is worth. So, you know, I mean, probably multifactorial reason why these calls are happening. Ryan Barnett  04:29And last question on this Mike is do you think that we are six months or seven months now into the year of a new political administration and and that may not be as favorable when it comes to taxes when it comes to business combinations? Mike Harvath  04:49Well, I I do think that you know, tax considerations are driving many sellers right now. We have we do have sell side mandates with clients that have come to us and Hey, the reason we're going to market now is because of a potential tax change. We hadn't planned to go to market yet. But we're coming to market now, because we're concerned about a tax change. Now, how real adtech genes is and when it'll occur, and if it'll occur, you know, I think is open for debate. I think there's plenty of room for the current administration to make moves on corporate taxes that don't involve changes to our material changes to capital gains, I think the fear that a lot of sellers have is that there's going to be a, you know, elimination of the of the capital gains tax or, you know, 9-10 percent increase in the capital gains tax, which, certainly, if you're selling a business that have a very material impact on the amount of money you get to keep, but I'm a bit of an outlier on that, I think there's gonna be other things like the buck tax and, you know, other levers that the current administration can pull to sort of increase, you know, taxes from corporations as well as enforcement activity that will occur in lieu of capital gains increases. And I think if the tax bill is going to get passed, it's probably going to have to look more like that. Because I do think that there are certainly plenty of people in Congress that are not going to be favor, favorably looking upon a capital gains increase. And certainly that'll be kind of a last resort type increase, I think, if they're going to get something passed this year. Ryan Barnett  06:42Yeah, exactly. That Well, that's it, it's, it's interesting, I think it's, overall, we certainly see the worry from our clients and companies coming to market, and that there could be radical changes. But I think no matter what the political environment, it's smart, to be cautious about how it goes, put it this way you have to put in, you have to incorporate taxes in order in the hole, when you're looking at your deal, and how to get that done. And that may change a bit, but you have to understand, work with your accountant on careful tax planning, and how that could impact the future. Mike Harvath  07:21Yeah, just to add that, I mean, it's a material thing, not only in the States, but certainly in Canada, we have a lot of listeners in Canada, and a lot of our clients are, frankly, in Canada. And this is similar around the world for global tax policy, there's structuring that you can do to be tax efficient in preparation for selling a business. And we certainly recommend that all business owners understand those options, and they understand those well in advance of selling maybe even years or, you know, many years in advance of selling, that's certainly the case. In Canada, there's some structuring that has to be put in place. So certainly structuring here in the US as it relates to your classification of a corporation to make it more efficient for selling a business tax wise, a small business, and particularly a services business. And so you know, you should be having those conversations with your accountant to make sure that you've done the early groundwork so that even if you're not ready to sell now, that you're you're in a position to do so when the time comes. Ryan Barnett  08:25Yeah, absolutely. And that's how I transitioned a little bit. The other topic that we had seen as of late is, companies, when you sell your company, there is typically a number of different transactions you can have. So, Mike, can you just explain to the audience something, you hear that cash free debt free? What's that mean? Mike Harvath  08:49Yeah, I mean, there's a couple things on structuring, we get a lot of questions about, you know, I want an asset deal or a stock deal, or I want, you know, all working capital to be a certain way. You know, we've talked about, you know, assets and stock deal before I can quickly address that, again here, which is for a tech services company, it really doesn't matter all that much. You know, I think in some cases, there's advisors in the market that give bad advice. Typically, these are accountants, they may be lawyers that are used to more you know, what I'll call asset intensive businesses, like manufacturing companies, or quick serve restaurants or, or even, you know, convenience stores and things like that, where they have a lot of assets and it does make a huge difference tax wise to a seller if it's a stock deal or an asset deal. In a technology consultancy, it really doesn't matter all that much. It has much more to do with the allocation of that purchase price and how its allocated to Goodwill or other asset classes. These kind of go hand in hand with working capital working capital. In order to sell a business you need to sell it as a going concern and the definition going concern would mean that it has enough working capital in the business to sell. A lot of sellers get advice from their advisors that they want to keep all of the assets in the business and try to, you know, sell the business with the liabilities. And that just doesn't really work. You have to have enough assets in the business and the appropriate allocations in the liability side of the business, in order for there to be enough working capital to operate the business by the buyer after the deal is done. And they don't have to be able to operate it assuming no revenue or you know, no profit, you know, blah, blah, blah for a long time, that you need to cover about a month's worth of expenses typically. And so understanding that clearly, is important. Now, most small businesses, most particularly IT services, businesses, if they're Runwell, are over capitalized, have more working capital than they need. And thus, the sellers can harvest some of that capital, or all of that excess working capital we call or the value in excess. Sometimes people use that term. Understanding what that working capital ratio is what's involved, what a buyer needs to run a going concern is important. Cash free debt free is not a very good strategy for the seller in a growing business. And the reason why that is, is because you have a lot of your asset, tied up in receivables. And this is particularly important if you're in a fast growth services firm. And it leaves too much capital in the business, or an excess amount of working capital, in our opinion in the business for the buyer. It also isn't very buyer friendly, because oftentimes, if someone does negotiate what we call a cash free debt free deal, it requires the buyer put cash into the deal in the first month to cover operating expenses. The theory is a good one. But it's one that doesn't always work perfectly in practice, because it assumes that that buyer is going to be collecting AR throughout the month. And that AR is going to fund operating expenses for payroll, which is a significant cost in an IT services, business and other expenses. And as much as that's true, and will be the case over time. They can't assume that they're going to be able to in a transaction, when things are changing with a customer base, that they are going to pay as consistently as they have up to that point, it will take a little bit of time for them to get used to the new buyer make sure that you know if there was changes and who they should pay that they've made those adjustments in their system, and it can create a little bit of a delay in collections doesn't mean they're bad, but just it's a delay. So we think it's a better idea to we have a combination of cash and receivables to cover off the liabilities and their curls in the business. And make it a little easier for the buyer to operate the business without putting cash in and be more faith and be more fair to the seller to take excess working capital out. Ryan Barnett  13:27It's really insightful and helpful. It's one of those areas that you don't necessarily think of until later in the transaction typically. That being said, as of late, we've seen a number of deals that have tried to look at cash early on in a negotiation. The factory we've even seen a bit of an attempt to calculate working capital before an ally. So we that's typically we don't see it that really when you start bringing cash in to the into the equation like when you are working through a deal. Mike Harvath  14:04Well, it's typically after the letter of intent, and it comes in through due diligence. oftentimes there's a comment in the letter of intent about adequate working capital, which is fine in more detail than that, or can specify a working capital ratio. But seldom does it get to a working capital peg as we call it, or the exact number until we're through due diligence, and it's part of the definitive agreement to begin to look at cash and working capital ahead of the letter of intent is premature. It's premature predominantly because working capital is a moving target, how much of it is in AR and cash and depending on invoicing cycles. How much money is left in the bank versus that has been paid out or is dividend out is a number that changes every month and it points in time throughout a month in a Typical cycle. So, you know, we think it's best practice to probably outline at a minimum that there'll be adequate working capital left in the business and excess working capital will be determined and able to be kept by the seller in the letter of intent. Or you can specify a working capital ratio or what some call coverage ratio into the letter of intent. And then the exact numbers calculated later and documented in the definitive agreement. Ryan Barnett  15:33Interesting, and then when you're talking about enterprise value, do you typically include cash? Mike Harvath  15:40No, enterprise value certainly will include adequate working capital. So back to this point, you know, it's a going concern, and it has enough capital to operate. That's what everyone wants. Now, that discussion about what's adequate is a negotiation. And, you know, some buyers want all the working capital that someone's had in the business over the last year, average or two years, and generally in small businesses, that is, that advantages the buyer, it's unfair to the seller. For all the reasons I've talked about before, we just had a conversation, the day we're recording this podcast, with a client that has, you know, $3 million in excess working capital and their balance sheet and cash. That's beyond what's needed to operate and run the business. From a working capital perspective. That should be the sellers money. It's not something that would be included in the transaction, typically. And so, you know, enterprise value, the way we see it is to define it as a going concern and then to be able to strip excess working capital. There's another reason for that it's not the way it is always in business valuations is that most businesses in IT services are valued based on free cash flow, and a multiple of free cash flow, not book value. There's certainly book value considerations and, you know, add the assets on the balance sheet in excess liabilities impacts book value. But in models that we run, we de emphasize the book value some, some people do evaluations and IT services completely disregard book value. We think at a minimum there should be a consideration. Because certainly if the business is under capitalized, that needs to impact valuation or impact a true up. Just like if it's over capitalized, the seller can harvest that money. More often than not, we see in the small businesses, if they're successful in growing, they tend to be over capitalized or have too much working capital, or excess working capital on the balance sheet. Pack close. Ryan Barnett  18:12And they're very interesting. It's a it's a topic that moves so much. It seems like it's something that doesn't necessarily get resolved until nearly the day of close. So I know when there's pushing and shoving on deals, we see this most often around working capital. Like is there just to wrap this kind of conversation up? Why is it such a tested item throughout? Mike Harvath  18:42Well, I think private equity firms have had a history of trying to take excess working capital to kind of cut to the chase on it on the guys that tried to do cash free debt free deals. That advantages the buyer and advantages a buyer that has capital to put into the business because almost all of these businesses, if it's done as cash free debt free, the buyer will have to float one month to expenses to be able to get through a collection cycle. They've for a long time private equity buyers required that they wanted to do that they would say we're gonna approach this deal as cash free debt free. Now I should say that all deals are generally debt free from a long term debt perspective, and if not, that, that needs to be reconciled with purchase price at the time of close or ahead of close and, and the only liabilities that really come by are come by past or what we call trade payables or or you know, putting some things on the balance sheet that would be appropriate for you to put there into liabilities like accruing for a payroll. So having an accrual for a payroll or a month of payroll is an appropriate best practice. When you're looking at working capital and working capital ratios, for example, I mean in IT services, it's the biggest expense. So the whole cash free debt free concept came out of capital market operatives that wanted to advantage or get their hands on more working capital and probably needed. And in a perfect world, if you had perfect receivables collection at 30 days or less, and you were not growing the business at all, then Caspi definitely could work and be fair. I think if you're if there's variables around the growth of the business, let's say the business is scaling and growing materially, which means you're continuing to grow month after month, and are your maybe your VSL your sales outstanding, or your AR Aging's are showing more than 30 days. In that scenario, it's always gonna advantage the buyer as it relates to kind of fair working capital. And we just don't know that that works out. We've even seen some buyers want the seller to clear the trade payables, which is completely we think a big land grab on on capital. And because, you know, working capital is sort of a not well understood principle. For most business owners. It's an area where people can take advantage of a seller, frankly, and you know, begin to subsidize their purchase price. And so it's probably a good business case to have a m&a advisor in the middle who negotiates working capital all the time, and can help you get your fair share of that excess working capital, or what I'd say all of that excess working capital that's not needed to run the business moving forward. Ryan Barnett  22:02Yeah, I totally agree. We're happy to help. And it's something that is core to every deal that we get done. Like this. That's all the questions I've got for you today. Appreciate you getting through this and I'll let you wrap it up. Mike Harvath  22:17Sounds great, right. So with that, tie a ribbon on it, hopefully enjoyed our conversation about working capital. Certainly if you have any questions about your own working capital, or how you would cap calculate a reasonable amount of working capital in your business pursuant to Sally be happy to advise you on that. Likewise happy to help you in any way we can on the m&a front or optimizing your strategy to grow. Hopefully you'll tune in next week we have a new podcast, coming to you from Minnesota. Talking about m&a and strategy for IT services reps, take care and have a good week.

Shoot the Moon with Revenue Rocket

Asset Sales vs Stock Sales and What to Consider in Both Scenarios

Read more about our insights on Custom Application Development trends in our recent blog post: https://www.revenuerocket.com/custom-application-development-trends-outlook-end-of-2021/ 

Custom Application Development Trends & Outlook

One of the most critical functions in an organization is the first person of contact for enabling an M&A transaction. If your competitor calls you and wants to buy you would you entertain that conversation? Having a third party like an advisor brings in standard operating procedures, best practices, and the proper etiquette that is paramount to creating engagement and good outcomes.Some key points Ashley and the team cover in this episode:Documenting outreachFraming up a discussion to present an opportunityRespecting the prospect's time and recognizing their toneCommunication methodsBest practices for follow upBusiness Development functionsRevenue Rocket standardsListen to the Shoot the Moon Podcast on Apple Podcasts or Spotify. Reach out to us for a no obligation introduction call at info@revenuerocket.com.

First Impressions and Persistence: The Difference between Success and Failure

Tune in to Matt and Mike's discussion with John Schmelzeis from Microsoft's Global Partner Solutions group as they talk through the changes, focus and opportunities within the Microsoft partner program and how tighter alignment can lead to improved performance. Hear how Revenue Rockets SVP program perfectly integrates into Microsoft's renewed focus surrounding Advanced Specialization as part of their partner effectiveness measurements now implemented within the program. From awareness, to acquisition and new ways to work with the Microsoft team, you don't want to miss this episode of Shoot the Moon!

Building Your Business with Microsoft feat. John Schmelzeis

At Revenue Rocket a fair amount of our clients fit into the category of managed service providers or MSP’s as we in the industry refer to them.  The category focuses on providing business and enterprise clients with predictable and scalable solutions for managing all facets of information technology (IT) within their corporate ecosystem.Macro trends:Simplify the hiring and maintenance of internal IT teams (outsource) Continued enablement of the remote worker Scale when dealing with the job swap boom (increased churn in enterprise)Managing the continued migration to cloud and the complexities that come with itHyper automation among key functions such as employee onboarding/offboardingVirtual service delivery (online tools and enablement) - Zoom erra AI and machine learning shift from buzz words to real world value Implementation and management of cyber security solutions New age testing and implementation of augmented reality (AR) and virtual reality (VR) solutions. 64% of brands have started to test the effectiveness of these solutions in the past 2 years. Expansion of VoiP solutions for staff connectivity outside of the four walls MSPs Interest in selling increased from 15% to 27% from 2019 to 2021Closing remarks:Combinations are fueled by: The need to achieve new levels of economies of scaleIncreased costs related to required growth to keep up with demand Attractiveness to bolt on additional solutions to the existing portfolioEstablishing or expanding diversity in target market segments (healthcare to manufacturing…) Valuations are up - no better time to exit (in some cases) Increased interest from financial buyers (PE, SPACs and more)Be sure to read up on our latest blog post covering these trends and more on our website at https://www.revenuerocket.com/msp-trends-predictions

MSP Trends & Predictions

Listen to the Shoot the Moon Podcast on Apple Podcasts or Spotify.

2021, The Cybersecurity Boom!

We are often faced with the overwhelming influence from sellers to put aggressive weighting on financial forecasting when it comes to determining valuations. The reality is that while forecasting has a significant impact in determining valuations it doesn't always have a positive impact. Points we discuss in this episode:Forward-looking performance of the company can be incorporated into earnout type structuresForecasts can shed light on new business lines maturing and becoming a more meaningful part of the financial pictureForecasts provide buyers with the information they need to make assumptions on a combined businesses performanceForecasts that are in line with historical performance are more likely to be weighted vs those with major spikes in performanceForecasts containing major reductions in OpEx to achieve a new degree of EBITDA need clear understanding and in many cases require some historical proof points to be considered in valuations.Forecasts with major upward shifts in revenue without any historical performance to support the improvement will almost certainly be discountedForecasts are an important part of valuations when the combination currency is stock/equity.  Mergers and acquisitions that are funded by stock almost always allow for a more aggressive valuation based on future performanceListen to Shoot the Moon on Apple Podcasts or Spotify.

Do's & Don'ts with Forecasting to Determine Valuations

In this episode, we discuss what defines a competitive market and what are the markers to look for.  Ensuring you buy right is critical to achieving the ROI on a combination and navigating inflated categories is especially important when structuring a deal. Learn how Revenue Rocket is navigating these competitive deals with structured processes, accretive deal architectures, and refined and accurate forecasting for both the target company and the future combined company.  From finding the ideal target to making the offer,  managing the process, and navigating the emotions that come with it.  You don't want to miss this episode! 

Buying in a Competitive Market

Revenue Rocket has worked with hundreds of firms to successfully complete transactions. We'd love to schedule an introduction with you and learn about your growth goals. Reach out anytime: info@revenuerocket.com

Your Deal Fell Apart, Now What?

Half of Revenue Rocket's business is organic growth strategy. We spend a lot of time with business owners looking to grow organically and utilize our SVP program. SVP stands for specialize, verticalize and productize and if you are not considering this methodology you're missing out on a lot of growth. The idea is to have all 3 of these components working in your business to effectively be in the top quartile for growth and profit realization. If you'd like to learn more about our SVP program, reach out to us or learn more here.In this episode, we are focusing on productization. Productization is essentially bundling your services to look like products to enable your business to add higher value, get to market quicker with your customers and be more competitive.Feature: something a project or service offering is able to do. For example, configuring a database, optimizing a cloud infrastructure set up to run faster.Benefit: why does that feature matter? Ask yourself, how can our client make more money or how can our client save more money from this feature?

Productizing: Benefits vs Features

We have all been there at one point in both our personal lives and quite possibly in our professional lives.  The nerve-racking and heart-racing introduction of a new intimate relationship. Yup, mergers, and acquisitions are intimate, exciting, and full of unknowns.  Mix in a few missed commitments, some late-term learnings that were never disclosed and you have yourself a normal, typical, term of dating life, I mean M&A process.  You get the point... in this episode, we will discuss the commonality between M&A and dating.  From selecting the right match to making it past the first date to potentially the alter.  Listen in as we navigate the parallel nature and uncomfortable situations that most certainly lay ahead. 

M&A Match Making: Do's and Don'ts

Having your ducks in a row going into a process will ensure that expectations are met, that valuations hold strong through the process and that the unknowns are limited and not factored into the economics of the deal.  Ideally you should work with an advisor to ensure your sell-side readiness and to be ahead of any pitfalls in the current inventory of documentation, reporting or assets associated with a transaction.Are you ready to sell today? Contact us for an introduction call: https://www.revenuerocket.com/contact-us/ or start by doing a quick check-up of what your business could be worth with our valuation calculator. Listen to the Shoot the Moon podcast on Apple Podcasts or Spotify. 

Ready, Set, Sell?

Are you ready to buy?Revenue Rocket has been helping buyers find the right partners for over 20 years. Consider a quick introduction call with us, and let's talk about your growth goals: https://www.revenuerocket.com/contact-us 

Are you Sure you're Ready to Buy?

When you embark upon a merger, what is the first and last things the seller should be thinking about? In this episode, we cover selling your firm and what it takes to get a deal done.Our advice to sellers covered in this episode: You need to fully understand what you are getting into when selling, it's a hard, unnatural act.Going to marketDo you know what you want to do next? What happens after the deal is done?Make sure to have clarityBumps in the road - are you ready?Valuation expectationsAccounting challengesARE YOU READY? What is your mindset?The effort that goes into a process to sell your business is substantial and will come with a cost of distraction, advisors and professional fees. Backing out over minor adjustments in valuation, timing or structure will not render an ROI for your efforts. Ways to keep deals on track covered in this episode:Set good expectationsBe truly transparent in your disclosuresCommit to the combined entity and vision of the futureBe fair in your assessment of chargebacks (boats in Miami are not legitimate business expenses)Be prepared to absorb some personal liabilityStructure the deal in such a way that it is always a win/win.Reps and warranties can protect both parties, so be prepared to accept holdbacks on payments or equity to allow additional time post-close to resolve allocation issues.Set good expectations with yourselfHow an advisor can help:We help clients see the whole picture, including the likely pushback, carve outs and challenges we see during a process.Advisor can be the “bad guy”Being prepared ahead of a process makes all the difference.Financial reporting (audited)Tax filingsDebt / balance sheetKeep the cap table clean (clean up old sins prior to the process)IP documentationLimited litigation pendingAdvisor can handle the majority of the tactical negotiations which helps keep the emotions out of the process.Eliminating the “Why” from the buyer's intent, or a term or condition that shows up last minute is key to avoid wondering what life will be like post close.

The Right Seller Mindset Near the End of the Deal

Today we are going to talk about the importance of cultural alignment during a merger or acquisition. Failure to consider cultural alignment in an M&A transaction can be the kiss of death. We see many times when two parties try to come together without an approach to implement and monitor culture it doesn’t work.Here at Revenue Rocket we always look at 3 important things: Strategic Fit, Financial Fit, and what are we talking about today, Cultural fit.Some things we'll dive into:Strategic FitIntegrationHeirarchyGoal alignmentFinancial FitUsing an advisorWe'd love to learn about your growth goals. Reach out to us to schedule a no-obligation introduction call: info@revenuerocket.com

The Importance of Cultural Fit During an M&A Transaction

The Shoot the Moon podcast is for IT business owners and executives. Host Mike Harvath, founder and CEO of Revenue Rocket brings his experience with M&A and growth strategies to IT Services company leaders worldwide. In each episode, Mike either discusses business topics or interviews an IT executive.

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Shoot the Moon with Revenue Rocket

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