Navigating GovCon M&A

Dive into the world of mergers and acquisitions within the government contracting sector with Sharon Heaton, CEO of SB Liftoff. Sharon, a seasoned M&A expert and author of "Liftoff," shares invaluable insights on the art of successful deals, emphasizing empathy, strategic negotiation, and the critical importance of understanding GovCon nuances. Whether you're contemplating selling your business or looking to acquire another company, this episode will help you navigate the complexities of M&A.

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Read Transcript Here:

Michael LeJeune: [00:00:00] Hey everybody, Mike LeJeune here with Game Changers for Government Contractors. I've got Sharon with me here today. Sharon, we're going to be talking about your book Liftoff here in a minute, but before we do that, why don't you tell everybody a little bit about who you are and what you do?

Sharon Heaton: Certainly. Thank you very much, Michael, for being here. I appreciate the invitation. My name is Sharon Heaton. I am the CEO of sbLiftOff. sbLiftOff is a national M& A advisory firm focused on the lower mid market in GovCon. So I kind of say that we've got three differentiators. First is, of course we know M&A. Two is we know GovCon. We live GovCon. We live NAICS codes and designations and all the rest of that. ?And then three is we are really focused on the 10 million to $75 million company in terms of revenue, which puts us squarely in that lower mid-market area where there's so much growth and change going on in the GovCon market.

Michael LeJeune: For folks who maybe you're catching this is the first episode of Game Changers, you may not have heard me harp on this issue, but anytime you're doing anything, I always recommend [00:01:00] somebody who knows their niche and understands GovCon. Because you could go hire an M& A firm who understands M& A and they're really, really good at it. But if they don't understand GovCon, they're not going to speak your language.

Sharon Heaton: Completely agree. And I say to people all the time, Hey, listen, I want you to hire us because I think that we're terrific, but if you don't hire us, please, please hire somebody who knows M&A, and knows GovCon. Same thing when people are choosing attorneys. There are lots of attorneys out there. But you don't want your brother in law who did your trust in the state to do your M& A transaction, right? You really want to have somebody who's done this a thousand times before, not somebody who's learning on your dime.

Michael LeJeune: It’s one thing to understand your niche, but if you don't understand the GovCon side, like you said, the attorneys, accountants, sales trainers, all those types of things. There's such a gap in their knowledge of how to translate from their market to our market, and that's where the drop off is. Because they're [00:02:00] probably really good. It's probably really good advice, but the translation between the two, you know, there's a lot that's going to get lost in that shuffle there.

Sharon Heaton: As we said, I'm an M& A attorney by training, I'm a recovering lawyer at this point. I'm not practicing anymore, but it's a 12 step program. I'm on the apology level at this point. I was talking to a P. E. firm that wanted to come in and buy a GovCon company. The GovCon company was small business, and I said you have funds under management, we're not going to be able to structure that so you could take advantage of that. I told them the rules, and they looked at me and they said, Okay, that's very nice. How do we get around those rules? And I laughed and I said, you don't. These are rules that are there and they're enforced and this is no kind of just checking the box. You actually need to know what it is you're doing. And they appropriately said, this is not the industry for us. And I agreed with them. You really need to know what you're doing when you're talking about GovCon.

Michael LeJeune: Absolutely. So today we're going to be talking about your book LIFTOFF. I love the book. I love the title there. LIFTOFF:12 things to know before selling [00:03:00] your business. You sent me two copies so I can send one to somebody else. Can add to my collection of assigned author copies there. We're going to be talking about 12 things to know about selling your business, but we don't have time for all 12.

We're going to be hitting on four of them that really jumped out to me. I want to go through these and I'm sure we'll talk on some other ones, but the first one that jumped out to me was in chapter two. What's the secret to a successful deal? We won’t go through the whole chapter, but what are two or three of your top things that make a successful deal?

Sharon Heaton: The first thing is a mindset. People go into these transactions thinking that it's all about the price or the networking capital target, or the reps and warranties. In truth M&A is referred to as the last art of finance. People focus on the finance part, but there's an art to it as well. And the art is that you're dealing with human beings. Particularly when you're dealing with a founder owned company, somebody who started that company from their kitchen table and has grown it over a period of 10, 15, 20 [00:04:00] years.

They think of that company very often the same way that they think of their children. When you're doing due diligence, you really don't want to say that your daughter is fat, your son is awkward. It may be true, but there's going to be better ways of saying it. So what I think is the most important aspect of doing a deal is the word, empathy. Sellers need to have empathy for the buyer and what the buyer's going through and buyers need to have empathy for the seller and what they're going through. And that empathy can be a superpower.

Narrator: ?If you're struggling with your government contracting business, I want to encourage you today to go sign up for a free coaching session with me. You can go in the description of this podcast. There's a link to my calendar and you can go pick a time where we can sit down for 30 minutes, talk about what you're doing right, what you're doing wrong, what you should change. And then if coaching makes sense for you, I'll actually go over the options on how you can get started with coaching so we can take your business to the next level.

Now let's get back into this episode.

Michael LeJeune: People [00:05:00] throw around the word mindset a lot. And I think a lot of folks roll their eyes at that. When they do, it's because they don't necessarily understand how important it is to have your head in the game and in the right space because of the decisions you make, the things you say, like you were saying there, and really having an understanding of your surroundings. It makes such a big difference to have the right mindset. And I think it is really undervalued if you were to ask me, so I'm glad you started with that one. Is there one other one that you would pick for like the secret to a successful deal?

Sharon Heaton: It is to focus on the fact that the goal is to expand the pie. It's not simply to divide it up. People will enter these transactions, these negotiations and say, well, if I want 10 and they want 12, or I want 25 and they want 30, then we're going to pull back and forth on those numbers. The reality is, there's a lot of factors at the table and to be able to put all those factors on the [00:06:00] table will allow the parties to consider a broader range than just the numbers.

For instance, sellers often care a lot about what happens to their employees or the quality of service given to their customers. We have found in many circumstances that sellers have not always chosen the offer that is the highest purchase price. They've basically balanced off that purchase price with who they thought would be successful in taking over their company.

So it's really to approach this with kind of a win-win scenario. It's not an I win, you lose or vice versa, but rather, how does everybody involved get to pretty much where they want? They're not going to get everything. That's why it's a negotiation. But we also have to be sensitive to the fact that it's not just the seller and it's not just the buyer at the table.

There are other parties as well. For the seller, there's going to be the employees, the customers, vendors. For the, buyer, there's going to be the financing source, any partners they have, if they have a company currently, the employees of that company. We need to look at the [00:07:00] entire ecosystem of people who are affected by this deal and come up with the best solution for everybody to the extent that we can.

Michael LeJeune: I think that's where people don't necessarily understand that sometimes the best deal is not about the money. The best deal is about something else. A real simple example was actually when we sold our house last year. When we were looking at that, we had offers coming in before it was on the market. We were in a market where, even before the craziness of the housing market, houses just didn't go on the market in this particular area. We were outside of a university town. It's just one of the things that just didn't happen.

And so when we were talking to the realtor, she was like, I've got three buyers and we haven't even listed this thing yet. I know three people that'll buy this thing. And sure enough, they all begged to look at it before it went on the market. We held them off. And then the day it went on the market, we got an offer and we knew there were two other people that were considering it. [00:08:00] But we immediately threw one of them out because we didn't like them. Their realtor was such a schmuck. And there was no other way to put it. He was such a horrible person that we were like, there's no way we're going to entertain an offer. We liked the people on that deal, but we didn't like the realtor. And we knew: how it begins is how it ends, right? We were going to have a bad experience with that realtor from beginning to end.

But then the people that made the offer came in at full asking price, in a market that goes well over asking. But it was a teacher in the community. My girls had both had the teacher. They liked the teacher. It was a young family. We could have held out for thousands of dollars over the asking price, but we were like, look, there's a really good family in a really good situation that's going to take over our thing and it's our asking price so we're happy with it.

Sharon Heaton: That sounds fantastic and it actually sounds pretty farsighted. When you're selling a house, [00:09:00] the truth is you're putting the keys on the table and you're walking out the door and maybe in the future you'll bump into those people and have some relationship. But not usually when you're selling a company. The sale is in fact the beginning, not the end. Very rarely in these transactions does the seller drop their keys off on the table and walk off and not think about the company again. Most of the time that seller has an ongoing role of some sort for some period of time. Liking the people matters a lot in M&A. We often have what's known as management meetings and management meetings historically were in person. Since the pandemic, they're much more over video calls. That's where the buyer and the seller are talking about all sorts of things to do with the company.

But an element of that, that is now coming back in full force, is the after management meeting dinner. Now, historically, those were always done in steakhouses. I don't know why, but they were done in steakhouses. Now they seem to be a little more varied. And that's the time that the buyer and the seller get to look at each other and say, Do I like this person? Is this [00:10:00] somebody that when there's a problem, I think is going to get down in the dirt with me and figure out how to fix it? Or are they going to go running for the hills? And those management meetings and the post dinners afterwards, incredibly important for the human connection. So necessary to make a deal stable.

Michael LeJeune: And I can imagine, if you're looking at selling and you know you're going to have to stay on for six months, a year, two years, which is often the case, or even if you're going to be a salaried employee with an indefinite type of contract, I've seen that as well. If you don't like those people that's going to steer you away from that deal. Like, how am I going to take money from them? And then how am I going to work with them for six months or 12 months or however long it is, because I just don't like them. And so I can see how that really factors in.

Talk to me a little bit about chapter four. You talk about, is my company sellable? And I think might be one of the most underrated questions for people to ask. Because I believe [00:11:00] everybody thinks they're sellable. Everybody thinks that their little baby is worth a small fortune. In fact, this one, it probably won't surprise you given what you do, but I was talking to a company recently. They were asking a hundred million dollars for their company. And I was like, wow, I'm going to be really impressed when I hit USASpending and I look at the numbers. I got in USASpending and I looked at the numbers and I was like, something must be wrong. So I reached back out and I said, um, can you clarify what your annual revenue is?

And they're like, Oh yeah, sure. I don't think everything shows up in USASpending. Let us send you a spreadsheet. I'm like, okay, maybe there's subcontracts or something's off, right? Maybe I got their UEI wrong. Something's off. So they sent me a spreadsheet and I was like, huh. It was off, but it wasn't all by that much and they were doing, this year there'll probably be a 4 million company. I'm like, how are you asking a [00:12:00] hundred million dollars for your company? I was just kind of floored by that.

But I talk to companies a lot and they're like, Hey, we're doing about a million and a half, 2 million. We're hoping to exit for 25, 30 because you know, next year our projections are that we're going to do this revenue. They're trying to sell the company on projections. And I'm like, what are you doing? It's just kind of craziness that I see. So that “is my company sellable” question. Talk to me about that. And how do people determine if it really is sellable?

Sharon Heaton: Well, there's two separate things. One is, is it sellable? And the second is, at what price? Pretty much everything is sellable at a price, but that price might be so low as to be negligible such as doesn't make any difference.

First, is it sellable? And the distinction that I make is whether or not you actually have a company or whether or not the owner has a job with staff helping him do that job. I was talking with a business owner who was in a food prep company, had about 20 million in revenue, profitable. We were sitting in [00:13:00] his conference room for about an hour and a half talking about the company and the history and where he wanted to go and et cetera. During this hour and a half, at least four or five different people came into the room to say, Mary didn't show up for work. What do I do? We can't find the invoices. Where should we look? The sink is backed up. How do we get it fixed?

After several of these conversations, interruptions, I turned to the business owner and I said, I don't know that this company is sellable. And he said, well, why is that? Because you're making every decision. Your staff comes to you to figure out the most mundane issues that come up in a company. If, God forbid, you were to walk out into a parking lot and get struck by lightning, what happens to your company the next day? And he went white. He was totally blanched saying, I don't know what to do in that circumstance. I said, well, if you're looking to have somebody buy your company, they're going to be putting money in your pocket and you're gonna walk out the door. Who's gonna play the role that you play? And he said, well, somebody else is gonna have [00:14:00] to do what I do. I said, you work 90 hours a week. You take care of every single detail that's going on. Nobody else is going to do that. You are a single point of failure. You own all the customer relationships. You understand all the logistics of your company, all of the HR. You have a job with a lot of staff to help you do your job, but you don't have a company.

One of the things that I think is very difficult for business owners to understand is that their company becomes more valuable, the less important that owner becomes. And if that owner is the critical point of failure in that company, that decreases the value of that company to the point that it might in fact not be sellable.

Michael LeJeune: I know there's some people listening to this saying, well, this is just not the scenario I'm in. And yet I have coaching calls all the time with big companies. We're not talking mom and pop companies. We're talking in the tens of millions of dollars where I say, well, who's responsible for this? Well, I, well, who's [00:15:00] responsible for that? Well, I am. Sales, marketing proposal writing, who runs the books, who's looking at this, who's looking at? And they kept saying, I am. I’ve had that conversation a lot and it's like, well, if you're responsible for everything, then, like you just said, what happens when you get sick? What happens when this, and how could you possibly do all of that work? Everything we just mentioned is a job by itself. And you're doing all those jobs or you're spinning all those plates.

That to me is one that hits home because I understand sometimes when people are part of the brand. In our business, people come to us because of US. That's a huge part of it. And we do have other people that work for us and we're helping them to build their brand and we train them to do things and we're involved in it, but we don't do all of it. And there are too many people that they are not only the face of the company, they're on the back end. It's kind of like, I don't know if you remember those costumes that were always the horse. And it was like, there was one person in the front and one person in [00:16:00] the back. They're actually trying to be the front and the back of the horse at the same time. It just doesn't work. It's just kind of crazy.

So, what else makes a company sellable?

Sharon Heaton: Some level of visibility as to where future revenues are coming from. And that's one of the truly wonderful things about GovCon. People can talk about the commercial market all they want, but getting a base year contract with four or five option years is a pretty fantastic thing. It's not recurring revenue in the way that people talk about it for a SaaS model, but it's pretty darn close.

Now, it's a major difference between having prime contracts and subcontracts. If you've got the prime contract, highly likely you're gonna have that for the full term of that contract. If it's a subcontract, there's a variety of factors that come into play. But I cannot overemphasize the importance of backlog to a GovCon company. And that kind of turns GovCon companies into two different categories. Those that have the traditional base year and option years with, that kind of recurring revenue visibility. And those that do [00:17:00] project based work.

So the project based work, let's say a construction firm. They might get a project that could go on for a year or two. But it's not going to go on for five years for the most part. So that would impact the value of that company and who the potential buyers are. Because what a buyer is really looking for is they look to see the past for determining how to value the company, but they're buying the company for the future. And what they want to see is where is the revenue going to come in that will create the net income that I can pay back whatever financing I'm taking on and over time put money in my pocket.

Michael LeJeune: That's a really interesting one. And I have seen people where they know that their friend is selling a company and they're even in a similar industry doing similar revenue. And they're like, what's going on? Why is he being offered all this money and I'm not? And you sit down and like, well, all you have is subcontracts and one offs and they have a quite a variety of mix in their contracts that you don't, and that makes a big difference. And sometimes people look like, well, revenue’s revenue. But it's [00:18:00] not all the same.

Sharon Heaton: Revenue is not revenue. One of the things that we tell buyers on a regular basis is, Please don't buy for revenue. Buy for capability and buy for employees, access to customers. There’s all sorts of reasons to acquire a GovCon company but simply to get more revenue is not a good choice.

A couple of things of what you said. Yes, a lot depends upon, let's say the commodity, the type of work that you're doing. Are you doing commodity work, butts in seats, or pulling a wire through a wall, or are you doing high end cybersecurity work? Do you need clearances or not? These things will have a major impact on who will be interested in your company.

One of the other kinds of things, of course, is margins. You might have 30 million of revenue, but if you've got 3 percent margins, it's not going to be nearly as desirable or even as sellable as if you've got 10 percent margins. That makes a huge difference. One thing that is an example I use in the book that kind of surprises people is that, particularly in the commercial market, but a little bit in the GovCon as well, I use the example of a very high end law firm. A law [00:19:00] firm with five or six lawyers who are doing incredibly high end work and making lots of money, versus a cardboard box manufacturer. Highly likely that that cardboard box manufacturer is going to get more money, cash or clothes than those lawyers will, because the cardboard box manufacturer has clients who care about those cardboard boxes. The clients of the law firm want those particular lawyers, and if those particular lawyers sell, then those customers may go away. So there's factors that you may not initially think about when you're thinking about the value of your company, but that's where it really helps to talk to people who are very experienced to say, here's some found value that maybe we weren't focusing on, but here are some concerns as well.

Michael LeJeune: That's a really good example. And I've seen ones where it's look at the same type of industry whether it's a high end law firm or two cardboard box manufacturers where one is still, they're fairly small, but they're very nimble and they don't have huge warehouses. Or in the law firm there, they don't have 17 floors of a big building and [00:20:00] granite floors and all that kind of stuff where they're paying millions of dollars in rent. And another one where they may have similar amount of lawyers, but they built their own building and it's a two story thing or whatever. And so their overhead is different.

One of my first coaching clients ever, almost 20 something years ago, owned a roller skating rink. So this was outside of GovCon, obviously. And when I sat down with them, what surprised me initially was they both drove up in Jaguars and I was like, huh? ?I went to their house and I'm like, it's one of the nice houses on the block. And they sat down and like, yeah, we make about 75 percent margin on this thing. You know, we're pulling out half a million dollars a year, And you're like, wow. This is a roller skating. I knew law firms that weren't making that kind of money. They're making doctor money as my kids would say. They're just letting people come in and roller skate. So you just never know. My favorite line is, it's not about how much you make. It's about how much you keep.

Sharon Heaton: Absolutely.

Michael LeJeune: The million [00:21:00] dollar question for a lot of people is How do I get paid? You talk about that in chapter five. There's a lot of different ways you get paid. Why don't we hit on that one?

Sharon Heaton: The first way people get paid is cash. It's clearly what every seller wants, and what buyers will do some amount of. But in the buying of a company, rarely do they pay a hundred percent cash or close. It's very different than when you're selling your house. When you're selling your house, you're basically going to drop off the keys. Somebody's going to pay you the full cash at close. You'll pay off your mortgage if you have one, and the rest of it goes into your pocket.

For a company, the buyer is very nervous about what's going on with that company. Regardless of how much due diligence that buyer does, on the day of closing, the seller will know more about that company than the buyer will. So one of the due diligence elements that a buyer is doing a little bit covertly is to see whether or not the seller is selling for a reason that makes sense, or are they selling because they want out and want to switch their problem to the buyer. Buyers get [00:22:00] very nervous about sellers who want 100 percent cash at close and won't consider anything else. Buyers will say, do you not believe in the future of your company? You're making these kinds of predictions as to what the revenue is going to be and what contracts you're going to win. Do you not believe that?

As a general matter, depending upon the transaction, you should get somewhere between 50 to 80 percent of the purchase price in cash. And not surprisingly, buyers trying to reduce down the amount of cash at close and sellers trying to increase it. But sellers should go in understanding that they're probably not going to get 100 percent cash at close. And, oh, by the way, for any amount of value that they get that's not cash at close. Sometimes the purchase price of that company could be higher. There's a bit of an all-cash discount so that if you're willing to take on the other types of consideration, the purchase price might go up. So let's talk about what those three types of consideration are.

After cash, the next one is seller financing. Now, seller financing is an IOU. It's the buyer turning to the seller and saying, I'm going to buy your 20 million company. I'm [00:23:00] going to need a 2 million loan from you, and I'm going to pay that 2 million to you over the next 3 years, 5 years, whatever it might be. Sellers are often hesitant to do that, but buyers get very nervous when the seller again is saying, I don't want any financial ties to the company, particularly something like seller financing, which is not contingent. Seller financing is that buyer owes 2 million. That seller is going to get that 2 million unless the company goes into bankruptcy. And the buyer really has to mess up pretty darn badly to turn into bankruptcy in that time period. Buyers will often look for some level of seller financing depending upon who the buyer is, and how sellers respond to that communicates information to the buyer that's worth considering.

The second non-cash consideration is equity rollover. That is, you could decide to sell 80 or 90 percent of your company and continue to hold 10 or 20%. Now, sometimes sellers will turn to me and say, Oh, why do I want to do that? That sounds like a terrible idea. If I'm no longer in control of it, I don't want to have any economic interest. [00:24:00] Buyers will look at that in terms of, we think that we're going to be able to stand on your platform and take the benefits that you've created and enhance them and create more value.

Sometimes the buyer specifically wants the seller to stay in as an equity owner. Sometimes they want them out. But again, if the buyer wants the seller to take some equity and the seller says, under no circumstances will I do that, is there some communication going on? The benefit of taking some equity rollover is that the seller gets what's called a second bite at the apple. If in fact the buyer is able to take that company, grow it and ultimately sell it, then they can be significantly more value for the seller than if they had sold it all the first time.

Those are the first three, cash at close, seller financing and equity rollover. And then we turn to the dreaded earn out. I'm sure you've heard about earn outs, Michael, and all of your listeners has as well. And earn outs have a terrible reputation. They've often been done based upon future profitability of the company, which is a [00:25:00] loser's game. You really need to make it on something more binary. We're strongly in favor of earn outs. Properly structured earn outs can be an important way of bridging gaps between buyers and sellers.

Michael LeJeune: I think all of those have a purpose and depending on what you're doing, there may be a hybrid deal of some sort that works really well for you. For the right person with the right mindset, going back to that first thing with the right mindset, I think that allows you to say, Hey, if we structure it this way with the right buyer, we're in the right situation here.

I know for a lot of folks, there's two reasons to shy away from those other options. And one of them is, they're scared of it. Like you said, it needs to be somebody else's problem instead of mine. I just want to walk away. And another part of it is just not trusting, like, Hey, I don't know you that well. And I'm afraid that, you know, are you going to pay? Are you going to make those payments that you're saying you're going to make in there? They have to put themselves in the shoes of the buyer who's saying, is your company what it says, or am I going to start turning over rocks and [00:26:00] find out that you've got some really dirty secrets here? There's a little bit of give and take here, which, like you said, gives the most money.

And in fact, as we're recording this, there was just a couple of days ago with that baseball player. I don't follow a lot of baseball. He just made that monster 700 million deal. It was wild to see. I don't know if you watched how he structured it. It’s a 700 million deal, but he's only taking 10 million up front over the next 10 years. So he's taking 2 million a year over the next 10 years and he'll take the remaining 680 million over the back half of a, it's basically a 20 year contract. So he gets paid 2 million a year for the first 10 and then he gets ?680 divided by 10, or 68 million. I guess he gets paid that each year for the next 10. Which allowed the team to actually spend more money up front because there's all these salary caps, right? They're going to spend more money up front, putting a team around him so that he can have a better chance of winning World Series, hopefully multiple times in their [00:27:00] eyes, and then he's going to get all the money on the back end.

But if he had done that deal the other way, where it was all cash up front, he likely wouldn't have gotten 700 million. He would have got a much lower number. So, I mean, this guy walked away with 700 million in his deal. It's very interesting to see something like that happen.

Sharon Heaton: That is a terrific example. I wouldn't think to use a sports analogy, but it's actually a very, very good example. And it goes back to where we started in terms of what makes for a successful deal. Empathy. That baseball player was empathetic to what the owners were thinking, which is, we have salary caps, and we gotta spend more money, and as good as this one guy is, there's nine people on this team, and we've gotta have really good other eight players. This player allowed the team to be able to build something around him, which is likely to make it more successful for everybody. That's the kind of empathetic thinking that I think creates stable deals and creates more value.

Michael LeJeune: And in the end, he makes out. Because he didn't need all the money, right? He didn't need 700. The [00:28:00] two or whatever: He's like, this is what I need for my lifestyle and my whatever. And then when I'm done with this, cause he'll be done with his career in 10 years, most likely. And I'll still be getting a check for another 10, this monster check. But he may get hurt in the third year. He doesn't know. But he's going to get paid on the back end.

So as we wrap up here today, I want to touch on one of the most important questions that everybody has on their mind. And you cover this in detail in chapter nine. How much is this going to cost me? Cause I know that's the one thing when people are going in and they're bringing partners in or companies in service providers to help them with the sale. They're thinking, how much is this going to cost?

Sharon Heaton: Well, it's very important to think about it from the perspective that you gave Michael. Which is: the purchase price is very nice. What are you actually going to put in your pocket at the end of that? So let's talk about those different costs for the seller.

By far, the biggest cost is going to be taxes. Now, capital gains rates are at historic lows. Nonetheless, 20 percent is not insignificant, and there are a little bit of add on fees on top of that. In 2021, there [00:29:00] was a bit of a panic that capital gains taxes were going to go increasing to the rate of ordinary income. So there was a flurry of transactions, and then capital gains rates did not change at all. But for the seller, by far, their biggest cost is going to be taxes.

Then, there is the prep work from the seller to get ready. We've had sellers hand us over audited financials with an incredibly clear look of what is their backlog and their pipeline and their margins by contract, et cetera. And we've also had sellers come to us with a snapshot of their whiteboard saying, well, that's a picture of my backlog. It's like, well, it's going to take longer and more money for the second company to prepare them for the first one. To some extent where you start defines how much that's going to cost. If you're already in pretty good shape, it's going to be pretty easy. If there's a fair amount of prep work to be done, well, there's going to be some more lawyer and accounting fees before that time.

Once you are ready to go to market, the costs are as follows for the seller and buyer. If they choose to use an M& A advisor, that is [00:30:00] clearly going to be a cost. What we've recently calculated is that we actually bring more value to our clients than in fact we end up costing. So I urge people, both on the M& A attorney, on the M& A advisor, on their accountants, do not go for the lowest cost option because it could end up costing you a lot in the long term.

We had one transaction that completely fell apart after a closing and it was very, very bad for the seller to have that happen. So obviously there's M& A, advisor fees. Then there's legal fees. You're going to have a lawyer, whether you're on the buy side or on the sell side. One of the things that a lot of people don't know is that the lawyer of the buyer is the one who drafts most of the agreements. So the seller's attorneys are extremely important, but they're not the ones doing finger to keyboard. And as a result, the legal fees for the buyer are often a bit higher than they are for the seller.

Accounting is going to be important for a couple of reasons. There's going to be a networking capital target, and that has to be determined. There might be a quality [00:31:00] of earnings, and a quality of earnings is a report done by the buyer. So that is a cost of the buyer, not of the seller. And it's something that's now become common. Ten years ago, a quality of earnings was kind of an occasional thing that would happen on a large deal, 50 million and above. It's now gone all the way down to 5 and 6 million dollar transactions, and it's a cost of the buyer.

So lawyers, accountants, the quality of earnings. Here's something that sellers don't think about. There's something called tail insurance. Tail insurance is that you probably had insurance when you owned your company and if there was a liability that occurred for a previous year, your insurance company would pick that up. When you sell your company, you're terminating that insurance and that protection that you had in the past goes away. So tail insurance is something that almost all buyers will require the seller to purchase. And it basically says that any liability that is discovered after the closing, but is attributed to the time that the seller owned the company will still be covered by insurance. That tail insurance is not terribly [00:32:00] expensive. It's going to be somewhere between 15,000 to 40,000, but you don't want it coming as a surprise to the seller. They should know something like that is coming.

There are miscellaneous things that come up. One of the most common is unpaid vacation time. Some sellers have been very good to their employees, give a lot of vacation time and allow their employees to roll it over from year to year. Well, if you limit it, say either no rolling over or only to a week or so, that liability is pretty small. We had one deal where that liability was over half a million dollars because there had been many employees that had not been taking vacations and had been there for 10 and 15 years. That could be a fairly major thing.

There are liabilities that sellers don't always think about that could come and bite them. And that's one of the reasons to know about these things in advance.

It's very important that the seller do due diligence so they know what's going to be coming as opposed to it being a surprise at the end.

Michael LeJeune: Those are some really good ones. I hadn't necessarily thought about all of them. When I go back in time and think about, I went through a couple of [00:33:00] transactions like this as an employee. One of the things in our last one was the seller came to all of the key employees and said, Hey, You know, this is going on. We know this is going on. We don't want you going anywhere during this timeframe. So here's a big chunk of money. It's, you know, 25, 30 percent of your salary, depending on how far you were in the company, it was 50 percent of your salary, to not go anywhere over the next year and stay with them.

Then what does the buyer do? The buyer sits down and says, Hey, we value you. We will pay you a chunk of your salary not to go anywhere. So both sides wound up paying bonuses to keep people. I wound up being one of the few who was in that little pool of people who got a bonus from both sides to stay with the company, one through the transaction and then the other one for at least 12 months after the transaction.

So, those are some costs that may or may not happen in a situation. I think there are two main types of cost. There's stuff that needs to happen before the sale [00:34:00] and then stuff that's going to come out of the sale. Which coming out of the sale again, kind of like your house, right, where you've got your realtor fees and all your stuff that you have to pay. But for the average company that is, and I'm not going to lock you into this because I know it's going to vary based on the size, but for the average company who's, let's say 10 million or 20 million and they're looking at selling, there's a lead time and all that. How much cash would you recommend they budget for the preparation of a sale. Is it 50,000, 100,000, 200,000? What would you recommend for that 10 to 20 million company to budget up front for them to prep for the sale.

Sharon Heaton: I'm going to give one of those terrible lawyer type answers of: it depends if they have their financials are very clean. There's not a lot of even adjustments, they've got a very good backlog, they understand their pipeline, they've got control of all their data: it's not going to cost [00:35:00] much. What we strongly recommend, because virtually every seller tells us that their finances are in incredibly good order and everybody's happy, is to allow some third party to take a look at them. They might make a lot of sense to the seller because you understand why you did all the things you did. But the seller who built a successful company, and God bless him for that, may not be an expert in GAP, Generally Accepted Accounting Principles. They may not be understanding the latest rules for what's going on for NAICS code changes, etc.

It's really worth having a third party take a look at it, so that you can do almost due diligence on yourself before you do due diligence elsewhere. If you're pretty clean, these costs are going to be modest. If, in fact, you're taking a picture of the whiteboard, then it might be more of an expense.

Michael LeJeune: Just so people know, I've seen somebody come in and do an audit and it costs less than five grand. It's in really good shape and they're like, man, you'd be able to provide everything for me. And then I've seen it where it's in the tens of thousands of dollars cause they're like, this is a disaster. You don't even know where to log in [00:36:00] to get me the stuff.

Sharon Heaton: I was working with a company like that. They had a buyer and the buyer said, we will buy you, but we need to have audited financials. And it took almost nine months to get those financials created. And we're talking about a company that had 15 million in revenue. So it was not a terribly complicated company, but the records were not in good shape.

Michael LeJeune: I appreciate that. Hey, great conversation today. I really appreciate that. For everybody who's on video, you'll see this. I'm holding a copy of the book here, LIFTOFF. It is the 12 things to know before selling your business here. I think it's really important that if you are in a situation where you're going to sell or thinking about selling, you prepare two, three years ahead of time. And picking up a book like this is a great way to prepare because it gives you a checklist of things that you need to be thinking about and looking at like your finances, like your employees, like, Hey, what am I willing to get paid? What do I need to get paid? All those kinds of things that you can answer before you go into this so you can have the right mindset.

Thanks for coming on and talking about this, Sharon. I really, really [00:37:00] appreciate this. And if anybody needs help with this and would like to talk to you, they can reach out your email address, website, all that kind of stuff will be on our website.

Narrator: I really hope you enjoyed the podcast today. If you did, I'd really appreciate it. If you would like and subscribe to the podcast and screenshot it and tag me on LinkedIn or whatever social media you use. Thank you again for joining us today and we'll see you next time.