October 8, 2025 • 39 mins
Deals rarely collapse because the idea is bad—they fall apart when the numbers can’t carry the story. We sat down with Patrick McMillan, a seasoned quality of earnings specialist with Ampleo, to show how sellers can turn diligence from a gauntlet into an advantage. From decoding what “quality” actually means in earnings to explaining why EBITDA is only a proxy for cash flow, we break down the practical steps that preserve price and speed to close.
We get specific about where value leaks: customer concentration, deferred revenue, under/over-billings in project work, and the accruals most teams skip—PTO and year-end bonuses. Patrick explains how a sell-side Quality of Earnings reframes the process: you uncover issues while you still control the fix, present a clean, defensible narrative, and walk buyers through a reconciled data room instead of apologizing under pressure. The result is fewer retrades, tighter timelines, and a higher “experience grade” from buyers who want to know they can work with your team after the ink dries.
If you’re preparing to sell, this conversation is your playbook for converting cash-basis chaos into accrual clarity, setting a realistic working capital peg, and translating adjustments into a story investment committees can approve. Whether you run SaaS, construction, or services, you’ll learn how to make your earnings more predictable, your cash flows more believable, and your valuation more durable.
If this was useful, follow the show, share it with a founder who’s thinking about an exit, and leave a quick review telling us the one diligence hurdle you want to master next.
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
SPEAKER_00 (00:04):
Hello and welcome to MA Murders and Accusations.
The good, the bad, and the uglyof selling your business.
We dig into what you need toknow and how not to kill the
cell of your business.
Now here's our host, Rick J.
Krebs, Mergers and AcquisitionsAdvisor.
SPEAKER_01 (00:24):
Hello, everyone, and welcome.
This is Rick, the MA Cowboy,coming to you from Heber City,
Utah.
And have we got a great showtoday?
Um I'm excited about our guest,Patrick and I.
Um, this is Patrick McMillan.
Hey, Patrick.
Hey, Rick.
Thanks for having me on.
(00:44):
You're sure welcome, and thankyou for doing this.
I was trying to think how longPatrick and I have been working
together.
Um, I want to say a coupleyears.
SPEAKER_02 (00:53):
At least two or three.
Just looking at my notes.
Looks like around end of 22.
So yeah, yeah, a few years,about this time, a few years
ago.
SPEAKER_01 (01:05):
Going on three years.
So we met we met through the uhexit planning chapter.
SPEAKER_02 (01:10):
Yeah.
SPEAKER_01 (01:11):
And uh you just started coming to the meetings,
we got to know each other.
And then Patrick, I'm gonna letyou give your background.
So tell us a little bit aboutyourself professionally, what
you do, and then tell uspersonally about yourself, and
then something that's kind ofcool that most people may not
know, and how you got into doingwhat you're doing, and then and
(01:31):
then we'll go ahead and getstarted.
SPEAKER_02 (01:33):
Love it.
Perfect.
Well, first and foremost, again,Rick, I love chatting with you
anytime.
We've had some amazingdiscussions.
The meetings are always a lot offun.
Our our Utah EPI chapter.
So uh give you my backgroundthen.
So, yes, I live here in Utah,but I am a southern boy.
I grew up in Northeast Tennesseein the Appalachian Mountains.
(01:56):
And so grew up hiking and bikingoutdoors.
I'll get into that, you know,when I get into kind of some of
my personal stuff.
As far as a career, what do Ido?
I'll start with the end in mind.
I am the Q of E guy, the qualityof earnings guy.
I work on financial duediligence.
How did I get into that?
This is uh very crazy andinteresting.
(02:18):
So I've always loved numbers,especially when they have dollar
signs attached to them.
And why, yes, it's fun, it's agame.
You know, for me, literally, Ilike changing stuff to see what
happens.
Um, but more importantly, thereare families behind those dollar
signs, and there's people.
(02:38):
And I've learned, Rick, justthroughout my life that people
are intriguing and interestingin their stories, you know, and
why they do certain things.
We're all different and similar,you know, in different ways and
similar ways and things.
And so how did I get into allthis?
So grew up in Tennessee, did myundergrad while I was doing it.
(03:00):
I got into accounts receivable,really enjoyed it, you know.
So I got my start intoaccounting while I was doing my
undergrad, which is not inaccounting.
My last verse is actually inSpanish and business.
I wanted to do internationalbusiness, but I got into
accounting and I loved it.
And so I stuck with that for awhile.
(03:21):
Uh, moved out here to Utah uh afew years later after I
graduated.
And this was in pre-2008.
So, Rick, like a lot of peopleduring that time, especially
here in Utah, I got caught up inreal estate, bought some
properties, sold properties,flips, uh, held, rented, you
know, did some lease to optionsto buy, you know, things like
(03:44):
that.
And it was fun.
And while I was doing that, Iactually bought and sold a very
small kind of took myselfthrough a couple small
transactions.
I bought my business partner outof our real estate holdings
company.
And around the same time frame,I also sold my mortgage loan
processing company to one of myclients.
(04:04):
And so you could say I kind ofgot my start in MA that way, but
I had no idea what I was doing.
I I learned quite a bit, but itwas just very, you know, touch,
very light touch.
I had some great advisors aroundme, you know, that helped me
through those transactions.
So 2008 hit, like everybodyelse, lost everything and got a
(04:28):
job.
And what was that job?
I was a corporate controller.
There was a conglomerate ofcompanies.
We had, I won't even go, therewere several different
industries, several differenttypes of companies, and and a
few different owners and severalinvestors.
And so I was their corporatecontroller and then later became
their acting CFO and took themthrough a lot of different
(04:51):
transactions as well.
And it was a blast.
I really enjoyed it.
It was crazy.
I drove myself nuts.
I still had no idea what I wasdoing, but I was learning really
fast.
Again, having great advisorsaround me, doing a lot of
research, you know, and learningon the go and making a lot of
mistakes.
Rick, I almost lost my job a fewtimes.
(05:12):
Well, there's that's a wholeother story for another day.
But I tell you what, I learnedquite a bit and it was great.
So after a few years with them,I uh I resigned.
We hired a real CFO to replaceme.
We hired a real controller toreplace me.
So two different individuals.
And then I became an independentfractional CFO, picked up seven
(05:34):
clients.
Most of them were our investors,you know, from my previous tent.
You know, helped them with someof their other companies, and
that was great.
Um, and then I joined the firmthat I'm with now.
When I joined, it was calledAdvanced CFO.
Since then, we've rebranded, sowe're Amplio.
AMP is grow Leo, like the line,courageous, so grow
(05:58):
courageously.
SPEAKER_01 (05:59):
Love that.
I wondered where Amplio camefrom.
I love that.
That's it.
Right there.
Yeah.
SPEAKER_02 (06:04):
Uh, and it's a lot of fun.
So when I joined uh almost sixyears ago, we had 40 consultants
at the time.
Um, now we have over 300professionals.
We have six divisions (06:16):
finance, marketing, HR, turnaround,
valuation, and sales tax.
So I'm in the finance divisionand I lead what's called our
transaction advisory.
So now enter what I do today,quality of earnings.
So that part of our transactionadvisory is specifically in
financial due diligence.
(06:37):
We say we can help before,during, and after a deal.
I or my team will specificallyjump in and do that, you know,
quality of earnings prep, oractually do a buy side or a sell
side QFE.
Gotcha.
So you do both sides.
SPEAKER_01 (06:52):
You're buyers and sellers.
SPEAKER_02 (06:53):
Okay.
Exactly.
I like that because we can learnhow to defend both sides.
And that's important.
You have to be able to present adefensible uh product and to be
able to help buyers and sellersunderstand what they're dealing
with and how they'retransacting.
So that's professional.
Uh, I'll take a quick minute,talk about personal, and then a
(07:16):
fun thing about me that some butnot a lot of people know.
So professionally, I mentioned Igrew up in Tennessee.
I love the outdoors, Rick.
Uh, we've we've talked aboutsnow build snowmobiling a little
bit.
Uh my wife and I have a cabinout in uh in Fairview, Utah.
We are excited for winter to gosnowmobiling out there.
We do a lot of off-roading.
(07:36):
Um, mountain biking is myabsolute love.
I love hiking, um, backpacking.
I've done that quite a bit.
I did King's Peak here in Utah afew weeks back.
I also did a bunch of running.
And so I just finished a I did amarathon in 22.
Uh, had a bad experience, but Iwant to do another one.
(07:57):
So I did a half marathon acouple of weeks ago, and I'll be
doing St.
George full marathon next year.
So here's the fun story.
So, with all this crazyactivity, Rick, my entire life,
I've never broken a bone in mybody until two years ago, I was
mountain biking here in Utah,very local trail, Corner Canyon,
(08:18):
for the for you Utah's who knowthe name here.
Been there at the very, veryend.
So you know why I'm light.
At the very very end, wherethere's just that last little
stint that lasts probably 30seconds, and you can go left or
go right.
I went left thinking there was ajump.
It's not a jump.
(08:39):
I broke four ribs, drove myselfand my buddy to the hospital
because he actually, unbeknownstto me, at the start of the
trail, hit a uh a slick spot andslammed into a tree and knocked
himself unconscious for a bit.
(09:00):
And some people had to knock himdown.
And this is a short story.
So there's I I'm crazy enough todo some.
I'll say I'm not stupid, butI've done some really dumb
things, but I am crazy.
So and that transfers thattranslates very well into my
career because I'm just scrappyenough to figure stuff out.
(09:21):
How's that for an intro?
SPEAKER_01 (09:23):
Hey, that's a great intro, Patrick.
I love it.
I learned some things that Ididn't know about you, so thank
you.
So let's get into the topic.
Uh, the topic today is qualityof earnings, Q of E.
And uh, and it's one that youyou work with all the time.
I work with it all the time.
You know, I want to say notuntil the last three or four
(09:45):
years has it become moreprevalent, more popular.
Um, accountants would do duediligence, but I I think it's
much more utilized in theindustry, both on the buy side
and the and the sell side.
So tell me what is quality ofearnings?
SPEAKER_02 (10:01):
Yeah, and and I love this.
I'm I'm I'm flipping through abook here I'm gonna show.
So this was copyright 1987.
Look at that.
And you're you nailed it, and soI'm holding up a book called
Quality of Earnings by ThorntonO'Glove.
So this was published in 1987,but you've nailed it, it hasn't
(10:23):
been prevalent until the lastfew years.
So Thornton O'Glove, he was hewas uh an analyst, he was a
buy-side analyst, and then hestarted publishing a lot of
things about public companiesthat people didn't like because
he was exposing rather than youknow recommending to buy, he was
(10:45):
saying, no, you should not buythis company.
Here's why he called that thequality of writing.
So that's really how it started.
But here recently, with just thewhole uptick in transactions and
things going on, a lot of peoplehave said, Oh my gosh, we could
actually do this with privatecompanies.
And it's been going on for along time.
I mean, there's even Daddy, youknow, the guy that's really
(11:06):
started uh, you know, as well,made it big.
That was 10, 15 years ago.
But the reason why it's becomeso prevalent today is because
businesses predominantlytransact on a multiple of
earnings.
Multiple of EBITDA.
There's a my shirt there for uhanybody that can see a warning,
(11:26):
may start talking about EBITDA.
So you really have to understandwhat the quality of those
earnings are.
So let's break that down.
Quality, high, medium, or low.
And I'm gonna use a very simpleexample customer concentration.
People talk about this a lot,right?
If you have a$10 million companythat comes from, and I'm gonna
(11:51):
be very facetious here, onecustomer, and that's an
extremely low quality.
Because if you lose that onecompany or that one customer,
your company's done.
Yep.
But on the flip side, if itcomes from hundreds of
customers, then you have verylow concentration, which means
(12:11):
it's high quality.
Those earnings are high qualitybecause there's a lot of
different customers, there'sprobably different contracts,
you know, and and we can getinto you know things such as,
you know, um recurry revenue andall that, but let's just let's
just stick to the to the tophere.
(12:32):
So that's what quality comesfrom.
Okay.
And it's not just customerconcentration, it's things such
as, okay, well, even vendorconcentration, employee
contracts, no, yeah, productproduct concentration or service
concentration.
SPEAKER_01 (12:47):
Yeah.
SPEAKER_02 (12:48):
Exactly.
Okay.
Exactly.
So there's a lot of differentthings you can derive at to say,
well, determine what type ofquality it is, a high, medium,
or low.
And then earnings, yes,companies trade most of the time
on a multiple of EBITDA.
EBITDA is a proxy proximate forcash flow.
There's a whole other subject wecan get into is EBITDA versus
(13:09):
cash flow versus net income andall that.
But that's so really what aquality of earnings is, is it
helps to determine what thequality of those earnings are.
When you buy a company, you'reacquiring an asset, you're
acquiring it for its cash flow,right?
So you want to understand whathow predictable is that cash
(13:29):
flow in the future?
And that's why you want to get aquality of earnings report, is
to really understand thehistorical things that went on
to be able to predict the futureof the company.
SPEAKER_01 (13:43):
So, um, how does it differ from an audit?
SPEAKER_02 (13:45):
Oh, I love this question.
I get asked this a lot.
So an audit will tell you what acompany is doing that's in
compliance with GAAP, generallyaccepted accounting principles.
A quality of earnings will tellyou how they're doing that and
why they're doing it that way.
So, for example, revenuerecognition.
(14:06):
Okay, let's talk about a SaaScompany, for example.
SPEAKER_01 (14:09):
Okay.
Love SaaS companies, work withthem all the time.
Yeah.
SPEAKER_02 (14:13):
Yeah.
Well, so if they're recordingtheir revenue based on cash,
cash basis.
And so when they record adeposit, whether that deposits
for one month or 12 months or 36months, if they're recording
that, that's cash basis.
That's not in compliance withrevenue recognition.
(14:34):
And so an audit will say, well,they're not in compliance with
gap.
Here's why.
Or sorry, here's what, here's,you know, the gap procedure and
everything.
But a quality of earnings willdive deeper into and say, well,
correct.
They're not in, and so it willactually start making looking at
what those adjustments wouldlook like and then the types of
(14:56):
customers, the actual contract,you know, things like that.
And then, well, how predictableis that customer for sticking
around the stickiness of it,right?
After a transaction.
So the predictability.
Predictability, exactly.
I love that.
So all in all it does, it justsays, well, are they in
compliance with GAAP or not?
But a quality of earnings willreally dive deep into it and
(15:19):
say, let's actually discuss thecustomer.
SPEAKER_01 (15:23):
Love it.
And and quality of earnings ismore uh income statement or PL
centric than balance sheet,right?
It's more about the earnings.
SPEAKER_02 (15:32):
More, yes.
But let's not forget theimportant balance sheet.
Let's also not forget the almostand sometimes even more
important statement of cashflows.
And that's where a lot of peoplethink that a Q of V will only
talk about EBATA and income.
Not the case, at least not agood Q of E.
(15:54):
A good Q of V will also discussbalance sheet because you got to
look at networking capital,which is very, very dependent
upon, you know, the balancesheet, current assets and
current liabilities, right?
But it'll also talk aboutaccruals.
Every accrual has to reverse.
And that's where we talk aboutthere again, SAS, deferred
(16:15):
revenues.
That's an accrued liability.
You've received revenue orsorry, you've received cash for
something that you still have todeliver on.
So that's a lot of money.
SPEAKER_01 (16:26):
I see that a lot.
If you have a cash basis, it'slumpy, right?
They pay 100% of theirsubscription up front in one
month.
So the revenue and your eBiddlelooks really good for that
month, but you have expenses for11 months to follow.
So bad.
So you mentioned bad Q of E.
So what's the difference betweena good one and a bad one for the
(16:48):
listeners?
SPEAKER_02 (16:49):
So, and there's a lot of QV providers out there,
and and I'm not going to talkabout any specific one, but just
in general sense.
So a good QV, again, will lookat income statement, balance
sheet, statement of cash flows,networking capital, revenue
vendor, all the differentconcentrations, um, cash to uh
(17:11):
uh cash to revenue proof, youknow, things like that.
Now, a good QV provider will beable to take all those things
and explain it to you, whoeveryou are, whether you're buyer,
seller, investor, you know, theconsumer of the of the analysis,
will be able to explain and walkthrough what those things are
(17:33):
and be able to help youunderstand how this will affect
your part of that transaction.
A bad one, as you mentioned, andI'm gonna use an example here.
I actually uh had earlier thisyear, I had a potential client
reach out, talked about thedeal, gave him a price on the
QV, uh, and he kindly said, youknow, hey, thank you.
(17:55):
But he actually went withsomeone else who was cheaper.
He messaged me back severalweeks later and said, Patrick,
can you help me, my QV provider,the target that I'm acquiring,
and the broker involved, none ofus can figure out the networking
capital.
(18:16):
I actually spent an hour or two,you know, kind of diving in and
digging in.
And it was interesting to mebecause I'm like, oh my gosh,
this was it, it wasn't simple,but it wasn't complex either.
So a good QV provider can reallydig in and ask not just the
right primary questions, but theright secondary questions to be
(18:38):
able to translate information,you know, can take rigor, can
simplify it, and then give it toyou that's clear clarity.
SPEAKER_01 (18:48):
Gotcha.
And so the deliverable is areport, right?
Is there a report?
SPEAKER_02 (18:52):
Yes, what's so there's two different types of
deliverables.
Every QV should at least deliveran Excel data book.
Okay, that way you can go inthere and you can see the
numbers and where they derive.
And then a lot of times, and wewill do this as well, you can
actually say, Hey, I want I wantthe actual report itself, not
just the data book, but thereport, which is a PDF or a
(19:15):
PowerPoint or something that hasall the nice long verbits behind
it.
Hey, here's what we did, here'sthe process, and here's the
explanation about it.
Not everybody needs your report,Rick.
Most people um are okay withjust the Excel data book, but
the individuals who usually wantthe report itself are like our
(19:38):
uh independent sponsors orprivate equity because they're
very used to having these verynice, and yeah, I'll use the
word fluffy, very nice, fluffy,very detailed.
Hey, here's the procedures wewent through, here's exactly
what this means.
Here's a translation.
So those reports, yeah, weupcharge a little bit to those
reports because they take abouta week to put together.
(20:00):
And those reports are 30 to 60pages long, you know, with a lot
of good, solid explanations,defendable explanations.
And so the idea behind a reportis you can actually send that to
a third party, they can readthat and not need the Q of E
person to explain things.
SPEAKER_01 (20:16):
Gotcha.
SPEAKER_02 (20:17):
Otherwise, an Excel data book, you know, and a one
to two hour phone call can walkthrough things.
SPEAKER_01 (20:22):
Yeah, yeah, that makes sense.
So I wanted to dive intosomething, a concept here, and
that is we're seeing themthey're more prevalent.
Buyers are doing private equityis asking for them.
I mean, I've got I've got uh tworight now under LOI were doing
the buyers are doing Q of E's onthem.
(20:43):
Nice, good, and so and so here'shere's what I've been thinking
about.
If you're a seller, and I Irepresent seller, sell side, if
you're a seller and the buyersare gonna do it anyway, why not
get ahead of the buyers and whynot do a quality of earnings
from a sell side first?
SPEAKER_02 (21:05):
100%, Rick.
And here's why.
And and I love doing sell sideQVs for a few reasons.
So why would a seller want to doit?
Yes, it's an added cost,especially if a buyer's gonna
end up doing it anyway.
But here's what I'm gonna say.
SPEAKER_01 (21:22):
Hold one second.
You use the word cost, yeah.
I'm gonna say it's aninvestment.
SPEAKER_02 (21:28):
I I love it.
You are correct.
And here's why.
So when a seller does a sellside QV, it does a few things.
Number one, it prepares theseller in a lot of different
ways.
Number one, it helps them to seewhat a buyer's gonna go through.
Buyers go through some very deepdiligence.
So this helps prepare the sellerto it's it's a practice run.
(21:51):
Yeah, but that's just surfacelevel.
Let's dig a bit deeper.
So, what it does is Rick, Idon't care if you're a private
company or a public company,your books are not perfect.
No one's books are ever perfect.
Okay.
So, what a silci QV does, whathelps get your books a lot
cleaner and closer, and I won'tsay perfection, but closer to
(22:15):
inducing confidence in a buyer.
So think about two scenarios.
If a buyer comes in, if you'relooking to acquire a company and
you sign the LOI and you startdoing your diligence, and the
books are a mess, and the QVuncovers the mess, the QV can
still get done, but it's messy.
There's a lot of adjustments.
What are you thinking in fillingas a buyer?
(22:36):
Your confidence level startswaning, right?
You're you're probably going toreduce that multiple a bit.
On the flip side, if you've donea sell site QV and you're
prepared and you've cleaned up alot of that stuff, then that
(22:58):
does a couple of things.
Number one, you can say, hey,buyer, you may or may not do a
QV, but here's one that we'vedone.
So number one, that immediatelysays, We're serious about this.
We prepared.
We've we've made someinvestments to prepare our
company for sale.
Number two, you already knowwhat most, if not all, the
questions the buyer's gonna askanyway and say, Yeah, we've
(23:20):
already addressed that.
Here we go, here's what we'vegot this in that data room,
here's the backup to it, youknow, here's the adjustments.
But you're you've already hadthat practice run.
But at the same time, now you'vegot those things cleaned up.
And so a buyer's gonna be like,Wow, it shortens the time frame,
where an eight-week QV probablytook three, two, four weeks
(23:42):
because you've done a lot of theprep work.
So that's really gonna induce awhole lot of confidence in a
buyer as well.
So that's something, and you'reexact that's why, and I love how
you said it, it's an investment,you know, to spend 20, 30, 40
grand to do a sale side QV, thenthat way your multiple is gonna
be strengthened with that.
SPEAKER_01 (24:03):
Yeah.
So what I'm thinking about isI'm thinking about deals that
blow up, things that havehappened.
We had a company recently that Iwas selling, and um, they got
into the books, and it was aconstruction-related company.
Construction are what you talkabout, they're like SaaS
companies where they get a bigdeposit up front, yeah, and then
(24:24):
they have to do the work, right?
Usually it's time to billingsand under billings, yep, over
and under, and they havescenario.
That's the billings next, yeah.
Yeah, so buyer gets into it,private equity gets into it, and
they're like, These books are amess, we need a Q of E.
Right.
And so they had to do the Q ofE.
They ended up splitting the costand uh fixing the books.
(24:46):
Yep.
And um that process was onewhere had the seller done their
own Q of E, they would betalking to the accountant who
they hired to do it, or the firmthat they hired.
And it's more of a friendlyconversation when it's your
client relationship with thatvendor, right?
(25:08):
Yeah, and so that's a muchdifferent, they're not defending
the numbers, they're justworking on getting them right.
SPEAKER_02 (25:14):
It's gaining understanding.
SPEAKER_01 (25:16):
Yep, gaining an understanding, getting the
numbers right, getting thebusiness cleaned up and ready
for sale.
Now, when we have a buy-side Qof E firm, the um the sellers
are in a defense mode.
Yeah, right.
And I like to lead thesetransactions on my toes, not on
my heels.
And if you let the buyers do theQ of E, you're on your heels.
(25:39):
You're always on the defense.
Yeah.
If the sellers are sayingdefensible, yeah, it's
defensible, right?
And and and um, it's just it's adifferent way to approach the
transaction and due diligence.
Do you want to lead on yourtoes?
Do you want to get ahead of it?
Do you want to have thequestions answered already and
be able to give them a niceclean report and an Excel
(26:00):
spreadsheet with the tabs andit's all tied out and it's from
a third-party CPA?
I mean, as a buyer, when they gointo these transactions, I don't
know what the fallout is, I'd beinterested.
But as they go in, there's a lotof them that do fall out in due
diligence because the financialsare not what was represented.
Either falls out or it'sretraded in price and goes down.
So buyers have some trepidationgoing into due diligence.
(26:21):
They're like, okay, now Ibelieve what you say, now it's
time to prove it.
But if it's already proven, Ithink the buyers like that.
In fact, I don't think thebuyers I I know, yeah.
Yeah, and and it becomes morevaluable of an asset and they're
willing to pay more, I wouldsay.
SPEAKER_02 (26:38):
And you've nailed it, and I love how you frame
that waiting on your toes ratherthan your heels.
Rick, there are so many times,and private equity buyers
especially love, they'll ask methis question often.
And when I'm delivering thefinal QV to them and I'm walking
them through everything, youknow, and the adjustments and
all that.
Their final question very oftenis, okay, Patrick, now we see
(27:00):
the numbers, now we know andunderstand the story.
Our final question is going tobe tell me about your
experience.
I want you to grade.
And often they'll even ask me,and this is interesting, I don't
know who started this, but oftenthey'll say, grade the sellers,
grade the team you worked with.
Are they an A or are they an F?
They want to know the experiencebecause a lot of times, most of
(27:25):
the time, that team's gonna haveto continue staying on board for
at least a couple of years.
And so want to know who they'regonna work with.
And so you know that when you'redoing a sell side Q of V, then
you're working a whole lot moretogether, you're leading on your
toes, you're understanding thestory.
And so then you typically have abetter experience.
(27:47):
And so even if the buy-side doestheir own buy-side Q of V, then
you're prepared, and thatexperience between those
interactions are still going tobe smoother.
And so then, yeah, the QVprovider can say, Oh my gosh,
let me tell you, here's a horrorstory, not a horror story, but
just an experience.
This is as of what is today,Wednesday.
(28:09):
This is as of last week.
Yes, one of my clients isacquiring, they're doing uh an
accounting firm roll-up.
I've done 15 or 20 Q of E's forthem in the last couple of
years.
Uh, my recent one last week, andI'm talking, I want to emphasize
this, Rick.
This is a CPA firm.
(28:30):
That's the target, that's theseller.
Okay.
With wait a minute, with badbooks?
Well, not the books, but theadjustments.
So typically a seller is gonnasay, Oh, there's some
adjustments in there.
Let me tell you, let me send youa spreadsheet of what those
adjustments are.
So I got this spreadsheet,right?
And it shows the trilling 12month adjustments, and they're
(28:52):
all hard-coded numbers.
I'm like, awesome.
I should, I got the QuickBooksfile.
I should be able to go in, he'sgot it separated, you know, in
categories.
I should be able to go in andfind these.
Rick, after two hours, Icouldn't find them.
So I called the seller.
I'm like, hey, you have X, Y,and Z, one, two, and three.
Help me to know where these are.
(29:13):
He fumbled.
He had to go through and try toremember where he got those
numbers from.
Now, we long story short, Rick,at the end of the day, we found
all the numbers, but it took areally long time and it was
disorganized.
This is a CPA firm.
About a four million dollar CPAfirm at that.
(29:36):
Wow.
That's not a small one, not ahuge one, but not a small one
either.
SPEAKER_01 (29:40):
Yeah, like bricklayer whose house is made
out of wood and it's fallendown.
SPEAKER_02 (29:43):
Exactly.
So I communicated to the buyer,to my client, and I said, Hey,
listen, his earnings were spoton.
You guys, you know, you you saidX, he said X, here we go.
So, but let me tell you aboutthe experience, let me tell you
about the organization skills.
You need some work.
Now, luckily, that's teachable.
(30:04):
Yeah.
But that's something that didn'tchange the multiple, but it
definitely is a differentexperience.
You would think someone would beextremely so that's something
that you know you see it really.
If you do a sell site QV, ithelps you, if nothing else, to
organize the data in apresentable format.
(30:26):
And that alone will induceconfidence to a buyer.
SPEAKER_01 (30:30):
And I'd never I didn't know that.
That's really interesting.
They ask, what's your experiencelike?
What is the team like?
How are you answered often?
SPEAKER_02 (30:38):
I love that question because I will tell you exactly
what I went through.
SPEAKER_01 (30:42):
Yeah, yeah, exactly.
But from a buyer standpoint,that's what I want to know.
Yeah.
Give me the juice, give me thedirty, give me the inside story
here, whatever it is.
You know, what am I dealingwith?
What am I buying?
Yep.
Who are the players?
How who am I playing with?
SPEAKER_02 (30:57):
Who am I gonna be married to for the next couple
of years in this deal?
That's right.
Because even if the numberspencil, if the team doesn't fit
and the experience is raunchy,you don't want to do business
with them.
You don't want to acquire them.
And yeah.
SPEAKER_01 (31:12):
No, no.
Wow, I had never thought aboutthat before.
So there's one other thing Iwanted to bring up.
I've got a few questions here.
Hey, but um, one of the things,and you had alluded to this,
that the sellers oftentimes justdo cash basis financials.
And when you go to market, thebuyers in all likelihood want
accrual-based financials.
SPEAKER_02 (31:32):
Yes.
SPEAKER_01 (31:32):
And so that requires some accounting work.
And I'm an accountant, I don'tdo it for my clients because
it's a conflict of interest, butthere's some accounting work to
get them presentable to thebuyer so the buyers can get them
presented to their investmentcommittee and so forth.
SPEAKER_02 (31:46):
Exactly.
SPEAKER_01 (31:47):
Some of the things I see them miss, deferred deferred
revenue is a huge one.
SPEAKER_02 (31:50):
Oh, yeah.
SPEAKER_01 (31:51):
Um, the other one are accruals.
I was uh just on the phoneyesterday with the CFO, and he's
like, Rick, I so wish I'd havetied my numbers out monthly
instead of annually, becausethese Q of E guys are beating me
up and they're driving me crazy,you know, Heinz 2020.
But they and and you're they'rebusy, they're running a
business, right?
And they don't necessarily needeverything tied out, need all
(32:13):
the accruals, but I seevacation, PTO, um, revenue in
excess of cost costs us anexcess of revenue, or they're
overbuilding or underbilling.
But these are things, if missed,can potentially swing the deal
hundreds of thousands andsometimes millions of dollars
because they impact workingcapital.
SPEAKER_02 (32:36):
Yes.
SPEAKER_01 (32:36):
And uh, and if you have a target and you're you
haven't calculated thesenumbers, well, that's a negative
to your working capital on thecruel side.
So then you have a deficiencywhich reduces your purchase
price.
SPEAKER_02 (32:47):
Dollar yes.
That's how everythingtranslates.
SPEAKER_01 (32:50):
Yes, over and over.
So there's just so manydifferent reasons to do this, to
make this investment, to get aquality of earnings report from
a capable person, I want to say,someone who provides the good
value.
And and this is what you do dayin and day out.
SPEAKER_02 (33:08):
Yes.
Um, can I emphasize one of thosepoints, Rick, especially with
the time of year that we're at?
So at the day of recording, thistoday is September 24th.
So we're coming up on holidayseason, right?
Thanksgiving, Christmas, andeverything.
Something that I see a lot ofcompanies miss on that specific
(33:29):
note of accrual.
So let's even go down to onevery specific accrual that most
companies don't even think aboutpay in payroll.
Okay.
Some companies will accruepayroll, okay.
But three things that they'remost of the time not accruing
commissions, which aren't supercommission structure is crazy.
(33:51):
We all know that, okay.
But commissions are typicallypaid out pretty frequently.
But let's talk about the PTO.
Let's talk about bonuses.
Okay.
The PTO will depend on, I don'tcare what your handbook says,
your handbook can say anythingit wants.
But let's talk about the statethat your company is based in
(34:12):
and the state that your employeeis living in.
Okay.
The PTO accrue and payout variesdependent upon state.
This is where our HR consultantscan jump in and help.
Regardless of what your handbooksays, most of the time you're
gonna have some type of PTOaccrued per employee just by
(34:35):
default.
But most companies are notputting that on the balance
sheet as a liability.
And what's gonna happen is comeNovember, December, what's
you're gonna have people taking10, 20, 30, 40 hours of paid
time off and getting paid forit, but not producing.
A buyer has to know that.
(34:56):
Because let's say the dealcloses on October 31st, and you
have a million, and the buyerhas half a million dollars in
networking capital to buyinventory and to make payroll.
But guess what?
Johnny, Susie, and George aregoing on vacation and they're
taking, you know, 20 hours each,or 60 hours of unproductivity
(35:19):
that you as a buyer have to pay,but the employees are not
producing, and so therefore,you're not invoicing for that.
So you need to make sure thatyour pay time off is accrued on
a monthly basis, okay?
To your point, exactly, on thebalance sheet and bonuses,
year-end bonuses.
(35:41):
50 grand, 500 grand, I don'tcare how much they are, accrue
them because it's the exact samething.
We're coming up on year-endstuff.
You're gonna December 31st, hey,we had a wonderful year, we're
gonna pay out 200 grand inbonuses.
But guess what?
Your income statement didn'treflect any of that.
SPEAKER_01 (35:59):
My favorite is they pay them in January, so it goes
on to the next year.
Exactly.
SPEAKER_02 (36:04):
This looked really good because they have to wait
till they had the cash to payit.
Those things need to be accruedfor on the income statement and
balance sheet so that buyer andseller can have those
conversations about networkingcapital on who's gonna pay who
win and how much and who's gonnafit that bill.
SPEAKER_01 (36:23):
Love it.
That's it.
SPEAKER_02 (36:24):
It's just a discussion, doesn't mean buyer
has to or seller has to justhave the discussion.
Come to the agreement.
SPEAKER_01 (36:32):
And sometimes, sometimes I've got the buyers to
accept it and they embrace thatand and assume that liability.
Yeah, right.
But it's the discussion needs tobe made.
Discussion needs to be made.
Yep.
So tell me and tell ourlisteners how do they get in
touch with you?
You got an email, a website.
How do they get in touch withyou?
They have additional questions.
SPEAKER_02 (36:52):
The easiest way is LinkedIn.
Patrick McMillan, MC-M-I-L-L-A-N.
I'm constantly on LinkedIn.
I will respond unless you'retrying to sell me something.
I will likely ghost you.
But if you're saying, hey,Patrick, want to learn more
about this, I'm looking atacquiring company.
Hey, I want to sell my companyhelp.
(37:13):
You know, I would love to jumpon a phone call.
I'll send you my calendar link.
So reach out to me on LinkedIn.
SPEAKER_01 (37:18):
Great.
Um, one other thing that I thinkthough, what's the cost?
Just a range on the QV.
SPEAKER_02 (37:23):
Yeah.
QVs, our range is between 20 and45,000.
Okay.
If it's a very, you know, I'llsay small, two to five million
dollar company, no inventory,one entity, uh, then yeah, it's
easy.
It'll be 20 grand.
Gotcha.
If it's a and the more hair onit, it's so really the cost will
(37:46):
depend upon size, scope, andcomplexity.
unknown (37:50):
Okay.
SPEAKER_02 (37:51):
The bigger it is, or the more scope it is, or the
more inventory, the moreentities, and yeah, that'll up
in cost.
SPEAKER_01 (37:57):
Gotcha.
So 20 to 40,000.
I'm not calling a cost, I'mcalling it an investment.
SPEAKER_02 (38:02):
Investment.
Yes, I'm gonna face my languageon that.
I like that.
Thank you.
SPEAKER_01 (38:07):
It truly what it is.
And well, and when we're sellingcompanies for millions of
dollars, it it just so muchbetter for the buyer.
So I uh we've geeked out alittle bit here as accountants
today, but uh hopefully theinformation has been valuable to
you.
And I'm gonna be sharing thisepisode with all of my sellers.
(38:27):
We're talking about preparingthe business for sale.
But thank you so much for yourtime today.
I appreciate that, Patrick.
And uh great to learn someinteresting things about you.
Four broken ribs on the trail.
I mean, I'm gonna have to hearthe rest of that story.
SPEAKER_02 (38:41):
All hold up.
SPEAKER_01 (38:43):
Good, that's good.
But uh, we appreciate it, and weappreciate the listeners today.
Until next time, this is Rickwith MA Murders and Accusations.
The good, the bad, and the uglyof selling your business.
Thank you.
SPEAKER_00 (38:57):
Thanks, Rick.
Thank you for attending ourpodcast.
We invite you to join us forfuture episodes of MA Murders
and Accusations the Good, theBad, and the Ugly of Selling
Your Business.
You can also visit us atwww.bsalesgroup.com or email
Rick directly at Rick atBSalesgroup.com.
Hello and welcome to MA Murders and Accusations.
The good, the bad, and the uglyof selling your business.
We dig into what you need toknow and how not to kill the
cell of your business.
Now here's our host, Rick J.
Krebs, Mergers and AcquisitionsAdvisor.
SPEAKER_01 (00:24):
Hello, everyone, and welcome.
This is Rick, the MA Cowboy,coming to you from Heber City,
Utah.
And have we got a great showtoday?
Um I'm excited about our guest,Patrick and I.
Um, this is Patrick McMillan.
Hey, Patrick.
Hey, Rick.
Thanks for having me on.
(00:44):
You're sure welcome, and thankyou for doing this.
I was trying to think how longPatrick and I have been working
together.
Um, I want to say a coupleyears.
SPEAKER_02 (00:53):
At least two or three.
Just looking at my notes.
Looks like around end of 22.
So yeah, yeah, a few years,about this time, a few years
ago.
SPEAKER_01 (01:05):
Going on three years.
So we met we met through the uhexit planning chapter.
SPEAKER_02 (01:10):
Yeah.
SPEAKER_01 (01:11):
And uh you just started coming to the meetings,
we got to know each other.
And then Patrick, I'm gonna letyou give your background.
So tell us a little bit aboutyourself professionally, what
you do, and then tell uspersonally about yourself, and
then something that's kind ofcool that most people may not
know, and how you got into doingwhat you're doing, and then and
(01:31):
then we'll go ahead and getstarted.
SPEAKER_02 (01:33):
Love it.
Perfect.
Well, first and foremost, again,Rick, I love chatting with you
anytime.
We've had some amazingdiscussions.
The meetings are always a lot offun.
Our our Utah EPI chapter.
So uh give you my backgroundthen.
So, yes, I live here in Utah,but I am a southern boy.
I grew up in Northeast Tennesseein the Appalachian Mountains.
(01:56):
And so grew up hiking and bikingoutdoors.
I'll get into that, you know,when I get into kind of some of
my personal stuff.
As far as a career, what do Ido?
I'll start with the end in mind.
I am the Q of E guy, the qualityof earnings guy.
I work on financial duediligence.
How did I get into that?
This is uh very crazy andinteresting.
(02:18):
So I've always loved numbers,especially when they have dollar
signs attached to them.
And why, yes, it's fun, it's agame.
You know, for me, literally, Ilike changing stuff to see what
happens.
Um, but more importantly, thereare families behind those dollar
signs, and there's people.
(02:38):
And I've learned, Rick, justthroughout my life that people
are intriguing and interestingin their stories, you know, and
why they do certain things.
We're all different and similar,you know, in different ways and
similar ways and things.
And so how did I get into allthis?
So grew up in Tennessee, did myundergrad while I was doing it.
(03:00):
I got into accounts receivable,really enjoyed it, you know.
So I got my start intoaccounting while I was doing my
undergrad, which is not inaccounting.
My last verse is actually inSpanish and business.
I wanted to do internationalbusiness, but I got into
accounting and I loved it.
And so I stuck with that for awhile.
(03:21):
Uh, moved out here to Utah uh afew years later after I
graduated.
And this was in pre-2008.
So, Rick, like a lot of peopleduring that time, especially
here in Utah, I got caught up inreal estate, bought some
properties, sold properties,flips, uh, held, rented, you
know, did some lease to optionsto buy, you know, things like
(03:44):
that.
And it was fun.
And while I was doing that, Iactually bought and sold a very
small kind of took myselfthrough a couple small
transactions.
I bought my business partner outof our real estate holdings
company.
And around the same time frame,I also sold my mortgage loan
processing company to one of myclients.
(04:04):
And so you could say I kind ofgot my start in MA that way, but
I had no idea what I was doing.
I I learned quite a bit, but itwas just very, you know, touch,
very light touch.
I had some great advisors aroundme, you know, that helped me
through those transactions.
So 2008 hit, like everybodyelse, lost everything and got a
(04:28):
job.
And what was that job?
I was a corporate controller.
There was a conglomerate ofcompanies.
We had, I won't even go, therewere several different
industries, several differenttypes of companies, and and a
few different owners and severalinvestors.
And so I was their corporatecontroller and then later became
their acting CFO and took themthrough a lot of different
(04:51):
transactions as well.
And it was a blast.
I really enjoyed it.
It was crazy.
I drove myself nuts.
I still had no idea what I wasdoing, but I was learning really
fast.
Again, having great advisorsaround me, doing a lot of
research, you know, and learningon the go and making a lot of
mistakes.
Rick, I almost lost my job a fewtimes.
(05:12):
Well, there's that's a wholeother story for another day.
But I tell you what, I learnedquite a bit and it was great.
So after a few years with them,I uh I resigned.
We hired a real CFO to replaceme.
We hired a real controller toreplace me.
So two different individuals.
And then I became an independentfractional CFO, picked up seven
(05:34):
clients.
Most of them were our investors,you know, from my previous tent.
You know, helped them with someof their other companies, and
that was great.
Um, and then I joined the firmthat I'm with now.
When I joined, it was calledAdvanced CFO.
Since then, we've rebranded, sowe're Amplio.
AMP is grow Leo, like the line,courageous, so grow
(05:58):
courageously.
SPEAKER_01 (05:59):
Love that.
I wondered where Amplio camefrom.
I love that.
That's it.
Right there.
Yeah.
SPEAKER_02 (06:04):
Uh, and it's a lot of fun.
So when I joined uh almost sixyears ago, we had 40 consultants
at the time.
Um, now we have over 300professionals.
We have six divisions (06:16):
finance, marketing, HR, turnaround,
valuation, and sales tax.
So I'm in the finance divisionand I lead what's called our
transaction advisory.
So now enter what I do today,quality of earnings.
So that part of our transactionadvisory is specifically in
financial due diligence.
(06:37):
We say we can help before,during, and after a deal.
I or my team will specificallyjump in and do that, you know,
quality of earnings prep, oractually do a buy side or a sell
side QFE.
Gotcha.
So you do both sides.
SPEAKER_01 (06:52):
You're buyers and sellers.
SPEAKER_02 (06:53):
Okay.
Exactly.
I like that because we can learnhow to defend both sides.
And that's important.
You have to be able to present adefensible uh product and to be
able to help buyers and sellersunderstand what they're dealing
with and how they'retransacting.
So that's professional.
Uh, I'll take a quick minute,talk about personal, and then a
(07:16):
fun thing about me that some butnot a lot of people know.
So professionally, I mentioned Igrew up in Tennessee.
I love the outdoors, Rick.
Uh, we've we've talked aboutsnow build snowmobiling a little
bit.
Uh my wife and I have a cabinout in uh in Fairview, Utah.
We are excited for winter to gosnowmobiling out there.
We do a lot of off-roading.
(07:36):
Um, mountain biking is myabsolute love.
I love hiking, um, backpacking.
I've done that quite a bit.
I did King's Peak here in Utah afew weeks back.
I also did a bunch of running.
And so I just finished a I did amarathon in 22.
Uh, had a bad experience, but Iwant to do another one.
(07:57):
So I did a half marathon acouple of weeks ago, and I'll be
doing St.
George full marathon next year.
So here's the fun story.
So, with all this crazyactivity, Rick, my entire life,
I've never broken a bone in mybody until two years ago, I was
mountain biking here in Utah,very local trail, Corner Canyon,
(08:18):
for the for you Utah's who knowthe name here.
Been there at the very, veryend.
So you know why I'm light.
At the very very end, wherethere's just that last little
stint that lasts probably 30seconds, and you can go left or
go right.
I went left thinking there was ajump.
It's not a jump.
(08:39):
I broke four ribs, drove myselfand my buddy to the hospital
because he actually, unbeknownstto me, at the start of the
trail, hit a uh a slick spot andslammed into a tree and knocked
himself unconscious for a bit.
(09:00):
And some people had to knock himdown.
And this is a short story.
So there's I I'm crazy enough todo some.
I'll say I'm not stupid, butI've done some really dumb
things, but I am crazy.
So and that transfers thattranslates very well into my
career because I'm just scrappyenough to figure stuff out.
(09:21):
How's that for an intro?
SPEAKER_01 (09:23):
Hey, that's a great intro, Patrick.
I love it.
I learned some things that Ididn't know about you, so thank
you.
So let's get into the topic.
Uh, the topic today is qualityof earnings, Q of E.
And uh, and it's one that youyou work with all the time.
I work with it all the time.
You know, I want to say notuntil the last three or four
(09:45):
years has it become moreprevalent, more popular.
Um, accountants would do duediligence, but I I think it's
much more utilized in theindustry, both on the buy side
and the and the sell side.
So tell me what is quality ofearnings?
SPEAKER_02 (10:01):
Yeah, and and I love this.
I'm I'm I'm flipping through abook here I'm gonna show.
So this was copyright 1987.
Look at that.
And you're you nailed it, and soI'm holding up a book called
Quality of Earnings by ThorntonO'Glove.
So this was published in 1987,but you've nailed it, it hasn't
(10:23):
been prevalent until the lastfew years.
So Thornton O'Glove, he was hewas uh an analyst, he was a
buy-side analyst, and then hestarted publishing a lot of
things about public companiesthat people didn't like because
he was exposing rather than youknow recommending to buy, he was
(10:45):
saying, no, you should not buythis company.
Here's why he called that thequality of writing.
So that's really how it started.
But here recently, with just thewhole uptick in transactions and
things going on, a lot of peoplehave said, Oh my gosh, we could
actually do this with privatecompanies.
And it's been going on for along time.
I mean, there's even Daddy, youknow, the guy that's really
(11:06):
started uh, you know, as well,made it big.
That was 10, 15 years ago.
But the reason why it's becomeso prevalent today is because
businesses predominantlytransact on a multiple of
earnings.
Multiple of EBITDA.
There's a my shirt there for uhanybody that can see a warning,
(11:26):
may start talking about EBITDA.
So you really have to understandwhat the quality of those
earnings are.
So let's break that down.
Quality, high, medium, or low.
And I'm gonna use a very simpleexample customer concentration.
People talk about this a lot,right?
If you have a$10 million companythat comes from, and I'm gonna
(11:51):
be very facetious here, onecustomer, and that's an
extremely low quality.
Because if you lose that onecompany or that one customer,
your company's done.
Yep.
But on the flip side, if itcomes from hundreds of
customers, then you have verylow concentration, which means
(12:11):
it's high quality.
Those earnings are high qualitybecause there's a lot of
different customers, there'sprobably different contracts,
you know, and and we can getinto you know things such as,
you know, um recurry revenue andall that, but let's just let's
just stick to the to the tophere.
(12:32):
So that's what quality comesfrom.
Okay.
And it's not just customerconcentration, it's things such
as, okay, well, even vendorconcentration, employee
contracts, no, yeah, productproduct concentration or service
concentration.
SPEAKER_01 (12:47):
Yeah.
SPEAKER_02 (12:48):
Exactly.
Okay.
Exactly.
So there's a lot of differentthings you can derive at to say,
well, determine what type ofquality it is, a high, medium,
or low.
And then earnings, yes,companies trade most of the time
on a multiple of EBITDA.
EBITDA is a proxy proximate forcash flow.
There's a whole other subject wecan get into is EBITDA versus
(13:09):
cash flow versus net income andall that.
But that's so really what aquality of earnings is, is it
helps to determine what thequality of those earnings are.
When you buy a company, you'reacquiring an asset, you're
acquiring it for its cash flow,right?
So you want to understand whathow predictable is that cash
(13:29):
flow in the future?
And that's why you want to get aquality of earnings report, is
to really understand thehistorical things that went on
to be able to predict the futureof the company.
SPEAKER_01 (13:43):
So, um, how does it differ from an audit?
SPEAKER_02 (13:45):
Oh, I love this question.
I get asked this a lot.
So an audit will tell you what acompany is doing that's in
compliance with GAAP, generallyaccepted accounting principles.
A quality of earnings will tellyou how they're doing that and
why they're doing it that way.
So, for example, revenuerecognition.
(14:06):
Okay, let's talk about a SaaScompany, for example.
SPEAKER_01 (14:09):
Okay.
Love SaaS companies, work withthem all the time.
Yeah.
SPEAKER_02 (14:13):
Yeah.
Well, so if they're recordingtheir revenue based on cash,
cash basis.
And so when they record adeposit, whether that deposits
for one month or 12 months or 36months, if they're recording
that, that's cash basis.
That's not in compliance withrevenue recognition.
(14:34):
And so an audit will say, well,they're not in compliance with
gap.
Here's why.
Or sorry, here's what, here's,you know, the gap procedure and
everything.
But a quality of earnings willdive deeper into and say, well,
correct.
They're not in, and so it willactually start making looking at
what those adjustments wouldlook like and then the types of
(14:56):
customers, the actual contract,you know, things like that.
And then, well, how predictableis that customer for sticking
around the stickiness of it,right?
After a transaction.
So the predictability.
Predictability, exactly.
I love that.
So all in all it does, it justsays, well, are they in
compliance with GAAP or not?
But a quality of earnings willreally dive deep into it and
(15:19):
say, let's actually discuss thecustomer.
SPEAKER_01 (15:23):
Love it.
And and quality of earnings ismore uh income statement or PL
centric than balance sheet,right?
It's more about the earnings.
SPEAKER_02 (15:32):
More, yes.
But let's not forget theimportant balance sheet.
Let's also not forget the almostand sometimes even more
important statement of cashflows.
And that's where a lot of peoplethink that a Q of V will only
talk about EBATA and income.
Not the case, at least not agood Q of E.
(15:54):
A good Q of V will also discussbalance sheet because you got to
look at networking capital,which is very, very dependent
upon, you know, the balancesheet, current assets and
current liabilities, right?
But it'll also talk aboutaccruals.
Every accrual has to reverse.
And that's where we talk aboutthere again, SAS, deferred
(16:15):
revenues.
That's an accrued liability.
You've received revenue orsorry, you've received cash for
something that you still have todeliver on.
So that's a lot of money.
SPEAKER_01 (16:26):
I see that a lot.
If you have a cash basis, it'slumpy, right?
They pay 100% of theirsubscription up front in one
month.
So the revenue and your eBiddlelooks really good for that
month, but you have expenses for11 months to follow.
So bad.
So you mentioned bad Q of E.
So what's the difference betweena good one and a bad one for the
(16:48):
listeners?
SPEAKER_02 (16:49):
So, and there's a lot of QV providers out there,
and and I'm not going to talkabout any specific one, but just
in general sense.
So a good QV, again, will lookat income statement, balance
sheet, statement of cash flows,networking capital, revenue
vendor, all the differentconcentrations, um, cash to uh
(17:11):
uh cash to revenue proof, youknow, things like that.
Now, a good QV provider will beable to take all those things
and explain it to you, whoeveryou are, whether you're buyer,
seller, investor, you know, theconsumer of the of the analysis,
will be able to explain and walkthrough what those things are
(17:33):
and be able to help youunderstand how this will affect
your part of that transaction.
A bad one, as you mentioned, andI'm gonna use an example here.
I actually uh had earlier thisyear, I had a potential client
reach out, talked about thedeal, gave him a price on the
QV, uh, and he kindly said, youknow, hey, thank you.
(17:55):
But he actually went withsomeone else who was cheaper.
He messaged me back severalweeks later and said, Patrick,
can you help me, my QV provider,the target that I'm acquiring,
and the broker involved, none ofus can figure out the networking
capital.
(18:16):
I actually spent an hour or two,you know, kind of diving in and
digging in.
And it was interesting to mebecause I'm like, oh my gosh,
this was it, it wasn't simple,but it wasn't complex either.
So a good QV provider can reallydig in and ask not just the
right primary questions, but theright secondary questions to be
(18:38):
able to translate information,you know, can take rigor, can
simplify it, and then give it toyou that's clear clarity.
SPEAKER_01 (18:48):
Gotcha.
And so the deliverable is areport, right?
Is there a report?
SPEAKER_02 (18:52):
Yes, what's so there's two different types of
deliverables.
Every QV should at least deliveran Excel data book.
Okay, that way you can go inthere and you can see the
numbers and where they derive.
And then a lot of times, and wewill do this as well, you can
actually say, Hey, I want I wantthe actual report itself, not
just the data book, but thereport, which is a PDF or a
(19:15):
PowerPoint or something that hasall the nice long verbits behind
it.
Hey, here's what we did, here'sthe process, and here's the
explanation about it.
Not everybody needs your report,Rick.
Most people um are okay withjust the Excel data book, but
the individuals who usually wantthe report itself are like our
(19:38):
uh independent sponsors orprivate equity because they're
very used to having these verynice, and yeah, I'll use the
word fluffy, very nice, fluffy,very detailed.
Hey, here's the procedures wewent through, here's exactly
what this means.
Here's a translation.
So those reports, yeah, weupcharge a little bit to those
reports because they take abouta week to put together.
(20:00):
And those reports are 30 to 60pages long, you know, with a lot
of good, solid explanations,defendable explanations.
And so the idea behind a reportis you can actually send that to
a third party, they can readthat and not need the Q of E
person to explain things.
SPEAKER_01 (20:16):
Gotcha.
SPEAKER_02 (20:17):
Otherwise, an Excel data book, you know, and a one
to two hour phone call can walkthrough things.
SPEAKER_01 (20:22):
Yeah, yeah, that makes sense.
So I wanted to dive intosomething, a concept here, and
that is we're seeing themthey're more prevalent.
Buyers are doing private equityis asking for them.
I mean, I've got I've got uh tworight now under LOI were doing
the buyers are doing Q of E's onthem.
(20:43):
Nice, good, and so and so here'shere's what I've been thinking
about.
If you're a seller, and I Irepresent seller, sell side, if
you're a seller and the buyersare gonna do it anyway, why not
get ahead of the buyers and whynot do a quality of earnings
from a sell side first?
SPEAKER_02 (21:05):
100%, Rick.
And here's why.
And and I love doing sell sideQVs for a few reasons.
So why would a seller want to doit?
Yes, it's an added cost,especially if a buyer's gonna
end up doing it anyway.
But here's what I'm gonna say.
SPEAKER_01 (21:22):
Hold one second.
You use the word cost, yeah.
I'm gonna say it's aninvestment.
SPEAKER_02 (21:28):
I I love it.
You are correct.
And here's why.
So when a seller does a sellside QV, it does a few things.
Number one, it prepares theseller in a lot of different
ways.
Number one, it helps them to seewhat a buyer's gonna go through.
Buyers go through some very deepdiligence.
So this helps prepare the sellerto it's it's a practice run.
(21:51):
Yeah, but that's just surfacelevel.
Let's dig a bit deeper.
So, what it does is Rick, Idon't care if you're a private
company or a public company,your books are not perfect.
No one's books are ever perfect.
Okay.
So, what a silci QV does, whathelps get your books a lot
cleaner and closer, and I won'tsay perfection, but closer to
(22:15):
inducing confidence in a buyer.
So think about two scenarios.
If a buyer comes in, if you'relooking to acquire a company and
you sign the LOI and you startdoing your diligence, and the
books are a mess, and the QVuncovers the mess, the QV can
still get done, but it's messy.
There's a lot of adjustments.
What are you thinking in fillingas a buyer?
(22:36):
Your confidence level startswaning, right?
You're you're probably going toreduce that multiple a bit.
On the flip side, if you've donea sell site QV and you're
prepared and you've cleaned up alot of that stuff, then that
(22:58):
does a couple of things.
Number one, you can say, hey,buyer, you may or may not do a
QV, but here's one that we'vedone.
So number one, that immediatelysays, We're serious about this.
We prepared.
We've we've made someinvestments to prepare our
company for sale.
Number two, you already knowwhat most, if not all, the
questions the buyer's gonna askanyway and say, Yeah, we've
(23:20):
already addressed that.
Here we go, here's what we'vegot this in that data room,
here's the backup to it, youknow, here's the adjustments.
But you're you've already hadthat practice run.
But at the same time, now you'vegot those things cleaned up.
And so a buyer's gonna be like,Wow, it shortens the time frame,
where an eight-week QV probablytook three, two, four weeks
(23:42):
because you've done a lot of theprep work.
So that's really gonna induce awhole lot of confidence in a
buyer as well.
So that's something, and you'reexact that's why, and I love how
you said it, it's an investment,you know, to spend 20, 30, 40
grand to do a sale side QV, thenthat way your multiple is gonna
be strengthened with that.
SPEAKER_01 (24:03):
Yeah.
So what I'm thinking about isI'm thinking about deals that
blow up, things that havehappened.
We had a company recently that Iwas selling, and um, they got
into the books, and it was aconstruction-related company.
Construction are what you talkabout, they're like SaaS
companies where they get a bigdeposit up front, yeah, and then
(24:24):
they have to do the work, right?
Usually it's time to billingsand under billings, yep, over
and under, and they havescenario.
That's the billings next, yeah.
Yeah, so buyer gets into it,private equity gets into it, and
they're like, These books are amess, we need a Q of E.
Right.
And so they had to do the Q ofE.
They ended up splitting the costand uh fixing the books.
(24:46):
Yep.
And um that process was onewhere had the seller done their
own Q of E, they would betalking to the accountant who
they hired to do it, or the firmthat they hired.
And it's more of a friendlyconversation when it's your
client relationship with thatvendor, right?
(25:08):
Yeah, and so that's a muchdifferent, they're not defending
the numbers, they're justworking on getting them right.
SPEAKER_02 (25:14):
It's gaining understanding.
SPEAKER_01 (25:16):
Yep, gaining an understanding, getting the
numbers right, getting thebusiness cleaned up and ready
for sale.
Now, when we have a buy-side Qof E firm, the um the sellers
are in a defense mode.
Yeah, right.
And I like to lead thesetransactions on my toes, not on
my heels.
And if you let the buyers do theQ of E, you're on your heels.
(25:39):
You're always on the defense.
Yeah.
If the sellers are sayingdefensible, yeah, it's
defensible, right?
And and and um, it's just it's adifferent way to approach the
transaction and due diligence.
Do you want to lead on yourtoes?
Do you want to get ahead of it?
Do you want to have thequestions answered already and
be able to give them a niceclean report and an Excel
(26:00):
spreadsheet with the tabs andit's all tied out and it's from
a third-party CPA?
I mean, as a buyer, when they gointo these transactions, I don't
know what the fallout is, I'd beinterested.
But as they go in, there's a lotof them that do fall out in due
diligence because the financialsare not what was represented.
Either falls out or it'sretraded in price and goes down.
So buyers have some trepidationgoing into due diligence.
(26:21):
They're like, okay, now Ibelieve what you say, now it's
time to prove it.
But if it's already proven, Ithink the buyers like that.
In fact, I don't think thebuyers I I know, yeah.
Yeah, and and it becomes morevaluable of an asset and they're
willing to pay more, I wouldsay.
SPEAKER_02 (26:38):
And you've nailed it, and I love how you frame
that waiting on your toes ratherthan your heels.
Rick, there are so many times,and private equity buyers
especially love, they'll ask methis question often.
And when I'm delivering thefinal QV to them and I'm walking
them through everything, youknow, and the adjustments and
all that.
Their final question very oftenis, okay, Patrick, now we see
(27:00):
the numbers, now we know andunderstand the story.
Our final question is going tobe tell me about your
experience.
I want you to grade.
And often they'll even ask me,and this is interesting, I don't
know who started this, but oftenthey'll say, grade the sellers,
grade the team you worked with.
Are they an A or are they an F?
They want to know the experiencebecause a lot of times, most of
(27:25):
the time, that team's gonna haveto continue staying on board for
at least a couple of years.
And so want to know who they'regonna work with.
And so you know that when you'redoing a sell side Q of V, then
you're working a whole lot moretogether, you're leading on your
toes, you're understanding thestory.
And so then you typically have abetter experience.
(27:47):
And so even if the buy-side doestheir own buy-side Q of V, then
you're prepared, and thatexperience between those
interactions are still going tobe smoother.
And so then, yeah, the QVprovider can say, Oh my gosh,
let me tell you, here's a horrorstory, not a horror story, but
just an experience.
This is as of what is today,Wednesday.
(28:09):
This is as of last week.
Yes, one of my clients isacquiring, they're doing uh an
accounting firm roll-up.
I've done 15 or 20 Q of E's forthem in the last couple of
years.
Uh, my recent one last week, andI'm talking, I want to emphasize
this, Rick.
This is a CPA firm.
(28:30):
That's the target, that's theseller.
Okay.
With wait a minute, with badbooks?
Well, not the books, but theadjustments.
So typically a seller is gonnasay, Oh, there's some
adjustments in there.
Let me tell you, let me send youa spreadsheet of what those
adjustments are.
So I got this spreadsheet,right?
And it shows the trilling 12month adjustments, and they're
(28:52):
all hard-coded numbers.
I'm like, awesome.
I should, I got the QuickBooksfile.
I should be able to go in, he'sgot it separated, you know, in
categories.
I should be able to go in andfind these.
Rick, after two hours, Icouldn't find them.
So I called the seller.
I'm like, hey, you have X, Y,and Z, one, two, and three.
Help me to know where these are.
(29:13):
He fumbled.
He had to go through and try toremember where he got those
numbers from.
Now, we long story short, Rick,at the end of the day, we found
all the numbers, but it took areally long time and it was
disorganized.
This is a CPA firm.
About a four million dollar CPAfirm at that.
(29:36):
Wow.
That's not a small one, not ahuge one, but not a small one
either.
SPEAKER_01 (29:40):
Yeah, like bricklayer whose house is made
out of wood and it's fallendown.
SPEAKER_02 (29:43):
Exactly.
So I communicated to the buyer,to my client, and I said, Hey,
listen, his earnings were spoton.
You guys, you know, you you saidX, he said X, here we go.
So, but let me tell you aboutthe experience, let me tell you
about the organization skills.
You need some work.
Now, luckily, that's teachable.
(30:04):
Yeah.
But that's something that didn'tchange the multiple, but it
definitely is a differentexperience.
You would think someone would beextremely so that's something
that you know you see it really.
If you do a sell site QV, ithelps you, if nothing else, to
organize the data in apresentable format.
(30:26):
And that alone will induceconfidence to a buyer.
SPEAKER_01 (30:30):
And I'd never I didn't know that.
That's really interesting.
They ask, what's your experiencelike?
What is the team like?
How are you answered often?
SPEAKER_02 (30:38):
I love that question because I will tell you exactly
what I went through.
SPEAKER_01 (30:42):
Yeah, yeah, exactly.
But from a buyer standpoint,that's what I want to know.
Yeah.
Give me the juice, give me thedirty, give me the inside story
here, whatever it is.
You know, what am I dealingwith?
What am I buying?
Yep.
Who are the players?
How who am I playing with?
SPEAKER_02 (30:57):
Who am I gonna be married to for the next couple
of years in this deal?
That's right.
Because even if the numberspencil, if the team doesn't fit
and the experience is raunchy,you don't want to do business
with them.
You don't want to acquire them.
And yeah.
SPEAKER_01 (31:12):
No, no.
Wow, I had never thought aboutthat before.
So there's one other thing Iwanted to bring up.
I've got a few questions here.
Hey, but um, one of the things,and you had alluded to this,
that the sellers oftentimes justdo cash basis financials.
And when you go to market, thebuyers in all likelihood want
accrual-based financials.
SPEAKER_02 (31:32):
Yes.
SPEAKER_01 (31:32):
And so that requires some accounting work.
And I'm an accountant, I don'tdo it for my clients because
it's a conflict of interest, butthere's some accounting work to
get them presentable to thebuyer so the buyers can get them
presented to their investmentcommittee and so forth.
SPEAKER_02 (31:46):
Exactly.
SPEAKER_01 (31:47):
Some of the things I see them miss, deferred deferred
revenue is a huge one.
SPEAKER_02 (31:50):
Oh, yeah.
SPEAKER_01 (31:51):
Um, the other one are accruals.
I was uh just on the phoneyesterday with the CFO, and he's
like, Rick, I so wish I'd havetied my numbers out monthly
instead of annually, becausethese Q of E guys are beating me
up and they're driving me crazy,you know, Heinz 2020.
But they and and you're they'rebusy, they're running a
business, right?
And they don't necessarily needeverything tied out, need all
(32:13):
the accruals, but I seevacation, PTO, um, revenue in
excess of cost costs us anexcess of revenue, or they're
overbuilding or underbilling.
But these are things, if missed,can potentially swing the deal
hundreds of thousands andsometimes millions of dollars
because they impact workingcapital.
SPEAKER_02 (32:36):
Yes.
SPEAKER_01 (32:36):
And uh, and if you have a target and you're you
haven't calculated thesenumbers, well, that's a negative
to your working capital on thecruel side.
So then you have a deficiencywhich reduces your purchase
price.
SPEAKER_02 (32:47):
Dollar yes.
That's how everythingtranslates.
SPEAKER_01 (32:50):
Yes, over and over.
So there's just so manydifferent reasons to do this, to
make this investment, to get aquality of earnings report from
a capable person, I want to say,someone who provides the good
value.
And and this is what you do dayin and day out.
SPEAKER_02 (33:08):
Yes.
Um, can I emphasize one of thosepoints, Rick, especially with
the time of year that we're at?
So at the day of recording, thistoday is September 24th.
So we're coming up on holidayseason, right?
Thanksgiving, Christmas, andeverything.
Something that I see a lot ofcompanies miss on that specific
(33:29):
note of accrual.
So let's even go down to onevery specific accrual that most
companies don't even think aboutpay in payroll.
Okay.
Some companies will accruepayroll, okay.
But three things that they'remost of the time not accruing
commissions, which aren't supercommission structure is crazy.
(33:51):
We all know that, okay.
But commissions are typicallypaid out pretty frequently.
But let's talk about the PTO.
Let's talk about bonuses.
Okay.
The PTO will depend on, I don'tcare what your handbook says,
your handbook can say anythingit wants.
But let's talk about the statethat your company is based in
(34:12):
and the state that your employeeis living in.
Okay.
The PTO accrue and payout variesdependent upon state.
This is where our HR consultantscan jump in and help.
Regardless of what your handbooksays, most of the time you're
gonna have some type of PTOaccrued per employee just by
(34:35):
default.
But most companies are notputting that on the balance
sheet as a liability.
And what's gonna happen is comeNovember, December, what's
you're gonna have people taking10, 20, 30, 40 hours of paid
time off and getting paid forit, but not producing.
A buyer has to know that.
(34:56):
Because let's say the dealcloses on October 31st, and you
have a million, and the buyerhas half a million dollars in
networking capital to buyinventory and to make payroll.
But guess what?
Johnny, Susie, and George aregoing on vacation and they're
taking, you know, 20 hours each,or 60 hours of unproductivity
(35:19):
that you as a buyer have to pay,but the employees are not
producing, and so therefore,you're not invoicing for that.
So you need to make sure thatyour pay time off is accrued on
a monthly basis, okay?
To your point, exactly, on thebalance sheet and bonuses,
year-end bonuses.
(35:41):
50 grand, 500 grand, I don'tcare how much they are, accrue
them because it's the exact samething.
We're coming up on year-endstuff.
You're gonna December 31st, hey,we had a wonderful year, we're
gonna pay out 200 grand inbonuses.
But guess what?
Your income statement didn'treflect any of that.
SPEAKER_01 (35:59):
My favorite is they pay them in January, so it goes
on to the next year.
Exactly.
SPEAKER_02 (36:04):
This looked really good because they have to wait
till they had the cash to payit.
Those things need to be accruedfor on the income statement and
balance sheet so that buyer andseller can have those
conversations about networkingcapital on who's gonna pay who
win and how much and who's gonnafit that bill.
SPEAKER_01 (36:23):
Love it.
That's it.
SPEAKER_02 (36:24):
It's just a discussion, doesn't mean buyer
has to or seller has to justhave the discussion.
Come to the agreement.
SPEAKER_01 (36:32):
And sometimes, sometimes I've got the buyers to
accept it and they embrace thatand and assume that liability.
Yeah, right.
But it's the discussion needs tobe made.
Discussion needs to be made.
Yep.
So tell me and tell ourlisteners how do they get in
touch with you?
You got an email, a website.
How do they get in touch withyou?
They have additional questions.
SPEAKER_02 (36:52):
The easiest way is LinkedIn.
Patrick McMillan, MC-M-I-L-L-A-N.
I'm constantly on LinkedIn.
I will respond unless you'retrying to sell me something.
I will likely ghost you.
But if you're saying, hey,Patrick, want to learn more
about this, I'm looking atacquiring company.
Hey, I want to sell my companyhelp.
(37:13):
You know, I would love to jumpon a phone call.
I'll send you my calendar link.
So reach out to me on LinkedIn.
SPEAKER_01 (37:18):
Great.
Um, one other thing that I thinkthough, what's the cost?
Just a range on the QV.
SPEAKER_02 (37:23):
Yeah.
QVs, our range is between 20 and45,000.
Okay.
If it's a very, you know, I'llsay small, two to five million
dollar company, no inventory,one entity, uh, then yeah, it's
easy.
It'll be 20 grand.
Gotcha.
If it's a and the more hair onit, it's so really the cost will
(37:46):
depend upon size, scope, andcomplexity.
unknown (37:50):
Okay.
SPEAKER_02 (37:51):
The bigger it is, or the more scope it is, or the
more inventory, the moreentities, and yeah, that'll up
in cost.
SPEAKER_01 (37:57):
Gotcha.
So 20 to 40,000.
I'm not calling a cost, I'mcalling it an investment.
SPEAKER_02 (38:02):
Investment.
Yes, I'm gonna face my languageon that.
I like that.
Thank you.
SPEAKER_01 (38:07):
It truly what it is.
And well, and when we're sellingcompanies for millions of
dollars, it it just so muchbetter for the buyer.
So I uh we've geeked out alittle bit here as accountants
today, but uh hopefully theinformation has been valuable to
you.
And I'm gonna be sharing thisepisode with all of my sellers.
(38:27):
We're talking about preparingthe business for sale.
But thank you so much for yourtime today.
I appreciate that, Patrick.
And uh great to learn someinteresting things about you.
Four broken ribs on the trail.
I mean, I'm gonna have to hearthe rest of that story.
SPEAKER_02 (38:41):
All hold up.
SPEAKER_01 (38:43):
Good, that's good.
But uh, we appreciate it, and weappreciate the listeners today.
Until next time, this is Rickwith MA Murders and Accusations.
The good, the bad, and the uglyof selling your business.
Thank you.
SPEAKER_00 (38:57):
Thanks, Rick.
Thank you for attending ourpodcast.
We invite you to join us forfuture episodes of MA Murders
and Accusations the Good, theBad, and the Ugly of Selling
Your Business.
You can also visit us atwww.bsalesgroup.com or email
Rick directly at Rick atBSalesgroup.com.
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