February 9, 2024 • 10 mins
Unlock the mystery behind working capital in M&A deals with Russell Cohen and me, your co-host Jeremy Wolf, as we dissect our colossal $100 million roofing company transaction. Grasp the concept that often spells the difference between a successful sale and a deal gone awry. In our latest podcast episode, Russell, an M&A maestro, breaks down the fundamentals of working capital in a way that's accessible to all. From explaining the calculations on a business's balance sheet to emphasizing the crucial timing for assessing it, we leave no stone unturned. This is not just a recount of our biggest deal to date; it's a masterclass in ensuring your financials are robust and 'PE ready' for that major sale.
Ever wondered why some business owners walk away from a deal feeling victorious while others are left scratching their heads? The answer often lies in the nuances of working capital. Join us as we shed light on strategies for managing this key aspect and why it's imperative to have seasoned advisors, like CPAs or fractional CFOs, in your corner. With Russell's expertise, we explore how growth trends affect financial health assessments and how this knowledge can lead to a smoother journey to the closing table. Get ready to be equipped with valuable insights that could significantly influence the payout of your next big deal.
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:02):
Welcome to the South Florida M&A Advisors podcast,
your trusted M&A team.
Here's your host, Russell Cohen.
Jeremy (00:13):
Hello everyone and welcome back to the South
Florida M&A Advisors podcast.
I'm your co-host, jeremy Wolfe,joined by your host, russell
Cohen.
Russell, good to see you again.
All right, thank you, jeremy.
Yeah, man, so we were talkingabout the biggest sale in South
Florida M&A Advisors history 100million dollar deal with a
roofing company that closedrecently.
Again, congratulations on that,thank you.
(00:34):
So I know you wanted to talk alittle bit more about that,
because there's so manydifferent components to a deal
like that.
There's so many differentfactors that go into it, one of
which is networking capital.
So why don't you start off bygiving kind of an overview of
what that is for people like methat don't even really
necessarily know what that termmeans, and then we can get into
how that pose challengesthroughout that process of that
sale.
Russell (00:54):
So the basic definition of networking capital is if you
go on a business balance sheet,you got the current assets and
the current liabilities.
So the current assets minus thecurrent liabilities will give
you a networking capital.
So what a private equity groupwill do is they'll go back 12 to
18 months, assuming if abusiness has consistent sales
(01:20):
and EBITDA, they'll go back 12to 18 months and get an average
of networking capital.
If a company is on a hockeystick growth, then they're going
to take a very close look atthe last three to six months and
there's going to look for anice fucking capital Now.
So the networking capital isprobably one of the biggest deal
(01:40):
killers in M&A Transaction.
Your advisor needs to bebringing this definition and
explaining to you networkingcapital on the first meeting
because basically what you'redoing is you're getting a great
multiple of your EBITDA butyou're leaving money behind to
run the machine.
Business owner builds thismonster of a company and it's a
(02:05):
machine and it needs money tofunction for the private equity
group or family office or theprivate company that buys it.
So they're going to give yougreat, great multiple but you
got to leave money money oraccounts receivable behind to
fuel the payroll to fuel theoverhead because they're buying
(02:26):
a pipeline but they got it.
They're not going to front yourexpenses, they're not going to
let you get a great multiple andthen you take your AR and run
out the door Again a contractstatement and not cut a profit.
So basically, so what happenshere is if you are um want a
larger type buyer, the quickeryou grasp a networking capital
(02:47):
then the more likelihood you canget to the closing table.
Um.
So I bring it up upfront andit's very important that we
calculate the networking capitalearly before we find a buyer.
And it's important that youcalculate the networking capital
while you're in the quality ofearnings and it's going to get
calculated at the end of thedeal.
So if we're doing it threetimes along in that process,
(03:11):
when the private equity group orthe buyer comes up with the
networking capital, you're notsurprised because you've been
educated.
So that is very, very important.
And sometimes you could haveyour CPA do the networking
capital analysis.
And if your CPA is notinterested in being there, by
your side, we work with CF uh,fractional CFOs that will hold
(03:34):
your hand through the entireprocess of from the accounting
side and make sure your businessis PE ready.
So networking capital thequicker that the business owner
takes on that, that definitionand understands the process, the
better chance they will getthat major payout six to 12
months later.
Jeremy (03:55):
So is there kind of like a standard amount?
I know you mentioned sometimesyou can go back 12 months, 18
months.
Sometimes if there's a hockeystick growth they'll take it for
three months.
It seems to me like you'll get,obviously get a better, um, the
picture of the old, the, thestate of the business over a
longer period of time.
Is there a standard that youtypically apply to take those
points of networking capitalthroughout the?
Russell (04:17):
uh yeah, yeah, most, most companies will do 12 to 18
months.
Most companies are not on ahockey stick growth.
They're more likely stable, orsometimes it's declining, which
is not a good trend.
Uh, you're trying to sell yourbusiness, um, so?
So then, yeah, then.
So when we were, you know ifwe're going to the, the roofing
deal you know we were dealingwith a hockey stick growth.
(04:40):
Right, it was going from a 13million EBITDA to a $20 million
EBITDA and and and.
So you know, looking back, thatdiscussion was not was not done
in the beginning, it was notdone in the middle, it was done
at the end, and and we had amajor challenge because the
private equity group did theircalculations and they had a lot
(05:03):
higher working capital versuswhat the seller thought.
And it ended up being there wassomething on the balance sheet
that caused the networkingcapital requirements to be
calculated higher.
So this could have been avoidedif we took the, if at that time
, took the approach to do itearly in the middle instead of
(05:23):
waiting to the end of the deal,and it created a lot of
instability in the transactionand it almost blew up the
transaction.
There was, you know.
So you're trying to avoidseller frustration.
That's.
That's the goal.
So in this case we were able towork it out, but it was
(05:44):
unneeded stress by by allparties, unfortunately.
Jeremy (05:47):
So was there any reason why you didn't do those
calculations earlier on in thein the deal?
Russell (05:53):
You know I was not personally running the deal.
I was leaning on my M&Aassociate and he's brilliant and
for some reason he he did not.
He did not do the beginningmiddle part of the networking
capital.
So, going forward, as I run myown deals or I partner with, you
know, my other M&A associatesI've made it.
(06:16):
Now that I experienced it, nowI try to bring in the fractional
CFO very early Becausetypically the spouse or the CPA
spouse it's over the spouse'shead when we start talking that
because they're not quick bookspro advisors, they're not a CPA
(06:37):
or high-end accounting person.
They're doing the books andthey're getting their way
through but they're not anexpert.
They don't have 75,000 hours ofaccounting to become an expert.
So I try to recommend to thesellers to bring in the
fractional CFO.
They will clean up, they willstart working on the networking
(06:57):
capital analysis and then asthey get into the quick books so
the sage books, they startseeing issues in the books and
the CFO would then say you'rereally not private equity ready
for the eyes of private equity,because sometimes in a larger
deal they gotta be gapaccounting and none of these
(07:18):
small businesses are based ongap accounting.
So we're trying to get it asvery close to the gap accounting
as possible.
And so when the CFO gets intothe books they see, they go into
their general ledger and theysee some funkiness and they
start correcting it.
And once we can get everythingcorrected now we can do the
(07:40):
networking capital analysis andeducate the owner on how much
money they're gonna leave behindbased on today, and once again
we get to the quality ofearnings.
The accounting firm, the Q of Efirm, will do the same and
we'll do the same, and at theend of the deal everyone does
(08:01):
the calculation and it becomespart of the contract.
But there's always a paragraphin the letter of intent that
talks about networking capital.
So it's brought up early, it'sin the LOI and we need to
address it early to get to thefinish line.
Jeremy (08:18):
Yeah, I think this speaks to the fact that every
business is different.
Right, there's no two that arethe same.
So when engaging in a deal likethis, there are gonna be so
many different factors toaddress and there's gonna be a
lot of curve balls that arethrown up.
There's no textbook blueprinton how to handle the perfect
deal, because every business isdifferent, so it is a learning
process, like with anything else, and you go through this.
(08:40):
Issues come up, you figure outhow to fix them and then, moving
forward, you apply that.
That's how you become a masterat your craft right Through
practice, through trial anderror and just continuing to
grow and get it better.
So it seems like you're doingthat beautifully, brother.
Russell (08:52):
Yeah, and bottom line is, if a business owner who
spent all the years buildingtheir business and they wanna
dance in the multiples ofprivate equity, they have to.
These are professional buyers.
They know they do this on adaily basis.
The business owner does not.
That's why they're hiring anadvisor like myself.
But they have to address thisparticular point and the quicker
(09:16):
they believe in it, support itis when they get that great
payday and it's a great payday,no doubt.
And if you build a greatcompany, multiples can be four,
five, six, seven, eight, eight,x of your EBITDA.
Those are generational numbersgenerational or signability.
Jeremy (09:37):
I was just writing that down.
I love that dance in themultiples of private equity.
Is that your?
Is that original?
Russell (09:45):
to you.
Yeah, that's awesome.
Jeremy (09:46):
Yeah.
Speaker 1 (09:47):
I didn't drop you in.
Jeremy (09:47):
I love that dance in the multiples of private equity.
I had to write that down.
That's good stuff, man.
All right, cool man.
I think we'll end this segmentthere a lot more to talk about.
Like you said, there's so manydifferent components to this
deal, so I'm sure we can pick upsome other things in future
segments.
Anything else you wanted toshare about that topic?
Russell (10:06):
I know, I think we had a good basis of that and it's
something that a business ownerwill have to if they want to
exit.
They need to be embracing thatconcept.
Jeremy (10:19):
All right, Russell sounds good.
Thanks everyone for tuning inand we will catch you all next
time.
Everyone take care.
Speaker 1 (10:26):
Thanks for listening to the South Florida M&A
Advisors Podcast.
For more information, visitsouthfloridmacom or contact
954-646-7651.
Welcome to the South Florida M&A Advisors podcast,
your trusted M&A team.
Here's your host, Russell Cohen.
Jeremy (00:13):
Hello everyone and welcome back to the South
Florida M&A Advisors podcast.
I'm your co-host, jeremy Wolfe,joined by your host, russell
Cohen.
Russell, good to see you again.
All right, thank you, jeremy.
Yeah, man, so we were talkingabout the biggest sale in South
Florida M&A Advisors history 100million dollar deal with a
roofing company that closedrecently.
Again, congratulations on that,thank you.
(00:34):
So I know you wanted to talk alittle bit more about that,
because there's so manydifferent components to a deal
like that.
There's so many differentfactors that go into it, one of
which is networking capital.
So why don't you start off bygiving kind of an overview of
what that is for people like methat don't even really
necessarily know what that termmeans, and then we can get into
how that pose challengesthroughout that process of that
sale.
Russell (00:54):
So the basic definition of networking capital is if you
go on a business balance sheet,you got the current assets and
the current liabilities.
So the current assets minus thecurrent liabilities will give
you a networking capital.
So what a private equity groupwill do is they'll go back 12 to
18 months, assuming if abusiness has consistent sales
(01:20):
and EBITDA, they'll go back 12to 18 months and get an average
of networking capital.
If a company is on a hockeystick growth, then they're going
to take a very close look atthe last three to six months and
there's going to look for anice fucking capital Now.
So the networking capital isprobably one of the biggest deal
(01:40):
killers in M&A Transaction.
Your advisor needs to bebringing this definition and
explaining to you networkingcapital on the first meeting
because basically what you'redoing is you're getting a great
multiple of your EBITDA butyou're leaving money behind to
run the machine.
Business owner builds thismonster of a company and it's a
(02:05):
machine and it needs money tofunction for the private equity
group or family office or theprivate company that buys it.
So they're going to give yougreat, great multiple but you
got to leave money money oraccounts receivable behind to
fuel the payroll to fuel theoverhead because they're buying
(02:26):
a pipeline but they got it.
They're not going to front yourexpenses, they're not going to
let you get a great multiple andthen you take your AR and run
out the door Again a contractstatement and not cut a profit.
So basically, so what happenshere is if you are um want a
larger type buyer, the quickeryou grasp a networking capital
(02:47):
then the more likelihood you canget to the closing table.
Um.
So I bring it up upfront andit's very important that we
calculate the networking capitalearly before we find a buyer.
And it's important that youcalculate the networking capital
while you're in the quality ofearnings and it's going to get
calculated at the end of thedeal.
So if we're doing it threetimes along in that process,
(03:11):
when the private equity group orthe buyer comes up with the
networking capital, you're notsurprised because you've been
educated.
So that is very, very important.
And sometimes you could haveyour CPA do the networking
capital analysis.
And if your CPA is notinterested in being there, by
your side, we work with CF uh,fractional CFOs that will hold
(03:34):
your hand through the entireprocess of from the accounting
side and make sure your businessis PE ready.
So networking capital thequicker that the business owner
takes on that, that definitionand understands the process, the
better chance they will getthat major payout six to 12
months later.
Jeremy (03:55):
So is there kind of like a standard amount?
I know you mentioned sometimesyou can go back 12 months, 18
months.
Sometimes if there's a hockeystick growth they'll take it for
three months.
It seems to me like you'll get,obviously get a better, um, the
picture of the old, the, thestate of the business over a
longer period of time.
Is there a standard that youtypically apply to take those
points of networking capitalthroughout the?
Russell (04:17):
uh yeah, yeah, most, most companies will do 12 to 18
months.
Most companies are not on ahockey stick growth.
They're more likely stable, orsometimes it's declining, which
is not a good trend.
Uh, you're trying to sell yourbusiness, um, so?
So then, yeah, then.
So when we were, you know ifwe're going to the, the roofing
deal you know we were dealingwith a hockey stick growth.
(04:40):
Right, it was going from a 13million EBITDA to a $20 million
EBITDA and and and.
So you know, looking back, thatdiscussion was not was not done
in the beginning, it was notdone in the middle, it was done
at the end, and and we had amajor challenge because the
private equity group did theircalculations and they had a lot
(05:03):
higher working capital versuswhat the seller thought.
And it ended up being there wassomething on the balance sheet
that caused the networkingcapital requirements to be
calculated higher.
So this could have been avoidedif we took the, if at that time
, took the approach to do itearly in the middle instead of
(05:23):
waiting to the end of the deal,and it created a lot of
instability in the transactionand it almost blew up the
transaction.
There was, you know.
So you're trying to avoidseller frustration.
That's.
That's the goal.
So in this case we were able towork it out, but it was
(05:44):
unneeded stress by by allparties, unfortunately.
Jeremy (05:47):
So was there any reason why you didn't do those
calculations earlier on in thein the deal?
Russell (05:53):
You know I was not personally running the deal.
I was leaning on my M&Aassociate and he's brilliant and
for some reason he he did not.
He did not do the beginningmiddle part of the networking
capital.
So, going forward, as I run myown deals or I partner with, you
know, my other M&A associatesI've made it.
(06:16):
Now that I experienced it, nowI try to bring in the fractional
CFO very early Becausetypically the spouse or the CPA
spouse it's over the spouse'shead when we start talking that
because they're not quick bookspro advisors, they're not a CPA
(06:37):
or high-end accounting person.
They're doing the books andthey're getting their way
through but they're not anexpert.
They don't have 75,000 hours ofaccounting to become an expert.
So I try to recommend to thesellers to bring in the
fractional CFO.
They will clean up, they willstart working on the networking
(06:57):
capital analysis and then asthey get into the quick books so
the sage books, they startseeing issues in the books and
the CFO would then say you'rereally not private equity ready
for the eyes of private equity,because sometimes in a larger
deal they gotta be gapaccounting and none of these
(07:18):
small businesses are based ongap accounting.
So we're trying to get it asvery close to the gap accounting
as possible.
And so when the CFO gets intothe books they see, they go into
their general ledger and theysee some funkiness and they
start correcting it.
And once we can get everythingcorrected now we can do the
(07:40):
networking capital analysis andeducate the owner on how much
money they're gonna leave behindbased on today, and once again
we get to the quality ofearnings.
The accounting firm, the Q of Efirm, will do the same and
we'll do the same, and at theend of the deal everyone does
(08:01):
the calculation and it becomespart of the contract.
But there's always a paragraphin the letter of intent that
talks about networking capital.
So it's brought up early, it'sin the LOI and we need to
address it early to get to thefinish line.
Jeremy (08:18):
Yeah, I think this speaks to the fact that every
business is different.
Right, there's no two that arethe same.
So when engaging in a deal likethis, there are gonna be so
many different factors toaddress and there's gonna be a
lot of curve balls that arethrown up.
There's no textbook blueprinton how to handle the perfect
deal, because every business isdifferent, so it is a learning
process, like with anything else, and you go through this.
(08:40):
Issues come up, you figure outhow to fix them and then, moving
forward, you apply that.
That's how you become a masterat your craft right Through
practice, through trial anderror and just continuing to
grow and get it better.
So it seems like you're doingthat beautifully, brother.
Russell (08:52):
Yeah, and bottom line is, if a business owner who
spent all the years buildingtheir business and they wanna
dance in the multiples ofprivate equity, they have to.
These are professional buyers.
They know they do this on adaily basis.
The business owner does not.
That's why they're hiring anadvisor like myself.
But they have to address thisparticular point and the quicker
(09:16):
they believe in it, support itis when they get that great
payday and it's a great payday,no doubt.
And if you build a greatcompany, multiples can be four,
five, six, seven, eight, eight,x of your EBITDA.
Those are generational numbersgenerational or signability.
Jeremy (09:37):
I was just writing that down.
I love that dance in themultiples of private equity.
Is that your?
Is that original?
Russell (09:45):
to you.
Yeah, that's awesome.
Jeremy (09:46):
Yeah.
Speaker 1 (09:47):
I didn't drop you in.
Jeremy (09:47):
I love that dance in the multiples of private equity.
I had to write that down.
That's good stuff, man.
All right, cool man.
I think we'll end this segmentthere a lot more to talk about.
Like you said, there's so manydifferent components to this
deal, so I'm sure we can pick upsome other things in future
segments.
Anything else you wanted toshare about that topic?
Russell (10:06):
I know, I think we had a good basis of that and it's
something that a business ownerwill have to if they want to
exit.
They need to be embracing thatconcept.
Jeremy (10:19):
All right, Russell sounds good.
Thanks everyone for tuning inand we will catch you all next
time.
Everyone take care.
Speaker 1 (10:26):
Thanks for listening to the South Florida M&A
Advisors Podcast.
For more information, visitsouthfloridmacom or contact
954-646-7651.
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