David Barnett | Business Brokerage Best Practices and the Value of Content Creation

John Corcoran 13:14

and without the benefits that you get from the real estate markets being able to broadcast that publicly.

David Barnett 13:19

Yeah, and and, you know, people that are in the real estate market, they’re doing many more transactions a lot more quickly. I was, you know, it sounds when I say 36 businesses over three years, it sounds like one a month. But that’s not the case. The reality is in all three of those years, and even if you looked at the financials, you would have seen growth every year. But what the financials wouldn’t tell you is that in each of those years, I had a drought between seven and nine months, and each year with no hoses. And so all of the overhead all the bills are still coming out of your pocket. Without the big commission checks landing. Yeah. And then when they do land, well, the first one that lands just fills in holes, it just pays off your credit cards and your lines of credit. And then if you have one land in your account, that gives you a big balance where you’re afraid to spend the money, because then you’re worried about when the next one is going to come in. And so I had young children at the time, it was, you know, put me in a situation where I struggled to create any kind of budget for the household, because the flow of funds was so inconsistent, and all the gray hair that you see on the sides of my head from the time in my life.

John Corcoran 14:29

I want to ask you, I want to ask you want to give a shout out to when we’ve got a couple of clients that buy and sell businesses. Joe Valley of Quiet Light is one of them. And he like you creates a lot of content. And he’s talked a lot about the importance of trust. And when it comes to buying selling businesses, it’s oftentimes the sellers most valuable asset of their lifetime. They put 1020 years however long of effort into this thing. They really needed to succeed. And so you put put a lot of effort and energy into creating content, putting it out there. Yeah, which helps to build trust. Of course, it helps to put good knowledge out into the universe talk a little bit about the importance of doing that. And why you do it.

David Barnett 15:18

Now, so. So I left the business brokerage industry at the end of 2011. And I went into banking, because of this crazy cashflow rollercoaster. And what started to happen was, people would start to call me because they were working on deals, and they were given my name here in the local area, and they said, I need help with this deal. And at first, I would tell people, like, I’m not in that business anymore, I don’t do it anymore. But eventually, you know, I realized, hey, these people need my help. And I have the knowledge and I’m able to help them I should be doing something. So I said, like, I don’t work for Commission’s anymore, I guess I could charge you like some kind of consultant. And people were eager to employ me, they wanted my help to help them navigate these deals, whether they were on the buy side or the sell side. And so eventually, what I realized was that there was a demand for this different kind of model. So not a business broker, but still somebody who helps people with the purchase and sale of a business. And so the content became about meeting the people who need my help. And so creating the YouTube videos, writing the books appearing on on podcasts like yours, is to get out there and to tell people that this kind of services available and to direct people to things like my YouTube channel, where I answer questions from people that are out there working on these deals every week. And, and a lot of people find me in that way. So they’ll they’ll be looking at a business opportunity. And they’ll have a question about deal making. And they’ll type that into Google. And they’ll end up finding a video I made maybe even years ago, that answers that specific question. And then the best, that’s the best. And then they start, you know, and when you when you go looking for some content like that, and then you say, Hey, this is directly applicable to what I’m looking for, of course, then the YouTube algorithm suggests more videos often from the same creator. And then I’ll get emails from people who say, you know, David, I’m looking at buying this business. I’ve just spent the last week watching your videos. And this is what I’m doing. And this is what I want to help with, and what does that look like. And so if you want to think about the sales cycle, we’ve often seen those images that show you know, the process of making a sale, there’s the rapport building, you know, exploring the needs of the customer, you know, crafting a solution, presenting it objection, handling, you know, whatever model you’re looking at, the the online content allows you to skip the rapport building, or rather automate the rapport building. Because the people out there able to really get a feel for who you are and how you operate and what kind of person you are. And so it, it makes the whole process go more quickly. For me when I meet someone who’s a prospective client to make the sale, and yeah, and to agree and start working on the project,

John Corcoran 18:04

couldn’t agree more. I mean, I started doing this 12 years ago, when I was practicing law for my practice. And you know, it’s been such an amazing tool, and it’s great to put good content and answer questions out there in the universe. Let’s dig a little bit more down into what you were just talking about, which is kind of the process of buying and selling businesses, after you are working with the client. And particularly like ways of structuring a business sale that protects really both sides. So talk a little bit about some of the ways that you approach that structure, buying and selling businesses in the process.

David Barnett 18:37

Yeah. So, you know, for people that own a business, particularly if it’s a profitable, successful business that’s been around for a long time, these are the businesses that people want to buy, right? Establish track record, good earnings history, well known in the marketplace, that owner is going to know everything there is to know about that business. Right? They’ve been in the buyer, on the other hand, does not know everything about that business, there is a definite information advantage on the part of the seller. And so the buyers, number one fear or concern is that there’s some kind of misrepresentation or error or lie that’s, that’s misstating the value of the business misstating the earnings or what have you. And so the buyer will come along and say I like this business, the seller will make certain representations. This is my sales, this is the money I’m earning, etc. And they’ll negotiate what they think the value of that business is. The buyers worry is what if it’s not real? What if it’s not true? And the solution to that for the most part is this process we call due diligence. Now, in the world of big businesses, when you’re going to buy another business, you do due diligence, and you bring in an army of people that investigate every little thing. And they try to uncover every problem that might exist and they verify every bit of information. And as you will might imagine, that army of people is very excited. As of right, if we’re going to look at a very small business, one that does a couple million in sales and might earn a couple $100,000 in cash flow, we’re certainly not going to invest $100,000 in due diligence to examine that business, it just doesn’t make sense. So what then is the solution? Right, the solution is to come up with some kind of middle ground, where the due diligence process is a more Express process. So we’re looking for the basic things. But at the end of the day, we want to be we want to have to rely on some of the stuff that the seller is telling us that we want to tie the seller into accountability. And the way that we do that is through some device like a seller financing note, which is subject to offsets, if it turns out after the transaction occurs, that there was some sort of material misrepresentation. Now, that balances the knowledge gap, right? Because now the buyer can say, well, if I don’t know 100%, of everything going on, but I have this backdoor mechanism for adjusting the price after the fact, I’m now willing to deal with a little bit of gray or unknown, right? Because I know that I’m protected by this, this mechanism. If the seller won’t do any amount of seller financing, it sends a big signal to that buyer, which is red flag maybe right? Well, it’s either this guy knows there’s a problem, or this person doesn’t believe I’m going to be a capable operator. Right? Because it because it’s a seller doing seller financing is also worrying a banker hat in that moment, is they’re they’re making a judgment on the buyer they’re trying to figure out is this person got what it takes to run this business, they don’t think you can run the business, they’re not gonna lend you money, right now. So in my opinion, if the seller doesn’t think you can run the business, you may want to buy into that opinion, because they know the business very well. So this could be a reason not to buy, right. So there’s, there’s the, the actual fraud cases are misrepresentation, that’s why someone won’t do it. There’s the concern that you don’t know what you’re doing. And so from a buyer’s point of view, if they’re if this mechanism is removed, then they step back and say, Well, if I have to pay all cash, I need to be ready for every contingency, every unknown, every possible risk. And the only thing left, then for that buyer to do is adjust the one remaining lever, which is price. So there are different markets around the world where sellers generally will not engage in any kind of seller financing. And at the end of the day, the price ends up being lower, because they want to know safety valves work in any possible outcome that might happen. And so for that buyer to be confident the price ends up coming down. So the seller financing not only allows the buyer to have greater confidence in the deal. It’s the tool that allows the seller to actually achieve the fair price.

John Corcoran 23:03

So a couple of questions. Is there a standard or a recommendation of how much a seller should finance? And then the other question was going to be around? How often? Are there issues that come up later down the line that affect that amount?

David Barnett 23:18

Great questions. So what’s what’s important to know is that this changes dramatically, depending on where you’re standing. So for people in the United States, there’s something in the States called the Small Business Administration, and the SBA does something that doesn’t happen anywhere else in the world. They guarantee loans on the purchase price of a business. So they remove part of the risk for the bank that’s making the loan. And they do it based on the purchase price of the business. And if the business is a profitable business, that certain amount of that purchase price will be goodwill, which is just the difference between the purchase price and the tangible asset value of the stuff inside the business, inventory, equipment, all that kind of thing. The Goodwill has no physical manifestation. We can’t go and seize the goodwill. It’s not a physical thing. It’s the representation of value that has been created in the market. In every other country on Earth. Banks will lend against the tangibles, but not to Goodwill, because he can’t repossess and auction off the goodwill. And so my normal recommendation to people is that if you’re going to borrow from a bank, you want to limit your borrowing to something that approximates the tangible asset value. So that if there is some kind of major problem in the business after the purchase, you at least have this plan B of liquidating tangible materials to satisfy that bank note. I always say that the goodwill component is your benchmark for tying to a seller note. So there’s there’s no value to the goodwill to anyone on Earth, potentially except the seller right? I think about this, if I bought a business, and I failed in the execution of the operation of the business, and I owed money to the seller, the seller is the only one who can come back and fix the business, because they know how to run it. And so the seller is in a unique situation where they can actually make that loan, and realize on the security of the goodwill component, so you asked about benchmarks. Most places, I say, the good the seller note needs to approximate the goodwill. And that might mean that it’s 3040 50% of the transaction price. In the states with the SBA, what ends up happening is the market gets skewed, because the SBA will will underwrite or guarantee these notes that are sometimes 80, or 90% of the purchase price. And so here’s where people get into trouble is the buyer will find a business, the seller knows that this SBA financing is available, the seller will then dig in their heels and say, I know you can borrow the money, I don’t want to do any financing. And at the end of the day, the seller ends up holding a note for five or 10%. Right. So if there was some kind of serious issue with the business that the seller managed to distract you from being aware of the seller is going to get 90 or 95% of their money on closing day. Is there really something tying that seller into that deal?

John Corcoran 26:30

Not really, if it’s only five or 10%, right?

David Barnett 26:33

But the buyer now is nine, the buyer has signed a note they owe the money to the bank. And if things don’t work out with them, they owe the bank. Right, interesting,

John Corcoran 26:41

because the way you put it, it’s like the risk has been shifted onto the buyer. Whereas like, I think the rationale behind it is to help more buyers by enabling more buyers to buy more businesses is by why the SBA does it right.

David Barnett 26:54

I challenge that assumption. And here’s why. If if you look at any other market on Earth, why is anyone financing cars? Why are car loans available? Is it to help people buy cars?

John Corcoran 27:09

Well, it’s because it’s a secure asset. And if the seller, if the if the borrower, the lender, if the the the borrower stops spending, it stops paying on that loan, they have something physical that they can repossess, and they can sell off to get repaid.

David Barnett 27:27

Because if you walk into a car dealership, they already have all of the lending solutions available, right? Because the availability of automobile financing helps people sell cars. And the availability of Home Loans help people sell houses. And so when you create an institution whose job it is to, to facilitate high leveraged acquisition loans for businesses, what you’re doing is you’re helping people sell businesses. And so so it’s a little bit of a controversial take. But in looking at what happens in the States, and in unfortunately, speaking to people who’ve been put into bad positions because of it, it’s one of the things I like to shine a light on to make sure that people are aware of because just because the SBA will guarantee a 90% loan in the States doesn’t mean a buyer needs to go and take a 90% loan, you can still structure a deal that works for you and helps to protect your interests, even though you’re going to end up maybe using a SBA seven a loan

John Corcoran 28:37

instead, so it sounds like what you’re saying even though a lot of your businesses in the states it sounds like the the way that the markets function outside of the states without the SBA is would you say is it functions more? Well, holistically or it’s a better functioning market,

David Barnett 28:57

I would say that it’s just an example of of a government program interfering with the functioning of a market. So it just it makes the outcomes show up a little differently. And I think one of the biggest examples of that I was working with someone the other day, who was looking at a nursery greenhouse nursery business, and I subscribe to these different databases of past sale transactions. And it was interesting, because when I was looking in this database, I’m able to see what a business sold for where the business was, how much it sold for what the sales, cash flow, etc, and the amount of sellers by seller financing that was involved in the deal. And these particular deals had a very large seller notes 4050 60% And I’m like, Okay, well, if you listen to the common conversation that’s happening, you know, are in the world of buying a business that involves the SBA, you don’t hear about those stories, because because nobody’s out selling that kind of deal. A lot of the conversation that you would run across online or you know, bankers and brokers and everyone who’s part of that industry, and they’re talking about the two Because of the trade and the available financing, etc. As soon as you have a deal that doesn’t qualify, or a buyer that doesn’t qualify or, you know, something that puts them outside of that circle, for qualifying for that SBA financing, even in the States, they end up falling into this normal, this normal, you know, sort of way of doing it, which is simply, hey, business is risky, we can’t find all the money, how are we going to put this deal together? Because I want to buy and you want to sell? So how are we going to work it out. And what invariably will happen, even without the help of someone like me, is a buyer will end up saying, Look, this is the money I can get. And if that Seller is motivated, and they need to move on, and most small businesses go up for sale, because of a pressing personal concern on the part of the seller, something in their life is forcing them to move on to something else, then they’re going to say, well, you know, what, if that’s all you can do, we’re gonna have to work with that. And so then you get a down payment, and the balance is paid over time. And the balance is paid over time can take many forms. So we’ve been talking about seller notes. So if you have a fixed price for the business, and you end up with a note saying I owe you this amount over this many years, maybe with interest, that’s a very simple way of doing it. With the oncoming recession, for example, a lot of people are worried that a business they might buy, perhaps will do poorly next year. And so then you open yourself up to all these other kinds of creative deal making mechanisms, like I’ll pay you a seller note. But if the sales dropped below a certain level, I want certain offsets, or certain maybe, you know, interest only payment periods, or I want some kind of mechanism that helps my cash flow. If the business is affected by you know, a downturn, or in the case of businesses that have had a huge increase in revenue in 2020. And 2021, you know, have have they benefited from the whole pandemic situation, right. So we’re seeing seller notes that are tied to future performance. You know, if the business reverts to its 2019 performance, then I don’t have to pay this part. For example. And, and if you borrow the money from a bank and give it to the seller, then you lose the ability to employ any of these kinds of creative strategies to try to mitigate that risk on the buyers part. And at the end of the day, if the buyers won’t participate, there is no market. Because for a market to occur, you have to have a buyer and a seller. Up until you know a certain point when the interest rates started to be increased here recently, there was a lot of cheap money available a lot of money chasing deals. And a lot of smart buyers who wanted to make a good deal for themselves might be outbid by someone who is, you know, a little more willing to throw down cash to acquire these businesses. But I think that it has started to change in a big way here recently, especially with the interest rate changes. Yeah, yeah.

John Corcoran 33:00

Now, I’m sure this never happens with any of the clients that you work with. But how often after a transaction happens, do does something come up afterwards that that might trigger one of those provisions that you’re talking about there.

David Barnett 33:14

So this is one of the neat things about structuring the deal this way. If a seller knows that part of the deal is to have a materially substantial amount of the deal financed through a seller note that has a clause in it that says this note subject offset, in the case of a material misrepresentation, or undeclared lived undiscovered liability or lien or whatever, then that seller knows that they’re on the hook, that seller knows they’re responsible for what they say. So that seller has an interest now in full disclosure, and they have an interest in the success of the buyer. Because if that buyer is going to make all those payments, they need to be successful in the business. And so this deal structure not only protects the buyer from risk, and the seller allows the seller to get the maximum payment. It also ensures that the sellers interests are aligned with the buyer. In as far as the success of the buyer. The takeover and operation of the marriage is collaboration between them encourages the you know, we often talk about a training and transition period. But I but I also talked about the coaching that goes beyond that, you know, if you buy a business from someone and you owe them payments over the next five years, three years from now, if something happens in your business and you’re looking for some sage advice, that person is taking your call, you still owe them money. Yeah, they want you to be successful. They don’t want to come back and take it over. They want you to make the payments. And so a lot of the times these buyers and sellers come together for these deals, they work through the transition period together, the seller moves off off into retirement or whatever their next thing is, but they usually end up staying in communication and many times they become friends. So to answer your question directly when I was had my business grow grudge office open, I told you there were 36 transactions that occurred. In one instance, the buyer came back to me and said, look, the sales that he was talking about have not materialized. And I said, Alright, so this is what you’re going to do you write him a letter, you say, this is why I’m not going to pay you anymore. It’s up to him now to prove the things he told you were true. And you know what happened in that case, John? Robin, the seller never responded in any way.

John Corcoran 35:35

Interesting. And so seller must have known something about sales that there was fluffing up saying we’re going to happen.

David Barnett 35:42

Yeah, I think so. I mean, if if he felt that, you know, he was being abused, he would have responded in some way. So that kind of reaffirmed to me like, yeah, like he knew he was representing something that maybe wasn’t didn’t have much in the way of substance.

John Corcoran 36:04

This is really fascinating. And we’re running short on time. And we’re watching the clock. But there’s one thing I do want to ask about. So another client of ours, Todd Taskey, Second Bite Podcast, he does brokerage as well. And he’s, I think it’s a different market than what you work with in a different model. But he’s a big fan of the reason he called his podcast. The Second Bite is because he’s a big fan of, you know, primarily in private equity, but businesses selling their business to another business, retaining some equity or rolling over equity. And then a couple of years later than that sold, all rolled together much higher multiple, talk a little bit about that strategy. And if that’s something that you you see a lot of,

David Barnett 36:49

so I don’t see a whole lot of it in the in the space that I work at. But that kind of model would achieve much of what I’m talking about, because the buyer in that case, still gets access to the seller, and the seller is still invested in the business because they still retain part of the ownership. One of my clients in the last couple of years did a deal like that, where they bought 60% of a business and the seller stayed on in a without an active management capacity. But they stayed on as a 40%. Owner, and it worked out really well the seller knew the future prospects of the business were good. The fact that they wanted to retain part of it sort of reinforced that and demonstrated, you know, put them put your money where your mouth is kind of thing. And the eventual plan is for the buyer to buy the whole thing. But they I don’t know if they’ve even set a timeline in that case, but it would serve the same kind of purpose. And instead of using a debt instrument or using equity, the issue with the world of small business is that a lot of small businesses are managed in a lifestyle fashion. So a lot of day to day decisions will be made with respect to how the owner and their family get along, and what they want to do as far as tax planning. So I personally wouldn’t want to own an equity stake and a lot of really small businesses, because then you start to say, Well, wait a minute, you went to a conference and you flew business class, and rented a fancy car. And you’re so the business owner is living well. They know what they’re doing. They’re trying to reduce their tax obligation while enjoying some of the finer things in life. But as a minority owner of the stock of that company by dividend stake is going to be correct. Right. So and that’s kind of the difference what happens in these small businesses. In a larger firm, you have more of an orderly professional kind of management structure. You know, policies, procedures, the way things are executed. It’s just a little bit different once you get into those bigger businesses, yeah,

John Corcoran 38:45

yeah. All right. Final question. And this has been so much fun to talk about this. But final question. I’m a big fan of gratitude, big fan of expressing gratitude, especially to those who have helped you along the way in your journey. A lot of people might mention family and friends. But really what I love to hear about is the peers and contemporaries however, you wanted to find that because you have had the author hat, you’ve had the speaker hat, you’ve had the consulting hat, content creator and of course business brokerage entrepreneur, who would you shout out? Who would you want to thank?

David Barnett 39:17

Well, you know, I think there’d be three people. The first would be Ed Pendarvis. He’s a guy who started Sunbelt Business Brokers back in the 60s, I was fortunate enough that I was able to start learning the business brokerage trade when Ed was still involved in education and teaching. The second would be Greg Kells, he is an Ottawa business broker who has been in the business for a long time. I learned a lot from from Greg as well. And the third would be Ted Leverette, who has been in the world of helping people buy businesses since the 1970s. And I talked to Ted frequently and I’ve learned a lot from him as well. So those would probably be the three that have really helped me a lot in learning the industry and learn Being dealmaking and you know, creating that foundation that’s allowed me to iterate and innovate upon those ideas, and come up with some of the some of the notions and ideas that I share with people.

John Corcoran 40:12

That’s great. Well, David, I love how much content you put out there into the world. Thank you for doing that. That’s really valuable. I encourage everyone to go check out your YouTube channel, your books, where should people go? Where’s the best spot to learn more about you?

David Barnett 40:23

Yeah, the easiest place to go is davidcbarnett.com. It’s my blog site. And you know, all the links to books and the online programs I have and podcasts and YouTube channel and all that stuff is there. And I would particularly highlight that if you’re interested in this whole idea of buying and selling and managing small businesses. Sign up for my email list. I you can choose what topics interest you, but I put out an email every day. That’s either a story an idea or a topic that relates to buying, selling, financing and managing small and medium-sized businesses.

John Corcoran 40:56

Excellent. David, thanks so much. 

David Barnett 40:58

Thank you.

Outro 40:59

Thank you for listening to the Smart Business Revolution Podcast with John Corcoran. Find out more at smartbusinessrevolution.com. And while you’re there, sign up for our email list and join the revolution. And be listening for the next episode of the Smart Business Revolution Podcast.