Case Study: How a $20k QoE Saved A Buyer $1.5 Million
Guardian Due Diligence specializes in SMB deals. We help buyers at all experience levels close awesome deals and avoid deals that aren’t what they seem. Much of the time, our due diligence process turns up information that can save you millions in your deal or negotiate more favorable deal terms. For our recent client Kishon, our findings amounted to a 75x ROI compared to his $20k Quality of Earnings investment by helping him save $1.5 Million on a storm windows business. Here’s how we did it.
What You’ll Learn:
Diligence findings can lead to price reductions creating huge ROI for your QoE investment
Negotiating with sellers on price with data in your hand makes it much easier
EBITDA, working capital, and trends in costs are all covered in a QoE giving you confidence in your investment
Storm Windows Business in Florida
Kishon was checking out an industrial company in South Florida with great reviews, years of industry awards, and a solid opportunity for future growth.
After getting his LOI signed, Kishon contacted Guardian to handle the due diligence process for his deal. Kishon advises other buyers: “Don’t be cheap!” Like many other acquisition entrepreneurs, Kishon considered handling the due diligence process on his own. He had experience running companies and was confident in his accounting skills, but he admits that he would have never discovered the EBITDA discrepancy that Guardian would eventually find. If he had handled due diligence himself, he would have ended up paying a much higher price inflated by fake profits.
What Guardian Added to The Deal
During the due diligence research process, Guardian discovered a major EBITDA discrepancy. Almost $400,000 of the reported EBITDA had been mischaracterized. This amount should have been reported as ongoing expenses of the business, but was incorrectly marked as “owner earnings.” Whether or not this disparity was purposeful, it meant that the purchase price for the business has been greatly over valued. When considering the 4x multiple, the company was valued $1.5 Million higher than it should have been.
Not only did Guardian conduct a thorough analysis of the business, but we were able to advise Kishon about how to use this information to negotiate a better deal. “Elliott is an amazing professional that understands the people side of the business,” Kishon said. “Yes, his analysis presents numbers but the true grit of Guardian is his ability to explain what the numbers mean and what I (the client) should do with them.”
Successful Negotiations
With plenty of time left in the due diligence period, Kishon was able to present Guardian’s QoE findings to the sellers. He entered into an informed discussion about the purchase price with evidence to back it up. He notified the sellers that he was willing to pay a fair price for the business that aligned with the adjusted EBITDA calculated during diligence. That meant the price would be lowered by $1.5 Million taking into account the 4x multiple. Kishon said, “It took some explaining and back and forth – but they accepted that the analysis was right and the adjustment was fair.”
The Guardian analysis helped Kishon lead a simple and informed discussion with the owners about a more accurate price. This arsenal of information is vital to non-CPA buyers allowing them to easily speak to another non-CPA seller. The clear analysis offered in a Guardian QoE empowers less knowledgeable parties to discuss the complex topic of valuation using a solid framework. Negotiations are easier with everyone on the same page.
Why Is a Quality of Earnings So Important?
Some SMB buyers decide to forgo a Quality of Earnings in favor of doing diligence themselves. For entrepreneurs new to the space, this can be a risky move. When evaluating a company, most of the cards will be stacked against you. Sellers have a multiplied incentive to maximize EBITDA, so they often find tricky ways to misrepresent their companies.
Without years of experience handling deals of this size, newer buyers might not know what to look for and miss facts that can change deals completely. Inexperienced buyers also struggle to hold onto objectivity when looking at a company that they absolutely love. It’s easy to let things go if you’re solely focused on closing a deal. By the end of due diligence, you might not know how to use the information you find to successfully negotiate a better deal. Like with Kishon’s deal above, having an experienced team back you up can be worth every penny.
What You Can Expect From a Quality of Earnings
A QoE provider like Guardian focuses on identifying and removing any accounting trickery or irregularities that might misrepresent a company’s actual or normalized performance and cash flow. These irregularities might result from accounting choices, the business climate, or management decisions. They are not repeatable or sustainable over time, so they should not be a metric used to judge the profitability of a company moving forward. QoE is established by calculating the percentage of income that is a direct result of higher sales and lower costs—and no other source.
You can expect a QoE report to include an EBITDA with adjustments, Cash Proof, and Profit Per Product or Service.
EBITDA (earnings before interest, tax, depreciation, and amortization) with adjustments will represent the profitability of the company after removing the expenses that will not be moving forward with the company after the deal is done.
The Cash Proof will compare the company’s financials with bank statements. It analyzes cash receipts and expenditures compared to reported EBITDA
The Profit Per Product or Service will show if the margin has been consistent as the business grew.
A QoE report will focus on a company’s income statement, but it will also drill down into the other financials to examine the condition and worth of assets on the balance sheet, consider the company’s systems of control, and inspect operations. The goal is to ensure you’re paying a reasonable price for the business and your investment will result in reliable returns.
