South Florida M&A Advisors Podcast
We are a team of highly experienced M&A advisors who specialize in offering bulge bracket like deal advisory services to lower middle-market companies across the United States and globally. Our team of experts have a deep understanding of the M&A process and a proven track record of successfully navigating complex transactions. Our focus is on delivering personalized, tailored solutions to meet the unique needs of each of our clients. Whether you are looking to buy or sell a business, or seeking guidance on a strategic financial decision, we have the expertise to help you achieve your goals.
To learn more visit: https://www.southfloridama.com/
contact (954) 646-7651
email: rcohen@southflorida,ma.com
South Florida M&A Advisors Podcast
EP #12: Renegotiating After the Quality of Earnings Report
Ever wonder what happens when the numbers don't add up during a business sale? When the quality of earnings report lands, it can either confirm your business valuation or send your deal into a tailspin of renegotiations.
Russell Cohen pulls back the curtain on what he calls "a colonoscopy on steroids" - the intensive financial investigation that private equity groups conduct before finalizing an acquisition. This critical phase exposes the gap between how entrepreneurs manage their books and the GAAP accounting standards institutional investors expect, often revealing uncomfortable truths about a business's true financial performance.
The podcast explores the red flags that commonly trigger post-QOE price adjustments: declining revenue trends, miscalculated job costs, improper worker classifications, inadequate insurance coverage, and ownership structures where real estate complicates valuation. Through real-world examples from his current deals, Russell demonstrates how these issues play out in practice and shares creative solutions for keeping deals alive despite financial discrepancies.
What becomes clear is that leverage in these sensitive negotiations often comes down to a simple question: who wants the deal more? A motivated buyer facing pressure to deploy capital by year-end may accept compromises that preserve headline valuations while adjusting payment structures. Conversely, a seller without urgency maintains significant power to hold firm on price or walk away entirely.
For business owners years away from selling, the message is simple but crucial: start preparing now. Invest in professional accounting, build management depth beyond yourself, ensure comprehensive insurance coverage, implement proper employee benefits, and maintain regulatory compliance. These foundations, established at least three years before a planned exit, create resilience that can withstand the scrutiny of acquisition due diligence.
Ready to start your exit planning journey? Contact Russell to begin positioning your business for a successful sale, whether your timeline is measured in months or years.
Welcome to the South Florida M&A Advisors Podcast, your trusted M&A team. Here's your host, Russell Cohen.
Speaker 2:You're deep in the deal, the numbers well, looking pretty solid, until the quality of earnings report drops. Well, suddenly, things don't look quite as promised. So what now? Today we're talking about the delicate yet high stakes move of renegotiating price post QOE when to push back, how to keep the deal alive and where buyers and sellers get it wrong. Welcome everyone to the South Florida M&A Advisors podcast, jeremy Wolf, here joined by the man, the myth, the legend, your host, russell Cohen. Russell, always a pleasure to see you, brother. Hey, good morning, jeremy.
Speaker 3:Thanks for doing these podcasts with me. It's a lot of fun and hopefully we're educating one seller at a time.
Speaker 2:Absolutely, man. Education is key. So with that in note, talk to the listener out there that maybe doesn't know what exactly is a quality of earnings report and why is it such a turning point in the deal process.
Speaker 3:Well, it's very simple. You work your entire life to build your business. You think your books are awesome, right, and sometimes you know I mean you spend a lot of money on your books. The private equity group is working off gap accounting and, and you're not, um. So there definitely could be discrepancies that you never thought would be, and they're not. They're not expecting all you know these smaller businesses that are growing up to be nice, nice, really large businesses, um, to be based on gap accounting. It's just just not there, um.
Speaker 3:But you know the quality of earnings. You just you went through that um, you know. You bring the business to market, interview a whole bunch of private equity groups. You go into negotiations, multiple lois, you finally get the deal. You negotiate the deal. The attorney is involved. Your your your bill on the attorney, clock starts and so everyone's spending money and you get to the and you have this incredible price.
Speaker 3:You're really happy, everything makes sense, and then you go through the quality of earnings, which is a colonoscopy on steroids. I always call it Crazy. They're going to look at everything. They're going to ask you to pull out documentation from 20 years ago. It's incredible.
Speaker 3:And the bigger the deal, the bigger the scope is basically so from accounting, from legal, from benefits, from environmental, from all different types of insurance it could be six different categories that go into your business. And then you just you spent like 60 to 75 days providing all this documentation. You're getting burned out and they come back with a quality of earnings report and it may not match to what you thought it was making. So, yeah, so the quality of earnings. The private equity group hires a very high powered accounting firm and that's their job to go through everything in your company because they have exposure themselves Post-closing. You close on this deal and they've missed it and they got exposure. So they are relentless to find, find out if your accounting is accurate too. So what you invest in in your business for your accounting, um, you know, eventually will either get you through or either canceled or completely renegotiated. So it's vital to have the right players in place and to put the money into the accounting to make it work.
Speaker 2:Yeah, absolutely Now. Is this commonplace? I'd imagine it is. Is this an issue that you encounter frequently in deals?
Speaker 3:Well, listen, if your business is growing and you're on a hockey stick, growth you're not concerned, You're, you know, you know the business just exploded.
Speaker 3:You'll never, you won't run into a problem. The private equity group would probably clear, through the diligence and and hoping that you're not going to renegotiate and so, but you know, if you, even if you have a, a, a great business, if the numbers are are trending down meaning maybe if you're in construction and the work has not kicked in and your, your current year numbers are not trailing 12 months or not what you represented in the calendar year, um, that will cause a renegotiation. So yeah, the private equity groups definitely want to renegotiate, but if you have a business that's so strong and growing, they can't. So that's where you want to be. You want to be where they're in a position that they can't negotiate with you, in a position that they can't negotiate with you.
Speaker 2:So you just mentioned a couple of kind of I guess red flags You're talking about. Obviously, if the business is on an uptrend, hockey stick growth is not so much of an issue and obviously if it's stagnating or even going down, it's going to bring some concerns up for the buyer. What are some other red flags that typically prompt the buyer to reconsider the agreed upon price?
Speaker 3:So I'm representing a plumbing company in South Florida and the majority in new construction. So in this particular scenario, their jobs, they miscalculated their jobs, their jobs didn't start on time. So you know, we're looking at the first four months and the revenues are down. So the trailing 12 months are not there, the first five months are not there, so yeah. So so when you enroll with me, you better keep your eye on the prize and keep the business running at full tilt, whatever it takes, because during the QV they're going to ask for a trailing 12 months and if the numbers are off, you're just giving them reasons to renegotiate.
Speaker 3:You know, a lot of times business owners might have 1099. Let's say, in construction they might have salespeople that are 1099. The private equity group has to put everyone on workers comp, w-2, put payroll taxes, so to convert the employees over you over, you wonder if you're going to lose the employees, or reference like that. Yeah, I mean, there's so many ways that a business can go sideways, but if you don't have the proper insurances under insured, that causes new expenses. If the owner owns the building, if they're not calculating a fair market rent, and you're dealing with a 10,000 square foot facility and you didn't calculate the proper rent, that will dig into the numbers. So that's why you hire a professional advisor, because if you own the building, chances are the private equity group is not going to buy it, they're going to rent it. So you got to put a regular rent in there.
Speaker 3:So you know, I like, if I have an open-minded seller, I like to bring in a fractional CFO to go through their books, just so we're we kind of know what we're walking into. I see the P&Ls, I see it very clean. But I'm not a CFO and I'm not an accounting expert. But if I can get a fractional CFO to dive into those QuickBooks, we can really see where the hurdles will be in the deal and how they're not tied to Gap Accounting and what the private equity group is going to do. So you got to be willing to spend a little money up front to kind of see where you're running around the track. And you got one hurdle here. You know when they jump over the hurdles. There's so many hurdles to jump over. You just got to be flexible to spend a little money up front to see where the challenges are going to be.
Speaker 2:Yeah, absolutely Best to lay it out on the table as early as possible rather than deal with issues on the back end. So this is obviously these can be difficult conversations. Right, you mentioned it. You work your whole life. You have this image in your mind, as the business owner, of what your business is, what it's worth. You've reviewed everything on your end and it looks like it's all right. And then, all of a sudden, the quality of earnings turns up and it's not what you expected. Now, how do you typically like, how are you going to approach a seller when these reports turn up issues? What's the right tone, timing, how do you approach that conversation?
Speaker 3:Well, I mean, it's a hard conversation. Once again, once you get that number, you think you're getting that number, so it becomes who wants it more? You know, in this scenario where I'm working on my current deal, you know, we know that this private equity group this is their first entry, so it's called a platform deal. We discussed that in the past with my roofing company. So this is their first entry with my roofing company. So this is their first entry. So they got to buy this company or they basically blew out 25 with no sales, because we're trying to get this deal done in a few months and there's not enough time to close the next deal. So this is this private equity group If they don't buy this business, they show nothing for the year of 25. So, and then they got money to deploy. They have to get it out. They got investors. So we're in a very good position because we could read. We could read the scenario okay, and and we know they need to buy.
Speaker 3:But so what ends up happening here is you know, we have discussion with the seller, we understand the need for them to buy. Seller really is, is in control, he understands the numbers are not hitting the numbers because the jobs haven't started. So a lot of time we try to keep the top line and what? The private equity group move more money of the purchase price into the earn out. And so what will end up happening? If, let's say, the down payment was eight million, uh, and it's a 14 million dollar deal, he, they moved the down payment down to seven and they put another million into the earn out. And what we're doing is, in this particular scenario, we kept the integrity of the price, moved one million to an earn out and the earn out begins upon closing for the next trailing 12 months. So there'll be like two earn out periods where they can get their money.
Speaker 3:And basically what you have here is if the seller has the pipeline which I know my seller does and they can get the jobs to start rolling in and work starts billing, then they believe they can get their earn out and not sacrifice. So we kept, we were able to negotiate and keep the price the same, but we just they, the private equity needed to buy the business, so they shifted some money to the earn out portion. So you know, there's ways to solve it If the private equity needs to buy. I, you know my seller does not need to sell. He would like to sell, but he can wait another year, which is not what I like, but it is what it is. That's kind of like do all the work and then get nothing and maybe never see a dollar from it, but that's a good example of solving it.
Speaker 2:Yeah, I mean the motivation is key, right, if you're uh who wants it more. Yeah, who wants it more? That's right if you're not desperate.
Speaker 3:You're gonna have more cards in your uh on the table and a lot of times the sellers have this incredible business. They're making lots of money and, you know, unless it's life-changing money, like the hundred million dollar deal, you know something it's. This particular deal is not life-changing because there's three partners and everything. They have a runway left in their career. It's not like they're 69, they need to sell tomorrow. They have time on the runway that they can keep working it until they get the right situation for them. That's's not good. I mean, obviously, whatever the seller wants for me, you know, what can I do? I mean, yeah, I'm here to satisfy the seller and if that's what ends up happening, that's what ends up happening. I go back to the drawing board, you know.
Speaker 2:So when should a buyer draw a line in the sand and walk away, versus trying to restructure a deal Like there's got to be a point where, yeah, it's time to just fold up shop and move on.
Speaker 3:Well, in that particular scenario if the seller drew a hard line or increased the down payment, you know then you could lose the deal. I think a lot of the deals are. You know, if you're able to get past that little negotiation then you know you move into the contract and that's where more minefields are out there in the contract. So we got this contract from the private equity group and I have like a three page response from the seller and the attorney on things they don't like and it's kind of like a 30,000 square foot view.
Speaker 3:And if we can't get past this, you know the seller doesn't want to, you know keep the tab going for the attorney bill. So he's kind of like drawing a line in the sand because you know there's a lot of parts on an LOI that never really get to the seller Because it's so many nuances and it all shows up on the contract. So I try to educate the seller way in advance because a lot of times if it doesn't show up in the LOI, we can put it in the LOI, but if it doesn't, then I try to make them aware of what's coming in the contract basically. But I think it really comes down to in the quality of earning, who wants it more or who wants it less, and in this case, seller is okay, he'll move on. You know what I mean. He'll move on if he has to.
Speaker 2:So many moving parts, russell. That's why I've said this virtually every time we talk. That's why it's so important to have a team like yourself to work with that's really super knowledgeable about this and very creative, because oftentimes just the communication alone can make or break a deal, and whether or not you're able to come up with, like you mentioned, instead of just reducing the price, coming up with workarounds and solutions that can be effective for both parties involved is really, really key. Let's talk a little bit about prevention. You mentioned bringing in a fractional CEO. Let's look a little bit earlier on in the process. What can sellers do? Talk to somebody out there that maybe is not even ready to sell yet, but they know they're going to be selling in the future, three, four, five years down the road, maybe even 10 years down the road. What are some of the things that you can do early on in the business to set the stage so that, when it comes time to sell, you can avoid these surprise QOEs in the first place?
Speaker 3:Yeah, I mean it's obviously don't be the legend in your business. Try to pull yourself away from the business and have that management team that is there for you, that will be there for the next owner Obviously the original owner, obviously the original owner is going to stay on for a couple of years. But eventual exit, so kind of prep one person in that team to be the next, you know, key person. So definitely have some key people. Do not be the legend in your own business. Invest in accounting. Make sure you got the right cfo, uh that really understands quickbooks or understand the construction in this or any any business that you're in. Uh it, if you know you, you got a professional cpa, uh, your cpa can probably tell you if your bookkeeper is A, b or C. Make the investment in the A, because then you'll really be backtracking and it's good you know companies of this size. You got to be looking at your balance sheet and your financials. You got to be looking at it all the time. So you can't run a company of that size without knowing what's going on. So if you're not, you're running by the seat of your pants, but you really have to make the investment. So you got a CFO. Or if you're going to outsource it, get an outsource accounting company that's going to do the QuickBooks and really take control of the books. There's companies out there. They act like a controller, but it's a lot less than 125 grand to really run your books and everything of that nature. So accounting is very important. Get your insurances in place. Make you have all insurances. Make sure you're offering benefits, because the private equity groups have benefits. Make sure you're in compliance with what's going on, your I-9s, all that stuff. You know don't have any illegals. You know it's endless how people cut corners in business. But as they get bigger and bigger they realize what they were 10 years ago is they can't run the business. But the books and records are vital. If you don't own the prop, if you don't own the property, that's fine, get it. Get a long-term lease, um, try to see if you get off the guarantee. That's important. And if you, if you do own the property, just understand you're gonna you're gonna charge fair market rent and you cannot kill the. You don't want to kill the cash flow without land. Just rent you. You want fair market rent and the private equity group is your best tenant because you're going to have a long-term residual effect and you'll be able to get market rent. It's what they're expecting.
Speaker 3:So many ways to deals to go sideways, sometimes out of your control, unfortunately. You have a lot of hands in the cookie jar. You've got attorneys, accountants. They're going to do all out of your control. Unfortunately, you have a lot of hands in the cookie jar. You got attorneys, accountants. You know they're going to do all types of lien searches. Make sure you don't have any liens. You know you're going to deliver the business debt free. So make sure your debt is, you know. Just make sure there's. You know the IRS is not bringing it down your back for tax payments. I mean all this comes out. You know the irs was not bringing down your back for tax payments. I mean all this comes out. You know lawsuits. If lawsuits can kill deals too, there's so many ways that you know you got to be upfront to your advisor. You got. You know no one wants to find out later on that. You know it's. It's been horrible. You know you got a lot of, a lot of skeletons that we call. So a lot of ways to skeletons that we call.
Speaker 2:So a lot of ways to make the deal go, a lot of dead bodies buried, yeah yeah.
Speaker 3:And this past deal that we're working on, you know, when we took the LOI, you know the private equity group came in with a four times multiple of the EBITDA. Okay, so they really didn't put a price on it, but we knew the EBITDA was like three, five and so we knew we were getting a $14 million deal. But you know, you know I'm not an expert in M&A and it was. I kind of felt like it was a setup to get renegotiated, because by the time you go through the quality of earnings, sometimes you don't hit that 3.5 because of the gap accounting and how, how, what they see as the EBITDA. And that sparked the renegotiation.
Speaker 3:You know, next time or in the future, I'll never, I'll never tell her seller to accept a multiple of EBITDA. We need a price. What is the price? What are you offering? Give me a number. They never put a hard number on the LOI. So lesson learned, all right. This particular plumber fell in love with this private equity group. We had offers for 90% cash and the seller wanted that earn out. They wanted the rollover equity. He had a son in the business so he wanted the.
Speaker 2:They wanted the whole kit and caboodle, as they say.
Speaker 3:I brought him cash, 90%, 95% cash offers. He went with an offer I never thought he would take and it was influenced by because the son has another 25-year runway and he wanted to make sure that he would have a piece of the action going forward. And that's fine. But you know, I just want to give a lot of choices and you know, these business owners are adults. They'll make their own decisions. They'll pick what's right for them, you know.
Speaker 2:You can only lead a horse to the water, you can't make him drink, right.
Speaker 3:Yeah, I mean looking back. You know, looking back. You know, listen, we had a 13.5 million cash. But it's scary, by the time you unwind what you're getting down, by the time you pay a commission, you pay capital gains, there's multiple holdbacks in the deal, in the deal, and by the time you get to the, you look at the closing statement, you're like, well, you know, maybe, maybe I made a mistake by. You know earn outs and rollover equity, and that's what I'm trying to avoid. You know where a seller gets scared at the end. You know.
Speaker 2:Yeah, okay, russell, before we wrap up here, I want you to give one piece of advice for buyers and one for sellers that are entering into the QOE stage. What would that be?
Speaker 3:Well, I mean, these buyers are professional buyers. This is what they do all day. They look at 700 companies a year. So I don't know what I could tell them. But obviously you know, the only thing I can say to them is that when I get a seller that's kind of focused on that price, I will tell the buyer they're not motivated. This is it. You're going to lose the deal if you start playing the renegotiation game. And I will tell them that I'm not afraid to stand up to a private equity group, and that's great advice.
Speaker 3:The private equity groups are calling me. They're asking me a lot of questions before we engage with a seller and they're asking me where you think this will land. And of course, we want the marketplace to give the final number. But we're selling businesses on planet Earth, we're not selling on Mars. So we're going to hit a multiple. That's fair and obviously every industry is different.
Speaker 3:But but with the seller, you know I I advise them it's going to be a rollercoaster ride. You're going to go through a lot of emotions. You just got to really remember why you chose this particular buyer and try to see it through, and I'll be there to kind of give you, you know warnings of the deal and what is coming your way. You know. Then you just got to. You know I do this on a day-to-day basis. A lot of people don't listen to me on my recommendations, but it's really what's coming at them. So the quicker you know, the quicker you know, the quicker you take my advice. And and you know you don't you can learn about what I'm saying doesn't mean you have to do it because you have accounts and cpa. You know accounts, cpas and attorneys, but, um, if you do take my advice, you'll be ready for the uh, for the negotiation and what's coming and that's important to get through the deal.
Speaker 2:All right, very good, I think. Unless there's anything else to add, I think we'll leave it at that. You have anything else to?
Speaker 3:touch upon Russell. Right now, there's still a lot of liquidity in the marketplace until there isn't. A lot of private equity groups want your business. They need to deploy capital by the end of the year and there are lots of private equity groups that we're talking. They want deals. So get your business up to that $1.5 million, $2 million magical number and the multiples are still there. Even though we're in an unstable, unpredictable economy, the private equity world is still going at a great neck speed. So there is still a very good window to get very good multiples until it's not.
Speaker 2:Absolutely so. If you're listening to this out there and maybe you're in that twilight phase, you're getting ready, the thought crossed your mind it might be time to sell the business. Reach out to Russell. He has a wealth of knowledge and it cannot hurt to have a conversation and try to get all your ducks in a row, even if it's years out, just to start having the conversations earlier. You're kind of changing and shifting your mindset and getting ready so that-.
Speaker 3:Three years out? Yeah, gotta be three years out to start.
Speaker 2:It's very smooth. Yeah, all right, if you found this content useful, you know the drill. Don't forget to like, subscribe all that fun stuff. We appreciate you tuning in and we will look forward to catching you next time on the next episode of the South Florida M&A Advisors Podcast. Everyone, take care, have a great day.
Speaker 1:Thank you. Thanks for listening to the South Florida M&A Advisors Podcast. For more information, visit southfloridamacom or contact 954-646-7651.