Jim Peddle

A seller's discretionary earnings figure can mask serious structural problems in a business. A business owner who built a software company over eight years had consistently strong cash flow. The P&L looked healthy. Revenue was growing. The seller's discretionary earnings number, once you added back the owner's salary, their spouse's consulting arrangement, and several equipment purchases that might not repeat, hit a number that made the business look genuinely valuable. When a buyer came in serious about acquisition, that number became the anchoring point for the entire valuation. The buyer used a multiple based on those adjusted earnings to propose a price. Negotiations happened around that figure. Everything moved fast. Then due diligence happened. The buyer's team dug into three years of actual transactions. They found that the owner's spouse's "consulting fees" were essentially personal expenses. Equipment purchases that had been classified as owner adds? Some were actually regular maintenance costs that would need to happen again. The customer acquisition cost was higher than the adjusted financials suggested because the owner had been doing a lot of the business development work personally, and had never charged that time back to the business. Once those adjustments were properly modeled out, the real recurring economics were about 30 percent lower than the initial seller's discretionary earnings had suggested. The valuation fell accordingly. The deal still closed, but at a significantly lower price, and the seller's credibility took a hit that made the negotiation harder than it needed to be. The lesson was simple. A seller's discretionary earnings number needs to reflect add-backs that truly recur. Personal expenses, one-time costs, and owner effort that can't be replicated at an acquirer shouldn't live in that calculation. A buyer with experienced advisors will find these gaps. When they do, the number loses its power, and the deal becomes contentious over something that could have been resolved cleanly at the start. Accuracy on your financials costs you nothing upfront. Fudging the adjusted earnings costs you everything when it matters.

I started my career in the M&A group at one of Wall Street's hottest firms (DLJ / CSFB). Here's what I learned during almost 20 years in the deal business. Process drives valuation. You can run all the amazing models you want, but ultimately it's the process that creates leverage and drives bidders to a higher price. That's why SMB buyers can still get great deals even in brokered processes. A lot of brokers run bad processes, and that's an opportunity. The lowest bidder generally gets the first management presentation. It's a dry run for management to dial in their messaging before the credible bidders enter the room. The banker's pitch book is a marketing document. Take their valuation expectations with a grain of salt. The market, and only the market, knows true price. The bell curve of bids is predictable. When you're selling a business in a broad process, you'll have a typical distribution of IOIs. You'll have a smattering of low-ball / tire-kickers, you'll have the meaty part of the curve, then you'll have a handful of outliers on the high-side. In my view, those are the most dangerous ones for your process because now your seller is anchored to what's likely an unrealistic number. Yes, sometimes it's legit. A strategic with a ton of synergy, a PE group with a kickass operator, whatever. But it's often buyers playing games to get into a mgmt presentation and now your seller has completely unrealistic expectations. There's a big difference between the headline price and the actual price. Give the seller the ability to brag to their country club friends that they got $250 million. The reality is, between the earnouts, the rolled equity, etc., the actual deal value's probably a lot lower. For a seller, every day in market is a bad day. Once you've committed to sell, you need to run as fast as you can to a closing. Only bad things happen. Earthquakes, hurricanes, a crappy stretch in the stock market, wars, whatever. If you sell businesses for a living, the whole 'time kills all deals' thing is all too real. Retrades happen ALL THE TIME. And yes, I've seen buyers incorporate this directly into their strategy. Overwhelm a seller with diligence requests, watch mgmt take their eye off the ball, see numbers slip marginally vs projections, cut the price. And let's face it, there are also a bunch of legit reasons that deals need to get recut before closing. As a seller, you need to limit the emotional reaction and decide how much you want to get a deal done. Customer concentration is the #1, #2, AND #3 killer of businesses. I've seen things... Best (worst) story was a PE firm who saw 40% of EBIT get wiped out within 90 days of closing an acquisition. Ultimately filed BK. Still boggles my mind that people can underwrite something like this. People really are clueless about working capital. Sellers don't understand it, lots of buyers don't understand it, and the banker shopping the deal has never seen it beyond an Excel model. Smart buyers know how to use this to their advantage. Strong negative correlation between the redlines in the NDA and the likelihood of closing. If someone pencil fvcks the NDA, they're going to be a pain in the as$ to deal with and almost certainly won't be your buyer. Beware the advisor(s). The divorce attorney negotiating reps & warranties. The CPA opining on valuation. The country club bros saying "You're getting screwed, Jerry got 12x ehbitduh for his widget co..." Lots of people have the ear of the seller - many of them are idiots and / or lying. Analysis paralysis is a real thing. As a buyer, the point of building a model is to force yourself to think through the key drivers of business value. Torturing yourself over 20bps of incremental return in year 5 is pointless. So much time and energy burned over meaningless assumptions and analysis. You know the market's near its peak when the boutique investment banks go public, sell themselves to the big guys, or when the big guys start middle market sell-side groups. The M&A process is nowhere near as complicated as people make it out to be. A lot of i-bankers are just glorified and highly-paid real estate agents - that's the reality. Price + Terms + Certainty of Close. You have to approach the negotiation recognizing that there's a balance between ALL of them. Maybe you give on price for greater certainty. A solid win on terms can be worth WAY MORE than a quarter turn of multiple. The art of doing a deal is striking the right balance. Only one thing more painful than busted deal costs... Doing a shitty deal. Sunk cost fallacy is real, and it's brutal.

STINKY SITUATION: People in Thornton, Illinois say a foul smell is coming from a water reservoir that is at 94% capacity due to recent rain. WGN's @AngieSanchezTV spoke with Thornton American Legion manager Lisa Gierucki, who said people aren't even going in their yards because of the stench. "It smells like a bunch of dirty poopy diapers or just poop on the street," Gierucki says. "When it rains and it's hot, it's horrific." WGN also spoke with the Village Clerk, who said the smell has become unbearable at times, and could get worse as water recedes this week. They added that there isn't much they can do, because the reservoir is run by the Metropolitan Water Reclamation District. The District has not responded to questions about the smell.