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Bryce DeGroot on The Valuation and Sale of Your Business

Bryce DeGroot on The Valuation and Sale of Your Business

Today, I am talking with none other than Bryce DeGroot, the President of Compass Advisors, a consulting firm that helps entrepreneurs achieve growth, capital, personal liquidity and eventually the sale and exit of their companies.  

Since 1991 Compass has advised in the sale of over 155 companies and served hundreds more through exit planning and business valuations.  

More importantly than that, Bryce is a good friend of mine and he’s a very smart cat that’s going to guide us through the conversation of considerations around buying or selling a portfolio.

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Topics covered:

  • (01:08) – Compass Advisors
      • (01:14) – Bryce shares his personal background and the type of business Compass engages in.
      • (01:57) – Bryce explains why the private business transaction marketplace can be very inefficient.
        • (02:22) – The network effect.
        • (02:39) – Misplaced expectations.
      • (03:11) – Discussing the ‘triggering event’ in the mind of a business owner looking to sell.
        • (03:59) – The percentage of people that go all the way to sale.
  • (04:35) – Valuations and Sales
      • (04:35) – Key questions in a sale.
        • (04:53) – The general factors, levers and considerations that tend to drive value.
          • (05:01) – Cash flow and risk.
      • (06:36) – How assets are categorized.
        • (07:08) – Perspectives of the buyer.
          • (07:19) – Buying the business as a going concern.
            • (07:42) – Earnings before interest, taxes, depreciation, and amortization (EBITDA).
          • (09:08) – Buying as a platform investment.
      • (12:46) – The biggest common unknowns for the seller.
        • (13:47) – The number one reason that intent to sell a company is unsuccessful.
      • (15:12) – Considerations that cause business owners to want to sell.
        • (16:08) – Getting the timing right for an exit strategy.
      • (20:09) – Discussing the variables of scale and infrastructure in facilitating sales.
        • (20:30) – Efficiency variables.
      • (21:52) – Bryce’s advice for potential sellers for preparing for maximizing value.
        • (22:27) – Early planning.
        • (22:46) – Education.
        • (23:56) – Build an advisory team.
          • (24:32) – The critical question regarding profit after taxes.
  • (25:53) – The Benchmarking Study
      • (26:40) – What stood out to Bryce as unique data.
        • (26:40) – Distribution of profit margins.
        • (27:46) – Discussing distortions of profitability due to owner compensation.
        • (31:37) – Management fee dollars versus average rent.
          • (32:14) – The consistency of profitability and revenue across high and low rent properties.
  • (38:17) – Tying It All Together
    • (38:48) – What companies that achieved maximal value were doing operationally in the years prior.
      • (38:48) – Building the business with the end goal in mind.
        • (39:29) – The Key Man Discount.
    • (41:18) – How clawbacks are typically structured.
      • (42:52) – Typical durations.
    • (43:14) – Discussing key terms, considerations and drivers of value.
      • (45:38) – Anticipating the demands of the sell process.
      • (50:22) – Ensuring harmonious negotiations.
      • (52:00) – When to involve your team.
    • (53:07) – Predatory brokerage tactics and red flags.

Resources mentioned:

Where to learn more:

If you want to learn more about Bryce’s business and get in contact with Compass, head over to their flagship website, Compass-Advisors.com.

Transcript:

Jordan: 0:00:00.0 Welcome closers, today we have another episode of The Profitable Property Management Podcast coming at you. This is Season Three on profit.

0:00:06.4 I’m your host Jordan Muela, and every week I interview world-class property management entrepreneurs and industry experts who share actionable insights to help you grow your property management empire.

0:00:17.2 Whether you manage 100 units or 1000, this broadcast is designed to help you see the big picture and give you the tools and tactics that you need to get to the next level.

0:00:26.7 Today, I am talking with none other than Bryce DeGroot, the President of Compass Advisors, a consulting firm that helps entrepreneurs achieve growth, capital, personal liquidity and eventually the sale and exit of their companies.

0:00:41.0 Since 1991 Compass has advised in the sale of over 155 companies and served hundreds more through exit planning and business valuations.

0:00:49.9 More importantly than that, Bryce is a good friend of mine and he’s a very smart cat that’s going to guide us through the conversation of considerations around buying or selling a portfolio.

0:01:00.9 Bryce, welcome to the show.

Bryce: 0:01:02.6 Jordan, good morning. I’m so glad we get to talk this morning and I’m looking forward to it.

Jordan: 0:01:08.7 Alright. Well let’s dive right in. So just finish up the context. What exactly does Compass do? What’s your background?

Bryce: 0:01:14.9 So my background personally – this is my first career.

I picked up an MBA and then – I have been for the last dozen years – I’ve been helping entrepreneurs grow value and mainly accomplish their exit strategy.

0:01:29.8 And so, help them gain personal liquidity and capture the value that they’ve built over the years.

0:01:38.3 When we look at the private business transaction marketplace, it can be a very inefficient marketplace.

0:01:44.6 And so, the role that we serve as a firm is helping our clients to navigate that marketplace, make it more efficient and help them optimize the results.

Jordan: 0:01:57.8 Got it. I love that word. Inefficient. Put some more color, because I can intuit what that means, but what does that mean to you to say the market is typically inefficient?

Bryce: 0:02:09.6 So, the market is inefficient for a couple of reasons. So, when we’re talking about the purchase and the acquisition, and the sale of private companies, the market is inefficient because – one is just the knowledge – it’s the network effect.

0:02:22.6 The fact that there’s not a very efficient network to connect buyers and sellers, it generally takes a lot of work to find the right match and the best fit for those type of transactions. 0:02:34.2 So, there’s a lot of labor that goes into that piece of it.

0:02:39.3 And then there’s also an expectation – it’s inefficient because there’s a lot of myths and misplaced expectations around valuation and process, and a lot of the factors around a business transaction, and so that creates an inefficiency.

0:02:55.6 That creates a friction in the transaction process that tends to slow down the process, it tends to reduce the success rate of getting transactions done and so those are some of the factors that make it inefficient.

Jordan: 0:03:11.2 So, having worked in a bunch of different industries and a bunch of different verticals, what’s the common thread when people come to you wanting to think about a sale? What is typically the triggering event?

Bryce: 0:03:22.9 So the triggering event – so in the mind of a business owner, let’s say they’re a founder or potentially – as they’re coming to the conversation around an exit, there number one question is typically, “What is my business worth?” That’s the big one.

0:03:41.4 And then, another question is around timing, “When should I sell? And how do I even approach this?”

0:03:47.5 So there’s sort of a – so the top three are value, timing and where do I start.

Jordan: 0:03:53.6 Got it. So those are kinds of the things that people are wanting to have a conversation around.

0:03:59.1 As people are kind of walking through that conversation – well, let me put it this way: what percentage of people that come to you actually go all the way?

0:04:08.3 Do you get a lot of folks that are early and just curious? Are you typically having conversations with people that are really serious and ready to take a transaction all the way to the finish line?

Bryce: 0:04:18.4 So we talk with a lot of people who are doing early exploration. And then some percentage of those will go all the way to the finish line and complete a transaction with us. 0:04:30.8 There’s a lot of exploration that happens that never gets to a transaction though.

Jordan: 0:04:35.7 Got it. So let’s now answer some of those key questions. So the number one question is, “What is my business worth?”

If you were here with me I could press you and we could get out a white board and give people the formula that they want. 0:04:51.1 But the truth is, it’s not that simple. There’s a lot of nuance.

0:04:53.4 So high level, what are the general factors, levers and considerations that trend to drive value?

Bryce: 0:05:01.2 Yeah. So at the highest level, value is about two factors: cash flow and risk. 0:05:07.2 And so, just to break down cash flow a little bit. It’s really about the expected future cash flow of the company.

0:05:14.0 And so, while historical cash flow can be an indicator that a buyer will plug that into their model and create a model of expected future cash flow.

0:05:25.8 And that is the return that an investor gets for investing and purchasing the business.

0:05:31.5 The other side of the equation is risk. And there’s a lot that goes into risk factors. And that includes industry risks, general business ownership risks such as legal risk and things like that.

0:05:49.5 And then there’s the company specific risk, which is – that is – those are company specific factors such as the team and the retention of the employees and retention of the customers.

You know, customer risk. And what kind of churn and what kind of customer retention would you expect.

0:06:09.5 So there’s a lot of company specific factors that come into it, but all those things influence what that cash flow is worth to a buyer.

0:06:20.4 So at the very highest level, cash flow and risk is the valuation concepts and then there’s a lot of – you know, when we get down to the base level of the real world in a business, there’s a lot of factors that influence those two.

Jordan: 0:06:36.0 Let’s talk about how the asset is categorized. Within property management, there are two types of transactions that we see.

0:06:40.2 There’s the transaction that values the business as a business. 0:06:44.1 As a complete thing with the brand, processes, staffing, culture, etc.

0:06:49.2 And then there’s the categorization that looks at it purely in terms of management contracts as the thing to be sucked out and flipped. Basically.

0:07:00.5 Do you see this in the businesses and the transactions that you work with where the buyer can have really two very different view points on what it actually is that they’re buying?

Bryce: 0:07:08.9 Absolutely. And those two view points can have a significant difference on how the company is valued and how a buyer – the lens through which the buyer is giving value.

0:07:19.0 So, the first category that you mentioned, where the company is being acquired as a going concern business.

In that case, the buyer is buying the good will. They’re buying the brand. They’re buying the team and the systems and in that case, typically the buyer’s looking to leave the organization more or less intact. 0:07:40.1 And then scale from there.

0:07:42.1 And in that case, really the buyer is interested in the entire organization. 0:07:50.3 And typically, in that scenario, the buyer is looking at a valuation that is based on multiple of earnings.

Typically of EBITDA, which is a measure of earnings. Earnings before interest, taxes, depreciation, and amortization. That’s the acronym for EBITDA.

0:08:07.3 And, as we – so that’s – in that case, the buyer is looking at – they’re very concerned about the profitability of the company as it stands. With the current team, with the current systems, they’re concerned about – as the company is operating today, this is the earnings that it’s generating. Right?

0:08:26.3 This is the cash flow it’s generating. 0:08:28.5 And then they’ll still make some assumptions about the future in terms of can they – what they can do with it in the future. 0:08:34.7 So there still is that forward looking perspective, but they’re very concerned about it as a package deal.

0:08:42.6 The other type of buyer that you mentioned, is very – so a case study of the first type of buyer – so, if a couple of buyers that would buy a property management firm at the going concern would be at the small end – could be an individual entrepreneur who’s looking to buy an existing property management company.

0:09:02.1 They don’t already have a company set up, so they’re looking to buy it as a going concern. As the whole organization.

0:09:08.1 Also, we find – we’ve seen some transactions where, let’s say, a private equity firm is doing a platform investment and they’re looking to enter the property management space.

0:09:20.7 And they’re wanting to buy a company that is going to be their platform in that industry. Right? 0:09:29.5 And then to segue into the second type of buyer.

Typically, let’s say that private equity firm, they might do some platform acquisitions or add on – excuse me, add on acquisitions, which is find books of business that will essentially buying a set of properties and management contracts. In that case.

0:09:50.0 So, the second type is, they might be specifically a company already in the industry. 0:09:54.8 They already have their systems set up, they already have all the backend systems and they’re just looking to plug in more properties into their existing model.

0:10:02.5 And in that case, they’re just looking for – the due diligence is typically more narrow in scope and they’re more concerned about the customers and what is the portfolio of property contracts that I’m buying and under that scenario, the valuation models that I’ve seen are more based on top-line revenue.

0:10:25.9 Because the buyer already knows what their profit margin is going to be within their operating structure. Right?

0:10:30.9 And so they’re – I’ve seen companies – in that scenario, you might have a company with – let’s say you have two companies with the same top-line revenue. The same number of doors they’re managing and one company is at break even. 0:10:44.5 Their net profit is break even.

0:10:46.1 And another company has a 30% net profit margin. A company that’s just buying a book of business, of you know, a portfolio of properties, is – I have seen them actually value those two companies very similarly because they heavily weight the top line revenue in those cases.

Jordan: 0:11:08.9 Got it. Interesting. So you’re saying that there is no right or wrong here in terms of the outcome for the business owner?

Can a business owner just expect one of those scenarios to be implicitly better than the other? 0:11:20.7 Because it seems like the situation where the buyer wants the whole enchilada is where you’re going to get a larger degree of credit for what you’ve built.

Bryce: 0:11:31.9 Yes. Well, yes. If a buyer’s wanting to buy the whole enchilada, you are going to get a – a buyer’s going to place more value on the going concern operation that you’ve built.

0:11:43.8 In the case of buying a book of business, typically they’re going to – essentially you’ve set aside some of the systems that you’ve built, potentially some of your people, your team, etc. 0:11:57.0 But that’s how they gain efficiency.

So they may be still willing, from a valuation perspective, you may actually get a premium value from a buyer who is looking to cut some costs and gain greater efficiency by plugging it into their business model in their existing company.

0:12:12.5 So from a valuation perspective, I think valuations can be very strong in either option. 0:12:20.0 From a legacy and sustaining of your business operation perspective, you’re going to see in the second buyer who’s just buying your book of business, is typically going to take out some parts and pieces and only keep what they want.

Jordan: 0:12:37.9 Got it. So if it’s your baby and you’re wanting to make sure that it stays intact, then you should just go in eyes wide open. That makes sense.

Bryce: 0:12:45.8 Absolutely. Absolutely.

Jordan: 0:12:46.7 So, what are some other things that people don’t know? When you start this conversation, what are the biggest common unknowns for sellers?

Bryce: 0:12:56.4 So, as we think of mindsets, and sellers often come to the table with I think – especially a seller that has not sold a company before.

0:13:11.4 So, if it’s a first time seller, there’s often a steep learning curve around some of the realities in the marketplace.

0:13:17.8 And there can be, among owners, there can be a view that if I build it, they will come and pay me a premium value.

0:13:28.5 And sometimes that’s a little bit simplistic in the sense that you have to build it right and you have to have a lot of clarity around what is driving the value and what buyers are looking for in the property management space.

0:13:47.4 And so, what we see is – the number one – many studies have shown, and our experience in our firm has shown that the number one reason that intent to sell a company is unsuccessful is due to misplaced or unrealistic expectations.

Jordan: Sure.

Bryce: 0:14:05.3 That’s the number one factor.

And so what we see – so if we think about unknowns, it’s those, “What should the expectations be?” 0:14:12.5 And so, the more that – there’s a few things that owners can do to create a winning exit strategy as opposed to one that is going to fall short of their goals.

Jordan: 0:14:24.9 Yeah, that makes sense. And maybe a part of that is just the conversation around what the anticipated outcome is.

And that relates to the conversation around what’s the right time to sell. 0:14:35.2 Which is really an open-ended question, but let’s just talk through some overall scenarios.

0:14:38.2 There’s the scenario where you’re set for life. Right? Any time you’re going from being bootstrapped to just grinding and maybe underpaying yourself to being able to sell and being set for life sounds great.

0:14:51.8 That just like, we can just make a blanket statement that that’s a wonderful outcome and if you can achieve that and maybe you’re ready for a break, go for it.

0:15:01.4 But for most business owners within my industry, for most transactions that are happening within residential single-family property management, it’s not going to be that kind of a scenario.

0:15:12.6 So, taking that off the table for the moment, what are the other considerations that cause clients that come to you to want to actually sell?

Bryce: 0:15:21.5 So, in – and I think that was very insightful that the primary motivation for driving a sale – for motivating a sale – personal motives of the owner.

0:15:33.3 But usually it’s not as much industry factors. Usually it’s the owner’s personal motives. 0:15:39.1 And those motives could be – it could be a health event, but more commonly what we see in our clients, it’s either a serial entrepreneur who is ready to start the next venture or it’s the retiring owner.

0:15:55.6 And so, what we see is it’s an entrepreneur that’s on the end of there – wanting to slow down or they’re fired up about that next venture.

Jordan: 0:16:05.8 So, in either case, they’ve lost the fire for the business?

Bryce: 0:16:08.0 Absolutely. And it’s so important to complete an exit before losing the fire. So, if you wait too long and you’ve lost the fire and once the fire goes cool, then it always has an impact on business performance.

0:16:27.8 And once you top out, you start coming down the other side, it’s a lot harder to capture that value. 0:16:35.1 And so, the timing becomes very, very important.

Jordan: 0:16:37.2 Yeah, wow. What a big issue. We see this with sports performance, with company performance.

0:16:42.8 Getting out at the zenith. Timing that. Knowing when it’s there and then having the gumption to actually sell at peak value is really challenging.

But it makes sense what you’re saying. As opposed to getting well past your prime and just kind of grinding it out and having the business slowly erode value as you’re just doing something that your heart’s not in.

Bryce: 0:17:06.2 Absolutely, absolutely. We see that a lot. And yeah, absolutely.

Jordan: 0:17:11.3 So, do you tend to work with more buyers or sellers?

Bryce: 0:17:15.4 As a firm, we work with sellers. So, our – yeah, we’re representing the exiting entrepreneur.

Jordan: 0:17:22.4 Can you talk to me about the maturity of the market? You’ve worked in a number of different verticals, surely you’ve seen that some markets are more efficient or less efficient. What are the characteristics or a more versus a less efficient market in terms of the maturity of the MNA function, the presence of entities, brokers, etc.? What’s the difference?

Bryce: 0:17:44.1 Ok, just to clarify the question, are you asking about between different verticals?

Jordan: Exactly.

Bryce: Comparisons between different verticals.

Jordan: Yeah. For example, property management, I would say, is not as mature when it comes to the presence of a well-developed and efficient MNA market. That’s my perception of things.

Bryce: And I should mention, Jordan, they’re mowing the lawn right outside my office window. Can you hear anything on your side?

Jordan: We’re good man, let’s keep going.

Bryce: You’re good. Ok, I just wanted to make sure we were good on audio. 0:18:18.6

0:18:19.7 Yeah, that’s a really great question.

0:18:30.2 Frankly, and this is might be off air here, but I honestly don’t – I’m not sure how I can answer that question in terms of the differences between the different verticals.

Jordan: Here’s what I’m getting at dude: for example, in a market that’s going to be more mature, there’s going to be more seller side representation. There’s going to be more acquisition and rollup plays. There’s just going to be more churn, momentum. That sort of thing.

Bryce: More activity?

Jordan: Yeah. More activity and more structured activity as opposed to, “I sent out a bunch of postcards to ask people if they wanted to sell.” Like, this is what’s happening right now: “I want to buy so I get a list somewhere, I send out a bunch of postcards and then” — like the last guy I talked to, he had 20 almost transactions like that but they didn’t go through because he had no idea what he was doing and that’s just a very inefficient kind of situation for people that are really motivated. Alright, so, what’s your answer? 0:19:23.6

Bryce: 0:19:26.1 I still don’t see a lot of difference. I think I know what you’re getting at, but I think it comes down to size, because I think in any industry – and I think you maybe we see it a lot in property management because’s there’s a lot – it’s so fragmented, there’s a lot of small transactions and that tends to be – there tends to be less structure and efficiency around some of the smaller transactions. 0:19:49.1 Almost in any industry where a single larger transaction, there’s a very well defined – there’s, I would say the advisors and the transactions have a much more structured approach to it.

Jordan: 0:20:06.9 Alright, we’re going to scratch that and I’m going to rephrase the question. 0:20:08.7

0:20:09.3 Bryce, talk to me a little bit about the difference between scale. So, in the industries that you work in where the average transaction size is larger, let’s say like north of five million versus smaller, south of a million, what’s going to be the difference in just kind of the infrastructure that exists to facilitate larger deals versus smaller deals?

Bryce: 0:20:30.5 So what we see in the larger deals is there’s more infrastructure. There’s more support by advisors. By professional advisors.

And there’s a more defined marketplace for transactions. 0:20:44.5 And the ability for sellers to reach buyers and vice versa is more efficient.

0:20:52.8 And one reason it’s more efficient is there’s fewer larger deals. There’s fewer large companies.

0:20:59.4 So, when you look at the distribution of company size, once you get north of five million, there’s a smaller set of companies.

0:21:07.9 And so it’s a lot more efficient to transact those companies. It can be. 0:21:12.5 What we see on the smaller end, of let’s say companies under a million dollars, it’s often more of a localized market. It’s harder to find. It’s more of a network based and localized market and it tends to be less efficient. 0:21:28.9 And those companies sometimes don’t have as much advisor support behind them.

Jordan: 0:21:35.0 Ok, so this is exactly the sweet spot of the types of clients that I’m interacting with. At least a fair number would be on the lower end of that transaction size.

There is less infrastructure, there’s less support, there’s fewer seller side representation options.

0:21:52.1 What is your brief playbook for the one or two or three things that a potential seller could do to prepare for maximizing value? Even if they’re not ready to do it this year or next year. Maybe they’re on a five year time horizon.

Bryce: 0:22:07.9 Absolutely. So, as we talked about before, the number one factor that prevents a sale from successfully happening is expectations. Is unrealistic expectations. 0:22:20.7

And so, on the flip side of that, we recommend a few things. 0:22:27.2 One is early planning. And early planning involves with beginning with the end in mind. To know where you’re headed with the business and to build the business so that it’s a transferable business that would be appealing to a buyer three to five years down the road. 0:22:46.1 So it’s that early planning.

0:22:46.2 The second is, I would say, get educated. 0:22:49.2 There’s some great books out there which I could recommend.

Jordan: Please!

Bryce: 0:22:53.3 There’s seminars. There’s a couple here and I have no connection to these books, but our clients have found them very valuable. One is, Walk Away Wealthy. It’s an exit planning playbook. We’ve found that to be helpful.

Another one is by John Warrillow, he’s an INC. Magazine columnist, called, Built to Sell. That’s another one that’s been valuable.

0:23:20.4 And so there’s some books out there, there’s some seminars and industry conferences that sometimes have content on these topics.

0:23:29.6 And so I would just get educated and also talk to people in the industry who have exited. 0:23:37.5 People you know through your industry associations and ask some deep questions about what was the experience?

What was the owner’s experience in selling their company? What do they wish they would have known? And to see it through the eyes of someone who has exited, it can be very valuable as well. 0:23:54.0 So then that second piece is get educated.

0:23:56.0 I would say the third thing is to build an advisory team. And for – it’s important for a business of any size to proactively seek out an advisory team.

Typically that includes an attorney, an accountant to do some tax planning. Typically there’s a financial advisor or wealth manger involved to do some planning.

0:24:22.9 And there should be some discussion around not only what is the business worth but whether you are the serial entrepreneur starting the next venture or whether you’re retiring.

0:24:32.6 There’s a very critical question is – after what is my business worth is, “What will I have left in my pocket after taxes? And what are the net sale proceeds going to be?”

So, those are some conversations – that is a very important number to know before you start negotiating the sale of your business.

0:24:53.6 A lot of negotiations have failed once the seller realizes what the tax bill is going to be. So be proactive. Work with your advisors to know that up front and to get ahead of that so that – and the more information you have the more control you have, the more – the stronger you’ll be in your negotiation process.

Jordan: 0:25:15.4 I like it. So, a lot of these considerations, to me, are the things that a shareholder would be thinking about. And there are these different roles within the business of shareholder, governance, versus operator.

0:25:27.5 And we tend to conflate these things and merge all those concerns together. 0:25:29.8 But they are distinct considerations. What the operator wants to do, maybe the shareholder might have a conflict with.

And if you can separate it out and really think cleanly, or at least make sure that distinct thought is happening in each one of those categories, it leads to a better holistic outcome. 0:25:50.6 That long-range planning, exit strategy, etc., is obviously a part of that.

0:25:53.1 I do want to transition to talk about the benchmarking study, which I know you’ve taken a look at.

And I wanted to hear some of your feedback on what stuck out for you. Given that you work in a number of different industries and verticals, what did you – what seemed unique or distinct within this vertical as opposed to the financial performance of the other industries that you looked at?

Bryce: 0:26:20.7 So, I noticed a very wide – and great job on the benchmarking study, I thought it had some highly relevant and granular data that I think would be – I think property management owners would be well advised to pay attention to.

0:26:40.7 A couple things that stood out to me. The distribution of profit margins in the industry is remarkable.

0:26:49.4 And one reason is, because there’s a fairly – unlike other industries, let’s say manufacturing or other industries that have a lot of variance in potentially raw material costs, and a lot of different cost inputs into their cost structure, property management is – there’s a lot of – it’s a fairly homogenous set of inputs that goes into managing properties.

0:27:13.9 And so, I would expect a tighter range of profit margins in that industry. So, super wide range. 0:27:23.9 And so, I think there’s a lot to be learned from that. And I think we should take notice.

Jordan: 0:27:31.2 It was about 90 points of variance in terms of the low end to the high end on profit margin. But obviously we were looking at adjusted profit margin, which was really important, because we wanted to see financial reality and to get rid of all the distortions.

0:27:46.5 How do you approach distortions around profitability and the distortions introduced by owner compensation and how that may be handled when you’re doing a valuation?

Bryce: 0:27:59.2 Absolutely. I was pleased to see that you adjusted and you normalized owner’s compensation as part of the study because there’s a wide variance in what owners pay themselves. 0:28:12.0 From zero up to several times maybe the market salary range.

0:28:17.5 And so, it’s critical when doing any sort of financial analysis or valuation analysis, it’s critical to normalize the owner and management compensation to market norms.

Jordan: 0:28:30.6 So this is just the base line kind of stuff you do. You absolutely make the same consideration to sanitize the financial performance.

Bryce: Absolutely.

Jordan: 0:28:39.6 what else stuck out to you?

Bryce: 0:28:43.0 Hold on for one second, I’m just pulling up this study. I think there’s one slide I wanted to reference here.

Jordan: No worries.

Bryce: Yeah, there was a couple things that we talked about…

Ok, I just want to make sure I’m getting the right…yeah.

Jordan: No worries, take your time.

Bryce: It was the management fee percentage versus dollars management fee, I believe.

Jordan: I should have numbered the slides, but management fee percent versus average rent and management fee dollars versus average rent.

Bryce: It was a different one. I’m sorry. I meant to print this out. Let’s see. I’m not finding it. I’m sorry. That’s…

Jordan: No worries. Well what you were thinking the point was?

Bryce: I was thinking about the – I thought there was a slide showing the dollar management fee per unit compared with the percentage management fee.

Jordan: Yeah, the title of that slide is, “Management Fee Percent Vs. Average Rent”. It’s like, slide – I should have numbered these slides. It’s after…

Bryce: Ok, yeah. But that’s versus average rent. Yeah, yeah, yeah. But that’s not showing dollars of…

Jordan: That’s on the next slide.

Bryce: Yeah. There we go. Ok, ok. The next slide. Yeah. Makes sense. Management fee dollars. Yeah, ok ok. That makes sense. Ok. Can I comment on that.

Jordan: sure. 0:31:36.3

0:31:37.6 So one thing that stood out to me in the benchmarking study, is the slide on management fee dollars versus average rent, which shows that the dollars per unit – the dollars of management fees per unit generated are fairly consistent across different rental – you know, from high and low rent properties.

0:32:02.6 And so, the percentage rate of the management fee essentially helps compensate for the, you know, high and low rent properties.

0:32:14.7 And so, it was interesting how both the profitability as well as the revenue generated across high and low rent properties was relatively consistent. It was a lot more consistent than I would have expected.

0:32:29.4 I’ve had some companies, some management companies that focused very heavily on getting the high rent properties and a more premium portfolio, but I was pleased to see that there’s also an opportunity to profitably manage properties that are lower rent properties.

Jordan: 0:32:48.8 Yeah. Absolutely. The way that I would put that is that the level of variance within the management fee was much wider than the actual outcome in terms of the actual dollars captured in terms of management fee revenue.

0:33:02.8 And I think that just speaks to the level of exactly what you said, focus and priority that should be placed on the management fee percent as being this highly deterministic outcome within the business.

0:33:15.5 What we saw is that you can make money on the high end of the market. You can make money on the low end of the market.

0:33:20.6 We did see revenue per door as being a significant factor. 0:33:25.3 Now, the reason for that – my opinion, at least what I would read into that is that the correlation between revenue per door and overall profitability could be purely a byproduct of rents.

0:33:37.9 Or it could be a byproduct of fee maximization and the degree to which you have ancillary fees and that you’re aggressively fighting for the full value that you provide. Does that make sense?

Bryce: 0:33:55.2 Absolutely.

Jordan: 0:33:57.1 Yeah, so there’s a lot of different ways to read these numbers, but there’s a ton of information in the benchmarking study.

I think this sort of information and this sort of analysis is kind of a starting point for having a more informed conversation.

0:34:12.2 And trying to bridge the chasm between the buyers that come in, the smart money that’s doing the math, that’s using metrics to figure out where to deploy capital. 0:34:23.6 That’s what’s happening.

0:34:24.0 Money doesn’t drop down from Wall St. on a whim, or because somebody knew a guy. It’s because there was an investment thesis that happened.

0:34:33.0 And on the other end of the spectrum are small business owners that are asking themselves, “You know what? If there’s money in the bank and I’m making a decent income, do I really have to worry about these numbers?”

0:34:44.5 I mean, I’ve heard that kind of feedback. 0:34:47.2 And everybody just has to decide what is it for you? Is it an income stream? Is it a business? What is the destiny and the end state that you want to pursue and what is the level of clarity and insight that you need in order to hit that target?

0:35:02.6 That’s the opportunity that I see in taking a more data driven approach. And doing what you’re talking about, which is just thinking about the long-term goal.

Bryce: 0:35:11.8 Absolutely. And I think an owner is well-served by identifying, “Is this a lifestyle business that I am comfortable with where things are at? Or am I really trying to drive value?”

0:35:28.2 And I think your benchmarking study gives a lot of insight into the levers of value that an owner can pull and focus on as they’re preparing to exit. 0:35:42.0 If value maximization is the goal.

0:35:43.4 And so, I think there’s a lot of impact there whether it’s tracking your churn rates and trying to reduce those and, you know, I was talking to a company yesterday about their churn rates. 0:35:55.4 And they admittedly hadn’t given a lot of attention to that.

0:36:02.4 And so, finding a few key metrics that you can track can be incredibly valuable as you work towards building value towards an exit.

Jordan: 0:36:13.4 There’s no doubt about it. So, for folks that are thinking about making that sale process at some point, or at least they’re really focused on what the value of the business is as a kind of legitimate success metric. 0:36:31.6 Even if they don’t want to sell, asking yourself the question of, “Am I building an asset of enduring value?” is a really important question from my perspective. 0:36:40.0 A lot of folks are slowly going through their process of at some point getting to the end of their comfortability zone, whether that’s 100 doors, 200 doors. And then being faced with that question of, “Should I go to the next level? Should I make these additional infrastructure investments?” 0:36:59.6 Those are hard questions to make. 0:37:02.9 As folks are in the operations and the day to day grind, do you have any advice or counsel for the things that you see as common success factors from the well-run companies that do achieve maximal exits when they work with you?

Bryce: 0:37:21.9 I would say a couple things. I think those that achieve – that have a winning mindset and achieve a successful exit are those who – you mentioned the, “Do I stay at this level?” versus, “Do I make the infrastructure investments to go to the next level?” 0:37:40.1 I think the – those that have achieved the highest exits are those that have reinvested in the business, reinvested toward growth and – scratch that. Let me start that one over.

Jordan: Alright, hit it.

Bryce: 0:37:57.0 Start that one over. And so, just to clarify your question, Jordan, you were asking what are some common things that I have seen in companies that have achieved – were you asking about operational decisions they’ve made at the operational level?

Jordan: I’ll re-clarify the entire question. 0:38:17.5

0:38:17.6 So Bryce, for folks that are in the day to day operations grind and hustle, and they’re thinking about valuations but it’s not immediately in the forefront of your mind, you’ve seen it from the reverse position. You’ve seen the subset of companies that achieve maximal value when they sell.

0:38:36.8 Operationally, what were they doing three, four, five years prior to selling that allowed them to get in that position before it was even on their mind? Or imminent?

Bryce: 0:38:48.0 So there’s a few key things. So, one: they built – they had to sell – typically as they were making operational decisions, they had the end goal. They had the exit goal in mind from the beginning.

0:38:59.8 And so, they built the business operationally so that it was not dependent on, let’s say, the owner, for example. 0:39:09.8 Like day to day operations.

0:39:11.5 But also, the sales function. Right? 0:39:14.2 Is the owner the only person in the company that – is the owner doing all the sales? Being the sole rain maker? Or is there a team that can generate and keep the business going without the owner’s – without the owner being present.

Jordan: 0:39:29.2 Alright, so let’s dig into that one. Key Man discount? What does that mean? How does it work? What does it look like?

Bryce: 0:39:35.6 So buyers – if a buyer’s going to invest in a company, and buyers are savvy. They dig in to what they’re buying.

And one of the things they look at is, is the business sustainable? And who are the key roles and how are those roles going to be filled into the future?

Can the business keep performing if the owner steps out? Is the key question. 0:40:00.2 And if not, what – who’s the successor to the owner’s roles?

And so, what we like to do is say – is have our owners identify their job description. 0:40:14.1 And typically, in a small company, the owner wears a lot of hats. It might be sales, it might be general management, there might be some customer service in there.

0:40:23.1 There might be managing cash flow and banking and financial management. There might be human resources and hiring and firing.

There’s – there might be a lot of different roles, but the idea is to break that down and delegate as much as possible so that the company can continue performing without that key person in place.

Jordan: 0:40:45.7 So the warm, fuzzy feeling I get of thinking that I’m the smartest guy in the room, the company couldn’t work without me, it’s directly related to the degree to which I can say that this is a true asset that has value divorced from me?

Bryce: 0:40:59.0 Absolutely. Absolutely. It’s directly correlated. The degree to which – the weight that the owner is pulling in the company is inversely correlated to the value of that company as a separate asset. You know, as an independent going concern asset.

Jordan: 0:41:18.4 Talk to me about clawbacks on both sides of the deal. How are those typically structured and how often do you see them coming up post transaction?

Bryce: 0:41:28.9 Yeah, so in a case of – in a property management industry, in a service based business with management contracts, we often will see some kind of clawback provision.

0:41:39.9 And those can look a lot of different ways. Sometimes it looks like an earn out and it’s based on revenue – kind of top line revenue based model.

0:41:49.2 Sometimes there’s specific clawbacks for specific accounts and there’s – it’s essentially a way of adjusting the purchase price and terms based on future events that happen. 0:42:01.0 That is the way I would describe a clawback in general.

0:42:07.3 And so, and what it does is it shares the risk. Right? 0:42:10.4 A buyer is coming in and what we see – we see a lot more clawbacks in earn out type of scenarios when the owner is the – you know, is running the show and doing all the rainmaking and all that.

0:42:23.7 And the reason is, the buyer is willing to pay a higher value if the business performs, but there’s a lot of uncertainty around whether that business can keep performing.

0:42:34.0 And so, it’s a risk sharing mechanism and what it does, it incentivizes the seller to continue pulling some weight through a transition period and doing whatever they can to maintain the business and keep the revenue rolling through that transition.

Jordan: 0:42:52.8 What are typical durations of that phase?

Bryce: 0:42:56.2 So we’ve seen them anywhere from six months to three years typically. I mean, they could go longer, but after a lot of water has passed under the bridge after three years. 0:43:09.5 So typically it’s six months to three years.

Jordan: 0:43:13.1 Got it. Yep. That makes sense. 0:43:14.9 What are some other criteria contingencies or considerations around key terms that you see being really significant value drivers in the transaction?

Bryce: 0:43:29.4 Yeah. So, as far as key terms go, it comes down to total valuation and then how it’s paid out. Is it cash at closing or is it on a note or an earn out type of basis?

0:43:37.6 A note would be a fixed payment over time, whereas an earn out would be this variable based on performance. Variable payments. 0:43:45.2 And so, those are some of the key factors.

I think the other key factors are around, it’s typically – and this is the part of the – you’re getting into the legal terms of the sale agreement. There’s going to be some representations and warranties in the agreement.

0:44:05.2 There’s going to be some indemnification, which is just basically a way of – both parties are making guarantees to each other of, “I’m giving you a…” basically, “I’ve told you the truth, I’m selling you an asset. It’s performing and there’s not skeletons in the closet.”

0:44:23.7 And so, those are some key terms that typically the legal team will develop around – that will develop – but it’s really important for sellers to be protected on that basis.

0:44:40.1 Some other key terms are I think around transition expectations and roles. 0:44:48.1 We’ve seen some messy scenarios. If the role of the seller in the transition phase is not clearly communicated and agreed in advance, there can be some misplaced expectations and it can get messy.

0:45:03.0 And so, often there’s a handoff period where the owner is handing off management to the new ownership. 0:45:14.9 And that’s an important phase to understand and to define clearly.

Jordan: 0:45:21.1 If it gets messy, do you typically see that around the seller – around over-involvement or under involvement on behalf of the seller? Post transaction.

Bryce: 0:45:30.3 It can go both ways. You have the sellers that can’t let go and then you have the sellers that get their cheque and they’re gone. Right?

Jordan: 0:45:38.1 I’m sure. I can see it. So, if somebody was wading into this process and they’re intimidated for a couple different reasons.

Number one, they don’t know what they don’t know. Number two, the heaviness of it. 0:45:49.9 You know, if I was to have this conversation, this hours and hours of NDA’s and due diligence.

How much work should people anticipate as they wade into this process? And how does that work get distributed over the different phases?

Bryce: 0:46:07.5 So when you think of the phases of the transaction process, there’s the initial – so let’s just say there’s an initial introduction to a buyer. 0:46:18.5 There’s some initial information sharing. We call that pre-due diligence.

0:46:24.7 So you share some initial financial statements and so forth. 0:46:27.2 Buyer would sign a non disclosure agreement. The NDA.

0:46:31.5 And then there’d typically be an offer in the form of a letter of intent.

0:46:39.3 And then you have some negotiation and then due diligence.

And then the closing documents and the closing process.

0:46:47.6 And so, as we look at the work load, it really depends a lot on how much the owner is relying on advisors through the process.

0:46:56.8 Do they have – you know, how much are they relying on advisors or how much are they doing it themselves.

0:47:03.5 If there’s a full team of advisors in place, then typically the business broker or merger and acquisition advisor M&A advisor would be handling a lot of the relations with buyers and NDA’s and information sharing on the early phase. 0:47:20.3 Typically it ramps up once you get to the offer stage.

Then there’s some negotiation and there’s some investment of time into the negotiation. 0:47:31.6 But then the biggest investment of time is typically in due diligence for the owner. That’s typically the highest work load.

0:47:37.5 And it’s always more invasive, and I always advise owners to expect it to be twice as invasive and twice as much work as you might imagine.

0:47:52.6 Think of it from a buyer’s perspective. Due diligence is really an opportunity for the buyer to understand the asset they’re buying. 0:48:00.3 Because there’s a big familiarity gap between buyer and seller. Right?

The seller, let’s say they started the company. You know, ten years ago or whatever, and they’ve built it from scratch. And they’ll do it from the ground up and they’re familiar with every detail in the company. Right? 0:48:15.8 They know every client, they know everything.

0:48:19.5 And whereas, a buyer coming in, they’re in the dark. And so, due diligence is how they get up to speed and it’s how they open up the hood and dig into, “What is this asset we’re actually buying?”

0:48:36.2 And so, due diligence is a very important time of disclosure where the more that can be disclosed and the more organization and clarity around the data and documents that are being shared, the greater the buyer’s comfort level is with the purchase.

0:48:55.7 And the lower their risk, their perception of risk. 0:49:00.7 And so, accommodating the buyer doing due diligence is a very important phase. Is a very important phase of disclosure.

Jordan: 0:49:07.2 And now, the due diligence process should be fairly portable, right? If I do the due diligence process for buyer A and it falls through at the eleventh hour, when we go to buyer B, I’ve already done a lot work that I’m going to get credit for right?

Bryce: 0:49:22.0 Absolutely. It should be set up in a digital – a secured digital data room or folder. You know, a Dropbox style folder where all the documents are available electronically and organized by legal documents and by management contracts and by financial statements and you know, by employee documentation and all of that.

0:49:48.1 And so, yes. It should be portable. And a lot of that can be done in advance so that it’s not a time crunch. A lot of that can be developed early so that it’s not a big event.

Jordan: 0:50:02.4 Got it. Yep. Makes sense. So the order of operations here was having the initial conversation, it’d be going under NDA, a letter of intent or an offer. Then due diligence and then some potential renegotiation and then a transaction. 0:50:21.1 I’m guess here, did I get this right?

Bryce: 0:50:22.5 Yep. Absolutely. Absolutely. And ideally, most the negotiation happens before the deep due diligence. Just because sometimes there’s legitimate reasons.

If there is new information discovered in due diligence that’s negative, the buyer may want to renegotiate.

0:50:42.9 But there’s also – it can also be used as a way to try to re-trade the deal and get a discount for no reason.

And that’s I think it’s important for – the more an owner is prepared and their advisors are prepared for due diligence, and the more they understand, if they can get out ahead of any potential red flags or concerns that might come up in due diligence – if you get those on the table up front and you negotiate the deal and you agree on a price, then you have a very strong negotiating position to hold the line on price and terms and not renegotiate.

0:51:27.5 And so, we recommend get out ahead of any issues that come up. It’s always better to tell the buyers in advance if there’s a concern or an issue rather than let them discover it in due diligence. 0:51:39.8 Because they’ll – not only does it undermine trust if they discover it in due diligence – it undermines trust but then they’ll try to renegotiate the deal. 0:51:50.8 And so, outcome is always better. Get ahead of those things and if you tell the story the right way up front you’re better off.

Jordan: 0:52:00.0 Wow, that’s some gold advice there. What about involving your team? At what stage do you think it makes sense to involve the team and notify them and get them involved in the process?

Bryce: 0:52:12.4 Yeah. The team – I would say involve the team as early as possible. Ideally three to five years out. And that involves some initial conversations around exit options, your intentions, your goals, and getting some council on what to do between now and the exit to help you accomplish those goals. To optimize your outcome.

Jordan: 0:52:40.7 Wow, wow. Because I was thinking in terms of the immediate transaction. Your answer was great. You answer was like three years before the transaction.

Bryce: 0:52:49.6 Absolutely. Absolutely. However, I would say it’s a lighter conversation three years out. And then when the transaction is imminent, then you’re engaging a lot more – you’re engaging a lot deeper with your advisors at that point and you’re spending a lot more time with them.

Jordan: 0:53:07.2 Love it. Final question I want to get some feedback from you on is, talk to me a little bit about predatory brokerage practices.

In any given market there’s going to be the good, there’s going to be the bad. What might be some red flags that a seller might pick up on if they’re approached by somebody that says, “Hey, I represent a buyer looking to purchase management companies” etc.? Are there any red flags that would kind of put you on notice?

Bryce: 0:53:34.6 Yeah, absolutely. So one tactic is to – that I would steer away from and I would advise owners to steer away from, is a broker who says, “I have a buyer for your business and I want you to sign some kind of a listing agreement locking your up for a period of time to let me market your business.”

0:53:58.9 And the reality is they probably don’t have a buyer for your business. They’re just fishing – they’re just using that as a the bait.

Jordan: 0:54:08.5 It’s like lead gen.

Bryce: 0:54:10.4 It’s lead gen, right?

Jordan: That’s terrible.

Bryce: 0:54:14.0 And the reality is they do have buyers. They might have buyers for a property management business, but I think there needs to be understanding and clarity and disclosure around, “Ok are you representing the buyer? Are you representing me?”

0:54:31.9 There needs to be an understanding around who’s representing who in that case. 0:54:34.3 And the reality is, if – and so, I think the other thing is, I would ask what is your success rate?

I would ask for disclosure around what is his success rate for clients that – if you’re representing a business owner, how many transactions do you get closed.

0:55:00.8 Because there’s a lot of brokers that will sign up as many sellers as possible and just kind of see what sticks. Kind of throw it at the wall and see what sticks.

0:55:10.9 And in that case there’s not a lot of value add advisory. It’s more of a listing service.

Jordan: Arbitrage. Yeah.

Bryce: 0:55:18.9 Absolutely. It’s a listing service. And so there’s not a lot of value add advisory. At least, you know, I recommend as owners are looking for advisors, and specifically we’re talking about, for example, in this case you ask about brokers like a business broker or M&A advisor is to look for someone who is willing to advise you and sometimes tell you what you may not want to hear but tell you the real truth about, “This is what you need to do to sell your company and optimize the outcome.” 0:55:49.4 And so, look for that type of advisor. And your outcome will be better.

Jordan: 0:55:56.9 And what’s a healthy success rate in your mind? If you were to ask somebody, “Well, what percentage of your transactions do you complete?”

Bryce: 0:56:03.1 Yeah, I mean definitely over 50%. I mean, there’s some solid companies that have like 50-90% success rates in getting transactions closed.

Jordan: 0:56:15.2 Wow. So the scenario you mentioned, somebody comes and they say, “I’ve got a buyer for your business”, that could be an immediate conflict of interest. If they have the buyer under contract and now they want to get you under contract, that’s the point that you’re making there?

Bryce: 0:56:26.1 Absolutely. Yeah, there could be conflict of interests. Absolutely. And they may or they may not – I think it’s a false pretext for selling the company. I think the key question is, “Is it the right time?” 0:56:40.9 And sometimes they’ll take you to that specific buyer they’re talking about or they’ll want to market you more broadly to a lot of buyers.

Jordan: Shop it.

Bryce: 0:56:50.7 But the real question is, “Is this the right time to sell the company? Is this the right time for the owner, for the market, for the business? Is it ready?”

0:57:00.3 And if it’s ready, then let’s go to market and find the best buyer, but whether or not that broker happens to have one buyer in their pocket is less relevant.

0:57:10.1 It’s really not the primary determining – like the primary determining factor for optimizing the outcome for the owner, for the seller, is not that that broker happens to know somebody who’s looking for a property management business.

0:57:24.2 Because there’s tons of buyers out there. It’s more about, “Is it the right time? Is this the time to optimize value and are we prepared to go do that.” 0:57:35.8 Because the buyer, anyone can connect with a buyer. It’s just not as compelling as maybe it sounds. 0:57:45.6 In terms of the actual value add to the process.

Jordan: 0:57:48.5 Yep. Totally makes sense. Do you believe that there is any such thing as a standard neutral EBITDA multiplier? Meaning, if you look across industries, do you think that there – just based on cash flow, agnostic of industry, do you believe that there is any kind of a baseline EBITDA multiplier that’s just accepted as being the going rate based on cash flows?

Bryce: 0:58:12.7 No. There’s no single multiplier. And the multiplier is basically – we talked about value being based on cash flow and risk. The EPITDA in this case, is the cash flow piece and the multiplier is basically the risk piece.

0:58:28.1 And it’s based on industry. So every industry is different, each individual company is different within the industry. You have different growth rates, you have different risk factors within each company.

0:58:36.8 And so, there’s really not a single number. I mean, we could talk about some ranges. 0:58:43.4 We could talk about some ranges and we’ve done transactions from, you know, three to 10 times 0:58:52.6 [Inaudible] more recently. I mean, there’s a lot of variance there. 0:58:56.2 But I couldn’t pick a single number that could apply broadly.

Jordan: 0:59:00.1 Fair enough. I think that’s a comforting answer. It depends. It’s not satisfactory but it makes sense that it’s going to be based on what you’ve built. And some people have built something worth a lot more than others.

0:59:13.1 Bryce, I appreciate you coming on the podcast today. For folks that want to get in touch, learn more about your business, what’s the best place for them to go?

Bryce: 0:59:19.8 Sure. The best place would be our website, which is www.Compass-Advisors.com Our firm is called Compass Advisors and I’d be happy to engage in conversation with owners.

Jordan: 0:59:36.3 Alright. So guys, if you want more information, Bryce would be a great guy to get in touch with. I’ve known him for a decade plus. Super savvy and he’s been in it. He’s an operator. He’s got the entrepreneur’s DNA. He understands what the journey looks like. So, Bryce, I do appreciate you coming on the show and let’s stay in touch.

Bryce: 0:59:55.5 Jordan, it’s been a fun time and thanks and I look forward to next time.

 

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