Caleb Basile: A Live Session on QoE After the October 1 SBA Changes

And we're live. All right. So very first Substack live for me in the Still Searching group. I think, Caleb, I've got Caleb here from QoE Prep. Is this your very first Substack live? This is my second one. Second one. All right. So we are breaking in Substack live. And the whole point here is we want to be able to talk a little bit about QoE, riff a little bit on some random topics. And if you have any questions, you can throw those in the chat. But just for context, I'm Jed Morris. I write Still Searching, which is a newsletter on Search itself. A lot of times from some of the lessons learned perspective. And I'll let Caleb introduce himself, but he's here from QoE Prep. Hi, I'm Caleb Basile of QoE Prep. I do quality of earnings reports for buyers. So I analyze a financials with someone buying a company. I also help sellers set up their financials when they're getting ready to sell a company. Yeah. And he's a little more modest than that. Caleb and his team are excellent. They are some of the best in the industry when it comes to quality of earnings. Perhaps not just for the lower middle market, but for the middle market also. And I know that firsthand because I've hired them to do QoE on a deal that we were working on last year and they were phenomenal. So it's not just Caleb. His whole team is fantastic. So I'm really excited that he's here so we can talk about financial diligence and then just whatever's happening kind of in the ETA space.

Awesome. Thanks, Jed. All right. Well, as we're getting started, I think the biggest and most pressing question that a lot of people have, especially since this is October 7th. And we're only six days removed from the SOP change for the SBA. Talk to us a little bit about what has changed with the new SBA change on October 1st. And even more specifically, how that impacts quality of earnings. Gotcha. So there's several changes. I'm probably going to forget a few of them and there's probably a few that will be updated. But basically the debt service coverage ratio has gone from 1.15 to 1.25, meaning that they can't lend. There has to be more earnings in order to lend up that business. They now require quality of earnings for deals over 3 million in purchase price. There's some change with investors. Like they now have to personally guarantee it and investors can't be taking payments or something like that. What are the other changes, Jed? I'm really just focused on a QoE change.

Yeah. And we're going to focus on that. And I think that makes the most sense. The other big change that people are screaming about is the 5% equity injection requirement by the buyer. And so up until now, it had been normal that if you were going to use the SBA loan, you could put about 10% down. But then you could kind of get around that 10% by using seller notes, especially if they're on full standby, raising money from other investors. Many SBA lenders didn't really care where that cash came from as long as the buyer was submitting the down payment cash. But now they're saying specifically 5% of the project price has to actually come from the personal finances of the buyer, which I think overall is a good move. Yeah. I mean, I think when you're buying a house, it used to be historically 20% down to buy a house, but that house had physical assets that if you defaulted, the bank can get their money back there. So it's secured loans. So like when you're buying a home, when you're buying a business that just has earnings and very low assets, it's not secured. It's unsecured. So it makes sense that 10% down is what they're requiring now.

Yeah, at a minimum. At a minimum. I think about this from the perspective of, look, the whole point of the SBA program, even when it started in the 50s, was to provide credit facilities and lending to small businesses, mainly because they're so inherently risky and volatile. And so without that, you know, it's not just buying, but small business owners wouldn't be able to have access to credit and banking through regular commercial banks because how can I let on your business, you know, only doing $2, $3 million of revenue. There's no consistency. There's a lot of risk. So the whole point here is to backstop that so that lenders feel more comfortable lending. And if my friend Caleb here wants to go buy a $5 million business and can't come up with $250,000 of cash out of his own pocket, then he's probably not ready. Just my two cents. Now, unfortunately, that's what the doctor's saying. But like, yeah, so I think the program is created like the 1950s and it was originally created for small businesses acquiring other small businesses. The whole new ETA or like communities pretty new. I mean, it's been happening for 10 years, but it really got big in 2020, I'd say, especially around COVID. There's a lot more buyers now.

But like, at that time, it was lending to a business owner who had earnings, buying another business with earnings. So even if the other business that they devolved and had a ton of earnings, they could still dip in from their first business earnings to pay off that loan. So it made that loan less risky for lenders and for the government that backs it. But now it's starting to change towards like a mini PE and you have first time business owners. Buying a business, which is a good thing when it happens really well, when it doesn't happen well, it's a challenge. Yeah, challenge to say the least. So back to the QoE portion, because this kind of hits you specifically. But one of the things about this whole space is I've always called it the Wild West of capitalism, this lower middle market space, because there are no rules really down here. You know, when you get further out market, you know, $40, $50 million plus.

We start getting into places like, you know, we don't have business brokers, we have investment banks and they're registered through FINRA, they have all kinds of very strict rules that they have to follow. But down here. And they're looking at audited financial statements. Yeah. I'm looking at just financial statements on the frozen yet. Yeah, exactly. We're looking at audited financial statements like we're being very critical of the business. And you know, it's all accrual. There's no cash based stuff. But down here, anybody can just raise their hand and be say, I'm a business broker now. And so, you know, there's so little regulation in this space. And none of this stuff is required. So, you know, if I want to go buy a company in order to get a loan from a bank, I just need to find a bank that will lend to me, which is, you know, they're all different. Maybe they're good at their underwriting. Maybe they're not. Maybe their credit box is a little bit looser. Maybe it's not. It really is like shopping. But there's no requirement that I use a broker. There's no requirement that I get a quality of earnings. There's no requirement that I get a lawyer, like much less one that has actual expertise in mergers and acquisitions. And so, this is one of the first steps we've seen from the SBA mandating any kind of diligence.

There's no requirement that a lawyer is involved. But now there's a requirement that there's a quality of earnings on purchases of $3 million or higher. I didn't realize there wasn't a requirement for a lawyer. Nope. You know, lawyer, it's insane. Yeah, you got it. All my clients use lawyers. I never had a client that doesn't use a lawyer. It's just, yeah, because like, I mean, I show you what the earnings are. I show you what the risk are. You decide the multiple. And then the lawyer helps you craft the terms and get the deal under the right terms. Yeah, you gotta be very careful. Hire a lawyer. Yeah. I'm an A lawyer for this. Yeah. So one of the interesting things I'm seeing happening, and this kind of comes back to like, why do we want to make sure earnings are accurate? Well, we want to make sure you're buying the business that's profitable, that'll pay you back and so that you can pay the lender back. The goal is that you buy a company that works for you, your employees, everyone, the government's happy. There's a saying in sports, winning cures all so it doesn't matter if the court is back and the wide receiver are mad at each other.

If they win at the end of the day, it's a good thing. Profits solve a lot of problems. Yeah, sales profit solves everything in terms of like lending and investors and buyers. But one of the challenges right now in this space, so any deal under 10 million is, well, what? Interests are going up. When interest rates go up, that means more of your profits are going to the bank. The amount of buyers is going up, which means sellers now have four options to who to sell to. So they can ask for a multiple, now that it's higher than they used to be able to ask for, to private equities joining this space. So one, so business owners like, yeah, I sold for seven X, he tells his buddy at the golf course and that book, but he's like, well, I want to sell for seven X. So I'm going to tell that searcher who doesn't own a business, he's got to buy me for seven X because I can't be worse than my friend, of course, you know, right? Yeah, doesn't doesn't really matter if he doesn't even support that. It's just like, you know, buyers, sellers have their own idea of what their business is worth.

But at the same time, and I could be wrong, but the economy for USA for smaller businesses is going down. It's going up for the larger businesses. All those tech companies, it's getting great. It's going really well, but the economy is going down for smaller businesses. I could be wrong, but it's just what I, what it's just what I sense, maybe from the deal selling like when I first started QoEs 2021, it was pretty easy because interest rates are so low, you could buy money was so easy to buy it was so easy to buy and be fine. And 24 is like, oh, wow, we need a little bit more scrutiny. And then 2025 QoEs came back, you know, diligence is in because a lot of businesses in 2025 showed lower probability than they did in 2024. And now that it happens, everyone, like right now, like when deals go down, let loans don't get paid back buyers feel like, oh, no, I'm losing money. So that's kind of like one of the things that's happening.

Yeah, I kind of sense the same thing that that vibe economy that we're kind of in. I have a lot of conversations with current owners, as well as searchers. And it's over and over. I hear the same things, you know, cost of goods are going up, supplies are going up. Home services, if you're doing like roofing or, or garage repair or any or HVAC, any of these things, all the inputs are way more expensive. And we're unable to really raise prices to compensate because the consumers don't have as much money as they used to, you know, two or three years ago. And so costs are going up labor costs are going up, you know, physical goods, especially imported physical goods, which is most of them costs are going up. Yeah. And you're not able to raise your price to compensate for that. And so small business owners are getting squeezed. And so a lot of times they're looking at to like, not just get through this by scaling by acquiring competitors and trying to get bigger. But now they're really careful. But the fact that like, you know, they have to be really careful with all of their individual accounting practices, you know, what, how much cash we're actually going to have 13 weeks from now. There's a lot of unknowns. And you're exactly right. If I'm living in a world where I'm no longer at 2% interest rates, now I'm at like seven. Well, that completely changes the math when it comes to debt service on these on these acquisitions. And I think rightly, I think, you know, when you have really low interest rates, and you also have this huge influx of, you know, online enthusiasm, we'll say, to go buy a company.

And, and now you're seeing some of that pushback, you know, lenders are like, hold on, we don't want to give every American citizen with a 670 credit score and a heartbeat the ability to just take out $5 million with very little diligence. We need to actually make sure that these companies can survive post close, not just on their own, but that the buyer has post close liquidity. It's not just enough to show up and pay for the diligence, which isn't cheap, and then have the down payment yourself, which isn't cheap, but you also have to have some cash afterwards so that you're not business rich and cash poor. And so things are changing a lot. I think the economy is driving a lot of that. Yeah, yeah, things are changing pretty quickly. And we'll see, like, I mean, acquisitions will always be a thing. I was listening to someone named Jackie Hirsch, I did one podcast with her, one live with her. And she said it's a seller's market. It's been a seller's market for 30 years. Yeah, there's less business owners than there are business buyers. And, and whether you're selling to an individual selling to another business private equity, a vector capital, it doesn't matter who you're selling to, the seller has the upper hand in both cases, like almost all.

Yeah, you know, it's funny because that's, I was actually talking about this yesterday on YouTube and you're exactly right because it's counterintuitive to the narrative that's out there. You know, the narrative that everybody here is this silver tsunami that the largest generation of baby boomers and all their companies that are all coming to market and no one's there to buy them. And we gotta, you know, there's way more sellers and not enough buyers. And the data just doesn't back it up. Maybe that'll change. Maybe we will see that change, you know, towards the end of the, you know, the 2027 2028 as we get closer to 2030. But as of now, people have been talking about it for the last 10 years almost. And we have not seen sales and businesses in any measurable way increase. In fact, they've been flat for the last three or four years. But what we have seen is it influx of buyers. I think it's I think small businesses are at least the SBA 7(a) loans went down by 20% this year. So I think it like this year's trending a little lower than the last year. And in terms of I don't know if this volume or not our number amount.

Yeah, it's definitely changing. So I mean, and it is private markets. So like, what data we have is very cloudy. Like, we know that like, only like 25% of SBA transactions or acquisitions, the rest of them go to current owners. And so we also know that, you know, just from intuition and other types of data, more than half of all transactions are going to be seller financed or some some sort of creative finance that doesn't include traditional bank lending. And so it's it's completely possible that we're saying all of these deals happen, you know, off market, so to speak, and not impacting SBA. But I don't think that really makes sense. I think eventually you're going to see an intake and uptick in SBA loans as well as other conventional loans, it wouldn't just be all off market. But we haven't seen that yet. Yeah, you're right. Yeah. So conventional and traditional loans, I think they typically have a lower, a lower interest rate. So like, if you can get the deal done that way, I was literally talking with like lenders at the from the SBA government or like people who worked at the SBA government and lenders are out there on a panel this morning.

And they're saying like, yeah, if you get a conventional loan, if it works for your deal, do that. You have to bring up more money, but it's going to be a better rate. So yeah, maybe the maybe the small businesses being sold with the SBA are the riskier businesses or the riskier buyers. I don't know where it's at. It might be a mix of everything. Yeah. All right, so let's circle back to this quality of earnings thing. So going forward, as of now, we're six days into this, this new policy change, but lenders are now required by the SBA to have a quality of earnings. So how does that work? Because there's been a lot of, you know, back and forth with how the SBA and lenders are trying to figure this out, because, you know, a seller could get a quality of earnings as part of their seller's package. A buyer is most likely going to want their own quality of earnings because they want to trust their own numbers. A quality of earnings is only as good as the firm that does it. And then obviously the SBA still has a, you know, they've got their own requirement for a quality of earnings. Who like, are we doing multiple quality of earnings for every deal? Like who's paying for these?

Like what counts? What doesn't? Yeah, I'd like to see at least six or seven quality of earnings all through your firm. Of course, just through my firm. So at this point in time, the best answers, we don't know fully yet. That's the best answer I could give you because it was announced seven weeks ago that all the changes, everyone's like running around. Oh, what are we going to do? What are we going to do? I had people tell me, oh, wow, you're going to lose your business, Caleb, because these lenders are just going to use the bigger CPA firms. I'm like, well, watch me. We'll see what happens. And I had my best month of sales ever in September. A lot of sales ideals, because I'm like, hey, look, it's going to be required. I just tell the broker, don't you want to sell the first time? And they say, of course. So I do a lot of sales ideals as well. But at this point in time, they're accepting a lender QoE, which is basically a vendor that the lender has approved. And they're accepting a buyer QoE, if there's a reliance letter that the QoE provider provides, which QoE providers do not do look reliance letters. It's not still auditors provide real fast, real fast. What do we mean by a reliance letter?

I don't know. But I don't really know. I think it means like access letter. Can I access this report and use it to underwrite? That's what I think it means. I've never seen a QoE reliance letter. I think because the AICPA basically says under audit, you look at the numbers and you review them and you say, okay, these numbers are right. QoE providers, we're analysts. So we're not testing the numbers with the same level of scrutiny that an auditor is. We're not, like at the end of the day, we're not being paid as much as auditors are. And we have two weeks to do this. So we're not calling customers, we're not calling employees, we're not calling vendors or any of that stuff. We're not, we're not doing as much as an auditor is doing on the balance sheet side. So there isn't an sense of a reliance letter. But what I can't see happening is, okay, QoE providers provide like an access letter allowing the lenders to view our QoEs as long as they limit our liabilities to 110% of our fees.

Gotcha. I don't know what's going to happen yet. But at this point in time, only 6% of my deals are buy side three to five million. Like I do a lot of sell side. I do deals larger, I deal smaller. But I don't know if a single QoE provider is like, yeah, I want to do lender QoEs. It's just, it doesn't, because ultimately you use us to find out to help you come up with a purchase price. Lenders wanted to get this thing, they're calling it QoE, but it's like this miniature thing with a very, very little scope. And they just want to make sure that they're going to get their loans paid. So it's a different thing. And everyone's confused, like, are they going to order it right away so that they could kill a bad deal right away? Or are they going to order at the very end to prevent fees, but then kill the bad deal on 90 days? So you can't really win yet. And there still isn't quite enough guidance. And a lot of it's going to be bank to bank. Yeah. My best answer I could give you. We don't know fully yet.

Yeah. Well, one thing we do know is that, you know, the lenders are in the business of mitigating risk. And so when it comes to deciding, like, you know, if, you know, not just if we need a QoE, now we know we need one. And so if we know we need one that we need to make sure that, you know, we're going through a QoE provider that the SBA isn't going to push back on and say, hey, you know, this mom and pop shop isn't really up to the quality level that we want. And so in some ways that could be beneficial because, you know, shops like QoE Prep where you're doing dozens and dozens and dozens of QoEs every single year. You've got specific expertise in it. You can say, hey, not only are we doing this, we're very good at it. We've been doing it for a long time. Here's a long track record of how it's done. That can provide some assurance to a lender that you're actually good at what you do. And then at the same time, it kind of prevents like just random CPAs, a lot of times who who maybe have never done a QoE, but then maybe a buyer has a friend who's a CPA is like, hey, go do a QoE for me. And the lender's like, no, I don't really, I don't really trust that this is going to be a reliable QoE. Yeah, I think you're underestimating how conservative CPAs are.

CPAs aren't CPAs and do it all. Like a CPA, most CPAs, this is just the way we are. We're very conservative. We stick to what we know. I do texts or I do audits or I do financial planning and analysis. But like, very rarely are you going to go to tax CPA and get them to do QoE? They're going to be like, oh, no, I've never done that. Find someone else. Like that's just like, we're all super busy. Like, yeah, it's very much like the legal field. You know, just because I need a, I need a mergers and acquisitions doesn't mean I'm going to go to my friend as a divorce lawyer, like, Hey, man, can you read through this contract for me? Because that would be ridiculous. Yeah. Yeah, that definitely would be. But yeah, so, but like, here's the thing, when I was at Baker Tilly, in order to be allowed to work on a QoE, and we can get into the financial professional requirements for the QoE. The SOP is talking about. But in order to be required, the guidance now says a financial professional has to do with QoE, which basically means you can't do it yourself, or you can't hire overseas and you can't hire, like, Claude to do it for you.

It has to be a financial professional for valuation. You have to be an ABV, CVA or ASA. In order to be an ABV, you have to be a CPA. Historically, now there's other ways of getting to that. And you have to have like two years of experience working underneath the professional. Like, there's a lot of requirements to doing the valuation, which is a $2,500 report versus the QoE for like a $5 million business, which is a $25,000 report. Sorry, Big Four, I'm undercutting it. But hey, I'll take your deals up again. Now, as far as the requirement, when I was at Baker Tilly, and they do QoEs, they do a great job. They mostly make bigger deals than mine, and they do a lot more product deals. So I don't think I'm a competitor to them at all. You had to be an auditor, and you had to have five years of experience and be a CPA. Like, you had to have all that experience in order to start doing QoEs, because it's one of the most important transactions of your client. They're selling their business, or they're buying a huge business, and it's a lot of money, and you want to get it right. So yeah, that's why you can't really just go to your local tax CPA and be like, hey, can you do this QoE?

I've done over 350 deals. I didn't start doing deals directly for clients until like 255. I did a lot of practice with other CPAs who've signed off on a lot of reports before I started doing my own. Now, I'm thankful that none of my clients have defaulted over the last 90 deals that I've done. All the deals that I've done directly, none of them have ever defaulted. And I think it's because I've done so many of those reps. Yeah, and like anything, when you do a lot of reps, you tend to get pretty good at what to look for. And like, before you ever, you know, get started with the QoE, you're like, all right, well, these are the, these are the top things that I'm going to look at that I know that like, if there's something fishy here, I need to dig deeper. And overall, if this one, if this, if this number looks good, or that number looks good, that I know overall things are probably a little stable, like you probably have a very succinct checklist of things to look at, before you even get started. Because you know where, like, if I'm trying to hide earnings, or if I'm trying to hide expenses, I, you kind of know where those things would be slipped away. I would imagine, right?

Yeah. So, I mean, like we said in the game, winning cures all basically, if you see the numbers going up, great numbers are going down, bad, revenue and earnings both. But then we validate their add-backs, like which of these can we accept, which of these are reasonable, which of these actually will happen again in the future, based on what this hour saying. And based on our experience. So imagine I'm a buyer and I'm coming to you and I'm thinking, I definitely know that, you know, I'm going to do a transaction. I know that it's going to be over $3 million. So even though, you know, I may have, you know, my own opinion about whether or not a QoE is required, I now know that it absolutely is. And so I know I'm getting a QoE, but I'm also like, I'm also hesitant because I'm a buyer. I've got limited cash and I don't want to get myself into a deal where the deal, you know, QoE is going to kill it. And so I want to make sure that I'm not just getting a lot of dead deal costs. I'm trying to protect myself because I know that if I do this three or four times and and pay for QoE is the odd deals that never actually closed, then I'm screwed.

And so what are some things I could do as a buyer, you know, before I ever get to the QoE stage where hopefully I can identify some big red flags that, you know, will help me, you know, who's not a CPA, who's not a QoE, help me like kill those deals before I ever pay for somebody else, you know, like you or another QoE provider to come back and say, Hey, man, that's, that's a bad deal. Yeah. Before I hop into that, your due diligence fees, so your CPA fees and your legal fees, they count as part of your equity injection for when you're buying a company. So we're essentially free to you now. If you close, if you close, but if you don't close, we prevented you from buying a bad business that didn't go. That's huge. And that's a, that's a, that's a soapbox I stand on all the time, because a lot of times you'll look at, you know, buyers will be like, Oh, well, if I don't close, and that's 10 grand out of pocket, that's 15 grand out of pocket, whatever you paid for QoE, I'm like, yeah, but it saved you on that $4 million deal that you were about to sign a personal guarantee for. That's a massive ROI in your favor. And sometimes it's hard to really, for us to really understand or appreciate the, the near misses, as opposed to just like the physical costs we see on day one.

Yeah. No, I appreciate that you talked about this. Like you did have the best experience, you know, but I think if more people talked about it, more people would be resistant to buying a business. And that's not a bad thing. This is a lot of money. Like if you're getting a $5 million loan, that's like, that's like what people are making two lifetimes. That's a ton of money. So you need to be cautious about it. And businesses fail without transactions, without being sold or without buying. Customers change. Key employees die. Like stuff happens and businesses still fail. But when you're buying a new business for the first time, you're taking on someone else's processes, someone else's sales team, someone else's customers, someone else's vendors. And it's typically not the industry you're in. That's what I'm saying. A lot of people buy or buy industries. Like I, I, I joke the other day that I can never own a construction company because I can't work outside. Like I'm, I'm not good at it, you know.

I, I, I can design things really well. Like, like I'm working on a patio outside. I paid for someone to do a patio outside. And I know how to make it look good. Like, hey, make these blocks in different order. But I'm not really great at flattening things out and doing it, doing it myself. So I couldn't own a company. I could own an accounting firm because I understand this stuff. I probably couldn't do a tax company because I think taxes are boring. It's a similar, a similar skill set, but I just think it's boring. I think you're really speaking to the ability of a buyer to be able to roll their sleeves and actually do the job, which is so important, especially in small business where, you know, SBA level is 5 million and under just on the death side. So, you know, total deal could be up to maybe as high as 10. But even then, like there's, there's, there's a good opportunity. You have to expect that you're going to be the guy or gal doing the work at some point. Yeah, so, so the big red flags. Number one, it's you. Can you run that business going forward? Number two, are the seller's taxes matching their, what they're saying they're earning?

So, you know, but essentially, we look at their financial statements and their tax and their tax returns. If their income and their tax returns match their financial statements, that's great. If they're small variances and it's due to depreciation or meals or meals and entertainment or something that's like you can't get that for tax purposes, but it is a business deduction. Yeah, fine. We tied out. But if they're not tying out closely, typically it's because the taxable income is showing less earnings than a financial statement. And that's because the, the owner is trying to do a tax strategy. Which is called very, very positive. We'll call it a tax strategy. Yeah. You know, I was talking with a buyer just two weeks ago, who was going through this very thing where they're, you know, they're, they're getting the accounting statements. They're getting the tax statements and they're taking that information. They're building their model and they're like, and they're showing me like, Hey, look at this model. This is how I projected cash flow and all this kind of stuff. And I'm thinking, okay, that's great. How did you get those numbers? And like, well, I got them from, you know, the prior three years financial statements from the seller plus their tax returns.

And I'm like, well, that's great. But again, the seller can put whatever they want in those statements. So you're just guessing like your, your fundamental data is a guess. And I think a lot of people don't realize that like, you know, what I submit is my tax returns for my business. And what I submit for my financial statements, I get to choose what that looks like. And as a result, I could put whatever the hell I want in there. And so there's a lot of people who have a lot of faith in even tax returns as a, as this is the gospel when in reality it's just whatever the seller reported. Yeah. Yeah. And, and brokers know that. So they say, Oh, for your last year, I want you to, to do things right, you know, basically pay yourself on a good salary. Don't have any personal expenses. So they do things right in the last year. And it shows earnings going higher. But that also means is they'll say, don't spend any discretionary. Don't do that. Stop discretionary spending. So like a business owner is like, well, why would I spend marketing? That's ridiculous. I don't need to spend marketing. Yeah. I mean, every CIM you've ever seen is like the, you know, we don't do any marketing. Everything's word of mouth. We've got a great reputation. I'm like, awesome. So how do you get sales?

Yeah, yeah. Well, like, like people will count marketing or like employees as not necessary. Like they'll say, yeah, you get to fire this employee. So it's a benefit to you because that's an excellent thing. But you don't have to be paying. But someone's got to do the work. If they're that bad of an employee, why have you employed them in the past four years? Yeah. So like, yeah, personnel, that's a huge thing. Are they saying that more people can, that less people can do the same amount of stuff because they're automating everything. There's like this AI thing. People are saying like, oh yeah, AI will take over all that stuff. So this business is worth more. But there was an article that blew up on X just last week about, you know, someone's like, oh yeah, you know, the big thing now is for people who know how to use AI, AI, AI automation. This is the perfect opportunity for you to go and buy a quote, boring business, infuse AI into it and see massive, you know, gains and returns. And I'm like, and I thought, well, that's, you know, I'm not saying you're wrong, but I am saying you're wrong. Because it clearly has never actually done this. Have you ever gone to a car wash because of the AI? I've never gone to a restaurant because of the AI. I really haven't. I don't know what industry it is where it's like, yeah, I use them because of their AI capabilities, you know, except for Substack.

I love the way. So at the end of this video, it's so cool. They're going to create all these shorts for us, like 15, we could just post them and they have the captions, which is amazing. I don't know if that's AI or something, but it's magic to me. But a lot of a lot of times, like, I don't like the brick and mortar companies that are being sold on BizBuySell, like, I don't really know what they can do for it. Like, unless it's maybe in that tech space or in that space, like, a lot of these businesses, if the business owner says it's worth more now to you than it is to me as an AI, it's hard to validate that. And I go off of historical earnings either way. And the narrative works, though, because, like we've already said, there's more buyers in the market than there are sellers. It's a seller's market. And, you know, there's a lot of buyers who are totally fine, paying up four, five, six times for a business. Otherwise, it wouldn't make sense. Yeah, yeah, definitely. So it's more important for you to have the discipline of knowing what you're looking for, what you're not looking for, and not getting caught up in a bidding war, because that's how you make really bad decisions.

Yeah, another big red flag is 10 hours a week. A business owner works 10. I think 10 and 40 are the biggest ones. If the broker says a business owner works 10 hours a week, I always think, oh, if they're 10 hours a week, why would they ever sell the business? It doesn't make sense. If they're working 40 hours a week, that means that they're full times, but maybe they're working two or three jobs, you know, get a new buyer, a kind of buyer realistically take on that level of responsibility with 40 hours. And I mentioned this to one of my clients who had like a, he had like a consulting background, and he goes, "Caleb, I don't think you understand. I can roll my sleeves up, and I can work a lot of ourself. I agree with you." That doesn't mean that this business is currently understaffed and the business owner is working a lot of hours. Like, yeah, I know it could be worth it to you if you work all those times, but like, I think the business owner is asking for a little bit too much, you know, so I kind of like make those points.

It's not that you can't do the work, it's that your, the purchase price is inflated based on the work that you have to do. And so it's so common, you know, that a business owner does not just one job, but many. They're the chief salesman, they're the chief marketer. A lot of times they're doing back office stuff, they're answering calls. And then a lot of times they've got a spouse in the business too, right? Bookkeeping or some other sort of admin or type of work. And so the two of them together are most likely doing four, maybe five jobs, right? And when one or both of them leave, well, then great, you can step in and yes, you can wear all those hats, but we have to add back not just the cost of the owner, but all the other work that they were doing that you now have to take over for. Yeah. Yeah. And then, um, yeah, so that's another big riff like family businesses, that's hard to take on that family. And like the owner's gonna say, yeah, my son's gonna stay, my daughter's gonna stay, they're at market rate, they love working here. I don't know. Like unless they get equity, I don't know if they will. Just, just from the pattern, like you're loyal to your parents, like when they employ you, but once they leave, why wouldn't you find something else? Or why wouldn't you start a competitor? The kids are not, the kids are not signing those non-competes. And then another huge red flag everyone knows about is customers, but then also the referral sources, like if they're getting their referrals from one or two referral sources.

So one of my competitors just sold. Okay. Um, and now I'm getting deals from loan brokers who used to send deals to that, that a QoE could provide that just sold because they're not doing as good of a job as the previous one. So that referral source, which was a large person of that competitor's referrals, they're not all coming to me. So that, that's going to happen when you sit, when someone sells their business and they get a lot of referrals from one or three sources, one or three, like they don't have a lot of referral sources. Like that's a huge risk because ultimately all these businesses under 5 million, the business owner is the business. Yes, there's a system, some team, but the business owner drives the value. Yeah, it's a double-sided problem because, you know, on, on the first half, a lot of that is driven by the relationship of the owner with how whoever they're getting those referrals from, however they're getting that business. And so you lose that. But then the other side of it is that when that business was bought or acquired, you know, the value of the business was based on the revenue that it was bringing in based on those referrals.

So not only did I lose the referrals and the customers, but I also overpaid because now I don't have the income that those referral customers used to be bringing. So I'm getting hit on both sides. Yeah. Yeah. I mean, and I don't want to just talk about the risk of buying a small business. There's also a lot of opportunity. You know, I have, I've had people that bought a business, like, what's your debt service coverage ratio now? Like, basically like, how much are you paying in loans versus how much are you profiting? He goes eight times. Eight times. So like, for every thousand dollars that he's paying out, he is making $8,000. And like, that's wonderful, that's wonderful. That's like, that's unheard of for the SBA. But that is rare. That is really rare. But, but he's doing a fantastic job. And then those employees, they keep their jobs. It's good for the small business. It's good for the small town, the communities. I mean, this is the whole point. This is the whole point why we have this. Like, I have conversations with searchers in Europe and Australia all the time. And they, you know, and as much as we, you know, as in America, we love to, you know, some people love to lament the SBA program of, oh my goodness, look at all this debt and look at, and look at how easy it is to get. You'd be amazed at how difficult it is to transfer ownership of businesses outside of the United States because they don't have this kind of program. And, you know, and, you know, the whole point here is like, if we didn't have a SBA type program,

well, first and foremost, it would be so much harder for existing business owners to get access to capital that they need to buy new trucks, buy new equipment, and actually be able to grow and compete. Because that's kind of the point of business. We want to keep growing. If you're not growing, you're dying. But then on the flip side, you know, if I don't have a market to be able to either sell or sell my company, then what do I do with it? Like, at some point, this business is going to close, right? Just shut down. Do I, do I sell that value destroyed that, you know, the employees have to find new jobs, the customers have to find new, you know, and this happens all the time in capitalism. But if we can help protect a little bit of that and allow the transfer, then that's a great thing, especially since it means that as the buyer, you know, I don't have to go out and basically have a network of rich people to raise money from. Right? If I'm in Australia or Europe or somewhere else, the opportunity to buy a company doesn't even exist unless I can go out and raise the money to do it. You know, so yeah, that, in a lot of ways, SBA democratizes the acquisition portion to, you know, pretty much anybody with who can bring up 5% of a purchase price.

Yeah, I mean, as far as I know, like, it's kind of a cool program because like it's made for small businesses and not to get political, but small business is something that like both Democrats and Republicans claim to be. Yeah, they're like, yeah, we are the party of small businesses. We want to help small businesses flourish. So, so it's one of those things that like everyone wants a small business to do well in the town. Like, I don't know if anyone does that. Yeah, we want that. We just want monopolies. We just want it to be one, one, I don't know, one giant company that sells everything. Yeah, we want a much more diverse ecosystem. That makes sense. We want people to have options, you know, when it comes to growing their business or selling their business and these are these are good things, you know, and so we want to support that we want to encourage it. And we also just want to be clear eyed about the risks involved. There's a very, very big difference between buying a $5 million business with understanding all of the incredible risks involved, while also taking all the appropriate steps and trying to, you know, do it the right way with, you know, legal and QoE and, and, you know, all the other types of diligence you can do and hopefully buying a business that you actually can be successful in as opposed to just winging it.

And, you know, so, you know, writing your purchase agreement on a napkin somewhere, just you and the seller and just kind of figuring it out. And it's recipe for disaster. I would absolutely love to be able to be tasked with looking at all the deals that went wrong and trying to find a core, what's the correlation? I would love that. That'd be so much fun. But like, like, why did this deal go wrong? Like pinpointing it and then trying to like correlate it and then trying to like make recommendations to the government like how to make it better. Yeah. And, you know, oddly enough, that's something I think you we're going to be able to work on together as we go forward, because one of the things that I found, you know, since talking openly about, you know, my experience as well as the risks of other people is that, you know, my DMs are starting to, they've been flooded for the last year plus even more so now people say, Hey, yeah, this happened to me. This happened to me. This was my story. And, you know, there's a lot of reasons why those stories don't get out. But we also don't see it in academic literature. We don't see it in any kind of like any kind of annualized report. We know the SBA data doesn't track that at all.

And let's be clear, I can have a million people reach out to me and get and say, Hey, I had a business failure and prove that like so we know that it is a real story. But it's it's not scientific. It's still anecdotal because these are all self reported. It's all just people. But the idea here is if I can collect enough data and be able to start drawing those lines through and say, Hey, these are the biggest risks, these are the things that most often go wrong, you know, anything could happen. But these are the things where if we can knock these out, you know, it's going to increase your odds by 80% or more. That's what I'm excited about seeing. From what you from your conversations, people, what are you seeing? What do you think it is like the number one reason? Like what are you what are you seeing so far? The number one reason is always a some sort of miscommunication or misalignment between the buyer and the seller, like every single time. And I don't know right now how best to describe that because in a lot of cases, it's fraud. The thing with small businesses in America is that, you know, we kind of touched on this before a small business owner in America is basically God King Caesar of their company, like they could do whatever they want. And as a respect, you know, they write their own tax returns, they write their own financial statements, they could run all their expenses to the business. No one from the outside can tell them how to run their business and all that is great.

That's what we want, you know, in America where there's freedom of, you know, you doing your thing. But it also lends to, you know, practices that are not legal practices that are not, you know, on the up and up. And so, you know, from all the ones that I've seen, it's not always fraud. There is a lot of fraud, you know, whether it's something small saying like, hey, yeah, you know, I've got these expenses, but they're, you know, they're all, they're all older than they're not current when in reality they're very current and they're just kind of left out of the books all the way to something major. But then sometimes, you know, like, that's a big portion of it. And it's very easy to get away with that when you don't bring in quality of earnings, when you don't have a really good legal representation. So it's very easy for sellers to get away with stuff like that. But the other part of it is there needs to be that alignment. You touched on earlier, like a lot of these are family businesses, you know, and, you know, maybe they have kids that are working in the business, maybe they have spouses working in the business, maybe they don't want to work in the business in the future. But a lot of times it's all relationship. And if you can't build a relationship with the seller to the point to where like, there's going to be a smooth transition where they're able to transfer their knowledge and skills and connections and network to you in some meaningful kind of kind of way.

And then you both have the integrity to where the seller is going to walk away, not interfere. And you're also not going to like damage that relationship as well. You know, there doesn't need to be fraud. If you guys can't get along, there's going to be problems. And so we see that all the time, too. And so ultimately, I think it's easy for us to get caught up in the spreadsheets and the numbers and forget that it's all just people. That's all it is. It is. It really is. I always ask him my question, or I'm like, all right, do you have any income or expenses that are not going through the bank statements and not on the books? I just like seeing it. Yeah. It's always fun. It's funny how you when you ask the question in a way that's different than how it's been asked to try to get the right a different answer. I remember when I was going into the military and the recruiter was like, we're doing all the stuff. And the recruiter asked me, so have you ever been in the backseat of a police car? And like, You know, he didn't ask me if I've ever been arrested. He didn't ask me if I'd ever been charged with a crime. He's like, you've never been in the backseat of a police car. It's like, you know, actually, yeah, one time, you know, there was like this demo thing at school, cops would come out and get in the back.

And he's like, okay, just want to know the right answer. You know, it's like, because then it makes you think about the question as opposed to like, you know, instead of asking an order, like. I forget what it is. I like August 4th. It's not July 4th. Like August 4th. There's something like called like America Day or something like that. Like service day. It's like the fireman and the police department and the search and rescue, all those people, they kind of go into like the parks near my city and we go in the car. So yeah, I have been in the back of a police police car as well. But like you said, it's a lot easier to ask, hey, are you running any fences outside the box at the post? Hey, Jim, have you committed fraud lately? Yeah, sometimes I'm like, all right, what's the worst part about your business that you don't want me to find out? Because I'll find out. I used to be like that. But now I realize that's not going to help the deal. And a lot of times I ask questions. I know the answer to just to see if you're honest or not. Because they don't they don't people that understand what a general ledger is. They don't know that I know every single financial thing about the business. So I already know it all. They think I'm just looking at the profit and loss.

But I know I know everything in our ledger. But the challenge a lot of times is like if you own a second business and you're making expenses for your business that's selling through the business that through the business that's not selling, that is something that like CPAs can't catch. So you just rely on their honesty. Yeah. And you know, you bring up a good point too, because, you know, you have to be able to judge the integrity of the other person on the other side of the table. And I get that question a lot. It's like, how do I know if someone is, you know, if they're being on the up and up, if they're being truthful. And, you know, sometimes it's, you know, you have to, it's a lot of EQ, it's a lot of feeling them out. Like, you know, we all kind of have that you get that weird creepy crawly feeling when we know someone lying to us. But then it's also like you learn you understanding and knowing enough about not just the business but also the industry to where you can ask questions that you already know the answer to and just see what the response looks like. And then a lot of times you're not looking for like these massive lies, you're looking for little white lies, little, you know, little, little, little things that are a little bit different, you know, designed to be like, they kind of put you in the best light when in reality just the truth would have been better.

Yeah, that's a lot. There's a lot of stories I could go into. I just, I was afraid to like talk about. Fair enough. Well, I'm excited. This has, this has been a lot of fun. I think that, you know, especially as buyers, they're trying to find, you know, not just a good company, but they want to be able to verify in some sense, you know, how, how much can I rely on this on this on the earnings of this company? Does it make sense for the long term? So I'm going to step back a little bit. And Caleb, I want you to talk to the buyers out there and the sellers too. Like, I think a lot of times, you know, we focus on the buyers, but I want to see at the sellers side as well. Like, give them that, give them the two second pitch, you know, like why QoE? It really matters and why you should probably consider getting one, even if your deal might be a little under three million. Yeah. So when you're on the sell side, if you're a business owner looking to sell your company, typically you want to sell it the first time. And you don't want the seller, the buyer to walk away 90 days into this transaction. So if you present your numbers with good financials, with a good sell side QoE, that QoE should hold up on the scrutiny under the buyers QoE.

And now under the letters QoE as well, if they do order a separate one, and it's going to make sure that this deal can get funded at the price that the sellers, the buyers willing to pay. So that's going to help you sell the first time. And business brokers, if you have a good sell side QoE, that's going to help you. You're, you, what do you call it? You've earned the right to ask for a shorter LOI time. If all the financials are there, there's a good sell side QoE. You have all the QuickBooks exports there. You can do a shorter LOI and you can now say, Hey, the first three weeks, the QoE gets ordered right away. If the earnings are farther than 10% away, the deal's done. You know, you want, you, because time and money matter a lot in this. And so if the deal's not going to go through, you want to find out right away and kill. Yeah, that's good for the buyers. It's good for the sellers. It's good for the brokers. It's good for everyone. And then on the buy side, there's a lot of deals that show that appear to be very lucrative, but you might be overpaying for that deal. And we will help you make sure that the earnings are as high as the sellers are saying they are. And then we'll show you the rest in this business that you might not see in a set.

They might not see just getting from conversations. I personally had done over 350 deals. My coworker, Chloe Barger, has also done over 350 deals. And so, so we know what to look for when you're buying a business. And, and we take pride that our buyers have never defaulted on their loan. And we want to, we want to keep that going. So yeah, if you're looking to buy a business and you want to QoE email me, Caleb@qoeprep.com. Yeah, so I have. Well, that's great. I think this is super helpful because it's going to help buyers make sure that they're, you know, taking up precautions to knowing that they're actually buying something. And if they're going to sign a personal guarantee that they're, they're doing that on financials that can actually hold up under scrutiny. And also for sellers, because, you know, like you said before, there's nothing better than stepping forward as a seller, knowing your numbers are legit, knowing that the buyer, if they push back, then you've actually got something to back that up. I was working with a seller just a month ago. And on the very first call, the seller told me that they didn't get a sell side QoE because they just wanted to move forward. They just, and I'm just like, wow, thank you for telling me that

your numbers aren't legit. And so now if I get it, if I get a buy side QoE, then what are you going to do? Like, I can adjust the price, I can adjust the multiple, like you've got nothing to push back on. And so I mean, you know, yeah. Also like a sell side QoE, I had, I was helping a law firm sell and the buyer came in and they're like, Hey, we're going to adjust the price down by $7 million and set it 33. We're going to, we're going to offer 7 million less. I said, why? Under what assumption? And they said, Oh, because of these two things. Basically, they were saying there's customer concentration. I said, Well, you can't really do it for this, this type of law firm, it's injury law, they would have allocated, they would have gotten more clients and allocated those employees over there. And so I say, I save the guy $7 million by doing that. Because I understood the industry and there was a good sell side QoE. So sometimes you just need to have your own accounting nerd on your side to help you get your numbers rather than just hoping that the buyers get a QoE company that those that they're doing.

Yeah, absolutely. Well, hey, thanks, Caleb. I think this is this has been fun. This has been informative. Yeah. And now that we have had a successful Substack live and by successful, I mean, it's been recording this whole time. And it's still We got five people. We're five live people. Hey, there we go. We'll get over 500 views at the end after the non live version, the dead version, this is good. And I expect that we're going to do a several more of these in the future. And then hopefully get some Q&A sessions as well. Because, you know, most people are not financial whizzes. And so having somebody like you on the call that can actually answer a lot of those questions in real time is super helpful. So thanks again for being here. Thanks, Jed. I really appreciate it. [BLANK_AUDIO]

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