Why Skipping Quality of Earnings Could Kill Your Deal with Caleb Basile

Hello, everybody. Welcome to another episode of Still Searching with Jed Morris. Today, I'm speaking with Caleb Basil. He runs a QoE prep company, so he's doing quality of earnings for business buyers. Thanks for being here, Caleb. Thanks, Jed. Appreciate it. Did I pronounce your last name right? I just realized that I wasn't sure if I was-- I wasn't even going to correct you, but it's Basile. Basile. I always ask because I want to make sure that that's done correctly, and I think it really matters. I've got one of those first names, Jed Adaya, where literally no one knows how to pronounce it correctly, and so it's always been kind of a thing for me. Yeah. You have to be a starress by the end to be able to pronounce your name. Yeah. Well, hey, thanks again for being here, and like I said, you run QoE prep, and you do quality of earnings for lower-middle market and mid-market companies, correct? Correct. All right. Well, hey, tell me about kind of how you got into the space and what exactly QoE prep is doing. Sure. A little background about myself. I started in-- I'm just going to turn off the

here. I started in public accounting back in 2017. Did a little bit of audits, payroll taxes, CFO services, taxes, just a little bit of everything for small businesses. I got to wear a lot of hats. From there, I decided I was going to focus on audit and work for Baker Tilly with the goal of becoming an audit partner at Baker Tilly. Within a year of being there, they said, "Hey, we need help with transaction advisory services called the quality earnings. Do you want to do this?" I said, "I don't know what that is, but I'll give a shot because I don't really want to do employee benefit plans over the summer." So I joined them, and within a week, they said, "All right, you're going to join us full-time on quality earnings. You're no longer doing audit. We like you. We really like working with you." So I said, "Great. I enjoy the work as well." It's a little bit more fun. You add more value to QoE, saying, "Hey, buyer, you're actually going to buy this for $500,000 less than when you say, 'Hey, you owe $20,000 in taxes.'"

Yeah, that's definitely much better news to deliver to your client. Yeah, or with an audit, yep, numbers look good. I don't know. It's just so much more buy added in quality earnings and transaction advisory work than an audit. But I did originally start off doing QoE's directly for clients. I wanted to stay on the larger deals. So I became a staffing firm, if you will, or a consultant with contractors working with me, all based in USA, and we'd work on these larger deals. And they pay us a percentage of their fees, but we'd run porn and everything, do everything from beginning to end for them. After a year of doing that, I said, "All right, I'll do my own deals." And I'd like to stay in the middle market, but I'm also in the lower market as well doing deals anywhere from $1 million to $50 million in revenue. Got it. So your bread and butter is kind of in the middle market then. So I imagine independent sponsors are kind of, and fund managers, those

are kind of like your primary clients, but you also dip down to financial buyers and first-time buyers who may be looking at the SBA route. Correct. Yeah, exactly. Okay, good. Well, that's really interesting because a lot of people that I talk to are the first-time buyers, and they're just kind of getting their feet wet with the idea of how to search for a business, how to do due diligence. And one of the biggest, I guess, gray areas of mystery, especially for first-time buyers, is the financial side. Now, we know that finances are only a piece of the deal, but in a lot of ways, they're the foundation for what the deal is on, right? You have to have them there in order to have the deal, and it doesn't mean the deal is going to work, but if the finances don't work, then there's no point in even having this conversation. So as we head into due diligence, that's typically where you bring in somebody to do quality of earnings. So what exactly is the quality of earnings and how do you approach it with your clients? Good question. So when you sign LLI, you're on a ticking time clock. Yeah, 60, 90, 45.

Some amount of days to do all due diligence before you say, "Hey, seller, I'm going to buy the company," or you say, "Seller, I'm not buying this company," or you say, "Seller, I'm going to buy it. Can we talk about pricing?" So the main diligence are financial and legal. I try to make my offer where you can do all your financial due diligence before doing legal. So I get it done in two weeks. I'm hammering. Two weeks? Yeah, in two weeks. That's amazing. Usually, it's like four to five. Well, one week of it is the QB provider. They'll be making sure they're allowed to do this and that there's no pelvic of interest. The next week is gathering data, and then they're just checking our everything. Or there's backlog because they have to do a lot of tax reports or a lot of audits as well. But since I'm a QB specialist, it's the only thing we do,

and we could start on day one. And I'll hop on the call with the seller and get all the stuff I need right away. I'm not going to delay. That makes a lot of sense. It's kind of like other businesses, and I know I'm digressing a little bit, but it's kind of like going to in and out burger. They only do the burger. There's nothing else there. Now, I'm cutting out all the other fluff. Or it's like Chick-fil-A. You're just getting a chicken sandwich. Don't show up if you're looking for burger. I'm going to Chick-fil-A. So that makes a lot of sense, though, because you're like, "Hey, I'm not doing all the other fluff. I'm just doing the QB, and as a result, I can give you a better product at a faster turnaround." Speed is everything. Yeah. And if the deal dies, I'd say, I don't know if these numbers are right. As a number of guys, I should know. But probably eight out of 10 times, it's the financial due diligence and not the legal due diligence. What have you seen? It's the same thing. I mean, there's been, and granted, I'm not on the services side as you, so I see far fewer deals. It's more of me. I'm talking to searchers who have had

experiences while they're buying successfully or backing out. And the vast majority of time is the finances that came out. It's waiting to find out if you haven't found anything already that's made you leave the deal. It's the Q of E coming back to either confirm or reject the numbers that you've already assessed. I mean, there's one or two times, I have seen one or two times where the legal did ruin it, where it's like there was a minority owner that nobody knew about or something like that, like a minority owner who had died a few years back and now the spouse like legally owned a piece of the business and they're just trying to sell it out from under. I've seen that ruin a deal, but you're right. I mean, yeah, I mean, you know how it is, small business. It's just total mess. But yeah, I mean, that's rare, but you're right. It's almost always the finances that ruin the deal. Wow. Okay. All right. So, okay, so you're doing the Q of E. It's all you're doing. You can return this thing in two weeks, but what is the Q of E? I'm a brand new buyer. What the hell

is this thing? And why should I pay you whatever your fee is to give me a Q of E? So I'd break it down in three sections for, I guess, you got the quality earnings piece, which basically we're looking at what the reported even is, what the seller's adjustments are, then what our adjustments are, which comes to the adjusted EBITDA amount. The adjusted EBITDA amount is very important because most businesses in the smaller space are going to be a multiple of adjusted EBITDA or sellers discretionary earnings, which add back all the money going to the seller as well. So we help verify that all the seller's adjustments or the broker's adjustments, because the broker's representing the seller, that all their adjustments are operating, reasonable, and that they calculated it right. So the first thing I do in the Q of E is I'll look at the seller's adjustments. I'll either accept them, deny them or recalculate.

And that right there is going to save you. It's going to help you. It's going to lower the purchase price unless they did it really, really well and are way too optimistic. So the QE is one piece of it. The next piece is the profit and loss analysis. I'll look at the revenue. I'm just doing this in order of my template. I'm not doing it in order of that I do the work. But you look at the revenue, the types of revenue, the customer concentration and the seasonality. And then you got the balance sheet section, which looks at count receivables, accounts payables, inventory, networking capital, customers and cycle. And then you got the reconciliations. The reconciliations are the first thing I do is the first phase that they don't pass. The deal typically dies and I'll only charge you half the amount. Some people say, oh, you're a QE provider. You should charge the full amount no matter what because you did the full service. Well, no, I give them a happy time to like, hey,

I'm done with half the work. If you want to leave the deal, because they're claiming a million in net earnings, but I'm only seeing 700K net earnings, you can leave and now we fund you half the amount or you can roll it to your next deal. No, I'm going to pause right there because that's actually a really great sale to the buyer because I've had this conversation a few times and people ask me, I'm like, blanket, I would not buy another business without a QE. That's my blanket response. And I understand there's different revenue levels. If you're buying under a million revenue, there's risk on. I would still argue that the ROI is there for a QE. Now, even with that though, like, you always run the risk of dead deal costs. Like, what if I get in there and I pay for this QE and then it proves that the deal is no good? Well, the truth is, is that it's still worth my money because you kept me from making a bad deal, but it doesn't change the fact that I now have to sunk deal costs. And so what I do personally is I go in there and I'm like, you know, for the first week or two, you know, once we're in due diligence, I'm doing my own financial due diligence from like, you know, I'm looking for any big red flags

as a non professional. And if I see a big red flag, then I'm like, okay, now I don't need to pay for it. I'm out whatever. But if I don't see any big red flags, then I'm like, okay, let's bring in QV. And you're kind of doing the same thing. You're like, Hey, I'm going to start off with these reconciliations because I know they're important. And once I knock those out of the park, you know, I'm going to give you the results of that. And if it's not, and if this is something like a big red flag, we're like, Hey, it's not even worth paying like going through the rest of this QV. You're saving my time. So I'm going to save you some money. But it's up to you as the client and the three main reconciliations are financial statements to the bank statements, bank, then financial statements to tax reports and the payroll counts to the payroll accounts. Then if they have revenue, like point of sales revenue system, I'll compare that as well to the revenue line item. And then I'll also look and look into the seller's ad backs, all their ad backs to make sure they're reasonable. And then at that point in time, I'll present it to the buyer and say, Hey, we're halfway done. Here are the numbers. Here's the variances. Do you want to keep going forward or stop?

That's incredible. So if you can do the whole QV in two weeks, are you saying you can do that to get the halfway point after one week? Yeah, one week. That's amazing. This is when I get the data. So if there are not going to be data at all, I can't do anything. I mean, if you're doing a QV in April, you're going to be delayed because a lot of their external accountants are saying, Hey, it's taxing themselves. There's deals where you won't get anything in April. If you're doing a QV in January, it's also going to be delayed because of audits. But most other months, you can get the data pretty fast. And if the seller's broker has done a good job, in the perfect world, a broker should never list a company without having everything in my replacement list, which is pretty basic. It's just reports from Quick Books, famous statements and tax reports, pair of reports. That's all. That's all you need to have. But it's very early that it's there. Yeah. Okay. So you're doing the reconciliation.

You get to that halfway point. And as the buyer, if I'm like, all right, well, big red flags, I don't want to keep going, then I can save some money, you save some time, and we just end it right there. But let's assume that it comes back and everything's looking pretty good. And I'm like, all right, let's keep going. What else are we looking at? So we're looking at the customer concentration, which is something you could probably do before signing LOI. We'll look at the revenue trends, also something you could do before signing an LOI. There's a lot of stuff people can do by themselves. The challenge with that is, is this just confirmation bias? And are you wanting to buy this company so bad that you're ignoring the bad stuff? It's kind of like, I'm really good at numbers and I'm really good at investing. I was fantastic. I won six out of seven years. And by winning, I mean, beating the S&P 500, I stopped doing it because it took up so much of my time. And because I would get emotional every now and then. And even though I knew the numbers were right

and I should have held on outside. So I stopped doing that type of investing. And I just buy like a next fund now or ETF to make it much easier. And because there's the emotional piece of it. But when you're buying one company and you're just using yourself, the risk is you might be glossing over stuff that you should be looking into. Yeah, the risk is enormous. You get that behavioral finance side where you're like, I love this deal and everything you put on the rose colored glasses and everything looks great. One of the things I've run into a lot is, as you know, I've been interviewing people for my upcoming book and we just finished. But in over 75% of those cases, I asked very directly, I'm like, Hey, when you finally got to the deal that we're now discussing, and was there buyer fatigue? And and they look back and like, yeah, I was searching for 12 months. I was searching for 14 months. You know, personal capital was waning. I was like, I was really getting stressed out about whether

I was going to find something. And so that buyer fatigue fed into them putting on their rose colored glasses and, you know, making some exceptions for the standards that they'd held up until that point. So having somebody like, like somebody on the outside who can look at it objectively is incredibly valuable, much less knows what they're looking at. Yeah, they're too caught up in trying to join your next podcast and done searching. Right. Yeah, that I mean, it makes sense, especially as the first time financial buyer and you're like, you know, you want to get to that ownership level so fast. And I had somebody reach out just yesterday and they're like, I tried searching for business last year, but I failed and now I'm trying to, you know, find another one. I'm like, Whoa, they failed. Yeah, I didn't find anything to buy. I'm like, that's, that's not failing. Failing is buying a bad business and buying that being four million, you know, in the whole personally guaranteed that's failing. Not buying is not failing, which is exactly what I love about the Q of E. So and you're right, a lot of these things, you know, you can look at, you know, free LOI, but it's more the confirmation because, you know, you're

trying to figure out, okay, well, I've got all this customer concentration, but based on the invoices and the payments, it could be more severe customer concentration than you thought going into it. Yeah, or I've seen clients, they'll call, they'll say they have seven, like seven customers in the top 10, but also those customers are the same customer just in different locations. Yep. They call it different things in QuickBooks. Yeah, I saw the same thing last week, someone bought and they said they, they, they knew the, the number one customer was 30% of revenue, but not until after they bought the company, they found out that it was actually 40% because there was a subsidiary also billing. Yeah. So yeah, that's an incredibly big risk. So as you're going through these Q of E's and just for context, how many of these deals are you doing every year, like more or less? So between me doing the deals directly for clients and doing deals like being outsourced to do the work, last year I did 57. Wow. 57 Q of E's. So it's, it's, I mean, you're seeing

a lot more of these than I am, that's for sure. And you're seeing a lot more than, than the typical buyer would be. And so we're seeing all of these different Q of E's. What are the, what are like the top three, like red flags you see, like right at the, it looks like it happens so often that you're like, yeah, these are the top three things that I just see over and over and over. So I like to look at the, the sellers add backs to make sure they're reasonable. A lot of times they'll be adding back stuff that's part of the operating business. I like to look at customer concentration, vendor concentration, salesman risk concentration. So if it's a not recurring business, I want to know who's making the sales as the owner making the sales and leaving. And then I also like to look at like a variance analysis. So I'll look at every single type of revenue and type of expense and see how it's trending over time. And just anything that jumps out, I'll talk to the owner about. Okay. That actually makes a lot of sense, especially the salesman part of it. Because we know that a lot of project-based work, you know, the owner typically is the number

one salesman. I recently spoke with somebody who declared bankruptcy last week. And that was the issue they ran into. They bought a company where, you know, 100% of the sales were coming from two salesmen split almost 50/50. And they, you know, they found out right from the beginning that, you know, the whole company hinged on these two salesmen. And this particular buyer was able to kind of limp by for a few years, but ultimately couldn't hire, you know, I tried hiring other salesmen, but just couldn't get past that point. So that's an incredible risk. Yep. I used to, so my brother is in sales and he galls and he looks to piece. And me and my younger brother will make fun of him. We're like thinking, oh, salesmen think there's a roll this stuff, but then I started my own firm and realize, yeah, we do deserve it all. It's hard. It is not easy selling. I mean, I'm lucky in that I'm a CPA, so people don't expect me to be like the most extroverted person and like selling like here and there and like helping them with all that stuff. And like my work in Excel will speak for itself. And then you get people selling for me basically. Yeah. But I get those sales people deserve

everything. It's hard. Absolutely. And I've talked to, uh, who was I was, I was speaking with Nathan Lindley a few weeks ago and he runs in HVAC. Um, I wouldn't say roll up more of an aggressive add on business in Texas. And, uh, he was talking about how like, uh, when he took over the business, the salesman were all like, they were paid plus commission and just not bringing in the sales he was looking for. And finally, he's just switched to pure commission and lot, you know, obviously lost the salesman he had and went through a few before he found a good ones, but he was like, but then everything changed. Like when he found a few salesmen who were just commission only, and they were just straight hunters. And he's like, he's like, these people I'll give them, I'll give them 20, 30%, whatever the, whatever the deal is because they're just bringing in all that revenue. And if you're bringing in this revenue, I will happily pay you the commission fee. Yeah. Yeah. I was explained that there's two types of salesmen. You got the hunters that are getting new business and then the farmers that are keeping the old business and I can farm. If I have a client, I'll keep them and I'll get them to tell their people about me.

As far as like going out, looking for new people, that's definitely a challenge for me. So I get why those sales people need to be paid a lot. Yeah. Okay. So, uh, sales risk makes sense. Um, one of the first things you mentioned was the ad backs. And this is something that a lot of, uh, first time buyers really get tripped up on. Um, whether they're looking at EBITDA or SDE, there's always a seller ad backs. Um, what are the, some of the most common ad backs that make sense you expect to see? And what are there's like one or two ad backs that are commonly thrown in there where you're like, yeah, that, that doesn't, that doesn't pass the test. Yeah. So not only do we need to make sure that they make sense in our common, in our reasonable, we need to make sure that it's in the profit and loss statement. Cause sometimes they'll be adding back ad back, adding back balance sheet items. So there's personal owner draws and it's something that's not hidden the profit and loss statement at all. It's only hitting the balance sheet, but they're still adding it back. So it's like, they're double counting it. Um, and I'm not saying that the seller doesn't know what they're

doing, that the seller's doing on purpose or the broker's doing on purpose, but it happens and unintentionally, cause they're not sure what they're doing or maybe intentionally. I don't know. It happens a lot of times. Um, so, uh, the, the owner pay, you add it back back, but then you have to act on the man on the QV due diligence, you got to add a manager pay going forward or the new owner pay going forward because, um, just because an owner's leaving, you got to find something to replace their work. And just on that piece, one, one common thing I've seen is where, you know, you get a lot of these, um, you know, trade businesses where the owner is paying themselves, you know, directly out of SDE, which makes total sense. Um, but then they usually have like a spouse or somebody else in the family who's running like the books are doing or running like the sales or whatever the case is, and they're not accounted for at all. Yeah. So you do see that you have to make sure you add their salary back as well. Yeah. If you got to add back their salary, but then you got to realize, let's say they're

taking care of the books, you got to either hire a manager, a someone to bookkeeper for them going forward, or they had to find outsource the bookkeeping to another company. So there's two ad apps going, one going each way, one from the seller, then the buyer does their own ad back as well. Yeah. I've also seen one where, you know, the seller, uh, was using their personal truck as a business truck. And then when they left, they added back the truck and I'm like, well, it makes sense. It's your truck, but if you're using it for the business, now the business has essentially lost a truck. Yeah. Yeah. So that's, and that's, that's one where it mixes with both the financial piece and the legal piece, like, okay, what assets are staying with the company? Um, well, will a new owner need a truck to do business? Yes. Yes. Then I'd probably say, keep everything in the P and L. Don't change it to you. Uh, and just say this is part of the purchase price that you're taking the truck away. Yeah. No, that makes no sense. All right. So with ad backs, what's one of the two, one

or two that you see that are, you know, consistently thrown in there, where you're like, no, got to remove those immediately? Um, so like increased advertising expense that did not bring in extra revenue. It's a red flag right there. So that's like, okay, they're trying to make more money. They spend a lot on Facebook or Google or LinkedIn ads or YouTube ads. I've never really spent any money on ads. I don't really know what people spend. Um, they're like, yeah, we spent all this money on ads and we're not getting any more revenue. So that's non operational. But if you look at tax, the tax return, advertising and marketing is one of the main, it's like, it's just a category. It's not another expense. It's part of the operational part of business. Um, or a lot of times I'll see on the bicep. So I'd be both sell side and buy side being part of the, doing the middle market. I'll see buyers try to just add back or like take

away one time revenue. Yeah. If I'm representing ourselves, I'm like, okay, if you're taking away the one time revenue, you got to take away the one time comms as well to make it fair. So just something to think about. Um, yeah, anything, it's a lot of like non operating type things, or they'll say it's not operational, but then I just say, yeah, it's operational or like a bad hire. A lot of times people will try to add back a bad hire. Like, yeah, this is a bad hire. We had to fire them. And it's an operational cost. Like people leave jobs every two to five years. Like it's part of the business or consulting fees. Um, I've seen that hiring consultants to help you sell the business. And they're like, well, we're going to add this back because obviously you're not going to need this consultant going forward. You know, well, you know, there's a, there's a thin line between where they helping me consult the business or where they helping me improve the business, which a lot of times, you know, building a business and sale is improving the business. Yeah. Yeah. And sometimes

like, okay, so like if an owner has expenses for selling a business, like he's paying a broker 10,000 a month to list this company, that's a reasonable add back. Um, because you're not going to be having that listing fees again going forward. Yeah. All right. Let's pull out of the weeds for a second. Okay. I love this, by the way, because I think we're, you're kind of shedding some light on kind of the financial due diligence that a lot of buyers, you know, they, if you're like most people, you shy away from the things that are uncomfortable. If you don't know it and it feels uncomfortable and it's hard to learn, then just like, well, if I get everything else right, then maybe I can just ignore this piece or hire somebody else to do it. Yeah. But what I've found is that, you know, when it's the financials, even the legal, like you have to find people who can, who are doing this stuff that are better than you. Like I, I'm always going to reach out to somebody like you who, who, you know, does Q of E as opposed to just trusting in myself to do it, because I'm not an expert. But at the same time, you have to know enough about the process to A, be able to vet the professional that you're hiring and B, being able to question

what they're coming up with. Otherwise you're not really taking ownership because at the end of the day, you know, you're going to get your fee, but as the buyer, I'm the one signing on the purchase agreement. So it's all on me at the end of the day. So taking a step back, you know, out of the weeds of it. Is there any circumstance, and I know you're biased on this, but is there any circumstance where you'd imagine like a Q of E may not be required? Like you would have ever advised a buyer to move forward with that one? Turn and tell because you don't know what you don't know. So like I've worked on like a small deal, the buyer's like, yeah, this isn't really that important. But I'm just doing it to check the box. And let's just say my service has added a lot more than checking the box because there's a lot of expenses. Very rarely you'll see someone overpaying in taxes, but he was missing a lot of expenses on his tax support and on his financial statement. I found it doing the poop of cash. So there's a lot more money running, leaving the business

in the bank statements that I could see than that will is being reported in the financial statements that ended with the seller firing his accountants. Oh, not it was not my goal to get people fired, right? But you're finding the problems. Yeah, I found that the huge problem of it. And he was overpaying in taxes too, which is kind of funny. You rarely see that people overpaying in taxes. Yeah. Yeah, I'm sure he wasn't happy about that. It's like the last thing you want to overpay in. Yeah. And then beyond that, you mentioned earlier about how, you know, if you go into an into due diligence and you believe EBITDA to be 1 million, and then after QV, you find out that EBITDA is only is 700,000, right? And some people are like, okay, great, you saved me 300 grand, but that's actually not true because we're buying based on the multiple. Yeah. You know, so if I'm buying based on what a 4X, you just saved me what $12 million? Yeah, I think it would be 1.2 million. Yeah. Yeah, exactly. I think that's why I need me. Well, it also gives you the like, it's okay

if the numbers are off a little bit and you come back and you still like the business. But then, you know, with that, with that, you know, third party QV, now I can actually approach the seller and renegotiate in good faith, as opposed to, you know, just trying to, you know, yeah, trying to do something else. And so here's the challenge, like, okay, you feel a good price amount that you're going to buy, you go to a seller and they might say, well, you know what, I had another buyer interested, I'm not interested in working with you anymore. So I feel for some reason, like businesses are really overpriced right now, because the economy is great. In some areas, it's really good. There's so many buyers wanting to buy companies, the SBA loan allows for like anyone to buy a company almost, like via decent credit and some cash. And now private equity is buying the smaller businesses as well. So more buyers drive the competition, every single company is going to be worth

more in some ways. But I mean, you can compare it to like the stock market, the big blue chip companies, you're paying 20, 30, 40 X earnings for these guys who just paying 45, 67, you're not paying as much as the other ones may to two, three X earnings really depends on the business industry. The risk is much higher though. I mean, if I'm buying if I'm buying GM at, you know, 14 X and whatever the earnings happens to be, I think the only training like eight or something. But even then, if I'm like, there's very little likelihood that they're going to go out of business next year, right? Whereas like a small business, I mean, you can get. Not sure how terrifically hit them, but I guess we'll see, right? Well, that's a whole different conversation, which may change by tomorrow. Who knows like how this is going. You look at what happened last week, stock market went down and right back up. So we'll see what happens. Yeah. And when you're doing your QV, obviously you're looking at all the history. You're, you're going through, you know, like revenues and not just revenues,

but quality of revenues, quality of the customer, a dilution, all this kind of stuff. By doing all that, do you provide any, any four leading projections or do you just kind of hand over the guidance to the buyer and say, Hey, now you can go talk to a fractional CFO about four leading projections. Yeah. So the QV is typically you buy a company and what it made last year, not what it'll make next year. However, if you're a strategic buyer, you can kind of like see what the trends are, how much has it gone up in revenue year over year? What are the fixed costs that are going to remain the same year over year? What are the variable costs that will go up and revenue go up and you can see what the numbers will look like. As far as projections, I can help, but I'll have the disclaimer of, or use will be assumptions of the buyer. So I can help build that for a buyer. You just made a comment there that reminded me, obviously some businesses are more capex

heavy than others. Like it's a big difference buying a commercial landscaping firm as opposed to a property management HOA company. And so as you're going through the QV, what do you, what, if anything, are you doing to kind of highlight businesses that are heavy capex? Like what the cost of that capex may be? Like, you know, there's a big difference between having to buy a business where they're, all their vehicle fleet is two years old. It's supposed to 12. Yeah. Yeah. So when it's, yeah, when it's higher capex, I, I don't a lot of times say right below even like, Hey, these are the even amounts, but here's what they paid in the last three years on average for capital expenditures or maintenance capex, which doesn't really make sense to me, but that's a term maintenance capital expenditures. Sounds like to me it's just maintenance or repairs expense, but it's the way people are making a company worth more. Yeah. So I'll just include that there. So they're aware of it, how much extra cash they'll need to maintain the stuff. Yeah.

That also helps. That also really helps the buyer see that if the seller has been neglecting their capex expenditures for the last, you know, 12 to 24 months because they're trying not to spend money on it. Yeah. Or you got to look at accounts payable as well. AP aging, if there's stuff over 90 days towards the end, like people are like, Hey, let me slam the new buyer with all this stuff I haven't paid yet. And that's what the networking capital, adjusted networking capital, networking capital peg helped you find out. So as a buyer, you want to buy a company and you want it to have money coming in and what they owe in the current assets, current liabilities, you want it to be at a good amount. You don't want it to be like you have no accounts receivable, no money coming in or none of these like little liabilities they have to pay. I love that. And this is exactly why I want to have this conversation. You know, people who see me on LinkedIn, they see that like one of the biggest things I harp on is the

cash conversion cycle, like you have to know how long it takes for you from the moment you make a sale to get through accounts receivable through all the way through your operations, all the way through accounts payable, like how long is that? And obviously that influences networking capital. But that cycle, I mean, the longer it is, especially on the front end, the more, the more risky the company. And so I think I tell buyers all the time, I'm like, look, you know, the people you're buying from nine times out of 10, they're not super financially sophisticated. They're not doing like five year leveraged buyout projections or anything else other crap, but they know where all their dollars are. They know exactly where their cash is. IE they understand the cash conversion cycle for their business. And if you don't understand that, then you're walking into disaster. And so, you know, I talk about this, but I have this unique opportunity to talk to a professional about this. So talk to us and explain the cash conversion cycle and why it's so important. Yeah. So basically, it's a formula that looks at the total sales divided by, I think I'm

getting this right, I could be getting it wrong. It's basically a formula between sales and accounts receivable. And it makes sure like how long it's taking you to collect. So if total sales are 1 million accounts receivables at 250K, your cash conversion cycle's 90 days for that account receivable piece. And then you look at the same thing for AP and costs of goods sold. And then you can also look at the same thing for inventory and costs of goods sold as well. And it just tells you how long it should take you to get the money. Another piece that I like to look at that can help out with this for the buyer is the seasonality of the business. So I look at it by month, but then I also look at each quarter and just to show what percentage of revenue is made in quarter one, two, three and four. And if it's over 30% or under 20%, it's just something that a buyer needs to be realized when they're buying a company.

Yeah. I saw you post on LinkedIn either yesterday or something, but you're going through this construction company and you're talking about the seasonality of it. And part of the work in the business I used to own was landscape construction. So I totally get where you're coming from where it's like, you know, you have these projects and it's not just the accounts receivable. It's how much of that project has been completed, how much has been accurately billed for. Like this is so important. And a lot of people are just skipping right over it. And I don't want people, especially people who are like looking at like HVAC companies or whatever and thinking, Oh, I don't have projects. I can ignore this. But this is really important. Like, how are we adjusting for the amount of money that you're receiving? And is it, is it accurate? Yeah. Yeah. Yeah. If you're buying a company where projects take a month or longer, you really need to look at the work in progress and ask the sellers, can I have your work in progress or percent of completion reports? They call different things, but they're basically the same thing. And if they don't have it on a monthly basis, you got to really look

into their numbers, look at their profit margin percentages, make sure the profit margin percentages are staying pretty even month or month. But yeah, that's what that that video was about, making sure that the financial standards are showing money when earned, not when billed. Yeah, exactly when earned because you can't pay payroll with accounts receivable. You have to pay with cold hard cash. Yeah. And it's not just, you know, when you've made the sale or when you've earned the cash, it's like, when you earn it, how fast do you get it? I mean, you know, it's, it really makes a difference if, you know, you're billing out all this cash on these larger projects, or even smaller ones, and your customers are, there's a difference between their, you know, paying via ACH, or they're just physically mailing you a check. Like how long is that going to take to arrive? And there's just, there's so many of these details that you really have to know. And, and that's, you know, I know we're, again, we're in the weeds, but this is why it's so important to talk to a professional because these are the things, these are the questions that buyers don't know

how to ask. And for those of you who are listening and you're enjoying this conversation, I just want to say like today, we're really going to kind of like a high level view of a QV, what it is, how we're looking at it, but we're going to have a follow on conversation. We're actually do a case study on this. So you can actually see what it looks like practically, you know, and how Caleb walks through his decisions, which is just incredible. Like until you see it, it's hard to really grasp the amount of detailed work that goes into it. And the biggest takeaway for me is like, when you actually see it, you'll stop thinking that you don't need it, that you can just do it yourself. Yeah, yeah, there's a lot of formulas. Yeah. And not just, I mean, yes, there's a lot of formulas and I'm not a, I'm not an Excel guru, so I don't even want to try to do that. But the biggest thing is like, like with everything, you can't answer the questions you don't know to ask. Like how many people right there probably didn't know to ask, okay, well, you know, how am I going to, how am I going to put the formula together for cash conversion cycle? And, you know, how does

that impact networking capital? Because it's one thing to say, all right, well, if I'm going to take like all the cash, this is something I hear a lot, I'm going to take all, I'm going to take all your, your bank statements for the last 12 months, and I'm going to average them together. And whatever the average is for over 60 days is your networking capital. Like, that's a pretty risky way to go about it. Because you don't know how long it takes for your inventory to look at it, look at it, you don't know how long it takes for your accounts receivable to come in, like you may get an estimate for networking capital and all of a sudden it's gone within the next two weeks. And now, now you're stuck. And without cash, you're insolvent. Yeah. Incredible. All right, well, hey, Caleb, this has been fantastic. Like I said, we're going to, we're going to bring you on for part two of this where we actually do a legit case study on this. Before I let you go, what watch are you wearing? Oh, it's a Garmin. I'm, I love running. Yes. Yeah. Garmin Phoenix six. What's your month 255? What's your workout method of choice? I just like the long, slow distance

run. Awesome. That's why I'm taking a break on it recently. But every time I notice it's like I tell people, I'm like, look, if you're in the Garmin group, you know, and if not, you don't understand. Yeah. Yeah. I have so many, like, I don't know. I feel like I get a lot of leads from Strava, because I'm on Strava as well. Yeah. Yeah. Awesome. All right. Well, hey, thanks again for being here, Caleb. Always excited to meet another runner, especially somebody who is a pro at Q of E and can really help break it down for us. So again, thanks again, and we'll see you on part two. So we can go through the case study. Hang on. I got to show you my Boston. There you go. There's my Boston. Yes. Wow. All right. You ran Boston. So okay. All right. Before we break. So what's the goal for this year? Oh, this year, I mean, I'm running daily. So I'm at like 610 running day streak. I would just like to do a faster 5k. I want to get under an eight minute 5k. There you go. What's your all time record

for the 5k? I think like a 1730 in college. That's booking. That's all right. Very cool. Well, thanks again for being here, Caleb. Looking forward to part two. See you.