Terminal Value

How Small and Medium Businesses can Grow through Leveraged Acquisition

Janine Bacani

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We have Gary Guseinov with us today, and what we are going to be talking about is how small and medium businesses can grow through leveraged acquisition. Now, I know to a lot of people who are listening, when you hear the phrase leveraged acquisition, it may make the hairs on the back of your neck stand up just a little bit. But the thing is, if you do it right, it can actually be a fantastic way to grow your business. Now, of course, I was in the corporate world for 20 years, and so I have seen a long laundry list of bungled acquisitions, many of which were taking place when I was at Intel Corporation, where intel paid tremendous amounts of money for these companies and usually ended up destroying whatever unique value they had absorbed. We can get into how and why that happens and how you can avoid it in just a minute. But Gary, please introduce yourself. 

Sure, yeah. Thanks for having me, Doug. My name is Gary Guseinov. I’m the CEO of Real Defense Holdings. We’re a holding company that acquires consumer privacy security companies in North America. With four acquisitions in the past four or five years, we’ve raised about $50 million. We’re profitable and growing. 

Got it. Well, okay, so let’s talk about this leveraged acquisition thing, because I think it’s something that’s really easy to misunderstand. And I think the place where it plays the best is when you have a business where you can acquire another company that’s either in the same business as you or in an adjacent business as you. And at least the way that I think about it is that you want to say, OK, you want to acquire a company that will have a significant crossover with the same customers that you are trying to serve, because then what you can do is you can market offers to those customers. And if you do it right, you should be able to generate enough additional revenue to where you can offset the acquisition cost or the interest payments, depending on what kind of situation you’re looking at. And you can end up having a situation where your net value ends up being a multiple of the acquired company. At least that’s the idea.

Right, and so there are three fundamental benefits to doing this. One is creative revenue. So you find the company, hopefully they have revenue, and you can add that revenue to your company profitability. If they’re a profitable business, you can add profit to your company by acquiring your competitor or a company that makes sense for you. And then the third one, most important one, is synergies of costs. So if you’re buying, a competitor does exactly what you do, or similar to your business, you don’t need twice as many expenses, right? So you can get rid of some of the costs and increase profitability of the new company you’re buying, as well as the overall new entity that you use. 

Precisely. Well. And I think one of the things at least that I’ve seen and of course, a number of the people I follow, like, for example, I follow Russell Brunson of ClickFunnels. And one of the things that he’s been talking about is how there have been a lot of businesses he’s been acquiring where there’ll be like, say, a website that runs a blog and it has a list of like, 50,000 people. And basically what they’ll do is they just send out their blog. They don’t even try to sell them anything. And he says, well, okay, you can pay a ridiculous multiple of their existing revenue. Then what you do is you just plug that list into your existing product stack, send them out, basically create and essentially what they call an irresistible offer, right? Just stack on so much value to an offer that people who are paying attention almost can’t not buy it. And now you pull them into your funnel and you can just immediately pop enough revenue to where you’re basically offsetting that you’re offsetting that acquisition costs and just growing your customer base. 

Yeah, there are lots of ways to sort of create value in your position target. You can buy an email list from a company, right, business, they have an email list that you can monetize. So that’s one way to do it. You can buy, I prefer acquisitions that have a quantifiable value they want. So that probably has to be created over time, but rather value you can see immediately. So if, let’s say you sell auto parts and there’s another auto parts company that sells auto parts online, you know, that they want to sell. You’ve come to terms in terms of value of the business. The value is reasonable. It’s an industry sort of norm. The multiple is reasonable. You make an offer and sometimes you’d be amazed what kind of offers you can make. Sometimes companies will finance the company, their own company they’re selling, you will finance it themselves. In other words, you don’t have to give them any money upfront. You’re just paying a monthly payment towards the acquisition price. There are banks that finance acquisitions. You’d be amazed how many banks want to finance acquisitions rather than finance startups or venture capital. There’s far more banks doing acquisition financing than there are banks doing or institutions doing venture capital. 

Let’s unpack that a little bit because I think it makes sense. But I think that’s something that’s really important because if we just think from an economic perspective, what a bank is looking for is they are looking for the highest probability possible that their loans will be repaid. 

Absolutely. Cash flow lending, it’s any bank that whether they give you a credit card or a home loan, all they care about is that you pay it back because the terms are set right, they’re going to tell you paying 6%, 10% what the interest rate is and they want to make sure the money gets paid. In venture capital, the anticipation of return is questionable. Right. I think like 80, 90% of venture capital transactions fail. So you’re investing into that 10% that will succeed. And arguably there are opportunities, obviously out there, there’s plenty of venture capitalists are making a lot of money out there. It’s a great business, but a lot of them don’t make any money. And you don’t hear about that. You hear about successes. Right. And in banking, there’s also failures that the percentages are much lower. Default rates. That’s almost inconsequential to you as a business. That shouldn’t bother you. What should be concerned? Your concern is how to grow your business, right? So you can do it organically or through your own money. In other words, you’re investing into customer acquisition. You’re paying for advertising, paying for marketing, you’re driving traffic, you’re doing a sale. You’re doing all those things that you work for yourself and work for other people. When you buy a business, you’re skipping all these things. You’re skipping all this risk because someone else took that risk. The company you’re buying, right? And you’re paying for this company if you’re buying it with debt. Let’s say you borrowed money from a bank. You can structure a loan where the loan value to the equity or to the profitability of the business is structured in such a way where, let’s say you’re buying a company for $2 million and the company generates 5000 in profit every year. You can borrow money, let’s say $2 million, so that the monthly payment is lower than the profit you’re generating from this new company. So that way you have profit day one in a $2 million transaction. Let’s say you put up 10%. It’s just like real estate, right? You’re buying 10% down payment, 90% bank finance, right? Bank finances, that 90%. They will probably structure a deal where you’re not paying principal, you’re just paying the interest. And then in five years, or 60 or 70s, whatever, the triple in, you pay off the balance. 

I was thinking this is like a smaller version of the leveraged buyouts that were really popular in the 1980s, except that a lot of those were financed with high interest rate bonds, high yield bonds, as they’re called now. Junk bonds, as they were called back then. 

Right. Actually, the junk bonds are structured properly. It’s a perfectly good scenario. But for a small company that’s generating anywhere between $500,000 and, say, ten, $15 million a year in revenue, there’s lots of opportunities out there. Your local bank can do this for you. You can go the bank of America and say, I want an acquisition loan. I have a company that’s doing 2 million revenue, 500,000 profit. I want to buy a competitor doing about the same. Here’s the structure. And they’ll tell you what they can find. They’ll give you terms and you go from there. If they can’t do it, there’s lots of other companies that can, a ton of them. Thousands of United States banks, private individuals, small institutions, credit unions. Lots of SBA does collision financing. So lots of options. What you need to focus on our fundamentals, the unit economics of the business is declining. Business is it flat? Is the management team and people that work for the company staying with the company. You need to prenegotiate those things. Make sure you’re not walking into a situation where you buy the company. Suddenly everybody quits. 

Yeah, that’s probably not ideal. 

Not ideal. So you have no asset there.

Human capital is really important. And then the asset, underlying asset, what is it, what kind of business is it? Is it a subscription business? If a subscription business, then are they doing everything by the book? You got to do diligence, right? And so you’ve done your diligence.

Hopefully you hired a law firm that knows how to do M&A. Hopefully you hired what’s called a company that has quality earnings. This is diligence of financials. They’ll do like forensic accounts. They’ll look at the numbers, make sure that the company actually generates the revenue. They’ll audit the money trail, make sure that everything’s going up and up. So if you do all those things properly, you’ll have a successful offer.

Excellent. Well, okay. One of the things that I would naturally think is that where are the places that you would find these kind of deals? Of course you can go to places like Biz, buy, sell, but those will tend to have, there will be some pyramid schemes. Pyramid schemes, Ponzi schemes. You’ll have some overpriced local businesses and then you’ll have a few legit deals. What are some of the other places where you’re going to find these legitimate opportunities at? 

Sure. That’s the hard part.  What everything I said prior to this is the easy part. The hard part is finding a company.

That’s just like real estate. Finding the deal. Find the deal. Right. All the problem.

All the financing, all the structures out there for the right deal. Right. Everybody’s willing to write a check for the right deal. So how do you do it? The first way to do it is to have relationships with people that run these businesses. You have to be in the know, like I said, our parts business. You gotta have friends who have these businesses. You have to socialize with them, go to the same events they go to. Go take them for drinks or dinner. If you know your competitors, go to industry events. If you don’t do that, you’re cutting yourself out from the opportunity up there. Because the best deals are going to be the ones that are not on the internet. They’re not online being marketed. There’s no broker involved. It’s just you talking to another person, another human being, a CEO of another company who says, hey, you know what? I’m going to retire next year. What do you think? About buying my business. That kind of conversation, right? That’s what you want, ideally. Now, if you don’t have that or you’re operating at scale, like you want to do an acquisition a month or six months, you’ve got your act together and you’re moving really fast. You may want to engage a broker that you tell them what you want to buy, and that broker then starts calling companies, literally picking up the phone, saying, hey, do you want to sell? Do you want to sell? And hopefully they’ll find you the right deal. 

I was just thinking when you said that, there was something that came to my mind. There was a fellow that I met in the real estate business of years ago, a fellow named Mitch Stevens. And so his whole thing is his whole thing was the fix and flip rehabs and recently got into self storage. But it’s funny, he is probably one of the least con technologically involved people I know. And so what he does is he basically just went down to the county registers office and found essentially got a list of the self storage units that are around his place. And then I think he just burned about like 300 copies of a letter. And then what he does is like, I think he just basically spreads them out per week and then he’ll send a letter out to all of them, send one set of letters out, and then three months later, he’ll just send them again and basically just says, hey, my name is Mitchell. I’d like to buy your business. And most of the time people say they just throw it away. What will happen is about once every two, three months is somebody will be like, hey, I want to sell, and then just starts a conversation. And it does not have to be high tech. 

No, not at all. In fact, that approach is playing the numbers game. And just the odds is a great approach as well. You just have to have a system. You have a source of these leads, and you do an outdoor campaign, and some of them will call you, and some will call you a year later, two years later, exactly remember you or they weren’t ready to sell at the moment. You’d be amazed how quickly things change. People change their mind about selling the business on a daily basis. It could be family issue, health issue, market conditions, financing. There’s all kinds of reasons. And the people that are most confident about not selling could be the turnaround in 24 hours because of some situation that they’re in. So it’s a good practice to be this proactive, and this person clearly knows what they’re doing. But if you’re not in the business of buying businesses, if you’re just a regular person, regular business owner, and you’re looking to increase your market share, increase your profit revenue, you don’t have to have all this in place. Like you can literally either hire a banker or you can yourself. Just go online and find your competitors and email them yourself. Find them on LinkedIn, find a CEO on LinkedIn, email the senior and say, I’m a CEO of this XYZ company. I understand buying a company. Do you want to have a conversation, yes or no? It’s easy, right? You have to think about that. If they’re interested in selling, they’ll call you back and let’s say, yes, have a conversation. If they are not interested, they may not get back to you. Fine, we’ll want to the next person, right? So you have to think about this. This is not rocket science. It doesn’t require PhD in marketing. You just have to act. And so this is another way. Now, these websites you mentioned this by sell, there’s about five or six other ones are pretty decent. The problem with them is that a lot of the businesses on there are really small. Like, these are 100,000 to 300,000 businesses. So that’s what you want to buy, it’s fine. But for someone who’s already established, this kind of acquisition is not going to work if you’re going to go in the category of multimillion dollar businesses, a lot of times the people that end up on these websites have had no luck selling other ways. So in other words, they hired a banker. That person failed. So they said, okay, I’ll move myself, maybe online, start trying to sell themselves. These businesses are not structured to sell. Otherwise they don’t have all of the financials. They don’t know how to provide financials. Sometimes their infrastructure is all over the place. They’re communicating with other businesses in terms of their resources and assets. And so it’s hard to pull it together. Once you start talking to them, they’re like, oh, I don’t have this, I have that. But then when you start doing diligence, it becomes problematic and complicated and expensive. You got to be careful. And then there’s also scams, the Ponzi schemes, all of that. Companies that generate revenue from advertising be very careful. Sometimes that advertising is fake, sometimes traffic is fake. And so you’re buying an asset that doesn’t have any value, and so you’re just running around hoping to profit one day. 

One of the things I’ve said I’ve seen a number of times too, is that a lot of times you have a listing, but the owner will not be accounting for the cost of their time. So in other words, what will happen is the financials will not be burdened for what it would cost to have an operator. You’ll have a business that’s valued based on a very key cost, not being in the PnL.

Right? Well, what you should do is if you’re buying a company, you’re going to run it yourself. Then you can assume that the owner is going to leave. And that profit that they were generating. Usually this is a small company. That profit that they were generating is not including the CEO’s salary. That’s drawing from the profit of the business. And so you need to take that into account. So if you’re not going to run that business, you have to hire someone to do it. That cost needs to be baked into the valuation process. In other words. Oh, so no CEO. Well, I got to add a CEO. How much is that going to cost? Oh, 150,000, $200,000. Well, that brings the profit of the company down.

You just kind of spurred a tangent thought here, and because this is another situation that I’ve helped a couple of my friends with, after you do that process, if that process of putting an adequately compensated CEO flips the cash flow negative, how do you value that? Because there’s still value there because obviously there are companies that lose money that still have very significant levels of market capitalization. But that’s always one of the things that I’ve had a hard time wrapping my head around, is when you have a business that has positive revenue but negative net profits, how do you appropriately value that?

Yeah, it’s difficult, and the financing sources change. Okay, so it’s no longer a cash flow lender. It’s an equity investor with a debt component or no debt, just pure equity. And investors. There are investors out there that have horizons of ten years, 15 years. They don’t need to have an exit in the next two, three years or five years. You have to find those investors and prove to them that after you buy the company, you have a track record of success. You’re going to turn things around, you’re going to improve on it, and you have to show that in your forecast what actions you’re going to take to make that happen. If those actions are quantifiable, if, for instance, the company has a lease, the lease expires in six months for their office space, and they don’t need all that office space, so the cost is going to go from 50,000 to 25,000. That’s a quantifiable event. That’s not hard to forecast. Right. But if you say things like, the market share is 5%, I’m going to take it to 10% because I’m really a smart marketer. I don’t know, what if it doesn’t work? Then what happens? Right? And so you can’t have one bullet in your chamber. You got to have, like, ten different bullets all need to fire maybe at the same time in order for you to get to your goal. And you’ll be amazed how difficult that is when you’re buying a company, it’s upside down and it’s cash flow. A lot of times the buyer doesn’t know how to maneuver around that. They get distracted from their core business and they start fixing something else, and then the core business starts to go down. And so you got to be really careful. You got to know what you’re doing. If you know exactly what to do, it’s obvious. Like, the supply chain is the obvious one. The company sources the product from this company, cost them $10. You have the same product, you manufacture it, so that cost goes away. $10 saved per unit. Great. Put that in your forecast and banks will sign off on it because that’s an easy one. You start doing all kinds of weird stuff and you’re saying, I’m going to open up an office on the moon, and I’m going to be flying ships from Mars to Earth. Those are not believable and hard to obtain. 

Yeah, well, because particularly where you’re talking about a growing market share to justify evaluation, because that was one of the classic things that we used to do for valuations at intel all the time. And the thing that every one of those analyses never bears in mind is, number one, what are you going to have to do to your pricing in order to double your market share? And then number two, what’s the competitive response going to be? And then number three, what’s everything going to look like after everything is reequalized? Because usually if you try to price your way into higher share, what will happen is your competitors will drop price, and then you’ll have to match. And you might gain about half as much as you thought before, but your margins will be lower. 

Right. Well, for a big company, what happens is like Intel they’re so big that if they bought a table until bought a billion dollar business and that business was upside down financially, that’s nothing would happen. It’s a rounding error on the back of their PnL. If that company went away the next day, nobody would care. But most businesses don’t have the luxury. They don’t have the luxury of diversification, of revenue and different currencies that they are transacting in and fluctuations of those currencies and cash balance sheet being large and availability of credit being available readily to them. So you have to rely on the most practical things. And my point to you is that

If you’re one of those companies doing a million to $10 million a year, you’re considered a small business. You’ve got to look at all this stuff very black and white. If it’s not black and white, get out. Just get out. Let’s get out of the way and move on to the next. If you can’t see it clearly and it’s not in your wheelhouse and you don’t understand what’s going on, you’re never going to understand what’s going on. Just move on to know what you do understand, and you’re going to be much more successful and less risk minimize risk. Because if you already have a business that’s successful, arguably you don’t need the other business. Right. You can just keep doing what you’re doing. So you got to buy only if it makes a lot of sense and it’s extremely easy to quantify.

Especially because it’s like you said, there are so many businesses out there which now, granted, there’s not an efficient way to get in contact with them, but there are so many businesses out there that could be available for sale, right? You don’t need to find a moonshot. You can just keep looking until you find a layup because they’re out there. 

They’re out there. And you’ll grow faster that way. That’s the magic sort of statement here, is that you can continue doing what you’re doing and invest into growth. Okay? Most people don’t have unlimited amount of capital to invest into a business. In fact, no one does. Even if you’re a Tesla, you still got to go. You have a cap like how much money you can borrow, how much equity you have. And so if you’re not one of those companies that have lots of capital resources, and you’re relying heavily on organic growth, meaning you’re reinvesting your profit into scale, acquisitions will be great for you, because you can leapfrog scale. Growth, maybe double the size of your business by acquiring wisely, like doing the things I just discussed, having the right, you know, capital structure in place, the right financial partner, and grow your business much quicker and without the risk of having to do it yourself. Because if you think about it, if you doubled your business, think about what you have to invest in your business to get to where you’re at. If you want to double that, arguably invest just as much or more to continue that growth. Right? But acquiring a business is going to be a lot less expensive, a lot less riskier, if done correctly. Because then in 30, 60 days, you’re double the size. After the acquisition. Right? And so it’s a very exciting thing. And if you’re an operator that knows how to create profit and opportunity from these types of acquisitions, you can do things like Upsell or product, like what we’re good at. My companies, we create bundles and we package products very well. And we increase lifespan, volume and customer acquisition costs. That’s what we do inside our business. If you know how to do that, then it’s even better for you. Because now you take something that’s going to take 10 million revenue, and you grow into $20 million revenue because you added more product into the sales pile. 

Got It. All right. Well, hey, Gary, it’s been a great conversation. Give us one or two last thoughts and then let everybody know where they can find you online.

Sure. So realdefen.se  just look at my name. Our brand is real defen.se. iolo is one of our products that we sell.i-o-l-o.com. You can contact me through that site or LinkedIn and do your diligence. When you do these acquisitions, look under the hood. Check their marketing. Check their products. Make sure you have experts around to help you. Don’t Try To do it on your own. It’s not that easy when it comes to LMN. And bring experts in. And make sure you negotiate your contracts wisely. Experts on that cheap. And they also want a decent percentage of the transaction, so make sure you negotiate that here.

Got it. Well. Hey, Gary. Really, really appreciate your time today. 

You got it. Thank you.

All right.

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