Transcription 01 – The Benefits Of Keeping Great Records
Marvin Storm: Hello, my name is Marvin Storm. We are on the Business Exit Stories podcast, and today we have Arthur Kessler joining us. Arthur is a senior business broker at BizEx Exchange out of Marina del Rey. And so today we’re going to introduce Arthur, and we’re going to explore some of his transactions and business stories that he has in assisting entrepreneurs and business owners in their selling and exit of their business. So Arthur, why don’t you just take a few minutes and introduce yourself and then we’ll get rolling here.
Arthur Kessler: Hi Marvin, thanks for having me on the show. I’m a senior business broker at BizEx business brokers in Marina del Rey, California.
Arthur Kessler: I’ve been helping people buy and sell businesses for more than 40 years. And hopefully today I can relate both a good story and a bad story. So if you’re thinking about selling your business anytime in the next five years you’ll be prepared to do it in a way that gets you the most value for your business.
Marvin Storm: Oh, well great. So as we’ve stated before on this podcast is most people don’t really think about selling their business until there’s something that happens that is an external motivator in selling a business.
Marvin Storm: In your experience, Arthur, can you share a story with us where a transaction just went really well, that the business owner was really well prepared and the transaction went smoothly. Give us a little idea of why those transactions happened in that manner.
Arthur Kessler: Okay, I’m happy to. I’m gonna pick a wrecking yard that was sold in the greater Los Angeles area. I got the listing because I knew someone who knew the owner, and said he was thinking of retiring, and I went out and met him and I could see that he had a very good business. He had lots of inventory and he was very much on top of everything he was doing. But his books and records needed a little bit of work.
Marvin Storm: If you could, tell us a little bit more about the individual. How long he had been in business, and any other types of personal information as far as what he did before he got into this business, and how long he had been in the business.
Arthur Kessler: Ok. He actually got in as a 16-year-old working for an uncle at another wrecking yard. And he learned a little bit about the business, had his own ideas, leased the property and started doing similar to what his uncle was doing and then dramatically increased everything because the more he did the more he understood and the more he got what he was doing.
Marvin Storm: And when you say got what he was doing, share a little bit more about that.
Arthur Kessler: So as every business and business owners out there know, there are tricks to every trade. So in wrecking yards, you could do either of two things. You can sell just parts, which some wrecking yards do, or you can sell parts and vehicles. He decided that he wanted to go from parts to parts and vehicles, in part because he liked cars and imports. He had some ideas that if you took a damaged car, and you didn’t completely fix it up but you made it look a little better, and you put it back in auction, you could make money because if it looked better people would pay more money for it. And I think he had the right idea and it proved to be very successful.
Marvin Storm: …and the type of revenue he was able to generate over a period of years on an annualized basis?
Arthur Kessler: Well, it grew from when I first met him he was making a little over a $1 million dollars a year. One of the things we had to do was to figure out how to price the business. And because the business had a lot of cash, there’s generally a 10-20% discount for a cash business because they’re harder to prove and harder to get loans for. But we decided that we wanted to price the business at about $1.4 million. This was partly based on his tax returns and his records. I was very fortunate in that he kept very detailed records of every car he bought and sold since he started doing business. And that was on a monthly basis so where sometimes it’s very hard to prove cash sales, we could prove it because he had an acquisition price and a sale price in every car.
When a buyer would come in and look, nobody makes up years and years of records like that. So I had a benefit from that. The problem I had was that it generally takes at least nine to 12 months to get a business sold from start to finish, so by the time we were in about month 10 he was doing better than the year before, so he wanted to raise the price. And I didn’t have a problem with that because although there are a number of indicators as to why you pick a price the most important one is what can the owner put in his pocket.
So as his earnings went up, we increased the price. And I had a little problem with buyers because they said, “wait a minute, it was $1.4 million. Now you want to go to $1.6 million.” Then we went to $1.8 million. And my justification was he’s making more money, so if you agree that the business is worth a one and a half multiple of what he’s making, then if he’s making more money the price has to go up. We also had a problem in that a lot of lenders do not want to do a business like an auto wrecking yard, part because there’s a lot of cash on the parts, and in part, because they just don’t like to do that type of business.
But I found a bank in Los Angeles who had a great history in the automotive industry. They owned the first gas station in L.A., they owned the first auto racetrack in Los Angeles, and they liked vehicles. So I got them interested, and like a lot of businesses that have cash, the seller did not report all his income and all of his net profit. So I explained to him that in order to get an SBA loan (a small business administration loan) the tax returns have to justify it. They have to include a decent salary for the new owner and then they have to have enough money to pay back the loan. So I had to get him to do a better tax return for year two, which he agreed to because if you get a Small Business Administration loan the seller gets paid in full at closing, and the buyer at that time only had to put down 25%. Now the buyer only has to put down between 10-15% and it’s a 10-year loan. So although you pay a little more interest it makes the monthly payments smaller, so it works very well for both the buyer and the seller. And he got it. He really didn’t want to take a note so he made a better tax return. It still didn’t report everything but it was better than the past and it was sufficient after the bank looked at it to say they could do an SBA loan.
Marvin Storm: Let’s talk a little bit about the SBA loans here. You know it’s something that most business owners, buyers, and sellers, when they’re looking at a business, are going to look to finance and some will do it through commercial and lenders. But this SBA loan is really crucial because of the length of payback and how it’s treated as far as a guarantee. So can you expand a little bit about how you went about getting the SBA loan? Was it a pre-qualified loan that you put in place before the business was listed?
Arthur Kessler: I actually did it after the business was listed but there are two types of lenders. There is what’s called a primary lender and someone who’s not a primary lender. Primary lenders are generally the bigger banks, and they’re pre-approved by the SBA so that if they send down the loan documents and all the boxes are checked it’s approved. A non-prime lender, all the paperwork has to go to the SBA and they work on approving it. Obviously a much longer and tedious process. So I prefer to deal with prime lenders.
The bank that we worked with was a prime lender and their head SBA guy was very skilled and had been doing SBA loans for a long time. So he could look at the numbers on the tax returns and tell me what he would need in order to get it approved for an SBA loan. Once I had all the information and the listing was up, I showed him that, and when the seller agreed to do a little better tax return I got a pre-approval letter from the bank so I could put in my advertisement that the business is pre-approved for an SBA loan. This opens it up to a lot more buyers because instead of having to put down 50% and have the seller take a note for 50%, they now only had to put down 25%. So it gave more people who didn’t have as much money to put down an opportunity to get into what was a really good business.
Marvin Storm: On the SBA loan that you had in place, what was the interest rate at the time?
Arthur Kessler: It’s usually prime plus 2.00-2.35% and it’s pretty steady on that. We’ve had increases over the last couple of years but with a rate cut yesterday we will have decreases and some of the banks will give you a rate that’s guaranteed for 10 years, and some of the banks will give you a rate that’s guaranteed for five years, and some of the banks won’t guarantee it. So we try and we try and recommend two or three lenders so that the buyer has an opportunity to make a decision himself and create some competition because if the lenders like the deal, some of them will cut a quarter of a point and that saves the buyer a lot of money over time. But the SBA rate is the same pretty much any bank you go to, but they usually have a quarter of a point that they can give if they like the deal.
Marvin Storm: So in this situation, we have an auto wrecking or salvage yard. From what you’re telling me and what I understand, is that the buyer was fairly sophisticated because he kept pretty good financial records on these transactions. You mentioned a little bit earlier that when he acquired the vehicles, he kept track of both what that price was and when he sold the vehicles he kept track. So that was a kind of a time-stamped revenue number. How did he keep track of that? What was used as verification?
Arthur Kessler: OK. In the beginning, he bought cars pretty much anywhere at auctions or from individuals and he sold to the public. But he quickly stopped doing that because when he was dealing directly with the public, he found two or three weeks later someone would come back and complain about something on the car, or ask “why do you have to take sales tax?” and other problems that you have when you’re doing a retail business. So he decided to do everything through the auto-auction site, and that industry has changed over the years so that you really can do everything online. You can literally go online, look at a car at an auction, look under the car, look inside the car, look under the hood, look in the trunk, and make your decision on what you want to do and then you bid against people.
So when he bought a car he got a receipt and a payment to the auto-auction house. He then would do some work on the car and then he would put it back into auction, and when he sold it he would get a receipt from the auction house along with a check. So he could show what he paid and what he sold the car for. Then in between the car, because he was a bit of a records freak, he kept track of every car. When it came in, what he did, what he put on the car, everything including a wash. So he could show what his cost was, what his expense was, and what his profit was. Therefore the majority of business he ended up doing was in vehicles. We could show for every car exactly what his profit was. So that the part of the business that was Cash became less important. That was very good because when some buyers came in he had every month for years, every car that he did that month with a copy of the sales receipt, with a copy of the purchase receipt, and then handwritten in the book next to that car everything from a wash to a fender or whatever he did on the car.
So if someone was willing to spend the time we could show that the business was making a lot more money than the tax returns show. But it was helpful that he understood the process of SBA loans and the need to have a tax return that would justify the loan. When he bought into that I knew we’d be able to make the deal. It’s just that he made more money each year. We keep raising the price until finally we got some buyers with enough time that we made a deal, and where he originally was looking for $1.4 million, it was sold for a little bit over $2 million. So the extra year or two that he put in was worth it and it was worth it that he kept good records even though part of the business was cash because that way we could get an SBA loan.
So I would urge listeners who if they’re planning to sell their business anytime in the next five years, it’s very important to have good profit and loss statements. It’s very important to have tax returns that will justify an SBA loan and I suggest you get in touch with a business broker like myself who can advise you. Even though it’s far in advance of what you’re going to need and what the business is worth, at least get our opinion and what you’re going to need on tax returns because then you can make a decision. Do you want to go for an SBA loan? Are you willing to do self-financing? Seller financing usually means 50% from the buyer and 50% for a note that the seller takes. So when you’re not going to get paid in full at the closing, you’ve got to be comfortable with the buyer that they can do the business. Hopefully, they have some collateral but very often they don’t. So it’s very important to talk with someone who knows what they’re doing and help you prepare your books and records because your books and records are going to determine how good a price you’re going to get and whether you can get a loan or not.
Marvin Storm: I think the takeaway from what you’re telling me, Arthur, is that you know most people inherently understand that records are important. However, actually having good records is an entirely different story. And then in this case the owner of the business understood that he kept good trackable verifiable transactional receipts that allowed him to verify the acquisition cost of his vehicles, what he put in to the vehicles, and actually what he sold the vehicle for because the sales receipts were time-stamped and were specific to a vehicle. And so that’s the big takeaway regardless of what type of business you’re in. If you think through the process of how that type of information is going to be important, and in this case, it was not only important for the buyer of the business, but for the loan officer in the US and the bank that was approving the SBA loan.
Arthur Kessler: I think Marvin if business owners can try and put themselves in the mind of a buyer. If they bought the business, try and think back of what were the things that concerned them when they wanted to buy the business, and if they just started it from scratch try and understand that the buyer doesn’t really know your business. So the easier you can make it for the buyer to understand, the business and the profitability of the business, the easier it’s going to be to get a buyer to buy the business.
So the most important thing, I get asked two questions whenever I have a business for sale. If it’s a good deal, why is he selling and what are the numbers? So, everything else adds up.
How many years you’ve been in business, type of business, and location. But the most important number is what can the buyer put in his pocket truly, and that may not be fully reflected on the tax returns. Very often in small businesses it’s not, but the tax return needs to reflect enough to justify a loan because that’s the best way to go for both the buyer and seller.
Marvin Storm: Well, that’s a great takeaway. Put yourself in the mindset of what the buyer is looking for, and if he finds what he’s looking for you’ll probably have more buyers at the table.
You’ve mentioned several times here, tax returns and going back and making sure the tax returns accurately reflect what the business is actually doing. Business owners that use their business to fund their lifestyle doesn’t always reflect in the tax returns.
So when you referenced that you went back and revisited the tax returns, tell me a little bit more about that process and what you actually were able to do and how you did it.
Arthur Kessler: Just a general rule of thumb, right now in southern California a lender will put a minimum of $60,000 as the salary for the business owner. In other words, to support a family barely, in Southern California $60,000 is the minimum. As the business goes up, for example the deal that I talked about, the bank attributed the salary of $100,000 because the business was making I think on the final tax return we showed $650,000. So they felt that $100,000 should be allotted for salary for the owner for their lifestyle, for a business earning that much money. In effect the business was really making closer to $2 million dollars.
But I grew up in a retail business and I started at 10 years old, and my father showed me “this goes in the register, and this goes on the side,” and every two years he and his partner bought a new car. So I had the benefit of growing up and understanding that not everything is reported. The important thing is that the tax returns show enough for a lifestyle salary and enough money to pay the loan.
So as the size of the loan goes up with an SBA loan, the reason the banks like to do it is the government guarantees 75% of the loan until the loan is paid off. So even if it’s in Year 10 and the loan fails and there’s $100,000 left on the loan, the government will eat $75,000 of it and the bank only has to eat $25,000. So the bank is taking 25% of the risk for 100% of the profit on the loan. Which is a good deal for the bank. But it’s a good deal for the seller and the buyer because it enables you to finance a business at a reasonable rate with a minimum down payment, and the seller gets fully paid. So it’s really a win-win for both the buyer and seller, and it’s very important that you plan in advance because you can’t go from bad tax return, bad tax return, and suddenly have a great tax return.
You need to work with your CPA and a business broker who really knows what he’s doing to tell you if you want to sell this business for $500,000 and you want to get an SBA loan for $425,000 to $450,000 your tax return has to show this much. Because when we had the recession, they want to see a profit and loss statement. They come out and they look at the business and try and understand it. But if the tax return doesn’t justify the loan they’re not going to make the loan. It doesn’t matter how good it is and what you could show.
Now there are things on a tax return that you can add back. You can add back the owner’s salary. If the owner is renting a nice Porsche you can add back the payments on the Porsche because obviously you don’t have to have a Porsche to run any business. Maybe you do if you have a Porsche dealership, but otherwise you don’t. However, if you have a health plan for the employees you can’t add that back because the new owner is going to have to give that health care plan to the employees or everybody is going to be very upset. So some things you can add back, some things you can’t. Depreciation, amortization, and owner’s salary are standard add backs. Those are things that you can use on a tax return to lower your taxes and at the same time still be able to add them back to the bottom line and get a loan.
Again, it’s important to work with both a business broker and accountant that knows what they’re doing so that you can help the owner and you’ve got a plan. So if your tax returns need to be a little better, you can make them a little better over the next coming years so it’s not a sudden leap, and doesn’t attract attention and it doesn’t cause you to pay any more taxes than you really have to to get the loan and to get the business solved. It’s important that people remember that both the accountant and the business broker are working for the seller and sometimes the buyer, not for the government. So this is all confidential stuff it’s not revealed to anybody else.
In the example that I gave, although the guy had monthly records, he didn’t want to show that to a buyer until he was convinced that that buyer was real and that buyer could show him that they had the money to do the business and that they had the ability to do the business. It wasn’t rocket science, but he wanted someone with energy. He had 19 people on his staff and he had to always be on top of them, because if you weren’t the guys would be sitting around and not doing what they’re supposed to be doing. So he didn’t just hand over all this detailed information. I would never ask a business owner to hand it over until they’re satisfied that the buyer is making their second or third meeting and now the seller is comfortable that I can do this.
For example, we register every buyer. So if a buyer won’t register with us and give us some background on them we’re not going to give them any information and the answer is real simple. My mother taught me smile and blame someone else so I blame the seller. Seller tells us if I don’t get some confidential information on the buyer, do not give them my information. So if someone is serious about the business, they’ll register and they’ll give us general information if they know their FICO score, their business background, how much money they can put down, how many miles they want to travel, a whole bunch of simple basic questions. But it at least gives us an idea as a business broker of, “Can this guy do this business, does this business fit this person.”
Marvin Storm: That is a fascinating transaction and a type of business you don’t think too much about. Salvage resale. Auction cars. Why don’t we move over to maybe discussing a transaction or story that you have in your archives here that maybe didn’t go so well? Sounds like this last business everyone won. Profitable business sold, new buyer probably going to take the business to the next level. But what about some businesses that are really pretty good that never closed?
Arthur Kessler: Yeah, I have a sad story for everybody. I feel very bad about it because I really liked the seller a lot. He was extremely good. Had come to the US years ago, classic American success story. Started renting a very small automobile shop to do repairs. He loved cars and had a real affinity for fixing cars. Cleaned apartments at night to get enough money so that he could build it up and rent a location in a good area in west L.A. Was truly a genius at cars and came up with things that other people weren’t doing. Was in a fairly well-to-do neighborhood so he could charge good prices. He was so good that he even had dealers sending him problems that they couldn’t figure out.
For about 14 straight years he did over a million dollars gross around $300,000 and change in net. But he got some other ideas and some other business ideas that he decided to get into. When I met him he wanted to sell the business so he could focus on the other things. I looked at his tax returns and they were horrendous. He basically wrote off every expense that he had (going to the movies, food, rent for the apartment, whatever) on the business, and there are ways to do that if you have an accountant with a sharp pencil. But a lender doesn’t want a shoe box full of receipts. They want to see a few add backs that make sense and not all these different things.
So the first thing I had to do was get him to change the way his accountant did his tax returns. The second thing was he still didn’t want to pay a reasonable amount or report a reasonable amount. I told them that you won’t get an SBA loan, and if you don’t get an SBA loan you’re going to decrease the number of people and you’re gonna have to take a note. So what we did each year is we did a proposed tax return and if we found a buyer it would be filed, and if not he could file a weaker tax return, and I was OK with that because when you file a tax return the lender is going to ask you to sign a form that gives them the right to look at the actual return from internal revenue. So the lenders are not going to take a phony return. It has to be the actual return.
The problem was as he got more and more involved with these other businesses he paid less and less attention to his business. So for the first time in 15 years the business started to go down. Then we originally listed the business for $900,000, then we went to $750,000, and we got an offer for $600,000 from a major auto-parts company who was looking to expand and it was a good offer. It was a fair offer, but they were a pain in the neck as many large corporations are, and we just had too many disputes. So we told them to go away. We got another buyer who was terrific and liked it. But during one of our discussions, he asked about their workman’s compensation and they said, “well, we don’t have any”, and the buyer said, “what?” and I said “what?” because their earlier tax returns had workman’s compensation as part of insurance expense. They said “Well, we had a problem. They wanted to raise our rates too much so we dropped it.” Well the buyer said, “Well, then I’m not buying the business because you’re not running a legal business”.
So we had to stop everything and the buyer had to go back and apply to get into a workman’s comp program, and I got him someone who was good at clearing up workman’s comp problems. Got them back in and got them workman’s compensation. But by that time the buyer was gone and the business was continuing to go down. So we changed it and we put our offer out at $300,000 and we had an offer for $250,000. Unfortunately, the seller did not take it and countered $275,000 and that buyer ended up buying something else.
So we go another six or seven months and the business continues to run down because the owners hardly ever there, and he put someone else in charge who was not doing a good job and we finally ended up saying, “OK, how about $100,000?”, and we had a buyer come in who was willing to pay $100,000, who wanted to open a couple of new branches of his auto-repair business, and really liked the location and liked what the guy was doing. But in the interim the seller got so busy and was so unhappy with the guy running his shop that he stopped doing business.
Unfortunately, he did not file closing tax returns with the state taxing authority, with a local business, or with the federal government. So when the buyer came back in and had one of his people come by, he said “Hey, they’re not really doing business!”, and I called the seller and he said “Yea, we stopped.” So we agreed on $75,000, and we put the deal into escrow. But when you put the deal into escrow they do a UCC search and as well as a publication….
Marvin Storm: Talk a little about what a UCC search is.
Arthur Kessler: OK. Under the Uniform Commercial Code which is US law, people who have a claim against a business can file a lien against that business. So that when escrow does a search that lien will pop up. It says ‘I’m owed money’. It doesn’t mean the seller owes the money it just means that someone has a claim. So escrow will not pay out the funds until all those claims are resolved. Well, because the seller did not file his tax returns, his final tax returns, his final state tax returns, his sales tax return, and his local taxes, the government just assumes if you didn’t file for this year you did the same as last year. So we’re assessing you those taxes you never filed. So he had claims. One from an individual but most of them from various governments well exceeding the money in the escrow account…
Marvin Storm: So what we talk about here, Arthur, I think this is an important part. That what you’re telling me is that the seller wound down his business, locked up the doors, did not file the tax returns with the sales tax in California. The franchise tax board, the state, and the federal, and because he didn’t file it, they made the assumption that he was still in business and just didn’t file the returns, and so they assessed him taxes as if he were still in business. Is that what you’re saying?
Arthur Kessler: Right. So he had some money that he really owed, but he had a lot more money that he didn’t owe. So, he had to retain an expert in dealing with governments and tax problems, who had to go back and negotiate, and had to show ‘I don’t owe any money for employee withholding because I didn’t have any employees during this period’. He had long negotiations and he had to pay more than he had to pay, because if he simply filed a final return saying, ‘For this year I didn’t do any business. I closed the business on such and such date, and I didn’t have any employees’, the state would not have said anything.
But coming back after the fact, they’re not just going to accept a business owner’s word that he didn’t do any business. He literally had to hire someone to negotiate all of this down for him and it cost him more money, and it delayed the closing, and the buyer came back and said, “Hey, this is a pain in the neck for me, it puts me at jeopardy because there’s a succession on tax money owed so that the new buyer would be responsible for those taxes if the seller didn’t pay it, because the government doesn’t care who is going to pay it”. Private debt is strictly stuck on the seller, but government debt passes through to a buyer. He said, “I’m taking $5000 off what I’m supposed to pay you because I’m not happy about this”. Not only did the seller have to pay more money that he really shouldn’t of had to pay to clear it up, but he lost an additional $5,000 from the buyer because of all the delays and the buyer being uncertain about how this was going to work out, or if the deal would even close. The lesson is the same, like the boy scouts said, ‘Be Prepared’. It’s important for business owners to think ahead and prepare the tax returns, and profit and loss statements, and everything else that’s necessary to get a business ready to sell.
In this sad case, although it was a good business, the seller should have taken offers that earlier he didn’t want to take whether he didn’t like the buyer or it wasn’t quite enough money. He ended up with much less money in the long run and because he failed to do what he needed to do in closing the business, he had to pay money to the government that he really shouldn’t have to pay. But in those cases, you kind of have to negotiate. They’re not just going to take your word that you weren’t doing business. He really couldn’t prove that he wasn’t doing business, because he was paying his lease because he was obligated to pay under the lease. It was a good example of an owner who was prepared and had his records, and appreciated the help that we and the lender could give him in getting everything right, and a seller that just got busy on other things that at the time were more important. But it cost him a couple hundred thousand dollars and a lot of grief. Because he didn’t take care of the books and records and doing what he was supposed to do.35:
Marvin Storm: Well it sounds like more than a couple hundred thousand dollars from what I hear you saying. Had a business that was doing $1 million dollars for 14-15 years and then he got sidetracked, and he ended up getting less than fifty/sixty thousand dollars for the business that was doing $1 million dollars a year.
Arthur Kessler: Yea. Well, he ended up getting nothing because the money in escrow had to go to pay some of the obligations, as well as he had to take some money out of his pocket.
Marvin Storm: Well, certainly a lot of takeaways here for the audience out there that are taking notes and listening to this. Some of the takeaways – being able to verify income for your salvage company that bought auction cars. They had a very successful exit of their business because they were able to provide the type of information that both the lenders and the buyers needed. Verifiable information. They kept business running even though they were in sales mode. They kept their business running at a pretty high level of efficiency.
Then we have a sad story of a person that came to this country, lived the American dream, built a business, a $1 million a year business, and got sidetracked and walked away from that business with nothing.
Arthur Kessler: Actually a minus.
Marvin Storm: Actually a minus, yea. Well Arthur, it’s been a delightful discussion. Two great stories with totally different outcomes. If someone wants to reach out to you, Arthur, what’s the best way for them to get in touch with you?
Arthur Kessler: Well, they can look me up at www.bizex.net. My biography is on the website. They can look at the broker’s biographies. My cell number is 310-650-7900. I’d be very happy to answer questions. I don’t care if you’re in Minnesota or in New York. I think if you create goodwill it comes back to you. It’s good karma. Ya know, I’m old enough when we used to talk about good karma. Feel free to contact me I’d be happy to answer any questions and help you in any way that I can.
Marvin Storm: Alright well, Arthur, thanks for taking the time. This is the episode of Business Exit Stories that I think has some good takeaways for everyone out there. Both buyers, sellers, and lenders that are handling transactions and facilitating those types of deals. Again, thanks a lot for being here. We’ll talk to you later. Bye.
Arthur Kessler: Alright, Thanks Marvin!