Reasons Acquisitions Fall Apart
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Ep. #785 - Reasons Acquisitions Fall Apart

In the 49th episode of the “How to Start a Tech Company” series, Matt DeCoursey and Matt Watson talks about different reasons acquisitions fall apart. Join the Matts and listen as they discuss why acquisitions fail.

Catch the next episode of the “How to Start a Tech Company” series for more insights into the life of a tech startup.

Covered In This Episode

There are many reasons acquisitions fall apart. The Matts are back and sharing what startup founders need to know about why acquisition fails, and that “break-ups” are more common than most people think. Hear important details to help you navigate a successful acquisition.

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Highlights

  • Acquisition fails are more common than you think (2:26)
  • Acquisition is both the end and a beginning (6:30)
  • The acquisition of VinSolutions (9:32)
  • Emotional attachment kills the deal (10:15)
  • Missing numbers (18:02)
  • Affiliated transactions (21:47)
  • Profits get stuck and shrinking margin (28:00)
  • Networking Capital (33:40)
  • The working capital Peg (35:37)
  • The funding behind the funding (42:08)
  • Wrapping up (42:47)

Key Quotes

The biggest reason for an acquisition or an offer not converting, it’s you as the founder or the seller, and, you know, it’s the actions and inactions of the owner preceding the sale. And the process, in most cases, kills the deal. And you know, one of them is as the very first on our list here is emotional attachment.

Matt Decoursey

And part of the problem is, your whole team is distracted by all this bullshit. We’re trying to sell the company that it’s hard to even run the damn business while you’re going through this. And it’s easy to miss your numbers because you’re, you’re distracted. So I mean, it’s a huge risk and a problem in the deal.

Matt Watson

It’s the opportunities missed that you look back on that feel, often feel the most expensive.

Matt Decoursey

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Rough Transcript

Following is an auto-generated text transcript of this episode. Apologies for any errors!

Matt DeCoursey 0:00
And we’re back for another episode of Startup Hustle, Matt DeCoursey. You’re with Matt Watson. Hi, Matt.

Matt Watson 0:06
What’s going on, man?

Matt DeCoursey 0:08
I am getting my voice back. It has no longer falling apart. But you know what does often fall apart? People’s acquisitions?

Matt Watson 0:19
I was thinking you were talking about yourself.

Matt DeCoursey 0:22
I’m constantly in a state of falling apart. That’s a completely different subject. I mean, if, yeah, I mean, now as an entrepreneur and a startup founder, if at several points every day you’re not falling apart, you are a total mess. Are you really trying not hard?

Matt Watson 0:40
Yeah. And you’re getting old to do so. I mean, you know, put it all together here. You’re just falling apart. Me too, though.

Matt DeCoursey 0:46
You know. So as we prepare to record this episode, we’re on our third really snowy day here in Kansas City, which is the hometown of Startup Hustle and Full Scale and Matt and Matt. And, you know, I’ve realized that I’ve gauged my own aging based on how often I complain about how easy it is to have a snow day now. So, yeah, there’s no, yeah, no, no lie on that one. Definitely aging. Now, you know, speaking of things that aren’t falling apart, today’s episode of Startup Hustle is sponsored by Gusto and Gusto as modern solutions for modern HR problems, whether it’s talent management, payroll, or onboarding tools, Gusto’s HR platform, how’s it all for you be smarter than your competitors. And you can try a three-month free subscription. Now you can sign up at gusto.com forward slash Startup Hustle to get started. Once again, that’s gusto.com forward slash Startup Hustle. Do me a favor, just scroll down to the link and click it. You don’t even have to remember any of it. Because that’s, that’s what links do, Matt, they take you to places that you might want to visit.

Matt Watson 1:48
Now, you’re not going to believe this, but I spent my entire morning dealing with HR bullshit that you know, I have to just take a moment and appreciate the people in the world that deal with HR things and use tools like Gusto because, you know, as we’re talking about acquisitions, today, we, I sold stock fi right, and I’m sitting here still trying to clean up the mess of that as like winding down old 401K’s and bullshit like that. And I just have a

Matt DeCoursey 2:18
business, you don’t even own any.

Matt Watson 2:21
I just have a great appreciation for people who do that. And tools like Gusto.

Matt DeCoursey 2:26
HR problems are like ghosts or Omegon. Maybe it was my hobby or other things that just don’t go away. Yeah, so well, you know, something else that can ruin a morning is learning that someone that wants to invest in your business is no longer interested. And then on a much more heavier situation, you know, like an acquisition falling apart. Now, you know, the interesting thing is, is when you watch when you read, you know, whatever it is your local news or the Business Journal in your hometown, or you know, TechCrunch you always hear about the funding, though, that company XYZ gets a gazillion dollars of funding and turns into a DECA corn. Right? And I like how we went from unicorn to DECA corn. I didn’t know what it was. Is there really a unicorn with ten horns? Because that seems weird. It seems like it could be a problem. But with that, you always hear about this, you hear about the acquisition, you hear about the IPO, you hear about the funding round, but what you never hear about is the fact that these things actually fall apart more than they don’t.

Matt Watson 3:37
And it took months of hard work to get up to that point. Yeah, yeah.

Matt DeCoursey 3:41
And, you know, I’ve experienced not the acquisition fails, but the funding fails, and there are 10 million reasons why that can fall apart. And you know, we, you know, so here we are, this is part 49 or 52. Or almost, we’re gonna finally finish this series around March of 2022, which will make it two months late. So one thing first off, when it comes to acquisitions and funding, they always take longer than you think they will. Is that a fair statement?

Matt Watson 4:09
Yeah, when I saw this dogfight took five to six months from the time we had the offer to the time that we closed the deal, it was five to six months, and a part of it was over the holidays Christmas holidays, so that dragged it on some but

Matt DeCoursey 4:24
but here’s the thing is okay, so whether that’s the winter or the summer because the Fourth of July and that week do kind of has the same effect. There’s always something that just doesn’t speed things up, and you know, realistically, you know, it’s hard if someone’s wanting to acquire your business or invest in it. It’s probably not advisable to just be like, come on, hurry up, write that check, close this deal because there’s a process, and we talked about that on our last episode with preparing for an exit which is an episode I wish we had a video for cars. The anguish on your face. Recalling all two acquisitions,

Matt Watson 5:09
there are highs and lows, highs and lows, man. I mean, we, you know, I’ll never forget on the VinSolutions side, you know, we were in a little different situation like business was booming, we were growing at a really fast pace. And, you know, before we sold the business, I mean, we were making half a million to a million dollars a month in profit, right? Like, we were doing great. We were living large, like, just things were going really, really well. Right. And, you know, it was actually kind of fun flying around to California and talking to people. And, you know, at the time, we thought the company be worth, like, 80 to $90 million, which at the time seemed like a crazy amount of money. And then we ended up selling it for a lot more almost double. Yeah, but we, we ended up with this phrase of, and I think I’ve told you this four of every day. And it’s because it’s like we would call each other meaning a couple of the other main owners and that was the job. It’s like, every day, we had a better offer. And it was honestly a lot of fun. We had a ton of fun through that process. And but, you know, there were some hairy moments where the whole deal could have fallen apart, even after we, you know, eventually figured out who we were going to take the offer from, I mean, the whole thing could have blown up in the end. A couple of times, I’ve got a couple of funny stories.

Matt DeCoursey 6:30
Yeah, let’s save one because, there’s one I have in mind about a meeting and someone trying to make a joke and saying something very, very inappropriate and kind of one of those moments that you’ll never forget. Now, you know, just once again, I want to go back a little bit because, you know, here we are, once again, part 49 or 52. Like we’re coming to the end here. And, you know, an acquisition is the end in some regards. And then a new beginning for a business because, you know, these things happen for a variety of reasons, many of which you don’t always get the inside look at, you know, you get a lot of and you well okay, so and you know there’s everything has a reason, so your first acquisition with VinSolutions was highly publicized. I mean, Matt has a Wikipedia page about him. I do, and I also realized that there’s a lot of well-known Matt Watson, so it’s so you want them one from Kansas City?

Matt Watson 7:28
I’m also a baseball player. Also.

Matt DeCoursey 7:31
Yeah, yeah. A gamer. A game. A streamer. Yeah. So we need to do a series on that because I have so many questions now that said, you know, back to the acquisition thing, you know, we recently we talked about raising capital in later stages because it’s way different. What is an acquisition? So go back and brush up on those if you’re just entering the series because there’s a lot to consider here now. When we talk about things falling apart. You know, so much of what we talked about last week was all the stuff that you need to be prepared for in an exit, and like I said, I don’t have enough time to go through what all of that stuff was just check out the episode, but there’s a lot of due diligence there’s a lot of fact-checking. There’s a lot of checking on you and the VA and validating and can, oh god, and I have

Matt Watson 8:21
another one of those crazy things when they’ll just tell you when when when I sold a company before, I won’t say which one they did background checks on everybody and found that one of them actually was a convicted criminal, and that raised some eyebrows in the deal too, so it’s just shit you don’t know man skeletons in the closet they all come out

Matt DeCoursey 8:46
well, and rightfully so, if people are making massive transactions and honestly on some levels, so we’re talking about, you know, the reason things fall apart, I want to point out that this can be a two-way street because sellers back out often along the way to the same way buyers would well, then it’s a moving target on Sundays you know, like something changes in the way that you’re looking at the numbers, the sales or whatever, or maybe even we talked about key people leaving and now all of a sudden your buyers like, well, there was last week’s price, and now there’s this price. So it’s good that leads to the seller being like, Dude, get the fuck out of here, man, take a check and go somewhere else.

Matt Watson 9:32
I mean, absolutely go back to the VinSolutions days, right? Like we’re doing great. We’re growing like crazy. We don’t need money. We’re profitable. And if somebody offers us 80 million and we’re like, or I can just wait six months, and it’s probably 150 because we’re growing, so let’s just wait six months, right? But the problem with that mentality is that it keeps going on forever, like and then another six months, you’re like, Oh, and another six months will be bigger and another six months will be bigger like at some point in time. You just have to cash the check. But you’re absolutely right. When you’re a seller, and you’re in the driver’s seat, it’s easy to tell the buyer like, we’ll just wait. The worst case scenario will be worth more money in three to six months. And we’ll just start the process over again.

Matt DeCoursey 10:15
Well, one thing that and I don’t, you know, I knew a lot better during the stack of acquisition that was sold to a private equity company VinSolutions was sold to AutoTrader, which had like a specific use case with that. And on top of that, and I’m not saying that multiple people weren’t interested, potentially interested in sacrified, but your term quote every day was the buzzword you would call, and you know, you guys are answering the phone every day, because every day someone else bid up the price. Yeah. So you look at say the buyer being in the driver’s seat? Well, first off, you can’t have an auction with one better. Yep. So you know, depending on like, where you’re selling and how you’re selling now, in the case of, and I don’t know, this is just pure speculation, I have no facts or info. But you know, in the case of your VinSolutions, exit, auto trader could have been like, hey, let’s not mess this up. Because we don’t want our competitor, right getting this either. So that’s that, that that can go two different ways. And you know, it can go up, it can go down. And I mean, there’s a lot and now really, overall and according according to the production team at Startup Hustle, which does more of the background on these episodes that we do, just to be honest, but the biggest reason for an acquisition or an offer not converting, it’s you as the founder or the seller, and, you know, it’s the actions and inactions of the owner preceding the sale. And the process, in most cases, kills the deal. And you know, one of them is as the very first on our list here is emotional attachment. So people don’t want to know, yeah, well, they’re attached to the baby, and they don’t want it, you know, so yeah, but here’s the thing, yes, sell the baby, someone else gets to raise it the way they want to raise it, they close it and do it the way they want, and maybe even changed the name. And you know, there’s a lot of people like, you know, the blood, sweat, tears and the DNA that a founder puts into, you know, that’s what math that’s why on the new founder brand T-shirts, we made, one of them has a thumbprint for the O and founder because founders put their thumbprint on a business and they get really attached to it. And they’re like, you know, and then honestly, some of them that smarter ones during these processes are like, hey, they realize this is a transaction and whatever someone’s going to do with the thing afterward is their business.

Matt Watson 12:34
Yeah, and part of that is before you decide to sell, you’ve got to come to grasp that, right? If, like, now’s the time, I’ve made the decision. But the but for sure, I’ve seen deals go down where you run into this, and you get all this weird baggage of like, okay, Joe’s currently the CEO, what are we going to do a Joe after the deal? Like he wants to stay around? Or is he going to be a consultant? Or what are we going to do with him, and, as the buyer, you potentially want to cut the head off, right? And you want that weird baggage to be gone. Like sometimes, you want Joe to be gone because you want everybody to fall in line, and do what the new business owner wants to be done, not necessarily have rogue Joe running around, right? And so you just get some really weird things that go on. And absolutely, you have a weird emotional attachment with the current CEO and owners that maybe some of them may not want to let go.

Matt DeCoursey 13:26
And some of the, you know, some of the subcategories and things that all go on and in a founder or seller’s head. Now once again, that’s, you know, like we’ve compared startups, so many times are snowflakes because they’re all different. They also have different cap tables, they have different ownerships, stuff, and you know, mountain, I own a business together, and you go to full scale.io and learn more about it. And we don’t each own 50% of the shares, right, which is great in some regards. But if you look at it like it, okay, mountain, I have the ability to make adult business decisions. If we didn’t, theoretically, either one of us could stop the other person from selling the company. And you know, so there are things that can or could occur there. And then also, you know, and Matt, I want you to talk about this for a second after I blaze through this list. But, you know, what am I going to do after I’ve sold? Do I really want to sell the business, as you mentioned? If I hold out, is it worth more later? And, you know, and if I wait, you know, will I be able to sell it, it will be worth less later. Now, as far as the like, what will I do after I’ve sold, you know, we go all the way back to like, Episode 10 with Lirael Holt, the founder of Car Story and say, Lyra, what who are you? He’s, I’m just the guy looking for something to do. You know, and that’s that I mean, well, right, right. So like, how much of at any point with VinSolutions were you like, I don’t want to sell because I don’t know what I’m going to do later. Are you like, Hey, this is a hell of a lot of money, and I’d be kind of dumb not to cash this check and then answer that question later.

Matt Watson 15:00
Well, we were definitely in that weird situation where we’re like, Okay, today the business is worth X. But we’re growing so fast that in 12 months now, it’s going to be worth like double that, or one and a half times that, right? And so it’s really easy to get into that. That mindset, if I hold out, I’ll receive more later. And that just perpetuates. But it was actually one of my friends who was one of the shareholders, and it was his dad. And he’s like, you know if they offer you X, you take the fucking money, and you run away, like, yes, have to stop at some point in time, like, you’re getting so much money, that it really doesn’t even matter if you get 20 million versus 25 million versus 30 million versus it’s just all a lot of millions just take the money, right? At some point in time, you just have to take the money. And but it’s difficult when you’re in that situation because it’s easy to have that mentality of like, well, I’ll just hold out and make more later.

Matt DeCoursey 15:54
Yeah, and you know, so the Buddha says that tomorrow and overcomes you always have today. Yeah. And that’s that kind of like that six month months, six months from now never comes. It’s always now. And if that’s it, it’s kind of like the, you know, I talked about my book balanced me the right time. Now, if people are like, I’m just gonna wait for the right time to do whatever. And the thing is, is really all that is, is just justifying why you’re not doing something. Today, it’s, it’s not the right time for me to start a diet. It’s not the right time for me to get a new job. It’s not the right time for me to seek investors. And you know, like, I mean, there are certain situations where it truly might not be the right time, but overwhelming, I’m going to toggle it 90% of the time. If you hear you’re saying yourself saying what you need to do, you need to check your head a little bit. Okay. So, you know, there’s obviously a lot of emotional things that go into this. We talked about that a little in the last one, you know, one thing that you talked about taking the money and running. So I’ve had kind of something that I’ve, you know, I’ll be I’ll tell you, I don’t have an exit history, like now. I’ve run some businesses that have made a shit ton of money. And I’m cool with that, that on the flip side, they weren’t necessarily like acquisition targets. Now I’ve known so many people like you, and peers and other guests that have, and they often refer to that kind of what I refer what I call that, that first sleepless night, which is when all of a sudden you’re like, oh, shit, I could have a massive payday here. And, you know, like, do you remember that night?

Matt Watson 17:31
Yeah, absolutely. And what’s crazy about all of it, when you own a business, you don’t necessarily think about the money side of it, right? Until you get to that kind of situation where like, oh, wow, we apps, we actually could get a giant pile of cash. And that could actually be X for me. Right up until that point, like, it’s, it’s sort of like, it sounds like a great idea. But you know, it doesn’t become reality until you get to that point, then all of a sudden, that reality kind of kicks in, and then you honestly start spending the money do

Matt DeCoursey 18:02
which, by the way, is not advisable. Yeah. Because it’s not I mean, me just in life, I don’t care if you’re in an acquisition spending money before you’ve got it as is often what people refer to as why they got the why they broke the lever, you know, so it happens. And that’s a tricky thing to now in this case. This is, this is a little different than when we look back at like raising capital. Because, like in raising capital, you think you’re getting an investment, then you don’t. You’ve made a bunch of commitments. And now you’re like, oh, what now? Okay, so another reason for that, that acquisitions fall apart and fail is missing numbers, meaning like you suddenly like, during the process, something happens, and your sales might dip drop or just stop growing? Or perhaps, Okay, so you look at, all right, so will this is on point, I’m not getting off-topic here, Enron fell apart, because their accounting was bullshit, right? So they were claiming they had revenue that wasn’t necessarily realized, or that they had assets. And, you know, once people get in there and start poking around, and they’re auditing your stuff, like they, you know, the way that you’ve been representing X, Y, or Z might not be seen the same way by whoever’s looking at it. So kind of all in the same.

Matt Watson 19:31
They’re well, and I saw the same issue. Even just tried to raise capital, right? But you know, just even raising like VC money, it’s like, okay, you’re growing, let’s say it’s 10%, a quarter or 20%, and a quarter, whatever. And all of a sudden, you have a bad quarter. Now they’re like, Oh, well, wait now because we want to see you get some momentum and get that growth going again, right? Well, now the problem you have is, you know, you take the LOI because you’re doing 10% A month or whatever it is, and then all of sudden you have a bad month. under a bad quarter, while you’re in the middle of this, like three to six month window of doing the deal, all of a sudden, they might be like, I don’t know about this. I mean, we were gonna buy this company for all this money because of the growth and all that. And now, all of a sudden, you’ve had a bad couple of months, and you got a big customer cancel, like, we don’t know anymore. We’re not sure. Right? And honestly, that is really scary. And part of the problem is, your whole team is distracted by all this bullshit. We’re trying to sell the company that it’s hard to even run the damn business while you’re going through this. And it’s easy to miss your numbers because you’re, you’re distracted. So I mean, it’s a huge risk and a problem in the deal.

Matt DeCoursey 20:41
Well, and that’s, and that’s why, you know, we refer to due diligence. So many times and due diligence is the process of verification, investigation, auditing potential or deal investment opportunities that confirm, like, relevant facts and finances and other information, like you mentioned before, maybe background checks, or, you know, talking to vendors. And we’ve mentioned that a little bit before like, I mean, it was no, it’s no real secret that Full Scale had a big team at Stackify. But when that trio wants to buy them, they want to make sure that could be also because you own part of Full Scale that we weren’t at a spot where we could have just doubled the prices and being like Ha ha ha and you know, that’s, and it’s understandable. But with that, there’s a ton of stuff to go through. And really realistically, at one point, we that could have been like a big problem. Right? You know, and because it, it required other people to, you know, to make deals and decisions that weren’t necessarily something you could control now, you know, go ahead.

Matt Watson 21:47
Well, so those are what it’s called affiliated transactions, right? And actually, in the VinSolutions days, our whole deal almost got could have got blown up because of not an affiliated transaction, but because of a partnership. So we had a partner, one of our partners was thinking about like an accounting system for car dealers that we needed, like an integration with them, or otherwise, we couldn’t service those customers. Well, that company didn’t like the fact that Auto Trader was going to acquire us and basically could have killed that negotiation and or jacked up our pricing so much that we could have lost like a big percentage of our customers. And that almost blew up the whole deal. And sometimes those sorts of weird partnerships, again, that one wasn’t a closely held affiliate that was, you know, an external third party. But those are the kinds of things that can blow up a deal is any kind of those types of partnerships or like third parties that are critical to the deal, right, like, you know, some sort of integration or data provider or whatever it is, that’s really critical to the business. If those parties don’t, you know, aren’t happy with the deal, the whole thing could blow up.

Matt DeCoursey 22:58
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Matt Watson 24:47
and you never know what they’re gonna ask for. Right? So in when we sold the company to Stockify or we sold stock if you know, Metro wanted to know like every customer we’ve ever had. What tool did they use before they signed up for our tool? And then if they canceled what tool? Did they sign up? Did they switch to after? You know, why did they cancel? How big an account? Were they? What programming language do they use? Do they use Azure to, like all this shit? Well, we didn’t even know. Right? So some of it, we had to go back through all of our notes from like, Zendesk support tickets and sales notes and all this stuff. Like, we spent, like hours and hours and hours and hours. Because they just wanted they were trying to understand the market, right? Like, who was the customer? And you know, how big were they? And what tools did they use before and why did they cancel and, and a lot of that, like, it makes total sense. But it’s not things that you track on a daily basis. And I’m not saying drop everything you do now to go track those things. But don’t be surprised if like some weird shit like that comes out of nowhere.

Matt DeCoursey 25:50
Well, then you get goofy stuff. And I think this is a good time for you to tell the funny story about the meeting and the inappropriate comment that was meant to be a joke and, like, just dumb shit. And little things can change the way that a seller looks at a buyer.

Matt Watson 26:08
Yeah, one of the craziest things I’ve ever seen in my entire life. And this, this goes on that list of things that you cannot make up.

Matt DeCoursey 26:16
And by the way, I’m gonna sit back comfortably and listen to this story, because I love it so much. So let me get there, Matt. Hang on. All right. All right. Go ahead. Go ahead.

Matt Watson 26:25
Alright, so, we had already signed the LOI and everything to sell the company to AutoTrader. As one of the steps, they brought in their whole a bunch of their management team. And we had all of our management team in a giant room. There had to be 15 or 20 people in this room. And they went around, had everybody introduce themselves, and tell everybody what their hobby was. And so we started going around the room, you know, no big deal. And we get to this one individual who will not be named, that worked for my company, who went on to tell everybody in the room that his hobby was masturbation. And, and I’m sitting next to, you know, one of the other guys on my team, and I looked at him, we just looked at each other, like, mortified, and we’re not sure if we should laugh or cry. And it was just like, like, time stopped for a minute. And we’re like, what the fuck just happened? And like, really didn’t know what to do or say. And honestly, they’re there. I had have conversations like, the next that day, and the next day, like with the executive team and Autotrader around, like, what do we do with this guy who just said this? Like, obviously, you know, obviously, their perception of him went down several degrees of like, we don’t know if we want this person around anymore. Like, it was a weird, weird time. And I couldn’t even make up for the craziness that ensued from that.

Matt DeCoursey 28:00
Yeah, and you know, so we at a company I want to work for before I work for myself, we would call that a CLM, a career-limiting move. And now they’re easy to make a man like Deming, just saying, like, I think the rule of thumb is, don’t say dumb shit. But yeah, that so that definitely falls into my category of, of things that should not be discussed in the workplace, which is religion, sex and politics, you really have, you don’t really have much, much of a chance of gaining favor as much as you do with losing it. But yeah, so you know, and I mean, what a wild story, because you’re talking to you in front of 15 people that are trying to buy your company, you’d like to think that someone would have enough common sense to not make that joke now, that was in honestly, man 12 years ago. And that while that’s a long time ago, and sometimes it doesn’t. I feel like if you did that now, they’d probably run you out of the room in most rooms because, you know, you just can’t I mean, that’s no one got time for that. All right. So thank you for sharing that. Yep. It’s been a while. Okay. So another reason that acquisitions all often fall apart is, you know, your profits are stuck, or you have shrinking margins that come up or static profit, despite revenue growth, that can be a red flag like the revenue is going up, and the expenses are growing even more. And this is just still back into that. That whole due diligence process, like an example, would be despite growing sales by, you know, by five to 10% a year, a company’s profit was still frozen at the same number for several years. So revenues going up, which makes it look like you’re growing, but really, in the end, and this is what’s so funny, because, you know, we’ve joked about this, like, at some point, your business isn’t going to just be in the business of raising capital people. You got to make a profit. Yeah. And, and if you’re not, you know, and there’s a lot of businesses that do a shitload of revenue and I honestly don’t have much of a hope of doing a profit and turning a profit like Netflix. Maybe? Well, I mean, you know, in some of them, like the ride-sharing companies, Uber and Lyft, were really in that boat, and they had rate raised like a gazillion dollars of capital. And, you know, they had to make big structural changes and everything that they did and how they did it, because it became for this kind of reason, like, okay, so your revenues growing, your usership is growing, but at what point is that ever going to be profitable? Because, you know, at some point, you’re just like, when you’re on series Q of investment, it’s like, people are gonna start to ask the question, it was the same thing with a lot of the a lot of the startups and a lot, you this really gets exposed with a lot of companies that explore going public. Yeah, you know, like, I can’t remember the name. But there was a match, like an online Mattress Company that went through this recently that it was like, literally, like, it looked really good, the revenue was growing, you could see him everywhere. And when people went in and really analyzed that they’re like, Okay, this is actually might not ever have any hope of being profitable. Now, you’re not not now not only are you not getting an IPO, you’re what I mean, we work was kind of the same way.

Matt Watson 31:13
Well, and if we relate this back to the tech business, the big thing that gets scrutinized will be your gross margin. So like your hosting cost, and you know, third party fees, you may have any kind of stuff like that, those your margins are really critical. And that’s something that they’ll dig into and try and figure out, okay, are they optimized? Are they not optimized? How can we optimize them? You know, as the business continues to scale, will the margins improve? Like all those sort of things become important. And sometimes, if you’re a really small company, they might expect your margins not to be great, because you just haven’t hit those like, you know, love levels of scale that help optimize it. But those are definitely conversations that happen and could scare a buyer away because your margins aren’t good enough for kind of their model.

Matt DeCoursey 31:55
Yeah, and then, you know, another thing too, and this is like the case with a business, like Full Scale. So Full Scale is tech services. And, you know, we help you build a software team. Go to FullScale.io. And now with that were our businesses, the valuation would be more heavily tilted towards EBIT, the earnings before interest, taxes, depreciation, and amortization, more so than revenue, because we don’t, it’s not like the software product that has could potentially just kind of go on forever, our business is truly people driven. And it wants to see a profit. Now that profit now, there are factors that go into that, like, you know, how long you’ve been in business, perhaps how big your company is, do you have specialty, how long your clients have been around the average lifetime value of a client, these things all are, you know, known factors in that, but, you know, one of the things that could kind of flip things on its head is that if your buyers came in looking that, I’d like to think that hopefully, they knew better before they got this far down the road where acquisitions actually falling apart, but they’re kind of like, oh, shit, we should be looking more at the, you know, the EBIT da or the profit centers of this business and where they are now. Because, you know, like, and a change in that, in that fundamental nature of how your business is viewed, can very much could very much have an impact on whether or not your deal goes through. So,

Matt Watson 33:25
yeah, and in any kind of, as we’ve been talking about, really any kind of major change or decline and in the business performance, you know, just before the acquisition, and during the acquisition process can always lead to the deal falling apart. Yeah, I

Matt DeCoursey 33:40
mean, so next on our list is related to networking capital. And before we talk about this, I want to, by the way, you know, actually, that topic, I will, I’m gonna pause because you used LOI and a couple of different, you know, you know, I don’t like undefined acronyms, because you have a letter of intent, that could also be a loss of income. Did you use that and use that in two different contexts? Or

Matt Watson 34:01
was No, I use the loss of income to sell the company. Yeah. And then two minutes

Matt DeCoursey 34:05
later, you mentioned LOI, which was a letter of intent. So sorry, yeah, I don’t like undefined acronyms. And that’s literally why we once had an episode about acronyms because those are both valid terms. Yeah, yeah. So anyway, alright. So, networking capital NWC, is the difference between a company’s current assets and liabilities on its balance sheet, and it’s a measure of a company’s liquidity, and its ability to meet short-term obligations as well as fund operations of the business now, you know, using Full Scale as a reference again, this is something we’ve had, we’ve discussed as we come up on our fourth birthday, and you know, that at one point, it was funded with Matt and Matt, and then, you know, we did some other things. We raised some venture debt. Now, these are things that exist on our balance sheet that get paid back. Now with that at the same time, we have In order to prevent borrowing money that we would pay interest on, or perhaps, you know, maybe not wanting to take investment capital, we, you know, we talk a lot about how much money do we really need to keep in the bank. And it’s going to be different for other businesses like some places. You need to have six months’ worth and some places Yeah. Now, when the pandemic hit, one of the things that I just thought was really alarming. Were facts coming out that like the average American business, especially food service, usually didn’t have more than, like, seven to 10 days of cash on hand.

Matt Watson 35:37
Yeah, and, and so what really, this comes down to when you’re selling the company, and honestly, I didn’t deal with any of this in the VinSolutions sale, but in the sacrifice sale, it took me probably three or four months to wrap my head around what the hell this should even meant, was what was called the working capital pig. And even in our loi, and in negotiating the all along, we kept talking about the working capital peg, the working capital peg, the working capital pig. And it’s like, What the fuck does that mean? And even after they

Matt DeCoursey 36:05
stop working

Matt Watson 36:06
capital pay, Peg, the peg. And even after they explained it to me several times, I never could understand what the hell they meant. But at the end of the day, it related back to some of the things you’ve just described. It’s like, okay, how much money do we have in the bank? How much money do we have in accounts receivable? How many prepaid expenses do we already have? Right? So think about your use of HubSpot, and you pay $20,000 a year for it. Well, if I just paid that last month, I’m not, you know, my company’s not gonna get the benefit of HubSpot for the rest of the 12-month period, because I don’t own the company anymore, right? So all these calculations come together to form what is called the working capital peg, which is the biggest boring, confusing bunch of bullshit in the whole process.

Matt DeCoursey 36:51
By the way, I just Googled it, man, cuz like, honestly, now, now that you explained it, I get it. And I know, I’ve never even referred to it. And it’s, according to Google, which has an answer for everything you might need, people really do. There’s probably nothing you can’t find on Google. I know that sounded like redundant advice, but some of you need to hear that enough. Okay. So what is a working capital peg, a network? A net working capital peg or simply referred to as the peg is a benchmark or baseline amount of net working capital that is agreed upon by a buyer, and a seller is usually determined towards the end of financial due diligence. Okay, so here’s the thing say that we’ll use Full Scale as an example. Again, say that we knew that we wanted $500,000 in the bank for working capital, but we chose to have 5 million in the bank at some point. This really becomes a question, is the acquiring party also getting your working capital that’s there? Or is that something that needs to be distributed? Maybe to the current owners? Does it get split and maths example with HubSpot, also, when you accumulate cash, you get to you get the value and benefit of prepaid discounts and a lot of other things? So in his case, in his example, you paid $20,000, for something that you have a month in, which reduces the money in the bank that might get distributed. So should you be essentially reimbursed?

Matt Watson 38:18
You know, a lot of it comes down to accounts receivables, and prepaid expenses, and getting the credits of those right, because, you know, if Full Scale has $600,000 in accounts receivable, then the new company is potentially going to get $600,000 More money later, right? But if what if, for whatever reason, those customers don’t pay? Then you’ve got to reduce that down. And, and what happens is after the deal closes, 30, 60, 90 days later, there’s a true-up of the working capital peg. Anyways, we this is the like, using subject ever.

Matt DeCoursey 38:52
According to the accounting class that I had to take three times in college, the same one. Yeah, that’s true. We’re just sharing real facts, you know. So with that, you know, the accounts receivables are assets, you know, and especially when they’re coming from vendors that are known to pay now, depending on how you collect money that, you know, that has a different cycle, because, you know, when I worked for Roland, which is a musical instrument manufacturer, I mean, the manufacturers have net terms that are often 180 days, sometimes longer, like they could be net 30, 60, 90, 180. However, it is, and these are, these are, these are assets that are on the books because someone’s going to see them on the return.

Matt Watson 39:37
And this is where the deal would blow up, right? Let’s say we have a customer with Full Scale that says, Look, we have a three-year contract with Full Scale, and we’re gonna pay them a million dollars a year for the next three years. Well, if we go to sell the company, there could be a huge discrepancy between us and the buyer around what that contract is worth. Right. And that’s where the deals can fall apart if you have these big contracts and AR and all that. And if we’re like, hey, this is guaranteed money, and they’re like, yeah, no, it’s not, then then you can have like a big fight around the value of the company.

Matt DeCoursey 40:06
True. True. You know what makes a lot of that easier is being prepared. So I want to give a quick reminder that today’s episode of Startup Hustle was sponsored by Gusto. And, you know, thanks gusto because you’ve sponsored a lot of Startup Hustle episodes at this point, we appreciate that. When we go to sell this podcast, we’re gonna bring that up in the peg. So you can manage your HR needs with Gusto. It’s the way to go, you know, make it easy to onboard new talent, handle payroll, support your people in any way. Gusto, this platform is powered by advanced technologies. So talent management and payroll processing will never be the same. Again, try Gusto for free gussto.com forward slash Startup Hustle, click the link in the show notes. And, you know, Matt, as we wrap up this episode, I mean, this was there was this was good. Like, honestly, we really only scratched the surface, like. These are some of the more common reasons that things crater, and there honestly, we didn’t even get we probably got one.

Matt Watson 41:07
Well, I have one more story I have to share, know that you know about that is the craziest of all of them, is what happens when you have a buyer that wants to buy something, but the buyer doesn’t even have any money. Do you remember that? Like, I, we know somebody locally that tried to acquire a business on the presumption that they had a bunch of money that they didn’t even have? And went through this whole process with a company that I know about?

Matt DeCoursey 41:38
One with more than one. Yeah, this was someone that appeared credible and was shopping for deals, running up legal bills, and a bunch of other stuff. Now a lot of this stuff, like you can get stuck holding the bag on that too. But yeah, and that same person considered bought investing in Full Scale. Yeah, and sacrifice and several other businesses, and then later, it just didn’t happen.

Matt Watson 42:05
Yeah, talk about the craziest shit ever. Like that was a wild one.

Matt DeCoursey 42:08
Yeah. And that was weird. And, you know, that was an that’s tough to determine. Because, you know, like, Well, I mean, and Yeah, true. So, you know, I’ve completely forgotten about that now. Yeah. And that might have done a defense mechanism of wanting to forget about it. So it’s things like we said, like, do you talk about investments, acquisitions, and other things falling apart? Like, and that is another thing that that can happen is, you know, whether it’s private equity or another company, I mean, I don’t know if Autotrader just has that money in the bank. But a lot of times, these things are funded. There’s the funding behind the funding.

Matt Watson 42:42
Right, and they have capital calls. And if, for some reason, they can’t call the capital on their end. Yeah, it could fall apart.

Matt DeCoursey 42:47
Yep. And, you know, and I mean, there’s a lot with that now. This, I mean, this is a real insight. I’m glad we did this episode because I think this is important stuff. Because it really, in the end, you know, I think, it’s the opportunities missed that you look back that feel added often feel the most expensive. You know, so I mean, if you can first off be professional, you know, don’t go into meetings and say dumb shit. Right? Like, I mean, do that, that that instance where your, your story there like that could have tanked a deal because that could have could have really reflected poorly on the culture. Yeah, existed at your company. So anyway, well, now we’re going to come back, we’re going to do this, we got three more of these buddies got 50, 51, and 52. And I’m gonna leave it a mystery about what we’re going to talk about because yeah, wait. The grand finale is near, folks. And, and then we’re jumping right in, we’re gonna, you know, well, let’s let the cat out of the bag. Because we know we’re doing this we’re gonna do. We’re gonna mountain I like doing series because we like getting deeper into things that you can’t necessarily always get into, and 45 minutes to an hour, but we’re not going to go too deep. But we’re going to talk to NFTs.

Matt Watson 44:06
Yeah, they’re, they’re all the rage these days. And I’m convinced I know why they really exist. But I’m excited to talk about it.

Matt DeCoursey 44:15
And we’re going to talk all about that and more. And we’re going to really like we have some fun and interesting stuff. This is going to be demonstrative and interactive for many years, or so I’m going to leave it at that now. Once again, Gusto. Thank you, and thank you for helping founders and businesses be prepared for what they need to be prepared for. And thanks again and Gusto for doing all the crap that we don’t want to do. I’m out

Matt Watson 44:40
Thanks, everybody.