Why Is Quality of Earnings Critical for Business Valuation with Patrick McMillian

Welcome to the B2B Growth Blueprint podcast, where we talk with entrepreneurs, founders, and leaders at B2B services, tech, and SaaS companies to learn the systems and processes they've used to create success for their business. We'll also learn from marketing and sales experts to provide insights to help you grow your business. I'm your host, Mark Osborne, and the podcast is brought to you by Modern Revenue Strategies and their 10x ROI B2B Growth Guarantee. Schedule a free diagnostic call to learn the fastest path to double your B2B revenues in just 90 days. Hello and welcome to another episode of the B2B Growth Blueprint podcast. I'm your host, Mark Osborne, and today I'm very excited to welcome my guest, Patrick McMillan. Now, I'm going to read Patrick's bio to make sure I get this right. He's a seasoned fractional CFO and a merger and acquisition or M&A advisor known in the deal community as the Q of E guy. We'll talk about what that means. Having bought and sold businesses of his own, he now helps others navigate acquisitions with clarity and confidence. He's the head of the transaction advisory practice at Amplio, And he leads quality of earnings, QoE, and financial due diligence engagements. His firm also supports and provides valuations, outsourced CFOs, controllers, HR, marketing, and sales tax support throughout the deal lifecycle. He's advised over 100 transactions totaling over $2 billion in value, holds an MBA in finance, and is a certified exit planning advisor. So Patrick, welcome to the show.

Thanks, Mark. It's a pleasure to be here. Looking forward to the conversation.

Absolutely. Well, before we dive in on some of the topics that you and I have sort of been chatting about, why don't you give our audience a little bit of background? Like, tell them the story of what you've done in your career, how that led you to where you are today.

Yeah, it's very fun to go over quickly and then dive into details at times. So I am a Southern boy from East Tennessee. I got my undergrad from East Tennessee State University. Uh, while I was doing my undergrad, got into accounting, got a job, uh, for Citigroup doing accounts receivable and really loved it. Got into some management there. Uh, had a lot of fun, learned quite a bit. Uh, long story short, moved out here to Utah, uh, which is where I currently live now. Moved out here about 20 years ago, bought and sold a small company. This is pre-2008. So I bought my partner out of our real estate holdings company.

Okay.

And then at around the same time, I sold my mortgage loan processing company to one of my clients. Had no idea what I was doing for either one. Made a lot of phone calls to a lot of advisors and said, hey, how in the world do I go through this? And so I did. Somehow it worked. Kind of got me interested in M&A, but I just kind of put that on hold. 2008 hit, everything crashed, got a job.

Yeah.

I became a corporate controller and then later acting CFO of a conglomerate of companies. We had several different various companies and industries. We grew quite a bit. So I was the one, I was the CFO working with all the shareholders, raising capital debt, board reports, losing my hair. It was crazy. It was fun. I loved it. But after a little bit of time doing that, I said, I've got to do something different. So I became a fractional CFO, uh, picked up 7 clients. A lot of those were a lot of our shareholders, you know, from my previous, you know, so there's a fun story behind all that for another day. Picked up 7 clients, was their fractional CFO for a bit, and it was a blast. But Mark, I realized I had 3 issues as an independent, uh, capacity, um, skills And the way I charged people, you know, capacity, I could only handle so many clients, skills, I only knew so much. I can't charge for research, right?

Sure.

And number 3, it's not fair to me if I'm charging various rates for various things, you know, to different clients. So I joined the firm at that time was called Advanced CFO. Since then, we've rebranded to Amplio. With my background, the first project I was, well, one of the first projects I was put on was a private equity inbound interest to a, or from private to one of our clients.

Uh-huh.

Uh, so worked up a, uh, basically a sell-side QOV, which I've never heard of, didn't even know what I was doing while I was doing it, but I did it. We sold the company and it was a phenomenal transaction. Since then, I learned what it was that I did and decided, oh my gosh, this is interesting. I'll bet we have more clients that need this. And so I started, uh, working with a lot of our other clients and, and building the process. And so fast forward to today, we do about 3 to 12 of those a month. I have a broad team to do it. So it's a blast, Mark. I love what I do and I love the people I work with and the clients I get to work with too.

So you talked about QOV. And so I want to take a little bit of a sidestep. You know, we joke about, you know, something being sellable revenue, the difference between revenue that looks good on paper, maybe top line, but doesn't always translate into bottom line EBITDA or things that a buyer gets excited about. Why don't you talk about what the quality of earnings or QOV means since you're the QOV guy? No one better to educate our audience.

Yeah, definitely. And I'm gonna refer back since I know this is video recorded too. So this is Thornton O'Glove, who, you know, the original QOV guy, not EBITDaddy, but the original QOV guy. He wrote this book in the mid-'80s. Quality of earnings. Let's dissect that real quick. So quality could be high, medium, or low. You're talking about sellable revenue. If it's a million-dollar company coming from one client, that's low quality.

That's right.

A lot of risk. If it's a million-dollar company coming from 100 clients, that's high quality. And whether it's revenue or EBITDA, I mean, there's a— so there again, there's quality and there's so many ways you can look at the quality of a firm. Like we talked about customer concentration, vendor concentration. How are they financing the company?

Yeah.

Uh, you know, is one way. Uh, you talk about cash-to-revenue proof, you know, okay, well, maybe they have $1 million in reported earnings, but the more adjustments you have to make to get there, then the lower the quality, uh, drops. If you have to make adjust— a whole lot of adjustments to get the cash to reconcile, then that quality starts dropping. So there's Quality is such a huge important part, you know, in QV, and then earnings, of course, you know. And and there's so many arguments, I guess, if you will, about you know well what about EBITDA or net income versus cash flow or free cash flow? It's like it's all important, you know. So I'm the QV guy. Yes, warning may start talking about EBITDA, you know, as the shirt says. But the thing is is every single bit of it's important. You have to understand. all the tools in the box and which time you want to pull out which tool. And even then, there's still different size hammers.

That's right.

You know, to use for different things. So, we can dive so deep into this, Mark.

Well, and it's funny, although there are tons of tools and, as you say, even different sizes of those tools, one of the things that I find to be helpful for companies is just, you know, as you think about how valuable is a business, don't just think through it from the lens of the owner of that business today, the operator, but think through, you know, price is set by willingness to pay. It's the market that really determines the value of something. So, if you look at it through the lens of a buyer or a potential buyer, that gives you a really good lens and filter to think through, well, how much is this business worth? And just as you said, that customer concentration, well, that's high risk. I'm willing to pay less for that. If it's all short-term contracts, well, that's higher risk. I'm willing to pay less for that. If it's in an industry that's on a decline, well, that's higher risk. I'm willing to pay less for that. It gives you a really good, you know, sort of rule of thumb as a way of starting to see, well, I can see why, you know, one million-dollar business would be worth more than another million-dollar business just through the lens of, well, what would it be like to buy that stream of revenue?

Yeah.

And how confident would I feel in that?

Yeah, there's multiple ways to value a business. I mean, there's the 3 predominant ways: income, market, and asset approach. But when you look at market approach, multiple of EBITDA, the industry that the company is in will set the range, the range of values, that 3 to 8x multiple. But where the company falls within that range will depend upon, well, what's the company doing? What are those concentrations? What is the quality of that? You know, and of course when I talk with sellers and I say, hey, your range is 3 to 8x, what's their mindset always? Oh, I'm an 8x.

Yeah, I'm, I'm definitely the high end. Yeah.

So then I started asking them, okay, do you have X, Y, Z, 1, 2, 3? No. Okay, well, we've got some of that. Well, you know, we've been working on that. It's in our heads. Well, okay, then you gotta remember that the 8x companies are the absolute, like almost Pretty much perfect companies.

Best in the world, right?

And those are very few and far between. And so you're probably more like the 3x. My firm will help you whether it's our fractional CFOs and controllers or marketing or HR or something. And we bring in other people as a CEPA, Certified Exit Planning Advisor. I can bring in wealth advisors, attorneys, other people and say, hey, you know what? Let's get you over the next 2 to 5 or so years from that 3x to at least closest to the 8x. And if you spend 2 years or 3 years and you change from a 3x to a 4x or 5x multiple, oh my gosh, it's so much worth it.

That's right. That's right. Well, and so we've been kind of hinting at this. business owners sit around and think about how much is my business worth? Well, one day I'll get there. One day I'll invest the time to do some of this. But you and I have talked about this, that, you know, the idea that exit planning shouldn't be a one-day activity. And in fact, if you make it an everyday activity, it has a lot of positive outcomes, both in terms of what it's like to run the business for today. what it's like to plan for, you know, selling that business in the future. And that's something that, you know, it's like life insurance. No one likes to think about dying, so they don't want to think about their life insurance. In the same way, a lot of people running their business are like, well, I may be running it, you know, until the wheels come off. But sometimes the wheels come off through things beyond your control. You could have a disagreement with your partner, or you could, you know, get sick or have someone in your family get sick that you need to spend more time taking care of. All sorts of things that impact that. Talk to me a little bit about how you— and I know this is a big focus of what you do with your local Exit Planning Institute chapter and other things— how do you help business owners get past this sort of daunting monolithic idea of like, exit planning is something I'm going to put off as long as possible and do in a rush when I have to, not today? What are some ways to think about that that can help?

Yeah, and you know that, Mark, there are multiple barriers for business owners, and they're understandable. Things such as, you know, time. Hey, I'm spending so much of my time building the business, I don't even have time to worry about exit planning. Or, you know, oh, well, that's a cost I don't want to have to worry about right now because I'm spending money on growing the business. Or I can't let my neighbors or family or employees know I'm exit planning. What are they going to I'm only X amount of age right now. I'm not ready to retire. But the way that we help others get through that, and we do this quite a bit through our EPI, Exit Planning Institute chapter here in Utah, especially now that we've expanded to another county, is we're helping them to understand that exit planning is good business planning.

That's right.

Because as you're going through all these, and there's so many ways you can work, 90-day sprints, working on 1 or 2 things at a time. But as you're working on that exit plan, and I'm gonna give you an example, okay?

Yeah.

Tightening up your employee contracts or maybe even writing employee contracts that you don't even have, that alone changes how your business is valued because now you're de-risking something there that will help. And so, as you do that, although that can be considered part of exit planning, That's just good business in general. It helps your employees feel more comfortable. You're managing the expectations of you and your employees of when they get paid, how often they get paid. PTO, paid time off. For example, a lot of companies don't book accrued PTO on the balance sheet, and they don't realize when they go through a transaction, oh my gosh, those $200,000 that my employees can cash in should have been as a liability on my balance sheet all along. But now it's going to mean adjustments to earnings. So, you've got to really think about those things. And so, we help businesses to understand that exit planning is just good business practice in general.

That's right.

Let's get things in line. Then that way, if one of those 5 Ds happen, you know, death, dismemberment, you know, disability, or whatever happens, or if you get an— we talked about this in our last chapter meeting— if you get an an unsolicited inbound offer, which is exactly what happened to my, to my first client, then it's like, oh my gosh, this feels like a Cinderella deal. Should I accept it?

Right.

Then you already know prior to that deal even coming in, and you don't have to spend, you know, weeks or months analyzing and preparing for it. You've got all that stuff ready. And then that way too, there's just so many things we can get into with this, Mark.

That's right.

Exit planning is good business planning and helping the businesses, you know, to build the founders to understand that, hey, yes, family member, neighbors, employees, we're doing exit planning. It doesn't mean we're going to sell tomorrow, maybe in 2 years, maybe in 5 years, maybe in 20 years. But you know what? This is going to help you guys because now we're helping to manage expectations All around in so many ways, and everybody gains a lot. It's gonna be uncomfortable at first, but as you go through it, then you start gaining so much more comfort.

Yeah.

And understanding. And those 2 things really raise the level of the business regardless of whether you're gonna exit or not. And let's face it, every business exits. Every single one will.

Yeah.

Either by death or by transfer or by just they're gonna shut down. I mean, something's gonna happen. No one lives beyond 125 years, you know, and so something's gonna happen to your business.

That's right. Well, and not only that, but a lot of the things that you do to make a business more attractive to be ready for exit actually make it more enjoyable to run on a day-to-day basis. So, it's not like You know, to use maybe a strained analogy, but, you know, saving for retirement that you can't touch until you get to be 60, and maybe you'll get hit by a truck between now and then, you never get to touch that thing that you save for, versus doing the things that make your business more attractive to other folks, actually make it more fun for you to run. And like, that's sort of— Yeah, one of the big things that, you know, makes a business more attractive is less owner dependency. When you have less owner dependency, you can take a vacation and things that a lot of business owners haven't done for a while. That's right. That's right. Which is just so— and a lot of things that keep owners up late at night is, oh, this one customer that I'm so dependent on, what if they went away? All that stress goes away if you remove some of that customer dependency.

Or are you risking the company?

That's right.

Which helps your cash flow, which helps you sleep at night, helps your employees sleep at night, and maybe it'll help your exit.

Wow. That's right. In the meantime, so I know that, you know, at the firm Amplio and even through, you know, sort of the CEPA certification, there's a framework that comes from, you know, either whether it's Exit Planning Institute or just sort of the overall value acceleration methodology. That actually creates a really unique dynamic for a business owner that's got, well, I am ready to start thinking about exit planning. As part of that, there's some big things. I need to have enough money to live off of and have the lifestyle that I want. So, there's a lot of things there. And I want to make sure that the business is at the right spot so I can capitalize on all that I've put into it and really get the highest sale point for it. Well, once it does sell, I want to mitigate my exposure to taxes or legal liabilities or all these other things so that I can prepare for that. So, there's a lot of moving parts there. And oftentimes, business owners can sort of feel daunted with, well, how do I bring all these moving parts together? Talk to me a little bit about how you've seen different advisors from different domains of expertise Or those kind of 3 different areas of sort of focus for a business owner. How have you seen them mesh together in an effective way that works out well for that business owner?

Yeah, I'm going to share both sides, a good and a bad one. And I'll start with the latter, the bad one. So, a lot of times, and Mark, you've nailed it, a lot of times you get different advisors involved and you have opposing agendas. Yeah, with those advisors, you know, for example, you've got the CPA, you know, who— what's their main focus, or at least should be, is to reduce the tax liability of the company, right?

Right.

But then you've got— but as you're doing that, you know, through the books, then you've got the value acceleration person who's like, oh my gosh, we have to show as much earnings as possible because that's really good. So you've got a lot of times you have those opposing things, and many, many times that's one of the reasons why business owners are so scared If you— it's because, well, this guy's telling me this and that guy's telling me that, and they're complete opposites. Which one do I believe? I don't know.

Yeah.

But that's why the framework that is more advantageous for a business owner to work in is exactly what is taught at Exit Planning Institute through the CEPA program, is you have the quarterback, you have someone who understands what the goals are of the, of the founder and the founders. what their wealth gap is, and then they plug in the right people and they make sure that everybody is managed and understands what the expectations are and everything is basically funneled up through that quarterback. Then that way, the owner has that one predominant advisor, point of contact, guide, quarterback, you know.

Yeah, for sure.

That way, they're driving the bus, but then all these other individuals are making sure that quarterback is making sure that all the other advisors are All in line with the goals of the owner, of the founder. And that's why too, you work in 90-day sprints, you know, as they're called and say, okay, these 90 days we're gonna work on X and Y. We're gonna bring in these 2 advisors and you make sure you have those, those meetings and, and, and set the expectations of that. And the next 90 days you're gonna do the next 1 or 2 things with those. So that way you're aligning things, you're picking off low-hanging fruit. To get the advisor excited, or sorry, to get the owner excited about, oh, wow, we've done this a little bit and we've gained this much. And then that way, when they get through those hard times, it's like, hey, you know what? We can get through this. We can work on this. And at the end of this, it's going to turn the juice up this much more. The complications are going to— the juice is— was it the lemon's worth the squeeze or juice is worth the squeeze?

The juice is worth the squeeze.

Right. And so that's where, yeah, that quarterback, the head advisor, is so important to make sure that they're— that's why you have a quarterback in football. You make sure that everybody is working on the same playbook.

Yeah, that's right. Well, and has a centralized focus, which, just as you say, CPAs trying to minimize tax liability, a sort of value advisor that's trying to show more income on paper, those are seemingly conflicting objectives. But if you approach it through the lens of what's going to make this look best to a potential buyer, well, then that creates that alignment and that sort of ease of, you know, sort of the measuring stick by which you can measure any decision is, well, what's going to do a better job of driving the value that we can show to the marketplace and then capture once we're ready to harvest that?

Well, there are even multiple options to harvesting. You know, it's not always through— people think, you know, exit, business exit. Oh, one big sale to a third party. Yeah, not all the time. What if you want to pass it to your kids or another family member? What if you want to transfer it to your employees?

That's right.

There are multiple options, you know, and that's what a good exit planning advisor would do is say, hey, okay, what are your goals? Let's explore the options. It's not always about getting top dollar.

That's right.

It's about making sure you achieve those goals that you're working for.

So we've talked a lot about how it's important to sort of think about this today to get an accurate picture of what the company's really worth. What is the quality of those earnings? How it doesn't have to be as daunting as it might seem. You can start to build some of that alignment to build the value of your practice today and also the enjoyment of running it, as well as sort of the ultimate value that you'll get from it at some future point. And we've talked a little bit about a framework for bringing together multiple different advisors so that there can be sort of harmony and clear objectives and alignment there. Talk to us a little bit about the work you do there at Amplio and how you bring multiple of those advisors together to help businesses be ready.

Yeah, let me— I would love to take a minute walking into that and just kind of share our background. We've been around since 1996, almost 30 years.

Wow.

The majority of that time we were just doing fractional CFO work. And as you think about it, okay, well, what is a CFO versus an accountant? Well, CFO is a strategic advisor that really does forward-looking things. For example, raising capital. board management, shareholder management, you know, all of those things where, you know, accounting is more backwards historical looking. And so as advisors, a lot of times our CFOs are consultants. We've really been involved in a lot of these planning things anyway, but without, you know, so much of the framework. So I think it's roughly, I don't know, 10 or so years ago, we brought on a partner who did turnaround and restructuring.

Yeah.

Because a lot of times things don't work out, right? And there's multiple reasons for that, uh, not worrying about the details, but a lot of times a company, we have to get in there, we really have to help them pre-bankruptcy or even during bankruptcy. A lot of times courts will hire us to become a court-appointed receiver.

Uh-huh.

So that brought on our second division. So first we had finance controllers and CFOs, right? Second, then we had turnaround and restructuring. And then a few years ago, we decided, you know what, while we're at the fractional side of things, and this is a long story short, we've had people asking us, well, what about someone to help out with marketing or HR? So we opened up those divisions. We have incredible presidents or managing directors, you know, who, who own and manage those divisions now. So we do full-stack marketing, full-stack HR. And they're phenomenal divisions where now we're able to really— kind of the joke of Joe Grover, our managing director of marketing. He says, Patrick, you guys as the CFOs will help save money and raise money. I help spend it. And that's— and he puts it in the right spots, you know, for marketing. He has an incredible resume for that. Abby, who manages our HR, same thing. She's ex-Google, ex-executive from Google. She lives in California. Those are 2 great joinings as far as HR. You have Google, who's huge. You have California, who sucks. HR laws are horrible. She knows how to manage all that. And then now to open up some more divisions, we made a few acquisitions ourselves. We've been through it. I bought and sold a couple of companies myself. A lot of us as partners and CFOs— I'm not one of the partners, but I manage our transaction advisory.

Yeah.

We have also bought companies. We as a firm acquired 3 companies last year, a marketing agency which expanded our marketing offering, a sales tax firm who is huge, the Sales Tax Guys out of St. George. They've been around since '92. They're phenomenal. And so we acquired them, and because we've known each other for decades, and we decided to join forces, and we acquired Peak Business Valuation. So a valuation firm.

Wow.

Mark, they do 25 to 30 valuations a week.

Wow.

And most of those are business acquisitions or divorce or some kind of split, but they also do feasibility studies and things like that. And so there's just so much of a breadth and depth, you know, that we now have 250 professionals on our team, you know, across one of the divisions, and we're able to really be able to jump in and help out. Now, even with all that, how we're able to— back to your question, you know, manage, you know, kind of all the other advisors to help a business— we've worked with in various capacities, you know, as CFOs or CMOs or HR or sales tax or valuation or turnaround. We've been able to really bring in the right people from the right— it's the right people on the right seats. of the right bus at the right time going in the right direction.

Yeah.

And so we're able to bring in other people from other advisors that we've worked with or known or work with the existing ones that you have and really make sure to help you as a business owner, whether it's just, hey, I just want to control it. That's all I want. Great, we can do that. Okay, that's fine. You don't have to use all our other divisions or anything. But we have those options available if you need them.

That's great. That's great. So, you're obviously an expert in a lot of really interesting topics that we could spend all day talking about, but I got to be mindful of your time. But you've painted a really sort of interesting picture about, you know, your practice there at Ampplio and how you help companies. So, for, you know, folks that are listening and, you know, maybe they're thinking about needing some of this advisory and they'd like it to be kind of unified around, you know, sort of a central approach like value acceleration. What's the sort of best way folks can get in touch with you? Like, what's the best way to engage?

Yeah, quickest and easiest, LinkedIn, Patrick McMillan. Reach out to me. I will point you in the right direction as far as which division to get in touch with.

Fantastic. Well, Patrick, thank you so much for taking the time to join us today. I know our audience learned a lot, and I sure did.

Well, thank you, Mark. It was a pleasure. I really enjoyed just talking and helping and listening and learning from others too.

All right, talk to you soon, Patrick.

See you soon. Thanks, Mark.

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