Why My Pro Forma Looked Right and Was Wrong

Welcome back to Bought the Biz. I am excited and terrified for this episode, and I know that's not the first time I've said that. Today I'm going to share and show you all the pro forma that I built when I acquired Top Dog Sales Center in October 2022. Christi is going to ask me questions. We're going to go through what worked, what didn't, what is different, and what would I do differently. So you're not going to want to miss this if you're searching for a business or recently stepped into the operator seat. We dig into the nitty-gritty financials. Bought the Biz is a podcast for ETA entrepreneurs who've gone from searching for a business to actually running one. It tells the real story of what happens after the deal closes. The day-to-day operational, emotional, strategic, and leadership challenges that just don't show up in the highlight reels.

The show is story-driven and practical, sharing real experiences from operators along with clear, actionable takeaways you can use in your own business today.

I'm Garth Fossano.

I'm Christi Loucks. Welcome to Bought the Biz. On this episode of Bought the Biz, we are doing something completely different. We are actually going back in time to look at Garth's financial model that he built for his acquisition, and we're going to compare that to what actually happened. So this is a real-world exercise of just how your expectations don't always align with reality. So if you are listening, we do have actual numbers shown on the screen. So you'll definitely have to go back and watch the video version of this to get the full rendition. But we are going to, yeah, hand it over to Garth to walk us through the nitty-gritty.

All right. This is exciting and a little bit terrifying. I'm sure there are some people that will critique my model, but The important part is, is this past muster, and this is what I submitted with my SBA financing documents and ultimately helped me get a loan for the business. So as a quick overview of the document, I created 3 different cases. A base case, basically the business continued based on the historical trends with very conservative projections for the revenue per client growth. I made a contraction case where we were, you know, going down, fewer clients, and then revenue was declining per client. And then I also made a growth case. And so I used all of these things to consider what could happen and sort of map out the scenarios as well as providing this to the bank as part of the loan documents.

So, Garth, wait, I'm going to ask you before you even jump into this, when was the last time you looked at this in, in like detail. Like this is a live scenario that we're running here.

Yeah. So the date on this file is July 27th, 2022, and I have probably not looked at it since July 27th, 2022.

So this is like A true reaction.

Yeah, I might need a little bit of a refresher on what I actually built in here too. It's a little terrifying, but, but, but, but, you know, this is also just part of the way that my brain works is I was thinking through the decision and weighing the trade-offs and what the implications would be. This is, this is how my wife and I thought through the process of the acquisition and what might happen.

Amazing.

And I mean, I'm actually impressed with my notes. This isn't, you know, my typical style, but I actually wrote down what I was doing in each of the 3 scenarios I modeled. Like here it says the contraction case was, you know, market factors cause a reduction in clients and revenue per client also decreases. Immediately lose 20 clients on January 1st, 2023. It's like, whoa, okay, that's terrifying. That would have been like a 20% drop in the business, you know, a couple of months after taking over. Meanwhile, revenue per client is declining as well. That would be a pretty scary situation.

Drastic.

That'd be drastic. Yeah, exactly.

But I think it's still good that you accounted for it.

Yeah.

As like the worst, worst case scenario.

I actually do think I remember sitting down with Peggy and modeling out the contraction scenario and she was like, that's not enough. Make it bigger. Make it worse.

Make it worse.

Yeah.

Make it more scary.

Yeah, exactly. Um, And, you know, at the time at least, and I'm sure it varies bank to bank, but it felt like this model was probably beyond what they were used to seeing. And I got very few questions back from them.

That's great.

Uh, so I think it worked and I don't know if—

Maybe this is a template we can even share.

Oh, I think there are far better templates that are out there in the world now. So, um, I don't know if that's the way I would if I would go that far, but it, it definitely was helpful for me at least to think through it. Um, okay. So we should go to the model. We should talk a little bit about it. And, uh, what I think the interesting thing is going to be what was true, what wasn't. And now looking back, some of the assumptions that I made and like how some of those were very flawed, but still overall, you know, everything worked out.

Okay.

And I can see the first thing on page 1 here. That was flawed. Okay.

Tell us.

Yeah. Principal and interest monthly payments right here. So total of $18,000 a month. And this was definitely big on my mind because going from a W-2 to owning the business, it was like, you know, if things go really far south, how do you make this monthly payment and not default on the loan? That was top of mind to me. Um, and this is for many of you operators will remember in late 2022 and 2023, rates were increasing and most SBA notes are variable. And so this quickly went up from $20,000 or $18,000 to $24,000 to $16,000 in total payments per month. And so that was one part where the model was definitely not correct.

Number one.

Yeah, I think you know a little bit about that too.

Yes. Yes. And that's where, I mean, we built a model similar to this and I would have gone more conservative.

Okay.

On some of like, on those payments even, just to say, I think this is what it actually is going to be, but I'm going to buffer in more.

Yes, yes, that makes sense. Did you— okay, so before I actually get into the model, did you build a similar base case and contraction and growth model for your business too?

Yeah, we did. And I think that's— this is a— if, if people aren't doing this, you know, they need to be thinking about it, just because you have to model out every terrible scenario that you can think of and best case and then amazing case. And similar to what you did, like our bank wanted to see this and Alex and I wanted to see it for our own sanity. So yes, we did basically the exact same thing. I think that in some cases, and obviously I don't have mine pulled up, but like in some cases we were far too aggressive, sometimes far too conservative, like looking back even on ours, it ebbed and flowed where we put which eggs we put into which baskets. Right. But I think the exercise itself is super important.

Yeah. So I think that the first thing to make sure you're modeling is increasing rates. At the time that I started the loan application process, rates were at 8% and within 6 months they went up to I think 10, 11%, and then eventually climbed to like 12.5, um, before starting to come back down as they have in 20, I think until recently. Yeah.

Okay. So let's, let's dive in. Let's jump into the meat.

Okay. Here it is. So I think that this is the base case model. Again, give me a little bit of, uh, leeway here because I haven't looked at this since July 2022. And, um, just to give you a little bit of a quick walkthrough of what we're seeing here, the cells in white are the sort of locked numbers from the prior business, and then yellow was forecasted, and, uh, blue is the, the annual total. So everything in yellow is what I was projecting, and I believe that this is the base case. And who knows if this is exactly the final model, so I don't know if it's completely the final version that we submitted today. Final version.

Yeah. But, but I mean, it's version 4, so it's probably, it's at least a bit revised down the process.

Yeah, exactly. Exactly. Okay.

So let's maybe like, do you want to just take it from the top or are there like specific line items that you know changed out the gate just based on your experience?

A couple things that, uh, that did change, I would say, probably in the first 18 months is we grew our client base up to 120 clients, uh, probably ahead of schedule, uh, or ahead of this forecast. Probably by spring 2023, I believe we were up to 120 clients. And so that was pretty awesome that that happened faster and ahead of schedule. The other thing is that our revenue per client increased, and that was because we introduced a new service. And now I can't remember exactly when, but at some point in 2023, we offered an additional service that increased our revenue per client. And I would say probably like half of our clients purchased that from us on an ongoing basis. So those two numbers increased ahead of schedule. And but I think at the same time, you know, there was a ceiling in the business because we were working with one franchisor. And so, you know, there was, you know, I can't remember how far out this model went, but, you know, we were, we were never— I guess I only modeled it to 2024. Like this was going to be the sort of theoretical cap inside of that business. And we had to go find new markets to go get into to continue expanding. And so I think I probably didn't recognize how hard that was going to be, although also in confidence in February 2023, we did sign a new client in a new vertical. And so, you know, that, that sort of— it happened very quickly, but it was a lot of work to support that.

So going back to that service line that you added.

Yep.

That brought in, I mean, how much did your revenue increase? Do you have any idea what you kind of did? Um, relative to the model?

You know, this is actually wild. I think in 2023 we hit exactly 3.6.

And that's crazy.

Yeah, I'm pretty sure it was 3.6 and we bought it. You know, you use calendar years when you're buying this. So we bought it off of a $2 million revenue base. So that was a pretty substantial growth. We might have done 3.75 because I know that, you know, some of these numbers pulled forward or maybe I have my years off a little bit of exactly when we introduced some of those new products and things like that. So that's, that's pretty wild.

So, and is that something that you planned to do? Like, did you go in assessing the business? I'm like, okay, I know I want to add this service line, or was that something you decided after you got in?

I mean, this is actually— let's go back to my scenario assumptions. I just saw that I added in here in the growth model was add additional franchise models to accelerate growth and revenue per client continues to increase. So I was definitely thinking about it. Like, okay, how do we try to get into another— yeah, but we'll quickly start prospecting new businesses and opportunities, starting with the proposed areas: pet training, pet grooming. So e-com stores. After piloting in Q1 2023, Garth hopes to be able to continue adding 5 new clients per month to produce a broader revenue base. So I mean, that kind of happened. I would say that the one word of caution is it was not linear like this in a model. Like, we signed a med spa, it sort of went really big and then contracted, um, and that sort of helped us learn what were the types of clients to address. So I think that the one flaw on this growth model was You know, you're going to have these ups and downs and it's going to be painful. You're going to spend a lot of time and money working to make those happen. And it's very difficult to budget that in your P&L, and especially off of a legacy business that has been running sort of status quo for 5 years or a decade. You're going to have no basis on how to model that.

I mean, your gut instincts here are very interesting. Look at you, pat on the back as you do a look back here.

That's wild. I can't believe I— it's wild that that number I think is actually true.

And maybe not for the same reasons that you thought it was going to be true, right?

Yeah, exactly. Exactly. Um, I think one other thing in this model is I did not model out these numbers individually or do a bottoms up. I did this tops down and looked at the percentages based in the prior P&L and sort of like brought that forward and then, you know, made a couple little tweaks, uh, here and there. So I think it was pretty like straight line in there. Um, you know, so could I have done a better job? I remember I took a little bit of time to do a full bottoms up P&L and that didn't make sense at the time.

Okay.

Yeah.

Okay. Can you just explain the difference on that real quick?

Okay. So the way I built this P&L was I just used the line items that were given to me by the seller, and I modeled and took an average of, you know, like, so for example, when you look at utilities, I just took an average of what utilities cost as a percentage of revenue or total, this total income line. And so then this $14,932 is just that percentage multiplied by the revenue. So that way, as your revenue grows, your utilities expense increases too. I think that the word of caution here though is that in a business, a lot of your contracts while they can expand like that, they don't go down in the same way. So if you need to wind down a contract, sometimes you have an annual contract, sometimes you have monthly. And so a lot of times your expenses stay higher a little bit longer. And so that is one of the flaws of that approach in your modeling.

Thanks. Just to make sure everybody's clear on, you know, definitions here.

Yeah.

Okay, so you hit— you— so you hit your revenue projections unintentionally, should I say. Um, and you had some interesting stuff with like your accounts receivable. Like, there was a lot of very unique factors to your business. So like, is there anything on this that is jumping out at you as you scroll through it? Maybe not specific to that, but I just know you had some like unique elements to the financials.

Right, the day sales outstanding was negative.

Yes.

And so that does not show up on the P&L, but that was on the balance sheet. And I'll be honest, the way that the seller had, you know, structured her QuickBooks, it probably didn't account for that correctly. And so there was a lot of cleanup that we did once I took over to get that. Straightened out. Gotcha. But like, you know, in this, you know, looking back, I have no idea what is in this utilities line item. That makes no sense to me because I would have thought that, that like there were zero utilities, there was no building. So I don't know what that was and I probably should have asked more. I think it was actually software licenses like the Salesforce and Five9 that were a part of COGS, and that, that would make sense for it to be there, but then why wouldn't it be in, you know, software licenses here? Uh, so a little bit confusing. And so I think that these are the things that you just got to get really curious about and make sure you understand before you jump in, because that'll help you understand the business better and better. Like taxes and licenses, $40,000 here. Maybe this one's Salesforce, like I don't know, that seems really high. I'm not sure what that is.

So you were, so you were overestimating on, yeah, some of this like infrastructure and then also the taxes and licenses.

Yes, yes.

Which probably isn't a bad thing to do, correct?

I would think you want to be—

I would err on that side.

Yeah, yeah, you want to be incredibly conservative. And, you know, the other thing that this model is doing that is not the way it actually plays out is, you know, it's averaging these costs across a larger period of time, like a year, 24 months, and then straight-line averaging them going forward. And that's not the way this actually plays out. Like, if you have a Salesforce contract, you usually pay it quarterly. If you have bonuses, you pay them annually or quarterly. And so you actually do have some months that, you know, you're going to have a lot more expenses and you have other months where, you know, you don't have those. And so your actual profitability is going to go up and down and your cash flow is going to go up and down. Maybe not profitability depending on how you run your books, but I think that's something else to keep an eye on.

Yeah. Yeah.

Like banking fees, $12,000.

Did you think it was banking fees?

I don't, you know, I have a feeling that like, because this is literally taken right out of the seller's books, like this is probably interest. Like, you know, I, I don't really know. I think that there was a PPP loan or something like that. So it's probably, probably that model forward, which I didn't have. And I think I put you know, my balance sheet, the debt down here. So I think this is how I was looking at it. So I put them below the lines there where she probably, she was probably using QuickBooks more to just manage cash flow. And so that should have been adjusted. Now, I will also say I did not do a sophisticated quality of earnings report, which I would recommend to everyone that is buying a business.

Yes. Did you do a Q of E? So I happen to be married to a CFO, basically. So he, in any deal that we got into, and we got pretty close on some deals that ultimately broke, he would do an initial, like, call it like an internal Q of E, where he would, because he's smart and can just do that stuff, He would run that informally, and then assuming everything checked out with his little model, let's call it, we would then hire out the more sophisticated, as you say, robust Q of E team to make sure that we weren't missing anything. Now, there was one instance we got, we were under LOI on a tire recycling business, which really, by the way, was a tire burying business. Like there was no recycling. It was just shredding and then putting it into the ground. So we were like, wow, this is an amazing opportunity to like actually make it a recycling company. Anyway, um, we did an initial Q of E on the financials that we received from the seller and the broker. And once we did hire the official Q of E team, they essentially figured out faster than we could that SDE was about 50% of what they had portrayed originally. So all that to say, like, even the preliminary screen, which we did just use to like flag anything major, um, but once we got into it, like, it was very clear that it was not actually represented well. They were running a lot of expenses through the business and it was not, uh, yeah, it was not accurate. So highly recommend paying the money for your quality Q of E because it saved us from a potentially like really bad situation.

How much did your Q of E in that example cost, by the way?

I mean, at least 30 grand.

Okay, got it.

For like the full— and now it was very time intensive because I— we drove. Okay, this is what acquisitions look like. We drove to the farm where this, uh, business was on basically, and we sat there with the owner and we pored over boxes and boxes of paper files to figure out expenses. And Alex and I are taking, you know, photos of like every single invoice, every single expense, like absolutely every document possible. And the seller was basically marking them, quote, from memory, years, years back on what was the farm expense versus what was a business expense. And so then we had to go categorize all of that. So like, it was crazy in terms of the process. And subsequently, you know, our Q of E team had to work a little harder too. That's, that's, it was wild. It was wild.

Yeah. I spent $500. Yeah.

So that's solid.

I would not recommend doing it that way, the way I did it either. Um, yeah. I think the EBITDA down here, uh, was actually pretty accurate.

Okay.

I think my numbers were probably conservative enough. And despite, you know, interest rates going up, that, that these were accurate and sort of on the low end. And so that was, that worked out pretty well.

Okay, great.

And I, as I'm looking through this now, I've not done some analysis to see what was right and wrong. I think it's because the seller had some weird things in here and going back to the financials that she provided and the add backs, because you were just sort of talking about how do you allocate these expenses. Hers were, I, you know, it was very clear to me and not that this shouldn't be verified, but it was very clear that it was done honestly. There are very few add backs that she did. So she had done this in a way so that it was very simple.

I think, which was helpful, I'm sure.

Yeah, we could try and pull that up too, but I think that the only add-backs were her salary and, uh, and like her cell phone or something like that. So very, very minimal. So I, I think that the, the things that are surprising to me on this is that I actually hit the forecast. Um, I didn't hit it the way I had thought I would. There are some very odd line items that I can't explain and feel like I probably should be able to explain. And, um, and, you know, maybe make it a little bit more conservative, especially around the rate environment, because that's something you have no control over.

Yeah, that's fair. So looking at your— so, okay, on your EBITDA then.

Okay. Yep.

Because that's what everyone cares about.

Yep.

How did this roughly compare?

From my memory, the forecast did number here for 2023, the 8.21. That is about 50% lower than what it turned out to be for 2023.

Okay.

Sorry, it was 50% higher in reality. Yeah.

Okay. So you were double that.

I landed at, I landed around 1.2.

Okay. Ish. Yeah.

Yeah.

Great. So you exceeded, exceeded expectations.

Exceeded expectations. Yes.

That's a success story right there.

It is. It is. But it doesn't stop then. That's the thing. Like, I think people need to remember that this is a 10-year journey to, on that SBA note. Right. Sort of realizing the benefit of this. Yeah.

Yeah. Well, and now even as you've pivoted the company into more of a, like, true SaaS model, right?

Yep.

I know that you've had changes to those numbers too.

Yes.

To your point on it being a 10-year and you just don't know what's going to happen between now and then.

I'm gonna look for the pro format as well and see if that's something that we should share and see what kind of add backs there were too. Cause I think that'll just be interesting to set the record straight. Do you have any other questions about the, that document?

So if you, if you're talking to 2022 Garth now, what would you say to do differently in that exercise?

Okay, that's a, that's a great question. Um, I feel like the process that I took was correct and I would sort of continue to recommend that you go through that with the base case, the upside case. I think get a lot more detailed on what is in each of those buckets on their P&L, and you need to know that off the top of your head. I think that that would be very valuable. And you should also just acknowledge that these, you know, QuickBooks statements are not going to be super clear. Like, you're not going to know what all these line items are, and that's going to be hard to decipher and understand. And they're not designed for a business analysis like this. They were just a way really to file taxes and for a lot of owners manage cash flow, really not they weren't doing this as proper books.

Yeah.

And so I think that's something to keep an eye on. I think I would continue to encourage folks to think about those downside cases, especially if you have a personal guarantee. And I think that the other part is in some of those line items you're looking at the customers and, and the customer counts growing. I would really think about tactically how that's going to happen because as I mentioned that our customer base was concentrated in one franchise when I acquired the business. What it took me some time to appreciate was that a lot of those customers were actually networked together. And so if you get one, you get all. And so while it was one brand that they were all under, it was, you know, I bought a business with roughly 100 independent businesses. but there were some network factors inside of those where one was actually 15 of that count. And so I think you really want to understand some of those dynamics. And, you know, in a business like this serving small businesses, that's going to be hard to uncover. And then the other part I would say is growth is not a linear process. You're going to have ups and downs. And so if you're thinking about expanding, especially something that's like a new service a new vertical, whatever that is, budget additional cost to make that happen. And, and I would also say give yourself the space and grace to recognize that it is not a linear up and right process. It's gonna go up, it's gonna go down. You're gonna relearn, you're gonna rework. There are gonna be expenses in that and probably hiring ahead of the revenue. And those are things that you just need to, to do.

Yeah. One more question for you. I think one of the biggest— so like, this is an exercise that everyone should do if you're buying business, but then the second you step into ownership, what lessons from this exercise can you take into modeling financial planning now that you're owner? Like, what would you recommend people do now as CEO, having done this exercise?

Oh yeah. I was probably not the most structured financial planner in the first year. I think it was sort of hang on and survive. I do too. Yeah. So I think a couple of things that I would probably have done differently, especially if I had had a business that didn't have negative days sales outstanding, was get a financial resource to run the books for you. I ran the books for the first year and I think if I had sort of a more normal payment terms like net 30, net 90, that would've been probably beyond my capacity to handle. I'm sure I could have figured it out and I'm sure if you can get a deal across the finish line, you can actually do that, but you need to be running your team, running your customers and not reconciling your books at the end of every month and figuring out the right tags. Like, that's not the best use of your time.

Yeah, I would say the exact same thing. Like, I, I don't— I didn't come from a finance background. Like, I, you know, took my B-school courses and like slightly dangerous, but like, I don't want to run QuickBooks. I don't want to be in there. And the best thing ever was having a solid, like, accountant, bookkeeper, somebody at a minimum to keep a pulse on all of that. And even to this day, I mean, he is so good at just letting me know, like, hey, here's what the next 13 weeks look like, and then here's how we can project that beyond. Here's your cash flow. Like, just, he just keeps me, like, on it, which I really, really appreciate. And We're not, we don't have like full CFO on our team yet. Like we're just still quite small, but like eventually when we do move to more of like the robust, like financial modeling, like I at least know the structure in which I'm working in, like to plan, and I've got good line of sight already from a very fundamental perspective. So I think that's mission critical for anybody stepping in. Don't do it yourself. Don't do it yourself.

I liked doing it for a bit to learn.

Yeah, but like, have somebody else do it and then just walk through the details. Yeah, that's fair. That's fair. Unless you're like an actual accountant, you can do it in your sleep. But like, but still, there's more you got to focus on other things.

Yeah, exactly.

Yeah. So yeah, I'm with you on that. Cool.

All right, let's wrap it up. This is awesome.

All right.

Thanks for walking through my Pro Forma. From 2022 with me.

Thanks for sharing.