How To Plan a Divestiture From an Accounting Perspective

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That was my lovely daughter Shyla. If you want to keep up with the latest on M and A Science, our live streams networking events. When we release new resources, visit mascience.com and subscribe to our newsletter. You can Also follow our LinkedIn page to catch highlights of our interviews and if you like our content, please tell a friend so we can keep growing our community of forward thinking M and a practitioners the HR M&A Roundtable's annual conference has gone virtual for 2020. This world class event focuses on one of the hardest parts of M and A the human side. Join me in a great lineup of expert practitioners as we share how to deliver transaction value through the people, leadership and culture elements of a deal. You can save 10% on your registration when you visit M&A Roundtable.com and use the discount code Science. Now on to the interview. I'm Kisam Patel and you're listening to M and A Science, where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies and what actually happened during M and A deals. Hi, I'm Kisan Patel, CEO and Founder of Deal Room. Today I'm here with Neil McNamara, co founder of Virtus Partners, an advisory firm specializing in preparing companies financially and operationally for M and A capital raises and restructuring. Neil currently leads a team preparing companies for their most critical transitions with an emphasis on exits and acquisitions, including corporate divestitures, which is our topic today. Today we're going to be discussing how to plan a divestiture from an accounting perspective. Neil, to kick things off, can you describe your role at Bert as partners and your previous experiment?

Sure. Thanks Keesen. So as another founder yourself, I think you can appreciate that there are quite a few roles that you have in a smaller company, but those that I spend the majority of time with are one just overall running the business, but also specifically leading our exits and acquisitions and accounting advisory practices. I've spent over 20 years in merger and acquisition consulting, the majority of the time spent on the corporate divestitures, which is what we're going to talk about today Great.

Let's talk about corporate divestitures. Where do you start with planning a divestiture?

The start is clearly defining what it is that you're selling. That is absolutely the most critical step. It's setting that we've called it the deal perimeter. And the structure of and the definition of what you're selling then drives the structure of the financial data that's going to be critical to getting the deal done and preparing it the way that we're going to talk about how we advise you should when you're doing these divestitures. And the financial complexity that arises from this definition where the information exists, who can speak to it all aligned to this definition, that's really what makes this challenging and something that does often take, especially if you're talking about carve outs, quite a bit of time.

Well, can you elaborate about in terms of the difference between a typical private company that goes through a sales process pretty familiar with, versus when you're working with a corporation that's carving an entity out?

Yeah. So on the corporate divestitures where you're doing a carve out, those are always complex at some level. Some can be ridiculously complex and some can be much less so because again, most of the time what you're selling has rarely been presented in the whole financially apart from the parent. And so the times that that is not quite the case could be if you're disposing of an entire segment. But even then you're disposing of an entire segment, it's rare that you're building complete standalone set of financial statements for that exact business that's being sold. So when you're doing the corporate carve out, by definition you are preparing and marketing a business that's never been looked at on a standalone basis. And the management team or finance team hasn't ever pulled together that complete set of financial historical information aligned to exactly what's being sold. Because when you're doing this definition, I mean this definition of what's being sold, it could be geographically based, it could be product based. We've done deals where it's been contract based. I remember this one deal that we did a decade ago, government contracts. I think we did 39 versions of the carve out financial statements because they kept it was all defined by the contracts that were being sold and they changed 38 times which contracts were included and excluded. So you think about this model that we had to build that had all the build out a full set of financial statements for specific contracts being sold. And every time that they added one or took one out. You had to rerun the entire model for the entire two or three years of history that you were presenting as what was being sold. So you can imagine that the corporate carve outs can be extremely complex from that perspective. Like I said, there's always some level of complexity on a complete divestiture of a complete organization. Like I said, private company, those can have similar levels of complexity just for somewhat different reasons. And it's really driven by if you've just got poor finance team, poor finance processes and or technologies. So you could have a privately held company that's been audited, but not at the same level of scrutiny and granularity that you would have in an SEC listed company. For example. You could have a team that could have a founder led organization who might have a family member as a cfo. You could have a founder led organization that's basically just done everything from a financial perspective, financial statement on a cash basis. And all they really care about is the cash flow and what they're reconciling the bank accounts, but not necessarily getting everything in the right period and reflecting things accurately from a historical accounting perspective. And so that's where you can get similar levels of complexity when you're preparing financially as a standalone private entity versus the carve out of a corporate.

What's interesting, the way you describe a carve out, it sounds like it's not clear cut and dry. It's almost like there's an infinite way to slice and dice.

It's never cut and dry. Everyone is different. And, and it's funny because you'll have some out there that can market that. They've got this, maybe a secret sauce, proprietary technology to execute it. Everyone is tailored, everyone is different. There isn't some kind of rinse and repeat process for doing a carve out. You've got to tailor your approach. You've got to tailor the data extraction, got to tailor the analysis for everyone.

What's the difference when you're working with a private company versus a public company? When approaching a carve out, it depends.

There on the type of exit or carve out that they're doing most of. Well, it depends on if the public company, because this really doesn't happen with a private. They're not going to do a carve out ipo. They rarely do that. But sometimes you can have a public company that's doing a carve out divestiture, but they're divesting through a tax free spinoff. Those are also normally larger deals and Whenever you involve the SEC in something, this gets tremendously more complicated, more expensive and more time consuming. So if you think about this, doing a tax free spinoff is essentially an ipo. So you are taking a piece of a publicly traded company, you're carving it out and you're going to issue existing shareholders, you're going to exchange shares. So you can say for every share you own in the former parent company, you're going to get whatever shares in this entity that we're spinning off. You can look at United Technologies just did this when they merged with Raytheon and they became Raytheon Technologies. But at the same time they spun off Otis and they spun off Carrier. And now those are complete, standalone, separate, publicly traded companies with no relation back to the former parent. When you do that, just like an ipo, you have to provide a standalone set of financial statements audited under PCAOB standards, full, you think through full perspectives level data that has to be filed with the SEC to complete that transaction. So you really go from something if you are a corporate that's divesting a business and selling it, or a private company carving out a piece of a business and just selling it, that's a process that can be months. Whereas the spinoffs that you can get in the years, really how long they actually prepare and execute and get effective.

Is there public disclosure requirements when you're doing a public spinoff?

Oh, absolutely, absolutely. So you're going to disclose that you're doing this and then you're going to have to issue this, It's a Form 10 that issue this document. You have to file this document with the sec, you're going to have to update it as periods become, as periods become stale. Up until the point that the transaction, the, the spinoff, the divestiture spinoff is effective and now you're a publicly traded company. But as part of that effectiveness, you're going to have these historical financial statements that are filed with the sec. And then you're just like any other public company with ongoing financial reporting. The other example involving public companies that's relevant to this discussion is you can be a smaller publicly traded company, maybe an emerging growth company, filed on the emerging growth rules. You're a publicly traded company, but you're maybe at break even income right now. And you buy a privately held company and it's a small privately held company. The SEC also has rules that if you buy something that's deemed significant and there's a formal test that you go through, but if you essentially are a publicly traded company that has breakeven net income. Anything you buy is significant because just the way the percentages work. And so I actually, you know, I've got a friend who's a CFO of public trading company in this situation. Now they're looking at buying a $50 million top line revenue business and they're going to have to, if they close that acquisition, they're going to have to file three years of financial statements audit under PCAOB rules, SEC compliant for a business that's owned that's. I don't even know if they've had maybe an audit in the past, but certainly been that literally and that would be a condition to actually close that transaction. If you think about it from the seller's perspective in this discussion, what that business should have done, should have realized that if you know this public traded or other public traded entities would be in the buyer universe, really their investment banker should have advised them on this. Not saying they did or didn't, but this is just what should happen, that they should have been prepared for that possibility and planned for it because that's going to add months upon months to the timeline of actually able of being able to complete that transaction.

Wow. Things get complicated when you're public. You got to deal with like audited financials, disclosures, longer time frame. When you mentioned pcab.

Say it one more time, pcaob. What?

Tell me about it.

Oh, well that's the oversight board that you know that issues the auditing rules and requirements for publicly traded companies. That's all. So that's where the requirement when you're having to get an audit under those standards with any publicly traded company, what the auditors have to do is a whole other level versus if you're a private company. What the auditors have to do is not nearly. Well, the reality is they don't have nearly as much risk so they don't do as much work. And I think that probably is a good segue into the other. Another I guess takeaway lesson learned from this process. If you are a privately held company getting ready to do a divestiture, whether it's a carve out divestiture or a wholesale divestiture, One of the things we have conversations about all the time is how often a set of audited financial statements is still wrong. And wrong can be loosely defined. But in the deal terminology, the purpose of an audit especially, well, the purpose of any audit is not just for valuing that company in an M and a transaction and especially when you get down to a privately held company. The audit is done under a different purpose than making sure that whoever's buying this understands how to value this company and the procedures that are done at a different level and for a different reason. Therefore, when we get involved in private company transactions, it's more likely than not that we're going to find adjustments to the historical financial statements. Truly accounting adjustments, not just deal adjustments or pro formas management adjustments, but things that really they got wrong and that the auditors just simply didn't catch. You could, rightly or wrongly. Sometimes it's fair that they didn't catch it, sometimes they should have. But the reality is almost always, we almost always find something they missed. And so one of the, I think the tactical takeaways, I know we talked about wanting to work those throughout this discussion. One of the tactical takeaways that I have and something that I normally bring up because this almost always comes up, especially if you're dealing with privately owned businesses. Well, we've got audits. Shouldn't we, can't we just rely on those? And the answer is unequivocally, no, you can't. It's not good enough. Done for a different purpose. And we almost always find things that auditors missed. So that's a real important piece of this. And if you also take that to the carve out scenario for a corporate divestiture, I can't really remember too many carve outs that I've done over the last two decades that we haven't had to again, adjust historical accounting within that entity. And I'm not talking about presenting it in a different way because it hasn't ever been presented that way. This is an accounting error that we're actually having to restore, restate historical financial information that really results back which ties back to the parent. So technically the parent should restate for this if it's material. The trick is most of the adjustments that you find, especially if it's a large parent divesting a small entity wouldn't be material at the consolidated level. Therefore, it's not a big issue from the parent company's perspective when you catch this. So it's not this big issue that you have. Generally speaking, it's almost fair. It's like, okay, well this is so small compared to the consolidated parent. It's not a big deal. Where this can become a big deal though is in the spin off scenario because I've been involved in quite a few transactions because you have the same owner issuing their opinion on the parent company financial statement. Generally parent company financial statements and then the spun off entity. I've been in the room many a time where that audit partner has a mandate that there will be no historical adjustments made to these financial statements that would indicate that there was something missed in the parent company, even though it was. So that again can add all sorts of fun jumping through hoops and trying to justify certain positions and whatnot so that things aren't, aren't restated within those financials. But I again I can't think of a carve out where we haven't found something that should be reflected differently just from the historical financial statement perspective.

So audits aren't always cut and dry either.

Just again they're done for a different purpose. Audits are their purpose is what their purpose is for and it's not for getting comfortable with how to present and value a divested business.

Where do Q of Es fall into.

All of this Q of Es? All right, so this is a bit of a soapbox at times for me. So QVs. So the quality of earnings, which again very loosely can be very broadly defined QVs in theory I would say are generally recognized to be done for three reasons. One, you reduce surprises that you will encounter when the buyers come in and perform their due diligence. Two, the package that's presented as part of the Q of E is going to result in the seller having more credibility with the buyers when they're analyzing the business, whether it's a carve out or a whole sale divestiture of a privately held company. And three, reduce the timeline of the buy side due diligence. So that theory is that if you do all the same work that the buy side team would do now, they don't have to do that. So in my experience, in my experience, number one, in my opinion, I guess the first there on reducing surprises should always that's criminal. If you have any capable service provider performing a sell side U of E you certainly should. You're doing the same procedures of the buy side would be doing. You should eliminate and find some gotchas that they would have found. So that should always happen 2 and 3. That certainly does not always happen and that you know whether two and three happen and going, you know whether you have more credibility, whether you reduce the timeline of buy side due diligence that really is determined by the scope and quality of the procedures done in that Q of E. I have plenty of of private equity clients that will get a sell side Q of E, take a look at it and throw it in the trash and do everything. They were going to do the same. So it does not always happen. But if you, again, if you perform targeted, detailed procedures with a thought to what the buyer really is interested in, what the buyer needs, that can be difficult because you can have a broad universe of buyers. So that makes it more challenging. Again, what a corporate entity that's looking to integrate this versus a private equity firm that's looking at this as a platform acquisition. Those can be dramatically different ways of assessing and analyzing the company. So that can make it challenging. But you can do this in a way, perform procedures that. That will result in gaining more credibility and reducing the timeline, I guess.

Would it also be a tool just in terms of preparation so you're just generally not blindsided by any of the sort of diligence coming on from the buyer? In general, yes.

It will open the management teams and owners or whoever's involved in the sale, it will open their eyes to what to expect, which can be very important. Especially if you're dealing with a management team or an ownership team that hasn't done this before, then it's a real shock to the system. So it's helpful to take them through those paces before it's being done by a party that's really working for somebody else. The other thing that it does, extremely important, is it can reset expectations on what you're, you know, on price. Again, many times we will get in, we will start pulling together what we believe an adjusted EBITDA looks like with a truly independent view. So not pulling together marketing, but, you know, looking at it as if we were on the other side beating the crap out of this stock. What would we be doing? What position would we take? And very quickly, and this has happened a number of times where it's like, we do that, and the buyer's like, or I'm sorry, the seller, especially in privately held businesses. And the seller's like, well, wait, that EBITDA times this multiple that my investment banks tell me about doesn't get me there. That's not good enough. What do we do? And a lot of times that too many times that results in them trying to get creative and work other adjustments into forecasts and whatnot. Other times we haven't seen this on the sell side as much, but you do have a lot of. And this is why some of our clients will just throw Q of your reports in the trash. Some of them will view those QV reports just as marketing documents that are all about the upward adjustments to EBITDA versus a more independent, an objective view of what the historical adjusted EBITDA should be. And sometimes it results in just deferring the deal. It's like, all right, well what you need to do is make some operational improvements to get that trailing twelve month EBITDA up to the level that gets you the, the exit that you're looking for here. You're not going to get there with playing with the accounting. Especially in private companies. If you're talking about the wholesale divestitures, there are almost always things that can be done to make operational improvements or you start exploring operational improvements that a new buyer could make that would result in higher levels and maybe get some credit for as well. So those are, those are some of the benefits of that Q of E process. But I think that again going back to will it really add credibility and reduce the timeline? I think to do that you need a scope of procedures that are very detailed that are not just off the shelf carbon copy, just generate a standard report. But it's something that I, if I'm coming on the other side can really just, it just walks me through so I don't have to dig this stuff out. I can look at and just almost like an audit trail, not for an audit, but just a bridge of all right, I can see how this data ties back to how you're pulling from the system. I can see the validations that have been done on an account by account basis. I can see where adjustments are made and I see all their support for these adjustments. And I can go back and understand exactly what was done and it holds together. That can really reduce that timeline, help the credibility, et cetera. But that's a lot of work as well. That's where you get the conflict of sometimes the sellers just want, they don't want to spend the money on it, they just want to report they want again and then it becomes more of a product and it's really, you're not going to get the value. So spend 50% more, 100% more at times to build a really great data set to accomplish those things instead of being a bit penny wise in this process.

That's interesting. It seems like a decade plus ago it really wasn't a part of the process.

Yes, you're absolutely right. I think you had some, there were early adopters in Europe. This has been happening forever. Vendor due diligence, I mean I spent, this is almost 20 years ago now when I worked for a few years in Zurich. And even then vendor due diligence was a absolute standard approach for selling any business. And we worked on them back then. When I repatriated back to the United States, it was so uncommon to do any form of vendor due diligence. Sell side due diligence quality of earnings was. There wasn't anything called the quality of earnings report necessarily back then. I think it was more just a due diligence report. There was a quality of earnings slide within there. It's been kind of like all rebranded now. But the work that we did, when I think about 20 years ago back and even maybe I guess 10, started adjusting. But it was the sell side preparation from an accounting perspective was much more focused on the big large transactions that had to have standalone carve out audited financial statements prepared. And that's what we worked on over and over and again. And that was a big piece. Whereas now it is rare if you find an investment bank that will take an entity to market without having one of these done. And again, what's the reason for that? Well, the reason for that is that they've been burned so many times by going to market with a set of numbers that get just blown up when the buy side diligence team come in. We were talking the other day about where does this go wrong. The cardinal sin I think in a sell side process is taking something to market with numbers that haven't been vetted by somebody like me. I can't tell you how many times I've seen that happen. I've had to come in and fix it.

Quoted on that, by the way, in the highlight reel. The cardinal sin is just not having financials on it. I love it.

We've got, we did a deal a year ago where I use this story quite often when somebody's asking why should we hire somebody like you? It's not even just you, right? Why should we hire somebody like you to do this work? That can be a discussion. I can be having that discussion with a sell side investment banker or a corporate entity or a founder. One of the examples I use is that we got brought into a deal a year or so ago and it was a carve out, it was a publicly traded company carve out a non core asset. The investment banker called us, brought us in and the story they told us was, all right, well we, we took this to market 18 months ago and we didn't do any of this financial prep and we took it to market, we got into due diligence and it was such a disaster that the offers were basically like fire sale offers. They're like the buyers kind of came in, most just Walked away and said, this is, we can't get comfortable with this. And then a couple that didn't really care, they're like, all right, this is so messy. I'll low ball the offer here. And if you'll, you know, if you want, if you want me to take it for a song, then I'll, then I'll do it. So 18 months later, so that, so then the seller said, yeah, no, and then the banker, you know, that's painful for the investment bank, right. They work completely on success fees. So they may got a small retainer. So they go to market, they spent all this time and got, you know, and basically have a loss engagement on their hands. So process spins back up 18 months later. And they said, and they told their client, they're like, listen, we will not start this process formally. We will not talk to anybody else. We're not gonna send a teaser out, we're not gonna contact any potential buyers until you do a full scrubbing and preparation of a standalone set of financial statements for this business. And you're hiring these guys, which I loved, obviously. And so they walked us in and we go and we do the full set prepare, you know, pull together. And this is again where we talk about was it a sell side qe? I wouldn't have just, I wouldn't say what we did was a sell side Q of E. You know, technically speaking, was there a sell side Q of E within the procedures? Yes. But what we did was we prepared a solid set of standalone financial statements that could be used as a, you know, as a baseline for due diligence to come in on the other side. And as we were doing that, you also then worked through all the standard management adjustments, pro forma adjustments and everything that's required, and the working capital analysis that's typically included within a scope of a sell side qb. But it was much more than that. And the result there was, it did actually go back to my three points. It did remove surprises, obviously it allowed the deal to go forward. It certainly we had more credibility with the buyers and it resulted in a more efficient due diligence process. And the best part about it is that the ending price that was paid was somewhere around 5 ish x what was offered 18 months earlier on a business that didn't change. So there were no market or business specific dynamics that resulted in this business being more valuable than it was taken to market 18 months earlier. It was simply sold for that much more because they did a good job preparing it and somebody could get their arms around what it was they were buying and have confidence that in how to analyze this.

Yeah, interesting. Clean financials mean better buyer confidence.

Absolutely, absolutely.

And.

Again, the investment banker's perspective is that. And it's why they mandate these now because they don't want those surprises. They don't want that example of spending all this time taking it to market and having it just blow up. They want a better chance of success. And so that is, like I said, it's. Now the exception is that they will allow a client not to hire an advisor to come in and do some form of sell side Q of these. Sell side due diligence.

Can you walk me through what planning a divestiture looks like from an accounting perspective?

Sure. So if we go back to the first question you asked me again, it starts with clearly defining what's being sold. And then once you've got that what's being sold, then you've got to. And I think about this pictorially, we always prepare a, you know, in the work that we do, we always prepare a pictorial representation of what's being sold here, you know, from an entity and business perspective. And then where's all the financial data coming from? And that is where the real heavy lift and can is, can be because or at least what makes that complicated, what makes that complicated could be whether you are pulling this from different systems, the quality of those systems, the consistency or lack thereof of the data and the people that can actually speak to the data that's coming out of those systems. So if you think about a carve out example, you could have a direct feed from the parent company ERP at some level to this. Maybe it's a business unit, maybe it's a legal entity, but maybe it's 100 legal entities. And so you can get a feed there that takes you down to some level of accounting. Sometimes that's only margin and a lot of times it's only margin. So you can get a direct margin for this business. But then everything else is in other places. So you could have a corporate entity that holds all the SGA from an accounting system for this business being sold. So now you gotta pull somehow figure out a way to pull SGA costs out of that system. Then you can also, from a balance sheet perspective, you can have assets and liabilities held in different entities across the board. So you got to go figure out and find out where that's coming from. You could have we have this one carve out that we were working on essentially splitting two businesses in half. But again we had in the business being sold, you had one entity that you had almost a full set of financial statements, but then you had a Chinese entity that was all the accounting was done overseas and we had to pull that in. Then you had another entity they just bought, but they didn't have access to all the financial statements. So you only had condensed financial information that somehow you had to feed all of that into one set. And so you can imagine as I'm using my hands here, you imagine the flowchart, these flow charts that we create that show this system, that system, this entity, that entity, all these things feed together to get to the end product of one column of adjusted ebitda. And so again, a lot of our, the volume of the work that we're putting into this, work that should go into this is building out. You think about all those different entities, systems, et cetera. Think of just a typical Excel sheet format where that's a different column. Here's the extract from here, here's the extract from here, here's the extract from here. Here's how it all comes together and ties into this one column of 2019 adjusted EBITDA or LTM adjusted EBITDA. That's a huge part of preparing financially for this divestiture. The other piece that's also very important is thinking through what other elements that aren't just an adjusted EBITDA are going to be important for the buyers in evaluating these transactions. A typical one would be gross margin by customer sku, et cetera. And does that data exist or if it does exist, what's the fidelity of it? Again, we've gotten brought in just certain deals where the banker is not even ready for a Q of E, but they're just like we need to figure out SKU margins and the CFO can't figure out how to pull that together for us. And can you guys parachute in there and dig into the systems and see if you can pull extract that information that we can use so that we can start assessing the evaluation impact for these margin level skews and the story that we're going to go to market with on this. And so first you got to identify does that data exist? How do you extract it? Once you extract it, can you tie it back to anything? It doesn't really help if you pull together this great pivot of gross margin by skew. But then your gross margin, when you sum up the gross margin by skew, it's off by millions of dollars from total gross margin. How do you reconcile that back to the financial Statement again, this is part of my mantra on don't release any of this until you get comfortable with everything. You don't put a teaser out there with some adjusted EBITDA that then we're gonna have to go back and try to figure out how to bridge to. Same way the thing is like don't go and show customer level skews until you make sure you got it all and you got it right. And that's a real heavy lift on the financial prep. And once you get to that, I would call it that baseline of comfort with the historical financial data. After you get there, that's when, that's when you can start focusing again. In my opinion that's when you can start focusing on the adjustments that you can start making to that that are more deal specific. So and this is where you get to quality of earnings adjustments. What you know. So now that you are comfortable, it's right from an accounting perspective that you've got stuff in the right periods that you haven't, you know, you've got appropriate revenue recognition, etc. Now you can take a look at that and say all right, let's try to keep that part off the table. So when diligence comes in, let's have them sail through that we have appropriate historical accounting. Let's let them focus on really digging into the deal specific items that impact the valuation to this and that's where the Q of E comes in. What are the historical adjustments that are for valuation purposes versus accounting purposes? So typical examples are we incurred a big, we had a big non recurring write off. And so if you're going to in the last 12 months did a restructuring, we had a big. You could say something about COVID but I won't get into. That's a whole other issue. But a non recurring expense that if you are going to be pricing us up off if you're going to put a multiple on a trailing twelve ebitda we shouldn't be dinged for this expense. So back that out of the historical adjustments and give us credit there and increase the EBITDA so that we get credit for that. Here are adjustments that or expenses that will go away if we're owned by somebody else. Very, very typical ones. Founder led organizations, you've got millions of expenses that the founder incurs that won't continue and it's owned by somebody else. So that is a very typical adjustment that's made there from these are management adjustments within the quality of earnings. Then you've got the pro forma type Adjustments on All right, well what is a standalone cost for this entity? This is especially relevant in a carve out where you might have an allocation from the corporate entity to this entity that just flows through these financials that we've prepared that are appropriate from an accounting perspective but don't necessarily reflect the costs. And it could be either way, it could be way underburdened, it could be way overburdened. Doesn't necessarily reflect what going forward costs would be once owned by somebody else. And that's always an interesting one as well because that answer of what standalone costs would be completely depends on the buyer. That view from a large corporate coming in, that's going to digest this entity versus a private equity that's buying this as a platform. It's a completely different number there. So one of my again I think we talked about tactical takeaways. One of the pieces of advice that I give when we're doing this work is don't spend a ton of time in that area. And so you really have a good understanding about your buyer, the buyer universe and get some broad based, get yourself educated on what they may come back with on what they believe the historical costs are. But at the end of the day they're going to layer in what they believe the costs are and they're going to ding the valuation or they're going to adjust the EBITDA themselves or whatever it is and maybe you'll be able to argue that. But wait until then. Don't spend, don't spend a lot of money on me going in and preparing what standalone costs could look like and evaluating corporate allocations until you have a better idea of what the buyers really are going to think and spend your time on other areas that are more objective and will help the diligence process more.

We talked about first step focus on the quality of data and really make sure that's present. And then we moving that into the sell side Q of E so you can really define what the adjustments are going to be for your valuation models and et cetera. And then it's understanding the value that comes in with working with your potential buyers and then getting to understand who those buyers are. What are some of the unique scenarios in divestitures from the accounting perspective?

One of the things that's I think unique to this is and consistent across most of these, whether it's a carve out, whether it's a private company sale, is the sellers almost always lack the appreciation for how hard this will likely be. So they really lack an appreciation for how messy it can be from pulling the data. They lack an appreciation for the effort that it takes to get that cleaned up. And they lack the appreciation. We talked about this earlier. For how beat up they're going to be when the other side comes in and is digging into this. That's pretty consistent there. And I think the other unique and surprising yet common occurrence of something I referred to before is it is so common to find errors in the historical accounting when you have somebody dig into it this way and evaluate the accounting and the history this way and evaluate your data this way. It's not uncommon at all. It's actually probably more common, I would say.

What are some of the other typical challenges you come across?

See, are there any that I haven't mentioned so far? The first is, the one that I was speaking to earlier is that the biggest challenge is when financials have been released. The cardinal sin I referenced earlier. Right. We release financial data before we've had a chance to really dig in and vet it. That makes everything harder. It's very frustrating to get the call and be brought in to do this sell side Q of E or other divestiture preparation. And. Yeah, well, the teaser's already gone out, the sims almost done, and we got all this. And it's just like, oh, and we have to have to work backwards, or have to. Not necessarily work backwards, but backtrack is the more difficult part. It's actually more difficult for the investment bank. They're the ones that released. It's not. It's not our problem per se, but we have to do quite a bit of work to help bridge. All right, here's what the history actually was and why it's different than what was released earlier. And that's just bad. And so the best practice there is, you gotta get this done, get this done before you go to market. That's the biggest challenge, I would say.

Is there like a timeframe you want to. And obviously it varies in the complexity of the company, but this is the theme I'm reoccurring throughout this conversation, that you got to prep early. You got to get your ducks in a row.

Here's the time frame. As soon as the investment. Well, if I'm speaking to an investment banker, the timeframe is as soon as you've signed up your mandate, you call us. And this actually happened yesterday. So it was good. I've got a good investment banking partner that did this. They literally. They got a mandate and they knew before they did a ounce of work that they needed to get this process in motion. Similarly, if you are a seller, corporate or private, again getting this process even while you're selecting ideally in my ideal world is that I'm having this conversation with the seller before they've even selected the investment bank and we start helping pull this data together. That actually allows them to make their selection of the investment banker easier and then again makes their and helps their mandates as well. And we can even participate in that process. That rarely happens. That rarely happens. So at least if you've, you know, you got to get it going before you get that teaser out is the very least the other two I think that come to my top of my head challenges when we're not given full access to data. That makes our. That's a real challenge here. What we like to have when we're helping is you just literally give us a seat on the erp. Give us direct access to everything. So we're not limited by whoever in management is in the know for what's happening and their capacity and capability to give us the data that we need. Just get it, get it to it, let us directly pull it out. Everybody wins in that scenario. The management team is not burdened with as much work in the transaction. We are delayed in our work. We don't have inefficiencies by somebody not being able to pull the data the right way, et cetera. And the other part is also when there's difference between look at the historicals and looking at the forecast. Other areas that we've been that deals have been burned have been. When the management team does all this work on the forecast with the investment bank and they keep us in our box of you guys just do this work on the sell side qb, you guys just do the, you know, you stay in your history accounting, we'll take care of the forecasts and then they're going to. And then they go to market and there's some blatantly different assumption that's used from a cost structure in the forecast than in the quality of earnings. Just like it would have taken us an hour or probably just been if we would just been sitting as part of conversations to have pointed out if we just would have been involved to have caught that before it goes out. We talked about the credibility factor. Credibility's blown completely blown up. And again it takes a good due diligence team on the other side about two hours to figure that out. They're looking at the forecast and comparing to the history there. So those are typical and large challenges that we incur during this process.

I appreciate you sharing those great examples. What's your advice to the buy side in order to get the deal done?

Ooh, okay, buy side. Because we do this, we do this as often on the buy side as we do the sale. And the advice really depends on the type of buyer and what they are being sold. So the first and obvious from this transaction, from this discussion is again, you've got to really dig into the financials. If there was a sell side Q of E, you really have to dig in and understand what, how good of a job, how detailed of a job that preparer did and what they didn't do, especially when it's a carve out. So that's there again, unique challenges, unique, unique ways of looking at that and evaluating those. So that's really getting. I mean, the reality is what we do on the sell side is. Or on the buy side is exactly. What we do on the sell side is we go through and we map out where all that data is coming from. We reconcile it back to historical books and records that feed into some level of an audited financial statement and make sure it all holds together. Before we start even getting into understanding and analyzing the management pro forma adjustments in the Q of E table, that's the first and I think obvious one, especially with regards to this conversation. I think the one that we haven't touched on at all is, well, we have private equity clients that specialize in buying corporate carve outs that aren't prepared in this way. They actually didn't go through the process of preparing in the way that we talked about. And they love that because they believe they can extract quite a bit of value because it wasn't well prepared. And they've got pros like us on the other side that can go in and do quite a bit of this and again identify where there are adjustments that the buyer should, the seller should have been aware of if they would have hired us or somebody like us on the other side, et cetera. And so they really know how to do this. But where they need to focus more time and effort on, less about actually getting the deal done, it's preparing for successfully transitioning the deal to their ownership. And that's about thinking on how, what does this look like day one for us operationally? If it's a platform acquisition, how am I going to take the extract this entity from the parent company and start operating as a standalone basis? And what's going to be challenging within that? And that's where my advice there is. You need to start, you need to do more of that preparation work within the due diligence process and then be ready to hit the ground running and execute that transition, especially in that finance function, et cetera, execute that transition Day one In a similar vein, you've had others on your podcast that talking about spoken about this from an integration perspective. If you're a corporate acquirer or if you're any add on acquisition, you need to spend more time during the due diligence phase on really understanding what the integration challenges are going to be and how you're going to integrate this company and hit the ground running once you've actually closed the. Once you close the acquisition.

Yeah, it's interesting. Does some of that map over well when you start looking financially at a company in terms of interpreting that into part of your integration plan, but even on a broader sense of looking at things functionally and how you'd integrate the company?

Yes, absolutely. Because you know in, in theory you should be, you should be evaluating what those standalone costs or what your synergies are in the due diligence process and therefore you should have an understanding of what you know, how you're going to actually do this and integrate it similar and likewise if again if it's a platform, when you layer in what your standalone use an example finance function guarantee you that the carve out financial statements will never have the cost of a finance org in there that are going to be close to what you're likely going to have on the same loan basis. It's a completely different structure and cost structure when you're doing that. And so you need to when again you're evaluating your quality of earnings adjustments and what you're going to really give, what you're going to look at and accept from a historical adjusted ebitda, you should, you know that cost needs to be in there and therefore you then should start thinking about well how am I going to actually execute to that cost once I once I own that, once I own this company, what are going to be my one time items that are going to come across that I just have to take on when we're in there actually standing up a new finance org and when I hire a CFO and when I implement a new erp because I don't get an ERP when I buy a car value, I get a transition service agreement for some period of time, I stand up a new erp, need to understand what all those costs are during diligence and start and have a plan to execute to those or all of a sudden in the first year you're going to be way off your targets.

What's the craziest thing have you seen in M and A?

I knew you're going to ask this question. I don't know if I haven't seen too many crazy things. I see some really dumb things. I probably had to do some really dumb things. When I think of maybe one of the. I'll go back. My first corporate carve out experience, I guess one could call this crazy was I was working in. It was when I was in Zurich and I was doing a deal in Germany. It was money from Germany that was listed on the US stock exchanges that was spinning off a big piece of business. And we had an army out there preparing the financial statements that were going to go into the. Go into the filing. And they didn't have again, confidential transaction space issues. It was a chemical manufacturer and they set up for, I think for many months they set up these wonderful offices for us which were, we call them the containers which are metal boxes without air conditioning at a chemical plant in Frankfurt in the middle of the summer. Back in the days where professional dress was also required. You got everybody in suits working 12 to 15 hour days sweating profusely trying to get this. Doing a carve out with half the team that's never done one before, it was not that fun. And I guess crazy is a word to describe the other crazy. Part of that transaction was part of the culture at least of that team was if, you know, if somebody was older than you in age, there was this extra level of respect and lack of your need to review their work product. Again, this is kind of how things have changed. You did this huge corporate carve out all in Excel and Excel 20 years ago operated a little differently. And the processing power of our, of our computers were different back then too. And we had this huge Excel model doing this corporate carve out. So you think about that map of all the data flows that we had all going into one person's computer. Not backed up on anything, not reviewed by anybody because nobody, because the guy was in his 50s, but he was. He never passed his German CPA exam. So he never got promoted to manager. So he just always stayed as this kind of associate level. But he was older than everybody on the team and so none of the senior managers or partners would review his work because it would be viewed as disrespectful.

Wow.

So as one could expect and the 11th hour there was a huge blow up, a formula error in the Excel file because nobody reviewed it. I remember sitting in the metal container at midnight with 20 people trying to figure out what to do because the Excel didn't work anymore. So that was another relatively crazy. I don't know. That's too crazy.

Hot box.

Yeah, it's in the metal box.

They at least give you fans and some bucket of ice.

You know, it's funny, we had some guy, we had like these little individual fans, but it's in August, just blowing hot air. It's not doing anything for it. Not doing anything for you.

Awesome. Neil. I enjoyed this conversation. Learned a lot about accounting procedures on the sell side.

Thank you. Always fun talking to you and yeah, appreciate this time.

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