What Lenders and Buyers Are Looking For ft Bill Koschak

[0:00] Thanks everyone for joining today. Welcome back to Out of the Weeds Live. My name is Nish Sampath. I’m the founder of Switch Advisory.

[0:08] When selling a company, most owners negotiate hard on the price. They get to a multiple they feel good about. They think the hard part’s over. But then diligence starts and the number begins to shift downwards — adjustments start to come out of the EBITDA. And what actually lands in your account is a lot different than the number you first agreed to. It’s the same story on the financing side. The business is doing fine, but the loan still gets rejected.

[0:36] So today we’re getting into what lenders and buyers actually test, and where the value leaks out before a deal ever closes.

[0:44] My guest is Bill Costchek, co-founder and CEO of Everest Advisors. He spent 14 years as a partner at KPMG, then ran finance inside Medtronic, and later as CFO of a public company. So he’s been on the audit side and seen this from the operator’s chair. Bill, welcome. Amazing to have you here. Thanks for joining today.

[1:08] Hey, you’re welcome, Nish. It’s great to be here with you and your audience.

[1:12] I love it. Tell us a bit about Everest quickly.

[1:16] You bet. So I founded the company 18 months ago. We put senior operators into the suite of closely held and growing companies on a fractional and interim basis — usually as the CFO, chief operating officer, chief marketing officer, chief people officer. We help owners that are heading into a raise, a sale, or a growth stretch that’s outrun their leadership team — and PE sponsors who need an operator inside a portfolio company. What makes us different? Everybody on my team has actually run something — be it a P&L, a finance team inside a big organization. Our mantra is: we’ve sat in your seat, now we’re in your corner.

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Chapter 1: The Journey — From Reporting Numbers to Owning the P&L

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[1:57] Love it. Before we get into the money side of things, I want people to hear about how you got here and what your journey’s been like — because frankly, you’ve sat on just about every side of this table. You went from reporting the numbers to owning a P&L. What did you get wrong in that first year?

[2:18] You know, a lot. How’s that? I was actually transitioning from a lifetime of looking backwards as an accountant, then moving forward into a finance role, and then later when I was at Medtronic I took on a general manager role. And sitting in every one of those chairs gives you a very unique perspective — on one hand you feel like you’re reporting the news, on another you’re both looking at what has happened and using it to imply what will happen. And then when you’re in the owner’s chair, obviously you’ve got to be able to take imperfect information and make decisions around strategy and spending and allocations of your time and capital — both people and financial.

[3:11] When I became the general manager, I was brought into a $680 million business with two big responsibilities: owning the P&L and having customer-facing responsibilities. I also had product development — two huge projects, $10 million or more in annual budget to reshape our device. We were behind the competition. They had recently launched and we had not innovated. Those projects were behind schedule and behind budget and fingers were getting pointed in every direction. I underestimated the amount of time and personal capital and will that it was going to take to get those two projects back on track.

[3:57] We spent a couple of months with meetings, project managers, etc. — didn’t really make any progress. So finally I had to pull together what I called a summit and brought everybody in right before the 4th of July for two days to sit in a room together — people from Puerto Rico to Boston to you name it, all brought into Fridley, Minnesota. We spent two days together both working as a team and getting some of these barriers out of the way. I even had the languages person there — that’s how broad a net we cast. We spent the time that it took to figure out what our first priorities needed to be. We needed more equipment in Puerto Rico. We needed six languages, not 32, for example when we were launching globally. That was the biggest thing I learned — the amount of time and energy and passion you had to bring to solve a massive problem like that.

[5:01] Especially when people are working in disparate locations and geographies — actually creating those relationships, bringing them face to face. Was that kind of the game-changer for that initiative?

[5:15] Absolutely. It was to get everybody in the same room, to get them to see one another instead of being on a phone call where you could turn your camera off and be faceless. This was all back in 2018, so pre-pandemic — nobody wanted to use a camera or video at the time. And we actually had a light first day where we kept it personal. We went and did something fun at the end of the day — it was really to build a team and get people to know one another and be comfortable. And then we came back the next day with a hard-hitting: okay, now what are we going to do?

[5:49] Yeah, I love that. Every once in a while, breaking bread makes a world of difference. Just having that personal relationship — you actually want to help each other and make the organization move the needle. It was the biggest leadership team I ever led. I had over 20 people on my leadership team — everybody from clinical to regulatory to quality — you name it. And that project team was close to 100 people that were part of that summit. It was a challenge for sure. That’s a lot of people to start organizing and getting fighting in the same direction.

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Chapter 2: Why Bill Left and Built Everest

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[6:35] So you had this amazing career in finance — a career that frankly most people aspire to. What made you leave and then go build Everest?

[6:47] Great question. I certainly didn’t end up where I am today by accident, and I didn’t end up here on purpose. It’s somewhere in the middle. My north star has always been to find a way to enjoy what I do, to be happy, to ultimately land corporate board roles, and give back after I would stop doing what I’m doing. That has been my mantra all along.

[7:17] I didn’t ever intend to leave KPMG. I didn’t intend to leave General Mills. That was the first 25 years of my career. At the end of the day, that north star — my desire to give back and that vast experience — after we sold the public company I worked for, I decided rather than being beholden to one company, I would rather go and work with many companies. There are many parts of what I’ve done in my career that are relevant to what I do now, and I’ve tried to find like-minded and like-experienced people to work on the Everest team so that we can all give back and feel like we’re doing something that can impact many instead of just one company.

[8:05] I’ve been asked the question just like you did — why aren’t you deep in one cap table instead of being involved with many? And I’ve found it to be really fun to be involved with many. I get to talk to and meet wonderful people that I never would have had I been locked into one company.

[8:22] Yeah, that resonates a lot. You know, with our fractional chief operating officers — we go in as the operating partner for these companies in the lower mid-market. And what we’ve found is our ability to move the needle in a company within that lower mid-market space is incredibly significant. Whereas moving the needle in big giant corporations is a lot — it’s a different conversation. It takes a lot more time. We can create a real impact really quickly.

[8:51] That is what I like as well. I’ve got an example I haven’t used yet — running a business at General Mills that was two billion in revenue, generating single-digit operating margins when I got there. The strategy was: let’s keep selling plants. Well, you’re not going to go very far working on that. My first CFO role ever. We used the financial tools at our disposal to come up with a better way to look at how the business was performing financially — what was working, what wasn’t. We reframed the entire strategy and it became the best performing business unit at General Mills within two years. We doubled the value of the business from two to four billion. But that was a huge effort. And what I like about what you and I both do now is you sit in a chair with the owner of the business and their smaller leadership team and you can figure out quickly: do you have the right people, right process, right infrastructure to support it? And let’s align on a goal and go get it.

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Chapter 3: The Challenges of Being the Actual Owner

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[9:56] I love it. So let’s talk about you in the CEO seat at Everest. What do you find challenging now about being the actual owner instead of the executive on the other side of the fence?

[10:11] You know, as an owner — and you know this well of being one yourself — when you’re writing the checks, you think really hard about how and what you want to do and it impacts how you structure things and what you can take on. For somebody who’s used to a big corporation where you go beg for the money sometimes — nonetheless, knowing that you’re the one whose personal brand is at risk every day, who’s funding all of the business’s activities. You need to devise a strategy and build a system that affects how you do sales, how you hire, what your cash looks like, who’s the brand — and do it all at once. And there’s no guaranteed payback. So it’s a high-risk endeavour.

[11:07] You’ve also got to be comfortable saying: I made a mistake. I was wrong on that point. We need to move. I would say at Everest, we’ve been around 18 months and we’re on version 3.0 of our business strategy already — not so much the strategy itself but the thought leadership and the marketing and the branding and what’s on our website. You have to be quick and adapt. The whole world of AEO, for example — we’ve taken a simple website and made it much more robust, quadrupled the number of pages, all within the last 60 days. I’m trying to do business development, client delivery, and then I’ve got to review web pages. There’s a lot to do as an owner.

[11:48] But I think the value is: once you’ve sat in that seat and felt the blood, sweat, and tears of having to run it yourself, you can bring that lens to your client. That allows you to have that empathy for what they’re going through and really help them through their journey.

[12:00] Absolutely. And the other part of your question that I should tackle is the part that’s challenged me the most. I think ultimately the four or five seminal moments I’ve had in this business where I’ve had to make tough decisions — the common theme is people. At the end of the day, it’s people on your team or a client or a prospect. You’ve got to be super selective in who you surround yourself with, who your partners and advisers are, and seek out the best always.

[12:36] Well, Bill, I’m glad to be in the circle.

[12:38] Right on. I’m glad you’re in the circle.

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Chapter 4: Raising Money — What It’s Actually About

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[12:43] All right, let’s switch gears a little bit. Let’s talk about raising money — money coming into the organization. Because a lot of owners aren’t ready to sell quite yet. They’re just trying to figure out how to fund the next stretch of growth. But most owners when they’re thinking about raising money, they’re mostly thinking about the pitch. What is it actually about?

[13:08] It’s not about you. You have to realize first off that it’s about de-risking somebody else’s decision. What do they need to hear from you that will allow them to mitigate the risk? And from my perspective, they’re always testing to see whether the numbers behind your story hold up without you in the room — without you as the owner or the CFO. They’re looking at how strong the business is, what the opportunities are, and then most importantly, what are the risks? What could go wrong?

[13:39] Every owner shows up with a lender or an investor with rose-coloured glasses. And you can’t — you’ve got to be realistic. People will see through assumptions if they’re not grounded in some sense of reality or supportable. So making sure you’ve got your risks covered, what you’ve done to address those, the quality of the assumptions — those are what you’ve got to have in place.

[14:10] Again, you’re de-risking somebody else’s decision. What you’ve got in your historical numbers, the coverage ratios, the collateral stories — those are what’ll get you the cheque. But the underwriter is going to look at your worst year, not your best year.

[14:27] So let’s do a contrast. What’s a lender looking at versus what it’s an owner actually spending their time trying to prepare?

[14:35] I think it’s very similar. The lenders tend to go straight at the financials and the quality of the numbers. Can the business cover the fixed charges in a downside case? How good are the projections — not just the upside scenario that you decided to put together that day and hand to them? They also want to know things like: what happens if your top customer leaves? Owners tend to spend their time talking about all the opportunities in front of them and they spend all of their time on that part of the story — and they don’t stress test the financials. So that strong narrative on top of a non-stress-tested set of financials will always create tension if not a no answer from a lender.

[15:28] Yeah. So they’re trying to frame this story about here’s how we’re going to create the hockey stick growth curve, but it’s unrealistic. And what they should be doing is just saying: here’s the journey we came through — best year, worst year — how are we going to make this defensible going forward, considering market conditions, what our strengths and weaknesses are, trends in the market.

[15:54] Exactly. And from my perspective, the other thing you’ve got to look at is preparedness. Have the financials ready and pressure-tested six months to a year before — not right as you’re leading into it, because then you don’t have time to think it through. If you’ve got something set up, you can then build your actuals into it and all of that continues to give you more credibility when you sit in front of a lender or a prospective buyer.

[16:31] Yeah. You know, we’ve worked with a lot of organizations getting them ready for an exit, removing that founder dependency. And one of the biggest challenges is cleaning up the financials — not just for the sale process, but so we can actually make some intelligent decisions within the organization, understand where we stand, and figure out if we’re even ready for an exit.

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Chapter 5: Why Good Businesses Get Turned Down

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[16:54] So what is it — why do businesses get turned down? A good business comes to a bank looking for some capital. What are generally the reasons they’re getting turned down?

[17:08] Usually it’s all about how the business is presented. The financials don’t make sense, don’t follow GAAP, or there’s a model that nobody can defend under strong questioning. That feels like ground we’ve already covered. However, the thing I would add — and this is a live scenario with a personal client engaged in a transaction right now — we’re working through putting everything into the data room. Their financials have all of the things I said not to have. Looking back at the questions around liabilities that are not disclosed — what do they know, any disputes and things like that.

[17:53] As an owner of a business, you need to put yourself — and this is where my auditing background comes in helpful — you need to ask the management team questions like: are you aware of any fraud or illegal acts? Is there any threatened litigation? Are we party to any lawsuits? Are there any pressures to create fraudulent transactions? Those are the types of questions you’ve got to ask yourself as an adviser to a business or as the owner of a business to make sure you’re prepared.

[18:28] And in this situation, that particular company has a dispute with a supplier that I know about because I heard about it from the supplier. I haven’t yet heard about it from the management team. And so we’ve got some work to do. Those are the types of things that catch you because if they don’t trust you — if they can’t look you in the eyes and say “I trust Nish” — they’re not going to give you the deal.

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Chapter 6: Personal Guarantees and Covenants

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[18:56] So then — when do personal guarantees come into play? I have a lot of clients taking loans where personal guarantees come into play. When do they generally ask for that? What’s on the hook? And how do you actually get released from some of those guarantees?

[19:19] From my perspective — try to avoid them at all costs. But oftentimes if it’s a smaller business, the more likely it is you’re going to need one because of the quality of the collateral involved. If you’re borrowing a lot of money, at the higher end of the spectrum, somebody’s willing to go there. The higher the risk of the loan or the experience level of the borrower often drive that personal guarantee.

[19:54] And we’ve got to be careful about what’s scoped in from a collateral perspective. I once had a client scope in all their intellectual property — which they did not intend to do — into their loan, and that caused them problems later. Trying to get out from under the guarantees is tough. It’s all about performance. You’ve got to build upon the track record you had, grow your way out of the tighter situation you were in. It’s probably going to take two years of work to get out from under that personal guarantee. And I would suggest you get an audit of your financial statements done so the lender has some comfort with the credibility of the financials.

[20:45] Okay. Same train of thought — let’s talk covenants. Which ones are generally tripping the ownership team up first? And what happens? How are they breaching those?

[21:01] From a covenant standpoint, the financial ones are the easiest to measure. The ones that get difficult — and I once had a board situation where this came into play, and then saw it again later with a client — there were covenants tied to the performance of the team. For example, both cases the company had a covenant that said you cannot have a material weakness. That becomes a really difficult thing if you’re in the management team. But it’s existential — in the case of the company I almost joined the board of, the lenders called cash and converted their unsecured notes to secured. And suddenly there was no runway. The company filed for bankruptcy. It no longer exists. It was publicly traded.

[21:47] And so you’ve got to know what your covenants are and then develop a plan for how do you monitor them. And back to people — that’s what cost that company. The entire company. They didn’t have the right people in the accounting seat to make sure that they did not have a material weakness. Scary situation.

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Chapter 7: What Actually Happens After the LOI

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[22:08] Let’s flip it around a bit. Let’s talk about when someone’s actually buying. The term sheet says one number — and you and I have seen this a lot — the term sheet says a number, you go home, you shake hands, everybody’s hooray, lots of excitement, owner assumes the deal is done. Walk us through what actually happens next. When a sponsor is looking at a $20 million business, what do they test first? What falls apart?

[22:42] Yeah, it’s one thing to get the LOI signed and somebody’s interested — it’s a whole other thing to get through the diligence process. And what we typically see happen — and this is why we advocate for being prepared — is that if you’re prepared, the things that could crater a deal after the LOI are a lot less likely to happen.

[23:04] So the first thing they’ll look at is: does the EBITDA hold up once you pull out one-time expenses, personal expenses, related-party agreements, and other things like that? Are there big revenue concentrations? How much of that $20 million in EBITDA is sitting with one or two customers? And the math is pretty unforgiving. Every dollar of EBITDA that doesn’t survive the test costs you the multiple. So a $500,000 adjustment is $3 million at a six times multiple. Your purchase price can move pretty drastically.

[23:48] So be prepared. Do your QofE. But before you do the QofE, take a look at your business top to bottom and understand what questions the buyers are going to ask. Bring in an expert to ask those questions of you beforehand — your banker is not likely going to do it, your M&A lawyer if you have one is not likely going to do it. You need somebody who has sat in a chair and been through a transaction and watched these things happen to ask you those questions as we would. We have a 57-question assessment we do for business owners that are interested in learning more about where they’re at. It answers these questions and protects the downside. And if you’d like, we can also help accelerate the upside.

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Chapter 8: Quality of Earnings — Should You Pay for It Before Going to Market?

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[24:38] Bill, you hit on QofE. Can you spell that out for our listeners and talk us through what that process looks like? And should a seller actually pay for that before they go to market?

[24:54] So quality of earnings — QofE — is what we’re talking about. And from my perspective, having sold a couple of companies, one we did do a sell-side QofE prior to taking it to market — so we were able to hand that to the prospective buyers so they knew exactly what they were getting their hands on.

[25:11] At the end of the day, the quality of earnings takes apart the composition of the company’s balance sheet, income statement, and statement of cash flows and breaks things down. It looks at whether your accounting policies follow GAAP. It tears apart various expenses — especially those related to the compensation structure of the organization, what’s market, what’s not. What sort of team do you need post-transaction? If you’re running really lean, a buyer may make an adjustment to add that team in post-transaction. You may want to tell them what you think you need so they don’t go try and figure it out on their own.

[26:01] Because the buyer is likely going to pay for one as well. You’d rather get yours done and hand it to them. But the types of adjustments that also get looked at in the QofE would be compensation that may be above market, one-time legal transaction costs, related party rent or any other fees that are off market, non-recurring revenue and other one-time items, and unsigned customer contracts.

[26:40] Unsigned customer contracts — that’s something you should flag or get them signed. I once had a transaction get hung up because the biggest customer had an unsigned contract and the buyer was not willing to pay anything until that got resolved.

[27:02] Does that actually happen? Yeah. I mean, obviously that’s the revenue side. But also from the operating cost side — staffing, sales resources, comp agreements not being signed. Have you had those issues come up?

[27:15] Yeah, it’s all part of the governance process. You’ve got to make sure you know where your contracts are, they’ve all been executed, and you’ve got good corporate books and records. The minutes — even if you just drafted the minutes for the last three years yesterday. Better to have that than nothing.

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Chapter 9: What Buyers Want to See in Your Revenue

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[27:36] So let’s talk about revenue. What does a buyer want to see about the revenue that most owners can actually produce?

[27:46] They always want to see revenue by customer and by product — not just the total. To be able to explain your revenue down to the minutia. They’ll want to see it sometimes by SKU or groups of SKUs. And if you’re a custom manufacturer or someone that works on large projects, you better be able to explain: how did you land that project? Who brought it in? Is there a chance it could come again? Because they will discount your revenue based on the size of the transactions. They’ll also want to know what percentage of your revenue is recurring, if any.

[28:35] So you’ve got to know the top number cold but you’ve got to be able to break it down to meaningful pieces. In a consumer business — what are the payments to different customers and why do they differ? How much is everyday promotion versus trying to get into shelf slotting? You’ve got to be able to explain your business in more detail than just the top-line numbers.

[29:08] Yeah. And I think the equivalent also exists on the cost of goods and operating cost side — we need that broken down and clearly articulated by location, site, product, etc. We ran into a scenario with a client recently where all of the operating costs were just bundled into one location when they actually had four. So three out of the four locations looked like they’re just rocketing and one looks like it’s doing terribly — which is not correct, obviously.

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Chapter 10: Working Capital — The Number Owners Never See Coming

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[29:52] All right, let’s talk about working capital. It’s that conversation owners never actually see coming. How much has it moved the numbers in the deals you’ve seen?

[30:02] You know, that’s a good one because a lot of owners don’t think about it in the transaction until they get to the end and somebody says, “Well, here’s your normalized working capital over the last 12 months” — and they’re like, “What?” A lot of owners focus on price. They don’t focus on working capital. And getting that number wrong moves real dollars at the end because it’s a deduction. What’s your net investment in working capital? Receivables and inventory less payables and accruals — that’s what you’ve got to come up with.

[30:48] Our goal when we come into situations — and this gets highlighted in the QofE but it’s also something we do in our preparedness engagements — is to go through and look at working capital and say: what are the things we could do to drive it down? I’ve had a situation where I worked at a company and more than one quarter’s worth of revenue was in accounts receivable at the end of the quarter. That’s how late in the quarter all the transactions happened. Not only do they need to have inventory on hand for most of the quarter to fulfill orders at the end — you end up with a double count from an asset perspective in your working capital calculation because you’re counting both inventory and receivables in that same quarter.

[32:01] And so the seller will get penalized by the buyer because they’ll tend to look at it by day. You’re carrying a huge balance through the quarter. That’s why working capital is so important in a transaction.

[32:16] And sometimes you’ve got unquantified liabilities. I’ve also seen people put up big escrows related to undefined or uncertain liabilities — when you can’t pin down what you think you might owe, buyers will take the uncertainty to the highest number possible.

[32:36] Where does that come up? Tell me a story.

[32:40] So sheet liabilities for unclaimed property on uncashed cheques. There are a lot of states in the US that have escheat rules where if somebody doesn’t cash a cheque, you’ve got to put up a liability because they may claim that cheque from you at some point down the road. We once had a business involved in fulfillment — they’d send out cheques for prizes and people wouldn’t cash them, and that added up to a lot of money over the years. They couldn’t really prove whether or not they owed this money back to the customers. And they didn’t send the money back for uncashed cheques — they just used it as part of their operating funds. Assumed the promotion was done and off they go. The “off we go” practice did not work well on that sale process. It actually cost them the deal. The buyer just walked eventually.

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Chapter 11: Where Value Disappears for Non-Financial Reasons

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[34:03] So as we’re going through this — what haven’t we talked about? Where does a business lose value for reasons that have nothing to do with financial performance?

[34:16] I think the biggest one — and it’s the hardest one to pin down — is around the sustainability of revenue. That always seems to be the one thing people are uncertain about. I have a friend who’s an investment banker trying to sell a consumer business with $20 million of EBITDA, but the buyers are uncertain about whether the product being sold is a trend or a fad. And right now people are landing on: it’s a fad. And the business has little to no interest from a buyer perspective. It’s really the ability of people to be comfortable with the certainty of revenue going forward.

[35:08] Yeah. And even with that, some of it comes down to what we see — heavy founder dependency, key man dependency. Somebody walks and does the whole thing start to fall apart again? Does the revenue generation sales engine start to break immediately? Our ability to actually execute on demand — does that fall apart very quickly? That’s big.

[35:32] Agree with all of that.

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Chapter 12: If You’re 24 Months Out — What to Start Tomorrow

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[35:34] Bill, we’re running low on time. So let’s say a founder is watching this and they’re thinking 24 months out from a sale. What’s the one thing they need to start looking at tomorrow?

[35:46] I think the first thing they have to decide for themselves is: are they ready for what life looks like after the sale? That would be my first piece of advice because I think the number one reason transactions don’t work or aren’t successful is because people either right at the end get cold feet or have remorse after the fact. So if you’re thinking about selling, make sure you understand that you’re ready for life on the other side.

[36:17] Beyond that, I think the other thing I would advise is to take on those things that are structural. Do you have a piece of real estate inside of a holdco? I once had a business we were trying to buy and the deal fell apart because of the way the business was structured — the assets were owned in the wrong way for tax purposes and the cost broke the deal. So you’ve got to make sure those big things are addressed. Do you have a successor in place? Do you have the right leadership team in place to get you through the transaction? Do you have the right person sitting in the finance chair to negotiate with a prospective buyer? Who’s going to do that if not you as the owner?

[37:08] So to me it’s: are you ready? Do you have the right team? Have you thought of those large structural items that take a long time? And the fourth would be working capital — given the length of time it takes to make changes, you want to trend it over 12 months.

[37:37] Bill, this is incredible information. Really appreciate this. Totally the kind of information that small business owners need for those informed decisions. And I think the part about actually asking yourself what you want out of that — that’s critical. We’ve seen a lot of transactions where we’re prepping an organization for sale and eventually the founder and CEO say, “You know what, now that we fixed everything, maybe we should just hang on to it.”

[38:08] Right. Exactly. And you know what I would say to that — which is ironic — is: always be preparing for a transition or a transaction. Because at the end of the day, you’ll end up with a business that’s better and more fun to run along the way. Why wouldn’t you get things straightened out sooner versus waiting until you are ready to sell the business?

[38:36] I love that. And just to that point — you leave the big corporate life and you go on this entrepreneurial journey. It’s supposed to be fun, and we forget about that during times of turmoil. But once you can put the structure back in place, it can get fun again.

[38:55] Exactly. That is so true.

[38:58] I love this, man. If anybody wants to reach out to you or learn more about Everest, how do they find you?

[39:04] Hey, it’s been my joy to be on the call today. They can find me at the Everest website — everestadvisorsllc.com — or email me directly at bill.costchek@everestadvisorsllc.com.

[39:21] Love it. All right, we’ll talk soon, my friend.

[39:23] You got it. Thanks again, Nish. Appreciate it. Take care. Bye.

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