Episode 111 – The Beginner’s Guide to the QOE (Quality of Earnings) Report – Member Case by Elliott Holland

Someday you will sell your firm. After all, none of us can run our firms from the afterlife. When your time to exit comes, you will need to know what your firm is worth. The tool often used to calculate a purchase price is called a QOE, or the quality of earnings report. On this episode, QOE expert Elliott Holland, Founder & CEO at Guardian Due Diligence, will help founders understand what a QOE is, when it is needed, who creates one, how it gets used, and why founders need to get familiar with it.


Greg Alexander [00:00:15] Welcome to the ProServ podcast with Collective 54, a podcast for leaders of thriving boutique professional services firms. For those who are not familiar with us, Collective 54 is the first mastermind community dedicated to the needs of boutique pro firms. My name’s Greg Alexander. I’m the founder and I’ll be your host today. On this episode, we’re going to talk about a tool that you’ll use someday when you’re trying to sell your firm. It’s called the q0e, which stands for Quality of Earnings. And we have a true expert who does this for a living. His name is Elliot Holland. He’s also a member of Collective 54. So, Elliot, it’s great to see you. Would you introduce yourself to the audience, please? 

Elliot Holland [00:01:02] Absolutely. Great to be here. I’m Elliot Cowan, Harvard Business School, former private equity professional. And now I run a business that helps entrepreneurial business buyers vet acquisition targets using an audit like service called Equality of Earnings that we’ll dive into deeper here in a second. But essentially, I try to help entrepreneurs and keep them away from losing money in very happy situations where there’s huge motivations for people to misstate the truth. 

Greg Alexander [00:01:34] Okay, sounds great. So let’s start at the very top. A lot of our members are first time founders. They’ve never been through an exit. Someday they all know that they will sell their firm someday because unfortunately, we can’t run our firms from the afterlife. And since they’ve never been through that process before, this term quote, equality of earnings, they don’t even know what it is. So can you just give us a basic definition? 

Elliot Holland [00:02:01] Sure it is an audit service. So for a public company, what they do each year is an audit which looks through extensive information and makes public stock accessible to everyone. What the quality of earnings is is a mini version of that specifically used for buyers of companies to assess the financials of private companies. Anyone on here who owns their own business knows how difficult tech firms can be and how difficult setting up your financials and keeping them straight can be. So imagine a buyer coming into that environment, and the quality of earnings is a tool that can standardize the business financials of any business owner into a package that any investor can consume and make an acquisition decision. But to sum it all up, it is very similar to an audit specifically for the you are buying a company. 

Greg Alexander [00:02:54] Okay, very good. And when as a founder, am I most likely to need to use or build a q. O. E. 

Elliot Holland [00:03:05] Sure. So the two times that you need to use it, one, if you are looking to grow by acquisition, you see a target company that’s in a market you want to get into. You see somebody you know who’s selling. When you decide to buy their business before you execute that transaction. You want to hire someone to do a quality of earnings. Why? Because there’s. Huge variability in financials relative to what’s presented often times and you don’t want to get had. So that’s one. The second time is if you are approached to sell your business or you decide to take your business to market. Greg talks about this all the time. You’re getting an investment banker or business broker. I would highly encourage you at that moment to get a quality of earnings as well. Here’s why you want to have your own point of view of your numbers before a bunch of picky buyers come in and start hiring the same providers for their benefit. And the pain for an owner who does their own quality of earnings. The pain during the selling process is drastically reduced if they have their own quality of earnings. So those are the two times people should think about quality earnings. 

Greg Alexander [00:04:20] Okay. And it sounds intimidating. How long does it take? And, you know, if I’m a first time founder who’s never done it before. Can I pull it off? 

Elliot Holland [00:04:32] So it’s easy peasy and I’m smiling only because I’m such an entrepreneurial advocate on both sides, buyers and sellers. So essentially, your bookkeeper, your CPA, and the person sitting in my seat as the equality of earnings company lead or accounting lead do 95% of the work. So to make the process super simple and easy to digest, it’s essentially three steps. As an owner who’s going through one, they send you a list of information. If they’re good at small business kilos, their list is 40 to 60 items. Of those items, two thirds will be handled by your bookkeeper or CPA, and the other third will be handled by maybe a half hour to a 45 minute conversation on the phone. So you get a list, you give it to people to fill it out. You get on a phone call for a half hour to 45 minutes to answer business, marketing certain questions about the business. And then you wait for 3 to 4 weeks for the work to be done. Now, there may be questions in between on step three. Those questions oftentimes are not all that detailed. And oftentimes your controller or your CPA can answer them. So for a owner, it may encumber. Let’s just say it takes 3 hours to sort of get your troops going on the day to another hour for a call. You invest between one and 4 hours in this process. And I’ll also say a lot of us as private business owners have done some interesting things in our financials. You should not be scared of sharing those things because the providers who do this are so used to handling it. Just just be honest. Get it all out and it’ll be done in four weeks. 

Greg Alexander [00:06:15] So let’s say I’m a founder and I have a successful firm, so I potentially have an inflated opinion of myself and I think I can do this on my own or I can pencil whip it just by, you know, exploiting my QuickBooks file. And that should be good enough. Am I nuts? 

Elliot Holland [00:06:34] Yes, I’d. I’d respectfully laugh at you. 

Greg Alexander [00:06:37] Okay. 

Elliot Holland [00:06:39] Here’s why. There’s too much money. Okay, So the people I’m speaking to are people who have businesses that are likely going to sell for 1000000 to 40 or $50 million. Right. They’re going to be sold at a lot of cash flow or EBITA. We won’t get into it, but just a multiple a profit to keep it simple. So when you say, hey, I’m going to go cheap and easy and homegrown and I’m going to export my QuickBooks and it’s accounting crap, they don’t care. My business is worth whatever. What you don’t realize is I’m going to be the one on the other side working for the buyer, picking your financials apart at in my 10th degree of detail and then telling you think about things about your financials that are accounting oriented but will affect the price that you won’t understand yet because you have not gone through the process for your own benefit. So let’s just walk you through an example. When sellers don’t do the quality of earnings before, when founders don’t do it, before you get into situations where accounting things, where something is is presented in one way is taken as a big deal, when it’s really a small deal and you’re getting a multiple of profit. So like a 10% difference. So if your profit is a million bucks, if the buyer can go through your front end and shows and show you that your true profit when all the accounting stuff is handled, is even 10% off, right on a4x deal, that $100,000 could be $400,000 worth of lost value. So by, you know, avoiding 22 for a quality of earnings, you just lost 400 K. 

Greg Alexander [00:08:15] Yep. 

Elliot Holland [00:08:17] That’s before I even talk about you have your own financials. You go through less pain through the whole process because people don’t have to ask as many questions. 

Greg Alexander [00:08:25] Yep. Now, so far we’ve been talking about if I, the founder of my firm, is planning on selling my firm, we haven’t talked about the counterparty on the other side of the desk. The firm was thinking about buying my firm and their due diligence process. So it’s likely it’s likely especially, you know, professional acquirers, they’re going to hire their own firm to do their own QE. So there’s really two of them being done. Is that correct? 

Elliot Holland [00:08:52] It depends on the size of the business and the buyer. So I would say in the deals that I’ve seen and I focus on deals sort of $2 million to 25, $35 million is where I live. If the seller does the quality of earnings typically be the buyer who comes in will either assess the quality of earnings and the quality of the firm that’s done it, and they may just get their accountants to review it. That’s most often the case because people don’t want to pay twice for the quality of earnings or if there is a second quality of earnings, it’s a sanity check, not a product, a logical exam. So if you’re going to have somebody go through your financials at that level, you want to be the one paying them. You don’t want somebody that somebody else paid doing that exam. 

Greg Alexander [00:09:38] Yeah. Okay. Now, the the person who’s buying the firm, the acquirer, they’re going to take this QC and they’re going to do what with it? 

Elliot Holland [00:09:48] So let’s just talk about $1,000,000 Eboni business, which is just cash flow, a profit and a four times deal. So you’re selling your business for $4 million. The buyer will come in and do a quality of earnings and say, I’m going to multiply whatever the evil that this found in my quality of earnings by four. So they’re going to go in and look at your income statement, your balance sheet, your working capital, your bank statements, your taxes. Running through that four week analysis. And then they’re going to come back and say, hey, based on our accounting team, your actual EBIT is $900,000. And so now they’re going to say $900,000 times four is 3.6 million, not 4 million. And so our price now just got adjusted, 400 K It also happens in the other way. So they may find that the profit is higher than what was presented, but they’re not in a position to tell you that. So what would buyers do with the quality of earnings is use it as the basis for the EBIT number that they multiply by to get to the value. 

Greg Alexander [00:10:52] Okay. And do they share it with the bank if they’re going to fund it that way? 

Elliot Holland [00:10:58] Oftentimes, sometimes not. But you should assume that the quality bearings will go to all interested investors, even though sometimes it doesn’t. Depending on the buyer, if they have good relationship with their banks, depending on the size of the deal. Also, as you get out of when you get out of sort of two, three, 4 million and get above that, then the answer is absolutely yes. 

Greg Alexander [00:11:22] Correct? Yep. Okay. One last question for you on this. This is a personal pet peeve of mine. Sometimes our members get advice from their broker, the M&A adviser or the investment banker that they got to spend a fortune on acuity and hire a big name firm like a p.w see, which I think is crazy for our members, because those can be very expensive and they don’t need to spend that kind of money because our members businesses, relatively speaking, are easy in simple businesses to do this. So, Eliot, what would you say to that advice? 

Elliot Holland [00:11:58] So I don’t think the big firms like Peter them you see, do strong in meeting business quality of earnings well at all. So my point of view is not only will you overpay for it, but you will get the debt. Not that it would be the C, but the DTI, the kids coming straight out of college. The partner who doesn’t want to spend a lot of time on it. You’re not an important entity in their ecosystem of a lot of private equity firms and multiple buyers. So you’re going to get the last bit of energy they have. And when a transaction is this big for you as a founder, it matters that you get the A-Team and a quality sort of driven firm. So I would highly encourage you to look for regional firms that are more that are priced more cost reasonable or due diligence firms like mine that focus on just quality of earnings that have great reputations in the marketplace. You don’t need a quarter million dollar, $100,000 quality of earnings. You need one that solid by a reputable firm. Yep. 

Greg Alexander [00:13:00] And not to put you on the spot here, but I know you do this for a living. Give me a range. What’s a ballpark budget figure for something like this? 

Elliot Holland [00:13:08] Sure. So 20 to $60000 should cover it for companies that are selling for 1 million to. 25, $30 million. When you get above that, you may ratchet that upper end of the range up a bit, but that is a very reasonable range. You get your quality of earnings done. 

Greg Alexander [00:13:26] Okay, Fantastic. Well, listen, we’re out of time. But Elliot, you and I have recently gotten to know each other. You’re a relatively new member. I’m so glad that you’re in the community. Your energy and enthusiasm is infectious, and your area of expertise, as we just learned today, is desperately needed for our community. So on behalf of all the other members, I appreciate you being part of Collective 54 and in particular for making the deposit in the Collective Knowledge Bank today. Thanks a bunch. 

Elliot Holland [00:13:52] So excited to be here. Thank you for having me. And I’m glad to be in collective 54 as well. 

Greg Alexander [00:13:58] All right, very good. So let me give the audience members a couple of call to action. So let’s say you’re not a member, but you’re thinking about it because you want to meet really interesting people like Elliot and learn about these tools like quality of earnings. Go to collective 54 dot com, fill out the contact us form, and one of our representatives will talk to you about being a member. If you if you are not ready quite yet to be a member and you want to educate yourself further, subscribe to collective 50 for insights and you going to get three things on Monday. You’re going to get a blog, on Wednesday, you’re going to get a podcast, and on Friday are you going to get the chart of the week? And that’s a good way for you to learn more about this if you are a member listening to this, my call to action is a little bit more precise. So the first thing I want you to do in the new Boutique Companion course, there is a Kuo e template I really want to emphasize. It’s an introductory basic template that will get you familiar with kind of what something like this looks like. Of course, to execute it, you’re going to need a professional like Elliott. And then also if you’re not quite ready for a cue because you’re not ready to sell your firm, but you’re really interested in what your firm might be worth on the website. Under resources, we have a tool called the Firm Estimate here. That’s a really fun tool. Takes about 15 minutes to fill out your answer ten questions. It gives you a ballpark range as to what your firm is worth. I really want to emphasize here a ballpark range. It’s not a precise valuation, but check that out if you’re interested. Okay. So that’s the end of today’s show. Thanks for listening. Thanks for being here. We really look forward to Elliott’s private Q&A with the members on one of our upcoming Friday member sessions. But until then, we’ll talk to you on the next one.

Episode 87 – Why Hiring an Investment Banker is the Right Move for First-time Founders Trying to Exit – Member Case with Frank Williamson

The value of your firm is influenced by the comparables for recently sold firms like yours. On this episode, we invited Frank Williamson, Founder & CEO at Oaklyn Consulting, to share details about comps, valuation, and the benefits of an investment banker. 


Greg Alexander [00:00:15] Welcome to the Boutique with Collective 54, a podcast for founders and leaders of boutique professional services firms. For those that are not familiar with Collective 54, we’re the first mastermind community to help you grow, scale and exit your firm bigger and faster. Specifically for pro serve firms. My name is Greg Alexander and I’m the founder and I’ll be your host. And our topic today is comparables. Otherwise known as comps. And this is for firms that would like to sell themselves at some point. And it discusses how being in the right category or being compared correctly to others like you can have a big impact on the purchase price and the terms of the deal. And to help me with this conversation, we’ve got an exceptional role model this morning. His name is Frank Williamson, and Frank runs Oakland Consulting, which is somebody who helps clients with this particular item. Their services include acquisitions, transaction management, private equity, capital service and so on. And and he and his firm probably know more about this than any any of us ever will. So we’re really lucky to have him with us. So. So, Frank, it’s good to see you. And would you please properly introduce yourself to the audience? 

Frank Williamson [00:01:37] Oh, Greg, it’s great to be here, and I really appreciate what you’re doing for the audience and for the founders of professional services firms. So, yes, we do just what you described, which was well done. We are we’re an investment banking boutique. We work with small and mid-sized companies, nonprofits, professional services firms and others. When there’s a major transaction to navigate, maybe it’s an incoming offer or maybe it’s a very planful strategic sale. You know, maybe it’s the need to raise capital to grow. But we try to be good guides to people through that process. 

Greg Alexander [00:02:17] Okay, fantastic. So, Frank, many of our members are first time founders and entrepreneurs. They haven’t been through an exit before. They probably have listened to guys and gals like me and read all the books and tried to educate themselves. But when I have this conversation regarding comparables and positioning yourself in the proper category, sometimes it’s deer in the headlights. It’s for some reason it’s an abstract idea that’s tough to understand. So I’m wondering if you might offer the audience your perspective on this topic. Maybe share an example or two just to bring some greater clarity to it. 

Frank Williamson [00:02:55] Well, the chapter of your book on comps does the really nice analogy of a real estate broker, and I think a lot of us have more opportunities in life to think about, well, how do I cut the cost per square foot of something? Then how do I comp the whole business? And and we might even wonder why that comping things idea make sense since businesses are so different from one another. But you know, you brought up the in the chapter, I thought, you know, some really good ways to look at it. One of them amounts to saying, well, who are you relative to other similar firms that someone you’re talking to might seem. And and I think importantly. Who are you relative to the kind of firm that in the bigger acquisitive. Company might buy you. Are you like them or unlike them? And I think that having a beat on that really gives people a chance to start talking with their exit. Or it’s a succession partner about how do we fit and what could we do together. And it you know, it’s easy for all of us to go into those kinds of conversations with some kind of analogy. Yeah. And that’s what I think comps are most useful, as is the analogy that gets the conversation going. 

Greg Alexander [00:04:24] Yeah. So for, for listeners that haven’t had a chance to read the book, let’s just stay on the real estate example because it’s easy. You know, let’s say you want to list your house and you hire real estate agents to represent you and you say, well, what’s the house worth? Well, they consider your neighborhood, your street homes that like yours, that have sold. And they boil it down to a metric sometimes, like in Texas where I live, it’s it’s cost per square foot. Then there’s other metrics that we use. Well, in the business world is very similar. If you have a firm that you want to sell, you would hire somebody like Frank’s company to help you do that, and you’d say, What’s it worth? And they would go out and and do some homework and come back with some comps and say, you know, this is this is a range of what your firm might be worth. And here’s what it will trade on. Sometimes it’s a multiple of revenue, sometimes it’s a multiple of immediate. There’s a bunch of different ways that you can value a firm, and getting that incorrect can cost you a lot of money. And I share my story in the book where at one point when I sold my firm, people thought we were a sales training firm and that carried a much lower comp. And we weren’t. We were a management consulting firm which carried a higher comp. And just moving into that category and being able to prove that that’s a category we belonged in, you know, got me a higher price in better terms. And that’s what’s so important. Now, Frank, it’s hard for founders to identify who their comps are, and that’s probably why they hire your firm and partners to figure that out. So how do you how do you find this difficult to locate information? Because these transactions are private companies. The data is not readily available. How do you learn what the going rate is, so to speak? 

Frank Williamson [00:05:56] Yeah, well, there are two parts that good question. One is who to be comped against. Yeah. And then the second one is we’ll get given that I did that, then what’s the going rate. If you don’t mind I’ll just do the, the first 1/1 because I think it’s a little bit easier. Bite of the apple, too, you know, to get in your mouth and you go in and we see many people who haven’t just figured out who are who is comparable to me, who are other people like me. And that I think people can do often on their own by just sort of scanning the business landscape. Who do I compete with? Who else is sold? Who I compete for staff with? You know who who is like me? And who do I want to be like? Like in the case of your story, do I want to be like a management consulting firm? I want to be like a sales training firm. And how will I prove that? Then comes the hard part, which is how do I get to a real number that makes any sense. And and as many people know, you know, price is. At least half the equation. Terms of the rest. You know, if I went out and heard a friend of mine. Tell me he sold his business for 20 times last year’s epitaph. But upon further. Probing with him or with the buyer. You know, I realized that it was eight times at closing and a big profit share that came along. And it was equally 12 times after that. And in any event, the buyer thought they were going to make twice as much off the business as the seller did. And so really the prior year’s earnings weren’t the right number two for the multiple against anyway. It wasn’t how the deal came together, but it makes a great headline. I sold my business for 20 times while going and using that 20 as the basis for account isn’t really going to. Help anyone beyond a great story over dinner about what a great negotiator you are. So it really is hard to get an honest bead on. What are firms like mine selling for in reality? And, you know, our experience is there are few good sources of data around the marketplace, number one. Number two, people who are active in the market have an anecdotal sense that add something important to the data. And number three. Even with that, there’s a big element of small operating companies trading in a market that just, you know, is a you don’t know until you ask kind of market. And finding the way to ask the right questions. It is a lot is a lot of what we do on behalf of clients is a lot of what people get out of investment bankers is can you find a way to ask what the terms really were such that you feel like you’ve got an honest answer? Yeah. 

Greg Alexander [00:09:22] You know, a little bit more about my story and how I stumbled into this because I was a first time father myself and this was a foreign world to me. So as we were gaining some some traction, one of the big consulting firms approached us and said, Hey, we would like to buy you or consider by you. Your firm is worth 1.25 trailing 12 month revenue. I didn’t know any better and I said, okay, well, that’s really not that interesting because we’re growing at 30% a year. So I just hold on to it and then we bid on a company. So we were on the other side of the desk and we participate in an auction run by an investment banker. And we lost. And I was surprised we lost. And when the banker called me and told me we lost and he said we were one third the price we offered, like I think it was like $20 million. And he sold for like 60 and I couldn’t believe the number. And I said to the banker, I said, My goodness, if you could get that for that business, what could you get for mine? And the banker did a great job and they said, Well, they’re adjacent to you. Not exactly like you, but you know, if you probably can get a little bit more because you’re bigger than them, but the only way to really find out is give it a try. So we hired them because they were the experts and they went out. And as luck would have it, thank goodness they got a number that I never thought possible. But what I learned from that experience is. Your business is worth what someone’s willing to pay for it. Right. 

Frank Williamson [00:10:47] And I think that’s such an important lesson and one that one that is hard to have come across when any business owner does probably their first encounter with getting their business valued, which is for some wealth planning purpose or tax planning purpose. They don’t get a valuation report and that uses a wide or very broad set of comps and describes a theoretical transaction to the satisfaction of the paperwork that the IRS needs. That’s you know, that’s a whole different way of thinking about it than what’s the actual transaction, the actual buyer, and what does that actual person need. What really jumped out to me about your story was that you went to develop a bid as a buyer. I assume you did it at what you thought would be a fair price. It would make sense after the deal and you came back with feedback that when you weren’t off by 20%, but it was X to three X. Yeah. In that range. And I think that so perfectly illustrates the question of, well, there was somebody in the market who really wanted that company that you were looking at to the tune of three times more than you wanted it. Yeah. And getting in the zone of what do people really want? What would they pay for is such an important part of really having good dialog. 

Greg Alexander [00:12:18] Yeah. You know, you talked earlier about terms and this is something also I think is underappreciated by our membership. You know, when they think about selling the firm, obviously the first question is, what’s it worth? Excuse me. But they they they don’t put enough emphasis on terms, in my opinion. The example that you gave earlier, you know, when you peel the when someone said, I sold over 20 times last year’s profit, but then you peel the onion back and not really. And I think comps also inform what the terms are. And there was an old phrase, I forget who said it, but you name the price, I’ll name the terms, something along those lines. Great. 

Frank Williamson [00:12:54] Great, great, great. 

Greg Alexander [00:12:55] Yeah. What what does comps and running a process with someone like yourself reveal about terms that typically surprise first time founders? 

Frank Williamson [00:13:09] I would say. I would say that people get surprised by two things. One is because we all talk about multiples and comps as if it were a clean price. Yeah, that’s one. One surprising thing is that buyers and for that matter, sellers don’t make the decision about the price on the basis of last year’s earnings. People are getting together to make a decision based on what’s going to happen after the deal. And it’s a convenient way to express it to say, well, it was some multiple of last year’s earnings that wasn’t really anybody’s decision. So that, I think comes as a surprise to people is, oh, the multiple. Wasn’t the reason that the multiple appear. The other related part that I think is surprising to people is, is for all you know, all of us do sales in the normal part of building our firms. Selling your business. In the end, it’s sales, you know, and it’s it’s it’s best done in my experience as a consultative selling process. When you’re sitting down with someone else, the topic is, What can I do that’s going to impact your business? And then how can we share the results of that? Yeah, and that conversation, in my experience, does as much influence terms as it does to influence price. Interesting cause that’s the point at which you accommodate. Well, was the day after the sale all about the buying company taking over operations and letting the founder leave? Or was it all about providing a new platform for the selling company’s founder so that. She could go run three times as fast as she was able to do alone. Hmm. It’s that kind of business plan that really drives terms and and it may also drive price but a little bit jokingly it can those things can get conflated right in my mind story which by the way, is a true one about the you know, about a client who sold for a price that he they in this case could honestly go say to their friends was 20 times and the buyer could honestly go say to their board, it was seven times because their respective views of what was going to happen afterwards were just different. Hmm. 

Greg Alexander [00:15:49] That is a great story. Well, listen, we’re at our time window here, but Frank, on behalf of the membership, this is an area that our members lack. Experience with so happy because their first time fathers, they haven’t been through a transaction before for the most part. So having an expert like yourself in the community is really helpful in the way the collective works is we all make deposits to the collective body of knowledge and we all learn from it. So on behalf of the members, thank you for doing that today. 

Frank Williamson [00:16:18] Well, thank you so much for having me. I’ve really valued being part of collective group. 

Greg Alexander [00:16:23] And if anybody is thinking about selling their business, I tell you, I say it in the book, I say it on the podcast, don’t go it alone. Hire somebody like Frank to represent you. It’s a mistake when you’re doing this to try to do it on your on your own. And usually a representation like Frank will make your life a lot easier and make you some more money, get you better terms, and just hold your hand through the process. So if you want to get a hold him, do so through the member portal. Okay. So for those that are interested in this topic and others like it, if you haven’t read the book yet, the boutique artist art scale and seller professional services firm, I’ll direct you to that. And then for those that are listening that are not members but would enjoy being part of a community of peers and meet exceptional people like Frank, consider joining our mastermind community. You can find it at collective54.com. Thanks again, Frank. Have a good rest of your day. 

Frank Williamson [00:17:19] Thank you, Greg. Goodbye.