Welcome back to the Business Buying Masterclass! In today’s session, we dive into the critical topic of financial due diligence, a cornerstone in the acquisition process. To enrich our discussion, we’ll integrate insights from industry experts Chris Williamson of Cayne Crossing and Elliott Holland of Guardian Due Diligence.Thank you for tuning in to the 11th session of this Business Buying Masterclass. Let’s get started!The Business Buying Masterclass is now part of The SMB Center! 🎉The SMB Center is your go-to destination for essential resources, practical tools, and expert insights tailored to small and medium-sized business entrepreneurs like you. This includes hundreds of articles on business buying (Entrepreneurship Through Acquisition) and valuable tools like our Leveraged Buyout Model and LOI Template — all for FREE.IntroductionCongratulations on making it through the toughest part: getting the seller and broker on board and finalizing your Letter of Intent (LOI).Now that you're under LOI, the seller is willing to lift the proverbial ‘hood’ of the business and provide access to detailed financial information. This is your first look at the data underlying the information provided in the Confidential Information Memorandum (CIM). It’s a crucial phase where the rubber meets the road, offering a real glimpse into the business’s actual performance and financial health.In this session, our goal is to help you navigate the post-LOI deal roadmap, focusing on the essential steps and best practices for conducting financial due diligence. We will explore the nuances of Quality of Earnings (QofE) reports, share expert advice on identifying red flags, and provide actionable tips to ensure you’re making a well-informed decision.Guest ContributorsElliott Holland is the founder and managing director of Guardian Due Diligence, a firm specializing in Quality of Earnings (QofE) for small and medium-sized business (SMB) transactions. With a rich background in private equity and a Harvard MBA, Elliott brings over 20 years of experience in evaluating and managing acquisitions. Guardian Due Diligence has supported numerous entrepreneurs and investors in making informed decisions by providing comprehensive financial due diligence and QofE reports. Elliott is known for his deep understanding of SMB dynamics and his commitment to ensuring clients avoid costly mistakes and uncover potential fraud in their transactions.Chris Williamson is a founding partner of Cayne Crossing, a boutique consulting firm focused exclusively on financial due diligence and Quality of Earnings (QofE) for small and medium-sized businesses (SMBs). With over 20 years of experience and a background in Big Four accounting, Chris has led over 1,000 transactions, providing clients with the insights needed to make informed decisions. Cayne Crossing is renowned for its hands-on approach and deep understanding of the unique challenges in the SMB market. Chris is passionate about entrepreneurship and leverages his extensive experience to help clients navigate the complexities of financial due diligence, ensuring they uncover the true financial health of potential acquisitions.Financial Due Diligence: The First Look Under the HoodFinancial due diligence is the process of verifying the financial information provided by the seller. It aims to confirm that the business's reported earnings, expenses, and assets are accurate and provide a true reflection of its financial health. This process typically includes a thorough review of financial statements, tax returns, customer contracts, and other relevant documents.Chris Williamson of Cayne Crossing emphasizes the importance of this step: "Financial statement quality across SMBs is the wild wild west. There is no concept of Generally Accepted Accounting Principles (GAAP) in this end of the world. This means the baseline of your valuation, EBITDA/SDE, may be totally incorrect and at the mercy of the seller’s (often) biased interpretation of their financial picture.”The Role of a Quality of Earnings (QofE) ReportA Quality of Earnings (QofE) report is a comprehensive financial assessment designed to bridge the gap between the business's financial statements and reality. Here is a clip from Mundane Millionaires of Elliott explaining what a QofE is: Chris further explains that: "A QofE focuses on illustrating the true or 'normalized' state of historical EBITDA and how it bridges to free cash flow. In short, what you receive from a seller or their broker is often an (unintentionally) misconstrued view of the reality of the business you will be taking over."Elliott Holland from Guardian Due Diligence adds, "The financial part of a quality of earnings is somewhat similar deal to deal. The data inputs vary. The work you have to do to get them into a standard format varies. But the output is pretty consistent. If you look at a hundred reputable firms' quality of earnings, we'll structure stuff ...
