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Coffee Conversations - Who's Buying Roofing Companies? - PODCAST TRANSCRIPTION

cc - trent cotney - ken kelley - transcription - 2023
April 13, 2023 at 6:00 a.m.

Editor's note: The following is the transcript of an live interview with Trent Cotney and Ken Kelly from Adams and ReeceLLP. You can read the interview below, listen to the podcast or watch the webinar.

Heidi J. Ellsworth: Good morning everyone. Welcome to Coffee Conversations. My name is Heidi Ellsworth. We are here today with two outstanding roofing industry leaders and we are going to have a conversation like no other, let me tell you. This is a conversation that everyone has been talking about and we are very excited to really talk about mergers and acquisitions. We have the chat open, so we're going to be getting going. This is so exciting. Before we do start, I want to remind everyone that this is being recorded and we will be having this on demand within 24 hours, so be sure to share it with all your friends. I know we've had a lot of people who were like, "We don't want to miss this." It will be available under Coffee Conversations by tomorrow, around noon. Let's get started this morning.

I would like to introduce our two panelists as we are talking about who's buying roofing companies, and mergers and acquisitions. If you were at the IRE or any trade show, this is the conversation that is happening everywhere. So we thought we would bring into Coffee Conversations with two folks who understand what it's all about and can really give some great advice and really share what's happening out there.

I would like to first thank our sponsor, Adams and Reese. Adams And Reese is the leading construction law firm that is really taking the whole industry to the next level. All of you know Trent Cotney. Trent Cotney is part of Adams and Reese, and they're our sponsors today. So thank you so much Adams and Reese for helping not only with construction law overall, but a lot of mergers and acquisitions too.

Speaking of Trent... Actually, we're going to start with Ken. I'd like to introduce Ken Kelly. Ken, thank you so much for being here today. You are so knowledgeable on all of this. If you could introduce yourself, tell us a little bit about Kelly Roofing, that would be great.

Ken Kelly: Yeah, Ken Kelly, president of Kelly Roofing, started by my father in 1972. We just celebrated 50 years. I took over in '93, which means I've got 30 years of running the company under my belt. We sold the private equity about two and a half years ago. What's interesting about this whole thing is Trent and his team were the ones who helped us with our due diligence and representation. So we have a really cool dynamic between the two of us because you'll hear all the nitty-gritty inside tips that you're going to want to know if this is something that's on your radar.

Heidi J. Ellsworth: Oh, this is so good. Okay. Thank you, Ken, so much. And now I'd like to introduce Trent Cotney. Don't need much of introduction, Trent. I think everybody knows you, but if you could introduce yourself and your company, that would be great.

Trent Cotney: Sure. Well, thank you Heidi. This is going to be great. Tell you, it's an honor to be able to sit on this panel with Ken because when it comes to this topic, I really think he's probably one of the most knowledgeable people I've met. So really looking forward to it today. I am a partner at the law firm of Adams and Reese, but I also serve as general counsel for a variety of roofing associations, including NRCA, Western States, FRSA, Chicago, so on and so forth. Over the years I've had a lot of opportunity to not only represent contractors in this area, but I've also had some personal experiences with it. So I'm looking forward to today's conversation. It's been on my radar for a while now, and I think we're going to have a great hour here.

Heidi J. Ellsworth: Yeah, I do too. This is going to be great. I want all of you to be a part of that hour, so the chat is open. I see everyone putting their name and where they're at and their company. That is great. Please share, say hi, tell us what kind of company you have, commercial, residential. And then the chat is open. So whether you want to make comments, ask questions, just join into the conversation, please, we are ready. I'll be reading those as we go through. So we'll be bringing your questions straight to Trent and Ken.

Okay, let's start talking about mergers and acquisitions. This is what we're seeing out there. Ken, starting with you, what... We're going to just go straight to... Because I think everyone wants to hear what happened with you. You have been in the thick with your company, with a merger acquisitions. Can you tell us what you're hearing and your experience, your story?

Ken Kelly: Sure. Let me start with my story and then I'll tell you what I'm seeing. So for me, coming up on the 50-year mark, coming out of a really solid couple years in the roofing business, especially with COVID, we just saw an opportunity to take some chips off the table, pocket some of the equity that we had built up, stay in the game, but yet use other people's money to grow. The typical way that private equity likes to grow is through acquisitions. We can get into specifics, but the idea is to grow an organization as a whole. And then as you reach certain milestones, you get a higher multiple. We could talk about that as well. Therefore, higher selling price. That's why we went into it.

The other piece is liability. As a business owner, gosh, one thing that kept me up at night was what happens if one of our guys, God forbid, fell off the roof or got in a car accident and hurt somebody? Now I'm personally liable, and all of this equity that I've built up for all these years and the family name and everything, it could be gone in a heartbeat. I didn't want that to happen. So what did I do? I said, "You know what? Let's look out there and see what the options are." We looked at ESOPs, we looked at a bunch of different things. The idea of running with private equity just made sense.

Since that journey two and a half years ago, we did do our first acquisition. We bought a company that was almost the same size as us, so we almost doubled overnight. It was a geographic play. It allowed us to be at both ends of the state of Florida. And so now we have statewide coverage and it works really well. It's a great team, great organization, fit well with our culture and it worked out extremely well.

Now, what's driving the market? There's a couple things that are driving it. First of all, if you look at what happened during COVID, there was a lot of money that was taken off the table. They saw that the economic downturn was going to happen, and large investors and private investors took their money and said, "Gosh, what am I going to do with this?" And then when the market was going down, they created these individual wealth funds. The wealth funds have a limited period of time to where they can invest that money. What did they do with it? They couldn't make money in the stock market. They couldn't make money in bonds because the interest rates were on the floor. So they said, "Let's buy companies and let's build them, use our money to build them, create larger companies and then roll them or sell them."

I think that's what's driven this. And now, there is a hyperactivity going on because they're coming up against the deadline. Typically, they have three-year funds or five-year funds, and they're coming up against some of those deadlines to where they have to roll. So it's, "Hey, let's go ahead and get as many of these entities together as we can. Let's get to $100 million of revenue or $10 million in EBITDA. Let's get our higher multiple up and then let's sell it." I think that's what you're seeing in the market right now and why I personally made the decision to do what we did.

Heidi J. Ellsworth: Wow. Trent, you have a similar story also with your company. And also, you are half your finger on the pulse of every single... I mean, you talk to so many contractors every single day about mergers and acquisitions. So can you tell us your story about your company and also what you're seeing in the industry?

Trent Cotney: Sure. My story is I started working at large law firms when I first practiced for about 12 or 13 years, and then I started my own company, Cotney Construction Law, and we were around for 10 years. I got to the end of that 10 years and I recognized that I was spending way too much time doing things that I didn't want to do. Talking with landlords and negotiating equipment leases, things like that isn't what I wanted to do and I wasn't having fun. So I knew that it was time to see what the market would bear and be able to go out there and figure out what next steps were. And had the opportunity to look and had some great discussions with Adams and Reese, and they were just very welcoming. They agreed to take my entire group, which was very important to me. I am nothing without the people that work with me. Any modicum of success I've experienced is because of all those great people that I've been able to meet and work within the trenches day after day after day. So that was really critical to me.

I can tell you that it's been fantastic. I've never once regretted the decision. I loved running a company, I loved building it, I loved expanding it, and we got fairly large and I was very proud of what we were able to accomplish. But I think we're accomplishing even more now because we have so much... I can do what I enjoy doing. The people that work with me, we've got a huge footprint and just been great in that regard.

I'll echo a lot of what Ken has said, mergers and acquisitions, buying and selling companies has been just gangbusters from about '21 on. It's changed a little bit this year. I think part of it is exactly what Ken said. I think there's sort of a frenetic pace to it because of some of these funds. But I'm also seeing, I guess this year, a little bit more consolidation among companies rather than outside PE investment. And I think some of that is the cost of money is rising. It's becoming more difficult to obtain money because of higher interest rates. I don't know if any of our listeners have gone to apply for a mortgage lately, but it's a lot different than it was last year. So I think we're going to continue to see a lot of this type of buying and selling, at least over this year, possibly next year as well. But it's going to continue at a pretty rapid pace I think until we get to a resting point.

Heidi J. Ellsworth: Well, I think that makes it more important than ever that contractors understand what this is all about, and with their roofing companies, because it's happening. I mean, anybody who was at the International Roofing Expo, there was PE, private equity groups, all over the show floor talking to everyone. We just already had a question from Greg Morrow. Thank you, Greg, so much for being on and for your question. He said, "What kind of multiples do roofing contractors trade for?" Ken, can you take that?

Ken Kelly: Yes. I want to qualify it too because you have to understand there are brackets. Not to insult anyone, I'm just going to give you the straight skinny on what they're looking for. I know because I've been leading some of that acquisition hunt, and I'll just tell you that everyone's a little bit different, but here's the things they're looking for. Number one, clean books. Our idea in roofing industry of clean books are much different than their idea. Do you have true audited financials? Are you truly an accrual system, not a cash-based accounting system? That's number one. But they look for three different areas when it comes to the due diligence side of things.

The books or the accounting side is one. Two is liability, all the way down to the building that you own, even if there's oil that's been spilled in the back corner of it, then nobody remembers from five years ago. I mean they're going to do a soil sample on your property property. This is something we wouldn't think about. They're going to look through all of your OSHA violations, if you have any, employee injuries, all of your liability from warranties and guarantees that you put out there. And if you're a company that has long listed guarantees or you've done a number of projects that are either multi-family or track or large commercial, that to them is a little bit of liability and they might not like that. And then of course there's the employee side of things. Have you had any EOC violations or that type of stuff, what do your employee manual and practices look like. That's why getting in touch with an attorney today and starting to clean up your books and clean up your liability is very, very important. Make sure you have all that documentation in place and that you're following that, because that's going to give you a higher multiple.

Before we talk about multiples, we have to make sure that everybody's on the same page. Again, I don't want to insult anyone's intelligence, but this is typically how the companies are rated. It doesn't matter how big your building is or how many trucks you have and how long you've been in business and what your reputation is. Yeah, maybe a little bit reputation. Really, what was your EBITDA in the trailing 12 months? Trailing 12 months, TTM, that's what is so important. That trailing 12 months goes right up until purchase date. So you have to keep into consideration that there is a buying period that goes to this and due diligence is well right up there with a rectal exam. It's not fun. You have to be able to continue running an organization, continue to be profitable because you don't want to get into the due diligence that lasts 90 days or 120 days and all of a sudden you lose sight of your business and you're not as profitable and then you lose out on money in your pocket and that your equity is diluted. You don't want that.

Let's talk about the brackets. This is the meat and potatoes of what everyone wants to know. "How much are you going to give me for my business?" That's typically what I hear when I talk to somebody we're thinking about acquiring. Again, it depends. So let's talk about brackets. If you're a small organization under $10 million of revenue a year and your EBITDA... That's earnings before interest, taxes, amortization and depreciation. If your EBITDA is less than around 8 or so percent, you're probably going to be in the 3X, the three multiple. That means whatever EBITDA you made in the prior 12 months, multiply that by three, that's probably what your business is going to be worth. So if let's say for instance, just for easy round math, you did $330,000 in EBITDA the trailing 12 months, you're probably worth $1 million. They'll give you $1 million, and of course you have to pay capital gains taxes out of that. Now, I'm not a tax guy, but there's going to be some kind of tax implication.

And then we go to bracket number two. That's the micro of microcap, the first bracket. The second bracket is now your organization is probably closer to the $10 to 20 million in revenue range. You've got some systems and processes, you have a leadership team. It's not necessarily the owner that's the head of everything. If the owner stepped aside, business will probably take a hit but would continue to run. And your EBITDA is maybe over that 10% mark. Double-digit profit is really tough in the roofing industry. But if you've managed to run an organization that size and get to that point, you're worth more. So now you're probably talking about a four or a five times multiple, so that's pretty good. If you did $250,000 a year, you're at that 4X range, now you're back to that million mark. I'm starting to paint a picture. It's really about profitability.

And then the last bracket that we're talking about, because I'm assuming there's not a lot of businesses on the call that are worth more than $100 million, is, let's call it the 20 to 50-ish million a year in revenue and you're somewhere between 10 and 15% EBITDA. This is the net profit type thing. You're probably going to be closer to the 6 to 8% multiple.

Now, there's one caveat in all of this. How strong is your leadership team? How good are your processes? And let's talk about runway. What is your business capable of doing? Not what it's doing today, but what is it capable of doing in the next one to three years? If private equity came in and gave you an infusion of cash, gave you some leadership or management help, could you double that organization? Or are you a platform company? Meaning, are your systems and processes so good that they could take your company as a model, acquire smaller companies, put them underneath your umbrella, get them to adopt your systems and processes, and then boom, mushroom into a much larger organization than you would probably earn a little more on the multiple side of things because there's more value there?

Now the holy grail to get from microcap to mid-cap space, is what a lot of these companies are trying to do, is trying to get to the over $10 million in EBITDA or a over a $100 million in revenue annually. They can do that through acquisition. They can do that through greenfielding. Or they can do that through organic growth. When they get to that range, now all of a sudden you get a multiple bump and now you're talking the 12 to 15X range, and that's the holy grail. They can double their money in three to five years by doing this model. So if you fit in there, that's probably where it's going to land.

Heidi J. Ellsworth: Wow. Wow. Okay. Trent, follow up on that, what you're seeing as you're talking. Because that's a lot to bring in and figure out as a contractor. So how are you helping contractors navigate this?

Trent Cotney: Yeah, I mean Ken's spot on as usually. I would say that the majority of the roofing contractors that are out there are going to fall within the three to five. One of the things that we do on the legal side of any acquisition is we always try to obtain a third-party valuation. Just like you would have an expert or a consultant in a defect case, you want someone else to say, "Hey, I've looked at the company. Here's some things to consider, and this is what I value it at."

The one thing I would mention that I'm seeing, and this is happening more and more, is that there's a big difference between how you value a retail roofing contractor versus a storm or insurance-based roofing contractor. What I say about that is I don't know if those same multiples would apply if you're 100% insurance-based. Because a lot of the insurance roofing contractors that I've seen are very few W-2s, primarily sub-labor processes and procedures and customer list and marketing, and that's about it. A lot of times it's the marketing aspect.

So when PE comes in and takes a look at insurance-based only contractors, it is a much different model and a much different viewpoint than how you would do traditional retail. That's something that I think catches a lot of contractors off guard when they're looking at that high top line number and they're going, "Okay, I'm doing 50 million, 100 million a year." But if it's insurance restoration work, when PE goes to look in there, they're looking to see, "Okay, what assets do you have? What workforce do you have? What does your structures look like?"

One of the other things that I would tell you to echo what Ken said is how you would maintain your books for you personally is much different than how you would maintain your books for an outside investor. A great example is you may do certain things in your company to minimize your tax liability. That may not reflect as well for a potential outside investor. So you definitely want to understand how to put yourself in the best position along those lines, making sure that you have your downstream arrangements taken care of. You have solid subcontract agreements. You have a solid understanding of how you interact with your workforce. I've seen investors do deep, deep digging when it comes to labor and how it's sourced and what is W-2 and what is 1099. So they really get into the weeds there. Yeah, it's definitely something that, I think, as we continue to go through 2023, you can expect even more of that type of due diligence.

Heidi J. Ellsworth: You just answered this, but I want to... We had a question come from Anuse, Anesu. I hope I said that. How do multiples change when a good majority of revenue is insurance storm? Because that's what you're saying. It all goes back to the assets involved compared... It changes a lot, right?

Trent Cotney: Yeah, absolutely. I'll try not to give you a lawyer answer, but it depends. Oftentimes that's why I think getting a third-party evaluation is good. One of the things that you want to do is let's say you are a 100% insurance storm-based and you want to go on the market, I would work on doing a lot of cleanup before you get to that point. Because again, even if you're doing $100 million but you have only sales employees and the 1099 the rest of your workforce, it's not as attractive sometimes as to retail. I will tell you what I'm seeing right now, Heidi, is I'm seeing a significant amount of consolidation where roofing contractors are buying roofing contractors. One of the key things that we're looking for is looking for labor. And part of that attraction is if you've got a stable W-2 workforce, that's something that attracts a lot of people, and then it also minimizes potential liability and risk. So a lot of different factors there. But yeah, I think overall insurance, I wouldn't say as a whole, because it depends on how it's structured and a lot of it depends on how many employees you have versus 1099s, but it can definitely vary as opposed to a traditional retail model.

Heidi J. Ellsworth: Yeah. I don't want to miss this question going back. Greg asked, "Is PE looking for a minimum of 51%, or what percentage?" Ken you said that was a good question, so can you address that?

Ken Kelly: Great question. First of all, they're typically not looking for property. So if you own the building, they will probably not purchase that from you. They'll probably say, "Why don't you retain holdings of that? Let's go ahead and sign an agreement, long-term lease or three-year lease or something along those lines." They just want to be able to flip the buildings and flip the business quickly. They don't want to have to worry about real estate valuations and everything to hold up the sale. That's just a side note to think about.

But on the ownership, they're going to typically want control of the business, so at least 50%. But depending on the PE firm, a lot of them like to see the leadership team or at least the owner stay on at least for their transition period, and roll ownership or roll equity, remain a member of the entity. Here is really how it goes down. Let us know now if you're staying or not. Like don't BS us. Seriously, are you going to stay on? Because if so, we'll continue to build the brand around you. Otherwise, we'll go ahead and bring in a management guru to replace you and we'll start that day one, do a 90-day transition and enjoy your retirement. They want to know that upfront. The way that they do that is by seeing how much you are willing to roll in your equity into the new entity. 25% is typically a good amount. That's enough of an investment to where they feel comfortable that the owner is truly going to remain and truly going to do what they need to do to continue to succeed from a company standpoint.

This is going to be tough for people. They don't want you to continue to live with the lifestyle that you were living. You're not going to be able to go golfing on every Thursday because you have a men's group and that's what you do. No, PE wants you at the office. They want you working every single day, so you're going to have to be okay with that. But that 25% is the way that they see is this owner serious about continuing in or not.

Heidi J. Ellsworth: Okay. Go ahead, Ken.

Trent Cotney: Heidi, I would... God, there's a lot. There's so much I want to talk about. Ken's absolutely right when it comes to PE, but we have also, on the representation side, assisted with angel investment, which is different. It's a smaller percentage. It's usually a silent investor. They're not looking for any type of ownership. Smaller transaction. One of the things that I would caution anybody that's looking to sell their business is you've got to check your ego. I'm speaking from my own knowledge. I invented all kinds of amazing software and marketing capability and everything, and I just thought it was the coolest thing ever, but it meant absolutely nothing when you take it out there. That's the kind of thing is what a private equity investor thinks is important, you may not think is important and vice versa. So you have to understand that most number crunchers are looking for. They're looking to tick certain boxes. And if you got that, you get to the next stage. This is different. That type of investment is much different than one roofing contractor buying another roofing contractor, because usually they know each other, they know what they're capable of, there's some relationship there. It's a little bit of a different transaction. So just something to think about.

Heidi J. Ellsworth: Going back to that, checking your ego, I think we talked about this ahead of time, but this is not the easiest. Selling your business, there's a lot that you have to go through that is not, I'm just going to say it again, that is not easy. So Ken, maybe talk a little bit about that, what contractors should expect with their life changing.

Ken Kelly: Only 15% of entrepreneurs typically make the transition into the PE world. You have to be okay having a boss. You're going to have to be okay with not making decisions anymore. And if you really want to be successful, you're going to have to learn how to quantify the decisions you do want to make and present them in a way that the board is going to accept. I mean, it's almost like you have to be a good presenter. And know your numbers, your company, the market. Be a good predictor of the future. Because that's what's going to give you the ability to take your ideas and continue to execute on them. Otherwise, a lot of it boils down to what's the number? Your number is your scorecard. Who was it? Was it Bill Parcells who says, "We are the team that our score reflects."?

That's tough for people who've made the decisions, who built this business, who have a lot of passion. And then all of a sudden they're like, "Oh yeah, we have to win this job." And the guy's like, "Nope, the margin's not good enough. Don't even bid it." You're like, "Wait, what? You don't understand. That property manager has 150 properties under management. We've been trying to get them for 10 years." "Nope, this job doesn't make money. We're not going to do it." Okay. You have to be okay with that. You have to just [inaudible 00:27:32] ego and shake it off and get up the next morning and say, "You know what? All right. Let's find the next opportunity."

Heidi J. Ellsworth: I've seen that so much, so many times. But when you think about it, and I had my own adventures with private equity too, it is all numbers. I think that's one of the things. And just a side note, but for those out there who have incorporated systems like EOS or different things where you are looking at your numbers all the time, it does help that transition a tad, because I didn't used to think that way at all. I wanted to make sure I didn't miss this from Lynn. And maybe, Trent, you could take this. But they wanted to discuss the benefit risk of stock versus asset sell. You talked about that a little bit, Ken. Let's address that first, Trent and Ken, on that.

Trent Cotney: Yeah. look, Adams and Reese is a huge M&A practice, tax practice all over our footprint. I would say as a whole, most of them are usually some type of asset purchase, because you don't want to necessarily buy the liability of an existing company. Now that's not always the case. Sometimes you are looking to maintain an existing footprint. So you may buy a company, and the only thing you're doing is really changing the ownership aspect of it. But one of the things that you want to figure out is you want to look at that liability and you want to see what is the potential risk there.

One of the things that contractors don't recognize is the ongoing liability that probably should be booked as it relates to warranties and warranty work. That's something that you have to constantly figure out. How does this transfer? What does this look like? So there's a lot of different issues there.

Generally for someone that is looking to purchase an asset, purchase agreement tends to be an easier, cleaner way to do it to, where there's less risk involved. If you want an entire purchase, more than likely there may be some money changing hands there to absorb it depending on what's going on. But yeah, I would say as a whole we probably see more APAs done than buying the entire thing. That's not always the case, but I would say that tends to be traditional.

Heidi J. Ellsworth: Ken, you're nodding?

Ken Kelly: Yeah. We don't necessarily want to take on everyone else's risk, so we mostly do asset purchases too.

Heidi J. Ellsworth: Yeah, thanks. Really interesting question. Going back to what we were talking about with insurance. But then as we well know, there's huge companies out there who are doing full exteriors. And so, one of the follow-up question was, "How does having exposure to these adjacent markets affect multiples, as in windows, siding, gutters, when you can offer all of those things or are offering?" Ken?

Ken Kelly: Yeah, I'll take that one. That depends on the PE firm. I've seen some PE firms that want a core competency because they have a plan, they're going to roll you into another entity. So if you're the roofer and they already have HVAC and plumbing and windows and doors and you're really, really good at roofing, that fits perfect into being able to offer a full exterior or full home improvement type offering. They're going to try to corner a geographic area that works perfectly for them.

There are other PPE firms that say, "What happens if it doesn't rain for 12 straight months and roofing all of a sudden isn't a viable revenue generator. What other products and offerings do you have competency in?" For instance, I saw a question in the chat, "What about commercial versus residential?" I know that when our PE firm approached us, although we weren't 50/50 commercial and residential, we had about 30% commercial, and they like that. Because typically when the residential market goes down, the commercial market hangs on for a little bit longer when you go into downturns, and then the residential bounces back. So you have more consistency in numbers. And the fact that we did maintenance repair and gutters and insulation and skylights and all of these things, that helped us. I think it'll probably help more than it'll hurt, but it depends on what the PE firm that you ultimately settle on is looking for.

Heidi J. Ellsworth: Yeah. Interesting. Going back to what we were talking about before too with the ownership and buy-in and management team, there was a question here, "Can your management team buy in as well? And what are you seeing on that front?" Trent or Ken, go ahead.

Ken Kelly: Just real quick. In our case, I had started gifting shares of the old CO to my two top people. So they were already owners and yes, they maintained ownership into the next entity when we rolled.

Trent Cotney: Yeah, I'd agree with that. Generally, any anybody that has an ownership interest has to be... Probably dealt with isn't the correct term, but that has to be reflected in whatever the agreement is. So if you want certain high ranking members of your management team or your sales team or whatever to make sure that they're on board, think about that before the transition occurs and you might want to relinquish a little bit of ownership, interest in order to make sure that they're covered.

Heidi J. Ellsworth: The questions are just rolling in. Thank you so much. This is great. I'm just going to keep going, but we're going to save some time too because we want to also be sure we get to some tips and tricks for you all at the end. But from Patrick, he said, "Do you recommend bringing 1099 subcontracted crews in-house to boost value. Even though they are 1099, 100% of their work is for us and have solid sub agreements, is it still better to have them, the Labor SW-2?"

Trent Cotney: Let me tackle this one. This is probably a different seminar. Sub-labor dominates the industry, and last stat I saw was roughly 85% of residential and it's creeping up over 55% of commercial now. Managing subcontractors, there's a lot of risk and a lot of potential liability. One of the biggest issues that we're dealing with now is what's known as misclassification, where you've got sub-crews that only work for you, they don't work for anybody else. They don't market, they don't advertise. They wear your gear. Guess what? They're really your employees, you're just not paying them correctly. You're not maintaining I-9s on them, you're not doing the kind of things that need to be done if they were designated correctly. That is a much, much bigger issue. I recognize the reality of roofing and the reality of construction and the use of sub-labor. I think it has increased because there is so little skilled labor available.

I think normally what we have seen is that one of the early questions, especially if it's another roofing company looking to buy a roofing company, is they want to know how much of your crew is W-2, how long have they been there, the stability of that. If you have 1099 relationships, they are looking deep within the documentation. They're looking within not just subcontracts, but your SOPs, your subcontractor checklist, what do you do internally to verify to handle QC, quality control, insurance, all those types of things. And they dig pretty deep. So I would say what would be most attractive would be a W-2 workforce that is highly skilled and has been with your company for some time. If you are a roofing contractor looking to buy another roofing contractor, that's probably something that would be more valuable.

Heidi J. Ellsworth: Yeah. Ken, any thoughts on that?

Ken Kelly: No. I defer to Trent. He told me years ago when we first started working together, "Make sure everyone is W-2." I've listened to him and it's kept us out of trouble. We've been through some audits, so yeah, I strongly agree with that.

Heidi J. Ellsworth: Yeah, that's good. Greg, I'm going to come back. You have a couple really great questions. I'm going to hit this one first from Bill Collins. Bill, thank you so much for being on. He said, "Should you set up a bidding war between PE firms?" Ken, thoughts?

Ken Kelly: Oh, we did. That starts with the broker, which is another question that's in there. We hired a broker, created a sim. The sim goes out, advertised just like you're selling a piece of property almost. There's like a listserv that puts all the businesses for sale. That gets the bidding wars going. We had 47 letters of interest. We had 12 letters of intent, which is an offer, where they lay out how much and the payment terms and all that kind of stuff. We narrowed the 12 down to three, the three down to two, the two down to one. And in the end, we did not pick the one that was offering the most amount of money. I'm going to save that tip for the end. That's a good one.

Heidi J. Ellsworth: Trent, any thoughts on those PE or setting it up that way, and working with a broker too? I think that's a really great question. And how to structure that.

Trent Cotney: Yeah, absolutely. I think it gives you the opportunity to potentially get not only more bids, but to get the bid values up. It's just like if it were an auction, you always want two bidders. Selecting the right broker, making sure that you've got someone that's knowledgeable is important, and also making sure that the bids that come in are well vetted. Over the years, I've seen a lot of what sounds great in an email that never becomes an LOI, a letter of intent. Or I've seen garbage LOIs that come through and you're like, "Okay, these guys are clowns." It's just like everything. You want to make sure that you're working with the right people.

Heidi J. Ellsworth: Okay. So as a roofing company owner... This is a question from Greg that I wanted to come back to and I think this is really important, Ken, because there's a lot of owners out there right now and they're thinking... We've already talked about the fact that you got to check your ego, that your world is going to change a little bit. But to stay on after the PE sale, how are salaries determined? How do you negotiate that? And then, does the require a board to be formed? I know you were just talking about your board.

Ken Kelly: Most PEs will form a board. That's a protection clause against a single person. Most PEs are representing a number of people. It's not just one owner. And there are angel investors out there and they want to invest and they want to be more intimate, but most PE, private equity set up funds because it's a way to spread liability. They'll invest in multiple different companies in multiple industries. It's just investing in your stock market. You're not going to put all of your money on red. So that's the way they do it in those entities as they form them. A board is required. So yes, they'll have a board.

How is salary determined? It's basically how much they would have to pay somebody to come in and do what you do. It's negotiable. You have intimacy with your market and you know people and you have loyalty. So you could give yourself a decent, a fair salary and then you can also negotiate weeks of vacation and if there's a severance, like anything was happening, whether I was to be terminated or whether I was to leave on my own accord, a severance payment, something along those lines. There's almost always a non-compete tied to it and usually a non-disclosure as well. They don't want you taking customer list and waiting out your two years and then taking that list that's firing up something else. Trent could probably talk more about the details on that, but salary is really what it would cost them to go find somebody and then get them trained into your position and run it.

Trent Cotney: I would say a few things there. We were all talking about this in one of our practice sessions. Owners make horrible employees. The reason I joke around with that is that when you own a business and you are suddenly taking orders from someone else, it's difficult to sit on the sidelines. Because, just like Ken said previously, you're seeing things that you want to change, that you want to do. "Why can't we do this?" It takes a while to work that out and figure out what the new role is and understand where you need to be. There's always a key person or three within a company that really drives us. Sometimes a company is led by someone that is so strong in the industry, somebody like Ken that is almost a cult of personality type that surrounds that person with the other employees. And it's very important that that person be taken care of. Because as the transition occurs, you want to structure the salary, you want to structure the benefits, you want to structure all that so that that person remains in check, remains motivated. That's from the perspective of the private equity investor. If you are that person, what do you want to do?

Okay. First thing is recognize that it's a marathon, not a sprint. The first few months are always challenging. There could be blips, there could be things like that that come up. But maintain your relationships within your company. Maintain the people that worked with you, the people that assist you. The ownership has changed, but your ethos and your culture should not, to the extent that you can continue to operate like that within the new structure. Culture and work relationships are absolutely key. It's absolutely key. It's like I said at the onset. I wanted to go to a place that honored my culture, the culture that I had in my company, and would allow us to develop and morph into even a new culture. That was what was most critical for me. If you are that key person, then you need to understand and make sure that you're not checked out, unless that's by design. If you're being bought out and you're heading to Mexico, then that's great. But if you're still working in the company, stay invested. Keep those ties in there. Keep those roots deep.

Heidi J. Ellsworth: Yeah. Wow. Okay. Just real quick and then I want to hit some of the things. We had two questions on this. What do you typically see for a broker's commission? Is it a sliding scale normally? What fee structures? We had two of those questions. Ken?

Ken Kelly: The bigger the deal, the lower the rate is going to be, the lower the commission. It's like selling a house. If it's a jumbo million dollar property, you're probably looking at 3%. If it's a $50 million sale, it's probably about 5%. And if it's a smaller deal, a million, 3 million, somewhere in that range, it's probably going to be an 8% broker fee.

One thing I want to say about brokers is not only do they bring more people to the table, they create the bidding war, they drive up values. Don't get me wrong. That's absolutely a big part of what you do. For me, the unspoken part that I didn't think about, was never mentioned to me but I was glad that I had a broker looking back, is when you go through due diligence and you're... I mean you're just being pawed at left and right, and you're getting frustrated. My broker and his team ended up being a part-time psychologist to keep me focused and keep everyone calm. And they took a lot of those questions off of me. "Ken, can you share your OneDrive so that we can see these files and documents and get them to them?" I'm like, "Yes. Oh my gosh, please take this off me." So yeah, it worked out really well.

Heidi J. Ellsworth: It's worth it. The role that once it's sold... And so people get a taste of what is going to happen, usually what role does the private equity team, board, group play in the business going forward? Ken, maybe you can address that. What should people expect?

Ken Kelly: Yeah, that's a great question. First of all, we've talked about having a boss. What does that mean? They're almost always going to take over the financial end because they're responsible to their group of investors. In our PE firm, including myself and my two partners, there's 43 total investors. There's a lot of money that people have put into this and they want to make sure it's protected. So they're going to bring in either controller or a CFO. I'm sorry, they're not going to trust your guy or gal.

On top of that, if there's any nepotism within the organization, they're probably going to root that out. So when a small organization, you hire your cousin and then they hire their best friend and your sister does this, that's not always good. Because there's opportunities for fraud and that kind of stuff. So they're going to either set up clear lines of separation to where those people no longer report to you or family units don't congregate, or they're going to release them and bring in somebody else, especially if it's in the money side of the business. You think you're going to be able to go to the guest or go take out a client and use your credit card and just swipe it and expect the business to pay for it, it may or may not be the case. You might have to do a requisition request and a reimbursement and prove the value and all that kind of stuff. That's the level at which you're going to, at the least, expect.

And at the most, you could have a chairman who just wants to put their fingers into everything. They'll run around you. They'll go to people all the way down the chain of command because they want to make sure that everything is firing to the best of its ability. They want to make sure that you are giving good information at the board meetings and in the slide decks. They want to make sure that there's no other ways to either shave cost or improve profitability or increase revenue and so forth. Because at the end of the day, for every $1 a profit, it could be 5, 10, even $15 to the bottom line on the next sale. So don't blame them for doing that. They're doing their job and there's a lot that we can learn as passionate entrepreneurs from focusing on profitability of the organization.

Heidi J. Ellsworth: Yeah. Wow. I'm just going to go because this question goes right with what you're talking about. What are some of the best practices that you have seen with change management? It just moved on me while I was reading that. With change management, implementation of new processes and the transition of ownership, how do you maximize synergies between entities? Emmett, thank you for that question. Ken or Trent, go.

Trent Cotney: Yeah, yeah. Let me. Ken will probably have a lot more to say in this, but I think a lot of times what I see is I see a culling. They'll come in and they'll clean house a little bit. It won't happen within the first few months, but you're going to see some changes. One of the things I really suggest is you try to work in advance to figure out what that change looks like so that you're not caught off guard. Because I see this a lot, especially with generational roofing contractors, A lot of family ties, a lot of, "This is how we've always done things." Historically, that's never been a great argument. So you've got to figure out that it's a necessity, it's going to happen. How can I protect certain people and let other people go?

As far as the question itself, technology is a big thing. Being able to communicate and understand technology is incredibly important. If you've got a PE company that is not interested in your sales software, your estimating software, your operational software, whatever it is that you're using, and wants to flip that over, that can be absolutely detrimental. Heidi, I've seen PE come into roofing contractors that decided to stir the pot too much, and I could probably list five or six that are out of business now. So you want to ask these questions in advance. It's not just about a big payout. It's about, is the company going to survive? What do they want to do? How in depth do they want to get? Will there be enough synergy there to make sure that what I've got in place is going to work? Software failure is probably the most frustrating and biggest thing that I've seen in a lot of these recent PE failures.

Heidi J. Ellsworth: Wow. Ken.

Ken Kelly: Yeah. The first chairman that we had sold his last business for 1.6 billion. If you think about that, it was drinking from the fire hose, learning all of his isms and all of the little tricks to business. Just absolutely loved working with him. But he was a little more hands off, so I worked hard on communicating these are the issues, here's what we need your help with, and all that kind of stuff. The new chairman is a lot more hands-on, and he goes and he digs for this type of stuff. What I realized is if I do a better job communicating the issues that we're faced with and bring them in and say, "Hey, I need your help with this. Is there any way... Right now our biggest issue... Is there any way that you can get our suppliers to deliver exactly what we put on a purchase order for the price that they said that they would deliver it?" I mean just something so simple. And he is like, "Yeah," and he brings the hammer. Oh my gosh. How do you make these huge distributors squirm? You bring in the hammer.

And so if you channel that, it could be a very positive, positive relationship. He saw an email about an inventory issue and I was like, "Oh, that's a distraction. That's not a problem. Don't even worry about that." He'd stop digging. It's like a scab. He just kept picking and picking and picking. And the next thing is it led to a $286,000 write down, and he was right. We had lost inventory and we had misallocated and mispriced inventory and it was a write-down. And so, don't think that they're there just to screw over the organization. They don't want it to fail. They want want it to succeed. Communication is going to be that one piece that's going to keep everyone sane, be on the same page. With that being said, you had mentioned EOS earlier, I think [inaudible 00:50:39] we're an EOS company, it changed slightly because the leadership team no longer can make all the decisions. But once we brought in our chair to our quarterlies and our annuals and some of the L10s... He doesn't sit in on all the L10s, but on some of them. All of a sudden they become that partner working together on these things because they see the true issues and they can help us.

Heidi J. Ellsworth: Yeah, that's it. I want to make sure we get to this. Ken, we would love to have you share your experience, some tips, some advice to everyone out there. As you go into that, I want you... One question in here that I think... I just want to make sure, and you probably will address it in this. Ken said, "If you were to sell, how do you keep it quiet that your company is at for sale?" My question would be, do you? And how do you keep the employees that you have from jumping ship as soon as they find out? Maybe answer that and then move on to that overall big picture.

Ken Kelly: I've seen it both ways, and I'm not saying that my way was the right way. The other way was not good. Okay. Trent might have a different idea. Two and a half years before we were going to sell, we told the team what we were doing. We brought everyone in on it and we worked hard together to clean up the organization to get it ready. I mean everything from interviewing potential PE firms, to post-purchase, everyone was involved. It made the transition seamless. It made it exciting. It made it, "Oh, cool. Okay, now we can run because we have backing. We don't have to be so cautious in some of the decisions that we were making."

On the other side, I've seen it where it was kept close to the vest, nobody knew anything. And when the hammer was dropped, there was some very upset people, like family members who worked for the organization who had no idea and felt absolutely betrayed. "We are building this together. How could you possibly do something like this with that?" I mean, we're talking siblings that do not speak and may not ever speak again because of that. the two ways to go about it, I would much rather see you communicate with the organization.

Here's one big reason why as well. I was very impressed at how people stood up. There are people who... I don't want to make light of this because everyone in the organization's important. But we had a customer service employee who I saw as a customer service employee. When we started talking about this and we said, "Okay, here's some of the things we need to clean up. Here's some of our challenges," she was like, "I'll do it." And I was like, "Yeah, but you don't really understand the whole business." "I'll learn it. Don't worry about it. I got that one." She rewrote parts of our employee manual, parts of our SOPs. We call it the Kelly Roofing Way. She started filming these videos on how to use our software. I mean, I was shocked at how much she put together and took off our plate. And now today, she's team leader. She has, in my opinion, the best running division in the whole company. Just an all-star. I feel like such a jerk for not seeing the potential in the employee. By bringing this up, it gave her the opportunity to say, "Hey, I could be a leader someday." Oh, she is.

Heidi J. Ellsworth: That's so cool. That's so cool. Tips. We're getting to the end of the thing. Share your wisdom.

Ken Kelly: Okay. I got a little list going over here. Clean your books. Think about this. For every 1 million in proceeds, it's conservatively about $50,000 a year for life, after tax. So all of a sudden, this starts meaning anything, right? Retirement's more about what you're capable of living on and not much necessarily how much you have, but that's an interesting way to think about things. Get with your attorney early, clean up all your liabilities. Profit is key. Don't forget about the trailing 12 months, the EBITDA. For every $1 you save could maybe get you $5 in a sale. So do you really need to go golfing or can you stay and maybe cut some cost or whatever? It's up to you how much money do you want to put in your pocket after the end.

How you are paid is just as important as what you are paid. Think about this. This is something that I haven't seen asked in the chat yet, so I'm really curious how many people like the answer here and like knowing this, because this was one of the things I didn't think about until my broker brought it to me. And wow, what a difference. We did not pick the largest offer because the offer was a phased payment. I wanted all the money up front, and I didn't know there was any other way of doing it. Well, a lot of people will do is they'll say, "Okay, if you hit certain milestones, certain stage gates, we'll give you the rest of the money as part of the lump sum."

So let's say, for instance, they're going to give you a $5 million and they're going to give you 1 million upfront. "And if you keep the same EBITDA 12 months from now, then we'll give you the next one." Listen, EBITDA... I don't trust any prospectus that comes out on the quarterly earnings from any publicly traded company anymore because they can reserve and allocate and do all kinds of accruals on all kinds of stuff to make the numbers look any way they want. And if you no longer have control of the books, well all of a sudden, "Oh, sorry, you didn't hit it," even though you know did. I don't want to play those games. I want to keep the relationship solid. Just give me my money. I'll do what I want with it. Boom.

Now, with that being said, earn-outs could be a great opportunity to make more if they're structured right. Settle on your price and then say, "Okay. Now if we do better than what we're doing now 12 months from now or three months from now, or whatever your timeframe is, could you give us a kicker on top of that? Could you boost the multiple? Could you do $500,000 lump sum?" whatever it is, and then be very specific on what those parameters are. So how you're paid is just as important as how much you're being paid. That's just my philosophy, but I think it's a good one.

We talked about the brokers. Don't accept the first offer. Really go out there, interview them all, as many people as you could possibly get interested in your organization. Interview them all. It's like entering a relationship. You want to take them for a test drive. You don't want to just buy a car online without driving it first, that kind of thing. And then, be patient. Due diligence is a horrible experience. I'm a very organized person. We have this real big computer system. I won the Microsoft Award in 2015 as a visionary. I thought I had all of this stuff organized, but gosh, they're going to ask you questions and they're going to dig and dig and dig, and you just... Why is that important? It is. So just be patient, lean on your broker. You'll get through it. Those are my tips.

Heidi J. Ellsworth: I love it.

Trent Cotney: Heidi, I know we got two minutes, so I'll narrow it down to three. Okay?

Heidi J. Ellsworth: Yes.

Trent Cotney: The first is figure out what it is that you want and work backwards from it. What I mean by that is make sure that you have an exit strategy and that you're giving yourself enough time to accomplish what that exit strategy is. It takes time. It takes time. This is not something that usually happens overnight. There are months and months and months of searching and due diligence, and it could take six months a year, even more than that. So often start at least a couple of years in advance of what you're doing.

The second word of advice, and this is probably the most important, is you must evaluate your taxes, your tax liability. Ken mentioned this a little bit with how you structure your payments. This could be hundreds of thousands of dollars on unwanted tax. So part of that is making sure that you have effectively figured out how to be paid to minimize the potential tax risk to you, not only during the immediate acquisition, but then afterwards.

The third thing that I would mention, and Ken touched on this a little bit with regard to employees, keeping and maintaining employees are absolutely critical, not only for the future success of the company, but because you like them. Right? I encourage you to broker deals with them in advance and work with PE to lock down those employees and incentivize them to stay on. So that when an announcement is made, then it's not as big a shock because you have something to say, "Yes, this is happening, but this is also happening to you. So here's the good thing." That's probably the other thing that I'll mention is critical. I'll stop with that.

Heidi J. Ellsworth: Wow. Well, I just want to say there is so much here and there are so many questions on there. Adams and Reese, get with Trent. These are questions that you can reach out to them. You can find them on the directory, RoofersCoffeeShop. You can find Adams and Reese really easy. We will get you both to Trent or Ken to answer some of these questions. Gentlemen, thank you. What a great day. What great conversation. I can't tell you how much I appreciate you sharing all of your wisdom.

Trent Cotney: Thank you.

Heidi J. Ellsworth: Thank you. Thank you Adams and Reese for being the sponsor of this, and Trent for everything you do for the industry. You keep us on a straight line, RoofersCoffeeShop included, so thank you so much.

Trent Cotney: Right back at you.

Heidi J. Ellsworth: I also want to invite everyone to join us in two weeks for thought leadership, visionaries on diversity, environment, technology. Really a deep dive that happened last summer in Chicago that you just don't want to miss, and we have a panel that you just can't believe. Join us for that, sponsored by Java in two weeks. We will see you on the next Coffee Conversation. Thank you for your chats. We will get back to everyone. Thank you all and have a great day.

Ken Kelly: Thank you.



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