Reoccurring Revenue vs. Recurring Revenue

Transcript

John Warrillow:

Hey there, it’s John Warrillow. Listen, if you’re brand new to Built to Sell Radio, welcome, it’s good to have you along for the ride. We’ve been doing this show now for five years, I’ve interviewed literally a different entrepreneur every week for the past five years, and I’ve taken some of their best practices, their tips and tricks and negotiation hacks, and distilled them all into a field guide. It’s a book called The Art of Selling Your Business, and it is a little bit of a recipe card for you to punch above your weight when it comes to negotiating with an acquirer, you can get it at builttosell.com/selling.

John Warrillow:

My next guest, Mike Malatesta built a waste management company up. He started off driving a truck, which makes his sale for $51.5 million, that much more incredible. He talks a lot about the experience of building to sell his company, and in particular, I want you to listen for the mistake he made in negotiating the sale of his business. A mistake that he estimates costed him around $4 million. We also talk about the difference between recurring and re-occurring revenue. The former made a big difference to the value of his company. Here to tell you the entire story is Mike Malatesta. Mike Malatesta, welcome to Built to Sell Radio.

Mike Malatesta:

Hey John, it’s a pleasure to be here. Thanks for having me on.

John Warrillow:

Yeah. So you started AWS. Now, AWS is what people hear that they’re going to think, “Amazon Web Services?” Mike started AWS, but it’s a different AWS. Tell me what you guys did.

Mike Malatesta:

It is a different AWS unfortunately. There’s a trademark lesson there, somewhere because I think we were first. So AWS is short for Advanced Waste Services, and Advanced Waste Services is a company that I co-founded in 1992. We started as a trucking company, trucking wastewater from manufacturer’s plants to water treatment plants, and then, over the years, John, we started treating wastewater ourselves and then we started processing waste from all kinds of different wastes from manufacturing operations. Then we grew into five states and we added all kinds of tangential value add services to the trucking. Yeah, and then we ultimately ended up as a $45 million or so revenue company.

John Warrillow:

Amazing. So if I’ve got a manufacturing facility and I’ve got dirty waste that I can’t just toss in the garbage, I hire you guys to come get rid of it for me?

Mike Malatesta:

Yeah. That’s actually a good way to put it because we handle pretty much everything that you couldn’t put in the garbage. The trash, not our thing, everything else, our thing.

John Warrillow:

Got it. It sounds like a capital intensive business. How did you finance it?

Mike Malatesta:

Well, at the beginning we financed it with 401k, loans from our parents, the little bit of money that we had, and we also were fortunate enough to get a bank loan, largely because we did have capital, we were buying trucks and equipment that if the thing failed, they could turn around and easily sell. So that’s how we got it off the ground initially, was just a 100, 000 or so inequity from me and my partners, and then 250 or 200 from a bank.

John Warrillow:

How did you guys split up the equity with the partners? Was it just a 50,50 deal down the middle or did you base it on how much cash you put into it? How did you structure that?

Mike Malatesta:

So, initially it was the amount of capital that we put in, so it was straight sort of thing. I’m not sure that was the best move or not, but that’s how we did it. Over time, we had a few structural changes in our partnership that we can go into or not go into. So, the relative percentages changed over time, but we basically went from the money that you put in and then when I last bought out my partners, we were equal partners.

John Warrillow:

Got it, got it, got it. That’s helpful. So, you built this business up, you started in ’92, is that right?

Mike Malatesta:

Yes. November.

John Warrillow:

And then you sold in 2015?

Mike Malatesta:

That’s right. Yeah.

John Warrillow:

And you were 45 million when you sold, what was the top line?

Mike Malatesta:

Yeah, around 45.

John Warrillow:

And how many employees?

Mike Malatesta:

150.

John Warrillow:

Man, that sounds like a lot of people to manage.

Mike Malatesta:

It gets easier as you get bigger.

John Warrillow:

Oh yeah. In what way?

Mike Malatesta:

Well, lots of ways. Well, if you want it to get easier, it gets easier, I should say that. So, it gets easier as you get bigger because you have a lot more people that are worrying about things that you, as a founder or CEO, would normally be worrying about at a smaller level. You also have people that are creative and bring great ideas that you never thought of, and those help improve the business, they improve the process of the business, which is a huge thing.

John Warrillow:

How did you evolve as a leader? ’92 to 2015, it’s a long stretch. Started the business from scratch to 150 employees. I’d imagine you evolved a lot. What was the evolution of Mike as a boss?

Mike Malatesta:

Yeah, slow. So I feel like I had some natural leadership tendencies, but like a lot of people that have natural leadership tendencies, they also have control tendencies, and I had control tendencies, not overtly like do it my way, but non overtly. So it was like, you create a system … I created a system where ultimately everything came up to me because I wanted to make sure that the decision we make is the right decision. That got me so far, really got me to about 10 years through about the first 10 years, John, and then-

John Warrillow:

Give me top line revenue in 10 years, how did that form of management get you to? What did that look like?

Mike Malatesta:

Yeah, 10.

John Warrillow:

10 million?

Mike Malatesta:

Yeah. So at that point, I had basically created a monster that I didn’t like. I call it being … like hitting a wall and dropping into a valley of uncertainty. So here I was, 10 years along, having employed this leadership strategy that seemed to work, but it was no longer making me happy, and if I’m not happy, the business probably isn’t doing as well as it could be doing. So, it took a little bit of a journey for me after that to, one, to understand why I had created where I was, I was blaming it in my mind on other things and other people, but it was really about me. I mean, it all happened because I asked it to happen that way.

Mike Malatesta:

So, getting clear about that and then figuring out what are the resources that I need to avail myself to, because I had been a very insular person too, John. I mean, it was a 100% on the business, in the business every day. I was one of those people who are like, “Oh, I don’t have time to go to that.” I mean, I felt like people who were out at networking events and stuff were just lazy, not that they just weren’t focused enough on their business. It was crazy. Yeah. Then I took a little bit of a journey and then I started to … first of all, I started to really think about what I wanted and then I had to find help. I had to go outside for the first time in a long time and ask for help, find help and learn from other people.

John Warrillow:

And where did you go next? Where did you find that help?

Mike Malatesta:

Well, the first thing I did was I joined a round table group at the city’s chamber of commerce, which was very helpful. It’s like a forum, I know we’ll talk about EO and some other things, but it’s like a forum but not, it’s very loose. But it was my first thing and I was around people from different industries, CEOs or presidents or entrepreneurs, whatever. So that was the first thing, and that got me started, at least I took the first step, and then I realized that there were limitations to this. This was not going to get me where I wanted to be.

Mike Malatesta:

The next thing I did was I joined a strategic coach, and a strategic coach is a wonderful, wonderful program for entrepreneurs that I think saved my entrepreneurial life really. Taught me so many things, exposed me to so many ideas, gave me the confidence that what I was feeling it wasn’t a sentence, it was just a phase, and if I wanted to get past the phase, I could do it. So strategic coach taught me a lot about how to do that. Then I joined, it’s called Vistage now in Wisconsin, at the time it was called TEC. Vistage is another wonderful program for business leaders that really teaches you strategic and tactical things about business that most of which I had not ever been exposed to. Then finally I joined YPO.

John Warrillow:

Young Presidents’ Organization? So you’ve got lots of outside input from other entrepreneurs? It sounds like.

Mike Malatesta:

Right, right. Because every time I took one step, I realized that there was something about that step that wasn’t getting me all the way to where I wanted to be. So, everything that I layered in on top of that was to fill what I perceived to be a need that I wasn’t having filled from the others, but I didn’t stop wanting to start the other, I did them together because they were all benefiting me in some significant way I thought.

John Warrillow:

You mentioned the conversation around partners, is funny, partners has been on my mind lately. I just did an interview with a guy named Greg Alexander who built a company, and it is in the consulting space. In his mind, this consulting company has traded around 1, 1.2 times revenue. So, in the early days was just him, and he hired a couple of employees. In part to make them feel like they were his partners and like he had friends along the way, he gave equity to these people. It was very early in the process, and again, he thought his business was trading at one times revenue and …

John Warrillow:

Long story short, he builds the company with 30 million in revenue when he gets an offer of $162 million for a $30 million company, and he realizes he has made an $80 million mistake, because he has given two employees who were great employees, but not 80 million-dollar employees, a huge chunk of the company. You alluded to the idea of your partners and how that ownership chain structured. What’s the story there?

Mike Malatesta:

Well, so the first structure change we had was, one of my partners was working for another company in the trash business. They essentially made it … he had an important position there, they made a divestiture and he, for some reason, did a very kind thing, and he took a part of the divestiture and he basically made it an asset of our company. So, at that time, in exchange for that, we all got basically more than what we had put into the company in the beginning, so it was really a recapitalization, and it leveled out our playing field from a percentage basis.

John Warrillow:

Who’s our?

Mike Malatesta:

Oh, sorry. So, me and three partners.

John Warrillow:

Okay.

Mike Malatesta:

So the original partners. So, that did that. Then one of my partners passed away in 2003, and that caused another reshuffling because the company took in his shares as treasury. So that made the remaining three of us, 33% roughly shareholder. So that’s kind of the dynamic of how that transpired.

John Warrillow:

Wow. What was it like to lose a partner? Was that expected or was it a sudden event?

Mike Malatesta:

Yeah.

John Warrillow:

What was the backstory there?

Mike Malatesta:

Yeah, in a word, it was horrible.

John Warrillow:

I imagine.

Mike Malatesta:

His name was Butch. Really it was he and I that started the business, the other two folks, Larry and Chuck came in as investors. Interestingly, we had never considered partners when we first put our business plan together and stuff besides the two of us, because we thought we had it all figured out, and when we went to get the bank loan, they said, “Yes, we’ll give you the bank loan, but you have to have 25,000 more in equity.” And we just didn’t have it. So, Chuck and Larry, the two guys came in, basically allowed us to start the company, but it wasn’t something that we had planned at all, we didn’t know them very well either.

Mike Malatesta:

I’m getting back to Butch, so it was horrible because Butch died as a result of a fire in one of our plants. So he was working on something, it caught on fire. Tank, it caught on fire and he was inside of the tank. It just burned him very, very badly. So he lived for three days after that and then passed away. So, it was the worst kind of partnership transition that you could imagine having, not just losing a phenomenal man and a phenomenal partner, but dealing with the family issues related to that, all the buy-sell stuff, all the OSHA. I mean, everything about it was just horrible and unfortunate.

John Warrillow:

I hear about the exit planners talk about the four Ds. So, in many cases, esoteric, it’s sort of this theory, but you lived it big time, the real.

Mike Malatesta:

Yeah. I mean, they say about insurance, right? It’s like the thing you buy and hope you’ll never need. Right? You never think you’re going to need it. Well, we didn’t think any differently than anyone else, they made us get it, and we put a buy-sell together and we had to have it. So, we had it, and never thought we’d need it, and then one day we needed it unfortunately.

John Warrillow:

How does that work? Because Butch’s shares when he passed would have presumably transferred to his next of kin. Is that how it works? Or did you have that agreement such that the insurance paid?

Mike Malatesta:

So, we had a funding mechanism for it.

John Warrillow:

What does that mean, a funding mechanism?

Mike Malatesta:

Key man life insurance policy.

John Warrillow:

Okay.

Mike Malatesta:

So, from the beginning, when we drew it up, John, we did not want … none of us wanted to partner with one of our wives or someone else. It just didn’t feel like that would be right for anybody. So, we made sure that we had it funded and we always had the right to purchase the shares. They would not transfer to a family member or something, unless we couldn’t pay.

John Warrillow:

So, if I understand this correctly, you have an insurance policy that in the event of the death of one of the owners, it triggers. So there’s a payment that pays for his shares effectively?

Mike Malatesta:

Yeah. Well, it pays for the … You basically set the insurance level where you think the payment is going to need to be or over, and then you hope that as the business grows you remember that, and you keep adjusting to it because obviously it’s often a squeeze if you’re underfunded.

John Warrillow:

Right. So, how did you value the business for that purpose?

Mike Malatesta:

We had a formula in the buy-sell, and I don’t remember exactly what it was, but it was a simple formula that maybe it netted out assets and added a multiple to it similarly to the way you’d sell a business. Not that you’d sell it by netting out assets, but same basic concept, and that’s what we did.

John Warrillow:

Okay. Did it turn out you had enough money to fund it?

Mike Malatesta:

We did.

John Warrillow:

Oh, great. Great. Okay. So, was that the ownership structure after that catastrophic event? Was there other changes to the ownership, or did you just ride it through you and the two other partners along the way?

Mike Malatesta:

In 2013, I was able to buy out my remaining two partners through a combination of money that I could borrow and note that they would take. So, yeah. So that happened in 2013, and after that, we had a 1% shareholder, someone that we had given some shares to sort of like what you were talking about before with that earlier story, but not anything like that from a numbers standpoint. Then after I bought out my partners, I invited two long time team members who had been very instrumental in the business to buy in because I’d wanted that for a long time, John, but with our structure, it just wasn’t something that made sense until-

John Warrillow:

What was the straw that broke the camel’s back, so to speak, with your two other partners, like what triggered you to want to buy them out?

Mike Malatesta:

They did. So, they were both 15 years older than me, give or take, and we had a long run 20 years together starting with partners who barely knew each other. Right? It was a wonderful, wonderful, wonderfully long ride together. We did really well together. But there came a time when they wanted to get their investment back. They approached me about it and we had that buy-sell still, but the number that the buy-sell indicated, the formula was … I just couldn’t pay that much. I couldn’t borrow that much, and they both wanted to get out at the same time. So, to their credit, we negotiated a side deal off of the buy-sell that worked for all three of us, and that’s how we were able to get that done.

John Warrillow:

Got it. Because your business had grown substantially, but where were you in 2013 as it relates to revenue, number of employees, that kind of stuff?

Mike Malatesta:

We were probably in the 40 million range.

John Warrillow:

Did you have a sense of what it was worth at that point, like the company?

Mike Malatesta:

Well, sure. I mean, we had a sense of what it was worth, but we didn’t have an offer, we didn’t have an offer.

John Warrillow:

What did you think it was worth ballpark?

Mike Malatesta:

I mean, I thought it was worth 15 or 20, probably 20.

John Warrillow:

Okay. So, that would have meant that you would have had to cut a huge check to your partners?

Mike Malatesta:

Right. That’s right.

John Warrillow:

If I’m one of the partners I’m like, “Hey, I took the risk like you, what did I get to bear the …” How did you have that conversation? What was that like to have that conversation that effectively meant that they were going to take less than the “market value” of what their shares were worth? If that makes sense.

Mike Malatesta:

Yeah. Well, again, I give them a lot of credit. It wasn’t like I said, “Well, I can only pay this much.” And they were like, “Okay, that’s all you can do, that’s all you can do.” But we kept talking, we were open to conversation, and we’d had a lot of trust built up between one another for a long time. I think they recognized the reality that I couldn’t come up with that money. I mean, they know the finances, they know the availability, so I think they were able to reconcile that to themselves and the fact that it was they who wanted to leave, they could have stayed.

John Warrillow:

Could they have forced you to sell the company?

Mike Malatesta:

Yeah. I mean, yeah, could have. Yeah. But they never did. For the most part, they treated me with what I would call tremendous respect and regard for having been instrumental in getting the company to where it is and not being possessive about it strictly from a share standpoint, which was their right. They could have done that, a lot of people would have done that, but they did not.

John Warrillow:

I’m putting words in Greg, the guy I referenced earlier, mouth, but I got the sense that there may have been a pinch of … what’s the word, resentment maybe, that he had given his equity, and it was his error, he admitted it, but at the end of the day, he felt that maybe he’d done a lot of the work to get the business to where it was. Was that something you experienced at all, that sense of resentment? Like you guys kicked in a bit of cash when you were a tiny business, and yet here it has blossomed, I’ve done all the work, I’ve been sweating it. Did you feel any of that sort of … I don’t know … I can’t think of a better word than resentment towards your shareholders who had benefited maybe disproportionately to …. Am I making any sense?

Mike Malatesta:

Yeah, you’re making a lot of sense. I don’t think I’d be human if I hadn’t thought that from time to time, John. But I never got fixated on it because there’s the opposite story to that story, and that is, well, if these guys hadn’t come along, you wouldn’t have what you have and you wouldn’t have been able to do what you’ve been able to do, and all of those things. Did I have those thoughts? Definitely. Did I stay wallowed in those thoughts for long? No, because I was always able to kick my own ass and say, “Here’s the reality.”

Mike Malatesta:

One thing I’ve learned over years and years and years for me, if I’ve made a deal with somebody, I made it with the best knowledge I had, and thinking that it would make me happy and everybody else. So, I don’t look back at those things and go, “Wow, what if?” Or kick myself over, paying someone more than I thought they were worth. If that was the deal, yeah, does is it sting? Yeah, it stings a little bit, but that’s the deal. Yeah, that’s how I process it.

John Warrillow:

Got it. So, in any event, build the business up beyond 2013, you’ve got a couple of key managers now, who are now shareholders as well, it sounds like.

Mike Malatesta:

Yeah.

John Warrillow:

What triggered you to want to sell in 2015?

Mike Malatesta:

A visit. So, around Thanksgiving, I got an email from a company that we did some business with, not a lot, but some. It was one of those like … it was from a salesperson, like, “Hey, Mike, the guy who runs our division is coming into town. I was wondering if we could get some lunch together.” I said, “Sure.” Because I thought it was going to be one of those, “Thanks for doing business with us. Hey, can we do more business?” “What more business?” “Just a regular sort of …”

John Warrillow:

So he’s a salesman from what company, what is he selling you?

Mike Malatesta:

Sorry, a sales person from a company called Covanta that we did business with. So she was our account rep.

John Warrillow:

Okay. And what business did you do with Covanta? What do they do and what was the nature of the business you guys did together?

Mike Malatesta:

Yeah. Covanta, their primary business is operating plants that burn trash to create electricity or steam.

John Warrillow:

So they take garbage, they burn it and it makes electricity and some of the garbage that you had, they thought they could burn and make more electricity. Is that the idea?

Mike Malatesta:

Yeah. What we had wasn’t garbage, it was industrial waste, and why they liked industrial waste is because they could charge more for it than they could charge for garbage. So it was a way to prop up margins, and it all went through the same process that the garbage went through. So, assuming it doesn’t mess up the process, it’s an easy way to juice a return, get a better return. That’s the business that we were doing with them at the time.

John Warrillow:

Got it. So they would buy the industrial waste from you and they would then turn it into electricity, is that the-

Mike Malatesta:

We pay them like four times what they would be paid for garbage. So yeah, that’s what I mean it was.

John Warrillow:

So you paid them?

Mike Malatesta:

We paid them, right, right.

John Warrillow:

You paid them for taking stuff off your hands.

Mike Malatesta:

Yeah. We pay them that because it’s a growing trend especially for larger companies to want their waste to be destroyed rather than landfilled. So, they are willing to pay more for destruction. So they’re willing to pay more, and Covanta had the destruction facilities, John, and so it was a natural thing for us to approach them and say, “Hey, we have this material, they want it destroyed.” Then pay what they wanted for it.

John Warrillow:

Got it. So, the sales rep calls you up to say, “Hey Mike, can we get a lunch, my division manager is coming to town?” Where does it go from there?

Mike Malatesta:

Yeah. At the lunch, instead of talking about how we can do more business together and that chit-chatty stuff, he said to me that they were thinking about getting into industrial waste side of the business to be closer to the actual customer, and they had already purchased one company in another part of the country and they were looking to build out something in the Midwest. So that’s where the conversation started, John.

John Warrillow:

What was your reaction to that?

Mike Malatesta:

It took me by surprise for a number of reasons, one, it was completely different from what I thought the conversation would be like, and I thought it wasn’t like a private conversation, we had like four or five people around. That was one part of it. The second was, I would not have seen that coming, it never occurred to me that that company would have an interest in doing what he was telling me they had an interest in doing.

John Warrillow:

So, once you realized it was a conversation they were having about acquiring your business, what emotions went through your mind at that point?

Mike Malatesta:

Well, for a while, a few weeks or something, I just let it go. I was just like, “Man, I don’t really see this.” At the time, it wasn’t a company that we were friendly, we were competitors and also customers of one another, right? Which is common in a lot of businesses. It’s common in the waste business, common in a lot of businesses, but it wasn’t like, I was like, “Oh, that’s the company that’s doing such a great job, I want to follow that and be part of that.” It wasn’t like that. So I just let it ride for a few weeks. Then over the Christmas break, I went to my wife and I went to dinner, like a birthday party dinner at a friend’s house, but we were about 10 years younger than all of the other couples that were there.

Mike Malatesta:

Three or four of them had sold businesses at some point, and they all seemed really happy. They just seemed happy with not a care in the world. So, I came away from that dinner and I was thinking to myself, “Well, maybe there’s something to this, maybe I should spend a little more time on it.” So I did, and I started running some numbers and started saying to myself, “Okay, where do I have …” kind of stuff you do, where do you have to be where it makes sense? I got there and my wife and I were like, “Yeah, if we can get this, this makes sense for us.”

John Warrillow:

What’s the calculation you’re doing in your head, Mike?

Mike Malatesta:

Lifetime of if I don’t want to do anything else, can I live the way that I live now and not have to worry about anything. It was pretty much that simple, and then I just put numbers to that, John. So then I reengaged, and I had some more conversations with them.

John Warrillow:

So, before we get into those conversations, how did you reinitiate? So after the Christmas dinner and always happy entrepreneurs, maybe they know something I don’t. So, how did you reengage with the division head from Covanta?

Mike Malatesta:

Yeah, so I just called them and I said, “I have been thinking about it.” Because I hadn’t had any interaction with them after the lunch and he gave me space obviously, because I hadn’t heard from him either. So I said, “I’ve been thinking about it and maybe there’s something that can be done here.” I mean, I knew what the next step was, but I asked, “What’s the next step you want to take? “Sign the NDA and provide some numbers.” Yeah. That’s what I did, John. At the same time, I approached another … what I thought would be a potential acquirer that had tried to acquire us earlier, and I said, “Look, there might be an opportunity now, because we have been approached by another company, time might be right, are you guys interested?”

Mike Malatesta:

So, I kind of created my own parallel process, I don’t think that’s the right thing for everybody to do, not without some help, but I had been through investment banking processes before. Like everybody, I was like, “Oh, I can do that. Just do it myself.” Right? So I basically created my own-

John Warrillow:

You’re a control freak still, you never get that out of your system apparently.

Mike Malatesta:

Yeah, I created my own investment banking process between these two firms. Ultimately, one of the offers was significantly better than the other. I’m not sure which party was right. One was significantly better than the other and that’s [crosstalk 00:36:07]

John Warrillow:

On percentage basis, Mike, what was the difference in offers?

Mike Malatesta:

Yeah, that’s a good question. I’d say it was probably 25%. It was big. It was a big number. So after I went through that process, then I made a decision to move forward with a letter of intent with Covanta, the company that ended up acquiring us.

John Warrillow:

What was your reaction to the letter of intent when you saw it and you saw the kind of financial terms that they were prepared to offer?

Mike Malatesta:

Well, I remember I showed it to my CFO who had become a shareholder after my original partners. So I brought her into my office and I just gave it to her, and her eyes got really wide. She looks at me and she’s like, “You have to take this.” I was like, “Yeah, that’s what I was thinking, but I wanted you to look at it and see if I was thinking the right thing.”

John Warrillow:

What was the offer?

Mike Malatesta:

Well, it started out about $55 million or so. Yeah, it was a big number, John.

John Warrillow:

What does that feel like to … I mean, you started a business in 1992.

Mike Malatesta:

Yeah. I was driving trucks.

John Warrillow:

Driving a truck.

Mike Malatesta:

Yeah.

John Warrillow:

And suddenly someone’s put a piece of paper in front of you saying that they want to buy your business for $55 million. What does that feel like?

Mike Malatesta:

Well, it doesn’t feel bad, I can tell you that. I don’t know if I can tell you exactly what it feels like, but it doesn’t feel bad, it felt good. I mean, it felt like all the stuff that you work on can pay off, it can happen. But of course, a letter of intent is just a nonbinding number, John, there’s a lot to do between that and naturally closing on a sale. By that time I bought or being in the process or involved in the process of buying, 12, 13 companies. Never as the seller, always as the buyer, but I had a pretty good idea of how these things work and what you can expect and how it makes someone feel. I mean, the people that we bought, they felt good about being able to monetize what had been just an imagined outcome, because it’s just imaginary until someone puts a number in front of you.

John Warrillow:

What multiple of earnings did the 55 million represent?

Mike Malatesta:

It was about 8.2 or three, I think.

John Warrillow:

Got it, got it. I’m assuming the acquirer was using earnings as the primary driver of value, right?

Mike Malatesta:

They were using EBITDA. So, I assume most of your listeners know what that is.

John Warrillow:

Yep. I would think are earnings before interest, tax, depreciation and amortization.

Mike Malatesta:

Well done, you got it. People talk about discounted cash flow in these other ways, but most of the transactions that I’ve been involved with either as an investor or as seller have been EBITDA based with maybe a little bit of like how much capital does it take to keep this business going every year? That’s essentially what was used as the primary way to value it.

John Warrillow:

I’m assuming it was like … What do they say? It’s like a debt free cash free basis, meaning you had to clear up any debt on the business with the proceeds or in advance of basically transacting?

Mike Malatesta:

Yeah. That is how it worked. Yeah. So you got to pay off everything you owe people. Well, in debt at least, and then you have a working capital adjustment to handle the payable receivable mix, keep the business going. Yeah, and then you keep whatever excess cash there is, right. Access of the working capital need, if there is any.

John Warrillow:

The other offer was 25% lower, were you able to create a bit of a bidding war at all? Did you get them to nudge up at all or was it sort of … how did that work?

Mike Malatesta:

No, they came up, but they just couldn’t come up, they just couldn’t come up with … I shouldn’t say they couldn’t, they didn’t want to come up to the level that the other offer was, even though they didn’t know what the other offer was, they didn’t want to come up past the point where they stopped. So I think they came up twice, John, but still it wasn’t close. There were other considerations, not to say that money wasn’t maybe the largest consideration, but the other consideration was that, the company that had the lower offer also had an established infrastructure for the type of business that we are.

Mike Malatesta:

So, there’s clearly going to be job reductions and synergies and all that other stuff if I went with them where with Covanta the company was going to be what they call a platform company. So, they were basically going to rely upon the management and the infrastructure and the people that we had because they didn’t have people doing those kinds of things. So it was a good opportunity to keep everyone employed and a good opportunity, I thought, to accelerate the advancement potential for some of the key players who could advance at a much slower level if they stayed with us doing what we were doing.

John Warrillow:

Got it. Was it a bidding war where A comes up, B goes up or was Covanta’s offer first and final at 55 and then the other person you nudged up twice, or was it back and forth, back and forth along the way?

Mike Malatesta:

I don’t think we went back and forth with Covanta until after I signed the letter of intent, before I was just using them as the high watermark.

John Warrillow:

Got it. Got it. I’d be curious to know how you nudged the other side. I mean, it sounds like you did not say, “Look, I’ve got an offer of X from Y, you’ve alluded to the offer.” I’d be curious to know what you did and what advice you might provide to other entrepreneurs who want to create that bidding war, but also don’t want to overplay their hand and come off kind of a dick in the process, so to speak.

Mike Malatesta:

Yeah. I’m glad you brought that up because I definitely didn’t do that. I mean, I knew these people a little bit because of my past experience with them, I respected them and what they had built. They’d done a great job. I wasn’t going to be the person who told them what to do. Instead, I think I just was very respectful in the process, and I said, “Look, guys …” Because ultimately, they’re looking at the construction of the EBITDA and the company one way and the other company is looking at it the other way. So, the only thing that I could really do was talk to them about why I thought the way that they were looking at it, like assuming they were using the same multiple, which they probably were, they were just looking at the EBITDA differently.

Mike Malatesta:

I said, “Well.” I would always say why … I mean, this isn’t verbatim of course, but I would say, “I can appreciate your looking at it this way, the other company is looking at it a different way, and I think you should at least consider this, this, or this.” So I just did my best to move them up. In retrospect, I could have … like I said, I was playing investment bank. I could have hired an investment bank to do this, and maybe they would have been more successful engaging others and also getting this second option to move up more aggressively. But I didn’t do that and I don’t regret not doing it, even though the investment bankers can bring a lot of value to the sale of a company, especially if you aren’t well versed in these things, trying to-

John Warrillow:

Sounds like in your case though, you’ve done it a dozen times or so.

Mike Malatesta:

I felt like well versed, I probably wasn’t as well versed as I was convincing myself I was, but I also didn’t want a process. I didn’t want to be out on the street with books in front of a 100 people asking them to bid on the business, that just wasn’t what I wanted to do.

John Warrillow:

Looking at the EBITDA and interpreting it through a different lens, it sounds like you thought of the EBITDA as somewhat subjective, like it was a creative project as opposed to a black and white, like this is the EBITDA of the company. What do you mean by they were looking at the EBITDA differently, isn’t the EBITDA just the EBITDA?

Mike Malatesta:

The EBITDA is the EBITDA, but the construction of it can be different and looked at differently. So for example, we had a large portion of our … EBITDA was a recurring revenue based, which of course most acquirers love recurring revenue. So we had a lot of that, a lot of recurring revenue, a lot of recurring EBITDA, but we also had a project component to our business. That project component could be episodic. So sometimes we’d have a big project, sometimes we wouldn’t have a big project, you’re batting basically.

Mike Malatesta:

Our history had said that we will continue to have these big projects, but they’re not booked. They’re not even jobs right now, they haven’t happened yet. So, I think you can get hung up on, is it the value of an episodic revenue or EBITDA dollar the same as the value of a recurring revenue? Ultimately, the one acquirer said, “Well, we think it’s closer to one to one than the other.” I guess. Again, I’m not in their internal meetings, so I don’t know, this is some speculation on my point part, but I’ve done enough of these things since then and after then … before then and after then that I’m sure that was … I mean, I would have been asking those questions if I was on the acquiring side.

John Warrillow:

What proportion of your revenue was recurring?

Mike Malatesta:

In a given year, about five or six million would be non-recurring or recurring but not the same, I guess. So we seemed to get it all the time, but it didn’t come from the same spaces. So, technically non-recurring.

John Warrillow:

I guess I think of the different as reoccurring as in like a rash that you keep getting but you don’t know when you’re going to get it, versus recurring being subscription-based or predictable.

Mike Malatesta:

That a good way to look at it, I hadn’t heard that before, but I like that. Yeah. Recurring versus reoccurring. Yes.

John Warrillow:

Yeah. So it sounds like you had about five or six million of reoccurring revenue and the rest was recurring?

Mike Malatesta:

Right.

John Warrillow:

Wow. Big proportion.

Mike Malatesta:

Yeah. Well, I’m a smokestack kind of guy, you know that’s how I grew up. That’s the business that I grew up in. The way that our business worked is, recurring revenue covers all the overhead, keeps everybody employed, make sure you got cash in the bank and all that, and the other juice really is the one that produces the majority. It’s like a waterfall. Of course, when we first started the business, we didn’t understand that, but as we came to be better business people, began to understand how that would work. So, that was our model really for doing it.

John Warrillow:

Got it. That’s for sure helpful. I want to kind of get underneath something because I looked at the Covanta press release, it released that the sale price is 50.5 and you mentioned the LOI, and I think you alluded to this, there was some drop-off between the LOI and the final.

Mike Malatesta:

Yeah.

John Warrillow:

So the LOI was at 55. So, what happened?

Mike Malatesta:

Yeah. This is where an investment banker would probably have been helpful. The number ended up being 51.5, John, I think that’s the number.

John Warrillow:

Got it. Okay 51. Okay.

Mike Malatesta:

Those are $4 million gap. So what happened was, we had a 90 day due diligence period. During that 90 day period, their team started to really dig in on the reoccurring versus recurring. Ultimately, I think I made a mistake, because I still had these notes to my partners.

John Warrillow:

Notes being debt?

Mike Malatesta:

Loans, debt.

John Warrillow:

Loan. Okay.

Mike Malatesta:

Yeah. Right. So, I owed them money because of the buyout, and the way that our agreement was written was that, if I still owed them money and sold the business, there would be a step up.

John Warrillow:

What does it mean to step up?

Mike Malatesta:

Step up, the value that I paid them for their shares would go up if I sold the business for more than our agreement. Does that make sense?

John Warrillow:

Yep.

Mike Malatesta:

Okay. In order for me to move forward with this and avoid a step up and fulfill my obligation to them, I would have to pay them in full before I could close. Where I think I made a mistake, relatively speaking, was letting the acquirer know that I had to do this. Because it was a big deal for me, there was a lot that went into doing that, like a lot of risk. As I think about.

John Warrillow:

Because if they had closed on the transaction, you would have paid out the stepped up fee, but then be out the cash and no transaction?

Mike Malatesta:

That’s right.

John Warrillow:

That was the risk you’re looking at?

Mike Malatesta:

Yeah. Right. It was like back to a startup sort of risk. Because it wasn’t insignificant amount, but anyway … So I think I made a mistake by letting them know that, and then they started to get more aggressive about wanting to walk back some of the value on the reoccurring part of the business, and so they came back with a different number and I was really mad at myself, John, because I felt like I walked into a trap. Now, I don’t know that they even had that conversation. So, that’s why I got past it quickly because I can spend my whole life trying to think about that.

Mike Malatesta:

But in the end, since the number that they had offered me first was higher than the number that I wrote on the piece of paper in the beginning, I said to myself, “Well, yeah, I don’t want to walk back like this, but they’re not totally wrong with what they’re saying, and it’s still good for me.” So I took it.

John Warrillow:

Well, thanks for sharing that. It’s not uncommon we hear about re-trading all the time, so it’s very common. I want to make sure I understand for our listeners, especially, so they can kind of understand the mistake that you feel like you might’ve made in revealing that information about the step up the need to pay back your … So, in what way did that undermine your negotiating leverage? Why did that make you weak? Maybe I just need to understand the mechanics of how that would work if you had agreed to the sale, you would have had to pay them back, but you would have had the money from the sale to pay them back. Maybe I just need to understand that risk better.

Mike Malatesta:

Yeah. So the risk was in the timing. Essentially we had a valuation established with my partners and it was at X level, and so this offer was at Y level. So if I still owed the money under the note when I sold it at Y level, their level would step up to Y level. So the proceeds that I would get, they would be significantly reduced. So it was important for me to live up to my obligation to them, to what we agreed to, but to do that, I had to do it without the certainty of a close, because that was the way it had to be, if that makes sense.

John Warrillow:

The way the agreement was written, it was prior to receiving the money that you would have to give them back?

Mike Malatesta:

Right. Not prior to an agreement to do it or anything like that prior to a close. Yeah.

John Warrillow:

Okay. So let’s just … I’ll put round numbers on it. So for sake of argument, let’s just make it fun and say, you owed them a $100 and you stood to gain 150 from the sale, but the idea was that you had to write a check for a $100 in advance of receiving the 150?

Mike Malatesta:

Yes.

John Warrillow:

I probably butchered, I probably made it all much less clear.

Mike Malatesta:

I think that’s clear enough, it paints a picture.

John Warrillow:

It probably butchered it, but I get the idea. So the risk was in the timing and having to basically pay the money in advance of receiving the consummated close sale.

Mike Malatesta:

Right, and me tipping my hat of that fact. I played into it.

John Warrillow:

Sorry. You think you might’ve played into it?

Mike Malatesta:

I think played into their decision to walk back on the number. I probably shouldn’t have said what I said, but like I said before, I get over that quick, it’s just a thing.

John Warrillow:

Have you read Chris Voss’s book Never Split the Difference?

Mike Malatesta:

Yeah, I wish I was using labeling and mirroring and the other techniques because I would have done better.

John Warrillow:

Yeah. Well, it sounds like you did just fine. It sounds like you just did very like … but it reminds me in that book he talks about … I can’t remember it, but I’m going to butcher it, but it’s basically, “He who talks the most loses.”

Mike Malatesta:

Right.

John Warrillow:

You know what I mean? He’s talking about the value of each morsel of information and it sounds like in your case, slipping that bit of information might’ve given them a bit of leverage.

Mike Malatesta:

Yeah. I definitely didn’t do it the way Chris would have done it. I’m quite sure of that.

John Warrillow:

It’s a fun book for sure, and great stories because it’s like FBI terrorist type stories, they’re all very, very dramatic and interesting contexts.

Mike Malatesta:

I think he says in there that you can’t meet in the middle on a human being or something like that. Right?

John Warrillow:

It’s so true. It’s so true.

Mike Malatesta:

This whole meet in the middle of stuff is just ridiculous. You can’t meet in the middle to give a vague.

John Warrillow:

Yeah. It’s so true.

Mike Malatesta:

Yeah, it makes sense.

John Warrillow:

Man. Did you buy yourself a trophy? Tell me you bought yourself a trophy. You bought yourself a beach house or fancy car. Did you do anything to celebrate?

Mike Malatesta:

Man, I’m going to sound boring here for a little while. The only thing I did that summer was, I bought … so this happened in May, that summer I bought a Corvette, and then besides that, John, I didn’t do anything for like two years except get the money with an investment. By the way, here’s a funny story. So, I didn’t have my investment accounts set. Like I was doing Schwab myself, I didn’t have like a money advisor or anything. This is really dumb. So I didn’t have anything set up to receive the money except my checking account. So, all of a sudden, there’s a decent chunk of money.

John Warrillow:

50 bucks in your checking account.

Mike Malatesta:

Yeah. Right. So, if you want to knock a bank or [inaudible 00:59:55] call them and say, “I want to transfer money from my checking account to …” There were so many hoops I had to go through like a voice authentication, just a terrible idea, don’t ever do that. When you do sell your business, have a proper place for the money to be deposited and someone who knows what they’re doing to help you with it, because … yeah, that’s a dumb thing, that’s a dumb thing.

John Warrillow:

I’m really glad you kind of raised life after the sale, I’ve done a bunch of interviews now. It seems that a lot of the entrepreneurs I talk with have a bit of … I don’t know, kind of a rollercoaster of emotions that they go through. I’m curious for you, I mean, you had that dinner where all those four or five folks seem really happy having sold their company. I’d be curious to know, did you get that experience or was it more nuanced? What was the emotional rollercoaster like for you?

Mike Malatesta:

I prepared myself before it occurred for two things, one, it wasn’t going to change me even though it did change my circumstances, and the second was, when I sell this, it’s no longer mine. I think that’s one of the things that entrepreneurs have a really hard time with, sometimes is they want to sell it, they want the money, but they don’t want to give up. They want to feel like they still own it, and you know what? When someone pays you for something, you don’t own it anymore. If they want to do something different with it, don’t be offended. That’s their prerogative. You would do the same thing if you were on the other side.

Mike Malatesta:

So, getting myself clear about those couple of things upfront, John, was really helpful because afterward I worked for the company for a couple of years and I saw my job as being to help make them successful, they own this. If they want my opinion, they’ll ask it, which they often did very respectfully. Did they always follow what I thought was the best way? No, they didn’t. I could either pout about that or say they’re stupid or do all these emotional things that I see a lot of other entrepreneurs do. Or I could just say, “How can I help you in the direction you want to go? How can I help you get there?”

John Warrillow:

Well, I think sometimes it’s because of the structure of the deal. Right?

Mike Malatesta:

Yeah, right earn-outs and…

John Warrillow:

Where an earn-out [crosstalk 01:02:48] Right? The owner is basically fighting with management to get the resources they need to hit the earn-out. So, in your case, what was the structure of your employment agreement? Did you have an earn-out or how did they structure that piece?

Mike Malatesta:

There was no earn-out, there was an escrow, that was the only thing.

John Warrillow:

What’s the difference for folks?

Mike Malatesta:

Yeah. So, an escrow is money that’s a portion of the sale price that’s put aside for, in my case, it was 18 months, and that’s there in case there’s a problem with one of your warranties or representations. So when you sell a business, you effectively give your assurance that you’re not aware of any lawsuits or penalties or-

John Warrillow:

Unpaid taxes.

Mike Malatesta:

Unpaid taxes or criminal charges or anything like that, that could affect the business, and it’s a legitimate thing because you may not know about things that could actually happen. So they set up beside that they call that an escrow. In my case, they released half of it at nine months, the other half at 18 months. An earn-out is money that you get over time based on the performance of the business after the business closes. I’ve done a lot of earn-outs, and if you’re dealing with the right people, earn-outs are fine, but you don’t know who the right people are. So, having been through all kinds of things now, if you have a business that more than one company would be willing to buy, it’s probably not in your best interest to take an earn-out or a significant earn-out.

Mike Malatesta:

On the other hand, if you have a business that no one else wants to buy, you’re probably going to take an earn-out. Escrows really can’t be messed with because there’s a whole structure to how they work. Earn-outs are accounting functions, and they can be manipulated, isn’t the right word, but they can be different, different interpretations of the same data. How’s that?

John Warrillow:

So, Mike, why did you agree to stay on for two years after the sale? Was there a financial incentive to do that? Was that part of the deal? It seems like a long time.

Mike Malatesta:

Yeah. Interestingly, I did not have an employment agreement at all. So, good question. Why did I choose to stay on? Ultimately, the thing I tell myself and I hope this is right, John, is that I wanted our team to feel like I hadn’t sold the business and run out on them. I told them that I thought, which I did, that we’d be a platform company, there would be more opportunity, everyone’s job would be preserved, and all of that did turn out to be true. I just wanted to make sure that it was true, and I probably stayed around too long to have that assurance. But I don’t know why, I don’t know why I stayed so long.

John Warrillow:

Why leave after two years?

Mike Malatesta:

It was just time. I got to the point where one of my team members had been promoted to my job. I started working part-time and then I was in special projects. Then all of a sudden, nobody knew what to do with me. Right? There were no expectations any longer, John. So, it was just like I don’t want … that’s not for me. Yeah, that’s how that happened.

John Warrillow:

Well, I appreciate you sharing this story. What do you do now? Ridding around in your vette?

Mike Malatesta:

Yeah, well, not when it’s zero out like it is today. Yeah, so I have a new waste company that I started with a private equity partner a couple of years ago. So I’m taking a different tact at it this time. So I’ve spent some time doing that, I’ve got a podcast called How’d It Happen, that I love doing. I’ve been doing that for a couple of years, and I interview … I really have conversations more than an interview because I don’t ask any scripted questions except one, which is how’d it happen for you? So, I just have conversations with successful people about how they did it and what happened to them. Oh, I lose my camera there for a second. Hang on a second.

John Warrillow:

That’s okay. So it’s called How’d It Happen-

Mike Malatesta:

How’d It Happen.

John Warrillow:

And folks can get that on iTunes, I’m assuming.

Mike Malatesta:

Yeah. Apple Podcast, my website is mikemalatesta.com. So that’s really easy. M-A-L-A-T-E-S-T-A. So feel free to.

John Warrillow:

I was teasing you before we hit record that Malatesta sounds like an Italian motor bike.

Mike Malatesta:

That’s the first time I heard that, it was really cool for you to say that, John.

John Warrillow:

Mikemalatesta.com.

Mike Malatesta:

That’s right.

John Warrillow:

You can get How’d It Happen on all the big podcasting channels.

Mike Malatesta:

Yeah. Stitcher, Apple Podcast, Spotify, I guess wherever you get your podcasts, you can find my podcast, I hope.

John Warrillow:

That’s awesome.

Mike Malatesta:

Should be.

John Warrillow:

That’s awesome. So we’ll look for How’d It Happen, and we’ll put that in the show notes as well. Mike, thanks for joining us.

Mike Malatesta:

Oh, it was my pleasure, John. Thanks for asking me.

John Warrillow:

Hey, if you liked today’s episode, you’re going to love my new book, The Art of Selling Your Business. The book was inspired by the cohort of my guests over the years, who’ve been able to negotiate an exit far better than the benchmark in their industry. Sometimes it’s two or three times more than I would have expected. I was curious to understand the tactics and strategies of these entrepreneurs and what they do differently from average performers. The result is a playbook for punching above your weight when it comes to selling your business. To learn more, go to builttosell.com/selling, where we put together a collection of gifts for listeners who order the book, just go to builttosell.com/selling.