Inside Buying & Selling Internet Businesses with Thomas Smale, Founder/CEO of FE International
On today’s episode, I’m exploring the realm of M&A (mergers and acquisitions) of SaaS, e-commerce, and content businesses.
My guest Thomas Smale is the founder and CEO of FE International, a professional services business focused on M&A that Thomas started somewhat by accident in college and bootstrapped, built from the ground up. Now, the firm has completed more than a billion dollars in market value transactions across online businesses.
We talk about the nuances of auditing, valuing, and transacting online businesses, and how Thomas thinks about business marketplaces.
Here’s what I learned from the episode:
M&A firms make money from only from commission; they don’t get paid if they don’t sell the business.
Smaller deals provide consistent cashflow and learning experiences for the team.
They have some one-time sellers, but many sellers are serial entrepreneurs and return to sell other businesses.
Sellers are likely to be loyal to one M&A firm, whereas buyers are more likely to shop around.
It is an ongoing challenge to find the balance between being objective and selling in prospectuses.
Goldman Sachs may have interns working on your deal, with a smaller firm like FE International, you get their best team focusing on it.
Thomas got started flipping small websites and domains in college, wrote a book about what he was doing, and then started to buy and sell businesses for friends.
Buyers generally fall into three categories: individual investors, strategic buyers, and investment funds or institutional buyers.
Sellers are a wider range of people, ranging from a stay-at-home bloggers to MBA graduates.
Thomas personally buys businesses too (can you imagine the dealflow!?)
While you can minimize the time you spend running a business, there's not really any that are entirely passive.
It is difficult to verify how much time owners spend on their business, and this is probably the most commonly misrepresented claim.
There is a big difference between launching a business and buying and managing a business.
A "good deal" is not necessarily paying the least amount of money upfront.
Most audit work is done behind the scenes, and to someone who doesn’t know what is going on behind the scenes, it may be difficult to tell the difference between a professionally done prospectus and one done by an amateur.
A lot of good businesses hire bad brokers, and a lot of bad businesses hire good brokers.
In a prospectus, you might see one tab of an Excel spreadsheet, but there are probably 40 to 50 tabs of analysis behind that one simplified tab.
Valuation is 80% science and 20% art.
Out of SaaS, e-commerce, and content businesses, SaaS businesses usually have the highest multiples.
It is never to early to start a conversation with an M&A firm.
Probably around half of all deals are done privately and the other half are listed through M&A firms.
Part of FE International’s service is helping with the transfer of the business. In buying a business, the most important time period is the first three months of ownership.
Learn more about Thomas Smale:
Additional episodes if you enjoyed:
Episode Transcript:
Thomas Smale: It's a bit of a catch 22. If a buyer does really well, they're never going to come back because they don't need to because they've turned their $10 million acquisition into a billion dollars. If they do really badly, they’re obviously not going to come back either. It's the ones in the middle that are most likely to come back. The guys buying businesses, like I said, where they have 15% annual return on a good bit, you can do that every single year, raise more money every single year, and it will compound quite nicely. They're the ones who come back and they're the ones, not the ones we care about, that's the wrong word, but they're the ones we focus on making sure they come back.
Eric Jorgenson: Hello again, my friends, and welcome. I'm Eric Jorgensen. And no one has figured out how to stop me from creating this podcast. This show explores technology, investing, entrepreneurship, and personal growth that will help you and the rest of humanity create a brighter, more abundant future. This podcast is one of a few projects I work on. To read my book, blog, newsletter, or invest alongside us in early-stage tech companies, visit ejorgenson.com. Today, my guest is Thomas Smale. He's the founder and CEO of FE International . Thomas is an entrepreneur and an M&A expert, that's mergers and acquisitions. He began building and selling small online companies while he was in college back in the early 2000s and started his M&A firm somewhat by accident back in 2010, just fielding demand from friends and connections. He has since completed more than a billion dollars in market value transactions across SaaS, e-commerce, and content businesses. Today, we talk all about how this business started – it is a professional services firm, it was bootstrapped, zero funds from the ground up – the many nuances of auditing, valuing and transacting online businesses, and how Thomas thinks about dispelling doubts about finding a good deal in business marketplaces – is there alpha left when a business is listed for sale publicly? Please enjoy this conversation arriving at your ears after one quick message from a sponsor.
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Thomas Smale, the founder and CEO of FE International, very good to meet you. I’m a longtime admirer of your work, excited to have this conversation.
Thomas Smale: Thank you very much for inviting me on, Eric.
Eric Jorgenson: I don't know if you're going to be mad at me for doing this, but I've gotten a little bit of a self-education from reading a lot of prospectuses from FE International. Is this something that you frown upon or encourage?
Thomas Smale: I think if you're ever thinking about buying a business, I think it's good to research. The worst thing to do is buy the first business you see or look at a thousand prospectuses and never do anything. So, there's a balance between researching and going in completely blind.
Eric Jorgenson: It's kind of like a- it's a beautiful medium because it's like the anti-propaganda. It's kind of like reading an S-1 as a value investor or something. You're kind of like, this is ideally very straightforward, very organized, very audited sort of information. And so, I think it's a really good- I don't know, reading prospectuses has been an educational hobby for me. I've learned a lot from it, and I think kind of each one gets me closer to feeling comfortable about maybe buying a business in the future or even understanding how to build a business better for sale on my own. There's a concept that I think I heard from Naval, and I don't know if he was quoting somebody, but that a business is just a nexus of contracts. Do you agree with that as a notion?
Thomas Smale: No, I don't think I do. Obviously, a lot of what we do is contract work. So yes, contracts are at the very base of everything we do, but ultimately, I think managing people, and I manage well over a hundred people now, contracts aren't really what drives people and what motivates people and what gets people to do what they should be doing or what they shouldn't be doing. There's a lot of gray area as well, but a contract says one thing. So, to an extent, at a very technical level, yes, I guess it is basically just a nexus of contracts, but in reality, contracts alone don't really build a business. You can have the best attorney in the world, that doesn't mean you have a good business. And you can have no attorney and very basic contracts or even agreements, and you can have a great business. So, I think it's a bit of a balance, but ultimately, contracts don't drive people. Most people sign contracts and don't even remember what they signed.
Eric Jorgenson: Or understand it in the first place. My read of that was a little more generalized, I think, not just contract, but agreement or sort of process or organized exchange maybe. I just thought it was a helpful kind of framework to be like if someone asked you what is a business, like that's actually kind of a hard- I would struggle to give a confident definition off the tip of my tongue.
Thomas Smale: Yeah, I wouldn't disagree. I think would usually talk about something that, I don't know how I would define it. I didn't do very well at school. But probably something along the lines of something created which sells something that makes money I think would be how I would define it.
Eric Jorgenson: Okay. It's interesting. I always love stories where people are like I didn't do well in school and you would never ever know based on the business that they built or the success that they've had in real life. So, I'm excited to contrast that concept with the story that you're about to share. So, tell us maybe a snapshot of what FE International looks like right now.
Thomas Smale: Yeah, so at a super high level, we're an M&A firm, so mergers and acquisitions. We primarily represent SaaS, software, e-commerce, content-based online businesses, and we work on businesses anywhere from low seven figure valuation up to a hundred-million-dollar valuation. Sometimes we work on larger. Sometimes we work on smaller. But that's probably our current sweet spot. At the moment, our head office is in New York. So, the majority of our team are there. We also have an office in London. We have an office in Miami. I'm in the Bay area, so just outside San Francisco. And then some of our team are remote, I guess, as is way with many companies at the moment. The team in total are well over 50 people now. All we do is M&A, so a hundred percent of our business is representing sellers. That's how we get paid. We don't do anything else. We have some very minor other revenue streams, but that's the vast majority. I also do some investing myself kind of on the side, outside of FE. So, we occasionally acquire businesses and things like that. But FE International, the M&A firm, is just M&A. Over the last 12 years, we've closed over 1200 deals, well over a billion dollars in total valuation there, and a real mix, clients all over the world, all sorts of different business models, different niches, different industries. You name it, we've probably seen it.
Eric Jorgenson: And I don't know much about the world of M&A firms. How would you- what is like the equation that drives that business? Maybe some of the economics involved at a high level.
Thomas Smale: So, all of what we do is we sell businesses, and then we get paid a commission when we sell the business. We almost never get paid retainers, so we don't get paid anything upfront. So, we're essentially investing in the process. We have a salaried team. We have a team in New York, a team in London, Miami. They're not cheap. They're not commission only. So we pay our team to work on the deal. We only get paid if it closes. I would say in the industry that is quite common. It's definitely becoming more common for as you go more up market to pay retainers, so not necessarily a hundred percent getting paid on success, but I guess the way I look at it as a business owner is we do a really good job of what we sell, i.e., our service. So, we don't necessarily need to get paid if we're not successful. The only time it ever really causes a challenge for us is if sellers get flaky, if they get halfway through the process and they're like, oh, I've changed my mind where usually we're out of pocket, but fundamentally, we sell almost every business we take on, assuming the seller hasn't changed their mind throughout the process. So, the economics work quite well for us.
Eric Jorgenson: Yeah, that's very interesting. I mean, probably halfway through that, I was stressed on your behalf. That's like an entirely- like fixed payroll sort of variable revenue sounds scary, but I guess you're 10 years into seeing 90% of your funnel convert and you can kind of underwrite that pretty confidently.
Thomas Smale: To an extent. I mean, definitely, as we've got bigger and people get paid more, particularly over the last few years, it definitely is a cashflow management challenge, but that's why we work on a real variety of deals. We don't just do one $100 million deal every six months, we have a million-dollar deal closing today, a $5 million deal closing in two weeks. So, we consistently have deals closing at different sizes. Yes, a million-dollar deal does not pay- it barely even pays our office rent for a month, but at the very least, it's that consistent cashflow. So, a lot of people have always wondered why we haven't stopped doing million dollar deals or $800,000 deals. And one of the main reasons is cashflow. We can sell those businesses quite quickly, relatively easily, like that good experience for the team as they're learning. So, they have many benefits beyond just topline revenue.
Eric Jorgenson: And is there a sense that sort of customers return or recur, or you like do a small transaction with them to get a larger transaction with them later? Is that a part of the dynamic, or do people just kind of tend to transact one or two businesses in their lives and go on?
Thomas Smale: Definitely, at a senior level, so it's like on my desk and some of the senior people who report directly in to me, repeat business is one of our most important metrics. Sometimes a lot of people are just one time. They just only ever buy one business. Maybe they get an SBA loan with a personal guarantee. They lend or also borrow as much as they can. And that's all they do. Maybe they come back in five years, but that's it. I'd say sellers are quite likely to come back because most people are serial entrepreneurs. They don't just start one business, they'll start multiple. We've had, I think the record I remember in terms of percentage increase was 7 years ago. Someone sold a site with us for around $30,000. And then he sold a business last year for 12 million. So that was quite a big- and he had done a reasonable number of deals in the meantime, but that was his first deal above seven figures. And then he obviously, in that case, broke eight figures as well. So, I've seen that many times. On the buyer side, we also have a lot of regular buyers. Buyers are less likely to be loyal to one M&A firm. You'll find a lot of sellers who are like this is my M&A, whether it's us or someone else, this is the only company I'll work with. Whereas the buyers who should objectively be kind of shopping everywhere and seeing what's out there. But there are a lot of buyers who either raised capital or buying is part of their business model, so they might do one deal a year and they've done that every year for the last 5 years. Some people might buy 10 in a year and then you never hear from them again. So, there is a real mix.
Eric Jorgenson: So, do you think of this mostly as like a professional services firm? Looking at the website, I was kind of like, oh, this is a marketplace, and hearing you talk through it, it sounds a little bit more like a professional services firm.
Thomas Smale: Yeah. We are a hundred percent professional services. Like our website, I guess, firstly, it is outdated, and it doesn't really- it's not a marketplace, but we cannot make any money without physically transacting with the people that come in. So, the website is, I wouldn't quite call it just dead because it needs to be there, but the vast majority of our communication is done by email and the phone, email outreach and things like that. So, the website alone doesn't really show you what's happening behind the scenes. And there's not really any automation there. It's really just kind of like an ad, like here's the business, request information, and then you're speaking to a real person. You're not going through an automation flow. You're speaking to a real person, probably in our New York or London office, and going through from there. So yeah, a hundred percent professional services. I think one thing on our medium-term roadmap is to start automating some of the earlier stages of the process, but for now, a hundred percent professional services. I don't see our revenue model changing. Maybe we can leverage technology slightly more efficiently, but that's a slightly separate challenge.
Eric Jorgenson: And given that it is professional services, I imagine this was like a bootstrapped business. Did you struggle to kind of manage cash flows or finance this thing as you've grown? I mean, to reach this scale in 10 years is meaningful.
Thomas Smale: I definitely didn't have any money starting out, no, but essentially it was just me to start. And then in the very early days, when we were getting off the ground, focusing on- we did a bunch of stuff starting out, because I was like I need to make money doing anything. And then I can kind of pay my own rent was number one priority. Then maybe buying food was number two priority. And then it was everything else. In the early days, the team we hired were commission only because we couldn't afford to pay them a salary. And then over time, that's changed. Now the team are primarily compensated with salary and then they get an annual bonus as well. So, they are incentivized by what they sell, but the vast majority of the team are primarily paid salary. So early days, it was definitely difficult. We've had to change the business model over time with our team. And ultimately, as deals get bigger and more complex, you can't- There are very few people out there who can do those deals who want to work commission only. We're competing against JP Morgan, Goldman Sachs, KPMG, PWC for talent, either in the accounting world or the investment banking world. We're not competing against kind of Main Street business broker or like realtor com business broker who have no real sophistication, they just know how to sell. Because to your point, when you read our prospectuses, they're not what I would describe as like a bullshit sales document. We actually put real work into it. And we basically have- the balance on my side is we have essentially a team of accountants preparing that document. So, it's a balance between objectivity and left to their own devices, they’d be a hundred percent objective and being also a sales document. We are trying to sell, but also trying to be objective and not- There's a very gray area between overselling something, misrepresenting it, which obviously we don't want to do, and being way too objective and not really doing our job, which is selling.
Eric Jorgenson: Yeah, I've read probably a few dozen prospectuses at least by now, and it does not surprise me to hear that they are written by accountants.
Thomas Smale: I guess the nature of it is they have to be factual. At the very fundamental level, the one thing we never want to happen is someone to make an offer on a business, get into the due diligence process, and then four weeks in say, oh, your prospectus said X, but I've now discovered Y. And that's just because we've kind of conflated the truth or we've changed something that we were told to make it sound better. Ultimately, yes, that might slow down the amount of time it takes you to get an offer, but it means our success rate is extremely high when we do get one, because generally, there were no issues with how we've represented the business. So, it's definitely a tradeoff and like an ongoing challenge.
Eric Jorgenson: Yeah, and it's an interesting- I mean, the game theory of it is for the best- for your business to succeed at the best, over a long time horizon, you have to build this really strong trust and brand and reputation with both sides of the marketplace. And so, you have to be really careful to like serve them both, I imagine, without ever putting a thumb on the scale, which has to be really tough.
Thomas Smale: Yeah, for sure. And particularly for us, like there's always- every year, there's a new kind of flavor of the week competitor that pops up and they're offering something that we know fundamentally cannot be offered, like we'll sell your business for free or we'll sell your business for double the market valuation or sell your business in three days, things like that which we know fundamentally can't be done. Maybe they can be done in certain market conditions, so maybe it is they can get buyers to pay them because buyers are particularly desperate for deals in that market and they don't need to charge sellers, or maybe they can sell under market value and there are people willing to buy in three days. But you can't build a sustainable business doing that. So for me, again, it's a bit of a balance between staying the course and being disciplined, making sure that we're continuing to do what we do. But that means 12 years into the business, we have a steady flow of consistent clients, consistent referrals, and yes, competitors who come and go. But I'm always quite confident that in say 3 years’ time, the fancy competitor everyone's talking about will have either gone away or it's not doing as much business.
Eric Jorgenson: Interesting. What is your vision for maybe the long term of FE International? Do you kind of want to increase the density and quality of your business? Are you trying to sort of continue to scale up? Where do you want to see it in 10 years or 20 years?
Thomas Smale: So, for us, it's primarily continuing to scale up. So, continuing to do the deals at the level we're doing right now, but also continuing to move further and further up market. This is an approximation, it's not the exact, but approximately every year, the biggest deal we've closed around doubles from what we've ever done before. So, if you go back say 5 years ago, the biggest deal we'd ever done was I think maybe like $5 million. Whereas today we're substantially bigger than that, and that only keeps increasing. So, you can continue going up and up market. And the way we look at it is a lot of the deals we work on now, essentially most of our team now have come from big investment banks or big accounting firms, so we don't lack the talent internally. Often when we are competing or working alongside another bank, we realize often we are actually better than them. A lot of these big banks are really quite inefficient, particularly on what they would describe as a small deal. So, say a $50 million deal, you get our best team. If you go to Goldman Sachs, you get like the interns, and our best team are significantly better than the Goldman Sachs interns. And we'll take it much more seriously. In a deal like that, the MD or the director or whoever it might be at Goldman Sachs might look at the deal once a month for 30 minutes. Whereas you don't quite have my undivided attention, but I'm definitely involved, definitely looking at it, and we're good at what we do. So, we're definitely encouraged as we've gone up market by the fact that we can at least surface ways we can deliver as good or better than the big banks. Does that mean we can always win business from them? No, that's a challenge, because to your point, we've been around 10, 12 years, which is a long time in this industry, but the big investment banks have been around a hundred years. So that's very difficult to catch up with.
Eric Jorgenson: Yeah. Nobody got fired for hiring Goldman Sachs, yeah. How did you come to start this business? Were you operating in the space independently before this?
Thomas Smale: So, I was at college at the time, and I was buying and selling small websites and domains myself. So, I'm talking like $100, $50, I guess what you’d call them was like flipping. I'd sell it for 200, then I'd take my $200 on my credit card, buy something, sell it in a month for $1000. So, I guess I learned the transactional side of selling, and selling doesn't really change whether it's selling something for $10, $1000, $100 million. The principles are essentially the same with slightly different sophistication. And then I learned the online space, and at the time, there were not really M&A firms representing e-commerce, software, online businesses. If you had a restaurant or a gas station or something like that, there are lots of firms that could represent you now and 10 years ago. But if you had an e-commerce business making 10 million a year or a SaaS business, yes, you could call those firms, but they wouldn't have a clue what they're doing. So, then kind of fell into it by accident because I was buying and selling myself. I then wrote a book about what I was doing the year I graduated because I needed to make some money basically. And then off the back of that, people were like, hey Thomas, you were buying and selling yourself, can you sell for me? And to my point about I didn't do well at school, I do technically have a business degree, but I didn't think it really occurred to me that that was M&A. I was like, yeah, I'll help you, just pay me if it works was essentially the premise. And then it did work. And then we got loads of word of mouth in the early days. We didn't even- people laugh at our website now and say it sucks. We didn't even have a website for our first two years. We just had an email address and they would email me and the team and we would handle it like in private. A lot of what we do is like very confidential, has to be behind closed doors. We're not publicizing the name of a business we're representing. We're doing it all in private. So that's been kind of the core of our business from day one. And then it really snowballed behind the scenes. And then, I guess the industry has exploded in size, more service providers, competitors, marketplaces have popped up. So, there's a lot more knowledge in the space. Years ago, podcasts like yours for example, wouldn't really exist or you wouldn't really want to talk to me because you'd be like I've never heard of you guys. Like who's even buying online businesses? Whereas today it's a much more compelling kind of pitch for me because there's lots of people in the industry, the average 21-year-old graduating college today does not dream of opening a restaurant, well, maybe they do, but they're launching an app or an online business or they're doing something in like crypto or whatever it might be. And that's, well, we don't do much in the crypto space, but that's really what we do. So, we pick up a lot of people very early on who are, I guess, similar to yourself, like, well, I'm window shopping and looking at businesses, seeing what I might want to buy. And also, there's a balance for us. We don't let people look at 300 businesses and never make an offer. But if people just want to like learn while they're raising capital or whatever, that's fine, as long as you're not wasting everyone’s time. Yeah, so that's kind of really where we are at the moment. It's kind of snowballed in the early days. And then today, the majority of our good business at least is still word of mouth or a form of word of mouth anyway.
Eric Jorgenson: That's super interesting. Because I was going to- like, there are so many- there's almost a business brokerage industry for each industry. I was going to ask you about the business brokerage space, but that doesn't even really seem like the right way to slice it now that you've kind of laid that out.
Thomas Smale: Yeah, we definitely got ourselves away from traditional business broker. I’d say business brokers, particularly in the US, so I'm from the UK originally and I now live in the Bay area. Business brokers in the US have a terrible reputation. And it's usually because they're not very good and they generally come from a real estate background, so they know about the real estate. So traditionally, businesses, because they are bricks and mortar, real estate was a big part of the transaction. So, you had to have a real estate license to sell a business. That's what business brokers are doing. So basically, then knew how to sell the real estate. And then the business was like, oh yeah, this is a shop, it makes a million a year. And then the owner takes home a hundred thousand, but check out the real estate. Whereas in our space- So, I mean, sometimes there are leases if it's an e-commerce business, but 95% of the time, there's no real estate. So, you have to be specialized. I don't know anything about real estate. I think I own a house, that's about the extent of my knowledge in the real estate space. So, you wouldn't call me and you definitely shouldn't call me if you want to sell a retail store because I wouldn't really know where to start, but just the same as a traditional business broker wouldn't have a clue how to sell an e-commerce business.
Eric Jorgenson: Yeah. I mean, the way you fell into it is interesting, but you couldn't have picked better timing and a better niche because I think the people who are interested in buying a digital business, so SaaS, e-commerce, content are I think the ones that you kind of highlight, are just so different and the dynamics are so different. They may be much more scalably managed. You can buy them from anywhere on earth, if not the country. You can manage them from anywhere. You can manage multiple of them in parallel. It's a totally different skillset in many cases, plenty of engineer's buying these that certainly wouldn't be buying a carwash business or a laundromat or something like that. So, yeah, golf claps for your timing and your context and like the way you oriented yourself to the tailwinds of the market is amazing.
Thomas Smale: Yeah, for sure. I mean, it definitely also came out of the back- So, I graduated into last- or not, I don't know if it was technically the last recession, but graduated in 2010, coming out the back of a recession. A lot of people were looking for other investment classes. So, I'd say now you would consider like online businesses almost as a mainstream investment class that people know about. And everyone now knows about it; the biggest public stocks are things like Netflix, or maybe not as of today, but companies like Netflix, Dropbox, Microsoft, and companies like Microsoft have transitioned to a SaaS model for most of their business. Like people now get what SaaS is because they're like, oh, I have to pay a subscription to Microsoft Word now. Whereas when I was a kid, you'd buy like the CD and it'd be like a hundred dollars. And then when they upgraded, you had to go buy another CD and all of that. But now it's all subscription, all cloud. Everyone now knows what SaaS is. So, if you say, hey, we're selling a SaaS business, maybe they don’t understand what the word SaaS, but they understand the concept of paying a monthly subscription to get access to the thing, whether that's software or otherwise.
Eric Jorgenson: I took a stab at the personas there in my last rant, but I don't want to put words in your mouth there. So how correct is that as a representative, like who are the buyers and who are the sellers? Who are the people behind these businesses and these listings that you've got?
Thomas Smale: So, say the buyers generally fall into- I’d say they generally fall into three very broad categories. One would be like an individual investor. So, somebody who's either made a bunch of money themselves. Maybe they have a job, and they want a side business. Maybe they have a job, and they want to buy a business and quit their job. Maybe they've already quit their job and they want to buy a business. Generally speaking, they will either have their own money or they'll take out a loan to buy a business. There’re still relatively limited options to raise external financing to acquire online businesses, but there's definitely becoming more options. So, individual investors, first group. The second group are some form of strategic buyer. And everyone thinks their business is going to sell to a strategic buyer. But the reality is strategic can mean many different things. Strategic can just mean they've raised money to buy a business like yours. So, their strategy is buying businesses. Does that mean they are what you would define- what most people would think of as a strategic buyer? No. But is it part of their strategy? Yes. So, I think strategic buyers is a very broad answer, but they usually- so strategic buyers in this context would be someone or a company that already owns a business in an industry and they want to buy something complimentary. And then the final group, and there's always the overlap between these three groups as well, the final group is funds, investment funds, institutional buyers who have raised capital which is not their own to acquire businesses. So, whether they have a fund and they just have US accredited investors, or maybe they have raised money from- they've raised debt to acquire businesses, whatever it might be, lots and lots of different ways to do that. But that's generally the third group. And then, on the flip side, sellers are a much wider range of people. Some of them are kind of stay-at-home mum who has never really worked before, and they've launched a blog about cooking and it now makes $50,000 a month, and they sell it and they're exceptionally successful. One of our most successful clients I remember, she lived in basically the middle of nowhere in the US. I don't think she'd ever got paid more than like 30,000 a year. She launched one product from home, long story short, built that business up in like three or four years, sold it for about 20 million. But if you met her, you would never know. She was exceptionally smart, but she was not like brash. She's not on social media. Since the sale post a couple of years ago, you would have literally no clue that she did that. So, you get a lot of people like that. Then you get the opposite. You also get kind of traditional, graduated with an MBA, have launched a really technical business with some other people in their MBA class. And then, yeah, so lots of people in between who want to launch business, the American dream, or maybe they're outside the US as well. We have clients all over the world. Maybe they've built up a service business around something they know about. Maybe they've launched a product in an industry they know. Maybe they've partnered up with a friend to build a business. Maybe it's kind of an ex-coworker or something like that. We have a very broad mix of sellers who come from all sorts of backgrounds. So, like I said, it could be the stay-at-home mom who no one would ever believe could launch a successful business, but often they are best business owners, because your first question about is it a nexus of contracts, they're like, well, no, I just produce content about the stuff I'm cooking at home, and then I share it on social media and people like it. And because it's so genuine, with social media in general, people love to share like real things that feel genuine from a real person. So often the best businesspeople don't mean to be good businesspeople because they're just producing something good. They are like, hey, here's this recipe. It's great. You should know about it. I'm going to share it. And then later on, they figure out how to monetize it. Whereas the MBA is like, oh, okay, the first thing I need is a trademark for the name of my business, and then I'm going to patent the way we present a recipe on the page, and then I'm going to raise funding because we definitely need investors to do social media. Whereas the stay-at-home mum blogger has already ran their content and they're already making money by the time the MBAs finish their PowerPoint. So, lots of different ways you can do it. They're not necessarily right or wrong, but I've seen everything.
Eric Jorgenson: So how do you as an investor- I mean, your really in the catbird seat, which I know is a term, but I still don't really know why that is a truism. Anyway, I don't know, like how do you look at that variety of businesses and decide, as an individual, what to invest in or what to buy as a company? Do you have a preference for one of those types?
Thomas Smale: Yes. I mean, the reason we buy, and we keep it very separate, so we try not to overlap, and we only really buy one or two businesses per year. Firstly, the reason I like doing that is so I kind of fully understand the process. I'm not just an advisor who doesn't do it myself. I think there's nothing worse than someone advising how to do something if they've never done it themselves. And secondly, I guess I'm fortunate, as the business have grown, financially, I've done better and better, but I don't know anything about anything other than what I do. So, if I have a million dollars, do I buy some real estate or do I buy a business I kind of know about and understand? That's always the way I've looked at it. And then primarily, I mean, I'm CEO. I'm very busy. I work all the time. I don’t really stop. So, I don't have time. So, whenever we buy anything, and I buy with my business partner primarily, and sometimes we have investors involved. We look for something where we can bring in a manager or someone to run it. So, our time involvement is as close to zero as possible. And generally, our only involvement is checking in with the manager once a week for a one-on-one, that's usually the extent of my involvement, but I don’t really do a huge amount of passive investing. I guess I'm still young enough and don't quite have enough resource where I still have to be hands-on and active. We're not buying like- It's not like buying a blue-chip stock and just getting dividends. Like running a business, you do actually have to run it. So, you have to be good at- if you want it to be hands-off as an investment, relatively, you still have to hire a good manager and you still have to manage a manager. You can't just hire a manager, leave him to it. I think there's a lot of, I wouldn’t necessarily call it misrepresentation, but the sort of overly simplified views of what it's like to run a business on social media, where people are like, yeah, buy a business, no money out of pocket, hire a manager, it is completely passive. Like that's not really how it works. Like ultimately, if there's a problem with the business and you can't make payroll, you're the one that's paying that out of pocket. If there's a problem with the manager and the manager quits on Thanksgiving, you are the one who's working on Thanksgiving. There's no one else that's going to help you. So, when it's good, it's really good. But when it's bad, it's really bad. I think a lot of people don’t realize like how bad it can get. So, you kind of have to know what you're getting yourself in for. Hence, why I like investing in the space because I already know it, and I do it day to day anyway, and I have a lot of contacts and resources already. Whereas if you said to me, hey, you just bought an apartment building and like the yard needs fixing, who'd you call? I have no idea. I’d just go on Google like everyone else and it is a guess.
Eric Jorgenson: So, you said if you buy one a year, that made me wonder what the denominator is. So is FE International doing like 20 a year or 500 a year? Like I don't even have a guess at the order of magnitude really.
Thomas Smale: Generally, over a hundred per year, so we generally do about two deals a week, can be higher than that, can be lower. I think in the region of maybe 150 last year. So yes, it's probably about 1% of our total deal volume is me involved.
Eric Jorgenson: Okay. And I think your point is well made on the like there's a lot of oversimplification and there's different- There's very different types of businesses, right? There's like the ones I tend to look at and snoop around at are like the very small, like how can you buy $5 or 10,000 a month in income? And those are usually people pitching like super low owner involvement. I answer tickets once a month for one hour and that's it. And otherwise, I just collect the money. And then there's like the next step up from that is it's a full-time income, but it's full-time work to manage this business and the risk involved. And then there's kind of what you were talking about, which is like it is big enough to support its own manager, salaried, and someone to kind of shield the owner from the day-to-day work of the business, which is probably the ideal, but it certainly comes with you've got to be able to find all of the capital because that business is inherently going to be bigger. But time, the prospectuses that I read where it's like the owner spends 5 hours a month on this business, I have a hard time believing that. And it seems like one of the parts that's particularly difficult to represent honestly. Like, are those owners just being crazy optimistic? Are these businesses way more common than I can imagine? And how do you look at those? How do you audit that claim?
Thomas Smale: Yeah, so firstly, it probably is the most commonly misrepresented claim, because to your point, it's very difficult to verify. That said, there are definitely business owners who do essentially nothing every month because they have a reliable manager, because I think in any business you can be- I choose to be hands on with everything I personally invest in, but you can be hands-off. I think, and maybe this is just me being a micromanager, but if you're a hands-on, I think you're generally going to have better success. But that doesn't mean- you can be hands off and the business will still do fine. I’m just saying it does better with involvement. I think one thing that a lot of sellers do prior to selling is they significantly ramp their time down. They might've worked 80 hours a week for 10 years, and then the 6 months before selling, they're like, oh, I don't really want to do this anymore. Then they actually start working 5 hours a week, and they'll say, oh yeah, I work 5 hours a week on the business, which is technically true today, but it was not necessarily true in the past. If I really wanted to, work with FE for example, I could hire a CEO to replace me and I could check in once a week or maybe never, well, almost never, and still make a bunch of money. If I was then selling the business, I could say I do nothing, there's a management team in place. That's very possible. So, it definitely happens. I won't go into our exact audit process of how we do it, how we verify even, because what sellers like to- I guess the short answer is we ask questions in such a way that sellers give us the correct answer without realizing what we're actually asking them. Because if people- if you say how much time are you spending on the business and they say 5 hours a week, and you're like, oh, what are you doing? And they're like, oh, I just like, Il just do social media. And you're like how much time are you spending on social media? And they're like, oh 5- they're going to say 5 hours a week. So we'll ask them like what they're doing. Like how many lines of code did you write? And while we're not- like how long does a line of code take to write, 10 seconds or 10 days? Like that's very broad, but there are definitely signals you can look at to figure out how much time someone is spending. Like, do they have an internal Slack channel? Are they checking in with their team every day being like, hey guys, great day? In that case, yes. They're probably not working 30 minutes a day. Yeah, there are things we’ll do. I would say it is difficult. We generally air on the side of caution, so we will overestimate. And a lot of times sellers will get a little frustrated with us, and they'll be like, oh, last week I spent 2 hours. I want to say 2 hours. And we'll say, no, the spirit of it is it supposed to be the average amount of time you spend, not the lowest week you've ever spent in the history of the business. It's got to be kind of a fair balance. But I would say privately, lots of people sell businesses, and we see this a lot where we say no to a business because we say, look, no one's going to buy this business because you've got two owners working full time, and you're barely even breaking even paying yourself 50,000 between you. What people will then do, unfortunately for the industry, there are lots of marketplaces out there where you kind of sell yourself, commission-free, that kind of thing. And you can kind of say whatever you want. And if you really want to, it's relatively easy to misrepresent your financials because you can have like a different company paying the expenses. So, you could pay, for example, let's say you have a content business, and you have an SEO agency, and you say, oh no, all of the links are organic. You could quite easily have a separate entity paying a SEO firm 50K a month for that work. And it's very difficult to prove that that work is happening. So, at a very fundamental level, like a big part of what we do is audit. Like that's boring and it's mostly accounting work, but we'll never list anything unless we're confident in the seller's claims around what they're doing and also their financials. And that's also to your point, one of the advantages of having a good reputation. We're not a fly by night M&A firm. If you really want to go kind of misrepresent a business and screw people over, we're not really the kind of company you would call because we're going to figure it out and we're going to say no. You go to the inexperienced broker who doesn't have any other deals and they're desperate to win anything and they'll take anything on. So that's one of the challenges for the industry. Like if you're trying to break in today, all these kind of new brokers doing it for free or whatever it might be, lowest commissions. Like it doesn't actually work fundamentally.
Eric Jorgenson: Yeah. That is a very interesting comparison. I mean, part of your value proposition is the auditing and the guarantee and like maybe some quality floor because your reputation is at least somewhat intertwined with the quality and honesty of the listing from the buyer's point of view. So, it's interesting to hear you talk through this because as I read a prospectus, I'm always imagining the seller basically answering the same question that I'm reading. It's like how many hours did you spend on the business on an average week? And them being like how few hours can I get away with saying? Two. And it's cool to hear like the actual process behind the creation of that, that you're trying to approach that as honestly as you can, even if the seller is- even like a potentially adversarial like relationship with the seller trying to sort of manipulate the process to merchandise their business the very best that they can.
Thomas Smale: Yeah. I think ultimately the way we approach it is like, hey, you've hired us for a reason. Like our advice is being truthful is the best approach. We will then position it in a good way. So, everyone knows starting out a business, yeah, you probably worked 80 hours a week. There's almost a no business owner who starting out did not work those kinds of hours. Like let's say they build an eight-figure business. I think you'd struggle to find anyone. Yes, can you build a business that makes 20,000 a month working five hours a week? Yes, but you're not going to get to eight figures working 5 hours a week to start with. I'm not smart enough to do that. Maybe it's possible, but I don't know how.
Eric Jorgenson: But that doesn't mean that they can't buy a business that is built that takes only that much time to maintain, which is a huge distinction.
Thomas Smale: For sure. But then I guess in that case, you're paying for the work that the seller has done in the first place to get there. And then the challenge is very different. It's a very big difference between launching a business and getting off the ground and buying a business and managing it. Like when I started out, I was like that very traditional ADHD entrepreneur. I would have been a terrible manager, didn't have a clue what I was doing. So, the thought of like now investing and then managing managers essentially would be the complete opposite of what you think I'm good at. But now I'm actually quite good at that. And if you say to me, hey, Thomas, come up with an idea to launch a new business. What would you do? Like what would you do if you sold FE International tomorrow? Honestly, I don't know if I would know. I think people change over time and I think you can mature over time. And I think, for some people, buying a business is the only thing that makes sense. For some people, launching a business is the only thing that makes sense. I think there are very few people who can do both effectively. Maybe there are some examples, but I can't really think of that many that I've seen that are really good on a consistent basis of creating but also managing because they're fundamentally different kinds of skills, at scale anyway.
Eric Jorgenson: Interesting. So, to follow on with kind of what you're saying about how you construct these processes and how you turn away businesses that you don't feel are actually saleable or representing themselves well. I have a friend, my friend Andrew Finn, who was one of the first episodes on this podcast, and he is a buyer of small businesses and he calls them like give me all the grimy ATMs I can find. They're on the smaller side in the business brokerage world. But he always says he's wary of anything that's basically listed on a marketplace because he views finding something in an obscure source that no one else will find as a source of alpha and that he is less sure that he's going to get a good business when something is listed on a place like FE International where it's a little bit more like an open auction process where there's maybe hundreds or thousands or tens of thousands of people on your mailing list, viewing every opportunity. And it's interesting to see that as a tradeoff maybe some minimum guarantee of quality. But like what's your response to that sort of line of thinking or that type of buyer?
Thomas Smale: Yeah. I mean, I think, firstly, you can do it in lots of different ways. There are lots of different ways to create alpha. You don't necessarily- I think it's a bit of an over-simplification to think that the only way you make money on a deal is on the way in. Like, yes, that is probably the most common way. If you can buy essentially a mispriced asset in a space which lacks transparency or whatever that that might be. Fundamentally, like what we do, we've tried to educate them. And part of the reason I come on podcasts, for example, is to try and educate people as to what their businesses are worth and how to approach it. I think generally a lot of buyers- So the flip side of that is a lot of buyers with capital will only buy through M&A firms because, firstly, it's a quicker process. You're dealing with you know a hundred percent or essentially a hundred percent of the sellers we're representing are motivated to sell. You know because we are representing them that they have realistic expectations around valuation. We're very realistic with people. We don't say, hey, your business is worth $10 million if it's actually worth 5, it's just a waste of everybody's time. And like I said, we only make money if it sells, so we have no incentive to lie. You'll save significant time in due diligence because we've already done a lot of the audit work. So, you're going to have way fewer deals that completely fall through. That said, if you're an expert buyer and you're good at negotiating and persuading people to sell their business to you and you're happy dealing with a bunch of mess, which you're going to get buying businesses privately and small, that business model can work. But that's definitely not for the average person. If you have a million dollars and you want to buy a business, you should almost definitely buy it where it's been professionally represented. I would say that'd be the kind of equivalent – again, I don't know much about real estate – but that'd be the equivalent of in real estate, you have a million dollar, you buy a, I don’t know, a duplex in Austin; that’s probably quite a good investment in the current market. Or do you buy represented by Cushman Wakefield or like a well-known real estate company. Or do you go and buy a foreclosure on Zillow for a million dollars in wherever? It's probably a terrible idea if you don't know what you're doing. So exactly the same in this industry. And I think the other way I look at it philosophically because I personally basically only invest in professionally represented businesses. So, versus your friend, he'll probably say I overpay in a hundred percent of transactions or close to a hundred percent, but there's a time value in there. And also getting a good deal or business that is going to make you money, the entry price is not the only important thing in there. Arguably, the best businesses are represented by M&A firms, and the best businesses, if they have the ability to grow or you've already identified something that can double that business within 6 months, which is very common, it's not necessarily a bad deal versus shopping around for 6 months, paying 20% less than I just paid. But I closed my deal 6 months ago because I bought through an M&A firm, I've already deployed my capital, I'm moving on. Yes, maybe I had to pay a bit more because it was a competitive process, but I also own a fundamentally better business. So yeah, there’s lots of different ways to look at it, but I'd say, fundamentally, a good deal is not necessarily paying the least amount of money upfront.
Eric Jorgenson: Yeah, it's an interesting trade-off on accepting a higher quality floor, maybe paying more for the asset but paying less in due diligence or effort or uncertainty or the work that you have to do to professionalize the business that hasn't been professionalized already. It reminded me a little bit as you were talking of the debate between Buffet and Munger, like a quality business at a fair price is better than a fair business at a quality price.
Thomas Smale: Exactly. I think that's kind of- that's my fundamental view. And I'd say, to my point earlier, that's definitely changed. If you asked me 10 years ago, I would say no, absolutely, the only way to do it is get a good deal on the way in, but that's because I was primarily like on the buy side and that's what I was doing. And my time was essentially worth nothing. Like if I could pay my rent and feed myself that month, that was an achievement. So, I have a, I guess, a different philosophy now. And also depending on how much capital you're deploying, if you're deploying millions on behalf of yourselves or investors, I think the number one aim is capital preservation. So don't lose money. If you buy a business and it only grows 15% a year for 10 years, yes, maybe the guy who bought the business 30% below market value is going to do better, but there's also, if you run scenario analysis, the guy growing the business 15% one year for 10 years is going to win in a significant number of those times. Yes, there will be the time where the other guy doubles the business every year for 10 years. But they're also going to have scenarios where they go to zero. So, I think part of it is kind of my adversity to risk has changed as I've become more fortunate in my financial position.
Eric Jorgenson: I think that's a really interesting- it's an underrated piece of the puzzle. I think people sort of stand fast and like draw their sword to defend their strategy no matter where their point is in life and forget to contextualize it in the sort of what their time is worth to them at the particular stage. Like what is the alternative, the BATNA of their incremental hour, how much capital do they have to risk, which is a huge consideration for all of these strategies. So, what is the- if I was sitting with two prospectuses on my desk and one was from an unaudited, shady, amateurish, let's just say, business broker versus an FE International prospectus, they might look the same to me if I was uninitiated and didn't know. So, what is the work that sort of differentiates an audited, guaranteed sort of like well processed prospectus from something that an amateur has whipped up to somebody who doesn't see behind the scenes?
Thomas Smale: Yeah, well, firstly, there are no guarantees. So yes, we do the work, but you're not getting a stamp of guarantee from us saying you buy this business, we a hundred percent guarantee all of this is accurate.
Eric Jorgenson: Sorry, poor choice of words on my part.
Thomas Smale: It's an important distinction because I'd be lying if I said we guarantee it. It's not what we can do. We go through and we verify and the reason we want to do that is ultimately we want buyers and sellers to do well. If buyers buy a business and it's misrepresented and they don't notice and they lose their money, that's not good for us. That's not good for the industry. We haven't been around 12 years by selling businesses which suck and are misrepresented. On the outside, if you just compared those two prospectuses, you probably wouldn't actually notice the difference because the majority of audit work is done behind the scenes. So, if a cost line says they spend $10,000 on X and the other perspective says $10,000 on X, probably the fundamental difference is we have verified that they've actually spent $10,000 on X, and the worst broker has almost definitely not done that. At best, they've taken the seller's word for it. And what we find in almost all cases when we do our financial audit, I would say in almost a hundred percent, so not quite, but almost a hundred percent, the financials given up front by sellers do not end up being the actual financials we end up with. And there's a tradeoff between were they misrepresenting intentionally? If they were, we drop them immediately. Were they- Accounting in business is complicated. It's not always that simple. So sometimes, particularly in like e-commerce businesses, for example, like the cogs are like, how much does it cost you to buy this? And they're like, I don't know, 10 cents, but then you actually look at it and say, okay, we'll actually cost them 11 cents for the last six months because, I don’t know, shipping costs have gone up or whatever it might be. So, a big part of what we do is kind of getting the sellers to understand their own numbers, it's not just taking what they tell us and being like, cool, we got them to sign off saying I verify this is accurate. So, the only way you're ever really going to know is when you get into due diligence and you start verifying the numbers. Or, I mean, the obvious way usually, and I would say most bad brokers will do this, they will make sentences or claims which are conflicting within the same document. So, they'll say like it's a growing business. And then you look at the P&L and it's clearly not a growing business. Or they'll say, I don't know, they'll say something like the seller’s devoted his life to building this business. And then how many hours a week do you work? Two. The things are conflicting. Ultimately the short answer is it's difficult until you get to actual due diligence and you start seeing bank statements. And I would say you have to be very disciplined because the average person who's misrepresenting will make up an excuse why they can't send you something. It's like, oh, I closed my bank account, I don't have access to bank statements, or my credit card provider won't give me this, or actually like my friend paid for this service, so I don't have access. So, you do have to be very disciplined. For us, we will almost never, and it’d have to get signed off by me if we're making some form of exception about something like that, for whatever it might be. But the average person misrepresenting, obviously, they know what they are doing, they will do it in such a way that you would not know unless you've done it, like we have, 1200 times. Like we know when people are lying because they'll be like, oh, this bank does not have an online login. We know it does because we have other clients who have, or you call the bank and you check. There are lots of different ways to get around things like that. But yeah, outside, you will not tell the two prospectuses are different. The worst brokers will generally have conflicting information in there, but that doesn't necessarily mean it's misrepresented. It's usually just that the broker is not very good. And that also does not necessarily mean the business is bad. A lot of good businesses hire bad brokers, and a lot of bad businesses hire good brokers. So, you can look it at lots of different ways.
Eric Jorgenson: Well, it feels a little like bowling with bumpers to have somebody who is a professional auditor kind of working with you on this process. Because I know like navigating that yourself and checking every assumption and drilling down and asking for every piece of information that might be hiding something. I have friends who have gone through this as business buyers, and it's a harrowing process of discovery and persistence and just trying to stay organized and look under every stone and find every risk. It's hard work. So, I don't begrudge you the service that you provide at all. That seems very necessary. And actually, thinking through this, it's like especially for a first-time buyer, I can really imagine a lot of value coming from having someone kind of hold your hand through experiencing a lot of these things and showing off what you can do and shopping in a marketplace with a certain quality afford to it. There's a lot to be said for that.
Thomas Smale: Yeah. I don't really think it helps a first-time buyer, but like I said, conversely, if you have a lot of capital to deploy and you need to buy one business a month for the rest of the year, then that can also help simplify your job. So, I guess there are advantages throughout the process. Fundamentally, like my philosophy since day one of the business is I want the overall industry, and this was essential starting out when the industry was tiny, I needed the industry to grow. The only way the industry grows is if legitimate transactions happen where sellers get rich and buyers also get rich and do well because those, the people who have their first exit selling online business, what do they do with their money? No, they don't go buy real estate. They go buy another business or they go to do some angel investing or they do some venture investing or they become an LP in a fund. So, a lot of the people we work with, they've come full circle. Maybe they're not launching another business from scratch, but you can be pretty sure they're not leaving the industry. Maybe they become mentors. Maybe they launch a coaching business. But they're all staying in the ecosystem and kind of being helpful. People generally don't make their fortune and leave an industry entirely.
Eric Jorgenson: After all that hard earned wisdom, absolutely. Speaking of hard-earned wisdom, I imagine that across these 1200 transactions, there is a treasure trove of data inside FE International. And from my perspective, as a voyeur, I only see basically PDF versions of this. Is there like a massive database of structured data that gives you this God's eye view of like marketplaces and industry and valuations and kind of helps you like screen out things? Like, are you looking at not different data, but differently contextualized data internally or when you kind of as an expert get to go shop in this industry?
Thomas Smale: For sure. I'd say on- So firstly, when we put together valuations, so in our prospectus, you might see from a financial perspective, you probably see a snapshot of one tab of an Excel spreadsheet, essentially. In reality, going into that deal behind the scenes, there are probably 40 or 50 tabs of analysis to then simplify and show it in a simple way. But there's tons of analysis going on behind the scenes. We track literally everything, all the data on everything. So, when we value a business, we’re I guess fortunate because we've done so many deals, we have a comp for everything or multiple comps, so we can value very accurately, particularly businesses we've sold before or similar before, we can be very confident in the accuracy of our evaluation. And we pull in all of that data so we can spot trends. We can make theories about what buyers are willing to pay for, what they're not willing to pay for. We can be very objective in our approach. We don't just look at a business and say that looks cool, I think someone will buy it. I read an article that said businesses are selling for this. Let's just choose that number. It's all of modeled out. There is an element of- there's a lot of science. There's definitely an element of art. I would say it’s 80% science, 20% art when it comes to valuation, because there is an element of this looks like a good business, we haven't sold something exactly like this before, but we know buyers will like it. Or actually, you know what? This looks like a good business, but there's actually a fundamental problem. We shouldn't take it on, even though it seems objectively like we should. Which I mean, ultimately is what we're- I guess ultimately talking about like alpha, that's how I make my money is making a good judgment call on what we can sell and what we can't sell. If we just took on everything that looks good, then we almost definitely would not have a business. Yeah, so tons of data to answer your question. What you see in the prospectus is a very summarized version of all the analysis we've done, but there's always a tradeoff between giving too much analysis and not enough. So, we keep the prospectus to a snapshot. And then if you ask our team, oh, hey, do you have a breakdown of like cost by product, we can send that to you. We will probably not send you what the actual product is and what the supplier name is. But we might say products one 10 cents, product two 15 cents, that kind of thing. So, it's all there, you just don't see it as a buyer.
Eric Jorgenson: Super interesting. So, it sounds like you're pretty opinionated about the valuations of these businesses. Is that a tough conversation with sellers who maybe come in with different notions of what their business should be going for?
Thomas Smale: There are lots of tough conversations, but ultimately, we're always honest with people. And I think fundamentally, because we only get paid if a business sells, we have no incentive to lie or misrepresent what we think a business is worth. Does that mean we're right a hundred percent of the time? Absolutely not, but we can be as accurate as we can. And then when we need to be, optimistic. We then make a judgment call. So, if we say, hey look a business, we think this business is worth 10 million, and the seller's like I really want 11, and we think it's a good business, we'll probably have a go. If we say it's worth 10 million and they're like no, I need 25, we're not going to take it on. So, we almost never take on- sorry, we never take on businesses where we think the valuation is unrealistic. I'd say the conversations have got not necessarily easier, but as the industry has got bigger, the average person in the space has got more knowledgeable, I'd say there's definitely less surprise conversations where people are like, oh my God, I was absolutely not aware that's what the market was like at the moment. I thought everyone was paying 20 times revenue for every business. I mean, there's definitely still some of that, but I'd say on average, the average person today is better educated around valuation then say 10 years ago. And we're always honest. We’ll, because I always say this is a team, it is always kind of maintained discipline within the team, the team will often get frustrated when another broker or M&A firm will list a business that we were speaking to, but they'll list it at double our valuation. But my point to the team is did we get the valuation wrong? Probably not. Are they just being overly optimistic and will the business not sell and will they then call us in 6 months? Yes, that's exactly what will happen. So, I mean, we've been doing this a very long time, so I've seen it all before at this stage and am happy to be disciplined and like wait it out.
Eric Jorgenson: I don't know if this is fair to ask you on the spot or if you're comfortable sharing, but would you be able to kind of ballpark multiples for maybe like content businesses, SaaS businesses, and e-com, your main three categories?
Thomas Smale: Yeah, I mean, in terms of at a high level, yes, at the moment in terms of multiples, and this is very broad, just an indication, because I'd say discussing how evaluations work is probably another couple of hours on a podcast discussing, fundamentally, if we break it into our three headline business models, which is SaaS, content, e-commerce. So, lots of SaaS business models within that. Yes, we sell some businesses which are hybrid. Yes, we sometimes sell service businesses which are not exactly fit within the exact business model, but they're very close. SaaS businesses are generally the highest of the three. Usually, we see multiples anywhere from 4 to 10 times annual SDE. So annual SDE, for simplicity’s sake, is essentially net profit of the business, not taking into account what the seller’s compensating themselves. Content businesses, anywhere from 2.5 to 4 times annual. And then e-commerce businesses, anywhere from 2.5 times to about 5 times annual. Again, that's very broad. That's our current data. In 12 months’ time, that will probably be different. 12 months ago, that was also different as well. But I’d say very broad, that's what businesses are selling for. Some will sell for more. There are a lot that will sell for less but businesses we would not take on. But just because the average business we represent and sell falls within that multiple, that does not mean the average business is in that because, arguably, we take on the upper threshold of like good businesses. So probably not the absolute best businesses because the absolute best businesses either do not get sold or they get bought privately for way above market. Do not sell the absolute worst businesses because they're not making any money. We sell like kind of let’s call it the top 20% of businesses, not including the top north 0.1%. Whereas the average business, just by the very definition of average, is probably not in that.
Eric Jorgenson: When I first learned this combination of things, there's kind of two concepts in that explanation that I remember understanding maybe for the first time when Brent Beshore explained them to me, and both of them sort of opened my world view and seeing like, oh, you can take a business that's earning a hundred grand a year or a million dollars a year, and the quality of that revenue and the durability of the business. Like this is where moats get quantified in the multiple that they earn at sale. So, if you own a business your whole life and you never sell it, it doesn't matter what the multiple might be if you're earning a million bucks a year. If you go to sell that business, all of a sudden, it matters a lot whether you get a 3X multiple for your million-dollar business, which means you sell the business for $3 million, or whether it's a 10X multiple, and you sell a business for $10 million. So that was a huge kind of like, if you're starting from zero and you're looking at these multiples, you're like, well, I was going to flip a coin and either start a content business or a SaaS business, you're like, oh shit, well, I'm going to start a SaaS business because I can sell it for way more. It is higher quality revenue. It's a more durable moat. And the other was seller earnings or seller discretionary earnings which is like for your definition of net profit plus what the seller is pulling out of the business, which in a lot of these businesses, and I tried to write a blog post about this, like proximity to profits. A lot of these small businesses, yeah, there's a hundred grand in net profit, but there's also 200 more grand where the seller is paying themselves rent, they're covering their vehicle expense, they're covering their home office. And the net sort of benefit to the owner of the business is maybe $300,000 instead of that pure hundred thousand that comes out as a net profit. The process of like adding all of that back in to valuing the businesses really is a gray area, but it's a really interesting sort of set of judgment calls. And I'm sure your accounting teams do a lot of this work to sort out what's a fair claim and what's not. And I don't know, understanding that all for the first time really opened my eyes to a lot of things about the business world.
Thomas Smale: Yeah, for sure. I mean, there's definitely a lot to learn and like the conversation around what's a valid add back in, how do you calculate SDE is an ongoing debate and there's no perfect answer. And one thing I would say, I know this is not a question, but I'm going to give an unsolicited answer, just because multiples are higher for a SaaS business, because people ask me this all the time, does not mean you should launch a SaaS business. If you are, to my earlier example, the mum blogger who is a great cook, you should write about your recipes, and people will read about your recipes and that will make you money. So, you should definitely focus on what you're good at. And also, while multiples for a SaaS business are higher than say content or e-commerce business, arguably, it can take longer to get off the ground and start. So, this is one way I position it. And I'm not arguing in favor of any of the particular business models, because it really depends on what you're good at and what you like. I've seen far more businesses in the e-commerce space get to a million dollars revenue in a year than I have seen SaaS businesses get to a million dollars in a year, which is, I would say in SaaS, it's almost never. And in e-commerce, it's reasonably common. So yeah, there's not necessarily- do not pick a business model because the current multiples are higher. So, while I believe like long-term because SaaS has that recurring flow of income, yes, those businesses will probably always be valued more than content and e-commerce. If you're starting a business today, you're not selling it for 3 years, 5 years, 10 years, so like you shouldn't really be looking at current valuations, maybe like the intrinsic parts of the business model that will not change.
Eric Jorgenson: Is there a way to get a price, while we're talking about valuations, on a business without like taking a ton of time, committing to the sale process? Is there like a Zestimate for businesses or is what we're talking about, the multiples, kind of like as close as you can get?
Thomas Smale: Yeah. So, one, you definitely can't get Zestimate. Again, I'm not in the real estate, so you can get an estimate. There are definitely people that tell you you can get a Zestimate. There are definitely like automated valuations you can get. But automated valuations for a business, I would say, do more harm than good because either they're going to give you a really broad range or they're going to give you an unrealistic range, or I guess there's also a possibility sometimes it'd be correct. But what if the automated valuation tool tells you your business is worth a third of what it's actually worth? Or what if it tells you it's worth 10 times more than it's actually worth? Like in neither situation is that good information to have. I mean, one thing we do fundamentally as a core of our services, we offer free valuations to anyone who has a business we think will be a fit. So, you don't have to hire us or pay us to do a valuation. I guess that's kind of our hook essentially. And because we're- it's kind of like a getting to know you process, like we want to make sure the business is a fit, we can actually sell it. And equally sellers want to kind of understand how we work, what we analyze and go from there.
Eric Jorgenson: That was a perfect AlleyOOP that I didn't even know I was throwing. That's a great service and it makes total sense. Cause I imagine there's people who- I mean, it's kind of also an answer to the question that I'm sure a lot of entrepreneurs have, which is like if I want to be planning to sell my business eventually, like how do I preserve that option? How do I optimize? How do I just avoid the dead ends that cut that option off for me in the future? So, starting a relationship maybe now and understanding some of the inputs to that valuation is the right approach.
Thomas Smale: Exactly, that's really my main tip is like start- like M&A firms like us, I mean, we've been in business 12 years. That does not mean that every single year, the people we do business with we met in that year. The vast majority of people we are working with today are people we met 5 years ago. So, it's never too early to start a conversation. And to my point earlier, like we'll be super honest and direct if it's not a fit for us. If you come to us with a restaurant and you say, hey, can you value it? No, we can't. Can we recommend somebody who can valuate it? Probably not either, because we just don't know that space. And I don't pretend to know that space. If you have a SaaS business and you want to get a valuation, we can value it and it will be accurate.
Eric Jorgenson: Do you have a sense- You mentioned something earlier that very top 0.01 or 0.1% of businesses sort of get done quietly for above market valuations. And then the bottom end of the businesses are just not probably sellable at all or are just in the process of going out of business. Do you have a sense of like what percent of deals get listed on a marketplace or with a firm publicly versus just get done quietly? Like, is that closer to 50/50? Is it closer to 90/10, 10/90? I wouldn't even know how to sort of guess at what that breakdown is.
Thomas Smale: Yeah, to be completely honest, it is very hard to know because one thing I've learned is what people tell you and what actually happened are not usually that accurate. So a lot of people say, oh, I had an exit, but an exit could have been like they assigned it to someone for a dollar. To your point about nexus of contracts, like yeah. So, a lot of people will say, and I will say, obviously I have a very privileged seat, I know a lot of private details about people. A lot of people that will tell you that you've had an amazing exit. I know their exit was actually relatively small. And people who you never hear from ever and might say, oh, I sold a small business have $20 million in their checking account. Whereas the person you think is the famous guy on social media of 150,000 followers who has on their bio three exits, those exits might have totaled like $40,000. So, while I'm not belittling, like any exit is a good exit, essentially. But I would say it's very hard to get the reality of private exits because in my experience, almost everyone lies or will slightly change what really happened and things like marketplaces, for example, where I guess you could argue that it's like a privately done deal rather than a represented deal. The way that often works is if someone like removes their business from the marketplace, they're like, oh, it sold. So, if they had it listed for $10 million and then they remove it or they actually sell it through a broker or something like that separately, it then gets removed, so the marketplace is like, wow, we did a $10 million deal. But the reality is they didn't. And it did actually happen for 10 million or did it actually happen to 2 million? Who knows? I would say they might get- if I were to guess, I would say probably about 50/50 deals done privately, deals done through M&A firms. And then I would say, or business brokers, I mean, there are lots of different categories depending on how big a business is. I would say as businesses get bigger, they are much more likely to have had professional representation. The smaller deals, more likely to have got done privately. The way I look at it internally is anything below- marketplaces have a place in the industry for businesses, but I’d say they're really only good below about a hundred thousand dollars in valuation where businesses relatively lack complexity, don't need a huge amount of legal deal structuring, buyers are paying cash. As deals get bigger than that and more complex, you need professional representation. So, do people try and do it themselves to save on the commission? Yes, but it's exactly the same as like people making a million a year who try to do their taxes with Turbo Tax. Can you do it? Yes. Did you save some money? Yes. Is it a good idea? No, because you probably actually lost money in deductions.
Eric Jorgenson: You should be thinking about return on headache, not saving every penny by that point. So just as we kind of wind up here, I'm curious a little about the kind of post-sale transition process. Like, what is the work required to actually hand over the keys between some of these businesses? I imagine that's not a small amount of work, but I also imagine it's a lot easier with a SaaS business than a carwash, but maybe I'm wrong. And how involved is FEI in that piece of the stage?
Thomas Smale: I’d say it depends. So firstly, we're as involved as the buyer and seller want us to be. At the very least, we are ensured that the legal element works properly. So, you are buying X, that includes a list of 20 assets. Here's a list of 20 assets and like the usernames and passwords or whatever it might be. So, we make sure that legally, the transaction is consummated and there is not a situation where some things got forgotten or missed out. The technical side of the transfer really depends on the business and the buyer. Like if you're a first time buyer and the seller is working full-time on the business, then the transfer is probably going to take quite a long time because the buyer's going to have to learn the business. The seller is super-involved, there’s probably a bunch of processes they haven't written down. But the flip side could be super experienced buyer who has a portfolio of 10 companies in that exact industry and the kind of seller is relatively hands off. And that the handover could literally be like here's the usernames and passwords, we'll have a call in like a month just to make sure we're doing everything properly. So, a real mix, but I'd say we've kind of got the time and hassle down to a minimum at this stage with our process. It's very much still part of our service. We're not just like- our job is not just to get the contract signed. Our job is to make sure the business is transferred because with, and this is what a lot of people don't realize, when you're buying a business, the most important time period is the first three months. If you take it over and you don't- you mess something in the transfer or you forget about something or you don't get trained properly, you probably are not going to do very well with that business. So, the initial handover and training is the most important part of the process. So, from a long-term success. So, we're very hands-on there. It really depends on the business in terms of how hard it is to take over. We'll do a reasonable amount of prep with sellers in advance. So, we'll ask them how well documented their code is, their processes are, their suppliers and things like that, and then we'll make them document it throughout the process, so when the sale actually happens, they're in a good spot.
Eric Jorgenson: I seriously could ask you questions all day. This is endlessly fascinating to me. I have one more that I'm deathly curious about and then maybe we'll just have to do this again because we're running out of time for my infinite curiosity and limited time and yours as well. What is the- like how much do you know about how successful your buyer alumni are? Like, whether personally or professionally, like is that part of the pitch on the buyer side is like 80% of our buyers have become successful? Can you not speak to that at all? Like neither would surprise me, but I guess I'm curious how much-
Thomas Smale: Yeah, we definitely track it. I'd say we don't pitch it as a sales pitch because, ultimately, we're representing the seller. We can't also represent the buyer. While we want to present ourselves as legitimate, what we're selling is not 80% of buyers are successful. Because ultimately buyer success doesn't, and this is the dirty secret no one will tell you, it doesn't really come down to the business you're buying. It comes down to how competent the person buying the business is. Like a good operator can run most businesses successfully, even if the business is not that great, and a bad operator is going to run a fantastic business into the ground, regardless of what happens. So, we don't pitch the percentages of success because there's too many variables that go into that. I’d say anecdotally, we have a lot of buyers who started out relatively small and they've built huge portfolios now, and they've now raised investor capital and they've done outside. A lot of people just buy one business, and they're quite happy making a nice living, working 5 hours a week, hanging out with their family and kids or whatever it might be. So, there's like what defines success? Is it growth? There are lots of people out there who just want to make a living. They don't want to be making millions a year. They just want to have time. And there's kind of always a tradeoff of time versus kind of return. So, no, we do not track it in a huge amount of detail, but we do at the same time, track repeat business; we want to make sure buyers come back. But there are lots of- It's a bit of a catch 22. If a buyer does really well, they're never going to come back because they don't need to because they've turned their $10 million acquisition into a billion dollars. If they do really badly, they’re obviously not going to come back either. It's the ones in the middle that are most likely to come back. The guys buying businesses, like I said, where they have 15% annual return on a good bit, you can do that every single year, raise more money every single year, and it will compound quite nicely. They're the ones who come back and they're the ones, not the ones we care about, that's the wrong word, but they're the ones we focus on making sure they come back.
Eric Jorgenson: Beautiful. Okay, well that is a wonderful overview I think of both things. I really appreciate you taking the time and being so candid and sharing everything that you know. So where would you recommend anybody who's still got to some curiosity to go follow up and dive deeper?
Thomas Smale: So, I’d say like on FE website, we have a lot of content we've published over the years, a lot of written content primarily, other podcasts I've been on where we might have discussed different topics, you can find them kind of as you navigate through our site. We regularly publish like white papers and more data, which is the kind of thing you might be interested in. Some people just want to read about like success stories. We have a real mix and a bit of everything. And then if you want to contact us, it's kind of obvious how you do it on our website. On social media, I'm pretty active on Twitter and LinkedIn and Facebook. They're probably the three easiest ways to get ahold of me. Or you can always email as well, and that will get picked up as well.
Eric Jorgenson: Okay. Thank you so much, Thomas, for taking the time. It was wonderful to meet you and learn a little bit about all the hard work behind the prospectuses that have taught me so much. I hope to do a transaction with you at some point in the future, but you’ve given me a lot to think about.
Thomas Smale: Me, too. Well, thanks so much for the discussion. It’s been good.
Eric Jorgenson: I appreciate you hanging out with us today. Thank you so much for listening. I learned a ton from Thomas, and I hope you did too. If you want to keep digging into similar topics, you will really enjoy my episode with Andrew Finn. It was an episode from very early on, but Andrew's the friend I mentioned in this episode. He is a buyer of these small businesses and talks really in depth about the shopping process, the valuation process, integrating those businesses, managing them, scaling them, and growing them. It's a very interesting episode. And I learned a lot from Andrew. Also in this vein, my episode with Codie Sanchez. Codie owns I think 26 businesses and equity in another couple dozen. She really talks about how to acquire some of these “boring” businesses, a little less tech focused than this one, but really interesting insights about how to sort of scale up one of these strategies and apply it consistently over time. Again, thank you to our sponsor founderspodcast.com. You can support the show by supporting them or by investing with me in Rolling Fun. Links to both are in the show notes. Check out my website at ejorgenson.com. And if you're looking for a free way to support the show, please leave a very quick review for the show or text this episode to a friend or coworker who you think would enjoy it. I really appreciate you listening. Thank you so much for taking the time.