How to Spot Financial Red Flags BEFORE You Buy a Business | Mitch Petracca

Brian Luebben (0:01)

All right, what is up, Action Academy Podcasts? Welcome back to another episode of the Action Academy Podcast, Corporate America's Least Favorite Podcast. Guys, today we are talking about a topic that is not normally discussed. It's not the sexiest topic at the very beginning of the acquisition journey. Everybody wants to talk about, oh, I'm gonna go get so many deals. I'm gonna talk to so many brokers. I'm gonna get under contract.

And then what? What happens? How do you know if a deal is lying to you? Spoiler alert, they probably are. It's just how much are they lying to you? And there's one way to find that out, ladies and gentlemen, which is through what's called a quality of earnings report. So today I have my friend on Mitch Petracca that's gonna be walking us through what a quality of earnings report is, how to identify when it's the best time to be able to pull one off, how to get the maximum ROI from one, and how to be able to differentiate between different providers and know which provider is the best one for you. So Mitch, welcome to the Actually Heavy Podcast. How are you doing?

Mitch Petracca (0:59)

What's going on, Brian? I'm doing great. Thanks. Appreciate you having me on.

Brian Luebben (1:02)

Yeah, I appreciate you coming on. Long time coming, mutual connection of Sam Silverman. So shout out Sam for making the connect and super excited to jump in here, man. So talk us a little bit about your background, kind of what got you into this space in general. And then of course, defining what quality of earnings is.

Mitch Petracca (1:19)

Yeah, absolutely. So I'm a CPA. I started my career at PwC and I was going the very traditional CPA route starting in the audit practice. Found out that I didn't really like checkmarking things that were pretty obvious within companies and wanted to add more value to them, rather than just pushing paper around. And so went into their M&A transaction advisory group and cut my teeth on upper market transactions, large private equity companies in Boston, primarily being capitals of the world and those types of things.

A little bit better there, but you could add value, look into a lot of new companies very quickly, but found that I could add even more value in the lower mid market. So I found in my own firm five years ago, really focusing on delivering quality of earnings to the lower mid market at a better quality. And a big part of that, Brian, is using technology to keep hours down so that we could hire the big four level quality, but keep the price to a reasonable amount that people going out and buying their first business could actually afford.

Brian Luebben (2:21)

A hundred percent. So let's walk through exactly what quality of earnings is, because for somebody that's outside of their first acquisition, maybe they're even familiar with buying a business and they're familiar with, okay, cool. I talk to a broker, I get a SIM, CIM, Confidential Information Memorandum. I see what the terms are. I talk to the seller, I submit an LOI. I get the LOI accepted and a lot of people haven't really walked through or talked through what happens after that.

And so a big thing that you do is you get a Quality of Earnings Professional on SpeedDow right away. So Mitch, what is Quality of Earnings? And walk us through what exactly this service even is.

Mitch Petracca (2:59)

Absolutely. So everyone refers to it as Quality of Earnings. I think the better way to think about it is financial due diligence, which is the other term that you hear people use. And that's an umbrella that includes a Quality of Earnings analysis. But basically what it means, Brian, is the company is telling you how much money it makes. Does it actually make that much money? And that's a pretty core thing to understand about a business that you're looking into, right? If they're telling you they make a million dollars a year, you better be sure that they're making a million dollars a year before you put an SBA loan on it. You're personally liable for that amount that you're going to have to pay back the bank. So the two things you need, no matter what business you're acquiring, no matter how big that business is, is a lawyer to do the legal agreement. I think we all know that based on real estate and everything else.

But the second is the quality of earnings and financial due diligence process to make sure that the numbers are clean and you're actually buying what you think you're buying from a cash flow generation perspective.