Piggy Bank or Performance Engine? Why Quality of Earnings Defines Valuation

Is your business a piggy bank or a performance engine?

In this episode of Buyers’ Frenzy, host Will Lindstrom sits down with Patrick McMillan, leader of the Transaction Advisory Practice at Amplio, to dig into why quality of earnings (QoE) determines whether your business earns a premium or leaves money on the table.

Patrick explains how EBITDA multiples are shaped not just by revenue, but by the strength and credibility of your financials. 

From customer concentration and vendor contracts to employee agreements and balance sheet integrity, he shows how real value is created by de-risking operations long before you sell.

Drawing on his CFO and advisory experience, Patrick shares how sloppy practices - like treating the company as a personal piggy bank - erode trust and suppress valuation, while clean books and proactive QoE reviews can add multiples to your exit.

Highlights Covered

• Why EBITDA is the “level playing field” for valuation in small and mid-sized companies
• How quality of earnings reveals both risk and opportunity in a business
• The dangers of using your company as a personal expense account
• Real-world examples of how clean books improved valuation (and reduced taxes)
• Why being “exit ready” is just good business, even if you’re not planning to sell
• How a proactive QoE report can strengthen operations today and maximize multiples tomorrow. 

Whether you’re actively preparing for an exit or simply want to run a stronger company, this conversation shows why quality of earnings is the linchpin of valuation success.

Have insights on “Deal Killers”? If you’re a CEPA, CPWA, CFP, or fiduciary with experience navigating the hidden risks that derail deals, we’d love to hear from you. Connect with us on LinkedIn or at theculturethinktank.com/contact

Chapters

• 0:00 Introduction to Patrick McMillan
• 1:12 EBITDA's Critical Role in Valuation
• 3:45 Quality of Earnings Case Study
• 8:37 Being Exit-Ready is Good Business
• 11:14 Quality Assessment at Any Time

Transcript

William Lindstrom: 0:00

Today I'm pleased to welcome Patrick McMillan. Patrick leads the Transaction Advisory Practice at Amplio, where he brings extensive CFO and Transaction Advisory experience, specializing in quality of earnings, financial due diligence and helping leaders prepare for exits and acquisitions. Over his career, patrick has advised companies across industries, guiding small and mid-sized businesses through the financial and cultural hurdles that often make or break a deal. He is known for combining technical rigor with people-first mindset, ensuring both the numbers and the leadership are aligned for success. So with that, I'd like to welcome Patrick. I appreciate you joining us here today.

Patrick McMillan: 0:38

William, my pleasure. Thanks for having me.

William Lindstrom: 0:40

Yeah, really appreciate it. So the topic that we've talked about before relates to EBITDA and how important getting your numbers right, particularly when it comes towards the due diligence process. Since you sat in the CFO seat and advised so many different companies through exits and acquisitions, how do you think through the EBITDA or the numbers question when it comes to valuation, and how important is it in making sure you get those adjusted EBITDA numbers right when it comes to building a good case to sell a company?

Patrick McMillan: 1:12

Yeah, I'm actually going to begin with the end in mind and answer that second part first. How is it important and why, Like it or not? There's so much controversy about EBITDA but, whether you like it or not, it's what companies use about EBITDA. But, whether you like it or not, it's what companies use small to medium-sized companies use to value. Whether you're selling to a private equity or raising money with venture capital and again, venture capital sometimes and sometimes not, will use it, but a lot of them will or any type, even a banking transaction, just raising debt they're all going to look at your EBITDA. So why is it important? It's really it's the level playing field that the companies look at. The industry that a company is in establishes the range, the range of multiples that a firm is in. For example, it's a I'm not going to cover a specific industry, let's just assume it's a four to eight X EBITDA multiple. Where your company falls within that range really is determined by what is your company doing? How high or low quality are those earnings, For example? Where do the revenues come from? How strong are those contracts with those clients? What's the customer concentration? And then, even on the other side, what about vendors and vendor contracts, and are those transferable to a new owner? What kind of contracts are those? Are prices locked in long term? Things like that? And now let's even go into OpEx. Now use employees as an example. Let's say you have three key employees. Do you have good, solid, not just verbal relationships but even contracts with those employees? The stronger that you have things like that in place, then the higher your multiple in that range will go into.

Patrick McMillan: 2:57

It's not just all about the income statement either, William. It's also about the balance sheet. What are your capital opportunities with customers? How much can you expand with customers? How are you funding the company? Are you accounting for things appropriately? For example, construction industry, you know. Do you have over and under billings in the balance sheet, you know? Or even in SaaS, do you have deferred revenue, Things like that? And so it's really those things are extremely important when you're looking at valuing a company. It's not to say that if you're not doing any of that, then your company doesn't have any value. But the more solid that you have things in place and really the best in class companies are going to be in that top range, Well, you have to do everything that's solid to be best in class to get that top valuation. So when I go in and I'm looking at EBITDA, I'm looking at quality of earnings. Those are a lot of the analysis of what I'm doing.

Patrick McMillan: 3:52

It's not just about the numbers, it's not just saying, okay, well, let's add back X, Y and Z, let's add back personal expenses, let's add back non-operating. Yeah, that's part of it. That's the science behind, where you actually have some fixed numbers in there. But the art that's behind it is truly understanding the firm, the owners, the company, the customers, everybody involved in the upline and downline, trying to figure out, well, really, what determines a good quality asset. It's all about risk. How are you de-risking the company as a seller so that the buyer can also have reduced risk? And when that asset, that company, is transferred to them, the more risk you have, then the lower valuation you're going to get. And so you really are trying to de-risk that, not just for a buyer, but let's even say for yourself, because the better you do that then the better you're going to run the company as long as you have it anyway.

William Lindstrom: 4:54

Yeah, if I could touch on that, because that's something that I hear a lot is, the quality of earnings is about valuations, it's about exiting, but I think what you're touching on is the theme that I think a lot of owners are missing or founders that are thinking about. It is actually just having good quality of earning practices is just going to make you a better company. And so can you talk a little bit about the difference between the mindset of, okay, I got to do this stuff when I'm selling, when I'm preparing it for sale, versus these are just the good things to be doing all along because they're just going to make me a stronger company and more successful.

Patrick McMillan: 5:25

Yeah, I'll give you a real example of a company I was involved in a handful of years ago and we hear a lot about probably not so much today, but we used to hear quite a bit about that corporate veil and what that means is make sure that you're keeping your personal stuff separated from your business stuff.

Patrick McMillan: 5:44

Now, let's be honest, not many people do that, especially when you're a small to medium-sized business. You're going to swipe your business card when you buy dinner. A lot of times. You're going to use your business account when you're booking that trip to Hawaii or Fiji because you want to reduce your taxes. But the thing is, is the more you do that, not only you're putting the company at risk, but also it's almost like a mind shift change. Now you're using a company for your personal piggy bank. So this company that was involved in several years ago, they were doing that quite a bit. It was a decent sized company, but what happened is they the owners and their CPA were not communicating about what was what the CPA was thinking. Oh my gosh, all of these expenses are personal expenses and so I'm going to book them as shareholder distributions. Well, that hits the equity section on the balance sheet. It doesn't hit the income statement. So that does two things. Number one it actually increases your earnings, or your net income, which increases your taxes. But here's the thing when I dug in on a quantity of earnings, I was able to look at a lot of those and I identified, over a three-year period, about $900,000 of business expenses legit business expenses. I'm talking about business travel for clients, I'm talking about business meals, you know things like that that were booked to distributions. But I had to move those. I moved them over onto expenses and income statement.

Patrick McMillan: 7:17

Now what did that do? Yes, it reduced the earnings and people listening probably saying well, patrick, oh my gosh, that reduces the multiple. Well, reduces the earnings, reduces the valuation. But here's what it does. It actually normalizes what the earnings you're looking at, what the true economics of the company are. Number one you really have to make sure that that company, the numbers that you're looking at, are the true economics. They reflect what the company is really doing. Number one. Number two yes, it reduced the earnings, but that also, in turn, reduced what taxes they should have paid.

Patrick McMillan: 7:52

So we went back and rethought tax returns so I was able to pay for myself and a lot more after that. So it really helped and we got the company to where it really was reflective. So the buyer that came in it was a private equity group the buyer that came in saw yes, they saw the reduced earnings, but they saw that things were inaccurate and that made a world of difference. You know, for them to be able to gain trust and what we were doing, we actually became their fractional CFO for years after that. So they brought us in to really help make sure that there was a continuity of that. That's why those things are important to be able to say, hey, you know what Earnings may be this, but let's make the adjustments to really truly reflect what they are, not just for you as the owner, but for anybody that's going to operate this business.

William Lindstrom: 8:42

So it sounds like because this is something else that someone shared with me is that you should always have your company prepared to sell, even if you're not thinking about selling. So that seems to be in line with that theme.

Patrick McMillan: 8:53

Yeah, and thank you for bringing us back to your original question Exit ready. Being exit ready or prepared to sell is just good business in general, because as you're doing those things to prepare for what an outside perspective would look like, then really you're just making your business more solid Again, you're reducing risk, not just for a buyer but for yourself, and as you do that, then inherently your business is going to become more solid and probably even grow, whether it's revenue and or earnings or both. And, let's face it, that's why you're in business. Right, you need to make money. It's probably something you are enjoying. I hope so.

William Lindstrom: 9:32

Yeah, and again, I think it's that quality of earnings and also making sure at least from what I'm hearing from you it doesn't matter the type of company or the size of the company. You don't want to treat your company like it's a lifestyle business. It's just not. You need to treat it like it's a business business. And that starts with the books.

Patrick McMillan: 9:47

Exactly To kind of bridge that gap between well, but I want to reduce my taxes and so I'm going to use it for a personal piggy bank. But the thing is is when you do prepare to sell and someone comes in and does a quality of earnings, the more adjustments that have to be made, the lower the quality is. And so if you start that practice now, make that separation, don't use it for your personal piggy bank then you're actually automatically by default increasing the quality, right there.

William Lindstrom: 10:17

And increasing the quality of earnings gets back to that multiple. So I think that's the other thing that people, if I'm doing my math right, you may reduce. Let's say you're a million dollar business and you may reduce it 200,000. So it's only reflecting 800,000 in earnings. But if your quality of earnings is greater and you're going from 3x multiple to a 4x multiple, your net on that actually turns out to be you're making significantly more money when you take into consider the exit.

Patrick McMillan: 10:46

Exactly. And when you look at an average let's just say a multiple is going to be 4x, then in your example that $200,000 times 4, that's automatically 800 grand more in purchase price.

William Lindstrom: 10:58

Yeah, and so that makes a big difference in all of that. No, I appreciate that that's all really really good insight about making sure that you run your business with strong quality of earnings from the very beginning, because it's just going to give you that extra one or two times X, which makes a big difference when you're exiting.

Patrick McMillan: 11:14

And William. If you don't mind, I want to add a point here.

William Lindstrom: 11:17

For sure.

Patrick McMillan: 11:18

You can get a quality of earnings at any time. It's not just for transactions. I have done a lot of sell side quality of earnings just to help a company see where they're at. My valuation company that we use will do valuations every year on many companies because they want to see how everything that they're doing actually helps create better value, and a quality of earnings will help you do that. I will do a list of hey, here's some recommendations I can set up for you so that you can have a better quality of earnings next time you do one.

William Lindstrom: 11:53

And that's I think. Again, it just sounds like the cleaner the books, the stronger the quality of earnings, the greater the multiple, and that's really what you're after. So you can't start too early is also what I'm hearing, because that's, I think, also what the wealth managers and the SIPAs are all about too is just get ready to sell even when you're not thinking about selling, so that way you just have a strong book of business.

Patrick McMillan: 12:16

Yeah, you nailed it right there.

William Lindstrom: 12:19

Awesome. Well, thank you so much for those insights. I really appreciate it. Again, thank you so much for your time and would love to stay connected and keep having these conversations with you.

Patrick McMillan: 12:28

Let's do it, please do. I'm excited to hear more about your research and how it goes. And, yeah, when you publish that, I'd love to read it.

William Lindstrom: 12:35

All right, we'll do. I will definitely share all of that good stuff.

Patrick McMillan: 12:38

Nice Sounds good. Thanks, man.

William Lindstrom: 12:40

Thank you.