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Creating Value In Business, Automatic Customers, and the Art of Selling Your Business with John Warrillow

Lace Gilger
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In this episode, we talk about the major factors that drive business value, how to build recurring revenue, and the inside baseball of how to make the right choices when selling a business with our guest John Warrilow. 

John Warrillow is the founder of The Value Builder System™, simple software for building the value of a company used by thousands of businesses worldwide. His best-selling book Built to Sell: Creating a Business That Can Thrive Without You was recognized by both Fortune and Inc. as one of the best business books of 2011 and has been translated into 12 languages. John is the host of Built to Sell Radio, ranked by Forbes as one of the world’s 10 best podcasts for business owners. In 2015, John wrote another best-selling book, The Automatic Customer: Creating a Subscription Business in Any Industry. John completes the trilogy with his latest book, The Art of Selling Your Business: Winning Strategies & Secret Hacks for Exiting on Top (being released Jan 12, 2021). You can follow John’s work by signing up at BuiltToSell.com.

  • What are the major factors that drive business value?

  • A business has to be able to THRIVE without the owner

  • A business is like your kids - you want them to be happy functioning adults, you want them to succeed on their terms - without you

  • Your job is to get your company to a place where it can stand alone

  • If you get this wrong, you often get stuck in long term earnouts or as a minority shareholder in your own company

  • If you can structure your company to run without you, you have the "ultimate poker hand"

  • Having a BATNA helps drive more effective decision making

  • What are the major drivers of building a company that can thrive without you?

    • Build recurring revenue (it doesn't have to be in a software company) - simple recurring revenues for things like service contracts

      • "Yeah yeah I know... but..."

      • The biggest impediment to coming up with a recurring revenue model is often owners trying to "boil the ocean"

        • Niche down / segment your customers by buying behavior and try to create homogeneous customer buckets based on BUYING BEHAVIOR.

    • The six forms of recurring revenue

      • Consumables - what do your customers run out of?

      • Sunk Money Consumables - buying a razor and then the razorblades

  • The "slow reveal" when selling and how to keep control over the sales process

  • Questions to avoid answers for acquirers

    • "What do you want for your company?" / "What do you think is a fair price?"

  • Classic mistakes that sellers tend to make

    • No-shop clauses in an LOI

    • Tell the acquirer that you will do the deal on one condition "no retrading"

    • Positioning your business in an industry with a low valuation multiple

      • Approach this as "staging" your house vs "renovating" your kitchen

  • The critically important relationship between price and terms

  • Major drivers and differences between price and terms

    • Working capital numbers

    • Earnouts

    • EBITDA Adjustments / Addbacks

      • TTM?

      • Last year?

      • What adjustments

  • Homework: Think about your "pull factors" (something you're excited to go do next) and "push factors" (what frustrates you about your business) - go TO something, don't leave something behind.

Thank you so much for listening!

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Episode Transcript

[00:00:04] ANNOUNCER: Welcome to the Science of Success; the number one evidence-based growth podcast on the Internet, bringing the world’s top experts right to you. Introducing your hosts, Matt Bodnar and Austin Fabel.

[00:00:19] MB: Welcome to the Science of Success, the number one evidence-based growth podcast on the Internet with more 5 million downloads and listeners in over a 100 countries.

In this episode, we talk about the major factors that drive business value, how to build recurring revenue, and the inside baseball of how to make the right choices when selling your business with our guest, John Warrillow.

Are you a fan of the show and have you been enjoying the content that we put together for you? If you have, I would love it if you signed up for our email list. We have some amazing content on there, along with a really great free course that we put a ton of time into, called How to Create Time for What Matters Most in Your Life. If that sounds exciting and interesting and you want a bunch of other free goodies and giveaways along with that, just go to successpodcast.com, you can sign up right on the homepage. That successpodcast.com. Or if you're on your phone right now, all you have to do is text the word smarter. That's S-M-A-R-T-E-R to the number 44-222.

In our previous episode, we discussed the powerful science behind why being hard on yourself often backfires, and how you can harness self-compassion to be healthier, happier, and more productive with our previous guest, Kristin Neff.

Now, for our interview with John.

John Warrillow is the Founder of the Value Builder System, a simple software for building the value of a company used by thousands of businesses worldwide. His best-selling book Built to Sell: Creating a Business That Can Thrive Without You was recognized by both Fortune, and Inc. as one of the best business books of 2011, has been translated into 12 languages. John is the host of Built to Sell Radio, author of the best-selling book The Automatic Customer, and has completed his trilogy with his latest book, The Art of Selling Your Business: Winning Strategies and Secret Hacks for Exiting on Top.

[00:02:15] MB: John, welcome to the Science of Success.

[00:02:18] JW: Good to be with you, Matt.

[00:02:19] MB: Well, we're very excited to have you on the show today. I'm a big fan of your work. The Value Builder System is such a great framework for thinking about and really approaching the way to structure and analyze your company.

[00:02:33] JW: That's great. Yeah. No, I appreciate that. Yeah, it's a systematic way to think about what drives the value of your business. I find, valuation is a very esoteric concept that's very nebulous, where people use a lot of buzzwords and acronyms to try to describe what essentially are a couple of major unique pillars that drive the value of your company. Our goal is to simplify that for entrepreneurs and teach them how to just drive up the value of their business.

[00:03:02] MB: It's such an important point, because a lot of people miss the cornerstones of what are really actually the major value drivers of business. I know, your trilogy of works, if you will, has really hit on a lot of those major pillars. Before we jump into some of the tactics and strategies that can really help you when you're actually ready to exit your business, I want to lay some foundational work and start with, as you said, those big pillars. What are the major factors that drive a business's value?

[00:03:37] JW: Yeah. I mean, there are eight unique drivers. They all have one thing in common. That is that for a business to be transferable, to be valuable in the eyes of an acquire, it's got to be able to thrive without the owner. So many companies, the owner is in the epicenter, right? They're the chief rainmaker for the business, they're the ones who oversee production of whatever product or service they provide.

Those companies are very difficult to sell, because of course, the owner, or the acquirer knows that once the owner leaves, there's nothing left to the business. What you've got to do is envision that your company has to be able to succeed without you. I use an analogy that I don't know if you've got kids, Matt. For me, it helps because I've got kids, and I think of my job primarily as a dad is to somehow get these kids to a point where they can be happy, functioning independent adults. If I've done that, I will feel happy about it. They don't need to go to Harvard. They don't need to play quarterback for Alabama. They just need to be able to succeed on their own terms.

If we think about entrepreneurship in the same way and envisioning our business as a 15-year-old adolescent, where our job is not necessarily to hit some revenue number, or hit some profit goal, it's actually just to get it to a point where it can live without you. If you've done that, you’ve built a company that you could sell.

[00:05:09] MB: It's such a key insight. I spend a lot of my time looking at and evaluating acquisition opportunities in the lower middle market. It's amazing how many deals you come across companies doing five, even up to maybe sometimes 10 million in revenue. The founder is the cornerstone of the entire company. They have the business listed for sale, and you look at and you go, “I don't understand how this deal could possibly work without the founder.”

[00:05:40] JW: Right, which leaves a lot of deals, where the owner sells 60% of the company and has to roll the 40% remaining into a new entity. The challenge, of course, there is the owner goes from a 100% shareholder, master of their own domain, to being having had just enough skin in the game that it hurts to walk away from that 40% of their equity. They've got to effectively run their company as a minority shareholder for years in the future. That's one of the challenges, I think, with a company that's so deeply dependent on the owner.

It also happens, as you see, I'm sure Matt and your work with service businesses that are acquired using an earn-out, where the acquirer buys a portion of the business, but a big part of the proceeds the entrepreneur stands to gain are at risk in a future set of payments that are contingent on them achieving a set of goals.

Of course, most entrepreneurs and I'm sure the science would bear this out, are not hardwired to work for somebody. Those years are incredibly painful. I'm reminded of a guy I interviewed on my podcast, this guy named Rod Drury. Do you know Rod? Have you ever had him on the show, Matt?

[00:07:00] MB: I don't think so.

[00:07:01] JW: Rod started the company Xero.

[00:07:04] MB: Oh, I’ve heard about him. Sure.

[00:07:05] JW: Yeah, so they're in a battle with QuickBooks for dominance in the accounting package space. They're a SaaS leader in cloud accounting. Anyways, Drury built a company called Aftermail and selling it gave him the money to start Xero. I interviewed him about Aftermail. He talked about his sale, which the New Zealand papers, which is where he's from, trumpeted as a 45-million-dollar acquisition.

If you peel back the layers, the actual sale price was 15 million dollars. Still a great achievement for Rod. The balance was in an earn-out. As Rod described to me, as I talked to him about it, I said, “What was that like being in an earn-out?” He said it was brutal, because he just gone through this incredibly emotional experience of selling his company. He'd been given enough money to live for the rest of his life, in that 15-million-dollar downstroke payment that he received. It was just impossible to navigate this corporate environment of this large enterprise company who'd bought his business.

Needless to say, about six months later, he left the company that acquired his business. Walked away from this entire earn-out, and went on to take the money and build Xero. I think that's a very common occurrence. Earn-outs of this mirage that you that acquires tend to use to try to make the owner feel like they're getting maximum value for their company. Once you get into an earn-out, it is very tough slogging for the entrepreneur.

[00:08:34] MB: Yeah. Without getting too much on that tangent, definitely being trapped in a huge corporate environment after running your own company, I imagine, would be very, very difficult to deal with. All of this really underscores the critical point and this notion that you've written and spoken about extensively, which is this idea of, if you engineer your business correctly from the front-end, and one of the fundamental principles that I think you've really nailed is this idea of beginning with the end in mind, right? Thinking about what are the fundamental drivers of business value? How can you engineer a business from the beginning to run without you, or to stand alone, or to be able to be acquired if you're no longer involved in it? To me, that fundamental lesson, if entrepreneurs can internalize it, is such a powerful learning.

[00:09:30] JW: It sure is. I like to think of it as an options strategy, which means that if you can structure your company that it can thrive without you, you've got the ultimate poker hand. You could sell your company if you want, but a lot of entrepreneurs don't really want to sell. They'd like to know that they could sell if they wanted to. Equally, you could bring in an outside manager to run your company day-to-day and take yourself up to the boardroom and make yourself a chairman. You could sell a portion of it to a private equity group and retain ownership. You could sell it again to a strategic, or you could just pass it down to your kids, or a management team and be confident that it's going to thrive without you.

It's the ultimate poker hand. It gives you everything in the way of options. There's nothing more that will trigger an outsize acquisition offer is to have negotiating leverage, to have it with a call up a BATNA in negotiating lingo, a best alternative to a negotiated agreement, which means you've got a plan B. If you've got a thing, a business that can thrive without you, you've just got lots of options. You could sell, but you're not required to. That gives you the ultimate leverage.

[00:10:47] MB: Yeah, and creating that BATNA and having your company run without you. Again, it creates so much optionality when you have that flexibility and you're not tied into the day-to-day operations of the business. That way you can say, “Hey, you know what? I'm just going to keep operating and cash flowing this company, or growing my equity value, or whatever you decide to do.” Or if I get a really attractive offer, I can sell it. If you're in the weeds every day, and you're an integral part of the major value drivers of the company, it's almost impossible to pull yourself out of that.

[00:11:18] JW: Yeah. It was funny, I was doing a speech to a group of entrepreneurs. This is just prior to the pandemic. I was talking to them about their aspirations. Raise your hand, if you think you want to sell your company. Raise your hand if you want to do a private equity deal, etc. The one guy raises his hand and says, “I want a sailboat business.” I'm like, “All right.” I’m like, “What's a sailboat business?” He said, “A sailboat business is a business that I can sit on my deck chair, put my feet up on the gunnels of myself sailboat, and people will just send me checks”.

[00:11:51] MB: Nice.

[00:11:53] JW: I’m like, “Perfect. That's exactly what I mean by building a business that can thrive without you.” I sometimes refer to a sailboat business in my own mind is this euphoric, or this mythical business that can succeed without its owner.

[00:12:10] MB: Without going super deep, because I want to get into the art of selling a business. Without getting super deep into this, what are a few of the major pillars, or lessons of engineering a business on the front-end to be able to thrive without you?

[00:12:26] JW: Well, I think one of the big things is recurring revenue. You mentioned earlier, your example of some of the deals you look at, where it's 10 or 15-million-dollar company, yet the owner is still the primary rainmaker. It's very common for an owner to naturally become the biggest salesperson in their organization.

That's great, except if you want to sell your company. Because if you are the primary rainmaker, it's not worth much to anybody. In the opposite, though, is to create recurring revenue, where you've got an automatic payment that's coming in, a stream or an annuity stream of revenue coming in that is predictable. It's usually something that's pretty easy to set up. Sometimes when I say recurring revenue, people think of software companies, like SaaS, software as a service businesses. That's certainly one form of recurring revenue. There's lots of others.

For a lot of even service-based businesses, you scratch their head at this idea. Like, “Well, how would I ever create recurring revenue?” Think about the magic of a service contract. Simple, recurring service for fee. If you clean carpets, as an example. My friend, Joe Polish, who does carpet cleaning, those businesses, you can wait till the phone rings, and/or you could set up a service contract, where every two weeks, you go and clean the carpets at the office of the home that you are contracted to do.

If you do that, it creates not only a more valuable company, it creates a more predictable company. All of a sudden, if you are a HVAC company, as an example, you do heating and air conditioning and you have a set of contracts, where you go every six months to change out the furnace filters and you make sure the air quality is good, etc. If that is a predictable service contract that you have, it's deliciously valuable. It's very, very attractive to an acquire. Again, you can predict how many folks you need, how many trucks you need to buy, how many furnace filters you need in advance, what your next quarter, next year is going to look like.

When you have a predictable business, it's a whole lot more profitable. It's also a lot more fun for the people working for you, because they know what is coming. Again, the service contract for in particular service businesses is this hidden gem, where you can take some of the benefits of the subscription offering and software as a service, and inject them into even the most simple of businesses.

[00:15:01] MB: I know you quite literally wrote the book on that concept as well. It's such an interesting idea and a great thought experiment to think about how can you take a business that traditionally doesn't have a recurring revenue model and generate, or create a novel way of having recurring revenue in an industry that typically, we always think of software, but a lot of other industries could also have recurring revenue businesses.

[00:15:27] JW: You bet. I think, the problem that a lot of entrepreneurs run into, or the obstacle a lot of owners face when they think about this idea, most people when you say, “Hey, you need recurring revenue.” They not up and down and go, “Yeah, yeah. I know, but.” The but is, “I have not figured out what my recurring revenue model could be.”

What I found is the biggest reason, or the biggest impediment to coming up with a recurring revenue model is that most owners try to boil the ocean. They try to come up with a subscription offering, or service contract to appeal to all of their customers. That's almost a definition, or almost a recipe for dilution. You're going to really make a crappy service offering, or a crappy subscription offering, if you're trying to create one offering for everybody, because everybody's got different needs. All your customers buy from you for different reasons.

Therefore, if you try to create some service contract that will appeal to everybody, it will really appeal to nobody. What I would recommend you do if you're struggling to find your subscription offering, is to first, niche down by buying behavior. Segmentation is something that lots of marketers talk about, the idea of segmenting by buying behaviors like, why do people buy from us? Try to create homogeneous buckets.

I'll give you an example of this. This does come directly from the Automatic Customer book. It's H.Bloom, the guys who sell flowers on subscription. They looked at all the people who bought flowers. We buy flowers for lots of different reasons, right? We buy flowers for weddings and funerals and graduations and birthdays, etc. They looked at one segment of the market that buys flowers for different reason. That is there's a segment, hotels, wealth management companies, some spas buy flowers to look fancy. They buy flowers to project an image to their customers of a boutique high-end image. Again, these are high-end retailers, high-end hotels, etc.

H.Bloom didn't try to create a subscription for anyone who buys flowers, which would have failed. They said, “No. We're going to go out and build a subscription just for people who are trying to project a boutique image; hotels, restaurants and spas.” They created H.Bloom. The average lifetime value of an H.Bloom subscribers, like last time I talked was over $1,400. Compare that to the average transaction of somebody who rocks up to a flower store and buys a dozen roses, it pales in comparison. They didn't start by just trying to create a subscription for anyone who buys flowers. The first step was to figure out, okay, what are our buying segments? Then building out a subscription model from there.

[00:18:12] MB: That's such a fantastic example. Really illustrates the power of that approach of segmenting your markets, but also how in an industry where you would on the surface say, “Well, there's no way you can have a recurring revenue business around buying flowers.” It's so seasonal, it's so specific. Yet, if you really think about the market in a different way and take a completely new approach to it, you can uncover recurring revenue opportunities that you may not have previously seen.

[00:18:42] JW: You bet. I'm a firm believer that virtually, any business can create at least some recurring revenue. Not all. Not every dollar that you generate would be from recurring revenue. I think, you can create your 10%, 20%, 30%, 40% in most businesses relatively easy. That triggers something called the Trojan Horse effect, which is the dirty little secret of the subscription model, if you will. That is that oftentimes, the very fact that a consumer subscribes to you, it triggers them to buy other things off subscription.

Let me say that again. Once people subscribe to your company, once you get an Amazon Prime subscription, for example and you've been buying from Amazon all your books and cat litter for years, you get that prime subscription. All of a sudden, it makes you much more likely to go beyond just cat litter and books. Now all of a sudden, you're checking out all the other things that Amazon offers. It's very similar. There’s a guy wrote about, named Jim Vagonis, who has a company called Hassle Free Homes, where you guessed it, you put a service contract in place for homeowners, manage your home for you.

Well, 50% of his revenue comes from people, not who he does – just their subscription, but for things that are one-off things that they ask Jim to do for them, because Jim's in their home every week. They've got the trust with Jim, and that Jim's got their credit card and there's a billing relationship. Once they subscribe to you, even if it's just 10% of your revenue, it creates this beautiful little relationship that is the foundation of your customers buying lots of other things from you.

[00:20:17] MB: Such a great insight. It's totally true. I mean, Amazon is one of the supreme examples of this. Even something as simple as having a billing relationship and saying, “Oh, I can just pay with my – I already got my billing setup. Okay, great. Makes me more likely to purchase something.”

[00:20:32] JW: My wife's always after me for this, because – I shouldn't joke, because it's terrible. I get a lot of Amazon packages and she's like, “You bought vitamins for – Really?” I could have gotten to the – I'm just totally a sucker for the fact that I've got my prime subscription, my credit card is all wired in, it's one-click and I'm done. Unfortunately, it's incredible inertia. Unfortunately, it's fortunate for Amazon and their shareholders. It's unfortunate for any retailers that are trying to compete, but it is just such an easy, easy thing to do.

Again, that's Amazon, and they're a giant gorilla. Even if you have a very small company, to go back to the HVAC example, you're basically repairing people's furnaces. Well, if you put them on that very inexpensive $100 a year service plan, guess who they're going to call when their furnace breaks? They're not going to call the yellow – They're not going to Google HVAC up. They're going to say, “Oh, these guys come in every six months. Let's just call them and have them replace it. They already know who we are, where we live, what our address is, we already have a building relationship.” It's just so much easier.

[00:21:39] MB: Yup. One other tidbit on recurring revenue that I want to ask and then we can expand this conversation a little bit, but do you have any specific strategies, or maybe tactics for a brainstorming exercise, or some way to let's say, somebody is listening that wants to think about how to add recurring revenue to their business? Is there a thought experiment, or a question that you really like to implement to help put that into place for your company?

[00:22:12] JW: Yeah. We talk about the six forms of recurring revenue. It starts with consumables. One thing you can just ask yourself is, what do my customers run out of? If you're a coffee drinker, you run out of coffee. We all run out of razor blades, we all run out of toner cartridge, we all run out of things. Asking yourself, what do we run out of? If you want to walk one step up the rung on the ladder of subscription offering. By the way, as you move up the ladder, the value of that subscription revenue increases in the eyes of acquirer. Each rung you go up, you get a better valuation.

The second rung up from consumables is sunk money consumables. Here, we're making a platform purchase. Again, the one that we all know is we buy a razor. Guess what? Once we buy a razor, we're way more likely to buy the blades that fit that razor. It’s a silly example, but you can project that out to virtually anything.

If your customer buys a widget, a piece of machinery from you, then ask yourself, “That's great. What part of that machine runs out? Is there some element of it that needs replenishing?” That's what can go on subscription. Those are effectively platforms that need replenishing. That's how you start to march up this hierarchy of getting more and more valuable subscription revenue in the eyes of acquirers.

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[00:25:31] MB: Now that we've laid some of this foundation for the principal ideas of how to approach building your business, how to potentially add some recurring revenue into your business, that brings us to the art of selling your business. Tell me a little bit about from a high-level perspective, how you approached the strategies and key tactics for exiting your company.

[00:26:01] JW: Yeah. I mean really, I have a first-hand ringside seat at the fight, in the sense that I do a podcast called Built to Sell Radio, where I interview a different entrepreneur every week. I've been doing it for five years. The purpose of the podcast is to ask entrepreneurs about their exit. I interview people who have sold a company and I say like, what did you learn? What did you write? What mistakes did you make? What would you do over B?

What I've come to see is that there is a small cohort of guests I've had on the podcast, who punched well above their weight in terms of negotiating leverage. They seem to get multiples that are much higher than the typical industry multiples that companies in that industry tend to get. It got me quite switched on and turned on to try to figure out what were these guys and gals doing that made their company so much more valuable than the prevailing wisdom in that industry.

I started to really analyze their secrets. That's really what the book is all about. It's a distillation of the transferable lessons from all of these entrepreneurs that seem to punch above their weight when they go to sell. I've tried to put together a bit of a field guide for entrepreneurs to have a spectacular exit; an exit that they can be proud of.

[00:27:27] MB: One of the ideas that I really enjoyed was this notion of controlling the process and the idea of the slow reveal. Tell me a little bit about that.

[00:27:38] JW: Yeah. I can't do it without using a very crude analogy. We can all imagine the striptease. I don't care if you like the striptease at Solid Gold or at Chippendales. It's not gender specific thing, but the striptease is the best analogy I can use for the way a M&A process should reveal information. Your clothing in this case is your data. Your data is incredibly valuable to the eyes of an acquirer. The sales projections that you have for the year ahead, your product roadmap, your gross margin, your profitability, all the stuff that an acquirer is going to want to ask you about is valuable.

The savviest sellers tend to reveal their information slowly. The opposite is also true. The first time rookie sellers typically get an acquirer on the line, the acquirer says, “Hey, why don't you just send me your books and I'll have a look and see what we think.” They'll pass on their credentials for QuickBooks online and said, “Well, here you go. Go ahead and look at all of our financials.” Of course, that's a recipe for giving way too much information.

What we've got to do is parse out, or hand out information in such a way that it increases the desire of the person receiving the information. Again, the most successful sellers are doing that. Well, they're doing that with other acquirers at the same time. What you're trying to do is get multiple bidders for your business to convalesce around, or congregate around your business at about the same time, so that you get competing offers. That's when you have leverage to start ginning up one offer off to get off the next.

You only do that if you're revealing information slowly in a deliberate fashion to lots of different acquirers at the same time, which is why there's a process we lay out in the book that gets you to a very step-by-step process of what information needs to be shared when, with, who.

[00:29:53] MB: Do you think about when you're looking at exiting, how do you approach the question of whether to bring on an advisor, or a broker of some kind?

[00:30:03] JW: Yeah, look. I know it can be tempting to go at it alone and just hire your accountant or your lawyer to sell your company. I mean, an M&A professional charges a success fee, as does a broker a commission. You can look at that and say, “Wow, I already know a couple of acquirers. I've already had a couple of offers. Why do I need an M&A professional?” I think that's short-sighted. I think it's penny rich and pound foolish. The reality is that when you go to sell your company, you really need a representative, somebody who's going to sell your business. They can act as a foil for the emotional ups and downs of selling. If you've got a third party representing you, you just – it's a layer of insulation. You can also get competing offers to compete with themselves for your company.

If you've got an M&A professional, well, that's their job is to create competitive tension for your deal. They're also really good and have been around the block a few times, to no illegitimate retraining when they see it. Retraining is effectively when you agree to a price, you both agreed to sell your business, sign a letter of intent, both agree to a price. Then 60 days after due diligence, the acquirer lowers the price, because in part, they know you're committed to the sale. While that's a very common strategy for acquirers, most good M&A professionals will sniff it out and nip it in the bud pretty early.

I could go on as to the value of an M&A professional. By the way, that's not what I do for a living, so I'm not saying it in a in a self-serving way. I'm saying that if I were selling another company, and I have done this, I would hire an M&A professional. I wouldn't sell a house, despite the fact that you can sell a house these days independently. I wouldn't do it without an agent. Similarly, I just wouldn't sell a company. It's a much more complicated entity than a house to sell. I think you just best served with somebody on your team in that role.

[00:32:02] MB: It underscores what you said a moment ago of, you're much, much, much more likely to generate a pool of interested bidders, if you bring on an M&A professional, as opposed to trying to do it yourself.

[00:32:15] JW: You're absolutely right. Your M&A professional is also going to guide you against answering some of the classic questions that acquirers ask that often get owners into trouble. I mean, one of the biggies that is very common among small business owners is they answer the question, what do you want for your company? An acquirer will get you into a corner. They'll buy you dinner, or lunch, or whatever. They'll say, “You know,” figuratively put their arm around you and says, “You built this great business. I mean, you must be super proud of it. What do you think is a fair price?”

It seems like a reasonable question. You want to make sure you're on the same page with the acquirer and there's a deal to be done. The moment you answer that question is the moment you put a ceiling on which you will never sell your business beyond. It's one of the classic tricks that acquirers will use to try to elicit your bottom line. Of course, they will make it their mission at that point forward, to never buy your business for a penny close to what you want for it.

Look, I think there's a way to answer that question that takes into consideration that you're a reasonable person, that you'll entertain a reasonable offer for your company, but you're not going to be the first one to lay the price. He who says his or her price first, virtually always loses. I think that's true in the case of an acquisition as well.

[00:33:42] MB: That's a great example. I'd be curious to hear what are some of the other big mistakes you see people making when they're selling their businesses? Or maybe more specifically, what are some of the other trap questions, or things you see acquirers doing that sellers should avoid, or try to counter?

[00:34:00] JW: Yeah. I mean, it's the whole theme of the book. There's tons and tons of them. I could talk about a few. The classic is a no shop clause that is in a letter of intent. When you sell your business, you're going to have to sign an LOI, or a letter of intent. That's like an engagement ring. You're committing not to effectively continue to negotiate with other buyers, that you are in fact, falling head over heels, in love with one acquirer. It's non-binding, however.

What you have to realize is that a letter of intent, in both cases is usually non-binding. I mean either party can walk away at any time. You've really got to make sure that the acquirer knows you are sensitive to the idea of re-trading. I talked about it earlier, the fact that prices can be dropped during due diligence. I think the secret and this comes from Barry Hinkley, who I interviewed, he just says, do the no re-trading handshake, where at the signing of the letter of intent, you get up, walk around the boardroom table, you shake the hand of the person. Of course, once this pandemic is over, you shake the hand of the person making the acquisition offer and you say, “I'll do this deal on one condition.”

He or she says, “What's that?” You say, “No re-trading.” By doing the no re-trading handshake, you're effectively just communicating to the acquirer that you know that game and then you're not going to fall victim to it. That's one of the classic things. Certainly, revealing too much information too early is another classic mistake. Another one is positioning your business in an industry that has a low valuation multiple.

For example, there's a story in the book from a guy named M. Banett. Banett was in the business of designing websites for colleges and universities. When in fact, close to you. Where you are in Vanderbilt. They work with a lot of the very famous universities and put together websites and converted some of their content into online courses. When they talked about their business, they talked about their business as a web design shop. As you might imagine, web design shops are a service businesses, the assets go up and down the elevator of United's, David Ogilvy said. They're project-based. They're very lumpy. There's nothing really too sexy about a project-based web design shop.

A three times multiple is a pretty fair, multiple for a generic service business. Well, Jeffrey Feldberg is the guy I interviewed, and he says, “We weren't happy with three times. We did some navel gazing, thought about the industry that we were in, thought about how we were positioning ourselves, what we were doing.” They decided to start positioning what they did as part of the e-learning phenomenon. This was around the time that Lynda was acquired by LinkedIn, that there was just tremendous interest in and excitement in the e-learning space.

Feldberg said, “Look, we're not going to position ourselves as a web design shop. We're going to position ourselves as a leader in the burgeoning e-learning category.” They made some changes to their business model. Two years later, they get acquired as a leader in the e-learning category, for roughly 13 times earnings. That's the power of positioning; getting yourself in the eyes of an acquirer into a category that is a higher valuation multiple category. There's some strategies and tactics to doing that, but it can be a tremendous way to lift the value of your company.

[00:37:39] MB: Yeah, that's such an illustrative example of the power of repositioning. I've heard many, many instances, or insights of that strategy. Sometimes when I look at the tactical implementation of that, how much do you need to, and I know it is case by case, but a lot of times, I feel like, you really need to change your business model in some instances, or make material changes to the business itself. How do you think about making those business pivots to try and be in a new industry, as opposed to just saying, “Oh, hey. We're just changing what we call ourselves and I feel like a smart buyer will oftentimes sniff that out and say, “Oh, but this is really just a marketing agency.””

[00:38:21] JW: Yeah, look. I think you're absolutely right. I would characterize the changing of your business to make it more valuable in two different ways. You think about a home. When you go to sell your home, as we've talked about, there's the staging that you do, right? The new paint job, the baking the cookies, when you have a showing, etc. That's staging. That's optics.

Then you have structural, like replacing the old kitchen. Construction projects that make your business more valuable. I think both are relevant. We've talked about some of the things you can do that structurally make your business more valuable; recurring revenue, making it succeed without you personally. There are though, also some optical things that you can do. You're rightly pointing out, I think in the case of M. Banett, they did both. There were structural changes to the model, they also changed cosmetically, or optically the way they positioned their company.

Optics do matter. I think they do matter. You're not going to buy a business based on optics, but you'll often filter out of business based on optics. For example, if you're one of the big acquiring groups, one of the most likely people to buy a company in the small to mid-size business space right now is a private equity group. Private equity groups do their research online. Let's imagine that you are a private equity group and you're looking to buy solar companies. Well, if you're a business owner and you offer alternative energy solutions, like geothermal, wind and solar, and you position yourself as a cosmopolitan, neopolitan patchwork quilt of alternative energy solutions, a private equity company is going to look at your business and say, “Yeah, I like the solar stuff, but I know nothing about windmills.” They're going to go on to the next company.

Whereas, if you know that private equity companies are rolling up solar businesses right now, then you're going to want to be on your front foot and positioning yourself as a solar company, that you’re solar first, that in the event that a solar solution is not practical, you'll also include potentially, a wind solution, or geothermal solution, but solar is your first choice. That's a private equity group, when they see that looking to roll up solar companies, they're going to be much more interested.

It's the same company, same revenue split, solar to geothermal. It's just the way you position it. As you look out in the landscape and find out what acquirers are looking for, where are these private equity companies rolling up, your private equity companies these days are rolling up just about any industry. I did a speech right before the pandemic, I get all the sexy gigs, Matt. I did a speech at the Carwash Owners Association.

[00:41:06] MB: Very exciting.

[00:41:06] JW: This is people as the name suggests that own car washes. Even there, they are rolling up – private equity companies or rolling up car washes. You can name virtually any industry. What you want to make sure is you're swimming downstream, that if a private equity company is rolling up businesses in your industry, you damn well want to make sure that you look like one of those businesses, everywhere from – go through a search engine optimization process and make sure that you are popping for a Google search in your industry, in your local market, because not only customers are going to find you, but acquirers are going to find you too.

[00:41:44] MB: Yeah. I really like the analogy you gave a moment ago of the difference between staging your house for sale and renovating your kitchen and how those two approaches, both can increase the value of your home. It's a really good way of contextualizing how you might reposition a company to be in a more profitable industry.

One other big theme that I want to touch on that you write about in the book is this idea of the difference between price and terms and the very interesting relationship between those two items. Tell me a little bit more about that.

[00:42:16] JW: Yeah. I mean, there's an old expression among M&A professionals. You set the price, I'll set the terms. Effectively, what that old cliché says, is you can name any price, but the terms will take that price away. What I mean by that is we can agree that your business, like I can want 10 times EBITDA for a business and you can want to buy it for five. I can agree, “Great. Well, you know what? I'll pay you 10 times, but I'm going to put 75% of the proceeds on an earn-out.” I'm going to make that earn-out so arduous and impossible for you to reach that I'm actually buying your business for pennies on the dollar.

The terms are so critical. Effectively, it comes down to how and when you're going to get your money. Under what conditions? The things that we talked about already are earn-outs are very commonly used to basically, bridge the gap between what a seller wants and what a buyer is willing to pay. Equally, the working capital calculation is also an important number to look at. It's the second most important number on an acquisition deal.

We all myopically go straight to the acquisition number, right? That's the number that we care about most. This working capital calculation is also very important. It's essentially the cash you need to leave in your company when you hand over the keys. Most owners, if they've been successful in running their business for many years, they've got retained earnings in their company, a little rainy-day fund, that they just keep in their company for emergencies.

Well, an acquirer looking at that business is going to say, “Great, I'm buying the business. I want the retained earnings.” The seller is going to say, “Those retaining earnings are mine. That's money I've had for three, four or five years ago.” That gets defined in the working capital calculation. You want to make sure that that number is vetted by your advisor. There's lots of different terms that are critical, that beyond just the headline number, you're going to want to look at.

Another one that we haven't talked about, but is equally important are adjusted EBITDA. We all talk about multiples as they are like fishing stories. My buddy got three times earnings, or she got five times earnings. It becomes this folklore. The key question though, when you're thinking about multiples is a multiple of what? Is it a multiple of trailing 12 months? Is it a multiple of last year's completed financial statements? Is it a multiple of the future?

The biggest driver of the overall value is going to be something called adjustments, where you're going to adjust your profit and loss statement for how your company would perform in the acquirer’s hands. The big change you're going to make to your profit and loss statement is to replace your executive compensation line item with a market rate salary for a general manager to do your job.

In most cases, we pay ourselves more than we would replace a general manager. What that does is when you change that number out for your salary and put in a general manager salary is you then increase your profitability. Therefore, if they're willing to pay five times EBITDA, then guess what? The EBITDA multiple goes up, or the EBITDA number, even if the multiple doesn't go up, the actual overall value of the company goes up.

I write about a guy named Ari Ackerman in the book, where he did exactly that. He went to sell his company Bunk1. Got a ho hum valuation. Then they went through the adjustment process. The acquirer was limited by board approval, that they could only pay X multiple for his business. What he did, what Ari did was changed the profitability by stripping out some of the one-time expenses, some of the things that they acquire, we're not going to have to pay for. He didn't actually get them to raise their multiple, but they applied it against a much fatter profit. Ultimately, he had a tremendous exit for his company, Bunk1. That's yet another way that the deal terms are almost more important than the price itself.

[00:46:14] MB: Such a great insight. I wish we could dig into those deeper. I want to take what we've talked about so far. What would be, if you had somebody listening to this and they wanted to take action, whether to sell their company, or prepare their company for sale, what would be one action item that you would give them, to take action on something that we've talked about today?

[00:46:36] JW: One thing is to conceive and think about your pull factors. I think, we all as owners have both push and pull factors. What do I mean by that? Push factors are things that frustrate you about your company. Government regulation, red tape, tax employees, blah, blah, blah. These are all things that are legitimate frustrations for a lot of business owners. Sometimes they boil up so much that you actually decide you want to sell your company, which is fine. That's not going to lead to a very happy exit.

A year after selling, when we talked to business owners about their exit, one of the biggest regrets they have is they were all push, no pull. What that means is that a pull factor is something you're excited to go do, a business you're excited to start, a company you want to fund, a charity you want to start, a speech you want to give, a book you want to write. All those things are pull factors. The happiest entrepreneurs are the ones with lots of pull factors.

They're going to something, not leaving something behind. That's probably one of the most – it's a fun exercise to do, especially in the times we're talking right now, in the midst of this pandemic, where travel has become impractical, and so forth. It's fun to get a pen and paper out and dream about what you would love to do. You'll find, I think that galvanizes your appetite to really start investing in some of the things we talked about today.

[00:47:58] MB: John, where can listeners find you and your work online?

[00:48:03] JW: All roads lead to builttosell.com. That's probably the best place, the central location. You can subscribe to the podcast there. You can get a bunch of white papers. If you go to builttosell.com/selling, there are some gifts we put together for people who order the new book. One of them that I'm really excited about is we're doing a seven-part Q&A with seven of the entrepreneurs I've interviewed for the book, everybody, all the way up to Jay Steinfeld, who sold a 100-million-dollar company, blinds.com. Folks can get access to that seven-part Q&A series. They're all video calls with some really special entrepreneurs. They just need to go to that URL, or the book from there. It's builttosell.com. Then if you go to /selling.

[00:48:55] MB: Awesome. Well, John. Thank you so much for coming on the show, for sharing all this wisdom, some tremendous insights into how to make a company more valuable and how to really extract as much value as possible when you exit.

[00:49:08] JW: Thanks, Matt. It was a pleasure to be with you.

[00:49:10] MB: Awesome.

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