Transcript of Advice for Entrepreneurs Who Want to Sell Their Companies written by John Jantsch read more at Duct Tape Marketing
Transcript
John Jantsch: Hello and welcome to another episode of the Duct Tape Marketing podcast. This is John Jantsch and my guest today is John Warrillow. He is the founder of the Value Builder System, a company that helps business owners improve the value of their company, and he’s also the author of the bestselling book, Built to Sell: Creating a Business That Can Thrive Without You. So, John, I have to say actually welcome back because I think we had you on for Built to Sell.
John Warrillow: You were good enough to do that. It’s great to be back. John, thanks for having me.
John Jantsch: So let’s just start, there’s a lot of business owners out there, some of whom are listening today, I suspect, that want to sell their company. So if I wake up one morning and think, “I want to sell my business,” what’s the first thing I need to do?
John Warrillow: I mean, the easiest thing to think about and the toughest thing to do is how well would your business thrive without you running it? Essentially, that’s the essence of building a valuable company because when somebody, obviously, buys it, it’s got to run without you. And if it runs well without you, you’ve got a valuable asset. If it doesn’t, then you’ve got changes to make. You got some changes to make.
John Jantsch: Well, does it also not have to be able to run without you? Do you have to actually demonstrate that as well? I mean you have to sort of prove that so that somebody can clearly see, “Oh, this isn’t dependent on you.”
John Warrillow: Yeah, for sure. I mean the smaller the company you have, the more skeptical a buyer is going to be that it runs without you. If you’ve got a 20, 30, $40 million company, nobody assumes that that’s being all run on the back of one owner. But if you’ve got a $500,000 company or a $300,000 company, that’s when their radar of the potential acquirer is way up, and they’re like, “Okay, what happens when we write you a check, and you hit the beach, does this whole thing kind of fall away?” And so the smaller you have a company the more skeptical they’re going to be.
John Jantsch: So you in the Value Builder System kind of lean on these drivers of salability kind of the things that people use to determine or demonstrate that a company has value. And I’m guessing one of them certainly is a lot of, “What’s the revenue? What’s the profit?” But does it go in terms of the financial part? Does it go kind of beyond showing a profit and loss statement?
John Warrillow: You’re right. Financial performance, I mean, you can’t get away from it. It’s important to acquirers, right? So what’s your top-line revenue? The more revenue you have, the more valuable your company is going to be, generally. Obviously, profitability’s going to be important. Things like gross margin are also important. Here’s why. When an acquirer looks at your company, if your gross margin is dropping consistently year over year, they’re going to draw the conclusion that you’ve lost your marketing differentiation. I know that’s something you talk a lot about with your customers.
John Warrillow: The idea that if you are starting to have to sort of compete and “buy business” and, therefore, your gross margin is dropping, they’re going to assume that the growth cycle of your company has matured and that’s going to be a real downward pressure on your value. If your gross margin, however, is consistent or growing, they’re going to assume that you’re increasing your pricing authority, meaning you’re becoming more differentiated for what you sell or do and, therefore, your business is going to be more attractive to acquire. So it’s important. Financial performance is important, but there are some nuances associated with it as well.
John Jantsch: I had somebody reach out to me a couple of years ago and they said, “Hey, there’s a company in your industry, they want to buy you out. They’re going to a couple of companies like yours and you’re a real target and they want to roll all these companies up.” And so I was like, “Okay, I’ll play, tell me what you’ve got in mind,” and they send me this list of about 47 things that they needed to see. And I was like, “I’m done. I’m out of here. That looks like a lot of work.” So in addition to just like your QuickBooks profit and loss, I mean, it seems to me people, I mean, they’re buying a business sort of on faith, but maybe they’re going to need more than faith.
John Warrillow: They sure are, and by the way, that’s a typical fishing letter used by either a private equity group or a business broker, as flattering as it can be, it probably doesn’t mean a whole lot. There’s you and 10,000 other people like you got the same letter, so it can be quite flattering but at the same time, I would have my radar up at letters like that and really be fairly conservative in their approach.
John Warrillow: Look, they’re going to want to know how repeatable is your business without you? And beyond just revenue and profits and gross margin, they’re also going to want to understand your recurring revenue. So subscription-based, annuity-based revenue, why is that important? Well, it predicts that in the future that revenue will come in again without you as the rainmaker. A lot of people know business owners are the sort of rainmakers in their company, and so acquirers want to know, “Okay, if we pull you out of the equation here, is this revenue going to continue?” That’s why they love service contracts, subscriptions, anything that where there’s that sort of a tail to the revenue.
John Jantsch: Yeah, and you actually wrote a book about that. I can’t remember, forgive me, A Subscription Economy or something like that?
John Warrillow: It’s not indelible in your mind, John?
John Jantsch: I’m sorry.
John Warrillow: It’s called The Automatic Customer.
John Jantsch: The Automatic Customer, [crosstalk] but that was the basis of it really, right? And I think that beyond the saleability of your company, I mean I think that’s just a great business practice, isn’t it? You need to build in some sort of recurring revenues?
John Warrillow: Yeah, I mean, it takes a lot of the stress away from running a company when you know at the beginning of the month you’ve got most of your revenue is already spoken for. I used to run, this goes back 20 years ago, a project-based consultancy and there was nothing worse than the beginning of the month because the beginning of the month you had to like being on a hamster wheel, start it all over again, right. And try to piece together [inaudible] revenue because win some projects, bid on some stuff and it was this constant scurrying around trying to find revenue, and in a good month you pieced it together like a patchwork quilt but for a lot of months, you didn’t. And so recurring revenue is one of those sort of de-stressors for people. It helps you predict what you’re going to need in your company many years or at least months in the future. I’m reminded of the guys at H.Bloom. Have you heard this story about H.Bloom before?
John Jantsch: I don’t think I have.
John Warrillow: So H.Bloom is a subscription-based flower store, a flower company. Essentially, you can buy a subscription to flowers. You might say, “Well, who on earth buys flowers on subscription?” Well, it turns out that a lot of very boutique-hotels and sort of upscale restaurants buy flowers every two weeks from H.Bloom because they want to give that professional image. Well, turns out the typical flower store throws out, garbages, 60% of its inventory every single month. Why? Because the stuff is dead in the fridge, right? They guess wrong on how many flowers they need to buy, yet H.Bloom’s spoilage rate is less than 2% per month because they know how many people are buying flowers that month in advance because they’re all buying them on subscription. And so yeah, it makes your business way less stressful and also helps you kind of figure out how many trucks you’re going to need on the road or how many guys you’re going to need or gals you’re going to need, six, 12, 18 months from now, which is huge.
John Jantsch: So you mentioned the idea of growth potential. You see every day these IPOs coming out of companies that we work, for example. Just had an IPO and last quarter they lost $700 million.
John Warrillow: Right.
John Jantsch: So are people banking on growth potential and if so, how do you demonstrate growth potential? Let’s go down to the small business. I think my business is awesome. I’ve done a lot of amazing things in my business. So clearly the growth potential is huge. So that was said facetiously, but, I mean, that’s obviously an important factor, but how do you demonstrate that or how do you even quantify that?
John Warrillow: Yeah, so growth potential is really important to investors and acquirers and a lot of it is going to be predicated on the industry that you’re in, right? So if you’re a law firm, most acquirers know that for a law firm to scale, it requires hiring a bunch of associates, onboarding them, training them, and it takes years to really get them to be effective associates, and as a result, those companies don’t scale very quickly, and their multiples are what people are willing to pay to buy a law firm tends to be fairly low. Whereas, if you’re a manufacturing company, and an acquirer can look at your business and say, “If we can get the sales and marketing right and bring in lots more business, we can just put on another shift, make the assembly line run twice as fast, or they can stamp out their widget much more quickly,” they’re going to pay a much higher multiple.
John Warrillow: It’s why technology companies, ones, in particular, that are based on SAS-based software, for example, are getting tremendous multiples because acquirers know they don’t need to invest in a lot of infrastructure to scale. They can simply grow quite quickly by winning new customers. So you’re going to want to demonstrate what’s the model? I love looking at cost per account acquired as a key metric to share with potential acquirers.
John Warrillow: So being able to demonstrate, like I put $1,000 at the top of the funnel. I invest a $1,000 in whatever marketing, telemarketing, Facebook marketing, whatever you choose to do in your marketing, I put $1,000 in and I get three customers. In other words, my cost to acquire account is $333, that’s huge information for potential acquirer because guess what? They’ve got lots of money, typically. So they can say, “Okay, if you’re getting three customers for every $1,000 I invest, well, it stands to reason that if I invest $10,000 a month, I get 30 customers and if I invested a hundred grand, I’d get 300 customers,” and so that information cost per account acquired is huge.
John Jantsch: Yeah, and if you could really nail that, I mean, you can make a case for saying, “Let’s go out and borrow money to do that, right, almost. I mean, if you can really get sure about that. “If we can make more money off of a client that it costs us to acquire and we know exactly what it costs us to acquire them, that’s a pretty valuable ratio.
John Warrillow: That’s huge. It’s huge. A lot of small businesses, and when I say small, I’m referring to kind of 10-person companies, 5-person companies, 20-person companies. They’re acquired, they’re purchased not by other companies, but by individuals and individuals buy businesses with debt. And they typically, in the United States at least, get an SBA Loan, Small Business Administration Loan. And the SBA is basically a government-guaranteed loan that a bank will offer, and it will allow an acquirer, an individual, to buy a business that they couldn’t ordinarily afford. Well, in order to be “bankable,” meaning a company that a bank would lend to, you have to have some of these metrics dialed in.
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John Jantsch: So long, long, long time ago, we’re talking 25 years ago when I started my consulting-
John Warrillow: Before I was born, Jantsch.
John Jantsch: When I started my consulting practice, I looked up one day and 60% of my business was coming from two customers. And, lo and behold, for no reason related to my work for them, they both decided to fire me and I had to scramble. What percentage of businesses kind of find themselves in that same boat and obviously, what role does something like that play in the salability of a company?
John Warrillow: Yeah, you’re talking about a value-driver we refer to as the Switzerland Structure and the Switzerland Structure, it’s named after the country of Switzerland, which as you know, is sort of obsessed with this idea of independence, not cozying up to any one kind of geopolitical faction, whatever. The same can be true of the most valuable companies. Meaning the most valuable companies are not dependent on any one constituency. And the typical three problem areas for a lot of small businesses are either they’re too dependent on a single employee, to dependent on a single supplier, or as you said in your example, to dependent on a single customer. And so most acquirers are going to get their radar up if more than 10% of your revenue comes from a single customer, and that’s because they’re just going to see that as a risk factor, right?
John Warrillow: They still may buy your business, but they might buy it and use an earn-out, which is a formula they put in place that says, “We’re not going to give you all of your money upfront. We’re going to give you part of it, but then you’re going to have to work for the second half by making sure those customers that you’ve been serving stay through the acquisition,” which is sort of the enemy for most entrepreneurs. Most entrepreneurs want to get their check and leave the next day. And so the only way you’re going to do that is if you can demonstrate that you’re not too dependent on a single customer. I shouldn’t say the only way. One of the important things you need to do in order to get up a high proportion of your money upfront is to demonstrate you’re not too dependent on a single customer.
John Jantsch: So because I’m a marketing consultant, I happen to think marketing strategy is the most important element of any business, and central to that is a strategy that allows you to differentiate yourself from the competition. I mean, just otherwise you’re competing on price. I mean, so I teach that greatly, but how important is that in somebody thinking that they’re going to buy a business that yeah, they may not have it forever, but they’ve got some sort of key differentiator that makes the competition a little bit irrelevant. I mean, obviously, that’s kind of the Holy Grail of selling your business, isn’t it?
John Warrillow: Oh, that’s so important. I’m so glad you brought this up. When an acquirer looks at buying a company, they make a secret little calculation that they never tell you the small business owner about it. It’s done behind closed doors in a boardroom somewhere. And that is the build versus buy decision, right? So they sit there, and they say, “Okay, John’s built this great company over here. Is it easier for us to just simply compete with John? In other words, basically replicate what he’s created, or should we just buy him?” And if the answer to it, “It would be cheaper to compete than buying him because he hasn’t really created anything that unique,” then they’re going to do just that. They’re going to create it, and so if you’re undifferentiated from a marketing perspective for what you do, if you’re responding to requests for proposals, RFPs, or if you’re pricing your product by the ounce, by the yard, the chances are you’re highly commoditized as a result.
John Warrillow: An acquirer is going to say, “Well, why do I need to buy this guy’s company? I’ll just lower the price, and by the way, I have much deeper pockets to weather a pricing war. I’ll just lower the price and pick up all his business.” Whereas if you’ve created something truly unique, and there’re two ways to make your business unique, right. One is to create some technology or something that really … a better mousetrap. But very few small businesses in my experience, have a better mousetrap. But a lot more of them have the second point of differentiation, which is better marketing, right? The belief in the eyes of their customers that whatever they do is unique. I’m looking at on my desk, I’ve got, I don’t know if you’ve seen these, they’re all over the place in REI and stores like it in the United States. Have you ever seen these YETI cups, John?
John Jantsch: Oh, yeah.
John Warrillow: Yeah, yeah, yeah. I go to a lot of my kids’ baseball games and every dad has an adult beverage in the YETI cup and we await … These guys have done a tremendous job of taking essentially a cooler glass, basically, a highly commoditized product that we all have in our kitchen cabinets and make it into a product that we’re spending, 20, $30 per cup, right? Because we believe it’s unique. Now, some of that is that it is unique. It’s a unique insulative cup, but a lot of it’s marketing and that’s huge for small businesses.
John Jantsch: Well, they all just chisel it out of the $700 cooler that they sell you as well.
John Warrillow: Right, you’ve seen those too. I haven’t been tempted to buy a $700 cooler quite yet.
John Jantsch: Nor have I. So a few years ago, somebody could have good marketing, have good revenue and good customers and everything looked hunky-dory, and then the internet came along. And now, if you’re not keeping your promises, somebody leaves a review, they create a YouTube channel talking about how awful you are, how important is that sort of social proof now become in the salability factor?
John Warrillow: Yeah, it’s big. It’s one of the other drivers we talk about at Value Builder and that is is how willing are your customers to refer you? And we use the standard kind of format that most acquirers have adopted, which is called Net Promoter Score. And I’m sure you’ve seen this, I mean it’s become sort of the gold standard among enterprise companies for measuring customer satisfaction. It’s developed by a guy named Fred Reichheld, made famous by Scott Cook at Intuit. Michael Dell at Dell uses it. These very large companies are all using the same methodology to measure their customer satisfaction, and it’s a single question. And when I tell you the question, you’ve heard it a thousand times, you’ve been asked it a thousand times, I’m sure, it’s simply, “On a scale of zero to 10 how likely are you to recommend us to a friend or colleague?” And if you’re a Rackspace user, or you’re an Enterprise rent a car customer, you’ve been asked that question hundreds of times, and it turns out that question is highly-predictive, highly-correlated, statistically linked to behaviors.
John Warrillow: Number one, the customer will indeed refer, and number two, the customer will repurchase. And so if you think about the sort of currencies or the raw materials for organic growth, and we go back to a growth potential is one of the drivers we talked about earlier, that’s really the raw material. And so that’s why you really want customers who are willing to refer you. And one of the ways we measure that is using Net Promoter Score at Value Builder but there’s lots of ways you could measure it. But the essence is, “Are my customers happy? Are they willing to talk about me and say nice things to their friends and colleagues?”
John Jantsch: So we’ll go back to the beginning kind of where you started all this, that it really comes down to how likely is the business to thrive without the owner? A lot of owners have kind of, I mean, they started it, they were the chief salesperson, they were the chief innovator. They were the chief implementer. Maybe eventually they brought people in who did some of those, but they’ve never really fully broken away from the control of the business. And I’m sure that sometimes, one of your consultants will come in and say, “Well, you have to give up control of the business. We have to start putting in processes that allow somebody else to make it rain.” Does that process happen overnight or does it take years?
John Warrillow: Oh, man. Yeah, we call it hub-and-spoke, but for a lot of small businesses they are hub-and-spoke managers, meaning they’re the hub in a wheel and all their customers, suppliers, vendor they’re all spokes and if anything needs to get done if a discount needs to be approved. If a customer wants a deal, if an employee wants a vacation, they have to go into the hub. In other words, the owner to answer that question. And, of course, hub-and-spoke models can be enormously efficient, right.
John Warrillow: It cuts down on a lot of backchannel communication if you’re a hub-and-spoke manager right up until the moment you want to take a vacation, in which time the entire business basically collapses without you. And so that’s the definition of an unsellable company when you’ve got a high hub-and-spoke score, meaning you’re really, you haven’t sort of empowered your people to make decisions without you. So that’s a big one, and to your point, I think it’s a journey that we’re all always on, to some extent. I’m reminded of, do you remember Peter Drucker, the guy who-
John Jantsch: Of course, I cite him all the time, The Practice of Management’s probably my most popular book.
John Warrillow: Yeah, so I mean he was sort of thought of as this sort of, I don’t know, the modern-day pioneer of management theory, and he talked about that managers and senior managers, should focus all of their energy or the vast majority of their hours in their day on two behaviors, on two kinds of tasks. One, product innovation, and two, sales and marketing. Those were the two sort of areas that he believed senior executives should focus on in terms of their time.
John Warrillow: And if you think about it, most business owners are in some ways spending most of their time focused on those two things. At the same time, and not to contradict what Drucker said, it’s those two things that you have to actually put into other people’s hands in order for your company to be transferable. So as counterintuitive as it feels for most owners, because most owners, they feel it’s the product or the service they offer where they really got to be front and center or winning new customers. Those are the two behaviors or the two tasks, you’ve got to somehow get into somebody else’s hands. And as you said in the beginning, it’s a journey. It takes a long time. It’s not something that you can buy some software, spend a course and teach people. It takes, in many cases, years.
John Jantsch: Whoa. In many cases, it’s deep psychological scars that have to be removed in order to let go the reins of some of these things as part of the challenge.
John Warrillow: Yeah. You joke, but we’ve just done some research and built a little tool actually called Pre-score. It’s fascinating. If you look at the data on business owners, and their mental health after they sell. Turns out 75% of business owners one year after selling end up regretting the decision to sell, 75%. Think about it. To the outsider, right, it’s like winning a lottery. You sell your company, it should be right up there with the birth of your child, your marriage, it’s these wonderful days, but 75% look back a year later and regret it. And you touched on, I think at just a critical point and that is that business owners are too emotionally tied to their companies.
John Warrillow: They haven’t done dis-aggregated or separated their ego, our sense of self-worth and our reason for being from their company. And if there’s one thing I would leave your listeners with beyond the practical stuff of recurring revenue and all that stuff is really do some thinking about who you are as a person. What other rules that you play in the world. Maybe you’re a coach or a dad or a volunteer firefighter, whatever you are, or a mom or whatever, and really getting clear on the value you add, and the rule those things play in your life. Because if you just cut the cord and sell your company, man, it’ll leave a huge void if you haven’t done some thinking about other areas of your life that give you a sense of purpose.
John Jantsch: Amen to that. So what I want to ask you one last question. On average, and you may not have a good number so you can generalize here, but on average when somebody contacts a Value Builder System Coach or what you’ve seen, how long is the process of actually getting like, I’m sure you have a checklist to say, “Wow, we’ve got to go work on these three things and cleaned them up.” I mean, what’s kind of the process before somebody really is ready to sell?
John Warrillow: So interesting. We did a study actually with one of our certified Value Builders, a guy named Steve Sutton, and we took a group of 40 small business owners through an eight month study, and we had them all complete the Value Builder question at the beginning of this study. We had them do it again at six months and again at eight months. And on average, the average participant in this study improved the value of their company by 18% so you may say, “Okay, 18%. Well, that’s not a big deal.” Well, actually, if you think about the context of this is your most valuable asset, most likely your business may be your house, but it’s probably even more valuable than your company and then your home. And we’re lucky to eke out five or 7% growth in our home.
John Warrillow: If we can create 18% of increased value in our business in just eight months, you annualize that, it’s whatever, more than 20%, so it’s a huge impact. So I think it’s a lifelong journey, John, as long as the business exists, I believe you should be tweaking it and fine-tuning it to sell, but even in as little as eight months, I think you can make a material impact on the value of your company.
John Jantsch: So, John, where can somebody out about, I know you have an oral assessment, that will help people get started on these eight drivers. So tell people where they can find that.
John Warrillow: Valuebuilder.com and you’re right, there’s the Value Builder questionnaire. It’s free to take. It’ll give you your score out of 100. A typical user-average is about 59 out of a possible 100. The folks that achieve a score of 90 or greater, so those would be our sort of all-stars are getting offers more than double that of the average user. So it’s just at value builder.com.
John Jantsch: Well, John, it was great catching up with you as always, and I know you’re going to be working with our consultant network depending upon when people are listening to this October in Savannah, Georgia. So that’s just another one of the benefits of being part of the Duct Tape Marketing Consultant Network. You get to hear from smart guys like John. So, John.
John Warrillow: I can’t wait to that session, because I think the other thing that we’ve talked about today is how important marketing is to almost every one of these drivers. So I’m keen to kind of be with your guys and learn from them as much as they’ll maybe take away a couple of things from me too.
John Jantsch: Awesome. Thanks again, John. Hopefully, well, I know, we’ll see you out there soon on the road.
John Warrillow: Looking forward to it.