Agent of Wealth Episode 73 – Business Owner Series: How a Business Owner Can Calculate Their Freedom Point

The #1 mistake entrepreneurs make is building a business that relies too heavily on them. So, when the time comes to sell, prospective buyers aren’t confident in the company’s future — whether it’s profitable or not. In this episode of The Agent of Wealth Podcast, Marc Bautis is joined by John Warrillow, the founder of The Value Builder System™, a practice management software for business advisors. 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. Prior to founding The Value Builder System™, he started and exited four companies, including one acquired by a public company.

In this episode, you will learn:

The basics of The Value Builder System™
How to identify your TVR (teachable, valuable, repeatable) to better scale your business.
Common mistakes entrepreneurs make and how to avoid them.
Warrilow’s take on the common question; When is the right time to sell?
What it means to reach the freedom point, and how you can determine if now is the time to tell your business.
And more!

This is the final installment of a two-part series for business owners. Listen to the first episode, “Maximizing the Value of Your Business Before Selling” with Michelle Seiler Tucker.

Resources:

Disclosure: The transcript below has been lightly edited for clarity and content. It is not a direct transcription of the full conversation, which can be listened to above.

Welcome back to The Agent of Wealth Podcast. On today’s episode, I brought on a special guest, John Warrillow. John is the founder of The Value Builder System, a software tool for building and increasing the value of a company. John’s also the author of multiple best-selling books, the latest of which is titled, The Art of Selling Your Business: Winning Strategies & Secret Hacks for Exiting on Top. He is also the host of Built to Sell Radio, where he’s interviewed hundreds of founders about their business exit. So if you’re a business owner or even thinking about starting a business, you’ll definitely want to listen to today’s episode. John, welcome to the show.

Thanks for having me, Marc.

I’m excited about today’s show. We work with a lot of business owners at Bautis Financial, and see first-hand the struggle some have at tapping into the value of their business. How did you get started in working with business owners?

Well, I’ve been an entrepreneur for a while. I’d say my initiation into the world of building value was a bit cold.

A Lesson in Business

I used to run a market research company, where we did quantitative market research. We had great clients — such as Bank of America and American Express. The challenge was that every project was unique. And yet, we were very profitable — about a 20-30% profit margin. So it was a good business, maybe five or six million of revenue.

I’ll never forget when I went to see a M and A guy in Toronto, Perry Maley. This goes back 20 years. I was rubbing my hands together, thinking, ‘this is going to be great.’ I owned this great business and believed it had to be worth a truckload.

So I asked Maley what he thought it was worth. He said, “Well, let me ask you two questions.”

Question 1: Who Does the Research?

I responded, “Well, it’s Bank of America. I mean, I got to show up for that. It’s a big client.

Question 2: Who Does the Selling?

I said, “Well, you can’t send anyone other than the founder and CEO to speak with American Express…”

He said, “Okay, John, let me get this straight. You do the research and you do the selling?” I could see where the conversation was going. “John, there’s nothing here to sell,” he said. “Your company is worthless.”

Man, it felt like a gut punch. I walked into that meeting thinking I was sitting on a gold mine. Despite having lots of profit and great clients, the business was — in his view — worthless.

That kicked this 20-year journey off for me, one where I’m constantly in search of understanding what it is that makes businesses more valuable. Long story short, that story had a bit of a happy ending. We ultimately changed to a subscription model and hired a bunch of salespeople. The business was then acquired by a public company years later. But that moment in Perry’s office was when I realized I needed to think differently about my company.

So what’d you do next?

Well, we spent two or three years making that business more sellable. Then, I wrote a book called Built to Sell. Some people write books because they have something to sell you, or they have a business they want to promote. That was not my intention with Built to Sell. I felt like I’d learned a bunch — and made a bunch of mistakes — and wanted to help people avoid some of the stuff that I screwed up, frankly.

We actually moved to Europe right after that book was published, which is the worst thing you could possibly do as an author — to leave town. But, it kicked off this journey that I’m on now with Value Builder, a software we developed based largely on some of the principles in the book Built to Sell, which entrepreneurs use to help them improve the value of their company leading up to an exit. So that’s what I do now, 90% of the time.

So how does Value Builder work? Can you give me a walkthrough of how a business owner utilizes the software?

Results From The Value Builder Software

So business owners don’t actually come to me directly, they go to one of our advisors. We have advisors around the world who are licensed to offer the Value Builder System to clients — coaches, consultants, etc.

The first step in the Value Builder System is to get their Value Builder score. The average score is 59 out of a possible 100.

By now, we’ve had 60,000 businesses go through the system, so we have a decent dataset. We know that the average business starts at a score of 59, and those companies trade or get offers of 3.5x their pre-tax profit. So relatively modest, no multiple of earnings. However, businesses that go through the value Builder System and improve their score up to 90 or greater get, on average, 7.1x their pre-tax profit.

It’s a process we take owners through to help them think differently about their company and build it so that it can be valuable to somebody else.

I’m sure that the answer varies, but how long does it take a company to go from a score of 59 to something in the eighties, nineties?

We actually did some research with an advisor of ours. They looked at an eight month window, and had everybody begin the Value Builder System at month one. By month eight, they went back and looked at how much of an improvement each business had. On average, they improved by 18%.

So again, you can extrapolate back as to whether you think you’ve got an average business, below average business or above average business, then how quickly you accelerate.

But, I think within a year you can make a material impact on the value of your company. Usually it’s six, seven figures worth of value that we were able to realize for the owners that go through it.

So, what happens in that year?

The advisor meets with the business owner usually once a month and there’s 12 modules, think of it as a stair step approach — each step leads to the next step. At the beginning of every month, the advisor will assign some homework for the owner, like a video tutorial to watch. Then, in month two, you meet with your advisor and discuss what came out of completing the questionnaire, watching the video, etc. That meeting would trigger a subsequent set of steps that the owner would take leading up to the next step.

So one step per month, and usually within 12 months, you’ve made material prudence. Then it begins again. It’s a circular process. So year two, you should go back to month one. And of course, everything has changed in your company and you go through the same set of steps, hopefully at that point with a more valuable company.

Going back to that original example you gave of your market research company, where you managed both research and sales. I come across that typical business a lot, one that is really dependent on one particular person. Are there simple things that that type of business can do to make themselves more sellable or more valuable?

How to Identify Your TVR: Method for Scaling Your Business

Yeah, I think it comes down to identifying your TVR: teachable, valuable, repeatable. The challenge with a lot of businesses is they come about because of an expertise — something that they have a unique knowledge of, or do really well — so, from the start, people want that service or product. But quickly, many reach a plateau.

Business owners run out of hours in the day. It might happen at $100,000 in revenue or $200,000 in revenue. They just can’t grow anymore because there are no more hours in the day. So, you’ve got to hire people.

It takes years to effectively teach employees what it’s taken you decades to learn. So usually, employees never meet a business owner’s expectations. Then, they throw their hands up in the air and say, “Oh, nobody does it as well as I do. I’ve just got to do it myself.”

Business owners get stuck in this perpetual ceiling beyond which they can’t grow their company. And it’s deeply dependent on the business owner. Frankly, it’s not sellable — as I found out the hard way.

So if you find yourself in that spot, sit down and grab a white board or a piece of paper and do your TVR.

Teachable: List the services and products you sell. Give them a score from 1-10 on the degree which you could teach employees to deliver them.
Valuable: Write down the extent to which they’re valuable coming from you. The opposite of valuable is a commodity.
Repeatable: Write down what customers have a repeat need for.

Then, look at the list and you identify which one scores the lowest. In other words, are likely most dependent on you and least scalable. And you ask yourself, is it worth continuing those when you could focus more on your TVR?

I think that’s an important process to go, particularly for a service business.

When is the Right Time to Sell?

That makes sense. Is there a right time to sell your business? What I’ve seen business owners do is push off selling when their business is profitable because they’re afraid to leave too much on the table. They believe their business is growing and next year it will be worth more, so on and so forth. I’m sure there’s other things that come into play than just looking at a valuation or numbers, but how does someone know?

It’s a great question. Trying to decide when to sell your company is a really tricky thing. Most entrepreneurs want to sell at peak, right? They want to sell when the business is booming. They want to sell when interest rates are low. And if you’re that good at timing it, good on you. But most of us are not that good at predicting the future.

The other thing I would say is most businesses will have some sort of transition period earn-out, where part of their proceeds will be tied to the goals the company has in the future. If you peak at the time of transit transaction, your chances of hitting your earn-out and the corresponding payout associated with that drops. And so now, you’re trying to time it two or three years before your peak. And that’s really even more difficult.

How to Avoid the Permanent Five Stage

When I talk to entrepreneurs, I find that they’re in this sort of permanent five stage. The permanent five is when you talk to an entrepreneur and ask, “Have you ever thought about selling this company? It looks really profitable.” And they reply, “Yeah, you know what? We’re probably five years away from selling.” Then you bump into them five years later and ask if they sold the company. They reply, “Well, no, we got a new location. We got a new product. So we’re probably five years away from selling.” So, it’s permanently five years away.

I think that’s really common and natural. We’re optimists as entrepreneurs. But it also means that we run the risk of riding it over the top. What I mean by that is effectively reaching a point in your business where the best days are behind it. By chasing the next tranche of revenue, the next product launch, you effectively destroy a lot of value.

Earlier, you mentioned my podcast Built to Sell Radio. I have done this podcast a couple of times where I interviewed Rand Fishkin. Have you ever had Rand on The Agent of Wealth?

No, I haven’t.

He’s a great entrepreneur who built a company called Moz up to around $5 million in revenue. Now Moz is a software company and they have really high valuations. He got a call from Brian Halligan, the co-founder of HubSpot — the big, all-in-one marketing software. Halligan offered Rand $25 million for his $5 million company, HubSpot stock and cash. Rand had gotten wind from somebody that his business should be worth four times top-line revenue. He was growing fast. And so, although they were at $5 million then, he expected to be at $10 million the next year. So he went back to Halligan and asked $40 million for a $5 million company. Ridiculous evaluations. Halligan, of course, says ,”No way. You’re crazy. There’s no way we’d pay that kind of money.” So they parted ways.

For Rand, that was fine. He focused on the businesses, and decided to raise venture capital. Moz raised a bunch of money and invested in a whole bunch of other products. None of which they were truly differentiated in, most of which were sucking cash out of the company.

The business started to spiral out of control, and Rand was removed as the CEO by the VCs that were invested. When I interviewed Rand, I asked what that was like. He said it was terrible watching his business — that he built — from the sidelines. I said, “But at least you’ve got Moz stock. That must be worth a truckload these days.” He said, “No, I don’t think it’s worth anything.” I said, “What do you mean it’s not worth anything?” He said that the way the VCs invested was they agreed upon a preferred return and a coupon that they cash out at the time of the exit. The length of time they’ve held means that they’re likely as preferred shareholders to get all of their money out. “I will probably be left with nothing,” Rand said. Out of curiosity, I asked what the offer from Halligan would be worth today, based on the appreciation of HubSpot’s stock. He said it would be worth close to $200 million.

That’s a tough one.

And so I tell you that story Marc, because I think it goes back to the question you asked earlier; When is the best time to sell? Frankly, the best time is when someone’s buying. When you get a call from Brian Halligan, ready to write you a check for $25 million — that’s a good time.

Who Should You Be Selling To?

Another question that comes up a lot is who to sell to. Many times, companies try to fly under the radar. They don’t want to get their product or services knocked off. They don’t want to announce it because they might feel sharks start to circle. They don’t want to look desperate, and they don’t want to get low-ball offers.

Also, a lot of times, the best people to buy are competitors. So what are some ways that you can get the word out that you are looking to sell, without going through some of these circumstances?

You’ve raised a ton of really important points. How do I figure out how many people I should inquire about buying my business? How do I keep it confidential? How do I not undermine my negotiating leverage by telling the whole world that I’m for sale? These are really challenging issues, because to sell your company to get good profits, you need competition. You need multiple bidders. I think that’s an essential ingredient to really getting a fair deal. Yet, the more people you go to, the more the chances of this very delicate secret getting out into the world. And then you can undermine and disqualify yourself from the whole process if too many people find out.

So it’s this balance between getting enough people interested while not getting so many people that you effectively let the cat out of the bag. I think that’s a very delicate dance.

Part of the answer is how many people have you inquired about buying your business? If you’ve had half a dozen serious inquiries from buyers who look genuinely interested, you can be pretty sure that interest won’t go away. So if you’ve got half a dozen of those in your back pocket, you likely could go to market by just inquiring with those six people. I’m reminded of a neat story.

I did an interview with Peter Kelly who started a company called Openlane, which is basically an Autotrader for car dealerships. People buy used cars on Autotrader, whereas used car dealers ha ndo equivalent. Previously, they bought their inventory at antiquated brick-and-mortar auctions. There’s three big auction houses where they sell the majority of used cars. Peter thought, ‘this is crazy — this is the most antiquated system.’ He knew there had to be a better way of doing things, so he created Openlane.

Not surprisingly, he received acquisition offers from all three of the brick-and-mortar legacy auctioneers, who saw what he was doing and realized he was going to put them out of business.

Peter didn’t take the offers. He continued to grow the business, but he constantly lived in fear that the OEMs (original equipment manufacturers) — like BMW, Ford and Honda — would see what he was doing and build their own auction houses.

Even though his business was doing amazing, Peter didn’t want to get put out when car brands figured out how to do it on their own. So when he decided to sell his business, he intentionally did not go to the original equipment manufacturers — the car brands — even though he probably would’ve gotten more money for his company.

All he did was go to the three auction houses and give them a shot to make an offer. He was careful not to reveal to the brands that he was for sale, because he didn’t want to have them set up shop and compete. Long story short, he sold his company for $200 million. It was an incredible outcome and a very successful story, the moral of which is figuring out how many people to disclose your intended exit to.

Yeah, that makes sense. I think it was good for him, because he didn’t have to let the secret out. That’s the same thing I see with a lot of entrepreneurs/business owners, they’re worried about someone stealing their thunder, and doing it better or faster.

Acquirers have to sign a non-disclosure agreement when they get underneath the sheets of your business. Some do it genuinely — with genuine interest in buying your company — but unfortunately there are some bad actors in the acquisition space, who do it for no other reason than to find out your secrets.

I would never recommend you put your business on the market to “test the waters.” You may put your house on the market to see if you can get the asking price. You may put your car on the market to see if you can get the asking price. In both instances, you won’t really be hurt in the process. Your house and car will still be sellable after the fact. But putting your business on the market to “test the waters” is not a good strategy. There’s just so many things that can go wrong with that approach.

And I think even transitioning into the risk business owners take on by not selling. You have a concept in your book called a freedom point. Can you tell me a little bit more about that?

The Freedom Point

The freedom point is the point at which the sale of your company, combined with whatever liquid wealth you’ve created outside of your company, creates a nest egg that will throw off enough passive income for you to live the lifestyle you aspire to have for the rest of your life.

A lot of entrepreneurs reach this freedom point almost unconsciously, because they start a business when they’re young and every year it grows 10-20%. By the time they’re 50-years-old, the business is worth millions of dollars.

Then again, comes the concept of riding it over the top. I think once you reach the freedom point, you must ask yourself: Would you risk something you value for something you don’t?

Very few entrepreneurs want to be the next Steve Jobs or Elon Musk. Instead, most entrepreneurs aspire to have freedom. Why would you give up the chance to have freedom, for launching the next product or another million in revenue? It’s worth asking yourself if now is the time.

Definitely. I come across a mix of people. There are some that build a business for a purpose, and they stay laser-focused on it. Others may even start with that intention, but then — all of a sudden — they get addicted to the success. Then it just becomes a game of wanting more.

My job as a financial advisor is to show them the options or the paths that their decisions can take. A lot of business owners are so laser focused on building their business that they forget about everything outside it.

Yeah. I love your use of the word addiction, because I do think entrepreneurship can be addictive. Especially when it’s going well.

Alright, John. We’re just about out of time. How best can someone reach out to you and find out more about what you do?

Yes, thanks for asking. We put together a few resources. You can go to builttosell.com and select the button that says free gifts. There, we have:

Eight videos on the eight value drivers.
A worksheet about subscription models,if you’re interested in creating recurring revenue.
A workbook that corresponds with the book, The Art of Selling Your Business.

Awesome, we’ll link to that in the show notes. Thank you again. You gave a lot of great information for business owners. I really appreciate you being on.

Thanks, Marc. It was fun.

And thank you everyone for tuning into today’s episode.

Episode 73 – Business Owner Series: How a Business Owner Can Calculate Their Freedom Point with John Warrillow