Speaker 0 00:00:04 We all want a business like Netflix or Amazon prime businesses, where once a customer engages with them, it becomes automatic and a part of their lifestyle from then on. But how do you build that forever transaction? I'm Robbie Kellman Baxter, and I have been studying subscription and membership models for nearly 20 years in this podcast, my guests and I share the secrets and strategies of the membership economy. Join us for subscription stories, true tales from the trenches today's guest. 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, a startup veteran himself who started and exited four companies. These days, John helps business owners build valuable businesses through his network of independent advisors, known as certified value builders. John and I first met when he published the automatic customer around the same time I released the membership economy and we fond it over a shared belief in the value of businesses that were optimized around recurring revenue and long-term relationships with customers. He's launching a new book, the art of selling your business. And so I invited him to subscription stories to connect the dots for us about why subscription businesses are so valuable, how to optimize business processes and dashboards to create more value and how to determine what your own business is actually worth.
Speaker 0 00:01:46 Welcome to the show, John, thanks. Robbie could be with you. It's great to have you. So you and I met a few years ago when you published the automatic customer focused on the power of recurring revenue and the impact subscriptions could have on the valuation of a company. What have you learned about subscription businesses since you were
Speaker 1 00:02:04 Oh man, so much. I think one of the things that a lot of businesses have trouble with who are going from the transaction economy to the subscription economy is I think we try to boil the ocean, meaning we try to come up with a subscription model that will serve all customers. And what I've learned is that there's a sort of a mini pre-step that you need to take in order to create a subscription offering. And that is to really bucket your customers niche down effectively into homogeneous buying groups, meaning put your customers together in segments, where they have a common reason to buy. And it's only after you take that extra sort of first step, do you realize, do the subscription offering start to bubble up to the surface? I think we've seen, and I'm sure in your work Robbie, you've seen lots of very diluted, crappy subscription models where people are like, Oh, this subscription thing is a great idea. Recurring revenue, reliable revenue, blah blah. And they put together a crappy model, which is essentially just dividing their revenue up across 12 payments. And it's like, that's not really what we mean by a forever transaction. Right? It's I think that the kind of key to getting it is first niching down, trying to come up with something your customers have in common, a need for on a regular basis and then building it up.
Speaker 2 00:03:19 Great. I love that. It's, it's this one simple step that really comes down to knowing your business and providing value to your customers. But I love how you, how you made it really like a clear step to niche down to get focused, to really know what you're doing and who you're doing it for. And then also that kind admonition to make sure that you're doing this for more than just getting subscription revenue, but rather because it makes sense for your customers to pay on a subscription basis. I love that.
Speaker 1 00:03:46 Yeah. I'll give you an example, Robbie, we're like for people listening, who may be like, I don't really still get what he's talking about. Take a look at H bloom. So H bloom does flowers on subscription and you're like, who, you know, like you think about every flower store sells all their flowers. Mother's day Valentine's day are the big days and then weddings and so forth. So each bloom says we want to sell flowers on subscription, right? But instead of just trying to again, sell a subscription of flowers for everybody who buys flowers, they said let's segment our customers. And they realized that they were hotels that buy flowers regularly, right? They want to put that bouquet of flowers on their reception table. And so they put together a subscription essentially for hotels that want flowers on subscription. So it wasn't all flower buyers. It was just hotels who happen to have this kind of weird idiosyncratic need for flowers on a regular cadence. That's what I mean by niching down.
Speaker 2 00:04:36 It's a great example because I would imagine that a lot of flourish, but if we cut down, if we niche down, we would lose all the weddings and the birthdays and the big Valentine's rush and we wouldn't be ready and it's distracting. But if you really focus on that, you actually, first of all, subscription, you get the subscription revenue and the subscription operations that people love, which is all about predictability. And you lose all of those spiky moments that are so hard for businesses to manage. So it's kind of counter-intuitive that by niching down, it actually gives you the ability to grow faster and more predictably.
Speaker 1 00:05:14 It also makes you so much more referrable right? Like it's a generic flower shop who does the same thing as everybody else does. Why would you buy it from that retailer from another well it's location, right? And as soon as you undermine your location or you're not the closest retailer, there's no reason to buy. Whereas if you say, look, we're the world's greatest flour company, supplying hotels on a regular basis. That's something you can get around referring people to. So
Speaker 2 00:05:40 Too memorable and credible. Yeah. Yeah, totally. Because if I say it's a flower shop and there there's one store and they're good at, Oh, they do weddings and birthdays and hotels and office buildings. And pretty much anything you could possibly imagine because they're geniuses with flowers. That's very forgettable. It sounds like everybody. But if you say, Oh, you know, they're funny, they only do hotels. Well, 90% of people are like, well, I'm at a hotel, but that 10% that are buying on behalf of a hospitality business, they're like, Oh wow. So they're going to understand all of my unique, quirky questions and problems. So it's great for both referenceability and credibility. So how has what you've learned come into play in this new book, the art of selling your business and what made you decide to take pen to paper again, metaphorically speaking, and go back into the dark tunnel of book writing,
Speaker 3 00:06:35 Catch up to you, man. You're a way to keep out selling me on Amazon. That's why I'm trying to beach. Not kidding. I do. I do a podcast
Speaker 1 00:06:46 Built to sell radio where I interview entrepreneurs who have sold the company. I've done something like 300 episodes now. And one of the things that I find fascinating is there is a subgroup of business owners. When they go to sell, they just punch above their weight class. They seem to be seeing to a different hymnbook. They've got some sort of playbook that they're following that allows them to get way more, better deal terms, way more for their business than the mass vast majority, frankly of business owners who often get unfortunately kind of taken advantage of when they go to sell their company. And so I wanted to try to codify what the best entrepreneurs do when they go to sell their company. And that was my mission is to try to pick the winning hacks, the best little ideas from entrepreneurs who seem to somehow punch well above their weight when it comes to selling
Speaker 2 00:07:33 Specific for subscription businesses that you've noticed. I mean, you've, you've helped entrepreneurs sell a lot of businesses, not to mention your own businesses. What is different, better, worse, harder for subscription businesses, where they're much easier.
Speaker 1 00:07:46 Well, they're much more desirable companies because of what you mentioned and write about all the time, this predictability, right? If any acquirers want anything, they want to make a business very predictable. That's their juice. That's what gets them going. And so the subscription model, especially with a low churn rate, you have tremendous predictability. And that's what they're after. I did an interview recently with a guy named Rob walling. Drip was his company, sold it to lead pages. So he built this company up to $2 million of annual revenues, a young guy. If you knew, if you saw him, you'd be like, okay, he's a young guy, guys, $2 million of annual revenue, not a huge company per se, but a successful one. And one growing quite quickly with very low term, he figures the company's worth between nine and 14 times a are our annual recurring revenue for a non-subscription based entrepreneur to hear nine to 14 times, they'd be thinking a multiple of earnings. Right. And
Speaker 3 00:08:40 Yeah, they'd be like, that's incredible to get nine to 14 a month revenue people Wallings getting nine to 14 times revenue.
Speaker 1 00:08:47 It's like, it's just blows the mind to think about that. Now his business was very unique. There were some unique circumstances that made it so valuable, but still one of the key differences between a subscription company and a transactional company is the valuation and subscription companies. They traded oftentimes multiples of revenue as opposed to multiples of EBITDA. And I know you know this, but that's just an incredible insight to take away, I think.
Speaker 2 00:09:11 Yeah. And I'm glad you're saying it because there are a lot of businesses that are very aware of it. In fact, as you pointed out that get into subscription models, change their episodic pricing into subscription pricing without changing anything else, because they're like, we want to get that big valuation. We want to be valued on our ARR without even having the business to support that. On the other hand, there are lots of organizations for whom this is still new news that they didn't. They're like, I just didn't know I've been busy running my business. And I didn't realize that recurring revenue is so much more valuable. And in fact, that many investors, if part of your business is subscription based and part of it is not, they will value the two parts of the business differently and then take that some of the parts valuation to decide what the company is worth. So you're saying, I just want to make sure we get this, that in fact, that is true, that what you see with your generally smaller, closely held businesses that are using subscription pricing that have subscription revenue are getting valuations based on revenue that are much higher than the valuations of their episodic counterpart.
Speaker 1 00:10:21 Absolutely. And you know, I think you bring up a really interesting point, Robbie, and that is this, this kind of notion of having two different forms of revenue, your episodic, as you described transactional revenue, and then you've got your subscription revenue and you're right. They will be valued by an acquire it very different rates for a software company. For example, oftentimes a software company will have SAS or subscription-based revenue and then they'll have on the side installation or one-off revenue or services, revenue, training, revenue, all these sorts of things. And again, the savvy buyer will very much tease apart, your profit and loss statement say, okay, we're going to give you X, multiple of ARR. And then we're going to deeply discount your training revenue, your one-off installation revenue, et cetera. And again, I think for folks who are sort of on the fence, half-pregnant a little bit with this subscription model.
Speaker 1 00:11:08 I think it's worth really considering why keep the episodic revenue. And I speak very much firsthand. I used to own a sub a market research company. We used to have an episodic business model. This goes back 10 years or so. And I tried to create a subscription model. I heard about your Thomson Reuters and all these sort of subscription-based research companies. And I thought, Oh, that sounds great. And probably for very similar reasons, you describe as not really rethinking the entire business, but wanting to kind of move. And so we kind of were half-pregnant we kept the old subscription-based or episode, sorry, the episodic market research business. And we tried to create a subscription. And every time we went to a customer, they would say, Oh, that's interesting that you've got that subscription over there, but you know, what we really want is a customized offering just for us.
Speaker 1 00:11:52 And we couldn't get the subscription off the ground because we left the flank of having a transactional business model open. And it wasn't until we turned off the episodic business that the subscription business started to actually grow. And that for me was a big lesson in the power of being all in on subscriptions. You know, I think about GNC, they've just declared bankruptcy or Chad, I can't remember with, they built a subscription company. So their, their protein supplements for a workout buff dudes who want to get big and protein powder. And, you know, like I said, but my guess is it wasn't translated all the way through the company. Because when you go into a store, the retail store manager is still incentivized to sell the product in the store, as opposed to getting you to buy the subscription to protein powder, though, they notionally had a subscription offering. It wasn't basically hardwired into their entire business model. So you had the subscription model competing with the store manager who wanted to sell same source sales increases. At course it failed. So you're got it. It's going to be all the way through the company.
Speaker 2 00:12:51 It gets so messy for a bunch of reasons. There are kind of what I think of as the innocent, we're trying our best reasons, which is it's complicated to track all the individual products and understand how to sell the subscription offering. And then there's the more cynical one, which is different people have different goals. And so, you know, if I'm getting comped on my same store sales for this quarter, I'm going to push different products than if I'm being compensated for signing up subscribers who come engage, stay and tell their friends over time. You know, and that's an issue, frankly, with a lot of businesses that transitioned to subscriptions without really changing their operations and their culture and their metrics is that there are people who are still being rewarded for short-term returns. And it's really hard to build long-term value in your business. If you're optimizing for short term returns,
Speaker 1 00:13:47 Well said, couldn't agree. More.
Speaker 2 00:13:49 One of the questions I had for you, I was really curious about is how sophisticated you think investors are these days about subscription businesses, because we've seen some pretty ugly mistakes, certainly in the public markets of investors getting really, really excited because they see that dollar sign in the subscription. And then they learn after the onion is peeled back for them. Usually after they've made the investment, that the company is spending all kinds of money on acquisition, acquiring all kinds of customers who aren't staying very long and where the customer lifetime value is negative, right? Or the customer lifetime value. Isn't there at all. One really public example of that blue apron, right? It was effectively I'm going to oversimplify just for the illustration, but it was costing. It was taking seven months for them to pay back that meal kit, early trial period, where people were actually getting free meal kits was taking seven months for that customer to become valuable, but the customers were staying about six months. So they're actually losing a month of revenue on every new customer, right over simplified a little bit, but the investors didn't see it because they saw big acquisition money going in. They saw lots of customers joining and they saw short-term revenue exploding. So let me ask you, are investors getting more savvy about digging into the numbers?
Speaker 1 00:15:08 Absolutely. And I think LTV to CAC is, is still probably the best metric single metric to look at. So LTV to CAC lifetime value of a customer over the costs to acquire her as a subscriber basically. And what most professional investors are looking for is at least a three to one LTV CAC ratio. So you're getting three times more lifetime value than it costs to acquire a customer. So in your blue apron example, it's, it's negative. So you're looking for three to one. And I think, I think a lot of acquirers are starting to get really educated about this. You can't have a very fast subscription company, just basically acquiring, acquiring, acquiring customers and have them fall out the leaky bucket at the bottom. You can get away with lots of churn very early in a subscription moment because it's easy to acquire customers and you can kind of make up for it.
Speaker 1 00:15:53 But as your miss subscription company matures, it's much more difficult to maintain any sort of churn. So I think overseeing a lot of that, I think it's happening in virtually every industry. One of the ones that I just love is the business of car washes. Like think about the most old school greasy business you could possibly imagine is like the business of washing cars, right? And in the old days, it was like, if you had a good location, if you were on a busy street corner, like that was a valuable business because you could sell the land. And that was how these things were bought and sold. Well, of course that's totally changed. As private equity has moved in to the carwash market, they have glommed onto the idea of subscription offerings. And so now virtually all car washes offer a unlimited membership where you can get your car washed as much as you want.
Speaker 1 00:16:40 And it's having profound impact on the lifetime value of your subscribers. Because if you live where I live in Toronto, it's nice to think about getting your carwash, but for as much as it snows and rains here, it's probably not worth it. Right. But you know, you get a busy day in April when the sun shining, everybody's got the salt and crap on their car. There's a lineup down the road of people who want to get the carwash. And so the carwash gets these big blips of revenue in a certain months. Whereas when a subscription, they get predictable revenue every single month, the carwash business has been transformed by the injection of sophisticated private equity groups tried to transition these businesses into subscription companies
Speaker 2 00:17:16 Or one of my favorite examples as well. I spoke at the international carwash association a couple of years ago. And what I was talking about was, you know, that the forever promise of a carwash is that your car is always clean, right? That's what you want in Toronto. Like we don't want to go to the carwash and wait in a line around the block and have our car look terrible for the days leading up to the moment when we actually have the time and the drive to get there. We just want our cars to be clean all the time. And I brought that up and I said, you know, you guys are talking about taking your carwash time from 10 minutes to nine and a half minutes with a special new kind of brush. And nobody cares customer doesn't get what the customer wants is I just want my car to be clean.
Speaker 2 00:17:55 In fact, if the carwash ferries came to my home in the middle of the night and spot cleaned it. So that even when there was the smallest Fleck of dirt on it, it was removed. I would pay more for that. Yeah. And so I suggested ideas like, you know, taking that carwash one step further, like what if your location instead of being in that expensive, busy area, which by the way puts you in the category of real estate investor, more than carwash operator, but that's a different story. What if you had your carwash in a, you know, low traffic, industrial area, because you were valet washing the cars, you were picking up people's cars at their homes or their offices and zipping them over to your carwash and then bringing them back, whether that's in the dead of night or while people are at work.
Speaker 2 00:18:37 And they, they said, well, no. Cause we have the sunk cost, which is one of the biggest challenges I've found in organizations really committing to subscription is the sunk cost. We already have this professional services team. We already have printing presses. We already have car washes. We don't want to be nimble and evolve to solve the customer's problem in a better and ongoing way because we have all this baggage. And I think it's great that investors are focusing on, what's really going to add value and what's going to really drive the numbers. And this brings me to the, what I think of as the meat of this conversation and what everybody is here for, which is tell us how to build value into the business before we sell it. So maybe you can start by talking about the value builder system and how you developed it.
Speaker 1 00:19:30 Yeah. So the value builder system, essentially we'll evaluate the value of your company now and show you prescribe a way to improve it. Leading up to an exit it's based on these eight drivers, we identified through quantitative market research with business owners. We've had 55,000 businesses go through it now. So it's all based on these eight factors that are attractive to acquire. So recurring revenue is one of the eight. Let's talk about that one. Yeah. I mean, that's, that's a huge driver of the value of your business. So the more recurring revenue you have in the higher quality recurring revenue you have, and going back to some of these LTB to CAC ratio, some of the important ratios to acquire, that's going to drive the value of your business. There's an underlying sort of theme through all eight of the factors. And that is for business to be valuable.
Speaker 1 00:20:15 It has to be successful without the founder. And I know you work with a lot of really big companies, Robbie, but for smaller companies, a startup businesses, that's a really tough thing to do because the owner is oftentimes very much involved in the, in the operations of the business. And so what we try to show them is across these eight dimensions that they've got to pull themselves out of the operations of the business in a lot of episodic, transactional business models, the owner is the Rainmaker in the company, right? Whereas moving to subscription allows that recurring or automatic revenue to essentially replace the owner as the chief sales person for the company. And so that's just, that's one of the kind of common themes. If you wanted to distill, like what's all this value building about it's it's how do you create this business so that it's not dependent on the founder? Any, any more or less dependent on the founder?
Speaker 2 00:21:03 That's so important. And it's, it's often counter-intuitive for that founder to sort of say, you've built this baby, you've built this thing that is so important to you, and that works so well. And now you need to figure out how to make it work without you and subscription can be a really great way to move the business in that direction. So how do you use that to calculate what the business is worth or whether the value of the business is increasing? And I know that, of course the value of the worth is the value of the business is ultimately determined by what someone is actually willing to pay for it. But by estimating what someone might be willing to pay for it, it's, it's so hard for organizations to know, because so much of it, I guess, depends on the buyers themselves and the moment of sale.
Speaker 1 00:21:48 Yeah, you're absolutely right. That beauty's in the eye of the beholder. The way to actually get a precise value on your company is to take it to market and figure it out. Having said that there are some benchmarks, especially in the SAS world software, as a service world that can help for very small company, a non-software company operating on a recurring revenue model. Usually the recurring revenue on a dollar for dollar basis is worth at least twice that of the transactional revenue. So I'll give you an example, you know, the guys who do security like security in your home, or you put a little pad in the, you know, they have two forms of revenue, they've got your installation revenue where they charge to wire, all the sensors up in your windows. And then they've got installation revenue. That's where they have the monitoring revenue, where they pay them $39 a month to call the cops.
Speaker 1 00:22:29 If somebody breaks in the transactional revenue, the installation revenue, typical private equity group, nowadays buying security companies will pay about 75% for every dollar of transactional revenue. Whereas the recurring revenue they'll pay about $2 for every dollar of, so in that case set, another way, every dollar of recurring revenues were two or three times that of the transactional revenue. So that's a, that's a subscription company. If you walk over to the world of software where you're looking at the incremental growth rates are so much easier to get because it's software, it doesn't require people and trucks and all that stuff it's even more pronounced. So, you know, you can have examples where a company growing very quickly and with very low net churn rates can get into the high single digit ARR multiples. And again, if we go back to Rob walling, he was thinking nine to 14 times AR but again, those are really reserved for the fastest growing lowest churn subscription companies that are software based.
Speaker 2 00:23:27 So insightful and so helpful. And when you were talking about Rob walling, you were talking about some of the other metrics that made, you know, you, you had alluded earlier. And I think everybody was probably, you know, their ears pricked up mind dead. He said, you know, nine to 14 times, which is higher than your average subscription business, because he had some other factors. And then you mentioned some that I think probably relevant, they're low churn and the really fast growth. So I'm wondering if you could talk about the systems you need, the metrics you should focus on as you're growing your business and maybe even as you're getting ready to sell it.
Speaker 1 00:23:59 Yeah, for sure. So I mean the, the ultimate metric is something in the, especially in the software world is the rule of 40. And that is that your growth rate and your profits rate percentage add up to at least 40.
Speaker 2 00:24:15 I love that. That's nice and easy.
Speaker 1 00:24:17 Yeah, very easy. Right. So if you had 25% profitability EBITDA margins and you had 20% growth rate, you add up to 45, 25 plus 20 is 45. Therefore you exceed the rule of 40 and that's what Gabby Therese was focused on. So Gabby is a woman that I write about a lot. She built a company called Bellfield systems, which did timekeeping for lawyers really kind of plumbing of kind of company, right. But it was based on a subscription offering. Lawyers loved as a way to monitor, measure their time. And she built the know law firms for this stuff every month, very sticky, very low churn rates because once lawyers figured out a system, they don't want to revamp, revamp it or pull it out. And so she was able to get to the rule of 40 when she started to realize that that company would be on the higher end of the valuation metrics or her estimates were that she was going to get between five and seven times for a R R well, she ended up getting on the top end of that range because she got multiple bidders and made some great choices.
Speaker 1 00:25:14 She got to the rule of 40 most importantly. So that's the panacea now, not all some shipping companies are going to get to the rule of 40, especially if you focus exclusively on growth and beginning of your model, but that's really the panacea. So it can also be flat profitability and 40% growth that's gets you to the rule of 40 or fat profit margins, 35% profit margins of 5% growth. Also the rule of 40, but that's the idea. And to get there, that's sort of a, in many ways, a lagging indicator, a forward-looking indicator of your ability to get there would be things like net churn rates and net share. And of course, and again, I know I'm preaching to the choir and even mentioning this to you, but, you know, gross churn less, your upgrade revenue gets you to nut Shern, that's going to be a key metric to look for. And then obviously even more of a leading indicator would be usage of your subscription. The more people use it, the less they're going to churn. So if you're wondering like what's the forward indicator, although this stuff like build a great offering that people love to use,
Speaker 2 00:26:09 It's interesting how you're talking about the systems you need and the tracking of not just those top level metrics that are the ones that the investors care about, but those underlying leading metrics that can help you actually manage the business as it's growing. And you talk about engagement, metrics, usage metrics. I think of those as the leading indicator for an organization of how well it's doing, if people are using your products regularly and well. And I think about recency frequency, depth, and breadth of usage, they're not that likely to leave. If they're getting value, if you're part of their habits, they're likely to stay. And if they're likely to stay, they're likely to keep paying which, you know, results in valuable, valuable revenue. So, you know, I like how you're talking about the metrics, the metrics change as you're readying the business for sale, or is this kind of a system that you should put into place on day one of running your business, and then you can kind of set it and forget it. And then when it's time to sell, you just have a really valuable thing.
Speaker 1 00:27:11 Look, I would do it from the beginning as much as possible because what investors crave again is de-risking right. Like that's what they pay a huge premium, you know, major multiples of revenue for is if they can be very confident that this business is going to continue to grow. And so it's the longevity of the reporting that is going to be very attractive. So if you rock up and say, Hey, we just did an LTV to CAC or a 4.6 to one, and that's helpful, but what's even more helpful is to know you've been tracking your LTV to CAC for five years, and it's gone from 2.6 all the way up to 4.6. That's way more valuable for an acquire equally. You know, you talk about usage, depth, breadth, frequency, recency, if you can show great positive trends in all those areas, that's what acquires crave. So it's the long <inaudible>, it's the length of time you've been tracking this stuff. So I would do it even if I was five years away from selling it, I would really want to be tracking that stuff now. So you can just demonstrate the improvement over time. That's really what investors are going to crave.
Speaker 2 00:28:09 What if you didn't do it from the beginning? Is it too late? When you're already thinking about selling the business to start creating the systems and the metrics, and I guess people say prettying it up for sale. Is that something that people do? Is that ethical? Is that effective? What's your take on, on prettying things up for sale?
Speaker 1 00:28:29 Yeah. Look, I think part of selling well is positioning your company in the most positive, favorable light possible. People invest a lifetime in creating a company and they should do everything they can to pretty it up for sale, everything they can to, to make it look as attractive as possible. So, you know, there's all that expression. What's the best time to plant a tree. Well, 60 years ago, what's the second best time now. So grab your metrics and it will have an impact for sure, on the ability to position your company for sale. But you might, if you're just starting to track your metrics, you might get an earn-out deal. And so an earn-out deal is where you get paid a little bit of money up front, or some portion of your proceeds, that value of your company upfront, but then there's this second payment or third payment down the road.
Speaker 1 00:29:15 If you achieve certain milestones as a division of their company. And that happens when number one, the buyer and the seller can't agree to a price. Number two, the buyer isn't really that confident in what you built yet. And I'm reminded of a guy, Roger rod founded zero, the accounting package, which is in this kind of big bowel right now with QuickBooks prior to zero, he started a company called aftermath. And that's what actually created the money to build zero was selling after mail. And they did. They basically helped you archive email. And this was around the time of Sarbanes Oxley and all these big fortune 500 companies having to do a lot better job of tracking their email and so forth. So rod builds this little product called after mail, which allows them to archive their email among other things. It's two of the fortune 500 companies to buy it for a million bucks. Each we get $2 million in revenue. Most people at that point would say, okay, I'm going to go find the other 498, right? He doesn't. He sells the company to a systems integrator who was working with all of the other fortune 500 companies and he sells it for $35 million. But here's the thing. It's a $2 million company. You might have $35 million, but 15 of that,
Speaker 2 00:30:19 That's a 17 X, 17 X ARR.
Speaker 1 00:30:22 It's crazy. But here's the trick. Here's the trick because it was so young. She didn't have his metrics to go back to what we were talking about earlier. The longevity that risk, all that stuff. He only got 50 only, he got 15 of his 35 upfront and the rest in the future tied to his ability to hit future payments. And like most entrepreneurs, if you put them inside a corporate environment, he lasted about six months before he bailed and walked away from his entire earn-out. So that's the downside of an earn-out deal where you get pay a little bit of money upfront, but you have lots in the future. Most entrepreneurs are, are not wired to work for someone. And so outs can be really challenging for them.
Speaker 2 00:31:05 Yeah. This is such an important point. So if you're a business owner and you want liquidity, meaning that you want some cash, you have this valuable business that you're running, it's throwing off a little bit of cash, but you know that as an asset, it's worth so much more, if you want that liquidity event, but you don't want to leave the business. How can you have that conversation? And what kinds of terms can you write into the agreement so that maybe you keep part of the business or you continue to work with the organization in some kind of way, or have some kind of leverage over this beautiful thing that you've spent your blood, sweat, and tears to build. How do you manage it if you do, or don't want to leave the business?
Speaker 1 00:31:48 I think that's actually becoming a very common way these days, that businesses are transaction, especially in the space that I spend a lot of time thinking about, which is kind of the, the one to $30 million company. So the value of, so roughly one to $30 million that company is, is oftentimes not that attractive to a strategic investor. It's just, quote-unquote, it's too small for a very large enterprise organization to buy a company of that size. So increasingly you're getting private equity groups, filling the gap. They are buying these small and mid-sized companies and rolling them up together. Oftentimes stitching them together and creating a larger company down the road, private equity companies to go back to your question, private equity companies, generally don't like buying a hundred percent of the businesses they acquire because they don't have managers in place. They don't know what they're doing, frankly, they're financial engineers.
Speaker 1 00:32:35 And so what they love to do is buy companies four by 60% of your company or 70% of your company. And so if that's a transaction that's attractive to you. In other words, selling the majority, but not all of your company and continuing to work in your business for a period of years into the future. A private equity transaction may be ideal for you. You get to put some money in your jeans and at the same time, you don't lose your job because they'll probably ask you to roll your remaining equity into a new entity that you will run as a effectively reporting to the private equity group on your board. So this can be a good exit option. Again, if you want to sell some, but not all of your company, the downside or the danger is you still got to make sure that the private equity company knows what they're doing.
Speaker 1 00:33:24 Because when you roll equity into that business effectively, they're going to leverage up your business. And they're going to need your business to be able to pay off that debt. I'm reminded of a, of a guy just interviewed for the podcast I do. And he sold his company. He sold 60% of it. So he lost operating control, rolled 40% into a new entity, the private equity group funded. And it wasn't long before they brought in new managers. They didn't know what they were doing. Private equity group. It started to lose traction. The company no longer was able to afford to pay the bank back its payments. Long story short that new entity went bankrupt and that entrepreneur lost everything in that transaction. So the 40% he had put at risk was gone. So you want to make sure if you're going to do that deal, you have a high degree of confidence that the private equity group you're working with knows what they're doing. You've got a sense of operationally what they're intending to do, and that they're not leaving up that debt so high that the payments are on a table for you to make, while you run the business as the new entity, that's a lot of complicated math, but essentially, hopefully that makes some sense.
Speaker 2 00:34:28 Yeah, absolutely. And you know, I think I mentioned to you before we started recording that I also have interviewed the season, um, Steve cake bread, the author of the IPO playbook, who's doing similar work, but with taking much larger companies public into the public markets and like you, I mean, it's funny because a lot of the themes are the same that it's not just about taking the money. It's about whose money you're taking. And it's about what your vision is for the longterm health of the business. And at its best, you can bring in partners that have deep pockets and can take you to, you know, if you want to stay with your business to the next level in terms of reach and credibility and staying power and sophistication. But if you don't go with the right partners, you really risk damaging your business. That you've, that you've invested so much. And so you really need to know, am I doing this to just get out and you know, no judgment there, or am I doing this because I truly want to take my business to the next level and have a little breathing room to do the next, the next part of the marathon.
Speaker 1 00:35:29 And you think about why private equity groups buy businesses like they're in the buy low sell high business, right? That private equity companies are simply structures, oftentimes funded by investors who are investing in a company. They're trying to buy it for as little as possible and then go around and flip it for as much as possible. How do they create value? They create value in many cases by trying to professionalize your company, air quotes, professionalized. So you think, Oh, well that sounds interesting. That sounds great. I'd love some Harvard MBA, Stanford MBA type thinking on my company until you realize, however, as the author of all the policies you've created, how you treat customers, how you treat employees, all those get ripped up and professionalized. And it's like for a lot of watch butters, it's like open-heart surgery without the anesthetic, right? It's like everything you've built, the culture you've created is just being professionalized. And so it's could be a very, a very
Speaker 2 00:36:23 For people listening, just know that every time John says professionalized, he uses air quotes,
Speaker 1 00:36:29 Right? Cause like it's a delicate alchemy running a company. Right. And yes, you, should you give people their birthday off? Well, no, that doesn't make any financial sense to give people a holiday on their birthday. But if that's part of your culture and you been doing it for 20 years, that could be an important policy, right.
Speaker 2 00:36:44 It may not make financial sense, but it does make strategic sense. Yeah. You don't want to lose the baby in the bath water as they, as they say in a horrible metaphor. Okay. So you ready for a little fun. We're going to do a speed round. Let's do it first. What's your one piece of advice for a business owner. Who's thinking about getting out and looking to put their business on sale.
Speaker 1 00:37:07 Thank you for your company as a child and adolescent, you're trying to create an into an adult that is a thriving, successful human being. That's your job is to get your business to a point where it can succeed without you best piece of advice. You recently received. It wasn't recent, but it was good. And that is don't get too high on the highs and low. And the low is Greg Clark guy founded at a company called college pro praters told me that he said entrepreneurship is personal. It's deeply personal. And you're going to get way too excited and happy when it goes well. And a way to depress when it goes badly. And the reality is it's never as good as it feels when it's other good days. It's never as bad as it feels on the bad days. I love that. That's good for all of us.
Speaker 2 00:37:50 What's the first subscription you ever remember getting
Speaker 1 00:37:56 Probably sports illustrated? Actually it was a magazine. Yeah. It was just sports illustrated. My parents bought it for me to try to encourage me to read. I was the worst thing in the world.
Speaker 2 00:38:05 Oh, it must be so proud that their kid who didn't like to read now is a, an accomplished author. So, uh, I just want to, you know, thank you so much, John, um, for being a guest on subscription stories and wish you all the best with your new book. I'm really excited to get it into the hands of my clients, the art of selling your business. And I wish you all the best. Thanks Robbie. That was John Warrillow founder
Speaker 0 00:38:36 Of the value builder system. You can find out more about John and his book, the art of selling your
[email protected] and for more about subscription stories, as well as a transcript of my conversation with Sean, go to Robbie Kellman, baxter.com/podcast. Also, if you like what you heard, please take a moment to write a review and give us a star rating reviews matters so much in helping others find us. Thanks for your support. And thanks for listening to subscription stories.
Speaker 4 00:39:08 <inaudible>.
