Succession Question 4: Is Your Business Scalable?

[00:00:00.880] - Rich Veltre

Hey, everyone. Welcome to another episode of Books and the biz. I'm Rich Veltre, and I'm here with my good friend Dan Paulson, and we are here to talk to you about things that cross over from the books to the biz. Hey, Dan, how are you doing?

[00:00:26.820] - Dan Paulson

I'm doing good, Rich. How are you doing?

[00:00:28.830] - Rich Veltre

I'm doing all right. I think today we're following along with our five points of if you're thinking about getting out of your business, retiring, selling, whatever the exit strategy is, I think we're going down our list of the questions that we told people were really important to think about. I think we've moved on to the topic of scalability, correct?

[00:00:52.820] - Dan Paulson

I believe we have. Let me just confirm that. Tadah! All right. There it is. Yes, you are correct.

[00:01:03.190] - Rich Veltre

There it is. So the question number four. You got that in your garage, right?

[00:01:11.290] - Dan Paulson

That one? No, no. I've got one that's a little bit redder. Wheel are covered, but probably goes about as fast.

[00:01:20.420] - Rich Veltre

I hear you. Yeah, I think this is an important topic that from our conversations over a long period of time, we've always about the fact that when you're trying to sell the business, you're looking at your financials, you're seeing what you did, and you're seeing what multiple you can get off of that to sell it because someone else will be interested in replicating what you've done. But I think there's another piece to it. The scalability factor comes into the fact that the buyer doesn't necessarily look at your business the way that you do. They look at it more from the standpoint of, What can I do with this? There's a little more forward-looking as opposed to the backward-looking. Backward-looking gets you your valuation as of today. Forward-looking gets you, Well, how can I get to a higher valuation later? Which is what most people are going to do if they're interested in buying your business. From the operations standpoint, do you follow the same logic there, Dan, or is there something else I need to think about?

[00:02:27.660] - Dan Paulson

I think you're spot on with that. When I look at it, there's a couple of different areas that come to mind. We've talked about different types of buyers for your business, and this is another variant of that. I believe there are people who want to buy a job and there are investor buyers. And the people who want to buy a job, typically you see this on smaller companies where they're coming in because they want to be the owner of this and to take it over and essentially replace the current owner of it. So they're stepping into the operations role, the sales role, every facet of the company, because they believe that they can take what the current owner has done and they can build on that further. But maybe it's not at a multiple like we typically talk about with, say, an investor group. Because the investor group is really looking again at the numbers. What opportunities do they have to grow the business going forward? And you and I have talked to the past. There's really three different groups that come in. There's the innovation side where they can grow based off of new technology.

[00:03:41.560] - Dan Paulson

Maybe they can come in and automate. With that, there might be some greater capital investments, but they also see by putting those machines in place that they can develop something that much quicker. There's the scalability from the volume side. Maybe the new owner understands how to ramp up volume. Maybe have a similar context sphere where they can expand sales dramatically over what the current business owner has done. Then the last one is really the product side of things where are there more verticals, more products that can be added in to get a greater multiple of return? Well, that can happen on both what I would call the owner buying his own business versus an investor, those are really the areas I see from an operations side that are what attract other people in to take the business over.

[00:04:35.720] - Rich Veltre

Yeah, I definitely have seen the same thing where from the finance side of it, scalability is important and they have to look at it from a standpoint of, Yes, we want to increase our revenue, increase our profit. And the question becomes, what is it going to take to get those revenues or profits increased? I'll give you an example. So if you're selling something that requires a handheld customer, so you're out there actually and you have to actually physically meet face to face to get these people to buy your product, the first thing that a buyer has to realize is they're going to hire more salespeople. So it can't just be, Well, I'm going to go and I'm going to sell your product and I'm just going to do it better. Nine times out of 10, they can't sell that to their investor group or to whoever is making the final decision on pulling the trigger on the acquisition. I've seen it where you're going into online to, let's say, and you're changing the business to go into online, the cost is different. You don't need five salesman salaries. You're just looking at the equipment, etc, to run a bigger or better website.

[00:05:49.900] - Dan Paulson

But there is a lot more marketing. So where you might not be paying a salesperson, you might be paying a marketing firm to generate the clicks to get people on your site.

[00:06:02.560] - Rich Veltre

Agreed. And that also pushes to the fact that these are the alternatives that someone that's buying the business. That's the stuff that they're doing. If you think about the fact that the seller, what the seller might be doing to prepare to actually get this up to market and get someone to buy it, they're probably not thinking about that. They're not thinking about where is this business going to go in five years? We're selling. We don't care. It's not on me to think about what are you going to do the next five years? I get you to hear and then you figure out what to do. So the buyers are the ones doing these multiple scenarios. Do I need to spend on physical people? Do I spend on a marketing agency? Is the website good enough and it's going to pick up more if I just spend more on the advertising, as you mentioned? They're going to do more than one scenario to decide which one do we think we're going to go with. And that's how they're going to evaluate what they're willing to pay.

[00:06:56.670] - Dan Paulson

Now here's something that just as you're sitting here talking about this. We've been talking a lot over the last several episodes about getting a company ready for sale and whatnot. But we really haven't talked about, and it's related to the scalability piece, what does a new owner have to be able to make to justify the purchase of the business? Because to me, there's a certain cost that the business is going to have, whatever that valuation comes out that is agreed upon by both parties. But you also have to make sure there's enough money in there to pay the new debt that's acquired by buying the business, pay for the new employees that are going to be added or new technology or new equipment, whatever it might be. And then the last step is there still has to be enough profit left over to justify that this spend was worthwhile.

[00:07:48.050] - Rich Veltre

Absolutely. That comes down to not only the buyer being able to put together what they think their projections are, but it also gets into the business is almost like it has a life of its own. And so it needs working capital. And the question becomes, how much is that working capital? Because a lot of times what will wind up happening is you'll get an offer for a purchase price and then at the end of the day, you still have to do that working capital analysis to see, well, how much money do I have to leave in the business? And a lot of times the seller forgets that part or in his advisors sometimes forget that.

[00:08:25.930] - Rich Veltre

Part too. Yeah, definitely.

[00:08:27.780] - Rich Veltre

They forget to explain that at the end of the day, the business is like a child. The owner had a child and the child is being taken care of in a certain way. And the owner thinks, well, when I leave, the money is coming out of my child. It's coming with me. But you can't leave it starving. You can't take the money out and say it's going to just starve unless the new owner puts in more money. The new owner is not going to like that.

[00:08:54.940] - Dan Paulson

Yeah, definitely.

[00:08:56.140] - Rich Veltre

They are not going to do that analysis after you close. Closed. They're going to do that analysis before you close and then they're going to say, Oh, by the way, you have to leave however much money in the business because we need that for 90 days of working capital. Some owners get really surprised by that.

[00:09:16.220] - Dan Paulson

I think they're believing that's going to help fund whatever new toys or things they're going to purchase or maybe their vacation once they leave is pulling that capital out and they'll live off of that for a while and plug the rest of the money in some retirement fund.

[00:09:32.200] - Rich Veltre

Yeah. And there's more to it, too. You have a lot of discussions that are going to go on. They're going to talk about, well, what about the receivables? We haven't collected the receivables yet. Who owns them? These are the kinds of things that you do in due diligence. These points are going to come out. I don't want to get too far off the topic and want to pull myself back a little bit to the scalability. But this all goes to scalability. It all goes to the new owner looking at it and saying, What am I going to be able to do on day two? Day one, we close, everybody's happy, we all shake hands. What am I doing on day two? What am I doing on day 10?

[00:10:16.500] - Rich Veltre

That's.

[00:10:16.980] - Rich Veltre

Where the scalability comes in. That's what they're figuring out before they close with you.

[00:10:22.180] - Dan Paulson

That goes back to your point on the financials about the profitability and how much money is in the company when that sale does close because they are going to need it to pay employees. They're going to need it to cover loan costs. They're going to need it to do whatever they need to do to also increase that business because maybe it is going to require some equipment investments. If there's no money in there and you've stripped everything except for the assets that basically the company needs to work from equipment wise, it's not going to be that successful. No future owner I know is going to take on something without at least a little bit of financial cushion, which is again why they're looking at buying the business. They believe it can be a multiple of something greater than it is now.

[00:11:12.610] - Rich Veltre

Yeah, and the buyer will also look at it as, okay, I have bought the business for X dollars, and if you strip the money out and the working capital shows that it needs, let's just use a round number, $200,000. They're going to take the $200,000 out of your purchase price. They're going to put that $200,000 in and say, Well, here's your net. Again, you're going to be surprised. So we'll tell you right now, don't be surprised. We're telling you in this episode, this is what's going to happen. And if it doesn't, you should be asking, why isn't it happening? You should ask your advisors, why am I not getting a working capital analysis? Why am I not seeing what I'm supposed to leave here? So my little tidbit for today, definitely ask the question.

[00:11:59.440] - Dan Paulson

Yeah, Yeah, you definitely need to. And that's why we're talking about this, because you said it well in the beginning. This part of the business is looking forward, which is usually not where that owner is positioning themselves. If they haven't checked out yet, this is the first step in that process of checking out. And in most cases, the owner doesn't really care what the future owner is going to do to increase sales. Now, they might care about the employees. They might care about the name of the company. There's all sorts of other factors that they might put greater weight on. But the bottom line is, they still have to be concerned that their company has room for growth, because that's the only thing that's going to attract a buyer in. If a buyer can't see any way that they can take what's currently built and make it better, it's a very hard justification to sell that business.

[00:12:59.920] - Rich Veltre

Yeah, it's tough. It's very tough for the current owner to actually look forward like that. I've always looked at it from the finance side. Even inside of your business, if you've grown it enough, you wind up with two different directions. You wind up with a controller-type person that's looking backwards at how did we do. Then you're talking about financial results and you're talking about taxes. Then you have the other side that's your FP&A. If you're staying in the business, you wind up building something that allows you to look forward. But yes, you get to this point and that FP&A person doesn't really matter to you as much anymore because you don't have that forward looking thinking.

[00:13:53.020] - Dan Paulson

Right. And that's really the key to what we're talking about here is you still have to do enough in those early stages. We've talked at last episode about timelines. And to me, part of the timeline is as you're busy structuring your business to function without you, you also still have to be looking at making sure the business is creating opportunities for future growth. Whether or not you take advantage of them, to me, is irrelevant. What is important, though, is that you are setting yourself up or you're setting your company up to be successful in the future because that's going to make it a much more attractive purchase than something that's a complete work in progress.

[00:14:37.720] - Rich Veltre

Yeah, I think those ideas tend to be something that you can plant some seeds with your buyers too.

[00:14:42.670] - Dan Paulson

Exactly.

[00:14:43.830] - Rich Veltre

Yeah.

[00:14:46.170] - Dan Paulson

So what are the first steps that you look at when it comes to working with an owner to talk about the the scalability side? From a financial side, what are you considering? With.

[00:15:00.540] - Rich Veltre

I think I don't always have from a buyer standpoint. Yes. From a buyer standpoint, I'm definitely looking at where are we up to this point and then seeing, okay, what's my assumption? I don't have a thought on what I can do going forward. Whether it is expansion to the point of being able to have additional facilities, and I'm using that as an example because we did this with one, where we switched their model. We knew that their model would be better off going from wholesale distribution to online retail. From there, we were able to build in the fact that the increased volume was going to require certain amounts of additional facilities because it was going to require more warehousing space. We were going to bring in more trailers, I guess you call them. We were going to bring in more of the actual product, so we needed more space to house it. We knew what those costs were going to be. We knew that the increase was going to be at least 20% in a very rapid fire fashion. So 20% wasn't even for the full year. It was almost 20% in the first quarter.

[00:16:21.450] - Rich Veltre

How did we get into a new facility? How did we get into the next phase of this business? That's what we were working on the buy-side because on the sell-side, it didn't matter as much. It wasn't for the seller. It was for what are we going to do with it? On the buy-side, it became this is the expansion model, what did it come out to be? And it didn't matter that we were able to give this seller a much higher multiple than maybe we would have another time because we knew that the growth factor of what we were going to do with it was five times bigger than what we were going to pay him. Right. It just became natural to build a completely different financial forecast model that we would know, here's what we're going to do. It became our budget. It became our plan for basically taking the business and changing it to something completely different. I think the only thing that really is the same is the logo.

[00:17:22.810] - Dan Paulson

Well, it's good that you bring up the planning because from an operations end, what I'm looking at is, is there a plan? And what plan do you have in place? So for me, one of the first steps I would take with the current owner is there would be a strategic plan we would have to create. I'm not talking about 300 pages of fluff and nothing. It's really a working plan that is probably no more than three to five pages. And then from there, we determine what is it that the current owner is going to invest in versus what is it we're doing to build a marketing opportunity to the future owner. So what you had brought up earlier is we're putting some of this stuff in place to make the company sellable. I used an example last time of the house and the foundation and the look and everything. There's people that come in and stage a house. They bring in furniture. They bring in pictures to hang on the wall and everything, because the last thing that sells a house is when everything is completely empty, at least for a higher price. Now, when you put furniture in, you give people the potential of what could be here versus what is here, and people tend to then look at that and factor in a higher valuation for it.

[00:18:41.870] - Dan Paulson

It's really no different on the business side. If you are setting the business up to show that there's an opportunity for growth and that you're putting the pieces in place, to me, that's a more attractive opportunity than somebody who is just says, well, here's ABC company, go ahead and do whatever you want to it.

[00:18:59.920] - Rich Veltre

Yeah, I think to your multiple points, they're all good. The new plan and as the seller, you're planning the seeds for the new buyer. And the new buyer needs to be able to use that and create a plan. It doesn't have to be quantitative. It has to be qualitative. I've seen too often where people came in for whatever reason, they just love the business, had to have it, wanted it, and they make a huge offer. Then on day two, they're sitting there and looking at their 350-page plan, and then they can't do any of it because for whatever reason, they missed a key factor or they didn't really analyze what they were saying. It's no different than a startup who doesn't really know its market. Exactly. Now you've got to make sure that that buyer is, especially if they, I hate to throw this wrinkle in there, what if the buyer convincing you to be the financer and the buyer didn't really have a good plan? Yeah, I don't like those deals, by the way. There's my tidbit for this episode.

[00:20:06.400] - Dan Paulson

That's a future episode that we can talk about.

[00:20:08.890] - Rich Veltre

Not a fan. Not a fan. You want to leave a piece to make sure that the buyer is enticed to hold on to everything and do things the right way and pay you, that's one thing. You want to hang on to the whole thing? Okay. I'm not there.

[00:20:24.290] - Dan Paulson

I'm not there. I can tell stories about that one too, why that's not a.

[00:20:27.260] - Rich Veltre

Good option. I'm sure we both can. I'msure we both can. But yeah, I think you want to make sure that you're... This is where as the seller, I think you want to be sure that your buyer is real. They really know what they're talking about and they have a solid plan for what they're going to do with your business. You don't necessarily care all that much, as long as you're getting your value out of it. But you do care that there's no reason for them not to be able to give you all of the value of it. I think that's just a key point of qualitative versus quantitative is important.

[00:21:06.850] - Dan Paulson

So in this area, there are many factors that owners really need to look at, check into, and ask a lot of questions about. You're probably not going to know all the questions to ask, and that's where we come in. Rich, how would they get a hold of you to ask those questions?

[00:21:22.670] - Rich Veltre

Yeah, I would definitely send me an email at rveltre@veltregroup.com. And Dan?

[00:21:28.810] - Dan Paulson

Well, they can always get a hold of me at danpaulsonletsgo.com. I'm sure one of the two of us can probably help you figure out more of these questions that need to be asked, and maybe you can figure out on your own. So we strongly consider or ask you to consider talking to one of us or another trusted professional that you have that might be able to walk you through this process. Rich, this has been the fourth of a series of five. Any other last parting words you can think of?

[00:21:57.810] - Rich Veltre

I think that yes, definitely put it in your mind, not necessarily in the forefront, but definitely keep in your mind that you will need to probably plant a couple of seeds with your buyer. Make sure that the buyer that you select is real and is serious and is not going to do something that's going to jeopardize you. And then lastly, scalability. Realize that the buyer is going to do a scenario analysis and take a look at what they're going to be able to accomplish with your business. So that's what they're doing behind the scenes that you may not know what it is, but trust me, they're doing it.

[00:22:39.280] - Dan Paulson

Great advice there. Well, this has been Books in the biz. You can watch future and past episodes if you go to booksnbiz.com, that is B-O-O-K-S, letter N-B-I-Z. Com. And we will see you on another episode, Rich.

[00:22:55.010] - Rich Veltre

All right. Talk to you later, Dan.

[00:22:56.710] - Dan Paulson

Thanks.