Today’s guest is a repeat offender, Rob Slee. Rob and I have been an ongoing conversation about how to correctly value a business for at least ten years. In today’s conversation, you’re going to learn that not only does your business have several values at the same time but you might not have much control over what that value is.
You see, the authorities for who sets values might be someone other than you thought. Who these authorities are might surprise you.
Here are some of the things you’ll learn today while listening to this episode:
- Learn who some of the authorities are that will determine the value of your business.
- Why you overvalue your business.
- You’ll learn what an intellectual capital sale is the only one that gets you a Unicorn valuation.
- Where selling to a billion dollar company makes sense.
- Understand the psychology of the sale.
Narrator: Welcome to The Sustainable Business Radio Show podcast where you’ll learn not only how to create a sustainable business but you’ll also learn the secrets of creating extraordinary value within your business and your life. In The Sustainable Business, we focus on what it’s going to take for you to take your successful business and make it economically and personally successful.
Your host, Josh Patrick, is going to help us through finding great thought leaders as well as providing insights he’s learned through his 40 years of owning, running, planning and thinking about what it takes to make a successful business sustainable.
Josh: Hey, how are you today? This is Josh Patrick and you’re at The Sustainable Business.
Today, we have a repeat guest. It’s my friend Rob Slee. Rob is arguably one of the smartest guys I know. And we’re going to try to get him to dumb stuff down so we can all understand it today. But he has written a book which I think is a required reading if you’re in the business of helping business owners get out of their business or actually even understand the capitalization of their business. It’s called Private Capital Markets 2. And today, we’re going to talk with Rob about one of the major things in this book which is what he calls value worlds. And we’ll have Rob explain exactly what that means.
But, you know, what we’re really talking about here is, if you own a private business, your business lives in several values at the same time. And depending on who you transfer your business to, they’re going to give you a different number for what that business is worth. So, let’s bring Rob in and talk about value worlds because, in my opinion, if you’re ever thinking about selling your business this is the thing you must – absolutely must understand. So, here’s Rob.
Hey, Rob. How are you today?
Rob: Hey, I’m fine. Thanks, Josh, for having me. I think this may be my third visit with you. I’m not sure if this is the second or third of the podcast.
Josh: Yeah. Well, I know it’s at least a second. And I think it actually is the third. I’ll have to look it up some day. We’re up to almost episode 100 now, so.
Rob: Oh, okay.
Josh: So, I lose track of who I’ve been doing what with over the years.
Rob: That’s right.
Josh: So, Rob, what exactly is a value world for a private business?
Rob: Well, 15 years ago, I wrote what became a seminal article called Business Owners Choose a Transfer Value and it appeared at the Journal of Financial Planning which is kind of like one of the big journals of financial planners. And that’s where I introduced the notion that every private company – and I mean, every private company, has dozens of correct values at any one time.
Well, this caused quite a storm because in academic circles, we’re taught, “Look, you go get an MBA.” And what you’re taught is every company has one true value – one true value, and that there’s only really one academic or theoretically correct way to find that one true value. And that’s if you forecast out a bunch of cashflows out into the future, earning or cashflows. And then you find the present value by using some sort of discount rate. And that’s the one true theoretically correct way of creating a value for company or determining value.
Well, that’s not the way it is at all – in private companies, because in private companies what we have is the reason you need to know the value creates a whole different valuation process. And this isn’t my opinion. What happens is—so if you need to go get a loan from a bank, the bank says, “All right, here’s how we view the value of business. You need to get an insurance policy for like business interruption insurance.” The insurance company says, “Here’s how we’re going to value your business.” If you want to get venture capital, the venture capitalist says, “Here’s the process we’re going to use to derive the value of your business.” Private equity, the same way. And it goes on.
And there’s dozens of reasons why any private business owner would need to know the value of his/her company at any one time. All legitimate. All with a different process for deciding value. And the reason is each of these, what I call, reason leads to a value world, each value world has an authority. Like for instance, the biggest authority – the biggest, baddest authority on the planet that we can all understand is the Internal Revenue Service.
The IRS is the authority for what’s called the fair market value world. And this is sort of the grand daddy of the value worlds. So, if you’re going to gift shares of stock, or if you were going to set up a charitable remainder trust, or any of these government compliance sort of things – estate planning compliance things, you are in the world of fair market value. So your shares must be— or your units must be appraised relative in that world. Who sets the rules for that world? Not me, not Josh – the IRS.
Now, we can all choose to ignore what the IRS does but the IRS has, as an authority in that world, tremendous sanctioning power – meaning they can throw you in jail. And so they have— some of these authorities have more sanctioning power than others. Like, if the bank, if you don’t like what the bank says the value of your business is worth and they’re only going to lend you a half million and you need a million. Well, the bank can’t throw you in jail for not taking their money. You just don’t get the money. You don’t take the money. Whereas, the IRS, if you ignore their power and their world of fair market value, you can get and will get eventually in big trouble. So that’s nature value world.
So, most owners have no idea about any of this. They think their business has one value. And so, they make all their decisions, you know, based on one value.
Josh: And in your experience, which of the value worlds do business owners often think their business lives in?
Rob: Their owner value. And what happens is, owners look in a mirror and say, “I just spent 20 years, or 30 years, or however many years. I missed my kid’s plays from all this. My business is worth X.”
Whenever an owner says that, what they’re really saying is, “In my mind, this business is worth – I’ve got to make up numbers here so we can– my business is worth $10 million.” Now, when they look in the mirror, it’s very important to them for psychological reasons that that business is worth $10 million. And to them, it is worth $10 million.
Now, that’s one specific world. And then I show in the book, Private Capital Markets, how an owner will determine and get to that $10 million. No one else on Earth is likely to view value in the same way.
So, the best way to look at this is, okay a buyer knocks on the door, or a prospective buyer for that business. The buyer isn’t looking through the same glasses – through the same lens as the owner. The buyer has their own. The investor has their own world where they’re the authority in investor value world.
And so, right there, you have a tension because the owner sees it as worth $10 million. The buyer probably sees it as worth $5 million. And there it goes. That’s why it’s so hard to ever get a deal done because you have authorities in two different worlds that view value completely different and correctly – each one’s correct in their own world.
Josh: You know what I find a lot of times, when I coach somebody to go through the sales process, is that if it’s a first time they’ve gone through it, it’s almost a guaranty the deal won’t get done.
Josh: But if it’s the second time through it, it’s almost guaranteed the deal will get done because the owner has learned that their value world is not a value world that is going to be realistic for anybody else in the universe.
And what we do is coach them into a neutral value world – a market value world. So, market value world is a world where neither the investor nor the owner is the authority. In this case, it’s the deal makers themselves that see lots and lots of different deals, and how the deal multiples come together, and how the deals are valued. And then we can go to both the investor and the owner at the same time and say, “Look, here’s how value is established for your type of company in market value world.” Ah, now either the parties are going to agree or not. You know, typically, there are still some disagreements obviously but that’s what deal makers are paid to do – is bridge that disagreement.
Josh: A disagreement is likely to be a whole lot smaller than if you just work it off the owner versus buyer’s value world without an intermediary.
I’ve only done one deal in 30 years. I’ve been an investment banker for 30 years and I’ve had hundreds of deals. One deal in 30 years that was done strictly in owner value. And that is a big company knocked on an owner’s door and then that big company wanted to go through that market space where the owner was sort of well positioned. And the owner said, “This is worth 50 million bucks. My company’s worth 50” and they paid it. Just because, to them, they had so many synergies and so many opportunities, they needed to get that guy out of the way. They needed to get him out of the market. And they just paid it. Other than that, that rarely happens.
Josh: That gets into the value world of what I call intellectual capital—
Josh: –where when you’re doing an intellectual capital sale which is almost as rare as a unicorn.
Josh: It probably is a unicorn.
Josh: Is that you have IP that the buyer values and the cashflow from your business is completely irrelevant.
Josh: I mean, you know, a good example of that is Microsoft buying Skype.
Josh: There’s no way in the world that Skype was worth what Microsoft paid for it, except Microsoft convinced themselves – and they do this all time, that the intellectual capital of Skype was actually worth what they were paying.
Rob: Yeah. We call it the second spreadsheet rule. And this is why I love representing owners where they’re selling IP or intellectual properties to big companies because the big companies come with the second spreadsheet that they never show you. But they think, “Oh, we can do all these wonderful things.”
Now, in some cases, they can. You know, obviously, there are examples where, you know, the big company actually did do a lot with the intellectual capital. But for the most part, I want to be on the side that gets paid all the money because that second spreadsheet’s really hard to deliver for the big company.
Josh: Well, the other thing is that when you take a look at a big company, if they do $4- or $5-billion in sales and you’re asking for an extra $5 million for your business, that’s a rounding error to them.
Rob: Yeah, that’s right. That’s why I always love to be on the sell side when I’m dealing with the CEO of a Fortune 500 company because first it’s not their money. It’s a public company. Second of all, like you stated, I mean, if they’ve got to round up, nobody gets fired there. It’s just one of these things. And they’ll fluff the numbers. Because I used to be in a big company as a CFO and head of planning, and the big company will fluff the numbers just to make a show. No, we’re still going to do just fine here. Maybe they will. Who knows? But I want to be on the other side negotiating.
Josh: I think, even the better place to be is when you get three public companies or Fortune 1000 companies where all three CEO’s egos are involved and then you get to completely dumb numbers.
Rob: Well, I’ve always said that in these deals, it’s more about psychology than economics because of the psychology, the CEO will not allow themselves to lose that deal. And like I said, it’s not coming out of their personal account anyway. And so, it’s like, “Oh, God, it’s like manna from heaven for me as a deal maker” when I have multiple CEOs. It’s just great.
Josh: So Rob, there’s two value worlds which most business owners will find themselves sort of running between. And that’s financial value and strategic acquisition value.
Josh: I mean, it seems to me almost all deals are somewhere in between there. And it seems to me that strategic value is always higher than financial value.
Rob: Yeah. And just so we can put this in brackets – the private equity groups – PEGS for short – private equity groups. They are almost always in financial market value because even though they may own a company in that space, they don’t want to share synergies.
Now, every once in a while, one will – especially for the gigantic deals. But for the most part, where I hang out, which is the lower middle market, middle market, medium-sized companies. For the most part, the private equity groups now are pushing value and creating most of the acquisitions, dong most of the acquisitions in the lower middle market. And they rarely will share synergies.
So this is where you hear about a five- or six-multiple that gets an adjusted earnings flow. That’s kind of where the private equity groups play versus when you have a synergy market value deal where you have maybe that same five- or six-multiple but your adjusted earnings are much bigger because the buyer will share some of the synergies.
That typically is what happened to me when I had the big company – the big strategic buyer. Then they’ll share some of the synergies. That’d make a big difference by the way in terms of the ultimate selling price of the owner – a big difference.
Josh: You know, when I sold my vending company, I actually got a piece of the synergies from the seller. And the only way I got it was I actually built a spreadsheet that showed them, if they paid me the price I wanted, they were paying for it in two and a half years.
Rob: Right. And we create those synergy studies, we call them. With the buyers, when we have a synergistic buyer and say, “Look, here’s what’s going to happen. You’re going to be able to shut down your St. Louis warehouse. You’re going to be able to buy better blah, blah, blah, blah.” And we’ll take a whack at it, maybe 10 or 15 items. No. No, it’s not always going to be exact but it’s directionally accurate.
And what we’ve learned – I’ve done studies of this that’s actually in the text book, Private Capital Markets, that about the best people do on that is the buyer will share about half of those synergies. And what I mean by that is, let’s say there’s $1 million worth of annual synergies, the buyer will give us credit as a seller for $ 500,000 times the multiple. You see, you just created a multiple of six times. He’s created a $3-million windfall for the seller because they got credit for synergies.
Josh: And for a seller to get that, they have to be able to exhibit to the buyer that they know what the deal is the buyer is getting.
Rob: Because the buyer has a fiduciary responsibility to not pay that 3 million. You know, to buy it as cheaply as possible. So, if the seller isn’t or the seller’s deal maker or whoever, if they’re not really aggressive at going after that, it’s never going to happen. That 3 million is just lost. And in most deals, by the way, it is. It’s just no deal happens because they’re not savvy enough on the sell side to know how to give it.
Josh: I think there are two things that always disappoint me in the mergers and acquisition world with the intermediary since that most intermediaries don’t know how to really talk about strategic purchase for the advantage of their sellers.
Josh: And the second is, they don’t know how to run a structured auction.
Rob: It’s true. And I’ve trained for 15 years, maybe 500 or 1000 intermediaries. And it’s just, some people get it, some people don’t. It’s better now than it was 15 years ago in terms of structured auctions. I called it an organized cattle herd where the buyers are the cattle and the end result is the slaughter which is a fair deal for the seller. That’s what a structured auction really is. And there’s still a lot of people out there who are just like a one-off sell profit that hurts its own.
Josh: So, Rob, I’m going to go to an area which I think is a little bit controversial which is “every business owner dreams about selling their business”.
Josh: There’s a lot of businesses out there which actually, if we do a liquidation or going out of business sale, the business owner gets a much better deal than trying to sell the darn business.
Josh: And the reason is two-fold, at least in my opinion, (1) is when you get into these deals where it’s not a great sale, the seller is always holding a whole bunch of paper which is a huge risk.
Josh: And the second is, a lot of times, a going out of business sale will get you more money than a reasonable multiple.
Rob: Yeah, asset market.
Josh: So, if you’re a business owner, how do you decide what is the best way for you to leave your business?
Rob: What I’ve seen in the market and practice is it’s a trial and error process. That a lot of these sellers go through five years or ten years of trying to exit their business – sell their business. I totally agree with you, over half the private businesses– and this is sort of a scary thing for America because this is where the job creation is too, over half the private businesses in America are worth probably more to shut down today than—
And first of all, they’re not going to be able to attract the buyer because if asset market value world is your highest value – that’s your liquidation value. Man, you’ve got trouble because most buyers don’t want to go near that. They don’t really want to fix businesses.
It is funny. You would think the private equity guys – there’s tens of thousands of them. You would think that they would be in the business of buying low and selling high but that’s not at all where they’re at. They’re at the business of buying high and trying to sell higher which has always been just a very strange position for me to think that trillions of dollars has gone to that model versus “let’s take something that’s sort of broken and fix it”. That’s a much better way to create tremendous amounts of value. But that’s not where 99% of the private equity people are. So the owners are stuck in their business.
What we’re really talking about here is we have millions of business owners in America that are going to die in their business or just shut them down because they really don’t have any exit. Even if they find a buyer, it’s just death value. Businesses have death value. That’s about it. And so, what’s he going to do?
Josh: That may be one of your new value roles – death value role.
Rob: Yeah. I mean, what are you going to? They’re going to die in it. And you and I have talked about this in the past offline. But the problem is the same owners that haven’t created value in their business, somebody like us who knows how to create value comes and shows them how to create value. There’s something genetically missing there with the owner. It’s a DNA issue. It’s a listening issue. It’s a “I don’t know what it is” issue. They won’t listen. And so, it’s almost impossible.
Now, if you wrest control and you just buy the darn thing at asset value, which is basically liquidation value, then you control the asset and you can do what’s necessary to increase the value. If you sit there and tell the owner- the current owner how to do that, they’re not going to listen to a word of it. I’m trying, they’re not. And so, what are you going to do?
Josh: Well, I actually have a theory. I have a theory behind everything. But I have a theory behind this. There’s two reasons most business owners are not really able to create value. And the first is, they’ve not been able to develop trust to delegate appropriately.
Rob: Right, that’s right.
Josh: And the second, which is like a first cousin of that, is they don’t know how to tolerate mistakes.
Rob: Yeah. That’s right. Both of them are true.
Josh: It’s that if they want to punish people for making mistakes, they don’t want to have the people learn from them.
Josh: And you just can’t grow a business if you don’t learn to trust your people and really develop a culture of mistakes where you learn from the darn thing. It’s because, frankly, mistakes are going to happen whether you want them or not.
Rob: Yeah, I say it in a slightly different way, a more mathematical way. But it’s exactly what you’re saying is we encourage all these owners to spend almost all their time on more than $500-an-hour activities which are strategic activities. You know, picking out the right niche, putting the right person in the right place. Whereas, most owners clearly spend their time at $50-an-hour activities which is actually doing the task. And you can’t leverage yourself if you’re busy all day licking envelopes. You know what I mean? You just can’t. So, most owners are, by design, never going to create value in their business. It’s never going to happen.
Josh: Yes. That’s my experience also.
So, Rob if I’m in the financial sale world, how do I move myself into the strategic sale world?
Rob: Well, it’s challenging because size matters here. What we found is, over time– now, once the private equity groups who are financial buyers moved in, a lot of the strategics really moved up in terms of size. So we have a client that’s doing $25 million in sales and above. We can generally attract strategic buyers but not always above $50 million in annual revenues [inaudible 00:19:03].
And so, this is the real problem. If you’re a smaller company, let’s say I’m doing 6- or 8 – or 10 million in sales or whatever it is, it’s extremely challenging to get the attention of the strategic buyers because they’d say, “Oh, geez, we could just start up something and get to that” because they have a lot of customers in that space blah, blah, blah, blah.
So, part of it is the size thing. Part of it is the global thing. So, when we sell a business to an overseas buyer, those are $50- to $100-million revenue businesses because the global buyer, whether it’s Chinese or they’re Japanese, whatever they are. They want to say, “Well, geez, we’re going to put a big stake in the ground in America. It’s got to be a sizable start” because they’re in position to organically grow stuff from the ground up. They need to sort of buy mass. And so, size does matter here. So, the answer to your question is, if I was going to be a deal maker – and I am a deal maker, and I wanted to participate mainly in strategic deals, you’ve got to get into the larger deals because there’s almost always synergistic buyers there.
Josh: Okay. That’s good to know.
So, Rob, we are out of time and I’m going to bet that there are some people who would want to contact you. And I’m hoping everybody who’s listening wants to read Private Capital Markets 2. So, (a) How would they find the book? and (b) How do they find you?
Rob: Yeah. The book’s published by Wiley’s – John Wiley & Sons. So, it’s Amazon. It’s almost always the cheapest place. It’s called Private Capital Markets by Rob Slee, S-L-E-E.
The best place to find me – I write a blog that a million people a week read [inaudible 00:20:29], most folks are in China. Well, you know, it’s hard to even explain how that happened. And so, it’s either through LinkedIn or I’ll just give my e-mail address because I answer all. Even when I travel half the time, I answer all e-mails, firstname.lastname@example.org. It’s probably the best way to get me and I’ll answer the e-mails.
Josh: Cool. Hey, Rob, thanks so much for your time.
And I always have something as an offer for you folks. I have this free one-hour audio CD I put together. It’s called Success to Sustainability: The five things you need to do build a sustainable business that’s economically and personally sustainable. It’s really easy to get. All you have to do is take out your smartphones – and you don’t do this if you’re driving. But take out your smartphone and text the word SUSTAINABLE to 44222. That’s the word SUSTAINABLE to 44222. You’ll give us your mailing address and we’ll mail out the CD to you and you’ll get it in about five days.
And this is Josh Patrick. You’ve been at the Sustainable Business. Thanks so much for stopping by today. I hope to see you back here really soon.
Narrator: You’ve been listening to The Sustainable Business podcast where we ask the question, “What would it take for your business to still be around 100 years from now?” If you like what you’ve heard and want more information, please contact Josh Patrick at 802‑846‑1264 ext 2, or visit us on our website at www.askjoshpatrick.com, or you can send Josh an e-mail at email@example.com.
Thanks for listening. We hope to see you at The Sustainable Business in the near future.