August 23, 2024 • 31 mins
Transform your painting business into an irresistible asset with our latest episode! Join us as we unpack the invaluable lessons Daniel gleaned from a workshop with business scaling experts Alex and Leila Hormozi. Discover the strategies that investment bankers use to value companies, and find out how these can be applied to make your painting business more attractive to buyers and investors. Through real-life examples and actionable insights, we promise you'll walk away with a clear understanding of how to increase your business's worth, just like sprucing up a house before a sale.
Understanding the lifetime value (LTV) to customer acquisition cost (CAC) ratio can revolutionize your approach to growing your painting business. We'll break down this essential metric, using a sample company with an impressive 5:1 ratio to illustrate how reducing customer acquisition costs while boosting revenue can significantly enhance your business value. We also tackle common risks like key man risk and key client risk, offering practical solutions to mitigate these issues and safeguard your business's health and appeal.
As we move into more complex territory, we discuss the critical aspects of business valuation and risk assessment, such as single channel risk, market risk, and data risk. Learn how improving revenue growth and EBITDA margins can dramatically increase your enterprise's value, using a painting business case study to make it tangible. Finally, we cover the ins and outs of selling your business within the painting industry, including how to engage with investment bankers and what to expect from the valuation process. Join our Facebook group, "Grow Your Painting Business," to continue the conversation and share your own experiences.
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
Welcome to the Profitable Painter Podcast.
The mission of this podcast issimple to help you navigate the
financial and tax aspects ofstarting, running and scaling a
professional painting business,from the brushes and ladders to
the spreadsheets and balancesheets.
We've got you covered.
But before we dive in, a quickword of caution While we strive
to provide accurate andup-to-date financial and tax
(00:20):
information, nothing you hear onthis podcast should be
considered as financial advicespecifically for you or your
business.
We're here to share generalknowledge and experiences, not
to replace the tailored adviceyou get from a professional
financial advisor or taxconsultant.
Speaker 2 (00:40):
We strongly recommend you seeking individualized
advice before making anysignificant financial decision.
This is Daniel, the founder of.
Speaker 3 (00:43):
Bookkeeping for Painters.
And this is Richard taxdirector.
How's it going?
It's going good.
My family just got back from anice summer vacation.
We were down in Florida for awhile and it was hot, but it was
a great time to just kind ofrelax, recharge the batteries
(01:03):
and come back refreshed to dosome more yeah, that's awesome
yeah, I guess it's differentwhen you live in florida.
Right, it's like the tourists,we enjoy the heat and the sun.
But when you live down thereand you have to work and it's
not quite as uh, enjoyable Ilike the, I like the heat and
the sun, so I I live.
Speaker 2 (01:25):
I have to be as close to the equator as possible,
even though my complexiondoesn't tell like wouldn't
signal that to somebody, butthat's the way I feel in my
heart.
Uh, so while you were onvacation I did something kind of
cool.
I went to Vegas.
(02:01):
Uh, alex Ramosi, who is thefounder of Acquisitioncom he was
holding a workshop with him andLayla we you're not familiar.
They've grown and scaled severalbusinesses that they've sold
for hundreds of millions ofdollars.
So they've done this before ata high level and they currently
(02:22):
own an equity firm where theybuy minority positions in
businesses and try to scale themas well.
So they're very involved inscaling businesses and getting
them to sell at high levels.
And so it was cool to go totheir workshop and kind of see
(02:43):
the way they think aboutbusiness, scaling businesses.
And they had a big part of whatthey did was using basically an
investment banker's calculatorto calculate what would your
business be worth if you triedto sell it to an investment
banker or an equity firm.
And so I basically today washoping we can go through, kind
(03:08):
of walk through this calculatorand discuss what makes your
business valuable to aninvestment banker, what makes it
interesting, what makes thebusiness healthy and sellable,
and walk through the actualformula that an investment
banker might use to value yourcompany.
Speaker 3 (03:27):
Awesome.
Yeah, different ways of kind ofmaking your company more
attractive and I know youmentioned specifically this is
for, like, investment bankers,private equity, but I'm sure
there are other people who wouldalso appreciate some of these
items as well.
So, maybe, like anotherpainting company or maybe a
private investor, anything wecan do to make our companies a
(03:51):
little bit more attractive, kindof put some of that makeup on
there.
I know what people are notmakeup, because makeup feels
fake.
Right, these are real thingsthat we're doing.
We're not just gussying upsomething that needs serious
help.
But what factors should we befocusing on in our businesses
that make them strong andhealthy and attractive to
potential buyers?
Speaker 2 (04:12):
I like it, or just to yourself really, because it's
the same things that you need todo to make it attractive for
someone to buy it.
Are the same things that makeit attractive for you to keep it
?
Yeah, absolutely.
The same things that make itattractive for you to keep it?
Yeah, absolutely.
So it's kind of like selling.
If you've ever sold your housebefore, you have to go through
all the things, uh like gettingrepainted, getting the, the roof
(04:36):
fixed and re-shingled, gettingthe interior all nice, fixing
the deck.
You know you have to do allthese things to get it as nice
as possible.
And by the time you finish allthose things, you're like I kind
of like it.
Now I don't even want to sell.
Speaker 3 (04:51):
Right.
So when we were on vacation mywife and I were watching HGTV
and they've got that show calledLove it or List it where they
do that, where they bring in theinterior designer and the
realtor and the interiordesigner tries to fix up the
house and convince the peoplenot to sell and the realtor
tries to find them a new place.
And it's kind of a competitionand it's funny how often people
(05:15):
who are sick of their housethey're not in love with it
anymore After some renovationsand some TLC now it's like a
whole new place and they don'twant to sell, they want to stay
there.
So I like that.
Maybe you're not looking tosell, but maybe you just like to
make that business a little bitmore attractive to you and feel
(05:35):
a little bit better about it.
Speaker 2 (05:38):
So, yeah, cool yeah, and that's kind of how my take
is Like I'm on the side of notwanting to sell, just creating a
business that's so awesome thatyou wouldn't want to sell it.
And so it's the same theformula to sell your business
and also the formula to make youwant to keep it.
(06:00):
It's the same factors here.
We'll go through each of themhere, so I'm going to actually
share my screen.
So if you're listening to this,we're going to talk through it,
but it might be helpful toactually go to YouTube and look
up the podcast on YouTube,because we'll be walking through
this calculator.
And so what I did was I tookone of our clients that we work
(06:21):
with We've been actually workingwith them for about eight years
, they're doing awesome and weplugged in their numbers to see
how much their business would beworth, just to kind of see how
things turned out.
And so we'll start up here.
At the top there's baselinevalue and then after that
(06:47):
there's a section called valueadders, value subtractors, and
then last is the valuation.
So the baseline value this isyour revenue and EBITDA.
So EBITDA is earnings beforeinterest, taxes, depreciation,
amortization If you're lookingat your QuickBooks and loss,
it's basically the net operatingincome is your EBITDA in most
(07:08):
cases.
So revenue top line and EBITDAaka your net operating income.
And so this is what makes yourbusiness interesting to an
investment maker that's buyingbusinesses.
The higher the revenue, thehigher the valuation.
In many cases, the higher theEBITDA, the higher the valuation
and this is going to be adirect driver of what your
(07:32):
multiple is.
So the larger the business, thelarger the multiple.
And in the previous podcast wewere talking about how much is
your business worth.
We discussed this.
But those companies traded onthe public stock exchange uh,
companies like like tesla and uhother companies, have super
(07:52):
high multiples, like theirearnings, um, what they trade at
versus what their earnings are.
The multiples are crazy.
So, uh, the larger your netoperating income or EBITDA, the
higher your multiple will be.
So then the value adderssection.
That is what makes yourbusiness healthy.
(08:15):
So this would be revenue growth, what your margins are, how
much does it cost you to acquirecustomers.
Those are the value adders.
And then the value subtractors.
That's a section of what arethe risks on the business, what
would make a?
Now, there's more than what arelisted here.
(08:35):
There's more risks that arelisted, but these are kind of
like the key risks thatinvestment bankers or anybody
trying to buy your businesswould look at.
And then, lastly, would be thecalculation.
So let's start at the top androll through this.
So first of all is the revenue.
(08:55):
This is straightforward.
In our example, our paintingbusiness has $2,800,000 in
revenue in the last 12 months,so that is 2.8 million revenue.
The next piece is the EBITDA ornet operating income over the
last 12 months is 513,000.
So for this level of EBITDA,the multiple for any business
(09:21):
that has an EBITDA or netoperating income of $1 million
or lower in the last 12 months,the multiple is one, so it's a
multiple of one.
Now, if you had one to 3million in EBITDA or net
operating income, your multiplewould be 2.5.
And then 5 million to 10million, the multiple is five
(09:42):
and the 10 million above themultiple is six.
So the multiple is going tomake more sense once we do the
calculation.
But basically this is the keynumber that we're going to
multiply your net operatingincome by by your multiple to
get what the value is.
Speaker 3 (10:01):
And so companies that generate because EBITDA is
really a calculation of profit,so to speak right, your revenue
is how much you sell, yourEBITDA is how much you keep.
And so companies that generatemore profit, they generate more
cash.
They're going to be moreattractive to potential buyers
than companies that generateless cash.
(10:23):
And it's not necessarily aone-to-one basis.
So companies that generate lessthan a million dollars a year
in cash are worth X, butcompanies that generate, you
know, five to ten milliondollars in cash are worth that
with a multiple of five.
And, daniel, you and I weretalking about this earlier A lot
of that has to do with just howattractive it is to buyers, the
(10:47):
potential for making changesand increasing profit and things
like that.
Because I'll be honest with you, when I first looked at this,
it didn't quite make a lot ofsense to me.
Why would there be an EBITDAmultiple?
Speaker 2 (10:59):
But just understanding what investment
bankers and private equity arelooking for when they look to
buy companies, it makes moresense that the more cash a
company generates, the morevaluable it would be to a
potential buyer right, because alot of times what they're
trying to do is is um, maybemake a few changes and get and
open up the profit margins andthen sell it at an even higher
(11:21):
multiple or combine it withanother company so that
combining one painting businesswith another painting business,
that puts it into another tierof a multiple.
So maybe let's say you buy twopainting businesses that are at
$2 million in, or let's say, uh,two painting businesses that
(11:44):
have a million, just over amillion in um in in ebita, and
so that's going to be 2.5multiple.
But the two of them togetherputs them in the uh, still in
the 2.5.
But then if you can make somechanges and you get them to 2
(12:04):
million or 3 million in EBITDAeach, that puts you into the
next tier, which is the 5million to 10 million multiple.
So now it's a multiple of 5instead of 2.5.
So combining companies, makingsome changes and getting it into
the next multiple can add a lotof value.
It allows them to sell it at aneven higher multiple.
Speaker 3 (12:30):
So what you're saying is, one company that generates
$5 million in EBITDA is morevaluable and has more potential
for growth than five companiesthat generate $1 million in
EBITDA.
Speaker 2 (12:43):
Yes, that is the concise way to say it.
I wanted to say it veryconvolutedly so that it's hard
to understand.
Speaker 3 (12:50):
No, no, no, you explained it well.
Sometimes I just need to recapthings in my own mind.
Speaker 2 (12:59):
Yeah, no, that was a way better way to say it.
So all right.
So now we understand the EBITDAmultiples and right now, the
example company that we're usingthey're at an EBITDA multiple
of one because they have under amillion dollars in EBITDA or
net operating income.
All right, so next let's go tothe value adders.
(13:19):
These are the things thatindicate that the company is
healthy.
So the first one is revenuegrowth.
Revenue growth typically toearn a point here.
So we're trying to.
Right now we're value adders.
If you have a favorable revenuegrowth, like if you're growing
(13:39):
quickly, you're going to getanother multiple, a point or two
added to your multiple.
So in this case, the paintingcompany that we're using,
they've kind of flatlined overthe last year compared to the
previous year, so at this pointthey don't have any revenue
growth, so they don't get anypoints here.
(14:01):
But if they had been growinglike, let's say, 30%, they would
have gotten one additionalpoint which would have been
added to their multiple, andgetting them to two, a multiple
of two instead of one.
Or if they were growing by ahundred percent, then that's two
points there.
So that's revenue growth.
(14:23):
The next value adder would beyearly revenue recognition, and
this is tough for paintingbusinesses.
So basically this is or, I'msorry, not recognition yearly
revenue retention, excuse me,yearly revenue retention.
So what this means is whatamount of clients are you
retaining year to year Now forpainting businesses, since a lot
(14:46):
of the times, especiallyresidential repaint you're
painting someone's house and youmight do it once every few
years.
It's hard to really doreoccurring yearly revenue but
you might be reactivating everycouple of years or every few
years for that particular client.
So it's difficult forresidential painting businesses
(15:09):
to get that revenue retentioneach year, but you should be at
least reactivating them everycouple of years at a minimum.
So yearly revenue retention forthis painting business is about
20%.
So they're basically gettingincome from the same customers
about 20% of the time from thesame customers.
So this is good for thisindustry, but not quite as much
(15:36):
revenue retention as what aninvestment banker would be
looking for.
They're looking for more like80%.
So another example might be ifyou have a long-term contract
with a government or commercialproperties where you're doing
maintenance painting over a longperiod of time and you have a
recurring revenue from that,maybe this looks different for
(15:58):
you, maybe you have a higheryearly revenue retention than
this painting business that isdoing residential repaint.
All right.
So the next one is the EBITDAmargin.
So this is simply taking yourEBITDA and dividing it by your
revenue and in this case, whenwe take 513,000 divided by 2.8
(16:22):
million, we get 18%.
So they have 18% EBITDA margin,which is pretty strong.
In order to get an additionalmultiplier you'd have to be
getting over 30% EBITDA margin.
So it's still strong, 18%, butit's just not high enough to get
(16:44):
that additional multiplier of0.5 for over 30%.
The next one is a lifetime valueto CAC ratio.
So lifetime value is the amountof income you're getting from a
client over the lifetime valueof them compared to what it
(17:06):
costs to acquire that customer.
So the lifetime value of acustomer would be we painted
their house in year one and thenin year three we reactivated
them, painted their house again,and the simple way to look at
this is basically forresidential repaint.
(17:28):
If you look at your top line,it's kind of hard to track your
LTV since it's so far apart.
For how often you're gettingjobs from folks.
There's a more complicatedformula, but to simply get this
ratio, you can take your topline revenue and divide it by
your customer acquisition cost,which is basically your
(17:48):
marketing cost, so how much youpay for marketing plus your
salesperson cost.
So for this company theirmarketing costs are at 15% and
their salesperson they pay 5%for closing are at 15% and their
(18:08):
salesperson they pay 5% forclosing.
So that's 20% customeracquisition costs compared to
revenue, which is a five to oneratio.
So top line divided by 20, 100%of your revenue divided by 20%,
is a five to one ratio.
So that is your LTV to CACratio for this one, and in order
to get an additional multiplier, you would need to have 10 or
(18:32):
greater.
So your customer acquisitioncosts would need to be basically
10% of what your revenue is.
Speaker 3 (18:39):
I think it's interesting.
We went through all these valueadders and our sample client
here didn't get any extra valueadders.
Now we know he's got asuccessful painting business,
like you know it's.
We're very proud of hisbusiness, uh.
But they just kind ofemphasizes that to get these,
these bonus points, you reallyhave to be doing something
(19:03):
extremely well.
And I wouldn't like, if you'retrying to evaluate your own
business and you're in line withthe average but you can't quite
hit these value adders, Iwouldn't necessarily consider
that to be something to be upsetabout.
These value adders are veryhard to obtain.
Speaker 2 (19:23):
Yeah, and I think.
But it's also a good thing tostrive for because although this
painting business is verysuccessful, there's still room
for improvement.
So I would definitely say like,hey, getting their LTV to CAC
ratio down would be something tolook at, trying to get their
customer acquisition costssmaller compared to lifetime
(19:47):
value.
Now the other thing is growth,and I'm sure Well I know that
they definitely want to grow thebusiness and they're just
working through some constraintsright now.
So the revenue growth 30% ispretty feasible to do year to
year and so that would beanother opportunity that's
(20:13):
completely within reach for them.
Revenue retention that's prettydifficult for their business
model.
Ebitda margin, considering,which we're going to get to this
in a second.
He doesn't have any key manrest but he's pretty much out of
the business.
That would be difficult to getin this industry, but not
(20:33):
impossible.
That would be difficult to getin this industry, but not
impossible.
I would look at the first twothat we talked about for the LTV
to CAC and the revenue growthones, to get those additional
multipliers going first and thenlook at the EBITDA margin.
Third so again just toemphasize the point, he's
probably not going to sell butlooking at ways to improve the
(20:56):
business and make it morevaluable to him.
Those looking at those metricswould be super helpful and good
focus points for him.
Speaker 3 (21:14):
Yeah, I like it because it kind of helps us
understand, you know what thegoals should be, what are the
things that we should focus on.
Speaker 2 (21:20):
So, yeah, that was really useful, All right.
Next section is valuesubtractors.
So these are the things thatare risks to the business, that
are going to take away from thevalue, and the first one is key
man risk, and this is thebiggest one.
This is going to have thebiggest decrease in your
multiple.
If you have this risk, and mostis the biggest one, this is
going to have the biggestdecrease in your multiple.
If you have this risk and mostof us do is the key man risk,
which is is there a person inthe business that is doing a lot
(21:45):
of things?
And if they were to get out ofthe business, it would
significantly impact thebusiness's ability to operate.
So, uh, most of the case, mostof the time, this is the the
owner.
Right, the owner is doing thesales, doing the operations.
You know they're leading thecompany, driving the growth,
whatever all those things.
(22:06):
Um, and if that's the case, ifyou're doing a lot in your
business, you might have thisrisk.
And in the case of our exampleclient here, he actually doesn't
live in the same state that thebusiness operates in, so the
business is running without him.
He does have some interactionwith his team throughout the
(22:29):
week, but it's pretty minimal.
So I would put him as a zerofor this risk.
Now, if you're still boots onthe ground, you're still doing
the sales or a significantamount of the work to make sure
things are operating, and youmight have this key man risk and
(22:50):
this is a big hit to themultiplier.
This is subtracting threepoints from the multiplier.
So since we only have one pointso far, if this business would
have had a key man risk,basically his business would be
worth zero from an investmentbanker's perspective.
Speaker 3 (23:12):
Yeah, so it's that the key man is that person that
if something was to happen tothem heaven forbid the business
would most likely it wouldlikely close or become very
close to closing.
Speaker 2 (23:26):
Yeah, yeah, all right .
The next one is key client risk.
So this is basically do youhave any clients that make up
10% or more of your revenue in aparticular year?
So in this case this is zerofor this client because they're
doing residential repaint,they're doing a lot of volume, a
lot of individual houses.
If they lose any particularclient, it has almost zero
(23:48):
effect on their revenue.
However, if you're a paintingbusiness that works with a
particular general contractorand they give you 50% of the
work of your revenue, then youwould definitely have this risk.
Or if you have a certaincommercial contract that's over
10% of your revenue for aparticular year, you would have
key client risk.
(24:08):
And so if you do have 10% ormore of revenue going to the
same client, same customer, thatwould be a minus two from your
multiple.
Speaker 3 (24:19):
Yeah, it's like having all your eggs in one
basket.
Yeah.
Yeah, it increases your risk.
Speaker 2 (24:28):
Which makes sense.
Your company, maybe all yournumbers look amazing.
But then they find out, oh, allyour revenue comes from one
general contractor who, if hedecides, he wakes up one morning
and decides he hates you, hecould fire you and then your
revenue goes to zero.
That'd be a huge risk.
Yeah, all right.
(24:49):
The next one is single channelrisk.
So this is how are you gettingyour clients?
How are you getting yourcustomers?
Do you have just one way thatyou get customers?
Maybe you just do Facebook adsand that's the only way.
So if Facebook kicks you offtheir platform now you have no
way to get customers.
So this is single channel risk.
(25:10):
Do you have only one way you'regetting customers?
If you only have one way to getcustomers, then that's a minus
one from your multiple.
And the next one is market risk.
So this is a look at theindustry.
You know, maybe ai issignificantly threatening that
(25:32):
industry.
That's going to make itundesirable for a investment
baker to buy that business.
So, uh, so this doesn't impactthe painting businesses.
So you listen this.
You probably don't have toworry about any market risk.
But just to give an example,this would be something like um,
like the designer space rightnow, just because AI can do a
(25:54):
lot of designs.
So that might be threatenedright now.
So that would be the marketrisk.
The next one is data risk.
So this is one of my favoriteones.
So if you have data risk, thismeans that you don't have good
insight into your numbers.
You don't know your numbers.
(26:15):
Maybe I'm going through thesenumbers right now and you're
like I actually don't know whatmy revenue or EBITDA, or how
much revenue growth I have, orwhat my revenue retention is, or
what my LTV to CAC is.
So if you're asking, you'resaying those things to yourself.
You probably have data riskbecause you don't know your
numbers.
You have no way to easilyaccess that information in some
(26:36):
sort of dashboard.
Maybe you have to go to fourdifferent, five different places
to pull this stuff together.
You probably have data risk.
So that would be a minus oneoff your multiple.
Speaker 3 (26:48):
Yeah, now I noticed that our example client does not
have data risk because he hasgreat financial reporting, his
books are very clean, his taxesare taken care of, so that's
nice to see Yep.
Speaker 2 (27:04):
He has a dashboard that gives him all this data, so
he's at zero for that one.
So he's at zero for that one.
And so, just to recap, he has aone multiple for his EBITDA
because he's under 1 million inEBITDA, so he's at a multiple of
one, since there was noadjustments.
And then we multiply one timeshis EBITDA to get the value,
(27:45):
which is $513,000.
So if an investment banker islooking at this painting
business, they would likelyvalue it somewhere around
$513,000.
Speaker 3 (27:54):
And that's basically one year's profit, exactly.
So now, if this client wantedto increase the value of his
business, we kind of identifiedthe areas that he could work on
Some of these value adders, suchas increase your revenue growth
to more than 30% year over year, increase your lifetime value
(28:18):
to your customer acquisitioncost.
Let's say he was able to dothose two things.
Now his multiplier would be 1plus 1 plus 0.5 or 2.5.
Speaker 2 (28:31):
Or two and a half, and his enterprise value, or the
price that an investment firmwould pay for his business, is
so if he did 30 growth, revenuegrowth which would get him to
3.64 million, and then heincreased his EBITDA margin to
28 percent, that would get him acouple additional multipliers.
(28:56):
One it would get him in the 2.5EBITDA multiple for being over
1 million in EBITDA, and solet's change that one, 2.5.
And then if he had his revenuegrowth 30%, that would get him
another point there, and we'resaying that he didn't quite hit
(29:19):
30% there.
So he just improved the revenuegrowth and he improved the
EBITDA margin, but not up to 30%, just a bit close.
So that's going to increase themultiple to 3.5.
So that's going to increase themultiple to 3.5.
All right, so 3.5 multiple onbasically a million bucks.
So that's 3.5 million.
(29:40):
So his current enterprise valuein one year if that's possible,
which is possible, it'll justbe a lot of work would be
$500,000 to $3.5 million.
Speaker 3 (29:58):
That is an enormous difference.
Yeah, yeah, yeah.
So I like this.
It kind of helps us understandwhere we need to focus, what
things need to change, becausechanging a few of these items
really impacts the enterprisevalue if you're changing the
right items.
Speaker 2 (30:18):
Yep, cool.
Well, hopefully that was useful.
I'd love to hear your thoughtson if you've tried to sell your
business.
Maybe you reached out to aninvestment banker.
There's different formulas outthere, but a lot of them,
according to Alex Ramosi, arevery similar to this kind of
(30:40):
breakdown that we went throughtoday.
Love to hear your thoughts onthe selling process or if you're
looking to sell or some of therisks or other things that we
went into today.
Love to hear your thoughts.
You can go to Facebook and typein grow your painting business
and go into the Facebook group.
Love to hear your thoughts.
Speaker 3 (31:01):
Yeah, thanks for listening everybody, and we hope
to see you on the next episode.
Welcome to the Profitable Painter Podcast.
The mission of this podcast issimple to help you navigate the
financial and tax aspects ofstarting, running and scaling a
professional painting business,from the brushes and ladders to
the spreadsheets and balancesheets.
We've got you covered.
But before we dive in, a quickword of caution While we strive
to provide accurate andup-to-date financial and tax
(00:20):
information, nothing you hear onthis podcast should be
considered as financial advicespecifically for you or your
business.
We're here to share generalknowledge and experiences, not
to replace the tailored adviceyou get from a professional
financial advisor or taxconsultant.
Speaker 2 (00:40):
We strongly recommend you seeking individualized
advice before making anysignificant financial decision.
This is Daniel, the founder of.
Speaker 3 (00:43):
Bookkeeping for Painters.
And this is Richard taxdirector.
How's it going?
It's going good.
My family just got back from anice summer vacation.
We were down in Florida for awhile and it was hot, but it was
a great time to just kind ofrelax, recharge the batteries
(01:03):
and come back refreshed to dosome more yeah, that's awesome
yeah, I guess it's differentwhen you live in florida.
Right, it's like the tourists,we enjoy the heat and the sun.
But when you live down thereand you have to work and it's
not quite as uh, enjoyable Ilike the, I like the heat and
the sun, so I I live.
Speaker 2 (01:25):
I have to be as close to the equator as possible,
even though my complexiondoesn't tell like wouldn't
signal that to somebody, butthat's the way I feel in my
heart.
Uh, so while you were onvacation I did something kind of
cool.
I went to Vegas.
(02:01):
Uh, alex Ramosi, who is thefounder of Acquisitioncom he was
holding a workshop with him andLayla we you're not familiar.
They've grown and scaled severalbusinesses that they've sold
for hundreds of millions ofdollars.
So they've done this before ata high level and they currently
(02:22):
own an equity firm where theybuy minority positions in
businesses and try to scale themas well.
So they're very involved inscaling businesses and getting
them to sell at high levels.
And so it was cool to go totheir workshop and kind of see
(02:43):
the way they think aboutbusiness, scaling businesses.
And they had a big part of whatthey did was using basically an
investment banker's calculatorto calculate what would your
business be worth if you triedto sell it to an investment
banker or an equity firm.
And so I basically today washoping we can go through, kind
(03:08):
of walk through this calculatorand discuss what makes your
business valuable to aninvestment banker, what makes it
interesting, what makes thebusiness healthy and sellable,
and walk through the actualformula that an investment
banker might use to value yourcompany.
Speaker 3 (03:27):
Awesome.
Yeah, different ways of kind ofmaking your company more
attractive and I know youmentioned specifically this is
for, like, investment bankers,private equity, but I'm sure
there are other people who wouldalso appreciate some of these
items as well.
So, maybe, like anotherpainting company or maybe a
private investor, anything wecan do to make our companies a
(03:51):
little bit more attractive, kindof put some of that makeup on
there.
I know what people are notmakeup, because makeup feels
fake.
Right, these are real thingsthat we're doing.
We're not just gussying upsomething that needs serious
help.
But what factors should we befocusing on in our businesses
that make them strong andhealthy and attractive to
potential buyers?
Speaker 2 (04:12):
I like it, or just to yourself really, because it's
the same things that you need todo to make it attractive for
someone to buy it.
Are the same things that makeit attractive for you to keep it
?
Yeah, absolutely.
The same things that make itattractive for you to keep it?
Yeah, absolutely.
So it's kind of like selling.
If you've ever sold your housebefore, you have to go through
all the things, uh like gettingrepainted, getting the, the roof
(04:36):
fixed and re-shingled, gettingthe interior all nice, fixing
the deck.
You know you have to do allthese things to get it as nice
as possible.
And by the time you finish allthose things, you're like I kind
of like it.
Now I don't even want to sell.
Speaker 3 (04:51):
Right.
So when we were on vacation mywife and I were watching HGTV
and they've got that show calledLove it or List it where they
do that, where they bring in theinterior designer and the
realtor and the interiordesigner tries to fix up the
house and convince the peoplenot to sell and the realtor
tries to find them a new place.
And it's kind of a competitionand it's funny how often people
(05:15):
who are sick of their housethey're not in love with it
anymore After some renovationsand some TLC now it's like a
whole new place and they don'twant to sell, they want to stay
there.
So I like that.
Maybe you're not looking tosell, but maybe you just like to
make that business a little bitmore attractive to you and feel
(05:35):
a little bit better about it.
Speaker 2 (05:38):
So, yeah, cool yeah, and that's kind of how my take
is Like I'm on the side of notwanting to sell, just creating a
business that's so awesome thatyou wouldn't want to sell it.
And so it's the same theformula to sell your business
and also the formula to make youwant to keep it.
(06:00):
It's the same factors here.
We'll go through each of themhere, so I'm going to actually
share my screen.
So if you're listening to this,we're going to talk through it,
but it might be helpful toactually go to YouTube and look
up the podcast on YouTube,because we'll be walking through
this calculator.
And so what I did was I tookone of our clients that we work
(06:21):
with We've been actually workingwith them for about eight years
, they're doing awesome and weplugged in their numbers to see
how much their business would beworth, just to kind of see how
things turned out.
And so we'll start up here.
At the top there's baselinevalue and then after that
(06:47):
there's a section called valueadders, value subtractors, and
then last is the valuation.
So the baseline value this isyour revenue and EBITDA.
So EBITDA is earnings beforeinterest, taxes, depreciation,
amortization If you're lookingat your QuickBooks and loss,
it's basically the net operatingincome is your EBITDA in most
(07:08):
cases.
So revenue top line and EBITDAaka your net operating income.
And so this is what makes yourbusiness interesting to an
investment maker that's buyingbusinesses.
The higher the revenue, thehigher the valuation.
In many cases, the higher theEBITDA, the higher the valuation
and this is going to be adirect driver of what your
(07:32):
multiple is.
So the larger the business, thelarger the multiple.
And in the previous podcast wewere talking about how much is
your business worth.
We discussed this.
But those companies traded onthe public stock exchange uh,
companies like like tesla and uhother companies, have super
(07:52):
high multiples, like theirearnings, um, what they trade at
versus what their earnings are.
The multiples are crazy.
So, uh, the larger your netoperating income or EBITDA, the
higher your multiple will be.
So then the value adderssection.
That is what makes yourbusiness healthy.
(08:15):
So this would be revenue growth, what your margins are, how
much does it cost you to acquirecustomers.
Those are the value adders.
And then the value subtractors.
That's a section of what arethe risks on the business, what
would make a?
Now, there's more than what arelisted here.
(08:35):
There's more risks that arelisted, but these are kind of
like the key risks thatinvestment bankers or anybody
trying to buy your businesswould look at.
And then, lastly, would be thecalculation.
So let's start at the top androll through this.
So first of all is the revenue.
(08:55):
This is straightforward.
In our example, our paintingbusiness has $2,800,000 in
revenue in the last 12 months,so that is 2.8 million revenue.
The next piece is the EBITDA ornet operating income over the
last 12 months is 513,000.
So for this level of EBITDA,the multiple for any business
(09:21):
that has an EBITDA or netoperating income of $1 million
or lower in the last 12 months,the multiple is one, so it's a
multiple of one.
Now, if you had one to 3million in EBITDA or net
operating income, your multiplewould be 2.5.
And then 5 million to 10million, the multiple is five
(09:42):
and the 10 million above themultiple is six.
So the multiple is going tomake more sense once we do the
calculation.
But basically this is the keynumber that we're going to
multiply your net operatingincome by by your multiple to
get what the value is.
Speaker 3 (10:01):
And so companies that generate because EBITDA is
really a calculation of profit,so to speak right, your revenue
is how much you sell, yourEBITDA is how much you keep.
And so companies that generatemore profit, they generate more
cash.
They're going to be moreattractive to potential buyers
than companies that generateless cash.
(10:23):
And it's not necessarily aone-to-one basis.
So companies that generate lessthan a million dollars a year
in cash are worth X, butcompanies that generate, you
know, five to ten milliondollars in cash are worth that
with a multiple of five.
And, daniel, you and I weretalking about this earlier A lot
of that has to do with just howattractive it is to buyers, the
(10:47):
potential for making changesand increasing profit and things
like that.
Because I'll be honest with you, when I first looked at this,
it didn't quite make a lot ofsense to me.
Why would there be an EBITDAmultiple?
Speaker 2 (10:59):
But just understanding what investment
bankers and private equity arelooking for when they look to
buy companies, it makes moresense that the more cash a
company generates, the morevaluable it would be to a
potential buyer right, because alot of times what they're
trying to do is is um, maybemake a few changes and get and
open up the profit margins andthen sell it at an even higher
(11:21):
multiple or combine it withanother company so that
combining one painting businesswith another painting business,
that puts it into another tierof a multiple.
So maybe let's say you buy twopainting businesses that are at
$2 million in, or let's say, uh,two painting businesses that
(11:44):
have a million, just over amillion in um in in ebita, and
so that's going to be 2.5multiple.
But the two of them togetherputs them in the uh, still in
the 2.5.
But then if you can make somechanges and you get them to 2
(12:04):
million or 3 million in EBITDAeach, that puts you into the
next tier, which is the 5million to 10 million multiple.
So now it's a multiple of 5instead of 2.5.
So combining companies, makingsome changes and getting it into
the next multiple can add a lotof value.
It allows them to sell it at aneven higher multiple.
Speaker 3 (12:30):
So what you're saying is, one company that generates
$5 million in EBITDA is morevaluable and has more potential
for growth than five companiesthat generate $1 million in
EBITDA.
Speaker 2 (12:43):
Yes, that is the concise way to say it.
I wanted to say it veryconvolutedly so that it's hard
to understand.
Speaker 3 (12:50):
No, no, no, you explained it well.
Sometimes I just need to recapthings in my own mind.
Speaker 2 (12:59):
Yeah, no, that was a way better way to say it.
So all right.
So now we understand the EBITDAmultiples and right now, the
example company that we're usingthey're at an EBITDA multiple
of one because they have under amillion dollars in EBITDA or
net operating income.
All right, so next let's go tothe value adders.
(13:19):
These are the things thatindicate that the company is
healthy.
So the first one is revenuegrowth.
Revenue growth typically toearn a point here.
So we're trying to.
Right now we're value adders.
If you have a favorable revenuegrowth, like if you're growing
(13:39):
quickly, you're going to getanother multiple, a point or two
added to your multiple.
So in this case, the paintingcompany that we're using,
they've kind of flatlined overthe last year compared to the
previous year, so at this pointthey don't have any revenue
growth, so they don't get anypoints here.
(14:01):
But if they had been growinglike, let's say, 30%, they would
have gotten one additionalpoint which would have been
added to their multiple, andgetting them to two, a multiple
of two instead of one.
Or if they were growing by ahundred percent, then that's two
points there.
So that's revenue growth.
(14:23):
The next value adder would beyearly revenue recognition, and
this is tough for paintingbusinesses.
So basically this is or, I'msorry, not recognition yearly
revenue retention, excuse me,yearly revenue retention.
So what this means is whatamount of clients are you
retaining year to year Now forpainting businesses, since a lot
(14:46):
of the times, especiallyresidential repaint you're
painting someone's house and youmight do it once every few
years.
It's hard to really doreoccurring yearly revenue but
you might be reactivating everycouple of years or every few
years for that particular client.
So it's difficult forresidential painting businesses
(15:09):
to get that revenue retentioneach year, but you should be at
least reactivating them everycouple of years at a minimum.
So yearly revenue retention forthis painting business is about
20%.
So they're basically gettingincome from the same customers
about 20% of the time from thesame customers.
So this is good for thisindustry, but not quite as much
(15:36):
revenue retention as what aninvestment banker would be
looking for.
They're looking for more like80%.
So another example might be ifyou have a long-term contract
with a government or commercialproperties where you're doing
maintenance painting over a longperiod of time and you have a
recurring revenue from that,maybe this looks different for
(15:58):
you, maybe you have a higheryearly revenue retention than
this painting business that isdoing residential repaint.
All right.
So the next one is the EBITDAmargin.
So this is simply taking yourEBITDA and dividing it by your
revenue and in this case, whenwe take 513,000 divided by 2.8
(16:22):
million, we get 18%.
So they have 18% EBITDA margin,which is pretty strong.
In order to get an additionalmultiplier you'd have to be
getting over 30% EBITDA margin.
So it's still strong, 18%, butit's just not high enough to get
(16:44):
that additional multiplier of0.5 for over 30%.
The next one is a lifetime valueto CAC ratio.
So lifetime value is the amountof income you're getting from a
client over the lifetime valueof them compared to what it
(17:06):
costs to acquire that customer.
So the lifetime value of acustomer would be we painted
their house in year one and thenin year three we reactivated
them, painted their house again,and the simple way to look at
this is basically forresidential repaint.
(17:28):
If you look at your top line,it's kind of hard to track your
LTV since it's so far apart.
For how often you're gettingjobs from folks.
There's a more complicatedformula, but to simply get this
ratio, you can take your topline revenue and divide it by
your customer acquisition cost,which is basically your
(17:48):
marketing cost, so how much youpay for marketing plus your
salesperson cost.
So for this company theirmarketing costs are at 15% and
their salesperson they pay 5%for closing are at 15% and their
(18:08):
salesperson they pay 5% forclosing.
So that's 20% customeracquisition costs compared to
revenue, which is a five to oneratio.
So top line divided by 20, 100%of your revenue divided by 20%,
is a five to one ratio.
So that is your LTV to CACratio for this one, and in order
to get an additional multiplier, you would need to have 10 or
(18:32):
greater.
So your customer acquisitioncosts would need to be basically
10% of what your revenue is.
Speaker 3 (18:39):
I think it's interesting.
We went through all these valueadders and our sample client
here didn't get any extra valueadders.
Now we know he's got asuccessful painting business,
like you know it's.
We're very proud of hisbusiness, uh.
But they just kind ofemphasizes that to get these,
these bonus points, you reallyhave to be doing something
(19:03):
extremely well.
And I wouldn't like, if you'retrying to evaluate your own
business and you're in line withthe average but you can't quite
hit these value adders, Iwouldn't necessarily consider
that to be something to be upsetabout.
These value adders are veryhard to obtain.
Speaker 2 (19:23):
Yeah, and I think.
But it's also a good thing tostrive for because although this
painting business is verysuccessful, there's still room
for improvement.
So I would definitely say like,hey, getting their LTV to CAC
ratio down would be something tolook at, trying to get their
customer acquisition costssmaller compared to lifetime
(19:47):
value.
Now the other thing is growth,and I'm sure Well I know that
they definitely want to grow thebusiness and they're just
working through some constraintsright now.
So the revenue growth 30% ispretty feasible to do year to
year and so that would beanother opportunity that's
(20:13):
completely within reach for them.
Revenue retention that's prettydifficult for their business
model.
Ebitda margin, considering,which we're going to get to this
in a second.
He doesn't have any key manrest but he's pretty much out of
the business.
That would be difficult to getin this industry, but not
(20:33):
impossible.
That would be difficult to getin this industry, but not
impossible.
I would look at the first twothat we talked about for the LTV
to CAC and the revenue growthones, to get those additional
multipliers going first and thenlook at the EBITDA margin.
Third so again just toemphasize the point, he's
probably not going to sell butlooking at ways to improve the
(20:56):
business and make it morevaluable to him.
Those looking at those metricswould be super helpful and good
focus points for him.
Speaker 3 (21:14):
Yeah, I like it because it kind of helps us
understand, you know what thegoals should be, what are the
things that we should focus on.
Speaker 2 (21:20):
So, yeah, that was really useful, All right.
Next section is valuesubtractors.
So these are the things thatare risks to the business, that
are going to take away from thevalue, and the first one is key
man risk, and this is thebiggest one.
This is going to have thebiggest decrease in your
multiple.
If you have this risk, and mostis the biggest one, this is
going to have the biggestdecrease in your multiple.
If you have this risk and mostof us do is the key man risk,
which is is there a person inthe business that is doing a lot
(21:45):
of things?
And if they were to get out ofthe business, it would
significantly impact thebusiness's ability to operate.
So, uh, most of the case, mostof the time, this is the the
owner.
Right, the owner is doing thesales, doing the operations.
You know they're leading thecompany, driving the growth,
whatever all those things.
(22:06):
Um, and if that's the case, ifyou're doing a lot in your
business, you might have thisrisk.
And in the case of our exampleclient here, he actually doesn't
live in the same state that thebusiness operates in, so the
business is running without him.
He does have some interactionwith his team throughout the
(22:29):
week, but it's pretty minimal.
So I would put him as a zerofor this risk.
Now, if you're still boots onthe ground, you're still doing
the sales or a significantamount of the work to make sure
things are operating, and youmight have this key man risk and
(22:50):
this is a big hit to themultiplier.
This is subtracting threepoints from the multiplier.
So since we only have one pointso far, if this business would
have had a key man risk,basically his business would be
worth zero from an investmentbanker's perspective.
Speaker 3 (23:12):
Yeah, so it's that the key man is that person that
if something was to happen tothem heaven forbid the business
would most likely it wouldlikely close or become very
close to closing.
Speaker 2 (23:26):
Yeah, yeah, all right .
The next one is key client risk.
So this is basically do youhave any clients that make up
10% or more of your revenue in aparticular year?
So in this case this is zerofor this client because they're
doing residential repaint,they're doing a lot of volume, a
lot of individual houses.
If they lose any particularclient, it has almost zero
(23:48):
effect on their revenue.
However, if you're a paintingbusiness that works with a
particular general contractorand they give you 50% of the
work of your revenue, then youwould definitely have this risk.
Or if you have a certaincommercial contract that's over
10% of your revenue for aparticular year, you would have
key client risk.
(24:08):
And so if you do have 10% ormore of revenue going to the
same client, same customer, thatwould be a minus two from your
multiple.
Speaker 3 (24:19):
Yeah, it's like having all your eggs in one
basket.
Yeah.
Yeah, it increases your risk.
Speaker 2 (24:28):
Which makes sense.
Your company, maybe all yournumbers look amazing.
But then they find out, oh, allyour revenue comes from one
general contractor who, if hedecides, he wakes up one morning
and decides he hates you, hecould fire you and then your
revenue goes to zero.
That'd be a huge risk.
Yeah, all right.
(24:49):
The next one is single channelrisk.
So this is how are you gettingyour clients?
How are you getting yourcustomers?
Do you have just one way thatyou get customers?
Maybe you just do Facebook adsand that's the only way.
So if Facebook kicks you offtheir platform now you have no
way to get customers.
So this is single channel risk.
(25:10):
Do you have only one way you'regetting customers?
If you only have one way to getcustomers, then that's a minus
one from your multiple.
And the next one is market risk.
So this is a look at theindustry.
You know, maybe ai issignificantly threatening that
(25:32):
industry.
That's going to make itundesirable for a investment
baker to buy that business.
So, uh, so this doesn't impactthe painting businesses.
So you listen this.
You probably don't have toworry about any market risk.
But just to give an example,this would be something like um,
like the designer space rightnow, just because AI can do a
(25:54):
lot of designs.
So that might be threatenedright now.
So that would be the marketrisk.
The next one is data risk.
So this is one of my favoriteones.
So if you have data risk, thismeans that you don't have good
insight into your numbers.
You don't know your numbers.
(26:15):
Maybe I'm going through thesenumbers right now and you're
like I actually don't know whatmy revenue or EBITDA, or how
much revenue growth I have, orwhat my revenue retention is, or
what my LTV to CAC is.
So if you're asking, you'resaying those things to yourself.
You probably have data riskbecause you don't know your
numbers.
You have no way to easilyaccess that information in some
(26:36):
sort of dashboard.
Maybe you have to go to fourdifferent, five different places
to pull this stuff together.
You probably have data risk.
So that would be a minus oneoff your multiple.
Speaker 3 (26:48):
Yeah, now I noticed that our example client does not
have data risk because he hasgreat financial reporting, his
books are very clean, his taxesare taken care of, so that's
nice to see Yep.
Speaker 2 (27:04):
He has a dashboard that gives him all this data, so
he's at zero for that one.
So he's at zero for that one.
And so, just to recap, he has aone multiple for his EBITDA
because he's under 1 million inEBITDA, so he's at a multiple of
one, since there was noadjustments.
And then we multiply one timeshis EBITDA to get the value,
(27:45):
which is $513,000.
So if an investment banker islooking at this painting
business, they would likelyvalue it somewhere around
$513,000.
Speaker 3 (27:54):
And that's basically one year's profit, exactly.
So now, if this client wantedto increase the value of his
business, we kind of identifiedthe areas that he could work on
Some of these value adders, suchas increase your revenue growth
to more than 30% year over year, increase your lifetime value
(28:18):
to your customer acquisitioncost.
Let's say he was able to dothose two things.
Now his multiplier would be 1plus 1 plus 0.5 or 2.5.
Speaker 2 (28:31):
Or two and a half, and his enterprise value, or the
price that an investment firmwould pay for his business, is
so if he did 30 growth, revenuegrowth which would get him to
3.64 million, and then heincreased his EBITDA margin to
28 percent, that would get him acouple additional multipliers.
(28:56):
One it would get him in the 2.5EBITDA multiple for being over
1 million in EBITDA, and solet's change that one, 2.5.
And then if he had his revenuegrowth 30%, that would get him
another point there, and we'resaying that he didn't quite hit
(29:19):
30% there.
So he just improved the revenuegrowth and he improved the
EBITDA margin, but not up to 30%, just a bit close.
So that's going to increase themultiple to 3.5.
So that's going to increase themultiple to 3.5.
All right, so 3.5 multiple onbasically a million bucks.
So that's 3.5 million.
(29:40):
So his current enterprise valuein one year if that's possible,
which is possible, it'll justbe a lot of work would be
$500,000 to $3.5 million.
Speaker 3 (29:58):
That is an enormous difference.
Yeah, yeah, yeah.
So I like this.
It kind of helps us understandwhere we need to focus, what
things need to change, becausechanging a few of these items
really impacts the enterprisevalue if you're changing the
right items.
Speaker 2 (30:18):
Yep, cool.
Well, hopefully that was useful.
I'd love to hear your thoughtson if you've tried to sell your
business.
Maybe you reached out to aninvestment banker.
There's different formulas outthere, but a lot of them,
according to Alex Ramosi, arevery similar to this kind of
(30:40):
breakdown that we went throughtoday.
Love to hear your thoughts onthe selling process or if you're
looking to sell or some of therisks or other things that we
went into today.
Love to hear your thoughts.
You can go to Facebook and typein grow your painting business
and go into the Facebook group.
Love to hear your thoughts.
Speaker 3 (31:01):
Yeah, thanks for listening everybody, and we hope
to see you on the next episode.
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