8 ways contractors can drive value and prepare their company for the future
This week, John Ratliffe of Scaling Up Coaches and align5 joins the podcast to drop some game-changing tips and insights for driving up the value of your construction business. Even if you don’t have plans to sell your business any time soon, you need to hear this episode. It’s never too early to think about the future of your business and you can start taking steps TODAY to increase its value.
Topics we cover in this episode include:
- The risk of customer concentration
- Communicating your strategic plan with key employees
- Recurring and predictable revenue
- Biggest mistake companies make when preparing to exit
- The importance of clear KPIs
- Gross margin and growth
- The Rembrandt in the Attic analogy
- How early should I think about exit planning, and how can I start?
LINKS
Find all episodes and related links at ContractorSuccessForum.com.
Watch the video version of this episode on YouTube.
Join the conversation on our LinkedIn page: https://www.linkedin.com/company/contractor-success-forum
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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | McWins.com
Rob Williams, Profit Strategist | IronGateESS.com
TRANSCRIPT
[00:00:00] Rob Williams: Welcome to the Contractor Success Forum. Today we are talking about how contractors drive value when planning their value for their company. And we have one of the world’s top experts over here, John Ratliff, of align5. He is one of the reasons that I became a coach. And so I’m really excited to have him on here.
Well, first let me introduce our guys. We have Stephen Brown with McDaniel Whitley Bonding and Insurance Agency, and we have Wade Carpenter, Carpenter Company CPAs, and I’m Rob Williams authoring the Pumpkin Plan for contractors. And John is really a big instigator in my coaching progress because as I was at a conference for Scaling Up, John was speaking and during that talk is when I decided to become a Scaling Up coach.
I was there as a business owner and his talk about business value and things. And then as we went on, as we talked later in the night, I found out my best friend is one of his best friends, Wei Chen, who was my business partner and stuff that we had a lot of things in there. And John has the same airplane that Wei and I flew around the world. So we had so many great things in common.
But John, just quick introduction of him, he has put together so many deals. He acquired, I think, well, 18, 20. I’ve heard rumors of all these different numbers.
[00:01:33] John Ratliff: 24 is the number we go with.
[00:01:36] Rob Williams: 24, even higher, acquisitions.
And he’s helped so many companies sell their companies for a strategic value that was much higher than the financial value that me as a finance MBA guy in valuation, I’ve fought with that in the construction industry and trying to understand different multipliers and how that worked and whether that was a multiplier of future growth.
And that’s the way I looked at it when he gave me that strategic value talk about a company being worth what it is to somebody else. I’ll let him explain a lot of that, but that changed my whole perception of selling your company and building the value and the different things that you need for that.
So, some other great interesting things that, that actually I heard your conversation about, I didn’t know this, I’ve known you for a little bit how you’re friends with Richard Branson and the things that y’all do together. I know that’s just sort of a who’s who thing, but I thought that was a pretty cool thing. Your charity y’all do together is great. But John is so humble and an unassuming guy a lot of times that when you read all this stuff, it’s like, really? John did all that? That’s amazing. So anyway, I’ll stop making you blush on here and let’s talk about what we came to talk about!
[00:02:48] John Ratliff: Don’t worry. I read it sometimes too, and I look and I go, yeah, that, that can’t be right. So, I’m with you on that.
[00:02:54] Rob Williams: Yeah, he sold his company for a really high value as well compared to his industry. That was one of the, I guess that was one of the main points I left off, so
[00:03:02] John Ratliff: Yeah. We actually exited, we had a call center company. We had a lot of contractors as clients actually, and both residential and commercial. And we exited that business for about a little over four times the industry average multiple, so.
[00:03:17] Rob Williams: That’s amazing.
[00:03:18] John Ratliff: Close to 450% above industry average, which is one of my, I’ve got lots of rants and lots of like hot button issues and the whole industry average thing. We could probably start right there. And I, it’s probably a great way to set the stage for today. And let me know if I jumped in too soon.
[00:03:35] Stephen Brown: No, I mean, John, it is important for our listeners to know that this podcast today is specifically addressing everything we’ve talked about for the last year. You value your company, you get it ready to sell, and you don’t have to sell it. That’s the point. But if you’re going to, and you value it properly, then you’re doing everything right that you need to do to run a construction company.
[00:04:00] John Ratliff: Yeah. And the beauty of that is a lot of times, there’s trade offs, right? If you’re gonna get an asset ready to do X, then you gotta trade off some Y. If you’re gonna, I, I don’t have a good example, but a lot of times you have to pick one or the other. What’s great about getting ready to sell a company or drive the value of a company, all the things that drive value for the entrepreneur are things that you’d want to have in place anyway.
And we’ll use the– we’re gonna use as many contractor analogies as we can today. It’s the whole concept of you’re gonna sell your home and what do you do in the six months leading up to sell the house? You run around– I’m doing it literally right now. We’re putting our primary residence on the market in the next two or three weeks. We just put $30,000 into the pool and $50,000 into repainting and fixing the roof. And our house will be in the best condition it’s ever gonna be in on the day it goes to market. And the sad part is we should have done all that, 2, 3, 5 years ago to enjoy it while we still owned it. It’s the same thing with the company.
All the things that get it really sale ready and, dot the i’s and cross the T’s and put the new stuff in for the pool, are the things that would make the entrepreneur’s life better while they own the company. So there, there’s no downside to getting a business ready. And you never know what life’s gonna bring, right? We joked in M&A, there’s the six Ds. There’s disease and death and divorce and disenchantment, and disillusion, I think is one. There’s six of them.
[00:05:40] Rob Williams: Yeah.
[00:05:40] John Ratliff: You never know when one of those things–
[00:05:42] Rob Williams: I think dumb ass. Is that dumb ass?
[00:05:44] John Ratliff: Dumb ass. That’s mine. That’s the hidden seventh D for me. Dumbass.
[00:05:48] Rob Williams: Yeah.
[00:05:49] John Ratliff: But you never know when one of those things is gonna happen.
So you, you should always be ready anyway. But again, the number one value driver and we talk about risk. And the more you can do to take risk out of an equation, the higher the value of that equation. And the biggest risk in any business is being completely dependent on one person. And in many cases, that one person is the entrepreneur.
Well, why build a business? Why build an asset and try and create value in an asset where if you go away, all the value goes away? So all the work that you do to get a business ready for the sale or for exit or to build value, call it whatever you want, is the same stuff you would do if an entrepreneur wants to be able to work 40 hours a week instead of the 80 that most of your listeners are probably working today. Or what if it’s 25 hours a week, or what if I could take three months off in the summer, or whatever that looks like.
And I think a lot of times we get caught in this idea, and it goes back to the industry average thing. We get caught in this idea that, well, I’m in the blank industry, therefore I have to do X, Y, and Z. That’s just how it is. And that’s how my industry works and that’s what companies in my industry are worth.
And we get into this group think mentality, but you look at the best companies in the world around strategy, they do it different than their peers. Southwest Airlines, you can’t book a seat in advance. You show up and you get in a line with a bunch of other people and they shove you on the airplane. That’s not just to be annoying. There’s a reason behind that strategy and it’s different than all the other airlines, and it’s one of the reasons it’s Southwest was profitable when a lot of other airlines struggled. And there’s lots of other underlying reasons.
But I’m a strategy guy at heart and I really believe to differentiate your strategy, you have to think differently than your peers. So I guess my challenge for your listeners and Rob, you as a Scaling Up coach for sure see this every day, is if you wanna grow the value of the business and trade above the average for your industry, you have to think a little bit differently than some of your peers. And working 80 hours a week, yeah, it comes with some kind of badge of honor and, against all odds and Superman and all those things, but it doesn’t have to be that way. And, the less that it’s that way, the more your business can be in service to you as opposed to the other way around.
[00:08:16] Rob Williams: Yeah, we talk about that in my book. The martyrdom that the contractors did. Especially we talk about the Marlboro man back in when I grew up in the seventies and the eighties, and, if you’re not there before daylight, you, what’s the matter? And you stay until after daylight, whether you’re just sitting there drinking beer or whatever, but you’re there. You don’t go home. You’ve got this martyr effect that you’re not supposed to enjoy life.
[00:08:39] John Ratliff: And by the way, I speak from experience and pain. And that’s where all my kind of knowledge comes from. I started a call center business 24 hours a day, seven days a week, 365 days a year. And in the beginning, I was the only employee. I lived in an apartment with a giant buzzer next to my bed, and when the phone rang at four o’clock in the morning, this buzzer would go off, waking me up, pissing off all of my neighbors, and I would get up and answer the phone until I could afford people to be there to do it.
And by the time I exited that business, we had 650 employees. We exited for four and a half to five times the industry average multiple in the call center space. And I was working 15, 20 hours a week and just working on strategy. So I have run the gamut from burned out, sleep deprived, martyr, the whole nine yards all the way through to see, hey, there may be a better way.
So, thi this isn’t, a platitude and I’m up on the hill saying, do this, do that. This is, I made every mistake there was to make probably a dozen times, went through the pain, but then saw a better way. And I always like to share kind of that better way.
And someone did that for me. Someone came along at the seven year mark and said, this is where the dumb ass part comes in. Hey, dumb ass. You don’t need to work 80 hours a week to make this business a success. There’s other ways. And someone pulled that curtain back. And in that moment I shifted my philosophy and it took nine, 10 more years to sell the business. But in those next 10 years, my quality of life exponentially improved.
And I agree you guys are talking about that. It’s a really important subject.
What is the value of your company if it’s dependent on you being there?
[00:10:27] Wade Carpenter: You just kinda led right into one question I was gonna ask, because I remember very vividly, probably three or four years ago, I was teaching a class of contractors about valuation, and we were talking about, what . Would be worth and things like that.
And one guy stood up and said, my, my construction company is worth nothing because, it’s all dependent on me and everything in my head. I turned around and said, well, you’re absolutely right if you run it that way. So what would you say to all the contractors out there that are, essentially it’s all dependent on them?
[00:11:00] John Ratliff: I think you hit the nail on the head Wade with that question and that sharing the story of that experience.
Open your mind to the idea that there’s a better way
[00:11:06] John Ratliff: The first thing you have to do is shift your mindset. So if your mindset is, well, it’s worth nothing because it depends on me, and that’s just how it’s done. You’re never gonna get, I don’t think you’re gonna get past that.
So step one is just open your mind to the idea that maybe there’s a better way. And there’s lots of relative examples in your space where entrepreneurs have gone on to create large companies that operate independently of them. There’s, you guys know them and can find them. So, so step one is to separate yourself from the idea that you have to be the hero every day or this thing falls apart.
This doesn’t mean just stop showing up for work tomorrow. There’s a lot of work that has to happen between it’s all dependent on me, and the business runs by itself. And know that’s gonna be a continuum. It might be two years, it might be three years, it might be five years.
If you accelerate it, you might be able to accomplish it in a year, but it doesn’t happen overnight. And it doesn’t happen by accident, and it certainly doesn’t happen without a lot of effort on your behalf.
But would you rather put an hour into doing it the way you’ve been doing it, knowing that you’re not creating value? Or would you rather put an hour or two hours into helping to get it to a point where it’s not totally dependent on you and you are creating some value? So that’s the first step is mindset.
And then the second step, I think you look at all the activities that you are doing on a day in and day out basis, and you start to ask the simple question, who else might be able to do this or that?
And again, this is where mindset is critical. If your ego says, nobody can do that except for me, you’re gonna set yourself up to fail. But if your beginner’s mind says, all right, well, I could probably hand off this, and this, that becomes a discipline that you build.
Delegation is a discipline that you start to create and build over time. Here’s how it goes most of the time you work 80 hours a week, you wake up one day and you’re like, I can’t do this anymore. This is not sustainable. Most 80 hour week entrepreneurs have a business that’s mediocre or maybe good, but not where it could be. But they’ve got a family life that’s a disaster. They have a personal life. That’s a disaster. They have depression and anxiety and statistics say 70% of your listeners, if they’re entrepreneurs, are suffering from depression, anxiety, family issues, drinking problems, runs the gamut. And I know at least a few people listening probably are in that boat.
So 80 hours a week, you wake up one day, I can’t do this anymore. And then you’re like, you just start handing stuff off. I don’t even care as long as somebody else does that, as long as it’s not me. That’s abdication not delegation.
So delegation for me is you close the loop. So if I’m gonna, let’s say, let’s just pick one that’s probably a bugaboo for everybody. Estimating and trying to win new business, right? How many of your clients love that job?
So I’m gonna hand off the first stage of estimating. And I’m 80 hours a week and I’m totally wiped out, Joe, you do it. I can’t do it anymore. But there’s no systems, there’s no process, there’s no accountability, there’s no closing the loop. Four months later, we realized that Joe doesn’t even know how to do estimating and we’re not winning any new business. And the four jobs that we’re working on now, we’re losing money on three of them because the estimates were wrong. And that’s abdication.
So the second step in all this is you look at all those to-dos and all those tasks and all those things, you probably should pick the ones that drain your energy the most. That’s a great place to start. Because you’ve got stuff you like and you’ve got stuff you don’t like. So find the ones that really are draining your energy and then create a system to give that to somebody else.
And a system is, this is how we do it here. It’s not, hey, I can’t do this anymore cause I’m burned out and I’m, fried. You do it. It’s first you do this, then you do this, then you do this. So as you make that transition from 80 hours a week, and it’s all in my head and no one can do it but me, you’re still gonna do all that.
But as you’re working in the business doing those things, you should be thinking about, okay, if I were to give this to somebody else, what would it look like? What would the process be? What would the system be? Then you can work on your business at the same time you’re working in your business with the idea that one day, then you can hand that off to somebody else.
And if your mindset’s wrong, forget it. You’re never going to, you’re never gonna get there. If you’re burned out to the point where you just can’t do it anymore, and you give it away, you’re not gonna get there. But if you’re really thoughtful about, okay, how do I replicate myself in this business? What if I had five of me? I’ve decided I’m the most important cog in this machine. What if I had four more cogs like me? What would I give those cogs to do? And how would I recreate my knowledge in others?
And that really is the beginning. And there, there’s a lot more steps that go after. And there’s financial accountabilities and all the things that you guys probably teach your clients, beating your head against the wall on a day-to-day basis.
But that’s where I would start, that mindset of, okay, systems process. How do I hand things off to others and close the loop with accountability? How do I measure whether we put together an effective estimate? How do I, instead of finding out four months into the job that we’re underwater on that job.
[00:16:47] Rob Williams: Yeah, that’s great. Now you think we’ve got a couple of tools you guys listening on here that can go back on systems and processes and how we can do that. So we’ll look it up and try to make a note in there somewhere. I don’t know where you guys can find it, but we’ll find it on our list.
[00:17:01] John Ratliff: Rob, just I’ll interrupt super quick and if you wanna challenge your listeners, pick the thing that you hate the most, this is my challenge to your listener group. Pick the thing that you hate the most, and whether you’re gonna do it ongoing or not, think about if somebody else did that one thing.
Just pick one thing. It doesn’t have to be your whole business, but pick the thing that you loathe the most and just build the process in the system to hand it off to someone else, whether you choose to do it or not. It’s a great thought exercise to begin to build that muscle of how to delegate and how to build systems, and you don’t even have to do it.
Just go through the exercise. You’re gonna work in the business anyway, doing the thing you hate. Just think today or tomorrow or next week or next month. All right, I hate this. How could I get somebody else to take this on instead of me? And that, that starts to build the discipline. All right. Go ahead. I, sorry for I’m–
[00:17:59] Rob Williams: That was great man. That reminded me of one of the big points in the Pumpkin Plan, our book, is talking about build those systems around your best customers and not your worst thing. So build them around your strengths. Because as you grow and get bigger, you’re going to want to do more of those strengths and not your weaknesses.
So we find people that never grow and get bigger because they build all this one right here. I spent so much time building my strengths against the bad things that happened, building my systems around that, rather than building on our strengths. Because as we start selling those strengths more, we’re just gonna drop these things that we’re not good at, and build our funnel up on that.
So that’s another those things that you have energy, but then where you’re good at, because everybody wants to fix the things they’re bad at first.
[00:18:44] John Ratliff: Yeah.
[00:18:44] Rob Williams: So, so there’s a different strategy, particularly in our Pumpkin Plan that we’ll talk about, which I’m integrating the Pumpkin Plan and putting some of John’s information on exit planning in there. I’ve got permission to put the Scaling up processes in there too. So we’ll talk about all this in the book. So we’ve talked about, in these value drivers, the entrepreneur being redundant, strategic planning process. And then I think we’re talking about customer concentration too. Isn’t that a huge thing?
Customer concentration is a risk
[00:19:10] John Ratliff: It’s a huge one. Yeah, for sure. This is a great idea, I think for all of your clients. Just imagine for a moment, and I’m a big kind of thought exercise. That’s a lot of what we do at Scaling Up, is to think about how we think.
So put yourself in the shoes of a buyer. Someone’s gonna come along and buy your business. And I’m gonna give you two identical companies over the last five years, and I’m just gonna use random numbers. These are just pulled out of the air. But imagine you have two businesses and they both did a hundred million in revenue in the last five years, and they both had 50% gross margin and 20% profit.
So they’re a hundred million in revenue, 50 million in gross margin, 20 million in profit over a five year span. Identical, financially identical in every way. Business A has a thousand customers and their biggest customer is 4% of the business. Business B has seven customers and their biggest customer is 63% of the business. Financially identical.
They performed identically over that period of time. Which business would you rather own? The one where the one guy can leave and you lost 63% of your company, or the other one where your biggest customer leaves and you lost 4% of your company? Customer concentration is a risk. And anything we can do that decrease risk, increases value. Anything that increases risk, decreases value. That’s why customer concentration is such a risk or can be such a risk.
[00:20:39] Stephen Brown: Okay, John, let me ask you a question. You put together a strategic vision to make all this happen. How do you communicate that with your key employees? How do you measure it?
Communicating your strategic plan with your key employees
[00:20:52] John Ratliff: Yeah, so I, I’m a big believer in and we obviously teach the Scaling Up methodology, Rob just referenced it as well. At the heart of the Scaling Up methodology is a strategic planning process based on four things: people, strategy, execution, and cash. But for me, the fundamental of scaling up is really a communication methodology.
So we do it through a sequence of meetings that start with a daily huddle. So you’ve built your vision, you’ve created your strategic plan, your three to five year, maybe your North Star. We call it a BHAG: big hairy, audacious goal. You build a plan for the year. Then we think about what do we have to do this quarter to accomplish the year? That ties into the three to five, that ties into the BHAG.
But then the two communication fundamentals for the whole team are the daily huddle and the weekly meeting. And I’ve got a really funny– we’re, we have a co-working space. I’m in our co-working space right now, 14,000 square feet. It was a building that was built between 1899 and 1906, I think was the construction timeline on the building. You can imagine the challenges we have here.
When we came in, the building was in complete disarray and we put together a strategic plan to rehab the building. And we were, and I know this is gonna come as a shock to everyone on this meeting, but we were about eight months behind and about two and a half times over budget with no end in sight.
And shame on me because we teach this every day. I finally said to everyone involved, I’m like, we need to start a daily huddle. We need to communicate 10 or 15 minutes every morning. And all we’re gonna do is we’re gonna tell each other our number one priority for the day, and we’re gonna tell each other where we’re stuck. And we’re gonna report out on two or three key metrics that we’re tracking.
And we went from no end in sight, two and a half times over budget, eight months overdue, we finished the project in about five and a half weeks. And it was all because we went to that daily huddle methodology. Rob, I don’t know how deep you guys go on daily huddle.
[00:23:03] Rob Williams: Oh yeah, we.
[00:23:03] John Ratliff: It’s an important discipline in Scaling Up. So every employee in the company should be every day in one of these five to 15 minute kind of status update meetings. I hate meetings. I’m not trying to add more meetings to anyone’s calendar. Our brand promise at Scaling Up is for every minute you spend in a daily huddle, you should save 10 minutes in your day.
So when I had the call center company, our daily huddle was 13 minutes, and I knew that would save everyone about two hours, 120, 130 minutes a day. That’s the brand promise on the daily. And then the daily rolls up. You do that four times a week, the daily rolls up to a weekly meeting where you go deeper on some kind of key ideas, customer feedback, report out more on metrics. And there’s a whole philosophy around the weekly.
But I strongly believe that once you’ve built a strategic plan, if you want to get everyone involved, and how many of your clients have Gen Z employees and Gen Y employees? That group wants to feel like they’re part of something bigger than themselves. They wanna see how they connect to the outcomes and to goals. And you can’t do that in a vacuum. You can’t set a strategy in a vacuum and not communicate, I believe every day. It’s important to do it every day. But at the very least every week, everyone in the company should be, have some line of sight to how they connect to that strategic goal.
And I also believe that the senior team, that the entrepreneur should own strategy. I will die on the hill for that one. It’s the owner of the business, the entrepreneur that really should set the strategy and direction. But they should do that with input from that senior leadership team. So, a handful of people once a week get together and just have a strategy conversation. Here’s where we are, here’s where I think we should go. Jim Collins writes about it in Good To Great. It’s called the Council.
[00:24:55] Rob Williams: Yeah.
[00:24:56] John Ratliff: Read about it in Good to Great. Called the Council.
[00:24:58] Rob Williams: –always telling us what page it’s on.
[00:25:00] John Ratliff: I know, and I should remember, I’ve heard them say it a thousand times, but so you start there and then everyone needs to be in that daily and weekly, and we saw it firsthand here.
And the funny sidebar story, we were having a problem with we were using glass to do the co-working space offices and there was a 13, 14 week delay getting glass in. But I had everyone, I had all the subs on this daily and they hated it in the beginning. They were like, I’m not getting on a call every day. And we said, well, then you’re not gonna be a sub on this job anymore.
And the glass guy couldn’t figure out how to get the glass. And we literally had the plumbing contractor on a daily huddle and he was like, well, couldn’t you use a shower door in this one instance instead of specialty glass that you’re ordering?
And within 48 hours from a local supply store, we had three shower doors that solved this whole problem that had been holding us up for 12 weeks. So it’s the collective intelligence of the group as well that’s powerful. So that’s how I, that’s how we communicate. And I think that strategy works really well.
[00:26:04] Rob Williams: That’s great. So let’s keep going down our list. I know this is gonna be a little bit longer episode than most of them, but I think it’s worth it guys. So, we decided about customer concentration.
Recurring and predictable revenue
[00:26:13] Rob Williams: Recurring and predictable revenue, how is that when you’re marketing these companies?
[00:26:18] John Ratliff: Yeah. So I’ll give you those two companies again. They’re both a hundred million, 50 million margin, 20 million profit, and company A the one that has the really diverse customer base, over the last five years, the revenue went, 15 million, 18 million, 21, 23, 25. That probably doesn’t add up to a hundred, but let’s just all assume that it does. And the other one went 8 million, 31 million, 17 million, 21 million, 9 million. Again, let’s assume that adds up to a hundred. Which one would you rather own?
You want the predictable, consistent revenue. And the way to get predictable consistent revenue is to find recurring revenue sources. And in your industry, that could be service contracts after the sale.
That could be, there, there’s some ways to build in, I know it’s hard when you’re in a business that does a lot of project based work to get recurring revenue, but predictable revenue is probably in your industry as important as recurring revenue in most.
[00:27:22] Rob Williams: Do you compare that to your backlog ratio that you talk about you need?
[00:27:27] John Ratliff: Yeah I think it really, it comes down to predictability for me.
[00:27:32] Rob Williams: Yeah.
[00:27:34] John Ratliff: So, and I, and again, that’s probably more of a Wade question. You obviously do the books for lots of these organizations and you probably see both sides of that coin. And, and by the way, it goes back to risk. It’s less risky to have predictability. It also makes you sleep better at night if you’re not worried about where the next payroll is gonna come from. And if we don’t land this project, we’re gonna be outta cash. And that creates a lot of stress on the entrepreneur as opposed to predictable and consistent.
Biggest mistakes companies make when preparing for sale or exit
[00:28:03] Wade Carpenter: Yeah. One question I had, dealing with all these companies that you’ve worked with, what are some of the mistakes they make when they’re trying to prepare a company for sale or exit?
[00:28:15] John Ratliff: All right. The biggest mistake is assuming ahead of time what their business is worth. And we see that whether you hire experts to help. I had this conversation sadly with someone in the UK last night, and their advisors decided way ahead of time what they were worth. They’re leaving a lot on the table because of that.
So that’s number one. Assuming what you’re worth. Number two and this is probably one A, someone comes along one day and says, hey, we’re interested in buying your company. Have you ever thought about that? No, I haven’t thought about that. Let’s talk about it.
You’re not ready. Your books are a mess. Your systems and process are either non-existent or a mess. Your senior team is not aligned. And you engage this one perspective buyer who builds this really rosy story about how much they’re gonna pay and what your life’s gonna be like after the sale. And you get all excited and there’s no other buyers around.
And as soon as that buyer knows, and by the way, the buyers have gotten incredibly sophisticated. Private equity has really driven sophistication among buyers to astronomical levels. So, a good private equity firm might do 50 or 60 transactions in a year, and an entrepreneur might do one or two in a lifetime. So it’s a complete mismatch of capabilities.
They engage with one buyer and they get down the road and they’ve already committed wow, that, yeah, I’m gonna buy a boat, I’m gonna get a vacation house, I’m not gonna work 80 hours a week anymore. And then the buyer knows they have all the leverage. And they pull the rug out at the 11th hour.
I can’t get into a lot of the specifics, but the call that I had last night was they had an offer for 32.5 million pounds, and the buyer knew they had all the leverage. They’re supposed to close next week. And a letter came through over the weekend, Easter weekend, by the way, where they knew that, they’d be with family talking about the transaction. There’s such a psychology to buyers.
And the offer was still 32 million pounds, 32.5, but instead of a hundred percent cash at close, it was 15 million pounds at close and 73 hoops to jump through to get to the 32.5 million pounds at the end. Had they had a slate of buyers and run a proper process and done some different things, that would’ve been a different story.
So, it’s not going into it, thinking it through in advance. It’s reacting to someone that showed up. Those are probably, there, there’s a thousand more mistakes. Those two are really– and trying to go it alone. You wouldn’t represent yourself in court. You wouldn’t represent yourself in, in, a negotiation to buy a business without your accounting or legal or, but somehow entrepreneurs think, well, I know everything there is to know about my business, so I’m gonna represent myself when I sell it. And they just are getting slaughtered.
It’s like you got your grandfather’s golf clubs out of the attic and you got to the first tee and there’s Tiger Woods and Rory McElroy, and who’s gonna win? That’s literally what it’s turned into. So it’s a very unlevel playing field in M&A.
[00:31:38] Rob Williams: Yeah. Well that’s great. Well on, on our list, because I definitely want to get these in here. We already talked about systems and processes so we can get through that. So we had recurring predictable revenue system, process, your KPIs and your metrics. We sort of hit that, but I, do you wanna say something else about that?
[00:31:53] John Ratliff: Yeah, again, it goes back to visibility.
The importance of having clear KPIs
[00:31:55] John Ratliff: Put yourself, always walk in the buyer’s shoes. So you’re gonna buy those two companies, again, a hundred million companies. One of them has these robust dashboards so you can, at a moment’s notice everything that’s going on in the business, you can sit at your desk and look at the KPIs and look at the
[00:32:13] Stephen Brown: Key Performance Indicators, listeners.
[00:32:15] Rob Williams: Oh yeah, thanks.
[00:32:17] John Ratliff: Sorry. Or OKRs, if you’re an OKR fan. But some semblance of visibility into performance versus the other one where they wake up, and I know you guys don’t have clients like this. I know we do. They wake up every morning and they’re making it up as they go along and hoping for the best. So Company A, visibility less risky, make it up as you go along. More risky. Same thing. Drives value both ways.
[00:32:42] Rob Williams: Oh yeah. Yeah. That’s great. I know Wade’s pretty strong into a lot of his accounting and key performance things on the accounting side and the numbers.
[00:32:50] John Ratliff: Yeah, Wade I’d be interested to know your take on it. In our experience, seven out of 10 entrepreneurs don’t know how to read a Profit and Loss Statement. Can’t even begin to understand a balance sheet. And their idea of cash flow statement is, I have more money in the bank yesterday than I did today, and that’s how they understand cash flow.
And it’s so detrimental in this process to not fully understand because. The buyers, the sophisticated buyers, they understand the financial statements at a level that probably rivals all of us in some cases. And an entrepreneur that doesn’t understand the financial statement is totally disadvantaged, both in the day-to-day operation of business, but then in the in the exit for sure.
[00:33:38] Stephen Brown: We love you, John. Thank you for saying, that’s everything we talk about every week. That’s all we talk about.
[00:33:46] John Ratliff: Pain and experience. I’m speaking from pain and experience. I finally got my financial statement education at like year six of owning my business when I made another dumb ass mistake and got on the wrong side of a bank covenant and didn’t understand why. And that was it, i, yeah.
Then I made it a point to be an expert on the finance side, so keep going with every week. I appreciate that. Because it’s so, so important.
[00:34:14] Rob Williams: Yeah. Keep it, keep driving those and it gives you something common to talk about. And when the owners, the new owners, the new buyers, if somebody buys your company, then you’ve really got something that they can see, that dashboard, having those KPIs to, to feel confident that it’s going well, and they can see your performance as you’re trailing off.
Many times. We, which this is about to lead to the next one, about the profitability, gross margin discussion.
Gross margin and growth
[00:34:41] John Ratliff: Yeah, that’s what I was gonna go to next is gross margin. It’s like the hidden stat on the financial statement. And gross margin is the incremental contribution to cover all the fixed costs. So you’ve got your trucks and you’ve got your office and you’ve got. You’re foreman that are on salary and you have all the things that, whether you do a dollar of revenue or a billion dollars of revenue, you’re gonna have to spend and pay for, regardless. That’s your fixed cost.
Then your variable cost is if you do a dollar of revenue to, you know, materials and subs and all the things that vary with the amount of business you do are your variable costs. Gross margin is the revenue on a job or a project or a business line minus those variable costs.
Gross margin, I believe is the most important single thing to understand on your financial statements, and it’s the most misunderstood by the entrepreneurs that we work with.
And here’s what happens. And I wanna put you in the shoes of the buyer again, because that’s what we do. A buyer comes along and they look at your business, they look at your financials. And they’ve got a grand vision for the future. They’re buying your company because they see a bigger future than the past. Otherwise, why would you buy a– unless you thought you could steal it and underpay for it, there’s no reason to buy a business in decline that has a bleak future.
So they’re thinking about the future, they’re future oriented. They’re gonna try and value on the past. Because if you’re growing, you’re worth more on the future than the past. So they wanna value you on the past, but they’re excited about the future. So they will look at, if I can put a dollar into growing this business and I can extract more value from that dollar than they are, than I, I’m excited about the future.
So what they’ll do is they’ll look at your gross margin over time as you’ve grown as a percentage of your revenue. This is really important: as a percentage of your revenue.
So let’s say in those two examples I gave, a hundred million with 50 million in gross margin, 20 million in profit on both sides. But the one company A, the one that has been the attractive one all the way along, their gross margin as a percentage of revenue– percentage, not the number, but percentage of revenue, was 42%, 45%, 48%, 53%, 57%, to get an average of 50. And the other one was 58%, 53%, 50%, 47%, 42%, same average across both.
But the one is trading gross margin percentage for growth, and the other one is improving gross margin percentage as they grow. Which one do you want to own? You wanna own the one where, you know, if you put a dollar in, not only can you grow the business, but you can grow the business profitably. You don’t have to trade that gross margin for growth.
And the other one, yeah, they’ve got a hundred million in revenue and yeah, they’ve got the 20 million in profit, but their gross margin’s going down, and eventually it’s gonna get to a point where they’re not gonna make money anymore. So that’s the first thing a sophisticated buy– that’s the first thing they look at when they pull a set of financial statements, is how is gross margin as a percentage, not the dollar amount, but as a percentage of revenue, how’s it changing over time? And if you can build a business where the percentage gets better as the company grows, it’s game over– you’re exponentially more valuable than your peer that’s going in the wrong direction.
[00:38:30] Rob Williams: Yeah, so, so that was the. Seventh point of the seven things that we’re talking about. However, in that circumstance, one of the things I was thinking about is what happens during that sales process. I love the story you were telling about this when you get bought and then you start letting this stuff slide because you’re so busy. You alluded to that a little bit, but not specifically in this case.
[00:38:53] John Ratliff: Yeah, it’s back to the sophisticated buyer thing again. And when you get your company ready for sale and you go through a process, it’s hard.
It’s the hardest typically on the CFO, not even the entrepreneur, but normally the CFO and a business bears the brunt–
[00:39:10] Rob Williams: Wade.
[00:39:11] John Ratliff: –of the process and the CFO oftentimes owns responsibility around protecting gross margin and profitability.
So now you’ve got this individual that was probably already overworked in a lot of your client businesses, now you’re gonna add this side project on their plate. That’s probably 40 hours a week in a complex process. And nobody has their eye on the margins because the overworked person now added 40 more hours a week.
And what’s gonna slide? I can’t tell you how many times we have a client, they go to market. I beg them, no matter what, don’t miss your projections. Don’t let your margins slide. Don’t let your revenue slide, don’t let your profitability erode. And you’re five months, eight months, 12 months into a process and we get the latest set of quarterly financials and low and behold, margins slip from 52% to 48%, which means EBITDA went from 16% to 11% and all of a sudden the buyer now has a thing to point to and go, sorry, can’t pay you what we said we were gonna pay you because you’re not performing well. Meanwhile, they’re looking at a 90 day slice of a business that might be 20 years old. But that’s enough of a kind of end to say, all right, we’re gonna retrade the deal. We’re gonna, we’re gonna lower our sale price.
Protect your margins once you get into a sales process
[00:40:39] John Ratliff: So if you get into a process, couple things. One is really think about getting your CFO some outside help, especially if they’re already overworked. A guy like Wade to sit side by side with the CFO and work through a process of going to market is invaluable.
I don’t care what you pay Wade. Not having your margins erode during a process, it is the most important thing in the entire process, is to keep the business healthy and growing and eight outta 10. It doesn’t happen that way. And as an advisor, we beg our clients, please don’t miss, I’m back in market with a client right now that had a big miss in the fourth quarter and we had an unbelievably good offer because we did a good job, and the offer got pulled because the margins eroded in the fourth quarter. And now here we are, it’s April, we had to finish 2022, recast all the numbers and we’re back in market again, which just is tragic. So, yeah, protect your margins in the process as much as you possibly can.
[00:41:47] Rob Williams: Yeah. I can’t let you get outta here without, one of my favorite things is John has a program that he did with Joe Polish, and, you talk about the Rembrandt in the attic.
The Rembrandt in the Attic
[00:41:58] Rob Williams: I can’t have John Ratliff on here without talking about the Rembrandt in the attic.
[00:42:03] John Ratliff: Yeah. I’ll do it quick.
[00:42:05] Rob Williams: Okay.
[00:42:05] John Ratliff: So when you think about the value of your company, again, your company’s worth what one buyer is willing to pay for it at one point in time. Every business has a financial value. So you can take the cash flow of a business, you can discount it over time and come up with a range of financial values for the business. That’s like the foundation of the business.
Then if there are things that the business does over and above the foundation that somebody will value, and it might mean a different value for me than it means for Rob or Stephen or Wade. If they’ll value something over and above the cash flow, they may pay extra. They may pay above.
So the example we give is, imagine you’re gonna buy a home. I’m li I’m doing it right now. I’m listing my home for sale in the next few weeks as we alluded to, and doesn’t matter. Let’s just say I’m gonna list it for a million dollars. So I’m gonna list my home for sale for a million dollars.
The realtor thinks it’s worth about that. The three of you are bidders. You think it’s worth about a million dollars. Rob, you love our kitchen. You might be willing to pay 1.05, right? Wade, you don’t like the backyard, we don’t have a nice backyard. You might be at 950,000. Stephen, you’re right down the middle at a million.
So we have all set the market for the house. We all agree it’s worth about. A million bucks within a range of 950 to 1.05. That’s the industry average multiple for the house. That’s what it should trade at. Now you guys come and you wanna see the house before you buy it, right? You’re gonna look around.
So Rob, you love the kitchen. You’re at 1.05. Fine. Wade, you really don’t like the backyard, Stephen, you’re right down the middle. But Wade, you happen to wander up into my attic just to see the HVAC system, right, that’s up there. And you notice hidden behind this wall in the attic is an original Rembrandt.
And from your art history class in college, that Rembrandt’s worth about 20 million bucks. Now I don’t know that it’s there because I bought the house from someone else that didn’t know that it was there. I never wandered up in that attic to see it. Rob, you don’t know it’s there, Stephen, you don’t know it’s there. Who’s gonna be the winning bidder for the house? Who’s gonna outbid weed for this house? Would you pay 2 million for it? Would you pay 5 million for it? There’s a 20 million Rembrandt in the attic. Of course you’d paid 19 million for it and it’s only worth a million, right? We’ve all set the market at a million.
Every single one of your clients has Rembrandts in their attic. The problem is, like me, the dumbass seller, I didn’t know that it was up there cause I never wandered up there to find it. Or I knew that it was up there, but I didn’t realize it was a Rembrandt. I thought it was a leftover oil painting that they bought at a flea market that was worth a hundred bucks.
And Wade, because you took the time to go to art history class, that’s no flea market painting. That’s a 20 million Rembrandt. So shame on me for not knowing I, I know that it’s up there, but I don’t know the value of it. The same thing applies in business. You all have clients that have these Rembrandts.
Now Rob you, you might be a Renoir fan, you might hate Rembrandt. You might not be willing to pay for it, but Wade, you, Rembrandt your favorite. You’d pay 19 million to get a 20 million Rembrandt and the house that comes with it. Oftentimes the Rembrandt is worth way more than the house that comes with it.
But if you don’t know that it’s there as the seller, you’re never gonna extract the value. Savvy buyers are art historians. They know how to find Rembrandts in the attic, and it’s your job as the entrepreneur, it’s your job as advisors to help your clients find the Rembrandt in their attic. They could be things like your customer list or I have a buddy of mine, he’s a contractor. All they do are renovations on McDonald’s, Wendy’s, Burger King and a local convenience store called Wawa. But they are the best on the planet at renovating McDonald’s. They don’t do other fast food brands, they don’t build residential houses, they don’t do anything else, but they’re the best in the world at McDonald’s.
That is a Rembrandt in their attic. And they had a buyer come along and they ended up not selling, but they had a buyer come along and offer five times the industry average multiple for a commercial construction company because these guys knew that if the fryer was off a 64th of an inch, you had to call the electrician back because the plug wasn’t gonna fit.
And they knew if we do it this way, we can keep the drive-through open for the seven weeks of construction and all their peers have to shut the whole restaurant down while they build. And there’s, the list is long, but that was a Rembrandt in their attic. And yeah, they were worth their financial value and their cash flow value.
But this one buyer’s like, we wanna do business with McDonald’s. We want that relationship, we want that knowledge. We’re willing to pay five times the industry average multiple for a commercial construction contractor. So I don’t wanna hear I, everybody tells me that’s great, but not in my industry. That’s not how it’s done here.
So I have a contractor example that I can say BS on that. It’s every business. It’s a creativity exercise. It’s a discovery exercise. There are Rembrandts in every listener that’s an entrepreneur., There are Rembrandt in your attic that you probably take for granted think they’re a flea market oil painting, or don’t even know they’re there.
All right? That’s my rant on that.
How early should I think about exit planning, and how do I start?
[00:47:41] Rob Williams: Yeah. Yeah, so Stephen, you were asking, you were wanting to ask, like when you start on this, didn’t you?
[00:47:47] Stephen Brown: Yeah. Yeah. When do you start? Here’s the thing. We talked earlier about, you decide it’s a good idea, your mindset changes. And so now you’re at a point, you want to get started on this. What’s the next step?
[00:48:00] Rob Williams: Yeah. When or when do you start? How early do you start on this, John?
[00:48:03] John Ratliff: So Wei Chen obviously the late Wei Chen sadly is was a close friend of both of ours. And there’s an old Chinese proverb I always get wrong, but the best day to plant an oak tree was a hundred years ago. And the second best day is today. The earlier, the better. The adage is the day you start your company, you should have the exit strategy in mind.
Whether you plan to exit or not. That’s really important. It this isn’t, you get forced into selling your company just because you go down the path. I believe that every responsible entrepreneur today, regardless of when they’re plans are, or what their future looks like, should be thinking about their exit strategy.
And they should be thinking about what’s next, whether you’re gonna hand it off to family, whether you’re gonna sell to your employees, whether you’re gonna sell it to a buyer, whatever it is, exit strategy should start today for everybody.
So now I’ll say it’s never too late, but it’s way harder for me as an M&A advisor to get someone that hasn’t thought about it at all and someone knocks on the door and says, hey, I wanna buy your company. We have a whole lot of work to do to get them ready. And if they had just done that work in advance, when the knock on the door comes, A, we’re gonna get four or five more people to knock on the door. That’s, you never want a sole source buyer.
But B, here you go here, it’s in a box, it’s ready to go. Here’s my audited financials, here’s my operations plan, here’s my strategic plan here’s the dashboards and the KPIs and the systems, and here’s the employment agreements. And this is my senior team. And if it’s Swiss watch, we talked about it in the beginning. If it’s running like a Swiss watch and you’ve planned for that value creation, that exit, it’s way easier to go through the process than if you’re having to do it in the 11th hour. So today is the time to start. And I know that sounds like a cliche and a–
[00:50:00] Stephen Brown: No.
[00:50:01] John Ratliff: Today.
[00:50:02] Stephen Brown: Yeah. Great.
[00:50:04] John Ratliff: For everybody, whether you’re ever gonna exit or not. But 1-800-GOT-JUNK. Brian Scudamore, one of my good friends. Brian’s like, I’m never gonna sell junk. I don’t need to think about my exit. I’m like, Brian, are you immortal? Are you gonna live forever or do you wanna leave a mess when that day comes for whoever’s gonna, because it’s not going away. 1-800-GOT-JUNK’s not going away. And so he changed his mindset a little on Brian, if you happened to stumble across this, I’d love to give that example because–
[00:50:34] Rob Williams: We’ll–
[00:50:34] John Ratliff: Adamant, I’m.
[00:50:35] Stephen Brown: Yeah, it is funny, John, my Swiss watch stopped running when I had Covid and I said, well, I’m gonna go get the battery replaced. And I went into jeweler. He said this is a self winding watch. So anyway.
[00:50:49] John Ratliff: I, I get it.
[00:50:51] Stephen Brown: For what it’s worth, you don’t want that. You want your job to run like a Swiss watch with a fresh battery in it.
You want to keep it running by itself, and you wanna add the value. You wanna look for those Rembrandt and the attic, you know what they are, and appreciate their value.
[00:51:08] John Ratliff: And if for no other reason because you’re sick and tired of working 80 hours a week, or 60 or 40. You’re either in service to your business or your business is in service to you. And if you’re in service to your business, it’s not worth very much. Wade, like the example you gave of the guy that was brave enough to stand up and say it. If your business is in service to you, it’s worth a whole lot more.
Why not build a business that serves you instead of the other way around? Again, pain and experience, it’s a way better way to live your life when your business is in service to you. And it’s possible for every, I guarantee there’s people right now, we’re 56 minutes in that are like, screw this guy. It wouldn’t work at my place. I’m just gonna be blunt and say, that’s totally wrong. And we’ve seen it in every industry. Unless you’re a solopreneur in a company of one, it’s possible in every single business.
[00:52:01] Rob Williams: Yeah. Yeah. So, so Wade, as a financial valuation master over there, what do you think about these things? I know you’re open-minded on these things, because I think a lot of people argue against all these other things and they just stick on the value. What do you think about our
[00:52:17] Wade Carpenter: Yeah, again, like going back to Michael Gerber and the e-myth, it’s if you build those systems, like John was saying, it’s gonna be worth more than the same company with the same revenue and same profit down the road as well.
[00:52:30] Rob Williams: Yeah,
[00:52:31] Wade Carpenter: Absolutely.
[00:52:32] Rob Williams: Yeah, I think John’s changed my mind because I felt these factors just enhanced the likelihood of you selling your company and just increased. But in my old way of thinking, I didn’t realize that it actually improves the value of the company, not just the marketability of the company.
I was so set in what I had been taught that I didn’t think the value changed very much unless you could show your sales projections were gonna be higher in the future, something, these can actually increase the value, not just the likelihood of you closing the deal. So.
[00:53:08] John Ratliff: And again, back to that Rembrandt thing I could give you amazing stories about how we sold a 3 million EBITDA company for 75 million dollars. That’s 25 times profitability. That’s in an industry that trades at six, so it’s four x the industry average, but the buyer had a problem. And this company solved that problem for the buyer, and the buyer was a billion dollar commercial real estate brokerage.
I was able to reverse engineer the volume of that problem. That problem was a hundred million dollar problem. They underpaid at 75 million to solve that problem, which we on a $1 bet, ferreted it out after.
[00:53:59] Rob Williams: Yeah.
[00:53:59] John Ratliff: They solved a hundred million dollar problem by buying a $3 million EBITDA business for $75 million. And I’ve got a dozen, two dozen more stories just like it. But that’s how to think about the value of that, that was the Rembrandt for them. Solving that a hundred million dollar problem.
[00:54:18] Rob Williams: Well, well this has been an amazing episode. I know this is definitely our longest episode. So everybody out there now, you’re at the end. Listen to it at double speed so you can get it done in half the time. So.
[00:54:29] John Ratliff: That’s my fault. I’m happy.
[00:54:31] Rob Williams: This is amazing, John. Thanks for doing it. So, guys, y’all have anything before we wrap up?
[00:54:36] Stephen Brown: No thanks John. We really enjoyed it.
[00:54:39] John Ratliff: Yeah, no problem. Happy to do it.
[00:54:41] Rob Williams: This is great. I feel really lucky to be working with you and part of align5, and STS Capital and Scaling Up and all the things that you bring to us and to our listeners on the Contractor Success Forum. So here with Wade Carpenter, Carpenter and Company CPAs, Stephen Brown with McDaniel Whitley Bonding and Insurance Agency. And I’m Rob Williams with the Pumpkin Plan for contractors and John Ratliff. You’re with so many different organizations. What do you say, align5? Who do you say?
[00:55:09] John Ratliff: We’ll just say Scaling Up. We’ll just say Scaling Up coaches and align5.
[00:55:13] Rob Williams: Yep. Because John actually owns Scaling Up coaching. I guess if you guys don’t know that he, since they brought him up, he used that and that he actually liked it so much because it helped him in his valuation that he purchased the company.
[00:55:26] John Ratliff: Yeah.
[00:55:26] Stephen Brown: I enjoyed checking out your YouTube videos too. John Ratliff YouTube.
[00:55:30] Rob Williams: Oh yeah. Where can they find you and watch you? I know I’d go to align5 to watch you, but I think you’re on a lot of places.
[00:55:36] John Ratliff: Yeah, align5.com. We have some stuff. Yeah. If you do a Google search on YouTube, there’s I’ve, I’m in our studio now. We’ve shot a lot of video in this studio, so yeah, there’s some–
[00:55:46] Rob Williams: Yeah. He has a lot of five minute videos too that are not a, an one hour long if you wanna watch these. And they’re kinda labeled and you can see that if you wanna hit some of these points. And he has so many things outside of what we talked about today too.
[00:55:59] John Ratliff: This stuff works. The reason I get so lit up and passionate about it, it works. It works in building companies and it works in exiting companies in an elegant way. And you’re gonna spend your whole life as an entrepreneur and build all this value and then you’re gonna get to the end and get taken advantage of. That’s a tragedy.
So if we can prevent one entrepreneur through our time together today from getting taken advantage of in the most important event for them and their family, the exit event where you build wealth, not income, then it’s worth spending the time. And I believe you just have to touch one person.
It’s worth the time.
[00:56:34] Rob Williams: Yeah. Well, that’s amazing. Well, thanks a lot and hear from the Contractor Success Forum. Like us, subscribe to us wherever you’re watching or listening to this. And we appreciate you being here. Ask us questions and we love to talk about what you want to know. So here we’re adding value to your business at the Contractor Success Forum. Come back and watch.
[00:56:55] John Ratliff: Thanks guys.