How Multiples Work In Business Valuations (Ep. 309)

well Mr patab here we are again how are you good how are you I'm good um so I am very excited to have this conversation because we just wrapped up a theme about how to view your company as a financial asset which you have teed up with you are the intro of that theme and as people are starting to get a feel for it you and I are uh introducing these themes as we continue to go on and right after someone starts thinking about their company as a financial asset the next question is well how the heck do valuations work and so what's it worth what does it matter how do we grow value if we don't even know what the heck value is and how to track and measure it and I want to start with this question I hope that's the question people are asking themselves that would be that would be a very good that's progress right that's progress so you know you you and I both get this question a lot which is or it's not necessarily a question it's a statement that I think you and I and our mission at Arona is to really to just debunk and it's this statement of you know what I'll never know what my company's worth till 10 years down the road when and how I decide to sell and someone's willing to write me a check the only time I'll ever know what it's worth is when someone's willing to pay me a certain purchase price down the road so I'm gonna just say what do what would your response be to that it's not true I mean that's not true it it I know it it seems daunting a little bit but but you know all kinds of companies do valuations get valuations you know on ongoing basis for various reasons esops companies that are esops get a valuation every year it's not because they're getting ready to sell or or something's happening that's just part of the law that they have to get evaluation so they can tell the participants in ESOP what their Shares are worth and and so it can be done there's it's really important once you start thinking about your business as an asset to figure out where you are and where you want to go I mean you you got to have all those pieces of information it's it's how you always talk about Google Maps you got to have a point a and a point B you know point a is well what is it worth today and what's it point B is what is it worth at some point in the future future whether or not you're thinking about selling you just want your asset to grow over the next five years you know you have no intentions of selling it so you can there's a there's a way we're not valuation licensed valuation experts but been through so many deals I mean and we understand that there's there's a way to come up with a a pretty good range of value for your company as it exists today and we're going to be unpacking the concepts there's a few different concepts that we're going to unpack I think it's close to 3 to five or something like that these Concepts to help people think about this as the as their ownership and we're talking about the ownership role now of the equity and the asset and you know there's this especially in today's Marketplace so much confusion of what really creates value like I mean you look on the stock market or you you the public markets get all the attention because people can log in 247 and see the tickers going up and down but then there's also this whole world of private equity and you and I talk about these stats where there's like 39 a little over 39 900 public companies and like 8,000 private Equity back companies that people can't log in and see a ticker symbol of how much they are worth but they're doing they're doing the same thing they're tracking and measuring how it's worth because you worked at a PE firm so like what is it that creates real value cash flow sustainable predictable and transferable cash flow when when you buy a stock or you invest in a company or something you're putting money down today that's worth based on the cash flows an anticipation of the cash flows that are coming in the future I don't care if you're buying Apple stock or you're buying a company to to own how about Pon well we won't go there but you know and just one comment the Market's the Market's correcting itself for those companies who've never made money that's that's a whole another topic but the value of a company is based on its cash flow in the future and valuation experts go through all this exercise of discounting the future cash flows and all these other things but what what it's really worth is the cash flow that it can generate in the future and the more sustainable predictable and transferable cash flow there is the more it's worth say it again sustainable predictable and transferable the more your cash flow are those three things sustainable predictable and transferable the more your company's worth because a buyer would say that's a really good business model they have sustainable predictable and transferable cash flow so I'm going to pay more for it as opposed to somebody who's thinking ah that cash flow is really risky I'm not sure you know I'm not sure it's going to show up after I own it so I'm not going to pay very much for it so understanding that is the first step in getting to the point where you can put a stake in the ground that says okay today my company's worth about X and I want it to be why in the future and and how do I get there and you you and I we've adopted this terminology just over the years from talking to owners of what really resonates is more sustainable predictable and transferable cash flow drisk the company so maybe in your words what does drisking the company mean to you and what does that due to the the overall value of the company the cash flow of the company is affected by a lot of things and it affects that sustainability predictability and transferability and I think that the easiest way is to give an example if if you had a if you if you and I own companies in the same industry same size same Revenue same iida when get to that later same cash flow my company has 80% of its Revenue coming from two customers and your company has no customer with more than 5% where the revenue is no more than five one customer is no more than 5 perc that alone says your company's worth more than mine because if I lost one or two of my customers 80% of my business would be gone mhm that's what we mean about risk of the cash flow if in my company if every decision runs across my desk and I have to make every single decision and nobody can do anything on their own and you've got a management team that's forward-looking and strategic thinking and and takes responsibility for their own things and you can go off on vacation for a month your company's worth more because the cash flow is more sustainable and predictable and transferable so there are things that affect the risk of that cash flow that when you start to realize those things you can address and say how do I drisk my company how how do I make decisions and Implement strategies that will that will reduce the risk of the cash flow in the future for for a company and you and I talk about this concept that um I have tended to really enjoy because I think it it helps me communicate the the the complex world of valuations into something that is easily understood of this intrinsic Financial value versus the transaction value strategic transaction value maybe you want to kind of give your definition of the intrinsic Financial value and then I'll I'll take the transaction value because then we want to talk about how to how like what people can control and what they can do about it yeah so the intrinsic value is the value of your cash flows as they exist in your company today period not that you're got it on the market and list listing it and and your competitor wants to buy it you're going to talk about that if if you were going to sell your business to me and I was just going to step into your owner shoes nothing else changed what's the value of that cash flow that's the intrinsic value and and valuations start there no purpose to the deal or anything it's just what is the value of that stream of cash flows into the future as they exist today in your company so that is the intrinsic value and you can measure that that's what esops do that's what all kinds of companies do is just measure their their intrinsic value and and even companies that are sold for what are called Financial multiples where it is just the ownership like yours transferring to me they would they would use a the intrinsic value to determine to determine that valuation and that's what we're going to continue to unpack for the most of this episode because the next episode we're going to be talking to financial buyers that understand like you know how they're viewing that cash flow and then the the the episode after that the transaction value but CU today we want to talk about these Concepts so people can understand them and what to do about them and just to talk briefly about the Strategic transaction value that again will be in the third episode of this series is like Pat said there's a buyer and a seller that come together and then there's the purpose of the deal there's like two entities or two partner or two there's a lot of human beings and emotions and strategies that go into play that someone could pay a premium as Pat said we're like you know they synergies back office get into G different Geographic locations product Services they pay a premium because they see the ability to get the return on investment someone might have a discount because it's a family business they don't need the liquidity and they're going to gift it to their kids through the estate plan point is that's what gets talked about and that's not something that you can plan on because you don't know what that's going to be and today we want to talk about what we can plan on and control so that way we have more choices to you know to vet out the different strategies later so we're going to put that into the parking lot and then talk about the concepts and the terminology that people can view to find that point a that you're talking about Pat and so when you're talking about the measuring and monitoring and projecting out the value of your business let's talk about like what you know there's a couple different there's only two numbers that are made up to get to the Enterprise Value and we're going to get to that in a sec but like let's start talking about what should people understand to truly understand as it relates to they if they have a company how do they start going about thinking about what that risk of that cash flow is today that of the company that they own well yeah and you I'm not sure this is where you're going the cash flow though do you want to talk about the risk of it or defining the cash flow first um honestly either way yeah either way because either way is a good starting spot yeah so the cash flow in the valuation world is represented by what's called iida earnings before interest taxes depreciation and amiz um it's what it's what the the investment World uses and it's a proxy for cash flow so there are couple different ways of calculating cash flow but that's what the investment world has settled on you can take your financial statements you take your net income you add back non-cash items like depreciation and amortization and you B add back interest and taxes because uh you assume a debt-free uh situation with the company um and so that is the can you let me let me pause you for for a sec can you explain why that that's important for the world valuations and investors why getting to that proxy for free cash was so important because it it puts everybody on the same on everybody's using the same definition of of what it is they're they're talking about when you go to sell your company and if I think my eida is a million bucks and you think it's 500,000 chances are we're never going to get to to a mutual to a mut ual transaction because we have just a different view of the world EA is a calculation you can you or I or anybody could look at a set of financial statements that had a sufficient detail and come up with what's called reported iida it is just the mathematical calculation of starting with net income adding those things back and getting to eida so that it is a proxy for cash flow and that's where it all starts and every business owner should be looking at this all the time because it it's just easy to calculate and it's and it's the starting point for coming up with what your what your company might be worth so then let's in in EIT you know so a company the Enterprise Value and again we'll get into Enterprise and Equity value in a little bit but you know there's two numbers there's the normaliz or adjusted e the Times by a multiple that gets to the value of the company so there's that's why you said it's so important to get on the same page because one of the two numbers that is Multiplied on you got to have agreement on both so IA is not one of those numbers it's normalizer adjusted e you want to kind of expand on that and then also why you shouldn't wait till the deal to be calculating that right so the first definition we talked about was what we call reported eida it's just the calculation right off the fin financial statements then you need to go through a process of what's called normalizing that eida and that is making adjustments to that reported eida number to get to a revised or normalized earnings uh even a number um which is really the true view of the cash flow of the company that would exist if you weren't the owner and and some examples of U um adjustments to eida and you you know this too from going through everything you've been through for example if you had somebody on the payroll who wasn't doing work now we're not at all suggesting people take tax deductions for for expenses where people aren't doing work but just let's just say for example that was the case maybe you know that's not a that's not an expense that's normal in the business that person's not doing the work and so because if you were the owner and that was happening and I bought the company I wouldn't have to do that to keep the machine going if my Uncle Billy was on the payroll not doing anything or I'm paying him and he spends 5 hours a week but I'm paying him some outrageous amount of money you know and and I sold the company that expense would go away so we're adding that back if you if you had in a particular year you redesign your website start to finish and you spent $50,000 well it's not something you do every year um so you you don't want to you don't want to have that expense in there you would add that back these are unusual or one-time expenses or expenses that really don't belong as as part of the cost structure of the company and you you you bro like I want I want to just kind of put a wrap around two parts of that cuz you you mentioned Uncle Billy and I think a lot of times people think about that they think about the cars or the tires or the different things that the owners I'm going to wrap it all into like owner's perks but then over here you talk about the website so you know let's talk about owner's perks that you know are the gray area whatever that everybody kind of assumes kind of put that over there maybe expand upon the website concept and why the website maybe we can throw a couple other examples on why those would be also considered the same same thing yeah because you're you're looking for a normalized iida over a number of years you want to look back two or three or four years and and if you have some big expenses you have a website uh expenditure that you have and you only have it every five or seven years you don't you don't want to burden you don't want to burden the year with that if if you were uh if you engage with a recruiter to hire a top executive and you you know that rarely happens you know it's the first time in year in your existence you've ever done that you spend you know $40,000 doing that that's that's an addback um so those are unusual or one-time expenses or ones that aren't really directly related to the to the cost structure of running the business those are ones you want to list and add back to eida to get to normalized eida if you think about a sale at some point down the road and you've got these expenses in your in your financial statements in your income St statement you're going to want to tell the potential buyer look here's a whole bunch of expenses that aren't really gerine to the business and so we've added them back to get to normalized evida you're going to need to give them that list they're not going to come to you and say hey you know why don't we add back $100,000 to to evida just you know because you probably have some expenses in there that that aren't legit so it it's really important plus in running the business you want to get a true picture of the cash flow how much is this business really Genera you know U as as a business excluding some of these unusual or onetime items and what I think that that helps and I've watched our clients or other business owners that run their company like assets like we're talking about Pat is that normalization exercise on a monthly basis first of all you don't get to a sale and you have to go back five years and think about the story that you have to then recreate and like my God but also is I watch people that like the owners that we talk about their the normalization that that recruiter expense or that website they have less cash that year but they're investing in the company for a reason and on the last uh series you and I talked about using the three statement model to project in the future and it's like hey you can see that yourself right and so like I think I guess my point about bringing that up is I think that a lot of owners the the stuff that sucks doing sometimes like installing a new website or an Erp system becomes more palatable when you know that there's a you're doing it right and and you think well this this is costing me you know when it when you know and I'm the accountant so I I like to watch the cost but but you know it's an investment in things but it it's important to do this because if you want to know what's my company worth today because I'm marching towards some future value at some point in the future again whether or not you're selling it I just want this asset to grow you know getting to that normalized eida number I mean you could literally have a company that shows zero net income that had a whole bunch of normalized eida so until you get to that number how do how do you have any idea uh what it is you're doing and you know you can track them in the in the financial statements without getting too technical you can have separate chart of account numbers that are like for these unusual one-time items I literally do that with clients and then in your financial statements you can just add it back it's not like you have to go through this big exercise every month you can just it can it can happen very me mechanically and you can say okay my year-to date or my trailing 12 months more importantly my trailing 12 months iida reported shows 600,000 but with the normalized Eva is 800,000 and that's what we're going to time a multipled bydon that's what we're going to times the multiple by so like I want the 800 not the 500 and also Pat I watch like it's the narrative or how people discuss this that really starts to show the behavior change and how they're viewing their company because like I remember one of our clients a couple years ago like I didn't do that well and then they told me their net income and then you go down to the normalized ebit normalized ebit to that month was actually higher than the previous month yeah so it's like you're just looking at the the wrong number because net income is not part of the valuation equation it's the normalized it's part of it but it's the beginning of it but part part of the math equation it's not the end result not the end number it's not it's that's not the proxy for cash flow I mean it it it literally is not I want I want to be careful too there's some adjustments to eida that can go the other way that can subtract from reported iida to get to normalized iida for example if you owned your company and for whatever reason you were CEO and you paid yourself $40,000 but Market it was 120 well that $80,000 a year is a negative you gotta you got to add cost or subtract from your reported Ida because if in a normal situation if you weren't the owner somebody would have to sit in that seat and be paid $120,000 so it's important to get these things right um without trying to skew it one way or the other because the day you transition your ownership and all ownership will transition in one day nobody lives forever so it's going to transition at one day a potential buyer is going to dig through this and and they're gonna they're going to come to understand that so it's it's you're just much better ahead you're leveling the playing field by by understanding this now as you go along and you're pulling on a concept that we talked about in the last theme which is your job versus your ownership role and that normalizing of your salary so many people play games with that I mean I don't know how many people it's got to be a a disproportionate percentage of the people play games one way or the other with the owner's salary and you can't get a clear picture of what your company's Worth or what your income needs are without doing that so again you're just lying to your the only person that matters is yourself in this situation taking a low salary and higher distributions for or the other way around for for whatever reason which I don't Advocate um you know you got to get to that true normalized eida that is very represent that's the representation of cash flow of a business and then you know then you got to figure out how it's sustainable predictable and transferable do you think it is um in in order to complete the the valuation equation so then there's this multiple that that normalized IA is is uh Times by multiplied by so you know people call it the multiple multiplier with all the different terminology but it's essentially another number we're gonna straighten that out today it's not multiplier it's many people say multiply I'm like what not a lot of math Majors all the entrepreneurs you know they bailed out and then the multiple so we're you know we're not going to get too Grand into the weighted average cost of capital but let's let's demystify a little bit of where the heck does that number come from and what is it representing so the multiple represents how risky somebody thinks your cash flow is in our situation that we were describing before was like a case study you and I have the same business same industry same Revenue same same normalized to eida but I've got customer concentration problems I've got a crappy management team my financials aren't good you know um and all that kind of thing and yours is just the opposite you know you've got no customer concentration problem you got a great management team um those kind of things somebody's going to be willing to pay more for your company than mine because they're going to view your cash flow as more sustainable predictable and transferable so the multiple represents the number of years of normalized De but a somebody's willing to pay you for your business um love it it could be a five for example or a seven you know so somebody if somebody says I'm G to pay you 5x and that's kind of how people do it say and you have a million dollars worth of normalized evida somebody's saying I'm G to pay you $5 million for your business from their point of view if nothing changes about the business they'll get their money back in five years and have an asset and have an asset in my in the case if they're buying mine they're like man you got a lot of problems in your company so we're only going to pay you a three because we're not sure that cash flow is going to show up um um because of all the risk associated with with what's going on in your in your company so it has to do with risk but in in in the valuation world it's a number of years that somebody's willing to pay number of years of cash flow that somebody's willing to pay you for your business when you're talking about intrinsic value there's industry guidelines and standards and valuation folks like your guests that are coming on the next couple weeks they have access to databases they can say Okay somebody in the automotive industry and this size this location this number of employees you know go through some metrics you know the the multiple is between four and six just just to give an example so you can get access to that information and then use that apply that to your formalized debit on an ongoing basis and and understand what your company could be worth in a in a uh in a intrinsic value way and you you you said the the perfect word it's directional guidelines right like this is not something you're going to transact on or buy out your partner on or anything it's to know is your company worth 2 million 20 million like I mean and and to get some realistic expectations that it's not 20 times Revenue because a SAS company at the Country Club also said that and you got a dry cleaner and I think just to speak on and we can unpack a little bit of the uh kind of the guidelines and because again you don't need to get a $30,000 valuation to get these guidelines you know we talk you know a lot of people talk about asset you know they the different Industries which private Equity firms call asset classes but we call them Industries I mean it's just all the same thing but a CPA firm has different risk than a e-commerce different risk than a SAS business different risk than manufacturing distribution you want to speak to kind of like just in I don't know if you have a comment on that or just kind of just realizing that that's also inherently built into some of these multiples oh yeah different Industries have different ranges of multiple size can matter typically the bigger you are the less risky the cash flow is I mean it's not always the case but generally geography age of company industry you know if if you were in California making plastic straws you know your multiple is probably not going to be very high because of of uh of of just the environment there but but you don't have to go through some gigantic exercise a lot of people belong to Industry trade groups there's a lot of information available today that says you know um What multiples might apply to certain sized companies pepperd I think you've had the I think you've had one of the the folks from Pepperdine University priv yeah private Capital Market study or something like that yeah um you know they publish some things we work with people valuation companies who will kind of who not kind of they will come in and do a streamline valuation they'll look at your company they'll take your financials they'll do some modeling have a management interview and say we think the multiples for your company are between five and seven what whatever it might be so and it's not super expensive there are ways to get this information that you can then apply to your financials on an ongoing basis to watch the trend of the value of your company it's really important to do today it's really important to say here's the stake in the ground today of my company might be worth between three and $4 million I want it to in 10 years I want it to be worth I'm I don't know if the Mas it eight or N9 million what whatever that might be if you don't know where you are today it's hard to know what to do to get to where you want to be at some point in the future again whether or not you're selling I can't I know I've said that a lot but this is not about waiting till you have somebody calling you want to buy your company or you're you know you turn my age and you're like you want okay I want to my business now what do I do I'm so I I it's my most disheartening conversation I have on a weekly basis with people it's like you don't have enough time yeah you you don't want to wait Now's the Time hopefully folks your age that are doing this there's and we've had people say oh I don't need to do that yet I'm not thinking about selling my business and I look at them and I say wrong answer this Point Blank wrong try again well and in and I don't want to take us too much on the tangent but I think it's a relevant comment here is that this is what I H why I have an issue with the words exit planning because someone waits till the year that they want to sell and it's like well you missed an opportunity of the 18 months it takes to hire the executive recruiter find the president put the comp plan in place roll the Strategic plan I mean like it takes time to invest in the things that gr grow the value of the company and Pat like I mean you how much better it is if you had 10 years to get to the valuation you want as opposed to 10 months right and I don't know of any private Equity Firm that does exit planning no they build assets and they trade them when the value is correct and I just and again I I think that there's a place to help people understand that but that's why I think just to put a big exclamation point behind what you said is this is about growing an asset that gives you the choices that you want long term and then you like if you're doing what you're saying by normalizing the Ia and tracking that you could figure out how do I want to invest my comp or my dollars to drisk my cash flow right I mean like otherwise you have no guidance I mean I how have you go go for it no go tell the because you tell it better than I do um the story about we had a client who thought his company was worth X and his his CPA or whoever saying oh you're in great shape and then he comes out to find it's worth third of the ACT won don't you tell that yeah I'll tell that and it's actually going to lean to the next uh couple topics about like understand what goes into your actual bank account but like you know this this gentleman that went through our training with you and I you know his wealth manager which I covered in the last uh Series where we were talking about don't put the Enterprise Value like the purchase price the wealth manager said I think it's worth 7 million bucks he was doing like 15 million in Revenue 1.1 in EB or something like that like 50 to 70 employees and it's like no it's not worth 7 million bucks the actual value is 5.5 pay some taxes pay some debt and he walks away 2.5 she's half a million or half five five million bucks short almost it's like geez and at that point he was what in his mid-60s or something so like how much in in like what it what breaks my heart is when it's the people that don't have energy to get the reward that they deserve for all that hard work and then it's like because by the time they say I want out and it's like to get the valuation you want you're gonna have to burn you know like reinvest your cash flow for the next four years to hopefully get it or some health event occurs you know and and you just don't you just can't you you can't do it find out today what it's worth regardless of where you are mentally thinking about selling even if you're thinking that's not even on the table that's fine it's a good feeling of course I got to be careful here in in in in June of of 2022 but to watch your stock portfolio your assets go up or your home value to go up or I mean that's a that's a cool feeling to watch the value of that you want to do the same with their your ownership in the business you want to you want to watch that value go up and be on a path that will get you to the point where you have choices to do with your ownership what you want to do and you but you don't know that in the absence of information it's just well and I think you and I like we we honed in on something when we did the story brand material on Arona a couple years ago we're like this this the innate anxiety and frustration for the lack of I'm going let you say it the lack of what people most people are feeling progress sorry I know I'm not trying not trying to do it to you not trying to put you on the spot you do that all the time to me I never know what you're gonna say but it's a lack of progress and I think you and I identified that that lack of progress is because people don't know why they're doing what they're doing like you're spending all this time money and energy and you have zero idea whether it's growing value or not and if if you don't understand what the value of your company is or what it's going to be how do you know if you're making progress it's ridiculous come and work and work hard and you know that's work and then is that manifesting itself in in your ownership that's that's what that's one of the missing pieces that I think causes business owners the most anxiety I Amen to that and had a had had a client once who before I met you who's like if you could help me sell my business and and get $15 million then sell it and I'm like no because it's worth a whole lot more than that he had he didn't even know I mean you know like a like significantly more than that significantly more I mean so you in order to measure progress you have to you have to know what the value is and before do that on ongoing basis well and before we even move on to the Enterprise Equity net proceeds is the people you and I did an episode I don't know if it was a year or two ago about the fact that most people don't even pick pick up the phone or the email about out the BL offers right and and why is that well because they they they won't know what to say if somebody offers me $3 million to my company or five million is that a good deal is that a bad deal is I don't even know the language to talk to them what language to use to talk to them so they just avoid that I mean can you imagine if somebody call and said hey I'm interested in buying your business they like of course you get an NDA but you're like okay here's here's my normalized Zea here's the multiple my size and my cash flow is really sustainable predictable and transferable here's why and I won't you know I won't take a dollar under X you you've just leveled the playing field I mean you're now talking the language of private equity and and all these other situations and those are the ones that that have the have the advantage and and you tell a story for the moment well what's funny because like there's two trillion dollars of dry powder from private Equity firms that are trying to buy good companies and I always say that the companies with the cash flow actually have the prize and the private Equity firms are chasing the prize so like acknowledge the fact that you have the upper hand especially if you have got this kind of language but also as we talk you tell this story about when you were running one of the businesses you bought a company and you paid the gentleman he was so happy you paid him about a third of what the company was worth and he told probably everyone he crushed it yeah I mean we we bought a company and like like you said we paid the the gentleman to the nickel what asked for and it was worth about a third U wasn't my job to tell him it was worth more I I worked you didn't do the normaliz and say hey by the way here's the next man I just said do I is this number right do I have I'll you I'll get you a docy sign in like four minutes hold on a minute Pur screen so but it's a little bit sad I don't want that to happen right to people we certainly don't want it to happen to our clients but but it's um it's not some big mystery I mean it it seems like this whole another world now I'm not minimizing the complexity of of valuations that world for transactions for esops for you know publicly traded companies for look it's a some of the people I respect most in the world live in the in the valuation World they and they super smart and it can be complicated but you can if when you're just trying to put that stake in the ground there's a way to do it that's not overly burdensome it's not burdensome at all and provides enough Clarity say okay here's within this range here's where I am today and I want to be within this range in x amount of time and then it gets to the value growth which is a whole another topic but but then you can if you know where you are and where you want to go you can then set upon developing strategies to get there W said I I want to expand you're welcome if it if it wasn't well said I'll just cut it no I'm just kidding uh so um is it is complicated but when you get to the transaction because there's people purposes of the deal like all of that stuff that comes to the table but I think to just reemphasize is you or anybody should be able to dig their heels in based on the story that they're telling about the risk of their cash flow and they should be able to yield that valuation because they engineered a company with that kind of cash flow then all the other becomes true noise and complexity but you have the option to say no if you don't like things that present themselves yeah if if you arm yourself with this information you make it a whole lot less complex when you get to the actual transaction so it really is you can just say here it is you know and and let me explain this to you one more time so tell the tell the story about how you like to negotiate of what the buyer said when well I would had a CL I worked at a company and it's okay our partner Matt worked there as well and somebody wanted to buy us and so we gave him a number and we didn't move off it we knew exactly what we wanted we knew I said here's the synergies here's the here's the normalized diva here's the mold I mean you know and and they kept trying to negotiate and we're like we were we were in ESOP loved it and uh we didn't move a nickel and they ended up paying it but in the end they said you guys have an interesting way of negotiating I said how's that he's like you don't we know what we want we know the numbers we you know we had done the homework we had we you know but we were in ESOP so we were doing valuation work we were coming up with that intrinsic value every single year and we hadn't been Nissan but for a couple years but we knew what that company was worth in an intrinsic value way they were laying on their needs to it which enabled us to get a premium but that that's a kind of a story and we we we'll be diving into that in the next couple episodes but now I want to go back to that story that I told about it was 7 million it was actually 5 million on his personal financial statement and that is what Enterprise Value is so you want you however you want to take it but there's the three layers and and then we'll unpack it so normalized evida which we talked about times a multiple based on industry size risk all those kinds of things when you multiply those together and you get value and we call that Enterprise Value so that is the top line what a purchase price would be those kinds of thing if you think about your house that's what the market value of of your house would be call that Enterprise Value simply the normalized EA times a multiple and that's where somebody will say oh my business is worth $8 million well it could be and they could be talking about Enterprise Value um so technically they're factually right right could be and you know and they and if they but they're making a mistake if they put that on their personal financial State why is that because from Enterprise Value you go to equity value just much much like your house goes from what the market says your house is worth your house may be worth $400,000 on the market but if you owe $300,000 your Equity value in your house is $100,000 same with a business if you if your business is worth $8 million but you have debt of6 million I'm making up a big number probably the equity value of your business is only $2 million not only I'm not minimizing $2 million but is it's certainly not eight so if you put eight million on your financial statements you sure as heck better have the $6 million of the company's debt on your financial statements and your financial statement as well or your your and our we had a client had that when he when he had the 7 million on there it was overstated by about almost three times of what it's so common it's so common it just it's it's so common that people almost sometimes don't believe us that it's like no this is truly just how math works and how valuations work and I just got to tell the story because it was so absurd it was years ago and there was a home service company and this owner said to me and I remember looking at your face when I told you the story and I said the owner said to me that well that's fine but I don't have to take I don't have to pay taxes if I'm over 55 your fa was about the way it is right now like oh that then just keep it keep it till you're over 50 56 man then you then that $4 million just magically disappears yeah it it's just it's it's not that complicated but people have so many so many wrong Impressions so Enterprise normaliz Zea times a multiple $8 million let's just stick with that example you have debt of of six you get to keep your cash if you were to sell your business the goal is to come up with a number that would go in your bank account if you were to sell your business today because Topline number I don't care if your house is worth a million dollars if you owe $999,000 on it and you sold it you wouldn't even get the $110,000 because you probably have cost related to it but the Enterprise Value minus the debt you do get to keep the cash if you have cash in the company call that debt gets you to equity value let's follow through our example 8 million minus the 6 million of debt is $2 million of equity value if you were to sell your business today you're going to have to pay taxes on the gain of your sale so let's just make up a number and say that's a half million dollars you subtract that from your Equity value you may have some cost related to doing the transtions all that let's just assume all that's captured in that 500 $100,000 now you're at a million and a half not making light of a million and a half dollars but it's not eight right and if by chance you have two or three partners and that gets split now it it's less so the idea and and those are called net proceeds after everything's said and done what would go in my bank account today if I were to sell it even if I'm not thinking about selling it because you could you could have built a company that has a tremendous amount of Enterprise Value but it's taken a huge amount of debt to get there so your Equity value is not where it should be and and you need to know that so you need to go through what's called this waterfall to get to net proceeds which is an estimate of what would go in your bank account today if you sold it go ahead well I was just going to say in this and just to kind of cover some more ground is the reason that people should measure and monitor the intrinsic value based on the cash flow is because they're not B banking on some hypothetical strategic buyer it's it's just B based on these in between the white lines of things that are relatively within everybody's control you can measure monitor all the things that you talked about on a monthly basis so maybe kind of you know get shed some light of like you know if someone's got a CFO like what you've been doing for our clients and our team does but anybody again you don't need to use us or anybody like this is all possible on a monthly basis so how do you get that visibility of the Enterprise equity and net proceeds on any and any regular basis without doing a deal oh yeah you just build it right into your financial statement package every month where where you're taking trailing 12 months which is you know takes out all the the fluctuations of the past year apply the adjustments to get to normalize do the reported DEA calculation list the adjustments get to normalized DEA put the range of multiples four to six do the math and do the math simple math then then you can subract you can add your cash subract out your debt to get Equity value and then assume a tax rate and a and a cost of doing the transaction and then you get to net proceeds it's literally can be part of your financial reporting package every month and then after you do this for a long period of time you can even go back and see where it was you know in in previous years but going forward then you can just graph and see what's my net proceeds estimate doing over time is it going up is it going down is it staying the same am I getting close to achieving my goal am I am I not um and and it's not hard to do it's just it's just you got to have clean financials and then you got to understand these Concepts and uh and just and just do the math and I would suggest for people listening in on the Arona website on the homepage where we have the five videos and the five principles and principal 4 Pat and I actually have a little bit of a video that we show of like kind of what this looks like I mean and going back to like what does this mean and how do people's Act change when they have this information so maybe kind of just I don't know if you have any stories in particular but like how do things change once you have this it is uh I don't want I don't want to overstate it it's it's very enlightening you know like most people think their company's worth more than it is and even on an Enterprise Value basis certainly on a net proceeds basis they haven't thought through all the adjustments to get through the waterfall to get from Enterprise to net proceeds and and sometimes it can be kind of a little bit of a shock like you're kidding me really it's you know and we had that a little bit with with we've had that with clients I think it's worth it's actually what would go in their bank accounts two and a half in in an odd way after the shock it's very enlightening and it's it's very empowering to say okay here's where I am and I want to get here then the next step is what's strategies do we do we develop and Implement to get us there but it can also say hey I'm pretty close to where I want to be then my options are I could do an ESOP I can transfer you know sell it to my management team or you know things like that on a on a financial multiple basis or somebody can say hey I need to squeeze every last nickel out of this when I sell it in 15 years or 10 years or whatever the number is so I'm going to develop strategies to do that you know knowing that that's going to be my option it's not for us to judge but when they when they get some insight into this it then kind of frees them up to think about the other things the strategies and the business and and those kind of things to to help them get to the point where they do have choices and and Achieve what it is they want to want to achieve so to as we're rounding close to home here um I think about like the intrinsic Financial value and like when to your words it was so empowering and lightning years ago when that hit home for me and this is all within the control of the people that own the companies that are listening into the showell right now and like when I when it for some reason when it hit me Pat and I don't know if this is just how I think um but it was about like the reason that that intrinsic Financial value is based on the risk of the cash flow has a lot to do with how the company is going to pay for the purchase to someone else right because it's a lot of a lot to do with the ability for that cash flow to service the debt for that next person so you want maybe kind of explain why that like why that would work for some like hyp you know go on that $8 million valuation like why that would work out based on just here's here's my point of this is that the owners that are listening in that focus on the intrinsic Financial value you can almost guarantee your compan is going to be worth it because it's proving that the story that can be the cash will can service the purchase price that everybody's discussing right yeah I mean some buyer who's going to analyze buying your company they're going to build this into their model like we do with our clients when we're when we're buying companies and just project out future years of cash flow what what kind of return am I going to get on this investment if I if I pay x million dollars for it and and you model it out through the three statements like we've talked about before and you come up with the internal rate of return and they're like okay this thing will pay for itself and I'll make money over the next five years or whatever third party buyers doing that with their infrastructure and their stuff right not the yeah sometimes but sometimes may analyze it just on the target just on the company they buy MH will it pay for itself if if the if the buyer can bring something to the table cross sell products you know those kind of things that's just kind of gravy on top of it but somebody's going to look at and say based on the intrinsic value will this if I buy this will it pay for itself over a period five six seven years whatever period of time it is and that's how people are looking at it and so the cash flow the sustainability of it and the predictability and the transferability is what's key to some buyer thinking okay this is this is a good deal I can I can do this because I can enhance the operations I can you know do whatever other things they they want to do with it if that if it's a strategic and it's about when you say pay for itself it's the ability to service the debt right cuz like and like it's so interesting too because like if someone like like in that $8 million let's say that person thought their company was worth 12 million I mean you could literally just run a math equation say it can't pay for itself right like the SBA loan won't lend too much or it would be too high of monthly payments and it's just the the numbers don't work oh and I've working with clients who are trying to buy companies and the and the seller wants a double what it's worth sometimes I've shown them the model like this will not pay for itself I mean this thing will not cash flow so why why would we do that you know just because you think it's worth 20x or whatever whatever we we really had one recently that thought they were worth for a nanc they thought they were worth 20x oh boy some fundamentals that that word hopefully mean will mean a lot more in the coming year and years so the to kind of wrap up because we've got other themes that you and I are going to be kicking off throughout the rest of the year we're going to be talking about how to grow value D RIS so we're going to get into a lot more of this meat but you and I talk about the three things that people can do today with their business you want to just take it because I I I love how succinct these three items are yeah you can increase your normalized Abida increase the multiple and pay down debt when you do all those things some of them increase Enterprise Value that water falls down to net proceeds some of them influence Equity value which which also um influence falls down and influences net proceeds focusing on those things will help you to maximize all three the Enterprise Value the equity value and the net proceeds of your business which is really what you're trying to get to you you want you want to you want to maximize what would go in your pocket MH on a on a transaction and that's what the real measure is I uh when I heard the I I did that panel with the private Equity Firm that just dropped those three things he's like Ryan is what we do is not that complicated we increase IA increase multiple we pay on debt we make a bunch of money doing it and he was so animated I was like there you can just tell he was spewing truth out of out of his mouth that's what every private equity in The Firm in country does that's what we did at ours so I would just say like for you and I discussion here for the listeners in you and I have created this intentional growth financial assessment that's got the foundation of the financials and four components and I would just suggest everybody go take that it's they don't need their financials and then the results page there's a couple videos I don't know if you want to maybe describe what we show in the couple videos or if you remember if I just force you to do force you to do a video you're the one that all does all the videos but it we try and show what good looks like and and you know there's just some foundational things that you need to have in place in order for what we talked about today you have to have good financials good monthly financials and you have to understand these things so taking that Financial assessment finding out where it is a lot of times not a lot of times sometimes people think oh the accounting and finance function is you know it's just kind of a pain it just pays the bills when you're a business owner and you start thinking about your business as an asset and you're your goal is to grow the value of that asset having good clean financials um that are accurate timely and useful is is essential and and you can't shortcircuit that and if you invest in that then it'll it'll literally pay itself pay dividends on it and I think about like the dynamic that you and I have had with Arona and then we watch a lot of our clients with themselves in the CFO it's like the Visionary and the financial reality behind it it's like being able to see the like how the impact of your ideas are and you know you and I have how many times we say like the language of business is the financials and every business owner you and I know can tell a really good story about the history of the company where it could go and then the next question is prove it someone's got final financials would tell the story of the business a part of the story of the business well all right Mr HBY thank you so much for coming on I don't even do you want to do even what's you know where to get in touch with you like do you have a Tik toac account Snapchat I'm all over social media all right well thank you so much for coming back on the show