Today’s guest is John Warrillow. He has a value builders system that creates a score on whether your company can sell and for how much. The key factors that he look for when he funds a startup is that the founder has humility, resilience and discipline. He looks to hear a story of showing those attributes. Be sure to find out how he decides what valuation things he looks for when he’s looking to decide whether he’s going to fund a startup or not. There’s wealth of information on how you need to know your numbers. Enjoy the episode.
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How To Sell Your Company for Maximum Value – Interview with John Warrillow
Hello. Welcome to The Successful Pitch. Today’s guest is John Warrillow, who is the author of not one, but two amazing books. It is called The Automatic Customer: Creating A Subscription Business In Any Industry. Also, Built To Sell: Creating a Business That Can Thrive Without You. He’s an Angel investor and the founder of the Value Builder System, which helps startups and anybody figure out how much their company is worth and how to increase it when they want to sell. John, welcome to the show.
Thanks for having me.
John, I always am fascinated to find out what is it that causes people to get started. Before you became an author, before you became an Angel investor, take us back to your own strategy of this is what I want to do and how did you get there.
I wrote Built To Sell after having been involved in a few startups myself and literally made most of the mistakes you can make in creating a startup. Writing the book helped me codify some of those mistakes and get them out on paper. I didn’t really have a business idea to … A lot of people have a business and they write a book to support the business. In this case, it was the opposite. I wrote a book and a business plopped out at the bottom of it where we put together a questionnaire that would allow business owners, readers to figure out how their business stacked up using the same lens we talk about in Built To Sell. In other words, how an acquirer would value and look at your business from the outside. The questionnaire was super popular. We built a business around it, we licensed it to advisors and now we’ve got something like 600 advisors around the world who use the platform. That’s a circuitous way to getting started.
Wow. Tell us about the first book that was Built To Sell, that was the first one and then out of that was the second one?
Actually, I wrote a book years ago, 2001, called Drilling for Gold, which is about how big companies can market to small companies. At the time, I was running a market research business where we had a unique niche. We worked with very large companies. American Express and Citibank, Intuit were all customers of ours. We help them reach the small business markets. I wrote a book about that topic. In that case, it was really to credentialize the company. That was a book that I wrote back in 2001. Built To Sell was written in 2011.
Got it. What is the big message in Built To Sell that you want readers to take away and why would somebody … Obviously the big lesson there?
One big lesson is that so companies are not built to sell because they’re too deeply dependent on the owner. I think in a lot of cases, entrepreneurs build … I think we confuse profits with value. We assume what will make us more profitable will also make us more valuable. If you just look at a company like Uber as an example, a company worth tens of billions of dollars, $80 billion last time I checked, something like that, it doesn’t have any profit. Clearly, just chasing profits is not the same thing as building a valuable company. I think one of the things we tried to communicate in that book was that for your business to have value, an acquirer really has to see how it’s going to operate without you. Of course, to buy you, they’re going to get rid of you. The next question is, how things are going to run without you? That’s if you were to distill 200 pages into one thought. It’s how you’d get it structured to work without you.
It’s a great tweet right there, “Don’t confuse profits with value.” I love it. What have you found, is 90% of people who buy a company and the founder doesn’t stay? Is that right or is it even more than that? Sometimes founders do want to stay, yes?
Most buyers want the founder to stay for a period of time. Most founders hate that experience. If you talk to an entrepreneur, it was one of the worst, lowest days of life. It was grinding your way through a two year earn out where you go from being in charge of your destiny, the founder making all the decisions, getting all the accolades, to reporting to the regional director of such and such who reports to the senior director, reports to the vice president. Brutal. You go from really being the king of a small castle to being a cog in a very large wheel. It’s horrible. Nobody likes it.
Let’s talk about the next book after that. What motivated you to write it? The whole concept of automatic customer. How do you create a subscription business in any industry? That’s what’s fascinating to me because usually it’s, “I understand it for this but would I do it for XYZ?”
When we looked at the kind of big drivers of company value, there are eight of them we discovered. One of them is recurring revenue. It is the one where a lot of entrepreneurs fall down. Some of the other ones are things like growth potential and how customer concentration and specific forth. We were seeing a lot of businesses, in particular non tech businesses, really struggle with recurring revenue. Because everybody thinks about SaaS companies and they say, “Sure, if I had a SaaS company, a software as a service business or a cloud based application, sure I can understand how it create recurring revenue. What if I own a distribution business or retail company or a manufacturing company? How on earth am I supposed to create recurring revenue?”
That’s really what the book’s about. It’s about we discovered nine different subscription models. The premise of the book is no matter what industry you’re in, you can create some recurring revenue, applying one of these subscription models to your business. The postscript is, that’s going to make your business more valuable. It’s also going to make it a lot more predictable. That’s really the reason we wrote the book.
Let’s have you put your Angel investor hat on for a second. What do you look for when you hear a pitch in terms of do they have a plan for recurring revenue?
I look for the LTV to CAC ratio, which is a very technical term. It stands for lifetime value to customer acquisition cost. What I’m looking for as a potential investor is at least a three to one LTV to CAC ratio. Meaning, for simplistic terms, imagine you have a subscription where over the life of the subscriber, she’s going to pay you $100 a month over twelve months. Your lifetime value of a subscriber, if that would be the average, would be $1200 or $100 times twelve. Your allowable cost to acquire her as a subscriber could not exceed $400 all up, including all your sales and marketing expenses, including your salaries, your software, your marketing if you’re buying lists and so forth. What I’m trying to look for are subscription models where the LTV to CAC ratio is better than three to one. Lots of companies fail to reach that threshold but the ones who are at least three to one have the potential to scale.
Two incredible takeaways right there. Number one, you have to understand the concept. If you get asked that question, you’re not deer in headlights. Some people think, “Oh, if I just know the cost to acquire a customer, I’m good.” It seems like it’s a little more sophisticated than that. Number two, I love how you broke it down to the three to one ratio. The cost to acquire is $400 and the lifetime value is $1200, there’s a three to one ratio. Did I get that right?
That’s right. Yet, if your cost to acquire is $700 and your lifetime value is $1200, clearly you’re underwater and you can’t scale.
Exactly. What I really love about what you said John is don’t just count how much money you spent on Facebook for example, to get that customer. You have to also account for all the other things that you suggested, overhead, salaries, etc. that I don’t think a lot of people realize goes into that cost to acquire a customer.
Just to be clear, the cost to acquire a customer would include all of your sales and marketing expenses. Not all of your overhead, not your office space, etc. but it would be all of your overhead associated directly with sales and marketing. If you had a VP sales for example, his or her salary would be part of your cost to acquire customers. If you have a subscription to HubSpot, it would be part of your cost. Your office manager would not be included in that calculation.
Got it. Thank you for that distinction. Do you see that that’s a mistake that a lot of people make, that they don’t include those sales, salaries and they just include the cost of the marketing?
Probably the classic mistake would be to not include the time of the owner. Most owners are the best pitch people for their company. If you’re paying yourself, whatever, $100,000 a year and 90% of your time is dedicated to sales and marketing, then 90 grand should be incorporated into the annual cost associated with marketing attributed directly to your salary. That’s probably the most common thing that’s left out of the calculation.
Thank you for that deep dive on both of those amazing books. Let’s talk about what made you start the Value Builder System and what problem are you solving and for who?
Three out of four small companies in the United States, and the number is the same in virtually every western economy, are planned exit their business in the next ten years. When they go to the negotiation table to do that, on the other side of the negotiation table, they will be faced with a mercenary business buyer, a killer, a shark. Somebody who’s trained to buy that business for as little cash upfront as possible. There are schools that teaches, there are techniques and sleazy, disgusting ways that they go out and buy businesses for less than they’re worth. For a lot of business owners, they get completely hosed in that situation because for most of us, we don’t have the opportunity to think about selling all day long. We’re making widgets, we’re hiring employees, we’re doing all the things that entrepreneurs do. It really only is one or two times where we actually get the opportunity to go through the sale of a business process.
What we’re trying to do at the Value Builder System is really tilt the world back in favor of the entrepreneur, is give entrepreneurs the tools, the resources, the content to really get them armed to go into that negotiation from a position of strength so that they’re not taken advantage of when some corporate development person had a big company or when some private equity partner offers you some massively under-weighted earn out or some huge vendor take back with horrible terms or when some venture capitalist frankly, comes in and says, “We wanted a 2x preference on our investment.” These kinds of things happen every day. We were trying to defend internally, we don’t usually talk about it too much publicly. We think of ourselves a little bit like the Robin Hood of a business. We want to defend the rights of the entrepreneur from the predators of which there are many.
I’m going to tweet that out. “Meet the Robin hood of small business.” The Value Builder, how soon should a small startup start using this? Before they even pitch to get funding so that there’s some strategy in place for an exit strategy? What do you recommend?
Anybody’s welcome to do it. You can just go to ValueBuilder.com and complete the questionnaire. Ideally, you’ve got some revenue. Ideally, you might have an employee or two before you do it. I can tell you that the majority of our users are business owners that have revenue between a million and $20 million and annual top line revenue between $1 and $20 million. You don’t have to have that but I can just tell you, that seems to be the sweet spot. Beyond that, you’ve typically got some sophisticated money people around the table, be it a CFO or outside investors. Below that, it’s usually the owner who again knows everything there is to know about making whatever widget they make but often doesn’t spend a lot of time thinking about what are my exit options, how do I value this, what are the ways that I can monetize this. That’s where we really play a role.
Let’s talk about cash flow, because that’s one of the things in your Value Builder System, is this valuation teeter totter. How does that work and help people improve their cash flow?
When you buy a business, if you can wear the hat of the acquirer for a moment, you’ve actually got to write two checks. Most of us, as entrepreneurs, we focus on the first check, which is the one that is written to us. The actual acquirer has to write a second check, and that is to the business that they are buying to fund its working capital. Working capital is MBA speak for, how much money does the business need in the bank the day that the new buyer takes over? To me, that’s immediate obligations.
If you have a model where you’re just sucking up a lot of cash, constant contact, had to dilute themselves a lot because they just sucked up a lot of cash, then that’s going to depress the value of your business in the eyes of a buyer because the buyer, although they write two separate checks, they’re both drawn on the same checkbook, the same account essentially. The more cash your company sucks up, you need a lot of inventory to run your business. You’ve got a really weird subscription model where you capture the lifetime value of the customer over years and get no money upfront. Those are situations where you’re underwater and then it takes a lot of time to recover the cost to acquire the customer. In those situations, your business is going to be discounted because somebody’s got to fund that working capital. In that case, the acquirer would.
Now, putting your Angel investor hat back on for a minute, what are some of the best pitches you’ve heard actually with somebody referring to the Value Builder System, ideally? I’m guessing there’s a story that somebody smart enough to have used that when they’re pitching you, yes?
Interestingly, no. Because we run the platform. Meaning, the platform is the software application, a set of tools and a set of lessons. We actually got to go to market through a network of advisors. We’re actually not directly serving the business owners that use the system, we license the platform to advisors who in turn will use the system with their clients. I can’t give you a pitch example from Value Builder. We’ve got lots of examples of companies that have used the system successfully. One comes to mind is a woman who ran a home cleaning service. She was in the business of basically holding yourself out as a home cleaning service. She had a few cleaning people who went out and clean people’s homes, very very low tech, analog business. She was doing it on a break-fix business model or a transaction business model, which is running advertising, waiting for the phone to ring, somebody had a party, they need a home cleaning service and she would dispatch a team to go clean the home. Of course, it’s a very difficult business model.
Through the Value Builder System, she learned that recurring revenue is going to A, make her business more predictable, also make it a lot more valuable. She changed the business model. It’s a very simplistic example but she just basically created subscriptions for home cleaning. Now, in her staff, she will sign up on a subscription, they then clean the home in the same week, in the same time every week. She’s built a recurring model that comes scales beyond her initial team, much more predictable, she knows how many cleaner she needs.
Another example, is a guy who runs a corporate cleaning business. I don’t know why I’ve got cleaning on my mind today. Maybe I’m feeling kind of dirty. Anyways, this cleaning company based in New Jersey, they would sit around waiting for the phone to ring, buy lots of advertising to try to get you to click on their ad when you needed your rugs cleaned. What they did is instead built a VIP Gold program where twice a year, without fail, they would come in a clean the carpets. The pitch was, “Look, the health of your employees is at risk if you don’t clean your carpets at least every six months. We’re going to take care of that for you, make it very predictable. They went from having a transactional business model, which was very expensive to stimulate demand, to one where the lifetime value of the customer is measured over a year. A couple little examples.
What type of startups do you like to invest in? What are you looking for when you hear a pitch?
I’ve spent a lot of time focused on SMB, small-medium businesses. For me, that’s just the space I get and know. I’m curious when I see businesses that have that as a target market, SMB, small-medium business. It’s usually an area that’s horribly misunderstood because we think of, the United States for example, the SBA boasts that there are 30 million small businesses in the United States. Reality, 22 million of those have no employees. They are home based, often times shell companies setup by lawyers to avoid taxes. The real market is something closer to eight million. Whenever I see a pitch that shows the SMB market as 30 million and we’re going to sell XYZ widget for $5000 to 28% of the 30 million, I know we’ve got a problem because it’s just a misunderstanding of the SMB market. For me, I look for B2B companies, business to business companies that have a specialization and focusing on the SMB market. Mostly just because my former company, we did a lot of market research in that area so we kind of have a bit of a sense of what it takes to get a company like that off the ground.
Interesting. It doesn’t have to necessarily be tech related or does it?
No, it doesn’t have to be by all means, no. SMBs buy in large are usually not as tech savvy as their large enterprise customer. One of the beauties of targeting SMB is you don’t have to be on the bleeding edge of technology. You don’t have to have the latest, coolest wiz bang technology. Intuit is a good example of that. Intuit, $28 billion market capitalization. They make QuickBooks and you could make a very good argument that QuickBooks is perhaps, on a feature to feature basis, less easy to use than Zero. You might make the argument that that’s okay because their customers are somewhat technology laggards. They’re not going to be adopting technology the same way as a larger enterprise company. That’s okay, if you’re not a bleeding edge technology company to be targeting SMB.
John, what do you look for in a team when you’re hearing a pitch to invest in?
I’m probably not really the right guy to ask that question in the sense that I think the founder is probably 90% of the equation. I think teams come and go. I think the one person that is going to make or break the business is the founder, or founders if there are multiple founders, then by all means, I’m evaluating them.
Let’s talk about what you evaluate in a founder or founders. What’s important for you in those people?
Competitive drive. What did they do in school for sports and how competitive were they. That usually says a lot about their resilience, their desire, their ability to overcome, their ability to be disciplined. A lot of humility. I like it when people say, “I don’t know the answer to this question but here’s the three ways that we’re planning to find that out.”
It’s pretty quick. I don’t I’m alone in this. I think it’s pretty easy to sniff out vapor ware and a superficial pitch. You wouldn’t need the money if you had all the answers. I like the pitch where there’s a hypothesis but there’s still a lot of questions on the table and a lot of humility among the founders, their desire to find out the answers.
I’m fascinated. I’ve never heard anybody describe the resilience story that you could tell about being in sports and school as a way to show how you have discipline and resilience. What a clever way to bring that to life during your pitch. Are you geographically agnostic?
For the most part. Obviously, I’m based in Toronto. Toronto base is a lot easier practically. Toronto is certainly not the only town that’s got great company. No, I don’t do deals in Asia or South America. First of all, I don’t speak the language. Second of all, there’s plenty of stuff to do here in North America.
You do speak French I noticed on your profile. Let’s talk a little bit about your podcast before I let you go. What would people learn listening to Built To Sell podcast? I got the name right?
It’s just called Built To Sell Radio where we interview once a week an entrepreneur who has sold their company. I ask them the nitty gritty plumbing of what was the deal structure like. How did you sell it? Who did you sell it to? Who made the first move? How did you figure out what it was worth? How did you negotiate a better price? How did you play one offer over the other? All the mechanics of selling a company. We don’t talk about how do you build a company, how do you start a company, how do you grow. Lots of good resources for that. We’re really focused on how do you exit successful. I just interview a different entrepreneur every day. The current one that I just did this week, we talk to a guy who had a $5 million software company. These aren’t massive companies, these are real businesses ran by real people. It’s not Mark Zuckerberg and Elon Musk, it’s real entrepreneurs who have, in many cases, this is their lifework, this is their retirement, this is the wealth they will create in their lives. We ask them how they did it and what mistakes they’d avoid.
I love it.
They’d recommend others avoid.
Really, The Successful Pitch podcast and your podcast are the perfect bookends, the beginning, how to get your pitch going to get funded, and then you’re the great one to go to figure out how to sell what you’ve created.
I think they’re even more aligned. I don’t know if I’d characterize them as bookends as much as peas in a pod in the sense that I think for a startup, to know what your exit strategy is is important. Because as we talked offline John, for anyone investing, whether it’s an Angel investor, venture capitalist, corporate buyer, they want to know what the exit strategy is. They want to know how they’re going to get out. That’s the only reason they’re going to invest. It’s not because they have some passion for your business or because they think you’re going to change world. It’s because like, “I want to make a dollar I invest in your company worth $10 in five years’ time.” Explaining in very clear terms how you’re going to make it worth $10 and how you’re going to exit, I think it’s very important. I’ll give you a quick example.
I interviewed a guy who had an ice cream company. He came up with a cool new ice cream concept, low fat ice cream. He wasn’t sure how to sell it. He started to create some retail stores. He also started to forge distribution relationships with big grocery stores. He went out and over 15 or 20 year period, he built 60 different ice cream stores, retail stores. Had to dilute himself, give up equity to finance it, had to hire all these people. A complete spaghetti ball mess of nonsense to create all these retail stores. He went to sell the business after 15 or 20 year run and he found that the only thing anybody who would be a likely buyer for his business cared about was his wholesale distribution network.
Anybody buying the business would immediately shut down the stores and focus exclusively on his relationships with Kroger and Safeway and all the big distribution companies, the big box retailers. That’s exactly what happened. He sold his business for a very low multiple because he wanted to be valued for all of his business, not only the retail distribution but also the wholesale distribution. But a buyer wasn’t willing to pay for the 60 stores because they’re going to shut them down. It’s one example. I think knowing what you’re acquirer is going to value and really being clear about that really from the earliest stages of your business I think gives you a really good place to start with your pitch.
We’ve come full circle, haven’t we? You started with don’t confuse profits with value and now you’ve closed with a fantastic example of someone doing just that.
That’s exactly right.bui
How fantastic. John, what is your Twitter handle? How can people follow you on Twitter and other social media?
Nice. It’s been fantastic having you. Thank you for sharing all your insights and wisdom on not just how important it is to have an exit strategy, but the details that need to be understood before you even enter into getting your first round of funding. Certainly, everybody should get your books and check out the Value Builder System.
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