Business Valuation Before the Sale: How to Build Value You Can Use Right Now

Thanks for joining me again, Mark.

0:08 Mark Lupton

Hey, it's a pleasure. I enjoyed it the first time and I'm sure I'll enjoy it even more this time.

0:18 Stephen Brown

It was a great episode. And in case somebody didn't listen to that, which they really should, give us a little introduction of yourself and how you got into ecommerce.

0:30 Mark Lupton

Sure. So, Mark Lupton, like you said, the founder and managing director of Greenhouse Business Advisors. We do fractional CFO services for growing, emerging, established ecommerce and consumer goods brands, especially in the eight figures and beyond.

I started this business almost five years ago now. And we've got a team of CFOs who are as experienced as anybody I've seen in the space, and I'm excited to share our insights on this topic today.

1:03 Stephen Brown

Awesome. So let's talk about business value.

You've got a lot of ideas, and I think part of it is, there's balancing, and we talked about this last time around strategic finance, but short term, midterm, long term values. Maybe we start there, thinking about the different timelines and what you should be thinking about as a business owner.

1:34 Cash flow, profit, value, and value beyond a sale

Mark Lupton

Absolutely. Last time we talked about strategic finance and we got a lot into founder mindset, which I always enjoy talking about. It's kind of upstream of everything that you do, is the mindset and even the heart set, and how you approach the work that you're doing. And I think that parlays nicely into the conversation that we're having today.

2:00 Mark Lupton

Strategic thinking is a shift from that short, fast thinking. Quick, responsive, reactive, that the founder operators have to live in. It's just the reality of running a business, especially at the earlier stages. But in time, as you scale, you need to transition and carve out space for the longer, slower thinking.

And so how that relates to finance is, oftentimes the short-term view, fast thinking, is related to cash flow. So you're thinking about how to generate cash and how to fund getting product to people. You price it a certain way based off your costs early on, and you've built in some level of margin that could have been very scientific and calculated, or just sort of lick your finger and put it to the wind, so to speak.

2:45 Mark Lupton

But the short-term view is often on cash flow, making ends meet, getting month to month, getting product out, growing.

And then you get more mature and you start to understand the difference between what changes in the bank account and your profitability. And so you start to focus on profit in the midterm. This is in line with what you guys over at LedgerGurus know well, which is the shift between cash and accrual accounting, where you start to really understand, is this business efficient? Is it making profit, not just cash?

3:20 Mark Lupton

And so, the short-term view cash flow, midterm view profit, and then there's the more long-term view as I see it, which is building value. And that's the longer, slower thinking oftentimes.

So running decisions through the framework of, how is this impacting cash flow? Yes. How is this impacting profit? Yes. But also, how is this impacting the value of the asset that I own? It's a different way of thinking.

A strategy should consider all three of those things in every decision that you make from the financial perspective. That should be a habit, those three things running through your mind. But today, talking about value, the long-term view is one that is focused on value.

3:57 Stephen Brown

Value is interesting, because I think when we think about business value, oftentimes we think about it in terms of selling the business. But what we're going to unpack here is not just the value of your business when you sell, but on an ongoing basis.

Let me just take a detour down this path to help enlighten people.

4:20 Stephen Brown

There are a lot of business statistics around how long small businesses last. I think the survival rate after like 10 years is like 66%. I don't know, or maybe it's 66% go out of business. But let's say you're a survivor.

I just pulled this up on ChatGPT, so hopefully it's right. 20 to 30% of businesses are ever sold. And of the businesses that go to market, only 20 to 40% of listed businesses actually sell.

5:00 Stephen Brown

So a significant number of businesses are going to go out of business. There are many that will never sell.

What we want to frame is ongoing business value. Whether you sell or not, selling a business is hard, the odds are low. But what is the value you can get as you go along? So let's keep going down that path.

5:25 Mark Lupton

I agree. People often sort of conflate business value with just selling, and there is reality to that.

I've heard it said that the value of your business, and your net worth therefore, is kind of like a Cadillac on the moon. You've got a Cadillac, but it's on the moon, you can't access it. And so the only way to really realize that value is to liquidate in some way, is to be able to pull cash from that in some way.

5:55 Mark Lupton

And oftentimes people think about that as a moment, as a singular transaction, an exchange of control of your equity to another person. And that's generally the narrow focus on how you actually extract that value. How do you get the Cadillac down from the moon and drive it around?

But I think the mindset shift is important here again. As one of our lead CFOs says, Andy Donaldson, he just in a prior call was talking about, the best thing we do is build a strong business, build a strong valuable business for yourselves. That's the best preparation for a sale. And so we come back to that. I just wanted to interject that for a moment before we continue.

6:37 Stephen Brown

So let's talk about some concepts of the value of a company. You gave us a high level, you've got a couple of ideas here. Let's go down those.

6:47 Thinking like your own acquirer

Mark Lupton

Sure. So I want to start, I suppose, with, as a founder, you are in the position where you can have the opportunity to think of your business from the perspective of someone purchasing.

Building a valuable business isn't just about selling it, it's about the value to you. You are the 100%, or some percentage, owner currently. And so thinking about the business from the perspective of a potential acquirer helps you, because you are currently the one who has acquired, if you will, the business.

7:30 Mark Lupton

And so I think that's the first frame of mind. Put on those lenses. We're putting on the lenses of a potential acquirer. If you're walking up to your own business right now, you're looking at it and saying, is this thing valuable to me? Would I opt into it?

So that's number one. And this is what a potential acquirer is doing. They're saying, am I going to opt into this?

8:00 Mark Lupton

And there's a combination of things that they consider when doing that, that you should consider, that any person running a business or who has a stake in a business should consider.

And those two very high level concepts are risk and opportunity. Opportunity for future gains, what's the potential that your business has, and then de-risking those opportunities.

Very simple in concept, but that's the highest level, and it trickles down to several other different types of levers that you pull and things that you need to consider to get very specific and tactical within that. Opportunity and risk. The potential of the business, and the chances of you actually receiving the gains from that potential, or achieving and realizing that potential.

8:36 Stephen Brown

I love that. I want to pull on this mindset for a second.

I've seen some customers, they have businesses that struggle and they think, hey, somebody's going to buy this and they're going to be able to figure out how to make it work.

And if you're having a hard time getting value out of the business where you are right now, does that exist? Do those businesses exist where somebody's like, I know how to solve your problems, I can unlock all this value? But the reality is, in that moment the business isn't valuable to you, you want to get rid of it. It's not going to be that valuable to somebody else.

9:20 Stephen Brown

And I think if you get in that mindset, it's really helpful. Which is interesting, it's this catch 22.

It's kind of like lending. The conversation around lending is, get lending before you need it. And you could maybe say the same thing goes with selling. The best time to sell your business is when you don't want to sell your business. Or you're not thinking about it. You're coming along, you're getting a lot of value out of it, you see a lot of upside, you're in a good mindset.

But I think one of the fallacies of selling your business is that somebody's going to find more value than you currently find in the business. That's not always the case. In fact, it's usually not.

9:58 Mark Lupton

Right. The person acquiring the business needs to be excited about it one way or another. And so if you're not excited about the prospects of growth, then there's a lower chance. It's maybe just a really basic indicator of whether someone else will be.

10:23 Opportunity

Stephen Brown

So let's go down the concept of opportunity. Talk about that.

10:23 Mark Lupton

Sure. So when you think about opportunity, this is where operators are spending a lot of their time. Thinking about areas for growth, improvement. Incremental, major, pivotal opportunities for growth and improvement.

And there's a variety of things within that. Expanding sales channels. This could be expanding marketing channels, how you're getting eyeballs. This could be reaching a new customer base. This could be expanding your customer lifetime value and repurchase rates. This is increasing your production capacity. This is getting more efficient in your operations. This is your team, your capabilities. Additional products, additional SKUs.

11:10 Mark Lupton

So it's all of these opportunities that founders are often weighing and prioritizing, in real time.

And so to me, this is the topic that, it's less about encouraging founders and operators to think about growing and expanding. That's just default, that's just how you survive and what you're doing day to day. It's more about the lens through which you view these opportunities.

11:40 Mark Lupton

The shiny object syndrome is everywhere. Are we running the decision to expand to another sales channel or a marketing channel, are we running that decision through the thinking that I mentioned at the beginning here? Are we considering the impacts of short-term, mid-term, long-term cash flow, short-term, mid-term, long-term profitability, and short-term, mid-term, long-term value? Because it's going to have different profiles for each of those. And this is where the slowed down thinking comes into play.

12:15 Mark Lupton

Oftentimes you'll see people get into a spot where they're just assuming that expansion into different channels or different products, more is better. Obviously not always the case.

And there's generally some level of logic that goes into justifying that decision. But what I'm asserting here is just to say that maybe that logic is more justifying something that you want to do, because you feel like it's the right thing just generally, versus having a systematic way of thinking through that decision, and writing down specifically how that impacts value, how that impacts profit, and how that impacts cash flow in the short, mid and long term.

12:50 Mark Lupton

So everybody's thinking about opportunity. Everybody's thinking about growth. Everybody's thinking about all the things they could do.

It's a matter not of just thinking about things you could do and acting on those, but the things that you ought to do, and how you approach deciding which of those things to do based off of your situation. And that's different for everybody. But the framework of thinking should be able to be applied.

13:07 Stephen Brown

Got it. Cash flow, profit, value. Cash flow, profit, value. Keep those three going.

So there's opportunity, and I think what I've seen is a lot of sellers do well at this. If you're struggling to find more opportunity, that's a sign that maybe it is time to sell, if your business is healthy. But usually that's not the problem I see. Usually I see them chasing opportunity maybe faster than they should.

13:45 Stephen Brown

New channels. I see two forms of thinking, and it's gotten better since things have gotten tighter. But I think there was a thought of, we just have to be everywhere now. Which I think is a good way to think about opportunity, the more places you're in, the more distribution. But if you're not executing well on every opportunity, more opportunities doesn't necessarily create more value. And it definitely can be a drag on cash flow and profit.

14:20 Stephen Brown

The other one is the desperation mindset, which I think is even more dangerous. Where it's like, business isn't working, I need to throw a Hail Mary. I'm really struggling on Amazon and the answer is to get on Shopify. I'm struggling on Shopify, I need to get onto Amazon.

And that to me is even more dangerous thinking. Thinking that chasing this other opportunity is the answer to all the problems. Which sometimes it is, but a lot of times it's just more challenges, less value.

14:45 Mark Lupton

Absolutely. Desperation is something I'm seeing more and more too, or temptation towards it at least.

Across the industry, I'm seeing that marketers in particular are needing to get creative. Over the last several years, everybody knows that the easy return on ad spend is not there as it used to be. Marketing engines are just less efficient.

15:20 Mark Lupton

With that said, it can create a feeling of desperation. The basic contribution margin economics that were at the core of my business two years past, a year and a half, 12 months past, are not the same anymore.

And I was noticing at the end of last year, a lot of people were trying to wrestle with that, understand why. We had a lot of questions around it.

15:50 Mark Lupton

Now I see a lot of people accepting that there's a new reality. And I see a trend, really a push, around generating a lot more creative, and trying to not just desperation leap to other channels or other marketing channels, but to do things like generate more creative than you ever have. Understand the customer and the appeal of your brand to that customer more than you ever have. Get more deeply in the shoes of the customer and know them better, so that your advertising efficiency grows, not based off of just amount of spend or audience changes, things like this, just different types of tactics, but also based off of the messaging and how you're positioning yourself in front of your customers.

16:40 Mark Lupton

That's one example that I see oftentimes can drive desperation, or can drive thoughtful experimentation and pressing into your core.

So a risk around saying, my core channel's not working as well as it used to, I need to jump to another channel. From a business value perspective, your business has been built on that core channel. And so when you jump to a different one with your time and attention, your calendar, if you will, is pointing to the fact that you are betting more so on something new fixing the overall system, as opposed to betting on the core engine getting better and incrementally better over time.

17:10 Mark Lupton

Definitely there is a need to diversify channels, and we can talk about that more later. There's much value in that de-risking, it definitely comes with diversification. But oftentimes the temptation in a desperate state to jump to something else without evaluating tactics to improve your core can be dangerous.

17:21 Risk, proof, protection, and Porter's Five Forces

Stephen Brown

Yeah, we're getting into risk. Let's talk about risk a little bit more.

And I think this is a good analogy, because the risk is, I'm exposed. I'm on one channel of selling, I'm on one channel of marketing. That is a risk, and your value can go up through diversification. But it's not guaranteed.

Diversification generates additional value when you are executing well across multiple channels. But if you leap over to a second channel and don't, it actually can increase your risk, because now your attention, your cash flow, profits are spread, and maybe being dragged down by that additional channel.

So what are some of the risks that people need to be thinking about as they're thinking about value?

18:15 Mark Lupton

There are a lot of places to go with that.

So the first thing I want to do is just go back to the broader concepts. When you're talking to yourself as your own acquirer, you're talking to yourself about the opportunities to grow, both within the current channels and current means you have of selling, of marketing, but also in new channels, new means. You're talking about opportunities to improve operational efficiency, all these things. You're talking to yourself about those opportunities, and you're evaluating priorities. Which one is the most important, and then how to attack those with what resources.

18:55 Mark Lupton

And then you're saying, what are the chances that I'm actually going to succeed at those things? This is the risk part.

So if you're looking at the business and you're talking to yourself again, this internal conversation, the conversation looks like the acquirer version of you talks to your operator self and says, these opportunities look great. Prove to me that it's not a pipe dream, but that it's really possible. This isn't just some fantasy, this is a high probability of a future that we could see.

19:30 Mark Lupton

And so the operator self says to the potential acquirer self, well, I'll show you two things. I'll show you proof, in the form of traction, evidence of what we've already done. And I'll show you protection.

Proof and protection. Those are two sub concepts under the idea of risk.

19:55 Mark Lupton

You want to prove that you have traction in the opportunities that you're pitching to the potential acquirer, or to yourself. You want to have proof that you can realistically see growth in those areas you're proposing. And then you want to also talk about not just proof that we can get there, but that there's protection in the event of threats to that in the future.

20:20 Mark Lupton

We touched on Porter's Five Forces last time briefly. This framework is super helpful when it comes to de-risking the future, and assessing where you should prioritize, what opportunities you should prioritize.

So I could get into that more later. But when it comes to risk, you think about proof and protection. I've got traction in certain areas that can prove my opportunities actually could come to fruition, I've got a reason to believe it could be real. And then I've got protection. I've got a moat, the proverbial moat, built around each of these things so that I'm protected from risk.

20:45 Stephen Brown

I'm going to give a good example.

I've got a customer right now who is exploring a sale of their business. They have expanded into wholesale, so they've had some initial traction. But part of the reason they're thinking of selling is they don't feel like they have the skills to continue to execute. They see the early opportunity.

21:20 Stephen Brown

They're talking to what the industry calls a strategic buyer, which is basically a bigger company who's interested in plugging you into them. Usually bigger companies have lots of existing relationships to distribute your product to as wholesalers.

So in that case the thesis would be, hey, I've tested, I've had some success, I've realized some opportunity, there's more opportunity. A buyer could come in and extract that, could execute against that opportunity. Because they're like, hey, we're good, we know all these people, every time we come around and talk to them we'll be like, here's their latest and greatest thing, get them on the shelves. Win-win scenario.

22:00 Stephen Brown

So there's an example of proof and then expanding upon that opportunity.

And sometimes the answer is, hey, I've had some success, I know how to go out and find some wholesale people, I can do it myself, and I can capitalize on the value.

22:13 Mark Lupton

That's a great example, and it gets to an important question also, which is around, when is it the right time to sell? I know there's a lot more to unpack with that. But the types of buyers also dictate types of potential value.

22:40 Mark Lupton

Another example that's coming to mind. So one opportunity you could see is, by expanding our product lines we have the opportunity to increase customer lifetime value and AOV. AOV and LTV will increase. That will then improve our MER in the course of the next year by X amount. And that will then reflect to EBITDA in this way. So that sort of domino effect.

23:05 Mark Lupton

And so you say, that's great. What is the proof? Well, in the past we've done these product launches, with this methodology, and we decided to do it this way, and this is the result that it yielded. And so we believe therefore that if we do this similar type of product launch, then we could see similar results in this way.

Example of proof. And so that's more operational and less dependent on a transaction. That's just one of many, as an example.

23:24 Stephen Brown

You mentioned Porter's Five Forces. Let's just go into that right now. This is a theory that's been around for many years, it's taught in business schools. What is Porter's Five Forces, and how do people use it?

23:26 Mark Lupton

Yeah. Porter's Five Forces of competition is the concept specifically. And the Porter's Five Forces, they're a great guide to understanding all the potential risks to your business's success.

It doesn't include absolutely everything, because there are many risks, including partnership relationships and all sorts of financial things. But it does expand your view of what competition really is, and more talks about what are the threats and what are the risks.

24:10 Mark Lupton

So there are five categories. Most people, when they think about competition, most people consider rivals. These are existing competitors who your customer is making a choice between. Obvious.

There are new entrants. There's a risk that some others will be able to come in and grab market share from you and grab your customer's attention away from you.

24:40 Mark Lupton

There's the threat of supplier power. And so if you are too dependent on one supplier, then there's a real risk that that supplier has the ability to completely wipe out your supply chain if they go bankrupt, for instance, or if they determine that you've breached contract somehow and they spend a lot of legal dollars, because they're bigger than you, to prove that out.

25:10 Mark Lupton

Customers. So this is concentration on customers. In the ecommerce world you have a wide range of individual customers. But what we're talking about here is maybe dependency on sales channels and things of that nature.

So if you're very dependent on Amazon, and Amazon decides for some reason or another that your product is at odds with their rules and regulations, then they could completely shut you down.

25:40 Mark Lupton

And additionally, another risk would be within the customer's heading. Another risk would be how much you own that customer. So if you're primarily an Amazon seller, there's a degree of separation between the ownership of that customer. And with that degree of separation that creates, you don't own that customer in the same way you do if they're coming straight to your website. So there's a lot more in there, there's a lot of nuance to that.

26:10 Mark Lupton

And then the last one is alternatives and substitutes. This is not rivals. This is not other things that people could buy necessarily that are direct competitors. This is other things that people could do to solve the same problem, scratch the same itch that your product is solving or scratching.

26:30 Mark Lupton

So those five components help give a widespread framework. It allows you to look across the entirety of your business and say, where are my weak spots? Where are my vulnerabilities?

And I hope right now anybody listening is able to quickly say, that one. I'm really dependent on that supplier. You know what, if they pulled the rug, that would be brutal for me. Well, the acquirer self, or a potential acquirer, would say the same thing.

26:47 Stephen Brown

I want to pull on that a little bit around the alternatives, because you defined it as things that could solve the same problem.

One of the things I think about is a lot of ecommerce is discretionary spending. So sometimes I think, what is the alternative to this thing? I co-own a skincare brand, so it could be another brand of skincare. But that's probably not the best example, because one could argue that's something that people use or they don't.

27:30 Stephen Brown

There's a lot of stuff, a lot of widgets, a lot of products, even apparel, where people are buying that because they want it, it makes them happy. Your alternative, especially in this higher inflation, much more difficult economy, they might be choosing between Netflix and that cool thing that they saw an ad for.

28:00 Stephen Brown

And so one of the concepts I've been pushing the last couple of months is the value economy. What is your value to the customer? Do you create value to that customer?

Because one of the competitive forces that I think we're experiencing, outside of what you described, is macroeconomic pressure. And then I think that gets manifested in the alternatives. We see a lot of people swapping brand names for generics. Or in my example, maybe they might not buy whatever it is you have at all, and keep something else that gives them happiness.

28:30 Mark Lupton

Absolutely. I think that's really well said, that macroeconomic pressures manifest themselves in the form of alternatives and substitutes. That people are going to start choosing things that are not just a direct competitor, but are something altogether different to scratch that itch or fill that need.

29:00 Mark Lupton

And so, getting way outside of the finance realm, but it is still strategic, is understanding that need. Just the core of all businesses really is relationships. It's just a network and series of relationships. And so with the customer, it's getting down to, what is the real deep value that I'm providing for that customer at all times, knowing that.

It's easy to get away from that and think tactics. And that's okay, that happens. You can't always fully be in the shoes of the customer because you've got a business to run, and there are operational realities to that.

29:40 Mark Lupton

But the challenge I hear you bringing up that's really important is for a strategy to be driven by sitting deeply in the customer's shoes and staying there and understanding your value prop to them.

Sounds so basic. It sounds like elementary school business. And sometimes I even hear the words go out of my mouth and I'm like, am I just spouting off the latest cliche?

30:10 Mark Lupton

But I would say these common sense ideas, these first principles, they don't go away just because they're cliche, just because they're common sense. They don't become less important or less relevant. The danger in just thinking, I already know that, is letting such a deep and important idea fall to the back of your mind instead of being front of mind where it belongs.

30:40 Mark Lupton

So, zooming back all the way to valuation, connecting the dots there. You lose an understanding of the customer value add. You don't have the creative that speaks to them. Your marketing efficiency isn't as solid. Their lifetime value goes down. Your EBITDA isn't as high as a result. The quality of earnings, if you will, or the reliability of your revenue going forward, is put at risk.

31:05 Mark Lupton

And you can see that slip over time. If you do a cohort analysis and look cohort by cohort, what's the LTV doing? What's the repurchase rate looking like? Cohort by cohort over time, that's evidence potentially of you allowing your true value add to customers, and what your brand means to them in their life, slipping.

And acquirers care about that. That's a financially quantifiable thing, in the form of LTV, in the form of customer cohort analysis, in the form of LTV to CAC ratio. All that gets played into diligence and evaluating the value of a business. It's not just soft talk.

31:32 Proving the financial engine works

Stephen Brown

So another concept you talk about with de-risking is the traction and evidence around things. Let's talk about that.

31:32 Mark Lupton

Yes, for sure. So I mentioned an example around LTV improvements.

Another part of proof and traction, evidence that we'll actually be able to achieve the opportunities that we pitched, is proving your financial engine works. And that's not just EBITDA. People talk in valuation terms often with EBITDA multiples, revenue multiples, this is P&L focused things.

32:10 Mark Lupton

A common valuation methodology is discounted cash flow. And so that's just a finance way of saying, how much cash will this thing spit out over the next handful of years? And we put a discount rate on it to risk it, literally, to bring it to present value.

So it's literally, what are the opportunities with cash, and what's the risk that surrounds that, in the form of discount rate? That's a very core way of evaluating a business. Opportunity, cash, risk, discount rate, discounted cash flow.

32:50 Mark Lupton

So with that, part of the proof and traction evidence is proving that that financial engine works. And specifically even the working capital engine, your cash conversion cycle.

We talked about this last time briefly also, Stephen, but it's this idea of a sustainable growth rate. If you have growth plans in your forecast that are going to require more capital into the business, an acquirer will see that as a deduction on your value.

33:25 Mark Lupton

So if your growth plans require lots of infusion of further capital, because you've exceeded what growth rate you can fund with your own cash flow, that is going to hurt your valuation.

And so, can you prove that your growth rate was fundable within the company's cash flows and current working capital debt structure stack, for instance? Does your cash conversion cycle need a lot of fuel from outside sources that a natural line of credit can't fund? If so, be aware of this, this is a real potential bottleneck.

34:00 Mark Lupton

So you want to be able to show, from a proof perspective, that I've achieved certain growth rates beyond the growth rates that we're looking to achieve in the future. And we've achieved those growth rates with this working capital structure, with this cash conversion cycle. And we can keep doing that.

34:25 Mark Lupton

Additionally, same thing goes, and this is all below EBITDA, into your balance sheet, into the less understood of the financial statements. Especially for manufacturing folks, we talk about asset intensity, another finance word. Do you need to buy more machines to keep growing? How many? How often? And how much capital outlay is that going to take? And who's going to pay for that? Have you saved for that? Is that part of the transaction here?

So I would consider these things both if you're looking at the value of the business from an acquirer's perspective, or if you're looking at it from your own perspective. You need to be able to prove that we can grow at the clip that we're proposing, within our own generated cash flows or within the already accessible working capital or debt structure that we have.

35:00 Stephen Brown

I think you bring up some really good points, that there are costs.

Here's some of my key takeaways of what you just said. There are costs of going into different opportunities, they might drag. And the reality is, let's look at channel expansion.

35:30 Stephen Brown

I think the long-term game of retail is a volume game. And as volume goes up, oftentimes margin will go down. Let's take a Shopify store versus an Amazon store. There's a decent chance that you're giving more margin to Amazon to sell on that platform. There's wholesale, you might have to give up a good chunk of margin to give them a wholesale rate.

But at the end of the day, the idea should be, your profit margin, that percentage of profits of revenue, might go down. But maybe your total profit dollars should go up.

36:13 Stephen Brown

One of the things you've got to think about is, there are going to be different margin structures, there are going to be different costs and investments that go into them. And whether it's you making that decision to pursue an opportunity or somebody else, that's something you have to consider. And that can increase the overall value. But you need to understand the implications of going into those different opportunities.

36:39 Mark Lupton

No question at all. And it gets back to that point around how you're evaluating and prioritizing those opportunities.

Going back to this theoretical conversation between yourself in the form of an operator and yourself in the form of an acquirer, where you're choosing to opt into this business or to not, and you're having a dialogue with yourself.

37:10 Mark Lupton

If you go back to that, the acquirer version of yourself is going to look at the operator version of yourself, and is going to have an assessment of the operator's capabilities based off of what they are focusing on and prioritizing. It is another proof point of management's capabilities.

And so, am I prioritizing the right things in my growth plan? That question has valuation impacts. Here's how we're going to grow, here's how we're going to do it. Well, the acquirer self talking to the operator self says, you're completely blind to this other thing. This is actually what's constraining your growth. And why don't I see any resources going in this direction?

38:00 Mark Lupton

So I come all the way back to that. How are we prioritizing what our opportunities are, what opportunities we're actually going to chase after? And we run that through the filter, like I mentioned before, of impacts on profit, cash flow, value.

And another way to run through that, which I really think is important, is to think about those bottlenecks. What's the bottleneck in the growth really? And attack that, throw the resources at that, and then do that systematically. What would be the next bottleneck?

So prioritization of those opportunities is key, and it has valuation impact as the acquirer assesses the capabilities of management.

38:35 How business value is determined, and why founders sell

Stephen Brown

Now you talked a little bit about a valuation method, discounted cash flow. How is business value determined? Let's talk about different ways that the value of a business is measured.

38:46 Mark Lupton

Yeah, sure. There are several different ways.

So I mentioned discounted cash flows. It's very basically a forecast of your best plans for growth. And the dollars flow all the way down to cash flow from revenue. There are some details about exactly what is included in that cash flow number, but we'll stay at this level for now.

39:20 Mark Lupton

And those cash flows are forecasted into years to come, with some value of estimated cash flows beyond what your forecast says. And then you slap a discount rate on it and say, for the risks that we're expecting to incur, for the time value of money, et cetera, this is what we think the value of those cash flows is today.

And so that's very simply what the discounted cash flow method is. It's standard, it often is measuring sort of the intrinsic value of the business's operation itself.

39:55 Mark Lupton

But then there's what everybody else is talking about, which is, how do we understand the market value versus the intrinsic value, so to speak? Intrinsic value may be future cash flows discounted back. The market value, which is what actually gets determined in a valuation setting, is where you hear the terms about multiples.

40:20 Mark Lupton

And so value determination versus value in the market is a little bit different, how we do those two things. A buyer is not going to come in with just a blanket multiple to apply to anything that's in this industry. There will be comparisons to public comps. There'll be comparisons to other private transactions done recently, and where those multiples have fallen generally.

But those multiples are results of deep due diligence and forecasting and practically what dollars we can expect to get back from this thing, especially on the private equity front.

41:00 Mark Lupton

So I'm not going to go into too much detail there, because I want to focus in on the founder building value.

And so if you're looking at your own business to determine its value, you look at the intrinsic value of those future cash flows. There are models that can help you out with that. There are people called Greenhouse Business Advisors that can help you out with that, figuring out those sorts of things. That's the model-driven way of understanding your business's present value to you. How much cash can I generate over the next several years?

41:35 Mark Lupton

Then there are the public comps that say, if I were to sell this thing, what are the public markets showing that these things are trading at? And then what are recent private transactions that have been done in my industry, in my space, in my vertical? And we can say, all right, if I sold it, that's what that would be worth.

But the key factor here. The market rate applies if you sell it. The intrinsic value applies if you keep it.

42:00 Mark Lupton

And there may be a big difference between those two sometimes. And it will depend on who the buyer is, certain buyers can value businesses in different ways.

But as a founder, you're valuing it based off of the cash flow that it can bring you. That's just the financial part. There are personal parts. Do you love it? Is it worth your time? Is it a legacy in your family? All this. But from a financial standpoint, that's how you really want to think about valuing it. Future cash flows.

42:11 Stephen Brown

And I like that, because as a business owner you can look at the profits, and profits don't always equal cash. Because you might be taking that cash immediately, using it to buy additional inventory because you want to keep growing.

And so your focus on cash flow is, you don't pay out of profits with these businesses, you pay out of cash flow. And usually cash flow from sales, not cash flow from investments. Cash flows from sales are what you can use to pay yourself.

42:50 Stephen Brown

I think there are also some intangibles that I've seen with founders. The value can be the purpose you get out of the business. You might be really passionate about the product, really love what you're doing, love the control. That can give you value even though you might not get a lot of money.

Ideally you should have a decent amount of both. You should have satisfaction in what you do.

43:20 Stephen Brown

I see some founders who get tired. The business might be doing really well, but they're tired and they're like, I just want to be done.

And you hear all the time, I was in a very acquisitive enterprise software company years ago and I bumped into a lot of folks that had sold their business. Sometimes they stepped away and then they got super bored.

43:36 Stephen Brown

And so if you're having great financial performance and you're unhappy, you can sometimes fix that problem. You can hire somebody to do the things you don't love anymore and focus on the things that you do love.

So as you think about value, we're talking specifically financial value, but value can extend to other areas of what it means to own a business. And you want to consider those just as well.

44:10 Stephen Brown

Mark, you and I would always be like, profits, cash flow, super important. Create a business of value, so if you did want to sell it one day, because eventually you're going to get old and you will need to find a way to move on from your business, whether it's giving somebody else ownership or maybe hiring a CEO or selling the business. But in the meantime there are a lot of ways to generate value, and you want to look at all of those intangibles as well.

44:34 Mark Lupton

Absolutely. There are many different reasons to sell a business or to transition from it.

And I do see more folks who are tired, and are discouraged even by the performance of their businesses, that maybe what they wished the value of it would have been five years ago is not what it has become today. And so they're coming to terms with that. I think what you're talking about is a real contingency of operators right now that feel that way, as far as I've seen.

45:15 Mark Lupton

Additionally, another reason to sell is, what does this brand need, as far as team, as far as resources, to become what you believe it's meant to become in the world?

And that may be something beyond you. And that oftentimes is a really good reason to consider handing this over, or in another way, to bring someone in who is that person to take it to the next level.

45:45 Stephen Brown

Well, let me pull on that thread real quick.

I talked about my customer who's considering a sale. You know what you need to do, you know you don't have the skills to do it. You feel like the risk of you gaining the skills, or finding somebody who could do the things that you know you can't do, is higher than the risk of going out and selling it and letting somebody who has those skills and capabilities do it.

46:20 Stephen Brown

And I think that's a very enlightened entrepreneur, when they know they've hit their limitations, but they see the value in their business. They do that risk assessment and say, you know what, I could do this, but the risk of me having success is lower than if I were to sell it to somebody who's got the capabilities of doing it.

That to me is one of the more enlightened positions I've seen with entrepreneurs. When they come to that place, they've had a level of success, they know what it would take to go to that next level, they do the risk analysis and say, I see the opportunity, but the risk is higher for me than it would be for somebody else.

47:00 Stephen Brown

And that usually ends up being a really good outcome too, because for the buyer they're like, yeah, that's a low risk for me, I do this all day. But that's when you get into a win-win outcome.

All right, let's wrap things up. If we were to summarize this conversation down to a few things, my key takeaway would be, value, looking at cash flows, profit, and just overall value. Why don't you give us your quick summary?

47:30 Mark Lupton

Yeah. Circling all the way back to the beginning, that initial question of, are you building an asset, are you building value, or are you building a job?

I think a lot of these factors, they improve enterprise value. But enterprise value is a representation of whether or not you're building something that's dependent on you completely, or is not. And so generally speaking, if your enterprise value is going up, it means that you're scaling to a place where it's not all dependent on you. That key man dependency, so to speak, is a big part of valuation.

48:20 Mark Lupton

But as you do these other things, build the team out, build out the capabilities, scale, focus on building protection around some of the opportunities, and vetting the opportunities with a clear systematic way of thinking, and you record how you're doing that, the business becomes less dependent on you. Because you've built a team out, you've built protections around it, you've built a way of thinking, a way of prioritizing strategic decision making. And then this becomes less of a job and more of an asset that you are responsible for stewarding.

49:00 Mark Lupton

And once it becomes that, then you think about it from that enlightened entrepreneur perspective that you just brought up, Stephen. Which is, am I the best person to steward this asset forward? And is this asset bringing me the returns, both personally from a personal fulfillment perspective, but also financially?

And if it's not, then I have the freedom and opportunity, and the asset itself that's functioning not independent of me, but less dependent than it's ever been. Do I have that freedom to then go in and look for a better partner, better opportunity?

So if I'm summing it all up, that's really what I'm landing on. You build enterprise value, and in doing so you're building something that isn't just a job. That's the way it works.

49:33 Stephen Brown

Awesome. If somebody wanted to connect with you, what's the best way to do it, Mark?

49:37 Mark Lupton

Yeah, so you can just email me directly at [email protected]. Greenhouse Business Advisors, so greenhouse.business is the website. But [email protected], or you can find me on LinkedIn, Mark Lupton. I'd love to connect with you directly.

49:51 Stephen Brown

Awesome. Thanks for joining me again, Mark. We'll have to do it again.

49:54 Mark Lupton

I enjoyed it. Thank you for having me.