Episode Transcript
[00:00:00] Speaker A: Welcome to the Independence by Design podcast where we discuss what it means to be a business owner and ways to get unstuck from the day to day so we can design a business that gives us a life of independence.
What are we talking about, Kim?
[00:00:14] Speaker B: The financial model and specifically in the view or lens of business valuation and how that ties back to the finances. But admittedly this is not my area of expertise. I've had random people ask me in the community. I'm like, go talk to Ryan because you want to talk.
[00:00:32] Speaker A: Because I'm the accountant. I'm the accountant.
[00:00:34] Speaker B: The guy that got the D in accounting is the accountant.
I'm just the revenue lady. But I'm excited to go through this with a specific lens to as everybody is going through their annual planning and we're gonna have the valuation workshop coming up in early December. So I'm excited to go through this and start getting people's heads wrapped around it all.
[00:00:56] Speaker A: Why do you think understanding the valuation of a business and understanding what it is today and what it needs to be in the future is important for everybody?
[00:01:09] Speaker B: From my layman's perspective, yeah, no, like I want to actually you is, I mean your business is an asset and it's to give you a return on life to some degree or provide value to you and it has that value, has to meet your expectation of what you needed to have as an asset. Like there's no point in me owning something as an asset if it's not going to give me back at some point in the future what I've invested into it.
[00:01:37] Speaker A: What do you think the knowledge on valuations does for decision making for people?
Think about like the guy we were just talking about. That's one of the new people going through the BoR blueprint or some of the other people that are coming out of the summit and like having the, like having the dynamic and variable of the valuation at the center of the. Well, when I say center, it's one of the three of time, cash flow and wealth. And it's a big component of the wealth. At the summit we talked about it and the person that was just going through the boardroom blueprint is now thinking about it like, how do you think it impacts people's decision making and like what it means to be an owner?
[00:02:15] Speaker B: I think it impacts it greatly. I think a lot of, if not all owner operators get so busy in the day to day in the running of the business and the focus on what's next, how do I keep growing that they don't know what they're driving towards. And so to have evaluation done to give you a current, real day benchmark of where you are today and then how could that possibly look in five years from now, in the future? And then what does that mean that I need to do to get to that?
It's having a target, right? Like, you know, what are you going to work for every day if you don't have a target in mind? Like, I have a target in mind for every single thing that I do. Like to the point where when I run errands, it's in a circle and I minimize any left hand turns that I need to take so that we don't have to cross the street. And like, so I have a target in mind of where I'm going to go and when. And like I can plan it down within like the minute of when I'm going to make it back home. But that's because I value my time. My time is my asset. And so for these business owners, their businesses are their asset. And to have a target in mind to know what you're, you're doing it
[00:03:14] Speaker A: every day, what has been your experience?
Like kind of becoming awake to like what? My dog is snoring so much right
[00:03:27] Speaker B: now I can't hear it.
[00:03:28] Speaker A: I know, like he's having more fun than me right now.
Like, I'm trying to think how to formulate the question. Kim is like spending decades plus in ITR with all of the exposure with your dad and Brian and what you guys did. And then like all of the owners that we've been exposed to, how valuation is not the focal point or the understanding the true under the real understanding of valuations. Like, how do you process all of that? I'm just, I don't know, like I said, I don't even know the words I'm trying to use, like, because mine has just been like, oh my goodness, how do you process it?
[00:04:15] Speaker B: I think in my experience, coming through my career, my understanding of being the owner was stressed out.
Lots of anxiety, lots of pressure to always make the right call.
Lots of pressure to be at my best at all the times. Like I never had the perspective of this is an asset for this person.
And I never even thought of like, what is the current date, like the value of this business. It was always just how do we grow and how do we do more?
Was the thought process. So coming into IBD and seeing the owners going through the IBD process, that same light bulb goes off. I see for all of them where they're just like well, wait a second. Like the business is supposed to work for me as the owner and not always just me for the business. And so, and how the valuation plays into that, again, it gives the owner that target. It gives them a reality check of what they've built so far and then a reality check of what is possible in the future based upon the constraints that they're willing to wait over that period in time.
[00:05:30] Speaker A: Yeah, it's fascinating like because I, I think there's a couple things that we're going to unpack because I'm going to pull up the spreadsheet, we're going to walk through just the, the math, the math and the mechanics behind it. So that way again we want to continue to demystify. Like here's how the sausage is made. Like you just, it's, it's, it's complicated but it's, it is knowable. And what. So I think it's fascinating as well. One is like how few people that are privately held have valuation as the focal point of the goal and that valuation being the focal point is that like you said, the right destination and it orients everything right. And like we're not saying that people have to maximize the value. There's, I'd say there's at least a third of the IBD community that's like I don't want to maximize value because maximizing value means that I have to reinvest every single penny and grow really fast to get to the wealth component faster. So like back to the time cash flow wealth dynamics is like if we over index for the wealth of the, the Venn diagram which is the valuation one, we got to know what the heck it means if you're going to over index for it and sacrifice all your time and cash flow for the wealth.
Therefore by definition it's the valuation and we should probably understand how it actually freaking works. So not just like, so like I'll even say like if there's maybe it might be too generous to say 90 10. And by the way for everybody listening, I'm not, I'm not including ESOPs or private equity firms because they have to have a built in valuation target like it just by definition of giving the return of capital back to the investors, this is people that are owner operators. So I'd say maybe it's probably too generous. Maybe, maybe 5, 95 5.
Then if we double click on that again Kim, other than the people that are in our community like being able to actually articulate what the hell valuations like how is it Actually calculated, like what is the discounted cash flow, what is the market multiple and then what are deal structures?
So there's very few people then. So it's like, okay, like there's like this thing called biz equity or there's like, I mean, I can't remember the. There's all these robot algorithm based valuations and people go, it's like, it's like someone pops out of this number out of the sky and then they grab onto it, but not knowing if it's overvalued or undervalued, like, how do we know if that's real or not? And the way I, the way I would think about that is like how many executives I know right now, Kim, that are driving themselves into the ground health wise and stress wise because they're making 2 to 400 grand at a VC backed company with a valuation target because they're going to maybe go public someday and it's all fake. There's no chance of them hitting that. So like, therefore, like all these expectations are lies, which is just then, then by definition you're totally wasting your time.
And the cash flow sacrifice, like it just doesn't. Like it just all of a sudden becomes not realistic. And so going back to then, okay, what do I mean by this is like having valu. The valuation has to be part of the equation. It doesn't have to be maximized.
Right. But it has to be part of the equation and we're going to walk through that and then understanding what it actually means empowers us to then go, what's the actual probability that I get what I want? Not just like hope. What did Bill call it? Hopium?
[00:09:10] Speaker B: Opium.
[00:09:11] Speaker A: So awesome. Thank you, Bill.
And so like we're eliminating the Hopium because we actually know the market valuation, not the random number that's thrown around. So like, thoughts about like any way of clarifying maybe more layman's terms about what I said, but that's kind of some of the stuff that comes to mind.
[00:09:32] Speaker B: Yeah, I think you explained it very well and I think it was very understandable. I'm excited to go through this episode and walk them through that. So that way, to your point at the beginning, we can explain how the sausage is made, right? Like knowledge is power and people know they want a number that they can trust. People know that they want to have this number and it's just going through and educating on how to get there.
[00:09:57] Speaker A: So what I'm going to do then.
And please interrupt me.
Last time I said that, I Talked for like 45 minutes on one of the episodes we didn't publish. So I.
Okay, so here's what I'm going to do, Kim, and kind of think about all because this is for our members pretty much first and foremost, because they're inviting their leaders into the community and there's just like so many people and then all the continued followers here.
What we're. What my intent is, is to walk through just the series of decision making, like, okay, why should evaluation be part of our annual planning? And like, what the heck does that mean? And what are the implications of that?
And if I were to just say first and foremost, Kim, like, unless we have our valuation target mathematically connected to today, so we have our five year, which, well, what we're looking here on the. So on the screen, everybody, you can go to YouTube or Spotify, have this video and you can check it out, but we'll try and make it so that way you can listen along, along the way anyways. And then there's also a bunch of additional podcasts, Kim, that we can put in there. We can make sure that. Thank you, AI. We'll connect all those podcasts of the Dave Deal podcast. And because the Prairie is going to be doing the valuation workshop with us about like deal structures, the different types of buyers, all those different topics are tied to this.
But where I'm going to start with is like this is a five year.
So right now we have columns B, C, D, E and F year 1, 2, 3 and 4 and 5.
Those are the five years. There's five columns. So we want to know every year what's our company worth?
Because like, how do we know what the trade offs are? And this is where I was going with this, Kim, is like, if, because everybody wants to know, should I keep the company, Should I sell the company or should I scale the company or should I step out? It's like one of those bigger decisions and like that are those big picture ones.
And then the next question is, well, what's that impact on my cash, my effort level?
There's zero way to answer that question unless we have this information.
Because we actually like, unless we. So what I mean by that. So let's take a look. And what my thoughts are, Kim, is I'm going to walk through why this has to be built out for us to get any information. Like we can't make any decisions about reinvestments or distributions. If we're going to reinvest back into the company, is it going to go into people? Is it Going to systems, is it going to launch into product or services, going to acquisition? Like what's the return if of that reinvestment or if we take out distributions, what's the hit that I'm going to have on the future growth potential of the valuation?
Like that's every single person that's listening to this. That's the number one decision that they have in front of them all the time. Everything's a derivative of that. Systems, processes, people, procedures, all that is part of reinvest or take the money out in relationship to what do I want the valuation to be in five years? And unless we have that mathematically connected three statement model to the five year, we by actual mechanical, literal definition cannot answer that question at all.
And that's what's just wild to me is like, because I've never seen anybody else with this, then everyone's actually guessing to a certain degree not to say it's yeah, right, because like and it, and it could in full. Like I know that there are people who have very, very educated guesses, right? And it's like a spectrum of educated guesses versus non educated guesses. And like when I was talking to my buddies over the weekend at our golf trip and I said there because we were talking about owners and like how their mindsets are and all this stuff about the big going on in the economy, I said, well there's kind of two spectrums I would rate everybody on. It's like every owner operator I've ever met on a scale of 1 to 10 has an intensity effort level of 10 out of 10.
I don't meet people that are like, oh, you know, I just kind of like lackadaisically doing this. It's like, no, everyone's putting their full effort into their business.
Then if we added another layer it would be what's the level of intentionality of 0 to 1 or 0 to 10?
I'd say most people are too. Like there's a lot of freaking people that are just lucky and they're, they're meeting that luck with really, really, really hard work. But then it's the luck of the business model. It's the luck of the industry is the luck. And they, but, and they're working their off and so there's no disagreement there. But very few people can pull up a five year plan, say here's where I'm at, here's where I'm going, here's why I'm going there, and here's how this all works and here's exactly What I'm planning on doing, I think to
[00:14:43] Speaker B: add to your intentionality comment really quickly in the luck comment. So what is it? The definition of luck is when preparation, opportunity meet.
And so I think that's, I would probably rate a little higher than a 2 with it under intentionality. But I think it's because when you unpack the word luck, it's when preparation and opportunity mean so the they have been preparing and building and then the opportunity arises and they're there and capable of then gaining benefit from it.
[00:15:13] Speaker A: Yeah, I would agree with you. And maybe the rating that I've got is under the.
Unless we have this, like, I've never
[00:15:23] Speaker B: golden standard, the golden rule, like you and I were talking about yesterday on the phone too. So it's like, I think this goes back to what we had on our T shirts, right? This leaves no room for doubt. Like there is no more debate. The truth is no longer up for debate. Right. Like this gives you that crystal clear picture. Anything short of this leaves room for doubt and leaves room for mistakes to
[00:15:47] Speaker A: be made because it's not part of the model then because, like, we don't know. Like, this is a closed loop system. Okay, so here's what I'm going to do is I'm going to walk through like, okay, why is what Kim and I just said true? That I, I believe it's true. And then what do we do about it? So in column F here, which is the year 2030 picked because of Kim, for everybody that's listening, December 2026 is actually the budgeting year. So you'd have to almost pretend we're in 2025 going into 2026. So everybody just moved the year ahead. Because I was working with GPT and I was like, I can change all of the years, but it's 32 tabs and it would just screw everything up right now. So I'm choosing to have it just as 2026 is next year. So we have a five year. So the budget, which is column B is the ground up budget for next year. So we would, in this example, this would be the December of 2027, if you're kind of thinking about like that. But like that's, this is the next year budget. Then column C, D, E and F are the next four years.
I will walk through the three lenses and value here, Kim, but I will first I wanted to show if we go over to column F, which is year five, we go down to market valuation. So that's lens number two of value of like we have the three lenses evaluations and essentially the three lenses. I'll just give a quick cliff note and then I'll follow through with the, with my detail. Here is owner's value Lens one is the discounted cash flow that allows us to determine what's this company worth to us if we keep it. Because we would have the five years of distributions that would be ours and then we will have the. We will still have owned the company in year five. So we use the terminal value which is the future valuation of that company in five years plus the five years of cash flow and we discount it to today based on the risk.
So that helps us understand the keep it. Should I keep like if I keep this business, what's the future cash flow and the future valuation worth to me based on the risk of that cash flow and that future valuation? That's called the discounted cash flow. And we're using all of that to calculate what that will be worth today if I keep it.
Market valuation Lens two is what are the four numbers that every single investment banker or buyer is going to primarily look at in the middle market.
And that is normalized EBITDA which is a proxy for cash flow. It's an income statement number, but it's a proxy. It's like all the one time noise like expenses or gains. What are the one time noises? Get rid of all that shit. And then we're going to times that by a multiple which is a proxy for the years of cash flow. So the years of that normalized ebitda a buyer is willing to pay based on the risk. So a three multiple is three years. A five year five multiple is five years. A three multiples more risk than the five year because someone's willing to pay for five years of that cash flow. Then when you sell a company you have to pay off your debt and you get to keep all your cash. It's called net debt. So cash free debt free company. So that's KPI number three and then KPI number four is you. We have to deliver a normal level of working capital. So the normal level of receivables, which might be 45 days, maybe it's 1.2 million bucks. It's the normal level of inventory.
So let's say it's 800 grand and then you minus the normal level of payables.
So you have that formula and like Those are the four KPIs.
And so what I, what, what I like about the market value came as we call it the Zillow value. Like what's the value of your, you know, like your price per square foot?
So that price per square foot is a knowable Zillow value based on comp comparables. And so that whole market value allows us to say, okay, well what's my company worth based on an esop, private equity firm, third party buyer, maybe a bank recap for my internal buy. Whatever the hell it is, we can then at least know not only today, but year two, three, four and five, what the company would be worth. Because what we're looking at here, Kim, is these numbers. So if I'm going out to year 2030 here and I will go over into, I mean, I can get really insanely geeky on some of this if we want to, but I. Because what ends up happening, Kim, and you can guide me here is like, there's people that are listening in who are like, I don't even know what Ryan just said. And then there's other people going, well, the discounted cash flow and the build up methodology and the weighted average house capital is that, you know, it's like, got it.
I got answers and I got, I got receipts for both.
But what we're doing is we're trying to just explain how this is built in practice. And in practice is we want to know what the hell my company's worth, what's it going to be worth tomorrow, what's it going to be worth in 20, 30 and should I do this or not? Right. So does that help kind of the level set? Because you've watched it even in the last week, you know, arguments that I get, you know, blasted from every single angle of technical people and it's like, it doesn't change what we're doing here.
[00:20:45] Speaker B: Yeah, I think I would stick more at probably just the owner operator level of the application and practicality of it and general understanding of why tying it all together fixes a lot of the questions in doubt and room for error.
And then certainly anybody that's listening in that has additional questions, you're welcome to reach out.
[00:21:08] Speaker A: So what you're saying is don't. So don't get into the fact that if everything is based on the discounted cash flow buildup methodology and the risk free rate is the treasury, that starts the pricing mechanism of every asset in the world. And the risk free rate is 4.8% and that's a lie because it's actually 10 because of inflation. That means that every single value asset in the entire world is mispriced because the Federal Reserve, we're Not going to go down that route, is that what you're saying?
[00:21:34] Speaker B: I mean, it would be entertaining.
[00:21:35] Speaker A: Okay, now you can be done now
[00:21:37] Speaker B: painting, but probably not because I want you to use this episode this time.
[00:21:42] Speaker A: I'm kidding. I got it out. All right, we can move on. So the market comp, the market valuation, the Zillow valuation is Lens two. And this is the primary, the primary mechanism that we're going to use to value the company every year, Kim.
And the reason we're doing this is because it's an income statement and balance. Like we, as long as we have all three statements every single month and every single year, we can mathematically calculate this like and, and, and actually there's no way for us to calculate the discounted cash flow without the five years and the three statements.
And unless we understand and mathematically connect everything together, it's a total freaking guess.
And so we have the ability to track this because of the three statement five year projections which we will back into. So people listening in and watching, I will back into this like where I'll show you then the out the five year projections of the three statement model, then the budget, then maybe some review tabs came of like what we're doing on a daily basis. But therefore when I look at this normalized EBITDA here, I'll bounce back and forth to show people here. So in this, this is the out year projections.
Sorry for the scroll. I'm just going to show some of the basic here. So we have the income statement, so we have revenue, gross profit margins and then earnings and then after so earnings being net operating income and net income. We have normalized EBITDA here.
Right.
So like we have all. And then you go, okay, well how do you get from net income to normalized EBITDA to there? Well, I'm going to go past the balance sheet and the cash flow statement to get to the normalized EBITDA adjustments underneath all three statements. So every single column, Kim, are the adjustments that we're going to have. So it might be an executive recruiter for 75 grand. Maybe you're putting an ERP system in for 250,000 bucks. Maybe there's a severance one time legal bill or market expansion, whatever the hell it's going to be.
We can think about this stuff into the future. Be like, I think I'm going to buy a company in 2029. Okay, put it in there. And so we have literally every single operational decision because we have the income statement for all five years.
And then we have the balance sheet for all five years. You got pushed back on a call that I was not on yesterday about, well, we can't do the balance sheet forecast because of blah, blah. Nope, it's just math.
Like, it's just math. And we can forecast out our balance sheet based on receivables, inventory and payables, and those terms, which is the same formula as the fourth KPI of every valuation.
And then we can understand our fixed assets, the depreciation schedules, the taxes, the distributions, and the debt, as long as we use our brain and we put it into the model.
And so, like, that's how we connect the income statement to the balance sheet, which then allows us to see the cash flow statement over the next five years.
So I'm going to bounce back to the. So this is the cash flow statement, Kim. And I'm gonna. I'm gonna go back to the valuation. I'm just bouncing back and forth to show the interconnection of this. So what I'm looking at here is lines 201 and. Or 201 and 203.
Well, 202 on 201 and 202, which is what are my taxes going to be over the next five years?
What are my distribution of? Like, what's the available ownership distribution? So that line 201 right here is the Advanced Solutions case study saying, I want 150 grand for the next two years, then 275, 400, 540 and 594 in free cash flow to ownership equity.
What that means, Kim, is like after debt payments, after payables, receivables and inventory, after reinvestment and after taxes. That's real money that goes to the person that owns this company.
Does that make sense?
[00:25:47] Speaker B: Yeah.
[00:25:48] Speaker A: Real money. Yep.
That line to a one is how the discounted cash flow is calculated, Kim. So what we're doing is we're actually adding up 151, 5275, 405, 40. And then we're discounting it to today based on, let's say it's a 30% risk factor.
That's called the net present value. So we're pulling all that cash flow to today and saying, well, if I kept all of that cash flow, that's what it's essentially that that first lens came and saying, okay, if I kept all of that cash, because that's my life, that's the owner's scorecard. Like, if I do this, if I stay on this journey, you get the money and you should be decoupling your time because you're putting people in payroll. So that's where inside of the three statement model, inside the income statement, we have the different areas.
I'll pull up here of like, so you can see these notes. All right, here's where we hire the CRO. Here's where we hire the CEO. Here's where we hire the CEOs. So you can see that the payroll line goes from 330 to 960.
So we know that that cash flow incorporates all that.
And so we're saving our time. So we're buying our time back while increasing our cash flow to distributions. And that's actually how the discounted cash flow is calculated.
[00:27:11] Speaker B: All right, so walk me through the net present value again because you said you add up like the 150, 150, 275, 400 and 540. But then you do something after that. You lost me after that.
[00:27:23] Speaker A: So the way that the discounted cash flow valuation formula works is we say, let's say you're the owner of Advanced Solutions here. I say, Kim, you're going to. Because we took every single operational decision. Every single one.
All of them. Like, every single, like when people go, what do you mean like? No, I mean like everything. Because the income statement is the operation. So like every single thing was put into the projections for the income statement. And then the balance sheet are the capital movement of like, okay, are we using, are we reinvesting our cash? Are, are how we taking on debt and equity for equipment, the taxes, the working capital, every single ownership capital allocation decisions in there, and that's what's left over for ownership distributions. And then there's cash in the checking account.
[00:28:10] Speaker B: Right?
[00:28:10] Speaker A: So what we're doing is we're saying, okay, Kim, if this is your company and you keep it, you would realize every one of those years of ownership distributions, it would go into your checking account.
Well, the world is extremely effed up and it's risky.
The chances of you perfectly doing this is what, like the way to think about this is like, okay, Kim, what's the chances of you getting 540 grand in 2030?
[00:28:42] Speaker B: So is it like the total less the 30% risk rate that you had like mentioned before? Like if they say like 30 for the risk rate.
[00:28:50] Speaker A: So what the net present value does is it takes 540 grand in 2030 and discounts that 30, uses that 30 discount rate to bring it forward to today. Okay, so the further out it gets, the larger the. I mean, so we're pulling all of that forward and inside of people that are community members, inside of module two, there's a whole DCF training module. But what we're doing is we're just pulling that forward. So, like, the example is like, if you have a hundred bucks, 100 bucks today is worth 100 bucks. 100 bucks worth at the end of 27 is gonna probably. I mean, it depends how much they print. It'll had to do it.
So, like, the 100 bucks is worth 90 next year. the end of the year, then it's actually worth 65 the year after that, and then 50 and it's. And then so it ends up getting. The further out it goes. And again, I'm not a math guy. I just know how this all works. So gbt, we'll put in the DCF formula. Not me. I don't have no idea how to do it. On my TA83 calculator. I played drug wars on that in high school. So the. So like, you're taking all of those years and you're pulling them forward based on how risky that cash flow is. And the risk, which is at 30% is based on your freaking operations and your company and your industry size.
[00:30:12] Speaker B: Yeah.
[00:30:12] Speaker A: So what we're doing is we're saying, okay, Kim, you would recognize, you would realize all of those cash flow, which is also what you want for your lifestyle. So, like, we're like, not only are you simultaneously getting visibility into your own cash flow for your life and your lifestyle, while at the same time, for the first time ever, getting visibility into your actual return on your asset.
So, like, when people also say return, Kim, there's so many topics tied to this. Like, people go, I bought this company, I hired these people, and I did this thing and I got a return on this. I'm like, return what? Like, what do you mean by return?
The actual way that we see the return, Kim, is if you think about, well, if you hired like a sales consulting firm, like, let's use our friend Casey from Boost Pricing, right? So Casey gets hired. You know, someone pays her 30,000 bucks.
That would go into SGA under training and development. It will be a normalization so it doesn't ding your valuation, because the normalization takes that out. You would obviously have 30 grand less in cash.
But then what would happen is you would the next year increase your conversion rates because your monkey salespeople aren't giving away all of the deals. And then therefore, it would result in higher conversion rates, higher margins, and more cash.
If we can't see how it creates more cash. There was no return, period, period, full stop. Like, and the only reason I think people use other proxies of this because they don't have the information.
So the world is full of all these proxies. But like look at that right here, 20, 29, 400 grand. And then the cash in the checking account will be 1.436 or 63539.
If we did not make more money, we did not get the return.
It's just that simple. So the discounted cash flow is answering, how much cash will I have over the next five years? And then here in 2030 we will still have owned the company.
So what we do, I'm going to go back to the valuation target.
[00:32:22] Speaker B: So where does that number show up over here?
[00:32:25] Speaker A: The dis. So the, the, that valuation in 2030. So year five. So the, the DCF is usually calculated with five years. So that's, I mean because you could do 30 years but like it just, it gets so absurd because like you don't know what things going to. So the typical thing is five years for the dcf. But what we do is we take those five years of cash flow for distributions to shareholders. Kim.
And then we also say, well we're also going to own the company though. So we're going to take the market valuation, which is the normalized EBIT times, the multiple net debt and working capital and we're going to discount that 20 million to today based on 30 as well.
So that, look at this. So actually you can tell. I know. Hopefully I know what I'm talking about because like I just walked through these numbers.
That's the present value of all of those cash flows.
So it's all of those cash flows based on the. Adding those all up and discounting them today. So it's a total of 615 grand.
The adjusted EBITDA in 2030 is 2.8.
The planning multiple is 6.6, which means the enterprise value is 18 million 18.9. So it's the 2030 or the 20,030,000. See how that's the same number.
So we're taking the market valuation in 2030 because we can build it all out and then the five year discount rate is, so we're doing a 27% discount right here, means that the present value of the 20 million is 5.3. So what we're doing is we're taking the 5.39 and adding the 615 cash flow. So we're taking the valuation plus the cash flow both of Those are present value, which equals 6 million bucks.
What that's saying is I need a 27 rate of return to own this company. I need these cash flows. This is the risk of the future cash flows. And if I keep this business and I end up in 2030, the company needs to be worth 20 million bucks. I need to have realized those cash flows because I'm taking a risk. I'm getting a 30% rate of return. So essentially what we're saying is if they go from 6 million to 20 million, you're getting a 30% keger.
[00:34:35] Speaker B: Yeah.
[00:34:35] Speaker A: And if you don't and someone says, well, I need, like, if people see this connection, then it's like, holy. People realize, like, I'm getting at 10%. It's like, yeah, no, 10% is, like, in par value with the money printer.
So, like, you're literally, by definition, eating for five years to stay in the same spot.
It's a. Like, it's math. And you go, oh, my God. Well, wouldn't that be like, this is what I did in my last business. And I went through this whole calculation. I'm like, I need to get the F out of this. There's no way to make this work for me. And so decision making, there's this, like, I could keep going, but I want to kind of zoom out, like, reground me here.
[00:35:17] Speaker B: How you feeling about it all is clicking and making sense. And I didn't understand how it was connected before, so I think that's really good. But I like how you were just starting to get back into the practicality of it and the decision making of it.
[00:35:28] Speaker A: Should I keep this business? What rate of return do I need to keep this business? If I keep it right now, it's worth $6 million, but in five years, it'll be worth 20. That's a 30% Keger. Bitcoin has been averaging 30% over four or five years. There's ups and downs, lots of volatility.
So more volatility equals higher rates of return. The treasury is not volatile, which is why it's for.
Right? So, like, people have, like. There's this weird, like. It's like, as we reduce the volatility, we're in. We're. It's. It's all. There's a lot of cognitive, like, pretzel moments here. But, like, what we're saying in layman's terms is I need a 30% rate of return. If I keep my business and go from $6 million to $20 million, it's about it's worth it. It's worth to keep it because I'm going to get the cash flow and I'll keep it when it's. When it's done. And I'm going to buy my time back by hiring executives.
[00:36:19] Speaker B: Yep.
[00:36:20] Speaker A: And that should be compared against. What else could you do with the money?
[00:36:23] Speaker B: Right.
[00:36:23] Speaker A: Because like, that's when I, When I think about the owner scorecard and the owner's value and like, what that means, Kim, is the.
Let's see here.
The.
[00:36:36] Speaker B: Where.
[00:36:36] Speaker A: There it is. You got my.
What the.
It's.
Sorry, I totally lost myself.
What was I saying? I was trying to find the recording.
[00:36:48] Speaker B: You're talking about the owner scorecard.
[00:36:51] Speaker A: This is putting like actual math behind. What level of effort is it gonna take to live my journey?
[00:37:01] Speaker B: Right.
[00:37:01] Speaker A: Like that's. It's very clearly putting math behind. Here's what my effort level is going to be for my time over five years. Here's how much cash flow I'm going to make over five years and what it's going to get me from salary versus distributions. And at the end, here's what my company will be worth.
[00:37:18] Speaker B: Yeah.
[00:37:19] Speaker A: And what we can do then with this, Val, with this thought process then, is say, okay, well, the reason, and I kind of want to get a little bit technical here because it's just I want to follow this idea through to completion.
The reason and I, I think I can thread the needle between geeky and common people, which, by the way, I, I said that in all, like, I don't want to.
[00:37:48] Speaker B: He doesn't.
[00:37:48] Speaker A: It's okay to be.
[00:37:50] Speaker B: Yeah, like, he doesn't mean it in a bad way.
[00:37:52] Speaker A: It's okay to not know this because it's ridiculous.
The reason we don't use the discounted cash flow, Kim, to trade value like on brokerage websites for when companies are getting sold or the investment banking world is because the discounted cash flow takes into consideration the entire entity structure, like C Corp. Llc, Escort. It takes into, you know, consideration your cost of capital, like your debt, your interest, all of the very specific nuances to like, if Kim owned Advanced Solutions. If I bought Advanced Solutions, I would have a different cash flow statement because my balance sheet would be totally different.
[00:38:34] Speaker B: Right.
[00:38:35] Speaker A: Does that make, does that make sense? So, like, we actually, like, I can't like, look at your cash flow statement and then extrapolate it into my world because your C Corp taxes, your debt structure all impact discounted cash flow for you, which is why I killed the owner's lens. It's your rate of return based on your journey of who you are in the business and the, and the whole structure.
So the reason we use these four KPIs for the market valuation lens, the Zillow lens, is because we even though cash flow is from the cash flow statement and the change of the balance sheet, I want to look at your company Advanced Solutions and be like what's your income statement? Because that's what's noble to me is your income statement the operations.
So then what we do is we say well the normalized EBITDA is an income statement adjustment. That make sense. So it's, that's why we call it a proxy for earnings because the real earnings are in the cash flow statement is that you follow me?
So it has to be a proxy. Like every single one of our members knows there's a big difference between 2 million and normalized EBITDA and freaking cash.
Like you might have a $2 million normalized EBITDA and no money because it's all stuck in receivables or you have too much debt, or you have too many interest payments or your debt structure's wrong or you took too much in distributions like all of that will impact the cash. But that's why there's no correlation. I mean there's a correlation, but it's not perfect for the owner. So what we do is we go okay, well what's the normalized earnings?
So the normalized EBIT takes all that one time stuff out and then the multiple is the assessment of the risk of that cash flow.
[00:40:17] Speaker B: Right.
[00:40:17] Speaker A: Which is why the inside the discounted cash flow buildup and or the multiple, our velocity score, which is our owner's roadmap is helping us understand what's the risk of this cash flow. Based on our functional of the finance function, the function of the revenue, the function of the operations and our planning structure and the leadership team and the compensation plans, all of the nine modules.
So the higher the rating in the nine modules and the velocity score out of 81, the lower the risk and the higher the multiple. Because the more years of cash flow someone's willing to pay you and this becomes the prove it. Like you and I are going through a couple deals with some clients and our ability to prove our story and prove this entire five year plan. So if I go back to the out year projections, the way I think about proving it, it's like here's our plan.
Our budget to actual variance is within 5% every single month and every single year we budget and then we plan and we get within 5%.
So now we believe the planning process, and then we come through and we go, okay, well, here's the plan. We're, here's like, we're telling a story and we're having the documentation. So, like with our clients, with the AI vault, with all of the material that they're building, it's like, here's a strategic plan. Here's the compensation plan. Here's our icp. Here's like, here, here, here, here, here, here. Here's all the stuff that proves the numbers.
So then we can say, well, we're, we're doubling down on reoccurring services. And here's why. Here's our strategic plan. Here's our icp. Here's like our conversion rates, here's our, our customer journey. And then we go down to the cost of goods. Here's why I approve this. Here's what we're doing. Here's who we're hiring. Here's our training program. Here's how we get labor efficiency. Here's how we get utilization. Like, and then you go, okay, it sounds like you, you told me all of that, and you get it within 5%, who's to argue with that then?
[00:42:08] Speaker B: Right.
[00:42:09] Speaker A: That is what allows us to increase that multiple. So, like, what we're saying is, okay, if this is doing all of those things is going to go us from 1.6 in EBITDA to 3.4 over 6 years.
Prove it.
Everything I just said is to prove it. Which now, going back to the valuation tab is why we go from 4.5 to 6.6 as a multiple.
[00:42:32] Speaker B: Yep.
[00:42:34] Speaker A: So we're able to, we're able to actually track the valuation every year, the market multiple and the market valuation, because we, the normalized EBITDA came from out your projections.
The multiple.
There's a whole long debate, people. We can do it online if you want, or whatever is the, the multiple is coming from a range. So professional services is 2 to 6, or home services is 3 to 8. I mean, like, so there's a range that you can get from brokers and investment bankers of what's going on in the marketplace. Like, but what we're trying to do, Kim, is we're trying to have a number that we can plan around.
Like to go to your industry association or your Vistage group or EO group, and everybody says everybody in your industry is getting a 12 multiple. Like, like what I, like what I could mathematically prove out, Kim, to people is there's no way for that company to Cash flow because what someone did was overpay for it.
If you're the seller, more power to you. And we're going to talk about the transaction value in Lens 3. But like, I'm not saying not take it, but what I'm saying is like there was a John Thwing from the SBA guy said there's a difference between probable and possible.
We want to plan around probable, not possible.
But what we want is a lens to understand if a strategic buyer comes out of the woodworks and gives us a offer we can't refuse, we have a lens to then and a framework to say, okay, what's it worth to me right now? Owner's lens. If I keep it, what's it worth to me in the marketplace now and over five years across all buyers? ESOPs Private Equity, third party bank recap.
We have a lens and so does that make sense? Is like we, we have a practical way of like this is a probable range and we want to know where we're at in the range of our peers. So if it's 2 to 6, we're using our velocity score to judge where people are at between 2 to 6. So if it's a score of 81 out of 81, essentially they would be a 6 because you're saying you've just essentially been become, you've become best in class. But if they have a low score, like the lowest, it would be a two multiple because you're not going to get a zero. Does that make sense?
[00:44:50] Speaker B: It does. And I like how it stepped over the years because it coincides with when the business is investing. And that is all accounted for in the model. Right, because you had in there, we're hiring the CRO or hiring the cfo, stuff like that. So you have it baked into the expenses of these initiatives that are strengthening your position for potential sale in the future, which then increases your multiple rate during that particular year. So I like how it's all. And it's within a normal range for that type of business, which is, to your point, readily available. You can get that information. What's the normal range for your type of business?
[00:45:27] Speaker A: Pepperdine Capital Market study.
There's a bunch out there and the.
I forgot where I was gonna go with that.
It's directionally. Oh, I know what I was gonna say. It's like. And so like if I like if. Let's say you were arguing with me about the 4.52 versus the 6.66, I would pull up the, the this out your projections all five Years of the income statement projections with all the notes and every single cell. Here's where we're hiring this person. Here's where we're doing the ERP system. Here's where we're like loading up in sales and marketing. We're gonna do trade shows here. Like, prove it. I can, I can prove it in the numbers. And then I'm gonna give you a shitload of documents that'll overwhelm you of, like, this is how we're gonna plant. This is how we're going to go from 4.52 to 6.66. And by the way, over the course of the last 36 months, every single time we do an annual planning process, we go through a whole planning process that we've been following. And we get within 8, we get within 5% of our plan.
[00:46:23] Speaker B: And all those documents that are going to overwhelm them are the documents I typically put together.
[00:46:27] Speaker A: Right, yeah, well, and you're on the revenue side, but then there's the operation side and then the cfo. Yeah, no, you're totally right. And like, it's. And it's what you typically put together. And that's what we've created in the AI vault, where like AI is creating this for everybody. Because this is all this is, is exactly what we all want to see anyways.
Like, show me the ideas that you have of like launching a product or service or diversifying away from a product or service or hiring someone or doing this or changing your pricing. It's all right here. It's all here. People go, well, it's like back to, I mean, the broken record of the way to be healthy is sleep eight hours, eat well, sleep well, push and pull something every day and have a purpose.
Like. And so it, it's just doing the annoying, tedious stuff, iterating over and over. Because the value of having the information is insane. Because otherwise we're guessing. So to keep us going, market valuation, normalize. Normalize. EBITDA times the multiple that gets us to what's called enterprise value.
Enterprise value is the purchase price. My house is worth 800 grand if I have $900,000 in debt on it. That sucks.
And so the enterprise value, like, my dad and I had a high eight figure enterprise value in 2009. When I started, we were below.
We were under underwater because of the debt and the whole structure. So like, back to, like, even if people are not focused on revenue and employee count and they're focused on valuation, if it's enterprise value, it doesn't fucking matter.
Like people like Joanne Fabrics went bankrupt. 98 of their stores were profitable. They had too much debt from the private equity firm. Toys R Us, Very profitable company. Too much debt from the private equity firm. And then it was Schwann's down in Minnesota. Like, like the Schwans, like cre, like home delivery, super profitable, went bankrupt.
[00:48:19] Speaker B: I used to love them.
[00:48:21] Speaker A: Yeah, private equity firm totally. I just nose dive into the ground.
It's like wealth extraction at a freaking pace that we've seen before. Because things can be profitable with too much debt. Then we go into, there's cash.
So cash that accumulates on that balance sheet and then there's funded debt.
So the funded debt is line of credit, any kind of loan structure, sba, conventional sellers notes, whatever it might be equals net debt. So net debt means here, there's a million dollars in debt over here. In 2030 we will have accumulated $1 million in cash above and beyond our debt.
Because when you sell a company it's cash free, debt free. So in this example in 2030 that the normalized EBIT is 2.85. Supposed to be 3. Because of our case study 6.6 gets us to enterprise value of almost 19 million bucks.
There's almost, there's 1.9 million in cash.
But then we have eight hundred and fifty grand in debt which leads us to we on top of that 19 million we have an extra million dollars in cash.
And then we have to deliver a normal level of payables, receivables and inventory. So this negative 285 shows that we are going to have to deliver a little bit more because that's just nor. That's a, that's a calculation that's showing that we are either going to owe oh or get more based on the formula of what our working capital would be. But we can go from an $8.9 million enterprise value to a $20 million equity valuation because we paid off our debt, kept the additional cash.
And all of these numbers right here Kim, are coming straight from these out your projections.
[00:50:13] Speaker B: Yeah.
[00:50:15] Speaker A: And what I like what people can do.
So let's say they don't have a three statement model. They can put in all that information but if it's not mathematically connected to today, to today, we have no idea what kind of reinvestment. Cash reinvestment versus debt debt payments, taxes, distributions. So we're making up so every single vistage workshop that I'm doing. Everybody I want 100 million.
Super creative. Everybody wants to be 100 million and they have no idea how much cash it's going to take to get there. And so I'll come back to the transaction value in a second, but you look at out your projections here back. So I, I want to go from the income statement down to the cash flow statement.
So we're in the cash flow statement now, which is the difference of the balance sheet every single year. So we're looking at the tax liability over the next five years, the distributions, and then we go into the cash in the checking account.
So came back to like the actual mathematical way of us showing that scorecard trade off. If someone said to us, like advanced Solutions said, I can't be worth $20 million. I can't have the valuation be worth 20 million. It needs to be worth 40.
What we could actually do is show them how fast they would have to grow over the next five years.
It would eat up every single ounce of cash. And I am almost convinced this is just a judgment call. This cash at the end of the period would all be negative and for a long, long time. And so the way that this model works, when this is negative, it means that you're going to be tapping your line of credit.
[00:52:05] Speaker B: Yeah.
[00:52:05] Speaker A: So this is just an easy way because it's not gap. It's like, because it should be on your line of credit, but that's not as fun as being able to look at the very bottom and go, cash. Yeah, real money. And so it's a very easy way to say, if this is negative 500 grand in 20, 28, your line of credit better damn well be 500 grand. Otherwise you're begging for money from someone.
And so that's where that decision tree starts coming in. Because you go, okay, I want 40 million. So I want my wealth to be higher.
But someone says, well, I can't, you know, give up my distributions.
Okay, Alice. Like, I want it all. Not Alice, it's the woman from the Willy Wonka. I want it now back to my, you know, Kevin Warshaw, Jerome Powell, I'm not the Fed. We can't print money. Like, we have to. We have constraints. And so if this is negative, then you go up the, the capital structure, okay, Tap your line of credit. If it's temporary, totally. Okay. You know, if you, if you're burning some cash and you're like, you want to put some stuff on your line of credit and your bank is fine with that because your growth, it's a great way to fund the growth. But then if it happens for like four years without you being Cash flow positive and you start, you know, busting bank covenants and you're starting to take distributions. The bank covenants might say you can't take distributions if you have certain thing things going on.
So then you have banking constraints, banking covenants, the line of credit size. You know, do you get a conventional loan for seven years? You get a conventional loan for 10, you know, an SBA loan for 10. I mean you start going through the whole debt structure. Then you're like, well that's not enough. None of you need mez financing or well maybe I don't want that. Maybe I need more equity. Where, because equity is cash infusions which comes right here, owner's contribution, stock.
But then you're selling part of your company and you go, I want to give up my control. And like this is where like you start to see all of the things that we get push back on. It's like I'm not going to tell you what to do. I'm just going to say this is exactly how it works.
[00:53:50] Speaker B: So like the trade offs.
[00:53:52] Speaker A: Yeah.
Is this, I spot check. How am I, how do you think I'm doing? How you. Any questions? Thinking about our, our members.
[00:54:01] Speaker B: I don't have any questions. I think this makes a lot of sense. I think you painted a really good picture for like all the different scenarios that business owners think through. I want growth, I need cash. I like all the different things.
You did a good job painting how they're all connected in this model and it allows you to see the trade offs between them and see it five years into the future. So that way you can see, see, maybe you're not going to meet the valuation goal that you had for like if you need that to be 40 million, like you're going to go broke in the process and you might not want to do some of the other options that you need to do. So 20 million is the realistic number for your wealth. And so it just, I think again it gives benchmarks, it gives realization and it's a tool to make informed decisions on how to manage the business moving forward.
[00:54:54] Speaker A: And what I was saying about like if you, it's because someone could put these numbers down. We used to do this in our, my workshop years and years and years ago, like putting people's goals out like this because that's super helpful. I really think it's like, okay, what do you think your normalized EBITDA target should be? What do you think your multiple target should be? Debt, Cash. But if there's not a mathematical series of events that gets us there.
We have absolutely no idea how much cash it's going to take or consume or what that does to anything. Right. So there's not a complete picture.
[00:55:26] Speaker B: That's why I love this model. The very first time you showed it to me, I was like drooling over it because it actually being in the revenue seat used to drive me nuts when people just write down their five year goals but they had nothing, they didn't have anything tied to it. Well, that's nice. But the how, how are you going to get there and what needs to happen in order to make that a reality? Like, I'm happy to like do my best, but I need to know the how. So that's why I love this model because it identifies any constraints and it shows you what all the trade offs are along the way.
[00:55:55] Speaker A: I think you know why you and I, when we started talking after you left Crow and ITR is like, hey, like my, my heart goes out to every single consultant or salesperson that is in like the revenue help bucket. I'm gonna call it the help bucket because what I hear when owners say I need more growth, you know what I hear?
I need more cash.
And they have absolutely no freaking idea how that's going to happen. And the bummer part is, is all of that pressure of that silver bullets getting put on your your shoulders and there's a solid chance that more growth creates more problems, more working capital, payables, receivables, inventory, more employees and less cash.
So when I say there's like a third of our members that are like, I'm gonna maintain this, optimize the out of my margins and print money because like they like one of the, one of the guys that did the testimony is like, I realized I'm already at my goal.
He's like, this is awesome. I'm like, yeah, don't screw it up. Yeah, it's like, like what a wild invert of like I need more growth and panic and fear to.
[00:57:05] Speaker B: Holy shit, I'm already there.
[00:57:07] Speaker A: Optimize this. Yeah, I'm like in. That doesn't happen all the time, but it does happen more often than most people think. And because we have this visibility of time, cash flow, wealth, trade offs.
All right, I know we only got 10 minutes here.
Maybe I'll wrap up a little bit as I'll keep going and then we can figure it out. So this market multiple cam is what is inside. Like these, each of these years are only possible because we have the three statements planned out for all five years. And they're all connected. So that's what I mean by the closed loop system. This is point B. Like the point B is everything's mathematically connected so we can see everything between now and when that point B happens.
Then the inevitable question comes is, oh my God. But people in my industry and private equity are overpaying for companies. I'm like, great, understood.
The chances that someone gets all cash at closing is very low.
Doesn't mean it doesn't happen. Doesn't mean it's not possible.
I wouldn't want to personally plan for five years around 100% cash at closing. And I have no wiggle room for that, for anything besides that. So what we're doing here is we're saying, okay, the market equity valuation, which is what we just had up here, right? So that's lens too. So everything kind of starts with the next one. That's why we call it three lenses. And I've got like the circles inside the circles because like we're looking through all three lenses on our monthly meetings, our annual planning and our quarterlies. Because I'm saying, should I keep the business? What's it worth to me? What's it worth to the outside market across all the different buyers? And then if I have a specific transaction in front of me, what does it mean to my owner scorecard? And it's like full circle and we just iterate with total clarity. So the market, the way we answer that, if I got a, like a situation where I might want to actually sell this thing regardless of the buyer, like esop, private equity management, bio, whatever it might be, you say, okay, well it starts with in each year we can, we can project this out. We can project out if I sold the business across all the years, regardless of the buyer. If we take some assumptions. So we say, okay, well market equity valuation is what we had market or in the lens to.
Let's assume I like planning around 60 cash at closing.
It's totally arbitrary and totally made up by me. But like what I, but I would say it's educated guess of like ESOPs you can get 50% cash at closing. Pretty, pretty straightforward. A bank where they'll recap and refinance based on Management buyout.
50% ish. So like, you know, private equities will pay more, third parties will buy more. Like, like, but like let's take, let's take 60 and we've got all these inputs over here, Kim, that anybody wants to argue with this. Like, I don't know, you and your AI go to town. But, like, this is the truth. So, like, you want to change things, go for it. But like, what we're doing is we're putting the variables in that, the constraints, like the outer perimeter of that puzzle. So, okay, 30%. I'm sorry, 60%.
So then we have gross cash at closing.
Gross meaning before taxes and fees, you're going to have to pay bankers, attorneys and CPAs.
And so there's a. I've got this.
[01:00:16] Speaker B: All right. I had to.
[01:00:19] Speaker A: Maybe it's a lot of tokens. Let's say, okay, you're going to have a fee. You have a fee.
I've got 5% cash or 5% deal fees.
It's a variable. I don't want to argue. It's a variable. It's got. You're going to have that somehow, if you're going to have a phantom stock plan, that's going to have to come out of the deal as well.
So for your executives, that's module 8. So then there's taxes of the gross cash at closing. This is assuming no basis. This. I mean, like I. You see what I'm saying here? Like, there's a lot of variables, but we've got the components here.
So I'm going to give the 2020, or I'm going to give the current year and then the five year. So market equity valuation, 6.2 million. 60% cash at close gives us to 3.7 million. We have 360 grand in tax, in fees, deal fees, and then we have 934 grand in taxes, leaves us with $2.4 million cash at closing on a $6.2 million equity valuation, which is a 7.2 million dollar enterprise value.
[01:01:25] Speaker B: Yep.
[01:01:25] Speaker A: They call it the waterfall. 7.2 less debt, 6.2 cash at closing, 3.7 taxes and transaction fees leads us to 2.4, 7.2 million down to 2.4.
And then you go, oh, and then there's the contingency. Contingency is rolled equity. It's earnouts, it's escrow. I don't want to get into the differences of all those. Right.
It's at risk of someone else running your company in the future.
So, yes, it's yours. But like, if most of the deal is still in contingency and you're not financially free, essentially you thought you got free, but now you've got a boss and you still have. You still have to keep working to retire.
And so closing cash plus net remaining deal is 4.9 million bucks.
And like but in 2030, we can go from a $19 million valuation plus our cash equals 20, roughly 21 million.
60% cash at closing is 12,000 or $12 million.
Deal fees, 940 grand. Phantom stock plan is 225,000.
Taxes are 3 million. Leads us to net cash at closing of 7 million.
7.8 of the 12 remaining deal values. 8 point. Call it $8 million. The remaining phantom stock is. I'm sorry, the phantom stock paid is the 225, which leads us to 7.7 million bucks.
But we have another remaining 8 million.
So we can at least see all of this. And the. The owner scorecard, essentially, Advanced Solutions wanted to net 15 million. They want their net worth.
So I'm going to go all the way over here real quick to the owner scorecard.
They wanted 15 million bucks in their net worth. So they're able to see how their time goes down because they're hiring people.
Their salary goes up and then goes down because they start getting the. The other. See the distributions.
And then we have the market equity valuation is 6.2 to 20, 21 million.
And their total net worth goes from 7.9 million to 22 million.
And you can see right here, see that we have seven. There's seven million short. If they sell today.
Short of goal, short of goal. And then they've got a surplus of. I'm sorry, not. Not sell. That's. That's. If they just. That's the valuation in their portfolio, they're. They're still short $7 million, but they're. They have a surplus of 7.3 in 2030.
But there's this wealth of you sold. It shows that there's still a shortfall because of that contingency.
[01:04:17] Speaker B: Right.
[01:04:17] Speaker A: They want $15 million as their target for their total portfolio, because 16 or 15 million at 4% wealth withdrawal equals 600 grand, which is their lifestyle. So that's escape velocity, where they've perfectly hit the passive income from their portfolio.
But what we're showing here is that the owner is still slightly short because their outside assets is $10 million. So they would take that, roughly that 7 or 8 million bucks cash at closing after taxes, plus their savings and investment and their house. And they're a little over 10 million bucks.
But they still have $8 million in rolled equity and other stuff.
Right? So it's not nothing. So the kind of. The thought process back to decision making, Kim, is this person goes, I'll take $10 million cash in my checking or in my portfolio.
Yeah, I Might have some at risk, but I really, truly want to be out and de risk this. So they're. They're technically not perfectly financially free on that passive 15 million 600 grand at closing. With all of the cash at closing, they still need some of that 8 million bucks, but they only need half of the 8 million.
[01:05:31] Speaker B: Yep, that makes sense. So it's this part here, this transactional section.
When you start baking in and continuing to reduce the number that I've seen, like, get people, because they don't realize how all that works either. They're like, oh, my business is worth 15 million, so I'm gonna get $15 million in cash. And then it's like, going through this whole exercise of, like, well, wait a second now I need my business to be valued at, like, 26 million so I can. And get the cash that I was looking to get out of it.
[01:05:59] Speaker A: You got a partner. How about two partners?
So you're sharing it with multiple partners and Uncle Sam, and then someone's going to be your boss, and you still have to work to get the money that you originally wanted. I mean, it's a total f job.
[01:06:14] Speaker B: Sounds like an ide.
[01:06:15] Speaker A: Choose your hard.
There is no easy button. I mean, is it possible that someone comes with a bag of cash, gives you more than you need because you have a specific thing, a customer, a product line or a, you know, a territory or whatever that you. It's 100% possible that someone gives you way more than you need without knowing how to do any of this stuff.
And what happens is that person then gets rich. They go on podcasts and say, all you need to do is insert ridiculous, stupid comments.
Kim, what does this mean? How does this all come together?
We need this. It's point B and it's three lenses. So that way, every single year in annual planning, we should know, what's this worth to me if I keep it? Which is my.
My. Like, I got my distributions. I can see everything. I can see everything. We just walked through. This is what it means to me. If I keep it 6 million bucks over the next five years, I can literally say every single year based on what I'm planning on doing with this business, I'm going to go from $6.2 million market valuation to $20 million because of all the things we talked about. And at any given point, if I get an out of the blue off for offer or on a quarterly board meeting or an annual planning, we're going to come back and say, well, what happens?
So not only is whether what's the offer but what's the deal structure more most importantly. And then we can we have like complete, we have complete visibility into all this stuff. And then we have to have the out your projections out your meaning years two through five.
Because if we're looking here at Kim at column X which is year 2026 again for everybody, that's essentially the budget year. So think about that being 2027 given when this is recording. So that would be the next year. So the budget is the ground up monthly budget, all three statements. Because that's the bridge Kim between now and then these out years, these out years are being calculated based on like here's some growth rates. Right you can see here we're really diving into that reoccurring service. We got an acquisition plan here. So like you're just putting it all in there.
Growth rates on all of the cost of goods, all the sgna. You're putting your balance sheet drivers in there for like cash versus debt of equipment and reinvestment. You're putting like all of it we back into then the 2026 budget which again is just next year. So think about 2027.
See how now we have this is the only year that's got all 12 columns for all 12 months and it's all three statements mathematically connected together. So when you look down here you can see the cash flow statement and say okay well here like so here's the 150 grand Kim. But you see how it's 12 five a month and then we've got our tax bills here.
[01:09:03] Speaker B: Yep.
[01:09:04] Speaker A: And so like you can just see it and say okay well we're gonna have 309 grand in taxes, 150 grand in distributions. And you can see your checking account number inside the budgeting tools. We can actually plop in there, say we want a minimum of 150 grand in cash because of our gut because whatever it is and we can see when that red lines we have all of our normalizations down here because like part of our budgeting plan. Plan should be like what are you going to be doing so right. Sizing owner's comp. Maybe there's add backs of coaching. Now all of our clients here, Coaching services is an ad back software. All those are just stuff as part of the budgeting process.
So the budgeting process that we're all going through right now is build up ground up revenue so we can prove these numbers. So not only do we have month by month by month, line by line by line with the very Specific growth rates and the seasonality. But then we have all of your material. That's the prove it. Like I don't really want to see the prove it every single day. As the owner and the, the board, I want when this is off, you better get up and explain to me in great detail why we're on tracker, off track.
That's what allows us to, to reduce that variance to get below a 5% accuracy of forecasting like what you did at ITR. So then the, all three statements are tied together, which is why then we're looking at the balance sheet drivers here. So this is part of that question that that one guy was giving you some pushback on.
Here's what we're doing for the balance sheet. We're actually like building out the balance sheet drivers and we're then able to forecast out the balance sheet based on what the income statement's doing, which then results in the cash flow statement.
Once we do all of this and we have this perfect three statement budget for next year, we can then connect that to the five year so we can get the valuation.
So now what that allows us to do is as I wrap up and zoom in for the, the, the, the home run here over the next five minutes is what we want to do next year is have monthly meetings on track, off track.
Zoom out a little bit more on the board meetings. Go on track, off track. Based on whether we're on track or off track, should we do different things with our capital allocation structure? Are we running out of cash? Should we not reinvest? Should we like, should we slow down some of the plans because we're off track?
We don't want to pull like the, the breaks on the monthlies. We want to use the quarterly board meeting to say how is everybody doing?
And the way we do this, Kim, like we've got here in this model, there's a scorecard we already reviewed. We have the, the tabs for each executive.
So here's the CEO's tab of all the metrics and the graphs.
So this is the CEO's tab. So on the fourth Tuesday of the month, this is what we do with our coaching calls. Review the KPIs. There's a CRO tab on track, off track with all the different revenue lines, client acquisition costs, revenue to budget the CFO's tab with all the on track, off track with all the CFO's numbers.
CEOs tab with all the on track, off track with all the CEO's numbers, which is, so it's Revenue, gross profit, and margins and earnings.
And then let's say we get to the quarterly where, like, you and I are doing a board meeting where the board is sitting down with the CEO, CRO, cfo, and COO on track, off track. Tell me the story.
So when we go here, we have this on track. Year to date.
This could be in here. If we. If this. Let's assume this was like the. A whole quarter. So this is the whole year. But what we're doing here is we're seeing Kim year to date versus last year.
Right. So we're going through then the revenue and say, okay, well, a year to date and 26 for. Or. Well, this year versus last year. So we're up 11%.
But then we go over here. Cam, look at this.
But our budget, we are actually over here. We're missing some stuff. So the variance is 1.4. So not only if people looked at like, oh, I'm only looking at last year. Look. Wow, we're up 11.
[01:13:15] Speaker B: Like, that's nice. How about to our budget? Yeah.
[01:13:18] Speaker A: And now it's only 1%. So, like, essentially, we're on track.
And then over here. So we got the year to date, actual versus last year, and then we got the year to date, actual versus budget.
What's the. Then my question would be like, okay, what's the full year again? All right, well, here's the full year. It's 10 million.
What's the gap to the target? 3.1. And then if we average that out per month, that's left.
We could do the same thing with cost of goods. Same thing, you know? So we look at the margins, like, okay, we're the difference. We went from seven point. We're at 7.9% in net opera. That's not the margins. We're at 35% in the margins. Now, last year was 35.
But over here. Oh, the. We. Our actual 35, we plan for 37. So we're down two points.
So, like, it's like it only. We should only be judging ourselves in relationship to where we want to be going next year. And next year needs to be in relationship to where we want to be going in year five.
And then this little area is so fun because you go, okay, well, what's.
What's the makeup of the gross profits? What we're seeing here is the revenue and the margins will impact the gross profit. So what we see here, Kim, is 6 point. Like, we did 6.1 in revenue and 6.8 this year. So 6.1 last year our gross margins were 35 last year and 35 this year.
Our gross profit, the dollar amount, was 2.1 last year. Now it's 2.4.
So this shows over here, Kim, that our gross profit is 230 grand more.
But that became. That only came because of the revenue growth and our margin change because of that margin shrinkage. We actually lost 9, 9, 700 because of that. So we still are up $239,000 against last year, but that's only because of revenue.
[01:15:14] Speaker B: Yeah.
[01:15:14] Speaker A: And down here we can see that the year to date versus budget, the gross profit with the revenue and the gross margin. So revenue of last year is 6.7. I'm sorry, the revenue budget for this year to date is 6.7.
Our gross margin target was 37, which leads to 2.5 million.
What we actually did was 6.8 at 35 margins, which means we have $2.4 million.
That means we are $105,000 short of our gross profit because of the 2% margin compression because of insert economic problem, inflation, payroll, whatever it might be.
But what we can see is like, well, what, what's the reason of the. Like where'd the 105 come from? Well, we actually made 35 grand more because of the revenue, but we lost $140,000 in actual profit because of the shrinkage of gross margin.
Insert Casey. Boo Casey at boost price. Right.
Sorry, Casey, just you were texting me. So we're thinking about you like, but this is how we provide that rate of return. And then this turns into real cash in the cash flow statement.
But can we go through on the monthly and the quarterly is going year to date versus budget, year to date versus last year. And then we do that for.
So this is where the CRO explain to me.
The COO for the margins explain to me.
And then the CFO is all the SGNA with the net operating income and then normalized EBITDA explained to me.
And then we go all the way down to. Then the owner cares about the cash distributions. I mean, so I think that that is like the only way we can do on track, off track and know where we're at in relationship to where we want to go is doing all this stuff.
[01:17:11] Speaker B: I agree. Like we said, the truth is no longer up for debate.
Like it shows you the performance of the business. It shows you all how everything ties together. It gives you your point point A, all the way to your point B over your five years. And it ties it all together.
So. And it's math. That's why I liked it. First time you showed it to me, I was like, this is amazing.
[01:17:32] Speaker A: Oh, and every single question that people have is inside of there.
[01:17:39] Speaker B: Yeah.
[01:17:39] Speaker A: Every operational decision, every ownership decision. And I just love the quote from Andrew Huberman. I'm not going to tell anybody what to do. I just want you to know what you're doing.
[01:17:49] Speaker B: Yeah.
[01:17:49] Speaker A: This is the only way. So like, all of the goals, all of the assumptions, all of the strategies, all of the sales stuff, all the operations, all the ownership decisions are 100% your call.
The math is not.
[01:18:04] Speaker B: Yeah. And you gotta just decide what the trade offs are. Right. So I mean, all of our clients are going through and going through this exercise right now. And I'm sure all these other businesses too, planning for next year. Do we hire that sdr, do we hire that executive leader? Do we invest in marketing next year? Do we invest in product development next year? Like in all those answers, questions could
[01:18:27] Speaker A: answer, what do you think just going
[01:18:29] Speaker B: through there in that exercise.
[01:18:30] Speaker A: So, yeah, well, and it's insanely powerful with AI because like when I walk through this with AI, I'm like, you cannot mathematically change the distributions, you cannot mathematically change the valuation targets, you cannot mathematically change the working capital formulas. So I like, like lock in all of the math for all five years of the, of the cat, the capital structure and the valuation target. So you can say, we are not moving this ever.
And then it's, then what happens is AI goes in there like, well, you can do this with revenue and this with margins, then this. And like, we then can use and leverage AI to say, like, I don't know, the infinite amount of things that I could do to accomplish the cash flow and the valuation targets. The infinite. We're going to quit selling copiers and start selling lawn mowing services. Okay, tell me why. Like, so, like, it's insanely powerful for working with their, you know, peers. Like, okay, now I know all this stuff. What do you think about this and what do you think about that and what do you think about this? And like leveraging AI, leveraging your peer groups, leveraging your advisors becomes so powerful because you're not wondering about the rest of the game. You're just like, okay, all that's just locked in. We just have to figure out how to do it within the constraints that we have.
[01:19:44] Speaker B: Yep, exactly. It's a very powerful tool you got to run.
[01:19:49] Speaker A: Thank you so much. We will put the link to the workshop, the, the valuation workshop. 100 bucks for anybody that's not a member. Everybody that's a member gets it for free. Valley Prairie Capital is going to be taking this conversation to a whole new level of, like, how it actually works within the.
The reality of the day to day of actual company evaluations.
[01:20:07] Speaker B: Yeah, I'm excited, excited for the workshop and hear them go through it. They provided so much value add and insights at the summit. So I'm really excited to have a dedicated workshop for it.
[01:20:18] Speaker A: All right, you gotta go, Sam.
