Podcast: What Factors Impact Predicting Future Value of a Company? Interview with Ken Sanginario
Ken Sanginario goes over the key areas to look at when evaluating the current and future values of your company.
About the Host
Ryan is an entrepreneur, podcast host of the show Life After Business and the co-owner of Solidity Financial. Having personally experienced the hazards of selling a business, he joined up with his friend Brandon Wood to educate others on the process. Through their business (Solidity Financial), they provide a platform for entrepreneurs called The Value Advantage™ that helps in exit planning, value building and financial management.
About the Guest
Ken Sanginario is the Founder of Corporate Value Metrics, creator of the Value Opportunity Profile® (͞”VOP”), and developer of the prestigious new Certified Value Growth Advisortm(“CVGA”) training and certification program.
Ken has more than 30 years of experience providing executive leadership and strategic advisory services to private middle market companies, developing and executing business improvement initiatives, turning around distressed operations, managing M&A transactions, valuing companies, and securing equity and debt growth capital.He is an instructor in the training and certification programs of the Alliance of M&A Advisors, Pinnacle Equity Solutions, and the Exit Planning Institute, teaching about business value growth in each program.
He also serves on the advisory board of the MidMarket Alliance as its educational leader, and serves on the Boards of Directors of several privately held companies Ken is a frequent speaker at national and regional conferences and private business owner functions, and has authored numerous articles on business value growth, corporate valuations, mergers & acquisitions, and turnaround management. Ken is also the Board President of Solutions at Work, a charitable organization focused on breaking the cycle of recurring poverty and homelessness.
If you listen, you will learn:
- Some of the milestones that got Ken to where he is today.
- The first thing Ken would do when getting into a turnaround in order to keep the company running.
- The importance of having a cash flow statement.
- The main things Ken looks at to determine the value of a particular company, as well as how its value would relate to transferability.
- How Ken would advise a business owner who is in the middle of a crisis.
- Some of the categories that Ken keeps in mind when figuring out a business’s valuation.
- Some specific challenges that Ken has helped companies overcome.
- Why it’s so hard for consultants to get business owners to change.
- Why having a process you can measure is essential.
Ryan: Welcome to Life After Business Podcast where I bring you all the information you need to exit your company and explore what life can be like on the other side. This is Ryan Tansom, your host. I hope you enjoy this episode.
Welcome back to the Life After Business Podcast. Today’s guest name is Ken Sanginario. Ken is the founder of the Corporate Value Metrics and creator of the Value Opportunity Profile and also the Certified Value Growth Advisor. Ken has had 30 years of extensive experience in the turnaround world, M&A, and valuations and has every formal certification under the sun that’s associated with these topics.
What Ken brings to the table with his crazy amount of experience and all of his knowledge is the system that he has developed that literally shows business owners what to do with their strategic plan and how to implement it and how to measure that. I think the biggest challenge that we all have is there’s the scaling up rockefeller habits, there’s traction, there’s all these different consulting practices out there that are very difficult to measure what the value is that we’re getting and what are the projects that we’re implementing and how do we measure that.
Ken’s system has 47 subcategories that roll up into eight key drivers that roll up into a business valuation and can show you and measure every investment of time and money, what that does to future value because value is the predictability and sustainability of future cash flows. Measurability is huge because every decision that you make, you wanna make sure that you’re going in the right direction to build value.
Ken gives us a little bit of a background on the turnaround work that he did and how he came to the conclusion to build this tool through the discrepancies of the reports that they would give in the turnaround companies to the banks. He decided that because there are discrepancies in the reports that they would give banks and how well the company was doing, that there needs to be a universal system on how to measure value based on all of these strategic things that companies are doing and then how to slowly continue to fund your growth through doing the right things.
Ken has a ton of great advice that he brings to us throughout the episode and he focuses on predictability, sustainability and transferability of a company and how that creates value so you can have options to do whatever you want in the future with your business.
I really hope you enjoy this episode with Ken, he’s got a ton of gold nuggets. Without further ado, here’s my episode with Ken.
This episode of Life After Business is sponsored by The Value Advantage. The Value Advantage is a platform delivered via peer groups and/or one-on-one to help you build a valuable company that can thrive without you while putting an exit plan in place so you have the options to sell when you want, to who you want, for how much you want. You’re able to manage the business by numbers, work in the business as much or as little as you want and you fully understand how the business impacts your personal financials. If you wanna know more, check out the show notes or the website.
Ken, how are you doing today?
Ken: Feeling great, Ryan. Thanks for having me. How are you doing?
Ryan: Doing good. Thanks for coming on the show. I’m looking forward to having you on because you’ve got a really, really depth knowledge in the topic that we’re gonna be talking about. As we get into building business valuations and building business value, can you give our listeners some of the milestones of how you got to where you are today?
Ken: I’ve been a consultant for about the last 18 years, focused a lot on turnaround. I’ve been a turnaround consultant, certified and trained. I’ve worked extensively with companies that have been underperforming, sometimes they're deeply distressed and didn’t realize that they were distressed.
Often I would be brought in by private equity firms or commercial banks when companies were in default or sometimes by the business owners themselves. I would often take a deep-dive executive level position, often CEO or Chief Restructuring Officer. I’ve had the mandate to develop and execute a turnaround strategy and then refinance or recapitalize or sell the company on the backend of that turnaround.
Those, often, would last anywhere from 6 to 18 months on a full plan basis. A number of those engagements over the years all around the US and some up in Canada as well and one in Europe as well. That was part of my practice. I also had a part of my practice that was focused on mergers and acquisitions and typically that was on the backend of the turnaround where if I was involved in the company for 6 to 18 months, who would know the company better than I?
I also was trained and certified in mergers and acquisitions and I could manage that transaction at the backend of the turnaround. Occasionally, I’d have an idea for just a really strong, healthy company outside of my turnaround world but typically, they were involved in a turnaround before the transaction.
The third big part of my services was business valuations which I also got trainings, certified. I would use the business valuation body of knowledge to help the private equity firms or the banks or the business owners or all of them to understand the value drivers in a company at the beginning of a turnaround and then be able to measure the impact of improvements that we’re making at the backend and then revalue the company at the backend of the process and so forth and get ready for a transaction.
Those have been my service props. Before that time, I was a CFO for a few different companies, one public and two private over a span of about 14 years. I did a lot of turnaround work in those capacities as well in addition to a lot of raising private equity capital to roll out concepts for a couple private equity companies and did a lot of restructurings as well. Before that, I was in one of what used to be the Big 8 accounting firms back in the early and mid-80s, now the big four.
That’s what my career has been like; but what I found is all of these different avenues, people would often ask me, “You’re involved in M&A, and turnaround, and business valuations? How do those service segments fit together?” In truth, they fit together better than anybody really realizes because whether you’re trying to fix a company, improve the performance, buy or sell a company or value a company, essentially the frontend of all of those processes are the same.
You need to get a very broad and deep understanding of the entire enterprise as quickly and efficiently as you can. That’s the commonality. After that frontend process, of course, the backend process is different for each one of those service segments, but they all impact each other and there are a lot of similarities in the overall processes.
Ryan: Through all those different experiences, you get the whole 360 picture of the company instead of just approaching it from one silo and from one specific angle.
Ken: Exactly, you really need to dig in. Even though my background was in finance, you really need to become an operationally focused financial expert. You need to be able to dig into the weeds of the company and understand everything there is to understand about the company and where the root drivers are relevant, the symptoms of problems.
A lot of times, business owners or private equity firms or banks, even, they think they understand where the problems are in a company. Too often, those perceived problems really are only symptoms of problems that are being driven by, sometimes, a multitude of factors that are elsewhere in the company. They don’t even realize that.
Ryan: It’s a ripple effect. The financial is telling a narrative but the narrative is in the people.
Ken: Everything is about the people and the systems and processes and everything they have setup and the operations and the efficiencies and inefficiencies. I found over the years that, virtually, every company is underperforming in some way, even healthy companies could be a lot healthier if they understood where their weaknesses are or where they might be imbalanced as an organization.
Ryan: I wanna dive into that because that comes into what you’re doing right now. But before we do that, I wanna peel back a little bit on some of the turnaround because I was in a very distressed family business when I first started. We had our own turnaround. First of all, the callousness that you must have and the ability to deal with stresses, you gotta be pretty phenomenal to want to go back over and over and over again.
Like I said, we’ll talk about how you’ve applied all of your experience and knowledge into understanding this in a very deep way. As you would go into these turnarounds, what would be the first thing that you used to do, the first couple things that you do because you’re essentially getting thrown right into the fire.
Ken: That’s actually right. Sometimes I get a phone call on a Friday from somebody saying, “Hey we got this client and they’re not gonna be able to make payroll next Thursday. Can you be on the ground Monday morning?” It’s halfway across the country.
Ryan: And you don’t have money, by the way.
Ken: They have no money.
Ryan: You’re not the one with the money. You’re going there, you’re not just gonna write a check, you’re going to fix the problem.
Ken: I’m going to fix the problem. They’re not calling me for capital, they’re calling either to come and pull the company out of fire. They’re not always that level of crisis but sometimes they were. But often, the first thing you have to do is quickly get your arms around the cash flows of the company. That’s usually the first thing you do, is [00:11:25] everybody and get a thorough understanding of cash flows and liabilities and work with the supply chain, which ones are shutting you off, which ones are critical, which ones you have to talk to right away to keep things moving.
The first step is to keep the company running because if the company shuts down, it’s very difficult for them to get back up and running. You need to understand the cash flows and then understand the supply chain in parallel and then understand the customer base and what’s in the sales pipeline. We would always build a 13 week, at a minimum 13 week, very detailed cash flow to be able to manage all of that.
As soon as you get that under control, sometimes that would take a week or longer just to talk with individual suppliers or customers or the bank or whoever is putting pressure on the company to get everybody to just step back, take a breath, it’s gonna be okay, there’s a business here, we’ll be able to make it, we need everybody to remain calm.
Ryan: The voice of reason in your head.
Ken: It is, it really is. That’s a big part of what a turnaround consultant does, keep everybody calm so that you can think through the issues in a methodical way and not react but rather respond to the challenges appropriately and be able to put in permanent fixes, not quick fixes that don’t last but you need patience from everybody. That’s typically how it would go to start off. The longer you’re there, the more permanent and long term improvements you can make.
Change in culture and things like that takes time but it’s amazing. At the end of the process, when you look back and you hear management teams say to you as they now have returned to profitability, they say, “Gosh, I just can’t even believe the way that we used to run this company and where we are today.” Doesn’t take many of those to get into your blood and then you’re hooked. It’s a very rewarding feeling to be able to turnaround a company like that and see them return to prosperity and so forth.
Ryan: There’s so many different things we can dive into as we talk about your methodology but just one quick question, how many people in the midmarket space that you’re going into actually had a cash flow statement when you went in?
Ken: None. I think it’s pretty much none. They might have a little bit of a spreadsheet but there was never at a granular enough level. Usually, they were relying heavily on banks, trying to predict when checks would cash or you’d walk in and they’d have 200 checks cut, they’d be sitting on the window sills of CFO offices or controller’s offices and there might be 12 weeks worth of checks that were cut and not being sent and they would pull checks out here and there as they were getting pressured by the suppliers and so forth.
Ryan: I’ve got a horrible visualization right now. It’s like, “Hey, this person yelled harder than the other person so we gotta get their check first today.”
Ken: But nobody really had a good handle on where the company was or how they are going to get out of their predicament.
Ryan: Let’s talk about how you’ve taken all of this knowledge and a little bit about your practice because your practice has to do with all of these value building strategies that you have. Let’s give the listeners a little bit of a backdrop of what you do now and then we can start peeling back all the different types of ways to build value within a company.
Ken: Back when the recession hit in 2008, we were getting engaged by some of the larger banks, the national banks, the workout groups in particular of those banks. As the workout groups were getting inundated with troubled corporate followers that were getting pushed in to work out, the workout groups needed help just triaging the influx.
They were engaging us to go into the field, spend a week or two assessing the company and then writing a report and coming back to the bank and giving them an invitation of, “Is this company a trainwreck that we need to fix right away, or can we put it on the back burner while we deal with other more urgent companies. Can it be fixed? If so, how and can you help fix it?”
We started doing a lot of these types of assessment engagements. As we were doing those, a couple things occurred to me. One was that if I assessed a particular client and then one of my partners went, if they were to go to assess the same client, our conclusions would probably end up to be the same because we all were very good at what we did but our reports would look very different, our writing styles were different.
We covered different issues and different sequences and different depths and so forth. But it occurred to me that there really should be a standardized approach to assess the company like this especially companies that are in trouble, where we could do it efficiently but have our reports all follow a standard flow so that if a bank is looking at our reports, they would know that all 10 of those reports were going to look and feel the same.
I thought if we can somehow figure out a way to assign some sort of scoring system to our assessments, then the bank could really easily just look at the score to figure out which company they needed to work on first, like that way a triage works in a medical emergency ward or something like that. That got me thinking about standardizing an approach but then I thought, “That’s the turnaround background, the body of knowledge that I’m bringing into that process.”
What would happen if we could ever incorporate the body of knowledge from the M&A industry? The due diligence part in particular. What would happen if we could also incorporate the body of knowledge from the business valuation industry and somehow integrate those three bodies of knowledge to be able to turn a process into not only an assessment or not only a business valuation or not only a due diligence exercise but a way to use those processes in a more strategic approach to help companies, maybe companies that were already healthy to become healthier.
If we could somehow conduct an assessment, incorporate the due diligence concept and tie those to a business valuation component, then we could use it to be able to explain to business owners at a deeper level why their value, their current baseline value is what it is. These are the weaknesses that came out of the due diligence type assessment. If we strengthen those weak areas, therefore, we could also show them what the impact might be on the value of their companies.
That was the thought process that I had to integrate these three disciplines and create a strategic process and a strategic system. I was developing it initially for my firm, but once I developed it, it took me a year to develop the first prototype and then another year to calibrate it, beta test it and calibrate it using in house files and then another year to beta test it on live paying clients in the field and then two more years to rebuild it in the cloud.
It was a five-year long development process before we launched but it was a very rigorous development process. Once we completed that, I realized that this has application far beyond our little consulting firm. This is something that really could change several industries, that could change the valuation industry, that could change the consulting industry in the middle market space. This is something that we should really be licensing out to other firms around the country. That’s the model that we adopted.
My business today is still partly doing some consulting but that part of it is really just to keep me fresh and sharp on the three bodies of knowledge. I do a little valuation work, I do some M&A and due diligence and I do a lot of performance improvement or value enhancement kind of work with clients using our system and our process.
The bigger part of my practice now is expanding the role out of using the software to some large national firms, some super regional firms and all the way down to some one and two man consulting firms. People anywhere from turnaround consulting, M&A advisories, business valuators, CPAs, and other general business consultancy license, they use our software and our process.
We teach and train them and certify them if they wanna go that far, and how to conduct this kind of service, how to provide the service and how to provide the implementation of the results of the upfront assessment part of it. That, typically, is a process of working with companies within for anywhere from two to four or five years at a time.
Ryan: You can’t move the needle right away. It’s interesting because when you were saying you were doing your turnaround work, you were doing stuff in 6 to 18 months which is pretty mind boggling if they asked because of how much stuff you probably had to do. What I love about your system is how you bring it to clarity because I think a lot of business owners, we struggle with how do we see this because there are things called traction or scaling up and the rockefeller habit, all these different ways of running your business.
The value is the most important part, that’s how you should make all your decisions and then all of your strategic rocks or plans or milestones should drive from the value of your company. What I love about how you’ve integrated your turnaround, your M&A, and your valuation expertise is you have to start from the numbers and the building value, the niche, the industry that you’re in. Your tool does a very good job at that.
Let’s do a little peek into the world that you’re measuring. Outside of topline and bottom-line which I think everybody is constantly concerned about, even the people that have any casual statements, but outside of that, what are some of the main things that you’re looking at and then we can maybe dive further into some of the most crucial key drivers.
Ken: When you use the term value, that can mean a lot of different things to different people. One common theme of the concept of value is that value is really a prophecy of what the future holds for a particular company. It’s far less related to what’s happened in the past than it is related to what will happen in the future and even in a healthy company. If a healthy company has a couple of strong years but they really don’t have the organization in place to be able to sustain those strong years or create predictability into the future of those strong years, then that company will likely not have a lot of value, it won’t have value commensurate with maybe a couple strong years that it's had.
The idea of value being a prophecy of the future suggests that the higher quality the company, the more predictable that company’s cash flow stream or benefit streams will be in the future. Profitability or cash flow is often used interchangeably but we use cash flows in the evaluation word primarily to calculate value. If you think about the quality of a company and you think about what’s the flipside of quality, the flipside of quality is risk.
A high quality company will have a lot of sustainability and predictability of future cash flows and low quality company is a riskier company in terms of being able to sustain or predict its future cash flows. That concept is relatively simple.
Ryan: You could have a very profitable, risky business. I think that’s one of these things that a lot of people forget. Let’s take the construction industry, potentially, because there’s a lot of very profitable projects that are out there but what’s the predictability of the future?
Ken: Absolutely, that’s exactly right. They could’ve had a better year, a couple years, but if that profitability is not sustainable and predictable, then it’s not going to be highly valuable because the prophecy of the future just isn’t there, the predictability of the future just isn’t there.
Ryan: I really like how you’ve phrased that because I’ve used transferable because it’s easily transferable to someone else which again is predictable. What are the ways that you measure this predictability?
Ken: Before I answer that, I’m glad you brought up the concept of transferability because that’s another concept. You can have a company that is very healthy and strong and profitable and it may even be sustainable and it may even have a highly predictable future as long as the current owner or CEO remains in place, because all of the knowledge base, all of the expertise might be in that owner’s head.
That could be a highly valuable company in the hands of its current owner but the value is not transferable on the outside because if that owner were to retire or become unable to lead the company or leave the company in a sale, then a lot of the value would leave with the owner. The value is not transferable to a buyer.
Ryan: That ranges between a lot of different company sizes too because there’s very large, mid-market companies where a lot of the decisions still go through the owner.
Ken: Absolutely right. The best companies with the highest sustainability, predictability and transferability of value are those companies that take the expertise and institutionalize the knowledge and expertise into the organization. The organization can run independently of the owner. When you think about transferability of value, think about a crane reaching into the company, lifting out the current owner, dropping him out in the parking lot and dropping in an independent operator who doesn’t know the business very well and putting them in the owner’s chair. Now what’s the value of the company? If all of the expertise is now out on the parking lot, there’s not a lot of value to that company.
To answer your question in terms of the factors that we measure, we measure the qualitative elements of a company across the entire enterprise and how well the knowledge and expertise has been institutionalized. We look at 47 different categories across the company. Eight primary categories that we consider to be the eight categories that every company has to have in place fully developed, fully functioning and very importantly in balance with each other in order to reach peak effectiveness and that’s developed, fully functioning and very importantly in balance with each other in order to reach peak effectiveness and maximum value.
There are eight categories, there’s a lot of science behind them. They are planning, leadership, sales, marketing, people, operations, finance, and legal. Those are the eight primary categories. We even picked those and break them down into 47 subcategories and then we go through methodically and assess the company across those 47 categories and against a theoretical best in class scale. How close is the company in each category to being a best in class company.
Best in class company would imply highest quality, lowest risk in that particular category. If you can take that approach across the entire enterprise and then measure how well the company has established in each of the areas, we’ll rollup all of your scores and come up with an overall quality/risk score, two sides of the same coin, you can then have an indication of where that company would fall in the spectrum of a valuation.
Ryan: Are you SIC codes or something like that where you’re able to compare to other companies so you can come up with that risk or the valuation because obviously you roll all those up into one number.
Ken: We don’t look at SIC code, we do look at published best practices by industry. Our industries are broad - manufacturing is an industry for us, professional services is an industry. We’re not looking at the real fine level industries but best practices are best practices. They’re most often the fundamentals of running a quality business. We look at published best practices by major industry category and we roll it all into our assessment criteria.
Ryan: You got the eight primary categories and then you have the 47 subcategories. As an entrepreneur, I think the biggest challenge if you would’ve came to me when we’re in the middle of the fire storm and we were to do this, how in the heck do you start it? It seems super daunting. It seems like a lot of stuff when all you’re doing is trying to hit payroll. How does a business owner tackle this entire project?
Ken: If I went into a company that was in crisis, I would first get the cash flow quickly under control and make sure that the supply chain wasn’t going to be interrupted, make sure that the customer and the sales pipeline was not going to be interrupted. I would follow that initial triage work. But as soon as practicable, I would dig in and do the assessment. The assessment only takes about a day to go through. Basically you sit with the management team in a conference room onsite or offsite and you walk through a standardized interview process.
We ask about roughly 400 questions. The questions are answered typically on a scale of 0 to 10 with 10 being best in class, no room for improvement and so forth. We ask the management team as a group to answer the questions. You’re asking the management team to answer questions about parts of the company that they may or may not even be involved in.
Often, there’s a lot of value in that process alone because for the first time, the management team is being exposed to parts of the business that they don’t typically even have to think about.
Ryan: What kind of questions do you ask?
Ken: One of the subcategories is called strategic planning and we might ask five questions. The first question might be on a scale of 0 to 10, does the company have a fully developed, written strategic business plan? A 10 means fully developed and written and basically it covers all the functional areas of the company. The first answer might be, “Oh sure, we’re on a seven.” We’d say, “Can I see the plan?” “It’s kind of in pieces.” “What are the pieces? Could I see them?” “We have projections for next year, we have some sales quotas.” “What else?” “That’s probably about it.” Maybe they are 1 on a scale of 0 to 10.
That’s not a strategic plan, that’s a tactical operating plan, it’s not even a full tactical plan nor strategic plan. We educate them as we go and it doesn’t take them very long before they understand the calibration. We help them calibrate their answers. In going through that process, the management team’s eyes get opened to how misaligned they are as a group, how dysfunctional they are as a group, how differently they each perceive the strengths and weaknesses of the company.
There’s a lot of discussion and debate that goes on about where they think their strengths and weaknesses are. They leave that first day assessment really feeling like, “For the first time, we are becoming aligned on how we think about our company, our business, and where we’re strong and where we’re weak.” That’s the foundation of the process.
Ryan: I think, even strategic planning, which has been said in the consulting world for years, the strategic plan has never been aligned like you have brought all together with the valuation and actually understanding what your business is like in the eyes of a buyer. If you were to ask me to buy a company where that whole management team is misaligned, they got no plan, why would you wanna buy that company? If you keep thinking that way, you’re gonna realize that there’s a reason you need to do this instead of just doing it to feel better.
Ken: Companies that go through the strategic planning program that we offer and that we teach to other consultants, companies never come out at the backend of that process looking like they did coming in the frontend. It is a very transformative process that come out in the other end much different looking, feeling, thinking company, much more disciplined, much more focused, much more directed in terms of where they’re going, how they’re going to get there. There’s a lot more accountability that ends up being part of the process and so forth.
They may run their companies differently going forward and the results fill that, they end up positioning themselves differently in the marketplace, growing faster, stronger. They get margin and profitability expansion and they dramatically increase value but it all starts with the upfront assessment which we view to be the current state of the company and then we use the strategic planning process as the future state and how do we get them the current state to the future state. The pieces go hand in hand.
Ryan: How do you approach that? Because out of the 8 primary and the 47 categories, without obviously going into every single one of them, is there low hanging fruit that you approach first because you only have so much time and so much capital in your business. How do you start aligning those processes? Is there a common three areas or places where you normally see a big bang for your buck because of where things are at? Something maybe a little bit more actionable for the listeners. Does that make sense? How do you really dive in and prioritize those things?
Ken: A couple ways, one is our 47 categories are each assigned a level of priority, priority 1, 2, 3. Those are pre-assigned, they don’t change company to company. Level one are the highest priority categories, we call level one the protect level. It’s designed to protect company against downside risks that could really damage the company’s future. Those are foundational level categories. Does the company have a full insurance package in place and in force?
If the company doesn’t have proper insurance coverage, that clearly would be a high priority level one category because a disaster or some kind of major accident or something could clearly put the company out of business. Those are level one. Roughly about 1/3 of the 47 categories are level priority categories.
Level three are categories that are relevant if the company aspires to high growth in the next several years, if they are happy just lumping along where they’ve been for the last 20 years into the future and they don’t want to grow aggressively, then some of the level 3 categories might not be important for them. It will still hold them back from being best in class but they may feel terrible about being best in class if they’re happy with where they are.
Ryan: My guess is level three takes capital and more risk.
Ken: Sometimes yes, sometimes no. An example might be board of directors. If the company is just lumping along and they’re happy with where they are, maybe they don’t need a board of directors. But if they wanna double or triple in sales in the next two or three years and the management team is not highly experienced at growing a company that fast and navigating the growth challenges, maybe they do need a board of directors, that’s a level three, to help them navigate the challenges and be able to succeed. That’s the level three.
Level two are all the categories that are in-between. They’re not life threatening but they’re still very important in terms of enhancing the quality of the company and increasing value. Level two might have to do with some of their IT systems. They’re getting by right now, it’s not mission critical but they change or improve their systems. But they really could become more efficient and add value to the company if they try an updated system or put in an ERP system or something. Some of those do take capital.
Ryan: Going back to the you only got so much time and so much capital, now we’ve got a prioritization system behind here. How do you quantify the return on investment? Before you answer that, I think one of the biggest topics has come up in multiple other episodes are with owners that I work with is it’s always that next level management team to go from your typical $80,000 to $100,000 manager, that’s your office manager, to the mid six figure, $150,000 top executives with profit-sharing or whatever.
It comes straight out of their pocket and there’s always, “I don’t want that.” But on the backend, it should increase your multiple or you should get a significant return on that depending on when and how you transfer. How are all these different things are you able to measure the actual return, because it’s not necessarily annual cash flow return, it’s actually return on value. How do you measure that?
Ken: The way that we measure it is, going back to value being about the future. We’re looking at future cash flows of the company and what’s the value of those future cash flows based on the current risk and quality profile of the company. The higher the quality, again, the higher the value of those future cash flows because they’re more predictable, more sustainable. What we do therefore is calculate the value of those future cash flows, we’re using a discount rate, we’re basically discounting future cash flows back to present value.
The discount rate is a reflection of the relative riskiness of the company, the relative quality of the company. We have all of our 47 categories directly linked to the calculation of that discount rate. Without getting too technical about the way that discount rates work, the discount rate is a well-known, well-taught, widely used methodology in the business valuation world that’s called the build up method to come up to a discount rate.
The build up method includes the cost of equity and includes a cost of debt and then includes a capital structure, a mix of equity and debt in a capital structure. Each one of those are risk adjusted. You have a risk adjusted cost of equity, a risk adjusted cost of debt and a risk adjusted mix or blend in the capital structure. What we do is we connect all of those 47 assessed categories to the risk level that impacts the capital structure, that in turn impacts the discount rate and in turn impacts the value calculation on the business.
By identifying any particular weaknesses that may be low hanging fruit, maybe high priority, maybe needed to bring the company the eight primary categories to balance with each other and I’ll come back to that in a minute because that’s important. By tagging each category to that discount rate, we can do what if analysis. What if we improve these 10 areas over the next 18 to 24 months, what impact would that have on the discount rate and therefore on the calculation of value.
Ryan: That’s a direct answer to my question.
Ken: That’s essentially how we do it. The balance part of it is that, often, we find companies, they might be really strong in one or more of the eight primary categories and really weak in other ones. For an example, an engineering driven company might be strong in operations, they might be very strong in the systems part of the company because they’re a systems focused kind of people but they might be very weak in the natural areas of their discipline, maybe they’re very weak in people or very weak in marketing because that’s just not their natural strength.
When we ask them where they’re investing their time and money and resources to grow the company, ironically, they’re investing it typically in the areas where they’re already strongest because that’s their comfort zone. We have to explain that that’s not getting you one dollar of additional growth capacity, additional profitability or additional value because the weakest areas are your constraints to building value in growing the company.
Until you bring those weak areas off to be more in balance, those will be your constraints. Get yourselves out of your comfort zone, let’s focus on the weakest areas first and the level one priority areas within those weak areas, bring the company into balance as best we can and then strengthen and invest in all eight categories equally as time goes on until you’re growing the company towards best in class altogether in a balanced manner.
Ryan: I can relate to that because coming from the copier and IT industry, it’s just a whole industry full of sales guys and gals and that’s always where your new dollars went, hiring more salespeople. Had the whole industry not gotten squeezed and got more competitive, that’s when people started all a sudden focusing on operations and service and actually tracking all that stuff because you need to squeeze to turn up even more but it took many decades for that industry to mature on the other parts of the business.
Ken: Often, we see a lot of companies that are becoming commoditized. In fact, I just met with an owner a couple days ago this week who is a $15 million service company. He said, “I feel like we’re in a long, slow death spiral. We’re getting squeezed on price from our customers, we’re getting squeezed on price because of the rising cost of labor and I can’t pass rising labor cost to my customers and I don’t know how to get out of this. We’re still profitable but our profits are rapidly shrinking year by year and I don’t know where the future is.”
It’s hard. Those kinds of companies have to find a new business model, they have to figure out a different way to compete in the market place other than strictly on price.
Ryan: Let’s take that example for a second because I think it’s a good one. Let’s say she was going through this system and technically, this $15 million business is balanced in the eight key categories because they’ve been using your system for a while. Is there part of the process that is exploring new avenues of revenue or new business models? There’s so many companies, there’s so many industries, we have to almost double down because of escrow, they have to reinvent themselves.
I think the biggest challenge is understanding is it worth it, that’s where my dad and I got to the point in the copier industry, is it worth doubling down and building up the whole IT services and we weren’t really sure because we couldn’t measure the value. How do you address that situation?
Ken: We address those questions directly in our strategic planning program. That program, by the way, is a six month long strategic planning process, very rigorous process. We follow a form of framework, some of which we use existing framework that are in the public domain and then we have our proprietary parts that we add into it. We teach our process as well to consultants but it’s basically about 12 half days with the management team spread over 6 months.
We go through some of the strategic frameworks that include whether the company should develop new markets for their existing services, new services for their existing markets or a combination of new markets and new services and diversify their market positioning and so forth. There are all these frameworks that we go through and how are you going to market, how are you connecting with your customers.
Are you doing it by having a deeper understanding, a customer intimacy level of knowledge with your customers or are you doing it by trying to be the cost leader so you can thrive in a commodity based industry or you’re trying to be some product or service innovator and leader in the marketplace so you increase your prices that way.
There are different frameworks that we take management teams through and we assess the most appropriate strategic frameworks for the companies and then we think about how to structure the company around those frameworks because whatever they select has downstream implications on the way they organize and structure the company, the type of people that they recruit, how they train and retain them, the systems that they use and so forth, how they price their services depending on the high level strategies that they adopt in their companies. It has a lot of ripple effect down to the organization.
We take them through that and one company, in particular, that I like to use as a perfect child, they’re in a commodity business five years ago, they were contract manufacturers, getting squeezed on price, getting squeezed on material cost and labor cost and so forth. Every company has some unique proposition that they can bring to market that nobody else can bring. Part of this process is to figure out what that is and most often companies don’t even know what it is.
The example of my client five years ago, they had a particular expertise in their engineering. They were really, really good at product development, helping customers develop their products, take cost out of development, out of the product and have a better developed product to manufacture. They were giving away that service and they were basically trying to give that away in order to get the commodity level manufacturing.
Once we figured that out through strategic planning, we repositioned them from being a contract manufacturer to being a solutions provider. We have them go engage with their client base instead of at the fulfilment level of their customers, we had them go and engage at the C suite level and try to get into the process of helping them develop their new products thoroughly in the development team.
They were able to increase their high level of relationships with their customers yet engineering contracts that were at a premium and then they were getting handed the commodity level manufacturing without even going to bids. They were no longer competing on price alone, they are competing on just basically the relationships that they’re able to establish.
Ryan: You’re able to measure the whole thing after you did it too which is the most beautiful part.
Ken: We could measure it not only in the predictability and reliability and sustainability of their business going forward but now they’ve grown almost 50% than where they were back then in topline and they’ve grown by probably 150% at the EBITDA level. Their value has probably tripled or quadrupled now from where they were five years ago. It’s because they have adopted this program and they totally committed and totally focused, they’ve developed the disciplines around it, they run their company based on this process now.
Ryan: No matter what, if you’re doing the right things, a financial buyer will be available, hopefully, if you’re hitting the right size because you’re building well oiled machines, someone will hopefully buy you no matter what. As you go through this, because it’s pretty important as you’re looking at when and how you wanna exit, what’s your timing, the amount of money that has to go into all that.
I just think about our old business, we could’ve used your services greatly because we doubled down, did an IT services software. In reality, we were a copier business and a lot of people are jumping into that but there was no way to measure that and building the value depending on where you wanted to go.
Ken: We try to start companies off — if they’re not in crisis, then we try to start them off making small changes, small bites at first. Let’s get some winds under our belt, let’s get the organization feeling what it feels like to succeed then make a change that works. Let’s get them feeling the impact with some small changes first. When you make small changes and they start to take effect, the small changes can start to fund more small changes and those small changes combined with the first set can start to fund bigger changes.
Over time, the company does have to make an investment into this process but over time, the improvements start to self-fund the process. If you can measure the impact on value in advance and then you can also measure the expected improvement in topline and bottom-line which will add even more value, then you can assess that against how much is it going to cost and how do we stage these improvements, how do we stage the changes in terms of cost and bandwidth and the team and so forth.
You can plan it out over as much or as little time as the owner wants to spend and as much or as little money as the owner wants to invest.
Ryan: Because you can measure it.
Ken: You can craft the customized plan and you can say, if you spend $300,000 over the next 18 months, your value might increase by $2 million and $3 million. Ideally, if you can get a 10X impact on what you’re investing, most business owners are going to be willing to do that.
Ryan: Our business, again, we were just spending money trying to reinvent ourselves and having zero idea how to engage it. Are you familiar with Traction?
Ken: Yes, I have read the book.
Ryan: You got Traction, you got Scaling Up, you got all these things. I think it’s fantastic because it puts a lot of clarity in how to run your business with the meetings, with your vision, all that stuff. My biggest gripe with it is it doesn’t measure value. You could implement really, really bad ideas really fast but you have no idea how to measure the rate of return that you had with the investment or the strategy that you had because it’s all up to the visionary of the business, they just pick something random that they wanna do.
Ken: One of the big reasons why it’s hard to get business owners to implement change and it’s hard for consultants to succeed is the point that you just made. Unless you quantify the impact of changes, business owners, it’s just too fuzzy for them. Yes, I understand, this should make my business stronger and healthier but I don’t really know how much and I don’t know if I wanna spend the time to even try to measure it. How am I going to measure it? Too subjective.
It’s too easy to blow it off at that point. The other thing is, there are so many issues that they have in their heads that it’s hard for them to get their arms around and prioritize, which ones they should work on first and what the impact of any of them would be, so they end up doing nothing. Coming to inertia, basically. They’re trying things that don’t work. If your organizations resist change because the organizations don’t understand what to expect for an impact, either.
If you can educate the owner and their management teams as to what the impact these changes will have, you get a lot more buy in from everybody to adopt change and make that part of their culture.
Ryan: You know exactly what the ramifications are. It’s so funny because the owners do it intuitively when they’re making decisions because they have the numbers in their head and they’ve always got these basic KPIs, ours was machine or fields and service, they’ve got these KPIs that they normally measure and then the cash flow. That’s just the basic baseline that they’re measuring on their head or a basic financial dashboard.
Every decision literally comes down to the numbers and then you can actually make a good decision on whether you want to make the investment or not or whether you want to sell it to the internal people or sell it to a strategic buyer because they’re all related. I don’t know how you can make decisions if you can’t quantify it.
Ken: I totally agree with you. Even if they feel like they can make decisions, how do they know which ones they should be doing and what sequence. Our process, because it’s prioritized and you can look at which ones will help us create better balance in the company as well as the most value and that helps them prioritize what they should work on first. It becomes just an ad hoc process, whatever the flavor of the day is what they end up working on.
Ryan: We go to a tradeshow with all of our industry companions across the US and then everybody has got this random ideas at the bar and then you go back and you’re completely distracted for six months and why you did it.
Ken: Organizations resist that because they know it’s concocted at a bar and they’re like, “Why are you putting us through all this pain when we know this isn’t going to stick?” But if you go with a process that’s proven and it’s disciplined and it’s methodical and they can see the impact as you go, it’s small changes to start and bigger ones as they’re getting comfortable with the process, that’s how you get change to stick over the long term.
It’s like somebody going on a crash diet. You get these people that go on crash diets and they lose a bunch of weight but six months later, they’ve gained back all the weight and then some because it was just a crash diet, there was no methodology to it as opposed to people that have a true lifestyle change, healthful lifestyle changes, they change their lifestyle and it sticks permanently.
Ryan: And it has to happen one little thing at a time.
Ken: One little bit at a time.
Ryan: I was talking to this guy, his name is David Horsager. He wrote the book The Trust Edge and he was talking about habits too. The 21 days is pretty much biased. Ray Dalio, his new book Principles, it’s 18 months. David Horsager, he did the habit style change by just cutting out any kind of pop and that’s just thing at a time. Again, you can’t go in and overhaul your whole company. You have to get those endorphins going with the little winds otherwise everybody is gonna be pissed off.
Ken: That’s right, that’s exactly right.
Ryan: As we’re wrapping up here, Ken, is there something you wanna highlight that we’ve talked about because we talked about a lot of stuff. One thing you wanna leave the listeners with?
Ken: I’ve been working with private middle market companies now for 30 years as CFO, as consultant, as CPA in my early days. One thing I can tell you with high level confidence is that every private company is underperforming. I have never seen a company that’s been best in class across the whole spectrum. Every company is underperforming to some degree, some more than others but they often don’t even realize that they’re underperforming.
They all need help, they all could use a fresh set of eyes, a fresh perspective to help them understand how to get their company into better balance and to be able to better support long term growth and profitability. Owners need to be educated about a process like this, some disciplined methodical process, it doesn’t have to be ours. I think ours works really well but there are others as well. Whatever process you use, have a process, if you’re an adviser or a consultant, have a process, don’t just go in ad hoc.
Ryan: Have a process that you can measure.
Ken: Have a process that you can measure and that is repeatable and that is proven and owner clients will have a lot more confidence in it, they’ll be willing to start the process more readily and you have a lot more success. Business owners, if any are listening, be open. You need help, all business owners are underperforming to some degree. I’ve never met a company that wasn’t.
Ryan: I think your approach, Ken, is just so different with the fact that you can measure it. I, being a victim of spending lots and lots and lots of money and wasted time and energy with consultants, I can’t measure crap and they come and distract everybody and leave, it is just beyond frustrating. To be able to measure something and measure how well you’re doing and how well the dollars you’re investing in is important.
Ken: Absolutely, I totally agree. That was the key link that made this all come together is when we brought the business valuation body of knowledge into the program and integrated with that, that was the game changer for it.
Ryan: Ken, what is the best way for our listeners to get in touch with you?
Ken: Probably by email which is [email protected]. That’s probably the easiest way.
Ryan: Ken, thank you so much for coming on the show.
Ken: Thanks, Ryan. Glad to be here. Thanks for having me.
Ryan: I hope you enjoyed that episode with Ken. I really enjoyed how he articulates value and the process. My main three takeaways are, the first one being how he describes value. Value being the value of your future cash flows and focusing on sustainability, transferability and predictability of those future cash flows is crucial to value. Anything that you’re doing today should make your business more sustainable, more transferable and more predictable. If it’s not, you’re not building value.
The second main point that I really got out of the interview with Ken is that it is unacceptable to have consulting or any kind of ideas or any kind of strategic plan that are not measurable. It’s just not necessary in today’s world where we have the technology and the tools to be able to measure the value that we’re getting. To implement a plan or implement a strategy and just go by the seed of your pants without understanding how you’re impacting the future value of your company is just not necessary.
That last key take away I’m actually gonna take from him and I think I’m just gonna reiterate it because the main point that he made is that every private company is underperforming to some degree. I couldn’t agree with him more because public companies are always trying to pursue value, increase shareholder value and always driving that direction. Every private business can constantly be doing something to improve the value of their company and to be able to measure that is important. Understanding how to have an open mind and how to measure things are a huge, huge piece of the puzzle. Ken did a great job in the interview explaining that.
I hope you enjoyed the episode. Until next week.
Written by Ryan Tansom
Ryan runs industry-specific podcasts on his website which pertain to mergers and acquisitions, and all the life lessons he wish he had known then. He strives to bring this knowledge to his listeners in a way that is effective and engaging by providing new material each week from industry experts.