Maximizing Business Value: Insights from Alex and Leila Hormozi for Painting Entrepreneurs

Welcome to the Profitable Painter Podcast. The mission of this podcast is simple: to help you navigate the financial and tax aspects of starting, running, and scaling a professional painting business. From the brushes and ladders to the spreadsheets and balance sheets, we've got you covered. But before we dive in, a quick word of caution: while we strive to provide accurate and up-to-date financial and tax information, nothing you hear on this podcast should be considered as financial advice specifically for you or your business. We're here to share general knowledge and experiences, not to replace the tailored advice you get from a professional financial advisor or tax consultant. We strongly recommend you seeking individualized advice before making any significant financial decision.

This is Daniel, the founder of Bookkeeping for Painters, and this is Richard, tax director.

How's it going?

It's going good. You know, I— my family just got back from a nice summer vacation. We were down in Florida for a while and it was hot. Lot, but it was a great time to just kind of relax, recharge the batteries, and come back refreshed to do some more.

Yeah, that's awesome.

Yeah, I guess it's different when you live in Florida, right? It's like the tourists, we enjoy the heat and the sun, but when you live down there and you have to work in it, it's not quite as enjoyable.

I like the, I like the heat and the sun, so I live I have to be as close to the equator as possible, even though my complexion doesn't tell, like, wouldn't signal that to somebody, but that's the way I feel in my heart. Uh, so while you were on vacation, I did something kind of cool. I went to Vegas. Uh, Alex Hormozi, who is the founder of acquisition.com, He was holding a workshop with, uh, him and Leila were holding a workshop with their team, uh, workshop on basically scaling your business. And I, I thought it was really, really interesting because Alex and Leila, if you're not familiar, they, they've grown and scaled several businesses that they've sold for, uh, hundreds of millions of dollars. So they, they've done this before at a high level, and they currently own an equity firm where they buy minority positions in businesses and try to scale them as well. So they're very involved in scaling businesses and getting them to sell at high levels. And so it was cool to go to their workshop and kind of see the way they think about business, scaling businesses. And they had a big part of what they did was using basically an investment banker's calculator to calculate what would your business be worth if you tried to sell it to an investment banker or an equity firm. And so I basically, today, was hoping we can go through, kind of walk through this calculator and discuss like what makes your business valuable to an investment banker, what makes it interesting, what makes the business healthy and sellable, and, and walk through the actual formula that an investment, investment banker might use to value your company.

Awesome. Yeah, different ways of kind of making your company more attractive And I know you mentioned specifically this is for like investment bankers, private equity, but I'm sure there are other people who would also appreciate some of these items as well. So maybe like another painting company or maybe a private investor, anything we can do to make our companies a little bit more attractive, kind of put some of that makeup on there. I know what people are— not makeup because makeup feels fake, right? These are, these are real things that we're doing. We're not, we're not just gussying up, you know, something that needs serious help. Uh, but what factors should we be focusing on in our businesses that make them strong and healthy and attractive to potential buyers?

Yeah, I like it. Or just to yourself, really, because it's the same— sure, the same things that you need to do to make it attractive for someone to buy it are the same things that make it attractive for you to keep it.

Yeah, absolutely.

So it's kind of like selling— if you've ever sold your house, before you have to go through all the things like getting repainted, getting the roof fixed and re-shingled, getting the interior all nice, fixing the deck. You know, you have to do all these things to get it as nice as possible. And by the time you finish all those things, you're like, I kind of like it now. I don't even want to sell.

Right. So when we were on vacation, my wife and I were watching HGTV and they've got that show called Love It or List It. Where they do that, where they bring in the interior designer and the realtor, and the interior designer tries to fix up the house and convince the people not to sell, and the realtor tries to find them a new place. And it's kind of a competition. And it's funny, like, how often people who are sick of their house, they're not in love with it anymore. After, you know, some renovations and some TLC, now It's like a whole new place and they don't want to sell. They want to stay there. So I like that, you know, maybe you're not looking to sell, but maybe you just like to make that business a little bit more attractive to you and feel a little bit better about it. So, yeah, cool.

Yeah. And that's kind of how my, my take is, is like I'm, I'm on the side of not wanting to sell, just creating a business that, that's so awesome that you wouldn't want to sell it. Uh, and so the, it's the same, the formula, uh, to sell your business and also the formula that to make you want to keep it, it's the same factors here. We'll go through each of them here. So I'm going to actually share my screen. So if you're listening to this, we're going to talk through it, but it might be helpful to actually go to YouTube and look up the podcast on YouTube because we'll be walking through this, this calculator. And so what I did was I took one of our clients that we work with. We've been actually working with them for about 8 years. They're doing awesome. And we plugged in their numbers to see how much their business would be worth, just to kind of see how things turned out. And so we'll start up here at the top. There's baseline value. Um, and then after that, there's a section called value adders, value subtractors, and then last is the valuation. So the baseline value, this is your revenue and EBITDA. So EBITDA is based— is earnings before interest, taxes, depreciation, amortization. If you're looking at your QuickBooks profit and loss, is basically the net operating income is, is your EBITDA in, in most cases. So revenue top line and EBITDA, AKA your net operating income. And so this is what makes your business interesting to an investment banker that's buying businesses. The higher the revenue, the higher the valuation. In many cases, the higher the EBITDA, the higher the valuation. And this is going to be a direct driver of what your, your, your multiple is. So the larger the business, the larger the multiple. And in the previous podcast, we were talking about, you know, how much is your business worth, and we kind of discussed this. But, you know, those, those companies traded on the public stock exchange, uh, companies like, like Tesla and, uh, other companies have super high multiples. Like, their earnings, um, what they trade at versus what their earnings are, the multiples are crazy. So, uh, the larger your net operating income or EBITDA, the, the higher your multiple will be. Um, so then the value adders section, that is what is— what makes your business healthy. So this would be like revenue growth, what your margins are, uh, how much does it cost you to acquire customers. Those are the, the value adders. And then the value subtractors, that's a section of what are the risks in the business. What would make a— now there's, there's more than what, uh, are listed here. There's more risks that are listed, but these are kind of like the key risks that investment bankers or anybody trying to buy your business would look at. Um, and then lastly would be the calculation. So let's start at the top and roll through this. So first of all is the revenue. This is straightforward. Uh, in our example, our painting business has $2,800,000 in revenue in the last 12 months, so that is $2.8 million revenue. The next piece is the EBITDA, or net operating income, over the last 12 months is $513,000. So, uh, for, for this level of EBITDA, the, the multiple for any business that has an EBITDA or net operating income of $1 million or lower in the last 12 months, the multiple is 1. So it's a multiple of 1. Now if you had $1 to $3 million in EBITDA or net operating income, your multiple would be 2.5. And then $5 million to $10 million, the multiple is 5. And the $10 million above, the multiple is 6. So the multiple It's going to make more sense once we do the calculation. But basically, this is the key number that we're going to multiply your net operating income by, by your multiple to get what the value is.

And so companies that generate— because EBITDA is really a calculation of profit, so to speak, right? Your revenue is how much you sell, your EBITDA is how much you keep. And so companies that generate more profit, they generate more cash, they're going to be more attractive to potential buyers than companies that generate less cash. And it's not necessarily a one-to-one basis. So companies that generate less than $1 million a year in cash, um, are worth X, but companies that generate, you know, $5 to $10 million in cash are worth that with a multiple of 5. Um, and Daniel, you and I were talking about this earlier, a lot of that has to do with just how attractive it is to buyers, the potential for making changes and increasing profit and things like that. Because I'll be honest, you know, when I first looked at this, it didn't quite make a lot of sense to me. You know, why would there be an EBITDA multiple? But just understanding what investment bankers and private equity are looking for when they look to buy companies, it makes more sense that the more cash a company generates, the more valuable it would be to a potential buyer.

Right, because a lot of times what they're trying to do is, is, um, maybe make a few changes and get and open up the profit margins and then sell it at an even higher multiple, or combine it with another company so that the combined— like combining one painting business with another painting business, that puts it into another tier of a multiple. So maybe let's say you buy two, uh, two painting businesses that are at 2 million in— or let's say, uh, 2 painting businesses that have a million, just over a million in, um, in, in EBITDA. And so that's going to be 2.5 multiple, but the 2 of them together puts them in the, uh, still in the 2.5. But then if you can make some changes and you get them to 2 million or 3 million in EBITDA each, that puts you into the second, uh, the next tier, which is the 5 million to 10 million multiple. So now it's a multiple of 5 instead of 2.5. So, you know, combining companies, making some changes, and getting it into the next multiple can add a lot of value. Uh, it allows them to sell, sell it at an even higher multiple.

So what you're saying is, is one company that generates $5 million in EBITDA is more valuable and has more potential for growth than 5 companies that generate $1 million in EBITDA?

Yes, that is the concise way to say it. I wanted to say it very convolutedly, uh, so that it's hard to understand.

No, no, no, you, you explained it well. Um, sometimes I just need to recap things in my own mind.

But yeah, no, that was a way better way to say it. So, all right, so now we understand the EBITDA multiples, and right now the example company that we're using, they're at an EBITDA multiple of 1 because they have under $1 million in EBITDA, or net operating income. All right, so next let's go to the value adders. These are the things that, uh, indicate that the company is healthy. So the first one is revenue growth. Revenue growth, typically to earn a point here— so we're trying to— right now we're value adders. If you have favorable revenue growth, like if you're growing quickly, you're going to get another multiple, a point or two added to your multiple. So in this case, Uh, the paint company that we're using, they've kind of flatlined over the last year compared to the previous year. So at this point, they don't have any revenue growth, so they don't get any points here. But if they had been growing, like, let's say 30%, they would, they would have gotten 1 additional point, which would have been added to their multiple and getting them to 2, a multiple of 2 instead of 1. or if they were growing by 100%, then that's 2 points there. So that's revenue growth. Uh, the next value adder would be yearly revenue recognition, and this is tough for painting businesses. So basically, um, this is— or I'm sorry, not recognition, yearly revenue retention. Excuse me, yearly revenue retention. So this, what this means is what amount of clients are you retaining year to year? Now, uh, for painting businesses, since a lot of times for especially residential repaint, you're painting someone's house and you might do it once every few years, it's hard to really do recurring yearly revenue, but you might be reactivating every couple years or every, every few years for that particular client. So, uh, it's, it's difficult for painting businesses, residential painting businesses, to get that revenue retention each year, but you should be at least reactivating them every couple of years at a minimum. So yearly revenue retention for this painting business is about 20%. So they're basically getting income from the same customers about 20% of the time from the same customers. So this is, this is good for this industry, but not quite as much revenue retention as what an investment maker would be looking for. They're looking for more like 80%. So another example might be if you have a long-term contract with a government or commercial properties where you're doing maintenance painting over a long period of time and you have recurring revenue from that, maybe this looks different for you. Maybe you have a higher, a higher yearly revenue retention. Than this painting business that is doing residential repaint. All right, so the next one is the EBITDA margin. So this is simply taking your, uh, EBITDA and dividing it by your revenue. And in this case, when we take $513,000 divided by $2.8 million, we get 18%. So they have 18% EBITDA margin. Which is, which is pretty strong. Uh, in order to get an additional multiplier, you'd have to be getting over 30% EBITDA margin. So it's, it's still strong, 18%, but it's just not high enough to get that additional multiplier of 0.5 for over 30%. The next one is a lifetime value to CAC ratio. So lifetime value is the amount of, the amount of income you're getting from a client over the lifetime, the lifetime value of them compared to what it costs to acquire that customer. So the lifetime value of a customer would be, you know, we painted their house in the year 1 and then in year 3 we reactivated them, painted their house again. And the simple way to look at this is basically for, for a residential repaint. If you look at your top line, it's kind of hard to track your LTV since it's so, so far apart for how often you're getting jobs from, from folks. There's a more complicated formula, but to simply get this ratio, you can take your top line revenue and divide it by your customer acquisition cost, which is basically your marketing cost. So how much you pay for marketing plus your salesperson cost. So for this company, their marketing costs are at 15% and their salesperson, they pay 5% for closing. So that's 20%, uh, customer acquisition costs compared to revenue, which is a 5-to-1 ratio. So top line divided by 20 100%, you know, of your revenue divided by 20% is a 5-to-1 ratio. So that is your LTV to CAC ratio for this one. And in order to get an additional multiplier, you would need to have 10 or greater. So your customer acquisition costs would need to be basically 10% of what your, your revenue is.

I think it's interesting we went through all these value adders And our sample client here didn't get any extra value adders. Now we know he's got a successful painting business. Like, you know, it's— be very proud of his business. But they just kind of emphasizes that to get these, these bonus points, you really have to be doing something extremely well. And I wouldn't like— like if you're trying to evaluate your own business and you're in line with the average, but you can't quite hit these value adders, I wouldn't necessarily consider that to be, you know, something to be upset about. These value adders are very hard to, to obtain.

Yeah. And I think— but it's also good, a good thing to strive for because although this painting business is very successful, there's still room for improvement. So I would definitely say like Hey, getting their LTV to CAC ratio down would be something to look at, trying to get their customer acquisition costs smaller compared to lifetime value. Now, the other thing is growth, and I'm sure— well, I know that they definitely want to grow the business, and they're just working through some constraints right now. Uh, so the revenue growth, 30%, is pretty feasible to do, uh, year to year. And so that would be another opportunity for that, that's completely within reach for them. Um, revenue retention, that's pretty difficult for their business model. Uh, EBITDA margin, considering— which we're gonna get to this in a second— he doesn't have any key man risk, but he's out, he's pretty much out of the business. Um, that would be difficult to get in this industry but not impossible. I would look at the first two that we talked about for the LTV to CAC and the revenue growth ones to, to get those additional multipliers going first, and then look at the EBITDA margin third. Um, so, you know, again, just to emphasize the point, he's probably not going to sell, but if looking at ways to improve the business and make it more valuable to him, uh, those— looking at those metrics would be super helpful and good focus points for, for him.

Yeah, I like it because it kind of helps us understand, you know, what the goals should be, what are the things that we should focus on. Um, so yeah, that was really useful.

All right, next section is value subtractors. So these are the things that are risks to the business that are going to take away from the value. And the first one is key man risk, and this is the biggest one. This is going to make the— have the biggest decrease in your multiple if you have this risk, and most of us do, is, uh, the key man risk, which is, is there a person in the business that is doing a lot of things, and if they were to get out of the business, it would significantly impact the business's ability to operate. So, uh, most of the case, most of the time, this is the, the owner, right? The owner is doing the sales, doing operations, you know, they're leading the company, driving the growth, whatever, all those things. Um, and if that's the case, if you're doing a lot in your business, you might, you might have this risk. In, in the case of our, uh, our example client here, he is— he actually doesn't live in the same state that the business operates in, so the business is running without him. He does have some interaction with his team throughout the week, but it's pretty minimal. So I would, I would put him as a 0 for this risk. Now, if you're still boots on the ground, you're still doing the sales or, uh, you know, a significant amount of the work to to make sure things are operating, and you might have this key man risk. And this is a big hit to the multiplier. This is a 3— subtracting 3 points from the multiplier. So if, uh, since we only have 1 point so far, if this business would have had a key man risk, he basically— his business would be worth zero from an investment banker's perspective.

Yeah. So it's that the key man is that person that if something was to happen to them, heaven forbid, the business would most likely— it would likely close or become very close to closing.

Yeah.

Yeah.

All right. The next one is key client risk. So this is basically, do you have any clients that make up 10% or more of your revenue in a particular year? So in this case, this is 0 for this client because they're doing residential repaint. They're doing a lot of volume, a lot of individual houses. If they lose any particular client, it has almost zero effect on their revenue. However, if you're a painting business that works with a particular general contractor and they give you 50% of the work of your revenue, then you would definitely have this risk. Or if you have a certain commercial contract that's over 10% of your revenue for a particular year, you would have key client risk. And so if you do have 10% or more of revenue going to the same client, same customer, that would be a -2 from your multiple.

Yeah, it's like having all your eggs in one basket. Yeah, it just, yeah, increases your risk, which makes sense if you're—

someone's looking to buy your, uh, your company, maybe all your numbers look amazing, but then they find out, oh, all your revenue comes from one, uh, general contractor who, if he decides— he wakes up one morning and decides he hates you, he could fire you and then your revenue goes to zero. That would be a huge risk.

Yeah.

All right, the next one is single channel risk. So this is how are you getting your clients, how are you getting your customers. Do you have just one way that you get customers? Maybe you just do Facebook ads. And that's the only way. So if Facebook kicks you off their platform, now you have no way to get customers. So this is single channel risk. Do you have only one way you're getting customers? If you only have one way to get customers, then that's a minus one from your multiple. And the next one is market risk. So this is a look at the industry. Is there some sort of risk that You know, maybe AI is significantly threatening that industry. That's going to make it undesirable for an investment banker to buy that business. So, so this doesn't impact the painting business. So you listen to this, you probably don't have to worry about any market risk, but just to give an example, this would be something like, like the designer space right now, just because AI can do a lot of designs. So that might be threatened, threatened right now. Um, so that would be the market risk. The next one is data risk. So this is, uh, this is one of my favorite ones. So if you have data risk, this means that you don't have good insight into your numbers. You don't know your numbers. Maybe I'm going through these numbers right now and you're like, I actually don't know what my revenue or EBITDA or how much revenue growth I have, or what my, uh, revenue retention is, or what my LTV to CAC is. So if you're asking— you're saying these things to yourself, you probably have data risk because you don't know your numbers. You have no way to easily access that information in some sort of dashboard. Maybe you have to go to 4 different, 5 different places to pull this stuff together. You probably have data risk. So that would be a -1 off your multiple.

Yeah, yeah. I noticed that our example client does not have data risk because he has great financial reporting. His books are very clean. His taxes are taken care of. So that's, that's, that's nice to see.

Yep. He has a dashboard that give him all this, all this data. So he's at 0 for that one. And so just to recap, He has a 1 multiple for his, uh, for his EBITDA because he's under $1 million in EBITDA. So he's at a multiple over 1. He doesn't have any value adders, uh, and he has no value subtractors. So that 1 carries down to the adjusted valuation multiple of, of 1 since there was no adjustments. And then we multiply 1 times his EBITDA to get the value, which is $513,000. So if an investment banker is looking at this painting business, they would likely value it somewhere around $513,000.

And that's basically one year's profit.

Exactly.

So now if this client wanted to increase the value of his business, we kind of identified the areas that he could work on. Some of these value adders such as increase your revenue growth to more than 30% year over year, increase your lifetime value to your customer acquisition cost. If you, let's say he was able to do those two things, now his multiplier would be 1 plus 1 plus 0.5 or 2.5 and his enterprise value or the price that an investment firm would pay for his business is—

so if he did 30% growth, revenue growth, which would get him to $3.64 million, and then he increased his EBITDA margin to 28%, that would get him a couple additional multiple multipliers. One, it would get him in the 2.5 EBITDA multiple for being over $1 million in EBITDA. And so let's change that one, 2.5. And then he— if he had his revenue growth 30%, that would get him another point there. And we're saying that he didn't quite hit 30% there, so he just improved the revenue growth and he improved the EBITDA margin, but not up to 30%, just but close. So that's going to increase the multiple to 3.5. All right, so 3.5 multiple on basically a million bucks, so that's $3.5 million. So his, his current enterprise value in one year, if that's, if that's possible, which is possible, it's just been a lot of work, um, would be $500,000 to $3.5 million.

That is an enormous difference.

Yeah.

Yeah. Yeah. So I like this. It kind of helps us understand where we need to focus, what, what things need to change, because changing a few of these items really impacts the enterprise value if you're changing the right items.

Yep. Cool. Well, uh, hopefully that was useful. I'd love to hear your thoughts on, you know, if you've tried to sell your business, maybe you reached out to investment banker. Um, there's different formulas out there, but a lot of them, apparently according to Alex Hormozy, are very similar to this kind of breakdown that we went through today. Um, love to hear your thoughts on on the, uh, the selling process, or if you're looking to sell, or some of the risks or other things that we went into today. Love to hear your thoughts. You can go to Facebook, uh, and type in Grow Your Painting Business and go into the Facebook group. Love to hear your thoughts.

Yeah, thanks for listening, everybody, and we hope to see you on the next episode.