Intentional Growth

Today we’re talking to Travis Steffen. Travis has exited seven companies so far, and he’s going to share what he’s learned along the way, including lessons learned from a botched exit. He will help us understand what builds a successful business. We will also touch upon following our passions and how to find happiness as an entrepreneur when you’re always chasing the next best thing. He’s got some great tips, so you won’t want to miss it! In This Episode You’ll Learn: The first time Travis decided to become an entrepreneur and how he funded his first company. The types of businesses that Travis has run and how he got into them. Travis’s mindset as he gets into his businesses: What is he trying to accomplish? Does he keep the end in mind? Travis discusses how he used opportunities as stepping stones. One particular example of the sale of a company that Travis wishes he’d handled differently, including what he’d do now that would significantly increase the value of the business when it came time to sell. Travis’s thoughts on how people can switch industries based on his experience. How people can free themselves from what they’ve built: Travis recommends steps to follow. How Travis’s different exits have changed his mindset on what constitutes a successful finish. Travis’s definition of meaningful work and happiness as well as where he finds his fulfillment. Travis’s best advice for the exit journey, before and after. Takeaways: It’s important to systematize internal processes. If you’re doing things more than once, figure out a way to never have to do it again. It’s important to find your passion. We are always chasing the numbers and the competition, but it’s more important to figure out the “why.” Buyers just want an investment. They want cashflow with a good ROI. Know that your baby will eventually be someone else’s investment. Links and Resources: The Value Advantage Viral Hero Bax.co About Travis Steffen: Travis Steffen, author of Viral Hero, is a serial entrepreneur with 7 successful exits (and a few crash-and-burn failures) to his name. As a growth engineer, he specializes in building products that grow themselves. After nearly a decade of running startups, Travis began to adopt a different way of building products by building the viral loops first, then finding product details that fit inside those structures. After seeing this strategy work, he set a goal to gain a deeper understanding of viral marketing mechanics so he could create a resource to teach founders and growth engineers how to use creative product architecture to grow their companies – rather than burning giant piles of cash. The result is Viral Hero – which has recently also expanded into an agency and accelerator. Travis currently lives in San Francisco, and serves as the Head of Growth at Lottery.com – which he’s gone on record as saying will be his “viral Mona Lisa”. He also loves poker, Muay Thai, space, fantasy football, cryptocurrency, and a good rack of ribs.

Today we are going to be talking to Erik Huberman. Erik found that discovering a company’s unfair advantage and exploiting it through digital marketing and sustainable business processes can take a company and its profits to new heights. Erik is the current owner of Hawke Media, has sold multiple companies and is on the Forbes 30 Under 30. He started Hawke Media three years ago with just seven employees and he has scaled it to 150 employees today. He’s also a cofounder of Arrowroot Capital. Today, we’re going to talk about how to build a sustainable business that is profitable and that gives you the option to sell whenever you want. Erik will explain the three pillars of marketing and how to make good decisions. In This Episode You’ll Learn: How Erik grew up with the entrepreneurial mindset, as well as how he went from small opportunities to a full-fledged business. Some of the things Erik has done to accelerate the growth of Hawke Media. Some of the things Erik did that ended up paying off when it came time to exit despite not building with the intent of selling. How he ended up selling his first business. How Erik’s mindset has changed when it comes to valuing companies. The dynamics Erik uses when setting up deal structures for either investing or selling. The types of industries and unfair advantages that Erik looks for when determining whether or not to take a risk. Some things that Erik has seen work and not work when it comes to raising funds. The three marketing pillars that Erik focuses on: Nurturing, awareness, and trust. He also talks about what most people are missing the most when it comes to these pillars. Erik’s top tip on hiring people. Erik’s definition of a sustainable business Takeaways: The importance of knowing what your unfair advantages are and leveraging them. The importance of knowing how you can let the world know about your unfair advantage and what unique value you can bring to others. The importance of knowing how you can build a sustainable and profitable business that will give you exit options later. Links and Resources: Hawke Media Erik on Facebook Erik on Twitter About Erik Huberman: Erik Huberman is the Founder & CEO of Hawke Media, a full-service Outsourced CMO based in Santa Monica, CA that launched in 2014 and has been valued at $60 million. In just 3 years, Hawke Media has grown from 7 to over 120 employees and has serviced 400+ brands including Raden, BeautyCon, Bottlekeeper, The Ridge Wallet, Buscemi, Red Bull, Evite, Verizon Wireless, HP. Hawke Media was recently named on the Inc 5000 list of “Fastest Growing Company’s” of 2017, one of CIOReview’s “Top 20 Most Promising Digital Marketing Solution Providers in 2017”, and a recipient of a gold STEVIE Award in the American Business Awards for “Company of the Year”. As a serial entrepreneur and brand marketing expert, Erik Huberman is a sought-after thought leader in the world of digital marketing, entrepreneurship, sales, and business. Prior to Hawke Media, Erik founded, grew and sold Swag of the Month and grew Ellie.com‘s sales to $1 million in four months. Erik is the recipient of numerous honors and awards including Forbes “30 Under 30”, Inc Magazine’s “Top 25 Marketing Influencers”, Influencive’s “Top Influencive Influencers of 2017”. Erik is a regular contributor to major media publications like Forbes, Entrepreneur, and Business Insider and is proud to have and recently joined XPRIZE as their key marketing advisor. Read on for the full transcription: Ryan:   Welcome back to the Life After Business Podcast. Today’s guest’s name is Erik Huberman. Erik is on the Forbes 30 Under 30. He has sold multiple companies and he’s the current owner of Hawke Media which is an outsourced marketing company that Erik started 3 years ago with 7 employees and has scaled it to 150 employees and works with some of the biggest brands like Red Bull. Erik has been addicted to growth since his early childhood, and has been applying his passionate addiction in extremely beneficial ways with his couple companies that he’s sold and for his current clients. Erik also is a cofounder of Arrowroot Capital and they have 27 companies in their portfolio that they invest in. On today’s episode, Erik and I talk about how to build a sustainable business that is profitable, that has options to sell whenever you want. Also, we talk about what are the strategic valuations that venture capitals and angel investors look at and how they actually come into evaluation if you’re looking to raise money and partner with a company like Arrowroot Capital. Erik explains the three pillars of marketing and how a lot of the companies, regardless of the industry or the maturity, have to make some decisions about where they’re missing the mark in digital marketing and online sales and then how to put fuel behind that to hit the growth projections that they need to eventually have those exit options that you want. I really hope you enjoy this episode with Erik. He shares a lot of different wisdom through the ventures that he’s in and the exits that he’s been a part of. Without further ado, here’s my interview with Erik. Good morning, Erik. How are you doing? Erik:    Good. How are you doing? Ryan:   Doing good. I’m really looking forward on having you on the show. You’ve done a lot of stuff at your age and I’m looking forward to hearing the different steps throughout your journey. For our listeners, can you go back to the first time that you really decided to jump in and become an entrepreneur? Erik:    There’s a couple, I don’t know which counts, so to speak. I don’t know if I should tell you this but when I was a little kid, my dad actually, to his credit, got me hooked on the idea of building wealth. He got me excited about the idea of owning a $50 bill and owning a $100 bill, not to buy anything, just the intrinsic value. I actually got super hooked to finding change and stuff to actually get up to that point. So what I ended up doing when I was six was taking a bunch of my parents’ things, throwing them into a trash bag, and trying to sell my parents’ stuff door to door. Ryan:   That’s awesome. Erik:    I didn’t understand the part where money actually then pays for something. It was just like I’m supposed to make money. When I was eight, I wanted an electric guitar and I asked my dad if I could get an electric guitar because my name is Erik. The only other Erik I knew was Eric Clapton, and so I needed to be a guitarist. I said, “Dad, I want an electric guitar.” His response was good, “Get a fucking job.” Not being able to get a job at eight years old, I actually started buying and selling Beanie Babies to make money, right in the middle of the Beanie Baby craze. I had no actual passion for Beanie Babies, I just saw an opportunity. Then I ended up making a few thousand dollars at eight years old. I bought the guitar, bought a BMX, saved some money for a car. It was pretty fun. Ryan:   That’s awesome. I’ve got two twin one-year old girls and we just found our huge stash of Beanie Babies. That’s really funny, I just brought that up. I saw you also were selling Cutco. I used to sell a little bit of knives back in the day as well. Erik:    Nice. In terms of hiring people, if I can find people that have Cutco experience, it’s a no-brainer. We have a few employees—there’s actually a tangible difference and it’s insane. Ryan:   They definitely put the training to a whole different level. How did you go from the different little journeys that you’re talking about there into actually a full-fledged operational business? Erik:    It’s funny, it kind of progressed slowly. I’ve had five actual businesses, filed corporations, did it officially, raise money sometimes or not but had real businesses. The first one was on the summer of my junior year in college. My friend found that the state of California had passed a law that you have to filter your storm drains and no one was doing it. So he came up with this idea but needed someone who understood marketing and sales to help him. I had just broken a bunch of records with Cutco as you mentioned it. He’s like, “Hey, you’ve got sales. Come help me build this.” That was the first. But the thing is, we weren’t sure if I was going to drop out of school in my senior year or go back or what. I did it for the summer and frankly realized, I didn’t want to filter storm drainage for the rest of my life, so I went back to school. What I’m highlighting is I kind of dipped my toe into entrepreneurship there while along the way had other little entrepreneur endeavors. When I got out of college, I actually went into real estate full-time for a year. I started a week before the entire banking industry collapsed. As a commercial real estate agent— Ryan:   I know. Erik:    It was still entrepreneurial. I didn’t make any money unless I sold something. I kept my own hours. My manager was there more as a guide than a traditional manager, because he didn’t actually pay me anything. But it was still enough structure I think, that when I went off a year later to start—I started working on a side project six months later, but a year later, I left to go pursue my first ecommerce company. I already had a bunch of disciplines, and a bunch of things that were guided so that I could really go full-fledge. From there, I’ve had three ecommerce companies and now Hawke Media. Ryan:   What I love about your background is you’ve got two sides of the coin of really growth acceleration and then also the exits too because I think they go hand in hand. A lot of entrepreneurs, they just chase revenue and growth for growth’s sake but then you’ve also gone through these exits. Let’s focus maybe on the growth too because you’ve got, which is what you’re doing, Hawke Media, how are you finding opportunities and then lighting the fire behind growing these companies at the rate that you have. With Swag Of The Month, you’ve really put some numbers behind your companies that you started. What are some of the things that you’re doing to accelerate the growth? Erik:   I would say a few things. One is I almost have an addiction to growth. I like growing things. It’s similar to like the six-year old running around, selling things of my parents. It’s not about the money, and that’s a very high-class statement to make. There’s all those studies, once you make $70,000 a year, your happiness and your stress goes away. Really after a six figure paycheck, it’s not about the money, it’s about something inherent, something that drives growth, for me, I always really cared about that. I always focus on it. Through focusing on it, I became pretty good at it. It’s like I was always looking for how do I grow this faster as opposed to a lot of other people have different priorities in their business but I always wanted scalability and growth. I was able to achieve it. I throw tons of things at a wall, and I got this advice early on from a guy named Chris Nella who ran acquisition marketing for Shoedazzle, GameFly, Soul Society, Tradesy, and now Thrive Market. It’s quite a resume. He gave me advice when I was first starting Swag Of The Month, my second ecommerce company. He said, “Yeah, marketing is just trying a bunch of shit and then doubling down where it works. You just have to test all the time.” I actually set up a framework to test properly but that’s really it. Ryan:   I’ve been following Digital Marketer, all the different people, you’ve got a lot of traditional businesses getting into ecommerce or have a nice little hybrid of both. I think everybody is doing exactly what you’re saying which is trying a bunch of shit as they’re trying to figure out how to scale their companies and grow. What are some of the things that you’ve seen in your different ventures that have really stuck and have been now then integrated to your process to keep scaling? Erik:    It’s been negatives and positives with each one. I learned in my first company, we targeted independent musicians and get one on one business coaching to help them grow. It was a great product, we had a bunch of success stories but at the end of the day, having independent artists who are usually struggling for money as a customer was terrible. I learned that in some ways you don’t pick your customer and then in some ways you do. Just make sure that you’re setting yourself up for success there. Swag of the Month, I learned all the problems of scalability and why—unit economics I already knew are important but still there’s a level of scale you have to get to before those unit economics come into play. It was a $17 subscription company. Even if our profit was $10 a person, $10 doesn’t go very far. We needed a lot of customers for it to mean anything. That was another lesson that I really took with me. With Ellie, the last company, it really came down to—I’m trying to think of the best way for this—with Ellie, it came down to, they gave me a large budget frankly, and I’ve got to try everything. I actually really learned how to manage a really large marketing budget. $2 million with a brand new company and they’re like, “Go, do whatever you want.” I was used to being scrappy and then got to just take off. Ryan:   Like a nice little kid in a candy shop, experiment. As you’re putting literally rocket fuel behind the marketing of these things, the biggest challenge is also growing intrinsic value because you’ve exited these companies as well. Are there certain things that you saw through these journeys that were very valuable when you actually came to the exit along with going through them while you owned the current company? Erik:    Can you repeat that question? Ryan:   As you’re scaling these businesses and as you’re growing and your revenues are going up that far, when you’re putting the dollars behind these different marketing tactics, was there certain things that you were putting in the operational or automating or repeating that when you saw the value, when you ended up selling the business because of that ease of transferability or of repeatability? Erik:    It’s funny, yes, we had certain things that were repeatable but that’s not usually why people bought my businesses. The few businesses that I sold were more for brand and customer base than processes and repeatability. Ryan:   Let’s fuel that back a little bit. Erik:    Sure. Ryan:   First of all, when you’re scaling these with the end in mind, knowing who your potential exits might be, what was your thought process around the timing and where you were going to eventually go with the business? What was the triggering event? Give us a little bit of narrative around the exits. Erik:    Sure. That’s the irony. No, I actually have never built a business with the intent of selling. I always know it’s an option. But don’t really aim for that because you can build a sustainable business on your own, if that works, you can sell it. There’s definitely a lot of businesses that don’t build a sustainable business and sell but I don’t really like that game. It’s not really for me. The first business I sold, Swag Of The Month, we’re almost in the position where we had to sell. We got to a point where, back to that scalability point, it was tough. When we had a bunch of subscribers and it was working and making good money, after always setting down on expenses and covering our own bills, etc., there wasn’t a lot left over so it was really hard to hire people to scale the business. We learned the reason why people raise money, frankly. We got to the point where it was like we can either raise money, sell the thing, or shut it down because we couldn’t perpetuate what we’re doing with some cash flow. I actually got a meeting with a guy named Howard Morgan who was one of the founders of First Round Capital. Which frankly, he’s like a legend in the venture capital world. I didn’t know any of this. I didn’t know anything about VC. I met with him and he thought that it was a great idea but he had just invested within this company called fab.com which if you don’t know, ended up being a huge disaster in the VC world. He said he couldn’t invest because of it. The guy have been incredibly successful I wasn’t meant to be demeaning. There weren’t all these podcasts talking about venture capital or selling a business, I didn’t know much about it, but at that point, I was like, “Well, I met the VC, he said no. I guess we’re moving on, there’s no other VCs out there.” It wasn’t like you’d reach out to 50 to 100 VCs. Ryan:   Just like the Cutco days, right? Erik:    It was just like, “Yeah, it’s done. Okay, next.” I moved on so then it was sell or shut down. Right then actually, a contact of mine reached out out of the blue and said, “Hey, I don’t know if you’re interested in selling your business but if you are, I’d like to talk about it.” It was just serendipitous. I took a meeting, told her how much we wanted for it and she wrote a check on the spot and bought the business. Ryan:   Did you think that you didn’t ask enough? Erik:    I mean, that’s definitely a case, but I was always happy with it. I could have gotten more obviously. I go, “This is how much.” And they go, “Yeah, okay. Here’s the check.” It’s like, “Oops,” but at the same time, I don’t regret it. I was always in the position where I had other things to move on to. It was actually nice enough and again, we didn’t have a lot of options. It was in a tough place. Ryan:   From sitting down with Howard Morgan, did you have any conversations about how he would have valued the business and how did you come up with that number when you eventually sold it? Did you use any tidbits that you learned from Howard on that call? Where were you getting that number from? Erik:    I can’t remember the number that we used to be honest but I think I might have it somewhere. I’m literally on my computer looking for the number. With him, we actually didn’t get that far, we talked more about the business and he looked over everything. He did look over a deck which I’m trying to remember, I’m looking at it now. Yeah, we had numbers. We were trying to raise $1,000,000. But I don’t think we established a valuation. Ryan:   Got it. When you came up with a number as you were actually selling it to the buyer, was it a number that you had just pulled out of the air to figure out what you could go on and do something else or did you have a multiple EBITA or revenue or anything? Erik:    No. Again, there was no valuation. We had no idea what we’re doing with VC. It was like, “I need $1 million. We’ll just negotiate with that.” Ryan:   With Swag Of The Month and then Ellie, and then now what you’re doing with Hawke, you are also an investor, correct? Erik:    Correct. Ryan:   How has your mindset changed in how you value companies? When you’re looking for value, what is it that you’re looking at? Is it cashflow, is it niche, is it some sort of IP? Erik:    It’s strategic advantage. It’s why are these guys going to beat everyone else out? I’ve heard it being talked about more and more but I was so surprised early on when I got into investing that this thing come up a lot. It’s like, why are these people going to succeed and what unfair advantage do they have? Because if someone is just starting a business because they have a good idea, good luck. You have to have something that will propel you past everyone else because you have something so solid as far as strategic, you can’t lose. That’s what I look for, or I look for where can we be that acceleration. We’ve got about 170 active clients. Is it a software that all of our clients can use? Those kind of things, so that we can become that unfair advantage is also an option. Ryan:   That’s interesting. Let’s go back to the first point you were making. This unfair advantage, what are some of the examples that you’ve seen that have given you the confidence that you need? Erik:    Let’s see. FabFitFun is a good example and it worked. That was my first angel investment. FabFitFun is an ecommerce subscription box. This year, they’ll do about $115 million profitably, and they’ve only raised $6,000,000. Just to give an idea. With them, they started as an email newsletter. They had a huge email list before they ever launched ecommerce, within it they raise the ecommerce business. When they went to launch it, they have every customer already in their database, they just need to mine that database. That’s an unfair advantage. Good job competing with that. Ryan:   If you’re taking a company like that that you’re investing in, how are you looking at the value that you would pay for because obviously, you’re looking for the unfair advantage. Do the people usually know it, the sellers or the people looking to raise money? Then, how do you place the valuation on that strategic investment or acquisition? Erik:    I actually don’t play any games in terms of valuation with entrepreneurs. I want someone smarter than me. Currently on paper, my best investment is a less than one-year old business. I can’t talk about it because they want to stay still. But it looks like they’re going to do about $55 million in their first year. They’ve already cash flowed like $20 million. The entrepreneur in it is honestly brilliant. I didn’t play games with the valuation. We came to a deal we’re both happy with. To this day, we came into deal, we’ve made, I’d say in terms of our investment on that, I think we’re about in one year, 30 times our investment. There could be a tendency to look into our pocket as an entrepreneur and be like, “I just made you 30 times your money in a year. You are overpaid.” But because we set up the deal in a way that was so fair and we didn’t argue anything, he’s totally happy. He’s like, “Good job. You bet on me early, we worked.” He’s excited. Ryan:   That’s awesome. You know the reason why I’m peeling the deal structures, the terms and the valuations is because it’s so different when you’ve got an immature business that’s been clipping away at the 5% to 7% increase and you’re looking at the EBITA and there’s even a multiple or discounted cash flow versus the strategic valuation. It’s so different because it’s a synergies of partnerships and people and talent. The valuation or how you come to that, I think is a complicated situation. I’ve got a friend that is looking to raise some money right now. There’s not a whole lot of play books around it because it comes down to negotiation. As far as the valuation, that’s why I was kind of going into that, but also the deal structure, what are the typical ways that you’ve seen when you were selling your companies or now you’re investing, that you’re structuring these deals whether it’s an ownership percentage or board seats? Give us a little bit of a rundown of the dynamics that you end up setting up. Erik:    We’ve got 27 portfolio companies here. Some of those are straight check investments as angel investors, some of those are hybrid services, equity, cash deals, sometimes they’re advisory positions. We’ve actually built a team here around servicing those so that we can give them, again, it’s all about that unfair advantage, we wanted to give them an unfair advantage. We haven’t actually taken an official board seat but we actually influence the company so much, because of what we have access to as Hawke Media, 115 people here running marketing for hundreds of brands. We can do a lot for companies’ companies. They let us have a lot of influence no matter what and we have a full team that is dedicated to that if you put in the time versus in venture capital, you’re not making enough cashflow to have teams dedicate these things for us. We’re actually taking a piece of the overall revenue of Hawke Media to hire a team to service these because we see it as a high risk high reward size of our business. Ryan:   That’s super interesting. That’s one of the biggest things that I have seen, when you have successful transactions like that, where it’s not just about the money, it’s about the leverage and the skills sets and the network because that’s where the value actually happens versus just having someone that’s going to fund you and sit there and dictate and micromanage you. Explain a little bit because I think it’s very interesting how you’ve leveraged Hawke Media and these portfolio companies, can you shed some light about how the dynamics and the relationships work? Erik:    Basically, obviously, it depends on the business. Certain businesses we actually are pretty passive with. FabFitFun at this point has by monthly to quarterly meetings to catch up and talk about strategies. They’ve got an amazing team over there. They don’t need a lot from us. But then there’s other companies that are on earlier stage that we come in and basically take over a big chunk of their marketing department or the whole thing in exchange for parts ownership and sometimes part cash. Then, there’s the third piece which is investing and then coming on as an active advisor as well. And actually even a fourth piece where we’re not necessarily running their marketing but we’re acting as an advisor for equity. Again, we have all these four different positions and with each one, we try to just bring our network, our connection, our clients, our knowledge, everything we can to make it a better company. Ryan:   I like it. I think before we go into a couple more questions, can you explain exactly what your services are at Hawke Media because I think the tie of what you’ve successfully done and how your growth associated with Hawke Media and the practices that you apply for your customers allows other—regardless of the industry scale up. Because I think in today’s world, I mean, every client that I have, everybody that I talk to, growing their companies is the biggest challenges. I came from the copier and IT services world. It was the old Cutco model of telemarketing and knocking on doors which just doesn’t work anymore. I think what you’re doing is scalable because you’ve got the business, the infrastructure, and you can also apply it to various industries. Give us a little bit of a backdrop on exactly Hawke Media and what the practices are that you’re doing that are working so well across these industries. Erik:    After all of those ecommerce companies I mentioned, the three, after I sold the last one, I started advising and consulting for a bunch of brands. I kept running through the same challenges that I ran over with my own which is when it came time to execute, it’s tough because there’s two options. It’s hiring an in-house team or hiring agency. What I found with hiring in-house isn’t cost-effective, that’s if you could find a talent but on the agency side, it seems like 98% of the agencies have no idea what they’re doing. Ryan:   Maybe 99%. Erik:    Just to be real. Yeah, exactly. Everyone’s experienced this. It’s like I’m not preaching to the choir. The few that are good though tend to be really expensive or want long contracts or have some other barrier they put up that makes them hard to work with. I got sick of it, decided to hire my own team. We started with seven people, an email marketer, Facebook search influencer, affiliate, web design and overall strategy. I went back to these companies and said, “Everything is a la carte month to month, cheaper than hiring in-house but basically, we can spin up a team that fits your needs based on this menu of services.” That’s how we started. Fast-forward, it’s been three and a half years. We’ve grown from 7 to about 115 people. Our services have obviously expanded quite a bit. But it’s this idea that we’ll go to a company, identify their holes and their expertise or bandwidth and then spin up with people overnight that can actually take that piece over. Ryan:   I think it’s something that really a lot of entrepreneurs are challenged with because in order to exit and actually get the top dollar for your company, you need to be growing at a predictable, successful rate and I think a lot of people are just running into walls constantly whether it’s digital marketing. It’s the whole combo of all the things that you have to do to be out there these days to keep the growth coming in. Because I believe that a lot of people do have a competitive idea or specific skillset but they don’t have an idea how to get their voice out. You’ve got Hawke Media and the infrastructure, are there certain industries that you’re applying and looking for out of these 27 portfolio companies or the ones that you’re looking at down the road? What kind of industries, what kind of unfair advantages are you looking for? Erik:    Again, it’s either a distribution channel, it’s expertise that don’t exist in other places, it’s some infrastructure that’s already being built or leveraged for this business. In terms of unfair advantage, there’s a lot of different ways it can manifest. It just really depends. As far as we look at, it’s either companies that we know how to grow. I guess we have three investment criteria or channels, so to speak. Companies that we know we can grow using our platform, companies that are good for our clients, software companies, things like that that we can utilize. Then the third one is just opportunistic, we like the team, we like what they’re doing, and we’re just going to come in as a partner just because there’s something there. The third one’s a little harder. I think that’s going to be where we’ll probably lose some money. Ryan:   It’s worth the risk. Erik:    It’s worth the risk and we hope for the best and it’s fun too. But they’re the ones that we just think that there’s something there and these people are super smart and we got asked to come into the round but it’s not necessarily anything we can affect which is harder to justify. Ryan:   Are there any of these portfolio companies that you guys have gone through the exits with together with the people that have founded the companies? Erik:    No. Our first investment I think is only two years old. We haven’t gotten to the point of exits yet. We’ve gotten plenty of raised money for new rounds and stuff like that. But we’ve not actually exited because we’re getting in early. We haven’t invested in any late stage companies. Ryan:   Explain a little bit of the process that you’ve gone through now because you’re providing some funds but then you’re also going out and helping people raise some funds. What are some of the couple main takeaways that you’ve seen that have worked really well and some that have not worked very well? Erik:    In terms of raising money, I’m always cautious with people about raising money. That’s why [00:28:44] I think it’s incredible that the guys raised $6 million then just built a profitable business and they’re at $150 million in revenue. I understand that at some point, a lot of companies have to but because I’ve been there, avoid it at all costs. There’s a lot of complicated ways to do it and just depending on what you’re dealing with. I’m trying to think of an example, sometimes you may want to take on debt, sometimes you may want to take on equity financing. The right VC or the right investor makes the difference. If you’re going to take money from someone, hope that they’re strategic, don’t just take the money because the guy has money. Generally even on the other side, if someone just wants to take your money because it’s money, that’s worrisome. That means that they’re not thinking about this in a complex enough way and that worries me about how they think about their business in general. There’s a lot of things that come into play here. Ryan:   When you’re doing that, you’ve been part of these situations, how are you actually getting down to the valuation? Just hopefully, some of them are running stable businesses where they got cashflow and not just an idea. How do you get to a point where you’re figuring out whether it is debt, whether it is one of your four roles to coming up with that valuation to say, “Okay, here’s exactly what the money is going to be and here’s what it’s going to be used for and here’s what we’re going to need in return”? Erik:    Because again, the deals we’re dealing are early staged. Usually, it’s just a conversation. If anyone tries to claim that there’s a science to valuation in the venture world, they’re full of shit. I can say that by looking at the valuations companies get. Private equity is a whole different world. That’s valued off usually trailing 12 months cash flow. That’s the way you do it. But you can’t really do that in venture because it’s all the upside and what you think. It’s usually just a conversation of what makes sense based on what they have and what works, whether it’s been invested already etc, and we just talk it out and decide what we feel good about. It’s kind of a gut check. Ryan:   I agree with you on that one. Like you said, I think people need to think that there should be a science to it but it’s really not. Erik:    There can’t be because that’s the thing about ventures. I invested in one company that frankly, if things go well, they can maybe sell for $15 million or $20 million. It’s not going to be a massive business but they’re raising $300,000 and a $2 million valuation. We hope in a year, it’ll sell at $15 million. That’s okay. Then there’s other companies like we invested in another company with $12 million valuation. We invested on a pro-rata on that company that’s going to do $55 million this year. They just finished around $12 million. Again, they’re going to do $55 million this year, like yeah, no-brainer. They haven’t done it yet so they can’t raise against that but I’m very involved in the business, I’m confident in the CEO so I wasn’t worried about it. Again, the valuations are all over the place, it’s depending on what’s going on with the business. Ryan:   When you’re getting out, let’s say the transaction’s complete and you guys are now, one of your four roles, you’re looking at it, as far as the marketing in the growth side, what are the ways that you go in to assess what they’ve got going on and then where do you focus on first? Erik:    We focus on whatever is missing. We look at marketing in three pillars, nurturing, awareness, and trust. Awareness is like advertising, get your brain out there. Nurturing is what do you do to take that awareness and turn it into a sale. Trust, 75% of the people say the most important, this is [00:32:15] studies, say the most important factor in a purchase decision is trust, building that trust through press, third party validation and influencer marketing and things like that. What we do is we go and assess do they have all their bases covered and to what degree and where should we focus on. That’s that marketing piece. With the Google Analytics, we’ll talk to the CMO or CEO or whoever’s running marketing, etc., and we’ll go from there. Ryan:   How many people do you interact with or come across who are actually doing these things correctly? Erik:    100% very, very few. They exist but it’s been a handful in the almost four years I’ve been doing this. Ryan:   What are the biggest gaps do you think as far as those three pillars? Where are people usually missing the most? Erik:    Usually, it’s the nurturing piece. Usually people think that they get pressed and they get awareness out there. That’s kind of trust and awareness. Then people just buy but without reminding people. In sales, follow-up is the key and they talk about it all the time. In marketing, people forget that piece. Ryan: When you’re talking nurturing, it’s a combination of email marketing, follow-ups. Is it individual phone calls, or is it email marketing, automated webinars? What are some of the technical things in the nurturing that you’ve seen that have capitalized in the awareness and trust that people have built, is it email marketing? Is it phone calls? Erik:    No. We’re talking about consumer businesses, phone calls are tough. It’s email marketing, it’s retargeting. Even Facebook messenger and chat bots have been a good one now. It’s all the ongoing communication while someone is trying to make a purchase decision. That’s the nurturing piece. Ryan:   Are there any industries, with our listeners, we had a combo of some young entrepreneurs like you and I and then also a combination of some baby boomers that have had some traditional businesses, the main street service businesses, are there things that you’ve seen that you know they’re not—let’s put it this way, let me rephrase my question. An HVAC business or someone that’s in the service business or manufacturing, I don’t see them doing a lot of this and I think they’re missing the boat because they have this unfair advantage, they built a sustainable business and applying this stuff, I think the opportunities are huge and understanding where do you start, because I think to accelerate the growth and sell it for a dollar that they want, they have to be moving into this realm. I don’t even think they understand where to start. Erik:    That’s basically why our business has grown so fast. We used to talk about like one of the lines we used to use is we are kind of the navigator of the digital world. It’s hard. That’s like me coming in and saying, “Okay, I want to start a hardware manufacturing business for auto parts. Where do I start?” “I don’t know. Read a lot.” It’s an old business. That’s what we actually run into. We worked with a lot of manufacturers and traditional businesses on getting into digital and it’s starting a new business. I articulate that to them every time now. It’s like be very aware. What you’re asking me to do for you is you to start a new business. It’s not an easy straightforward thing. Ryan:   That’s interesting because I think that the challenge that a lot of these mature businesses have is it worth to start this new business or is it worth it to just sell it because I think you have to double down. It’s new operations, it’s new talent. It’s having that hybrid of now you’re selling online, you’ve got a presence online. I don’t know exactly what my question would be because I think it’s trying to determine is it worth starting this new business. Is it worth the effort and who’s the champion internally? Because I think a lot of the entrepreneurs, it’s not them, they don’t necessarily want to be. Erik:    Again, it just depends on what your desire is. It’s hard to have someone internally to champion it, that’s what I kept running into, it’s hiring people internally. If you’re not a sexy startup like Dollar Shave, now it’s not anymore but at the time, Dollar Shave Club, this kind of companies, they can attract anyone. One of my first clients was a manufacturer out in east L.A., in the middle of nowhere, with no place for lunch, it was just like warehouse, it just sucked. Good luck trying to attract a really talented marketer out there for anything less than double what they’re usually paid which is already obscene if they’re a good marketer because a good marketer can make their own money or they’re not very good. It becomes very hard. That’s really where the impetus of my business model came from. That was hard and I couldn’t find the agencies that were any better so I just started my own. I never planned on building an agency like this. I actually, at that time, was building a tea company, like a drinking tea company that’s on my shelf that I shut down. Ryan:   Crazy. I totally agree with you because there’s a couple companies like yours that have really blown up. Explain what it’s like to start that engagement with you. Like you said, so many people have been burned by agencies and so many people don’t even know what do you Google on Indeed just to say, “marketing specialists”—there’s so many different talents. You’ve got 115 people with different talents. Once you do this assessment of what it is that you want, where do you start with the skillsets? If you were to go to that manufacturing or something, what is plan a to c? Erik:    This is something I’ve learned myself too. It depends on your business and what we’re talking about because it sounds like we’re talking about companies already in the later stage, at that point, you don’t hire young, scrappy people. People still hire their daughter because she has a Facebook, or a son, it’s not a sexist thing, their kid, because they have a Facebook to come and run social media. No, no, no. I’ve learned a really good, small, basic tip on hiring, once you’re at a point where you need to hire for people to do something and not to learn on your time, when you’re getting to a mid-stage business, you want to hire people that have already done what you’re looking to have to do. You don’t want people to learn, you don’t want someone that’s got a resume that says they have ten years of digital marketing experience, you have to set up a goal and find someone that’s hit that goal already. It’s like if you want a Super Bowl winning team, hire someone that’s been to the Super Bowl and won. If you want to get to $50 million business through marketing, find someone that’s marketed a business and grown it to $50 million. Get that person. It’s worth paying for if they’re good. Ryan:   I’ll agree with that. I think you nailed it when you said so many people have people learn on their dollar. There’s this biggest connection of like you said, they’re probably building awareness or trust. Whether it’s the people you’re investing in or a late stage business, people have something to say and they’ve got something that’s worth of value but getting that voice out into the world is challenging. The biggest false notion now is that you can’t track it because you can. Like you said, you can actually put this and show the return on investment if you get it setup correctly. Erik: Yeah. Ryan: As we’re wrapping up because we’re short on time, Erik, if there’s something you want to highlight or if there’s a takeaway for our listeners as far as growth and exits and valuations, what is something you want to highlight or leave our listeners with? Erik:    I would say at the end of the day, don’t focus on the sale and you’ll get it. I really believe that. I’ve watched companies, don’t get me wrong, there’s companies that push the limits, grow as fast as they can, burn through cash and sell before they fail but before you do that, build a sustainable business. You have options. We’ve been offered to sell this company, Hawke Media, 7 or 8 times seriously and probably 30 times not seriously. In that process, we’ve realized, we don’t really want to sell. Don’t get me wrong, if an obscene crazy number that everyone in Hawke Media is going to be rich off of comes through the door, sure. I’m not going to say never but in terms of market valuation, I have no desire to sell right now. I have that option. I don’t have to sell it. It’s a profitable, sustainable business. It’s really nice to build a business that way and then decide later what you want to do but don’t build to sell. I actually don’t like that way of doing things. Ryan:   Let’s get your definition of a sustainable business. Erik:    Profitable. At a level that you can have a little cushion too in case mistakes happen and hiccups etc. It’s not just like you’re making 1% profit, I mean like real profit. I know that the margin is different with every business but something that can actually sustain if your business goes through a change or a hiccup etc., you’ve got some award chest you’re building over time. Don’t get me wrong, I know that Amazon is not profitable. I know that there’s certain ways not to be profitable and reinvest but Amazon could be profitable. It’s a little nuance there. In most businesses, that’s the reason you start a business. It’s only the past 20 years that there’s like a whole build to sell mentality came to be. It was really in the late 90s that the first tech boomed. Now, people forget that business is about making money. That’s why you build a business. It’s maximizing profit. There’s a lot of other cool things you can do in terms of helping around the world and helping your employees and all that but at the end of the day, you need to keep it sustainable. That’s the most important part. Ryan:   I agree and I just want to reiterate because when you say build a sustainable and profitable business, what we talk about a lot on the show—because the strategic acquisition or partnership is ideal for everybody because of the synergies and the people and the talent and the opportunities but if you build a sustainable, profitable business, like you said, you’ll have options because any financial buyer will come in because you’re continuously profitable. Then there’s a plethora of financial buyers out there. If you can’t hit your strategic sale, then you’ve got, like you said, tons of options. Erik:    Yep. Exactly. That’s the thing. It’s just about not limiting your options. I’ve watched friends get stuck in having to sell when they don’t want to. That happened to me basically with Swag Of The Month. I would have loved to keep running that business at that time. I’m happy with the outcome but it was just we didn’t really have any options. We didn’t even try to build to sell but we hit a point. If you’re not even keeping in mind unit economics or building a sustainable business, it gets rough. Ryan:   Erik, what is the best way for our listeners to get in touch with you? Erik:    You can always email me e@hawkemedia.com and then it’s just erikhuberman on any social media channel, / or @. Ryan:   Perfect. I really appreciate you coming on the show and sharing your stories. Erik:    Yeah. Thank you for having me. Ryan:   I hope you enjoyed the interview with Erik. I loved how much we bounced around because I think all of the topics we’ve talked about are extremely important whether it is raising the money or the valuations or building a sustainable business. But the three main takeaways that I had, I’m going to actually reverse it and say the three questions that I think every entrepreneur needs to answer for themselves to build a sustainable business are one, what is your unfair advantage. I think Erik highlighted that perfectly because knowing why your business and why you have an unfair advantage over your competition is extremely important because you cannot leverage that unless you know that. Then the second question I think you need to answer is how do you let the world know about your unfair advantage that you have and the unique competitive advantage that they will have if they leverage you and your services, and how do you effectively and repeatedly fuel the growth behind that through a combination of digital marketing and sales that allow you to repeatedly see the growth that you need to because we all need to see that, we all need to get our voices out but we need to focus and really put a plan in place around how we do that so that way, we could see the repeatable increase in revenues and profit. The third question that I think entrepreneurs, we all need to answer is how do you build a sustainable and profitable business that has options down the road? Because if you focus on the business and not working in the business but focus on building this machine that can fuel growth and that can leverage your competitive advantage, then you will have options just by the nature of what you’re doing and working on the machine and the business that you have created. I really hope you enjoyed the interview with Erik, he had lots of good pieces of wisdom throughout the interview and if you want to check anything out, look at the show notes. Until next week!

Today we are talking to Jim Zuehlke, who will be speaking about a board of directors: why they’re important, how to build one, how to compensate them, and how to upgrade the talent of your current board of directors. Jim has tons of experience as a builder of a boards of directors. Although many perceive a board of directors or board of advisors to be solely for extremely profitable companies, the truth is that any company can benefit. Today’s episode is a must-listen for anyone who wants to take their company to the next level. In This Episode You’ll Learn: Jim’s background and how he got into his business, as well as how he got into building and developing boards of directors. What Jim asked candidates for boards of directors and what many of them have in common. The difference between a board of directors and a board of advisors and why the former is important. Where to start in forming a board. Jim lays out the steps to follow as well as some of the common mistakes companies make. Your obligation in compensating your board of directors. The factors that make a successful operating board and why it’s helpful to compare it to marriage, as well as balancing out the skillsets of the people involved. How to know that you’re not where you should be with your board of directors as well as tips on how to make changes. Jim’s recruitment process for someone who doesn’t have a board already. The typical set of subject pillars that Jim uses as he blends groups of people together, as well as Jim’s thoughts on diversity on boards and how that will change in the next decade or so How to Build a Board of Directors Takeaways: Jim gave a very clear definition of a board of directors as well as how their role differs from those of a board of advisors and from a CEO’s peer advisory group. If you have a family business or a business with a crucial CEO, having a board of directors to be the voice of reason can eliminate some of the politics that goes along with having multiple invested interests. It’s important to know the qualities of a great board member and Jim gave us some excellent qualities to look for when searching for the expertise a company needs.   Links and Resources: Cardinal Board Services Principles About Jim Zuehlke: Jim’s company, Cardinal Board Services, is passionate about maximizing the effectiveness our clients boards. Whether it be a Board of Directors or the Board of Advisors, they help organizations with board formation, bylaw creation, recruitment & hiring of directors as well as facilitating the initial board meetings. His clients range in size from $30M to over $1B companies from a variety of industries including manufacturing, construction, technology, CPG, wholesale apparel and medical. Our clients are mostly private companies seeking to grow their business, transition to a new generation or bring in outside management. Full Transcription: Ryan:               Welcome back to the Life After Business podcast. Today’s guest name is Jim Zuehlke. Jim is on the show today to talk about how to build a board of directors, why a board of directors is important, the functions that the board of directors plas, actually how to strategically build them with the different roles and experiences, and then what happens if you need to upgrade your talent of your board if you already have a board of directors set up. Jim has a ton of experience to be able to speak to this because he started his company, Cardinal Mark, Inc. decades ago in an executive search firm and he was recruiting for billion dollar companies to help search for CFOs, CEOs, and top execs. He got into the board of director search because they understood Jim knew their culture and what they were trying to do and where they were going so well that it was a natural fit to start building the board of directors and searching for the board members for these companies. The reason that I wanted to have Jim on the podcast is because I think board of directors or board of advisors is this perceived resource that billion dollar companies have, but the reality is any size company can utilize a board of directors. If setup correctly, the business owner, the entrepreneur that is willing to put the effort in will get dividends back because of the level of expertise they’re surrounding themselves with, they’re holding themselves and their company accountable, and they’re looking out for the stakeholders and bridging the gap between where they want to be and where they are today with the people that have been there and done that. Jim lays out specifically how to build a board, the things that you need to do, the things to look out for, how to compensate them, and then how to actually set up the bylaws to make sure that everything goes correctly. But then also how to upgrade your members, should the fit not work. I think this is an absolute must listen for anybody because an executive CEO peer group is not a board of directors, and having the right employees is also one thing, but this is something that I think is applicable to anybody that wants to take their company to the next level and help guide them in the direction that they need to go. Without further ado, I really hope you enjoy the interview with Jim. Good morning, Jim! How are you doing? Jim:                  Great. Good to talk to you, Ryan. Ryan:               I’m really excited to have you on the show today. Your expertise is something that I think is really missed out in the mid-market entrepreneurs and the businesses that are in our community. We came across each other through a local event that People host called Club E where you just recently did a panel. But for our listeners, before we kick it off, can you just kind of give a little bit of a background of how you got into the business that you are today? Jim:                  Sure, Ryan. I would love to talk about that. I’m going to go back away to give you some better background. Whenever I sit down with a CEO that I’m going to either do work for or that we’re going to potentially recruit to a board of directors, I ask one question. A truism I find with every successful business person I say, “Did something happen to you between the age of 5 and age 20 that shaped who you are today and the success that you’ve had in your career?” I ask them, “What is that?” The answers that I get are just amazing, the stories that they tell me. In doing that, I also said I have to answer that question. So let me answer that to you. I grew up, born and raised in Rochester, Minnesota. I was an avid hockey player growing up. I went to the catholic school and they didn’t have a hockey team. So I switched high schools and I went to Rochester Mayo, my alma mater. I was a shy, young guy coming in, didn’t know anybody and I tried out for hockey. What I see happened was I was doing the tryouts and the most famous hockey player in Rochester was one of my coaches at one point in time, his name is Art Strobel. Art came up and talked to the varsity hockey coach and he pointed me out and he made a comment to him, I couldn’t hear him, but he made a comment to him. Later on, after I made the team, I asked him, “So on the first day of practice when Art Strobel came in, what did he say to you?” He says, “Pay attention to Jim, he’s a good hockey player. He works hard. He’s going to go places.” He made the decision to put me on the team partly by that reference from Art. To this day, what the passion that I have for helping companies and helping individuals was born back when I was 15 years old and saw that how somebody—if you’re determined to go on your way to help somebody, you can pay it forward and that’s kind of the way I build my life on. I grew up influenced heavily by my father, big Ed. He owned his own business and he was very much part of the community when he died at 93. There’s not many people left at 93, he filled the church. I could see the impact that dad had. He really had a big influence on me. My first job out of college, I worked for a company called Burroughs Corporation. It’s now called Unisys. Burroughs sold accounting computers to first-time computer users. I went and had a territory in Saint Paul and I cold called businesses to say, “Tell me about your business. Tell me about what you do and maybe I can help you with this thing called a computer,” which they didn’t know about so much in 1976. I really learned how businesses run and how does a company make money. I did that for a number of years, it was in a technology executive. And then 25 plus years ago, I decided to go and switch careers. I want to run my own thing like my father had done. I started in the executive search business. One guy really set me straight when it comes to boards. He was a close friend of mine here in the Twin Cities by the name Greg Palen, maybe one of the more famous board members. He was formerly the chairman of Polaris. He was on the Valspar board. He’s been on a dozen other boards. He’s really well-known. I’ve helped him. I was sat in his board of directors, I helped him with his board and he said, “There’s a real market here for the mid-size company to have a board or upgrade their board and nobody pays attention to it.” That’s the reason why I focused on it and I’ve had an amazing career with that last ten years focusing just on boards and helping him out. Ryan:               I love it. Specifically the last point about the opportunity in the mid-market which is what we’re going to address today. It’s a really cool story. Did your company start an executive search and then you migrated in the boards? What’s the kind of correlation there? Jim:                  We have two companies. We have Cardinal Mark which is an executive search firm. We do it a little bit different because we get really tight with the senior executives of the company and we help them really in the most difficult searches that they need. It could be anywhere in the world. The company could be located anywhere in the world. We have lots of different clients. When you get close with the senior executives—if it’s a company, it could be a public or private company, they go, “I could use some help with my board and Jim, I trust you because you understand number one, our culture, and number two, our business. It’d be nice to have somebody that is out there representing our company.” We backed into it and then we did some board searches and realized this is completely different than an executive search that we might do for a chief operating officer or chief financial officer or something like that. We said, “We should make a business out of this.” And that’s how ten years ago, we started Cardinal Board Services to go out there and help companies build better boards. Ryan:               I love it. So the difference between the executives that you’re searching for and the board of directors, how did the board of directors that you’re looking for—was there a common theme in the one question that you ask them? Jim:                  I would say 50% of the answers usually revolve around an influential person, lot of times a teacher or somebody they knew that said, “I see something more in you. You can do better. Quit coasting. Push yourself a little bit.” The person woke up to that idea and they all of a sudden start trying harder in school or trying harder in their career and it just took a big jump up and they go, “Wow. Maybe I should really try to reach for the stars.” That’s usually the one common thing that you’d see that somebody influenced them along the way. Ryan:               I’m assuming that you want to give back as a board member because you’re kind of switching roles. We can get into that a little bit more as we talk about the types of candidates and why they know from their perspective. Maybe before we do that, for the listeners, we can go back and ask some of the questions, why boards and maybe give your definition of exactly, in your mind, what is a board of directors versus a board of advisors because I think some clarity around that is very, very important. Jim:                  Very, very good question. I ask myself the question, why are boards important? Well, there’s some places where it’s by law. I use the phrase, “If you’ve got other people’s minds, OPM, other people’s money, you’re going to have a board.” If you’re an ESA or you’re a public company or if you’re a non-profit, in some other situation with private equity, if there’s other people’s money invested in your company, you’re going to need a board either legally or ethically to watch over management, to make sure it’s being done right. Sometimes it’s a necessity, it’s legal, it’s part of the law system, the law of the country to do that. The second part is really governance. The word governance, I was looking up the definition of what I’m going to talk to you. I typed into Google and got the definition. Google has this thing now where you can see how much is the word used. Since 1980, the word governance appears nine times more often in our daily culture today than it did in 1990. People are thinking about governance, how to oversee things. You look at governance, it’s a lot like exercise. It’s good for you but it’s work. Ryan:               It might not feel good, right? Jim:                  But it’s good. It takes work. There’s no question about it. The other reason why you might have governance is you have to satisfy shareholders. The best example is a multi-generational family owned business. A lot of our clients are that way and they’re on the third or fourth generation. You can imagine by the time you get to the third or fourth generation, there’s a lot of shareholders. Grandpa had five kids and those five kids had five. The family tree is pretty large. Often times, governance is important because you have this big group of private shareholders that have different needs or different desires to do things. That’s an important part as well. Ryan:               Before we continue, what was the actual definition of governance and as you continue to use it throughout the show, what are you kind of referring to in that mindset? Jim:                  Oversight of management. Really straightforward, oversight of management. The last reason why people have boards is expertise. Some small companies may need some doors opened up in their industry because they have a small company and they need to understand how to get into some customer base. They may hire the expertise for that. Somebody might bring in expertise. One of the first board searches I did was an o-line manufacturing company that you wouldn’t think would be important but they said, “We need to get somebody that understands Lean and Six Sigma because that’s going to be our differentiating value to our customers going forward.” We’re on an active path inside our company. We could use a board member to help us make sure that we are investing in the right things and then oversee it. There’s some expertise that person was able to bring to the board for a period of time. The last reason why companies look at boards and why they’re important is it’s really one of the key elements to the optimization of the company. When you’re running the company, you look for ways to optimize it. It could be a CRM system or it could be Lean or Six Sigma. Things like that, you look for optimizing always. But for the business itself, a board can help you optimize to keep you away from doing things that don’t make sense and encourage you in ways that you’re going to be able to grow faster or get into new markets. Ryan:               I think those are very, very well said points to it. Think about how you came from these large corporations, public companies, and now we’re talking about bringing into the mid-market and this opportunity that you referred to because I think everybody needs what you just said. Now I think it’ll bring us into some of the main points that we want to make. But what size companies are these applicable to and what’s the biggest difference between a board of directors and a board of advisors? How do you formulize that? Because I think there’s a big distinguishment of having a really good family friend or neighbor that gives you advice versus what you’re talking about. I think there’s major distinctions that need to be made. Jim:                  The difference between board of directors and board of advisors I would say is when you have a true board of directors, they vote on issues that the company is facing that needs to be put to a vote and they can turn down that. It could be wrong compensation, it could be wrong acquisition. They often say that in a public company, the board of directors has two main functions, to hire and fire CEOs and to approve strategy. There’s many other things they do around audit and around governance and all the other things but those are the two primary functions of a public board of directors. You may have a private company and you’re not going to fire a CEO. Ryan:               Let’s hire someone that’s going to fire us. Jim:                  There might be other reasons why you would have board of directors. Part of it is because like what I talked about, you have a multi-generational family. You want that board to put their stamp of approval and what the strategy is for all these shareholders. I know one local CEO of a fourth generation family business, he says he spends 25% of his time just dealing with his family’s shareholders. There’s a lot of work that goes in. You need a board to make sure that those family members feel that the strategy is right. For a board of advisors, it’s a really simple task. If somebody owns more than 50% of the company, you’re kind of really doing a board advice because they get to do whatever they want, they own majority of the company. But in reality, a board of advisors can act very much like a board of directors but the owners and the CEO goes off and goes on what they want anyway but they’re using them as a sounding board which I’ll go back to and I’ll use an example. I used to have different opinions about this. Definitely, if you’re a billion-dollar company, you probably need to have a board of directors or board of advisors, you might say. It gets real fuzzy and grey between the two. But I’m thinking, “What about if you’re 50?” I know a local company here in town, I know the CEO pretty well. He was brought in. He’s not the founder, they had two founders. The business was stalled out, he was brought in to be a catalyst to drive the business forward. Put together a board of advisors just to help—so it’s not just his idea but his board’s idea. It’s a $5 million company. He grew it to $15,000,000 and then sold it. One of the reasons why he looked at the board of advisors being so good is once you quarter basis, he had over a hundred years of experience sitting around his table talking about the strategy and the issues his company is facing. And because they were on the board, they knew the business from a financial standpoint, from strategy, what the market sector is, they knew it well and they could provide some continuity from quarter to quarter and help him guide the waters of what he’s trying to do in building the company. Is it too small? The one factor is if they’re just one executive and they really don’t have much management underneath them, a board of advisors or a board of directors is probably not as effective as needed because they need to have a management team to be able to execute on all this as well. If you’re a small business, you might even be hitting $20 million in sales but all you have is some salespeople, it’s a branch of people working for you. You don’t need this board because you’re going to do what you want everyday anyway, and it’s not going to be of value. Ryan:               I think you hit on a bunch of really good points. First of all, I just think about when we run our business, why would you not want that kind of advice sitting next to you and actually helping you push yourself and the company in the right direction. I think the biggest difference too is your employees always have some sort of stake in the game. They’re not going to get the purest advice outside of the bubble of where you’re in, getting the different angles. We can talk a little bit in a second about the different set of expertise but before we do that, can you explain, Jim, I think a lot of people, from my experience, think that their Vistage group, EO group or whatever peer group might replace a board of directors, can you explain how those two maybe fit together or are different? Jim:                  A CEO Coach, Vistage, YPO, CEO, there’s lots of them out there. What those are really for the CEO. The CEO goes into this round table group and says, “Here’s the struggles I’m having.” It could be at home, it could be at the job, it could be at some employees. He’s got no one else to talk to. This is a set of peers that are not competitive that can really help you be a better performer as a CEO. That’s what they’re for. The board of directors, the board of advisors is to help the company optimize, as I said before, it’s optimization for the company. The CEO’s gotta have their own training but think of this as a lot of professional athletes have personal coaches but they also have a coach to their team. It’s just different. Ryan:               I think that was a perfect way of explaining that. In the peer groups, you’re getting basic, high-level contacts but you’re not really in the trenches counseling working on the business, it’s just random hot topics that are going out. I think you did a very good job. I totally agree with you. Then, dive into how do you form a board. Where do you start? Jim:                  There’s really a couple of steps to building a board, there’s kind of four or five steps. The first thing you do is you’ve got to realize that this is something you want to do, you’ve got to come up with some by-laws. By-laws, you can get and you can research and do them but you need a set of rules to operate this board by. You don’t want to be super stringent but you don’t want to be too lax as well. The by-laws become really important. It’s your math going forward. This is if I have a board, these are all the things I can do to go back and improve my board as well. Ryan:               Can you give an example of some by-laws? I think I just think about the entrepreneurs that I know that are so busy running their company and to sit down and do this is foresight which is important. Are they putting rules for themselves, for the board of directors, for their company? What exactly are by-laws? Jim:                  There’s one that’s really a gotcha and they’re almost everyone I’ve ever read. By-laws is going to be how many times a year we’re going to meet, are we going to have committees, what is their compensation plan going to be, what’s our term limits going to be, what’s our expectations? Do you have to abide by every little detail? No. But at least you’ve written it down and thought about it. Probably the number one mistake boards make in their by-laws is they have no way to get rid of a director. What’s the big deal? Let me tell you a story. I have a son who lives in Colorado and he called me up one day and he says, “Dad, I’m thinking about moving in with Annie, my girlfriend.” I said, “Wow, Adam, you’re 30 years old. You don’t need my approval.” “I don’t need your approval but I like to understand what your thoughts are.” I said, “Well Adam, let me tell you something I’ve learned. It’s really easy moving in, it’s really hard moving out.” Three years later, he’s moving out and it was messy. A lot of bylaws don’t think about when things aren’t going well. How do you get exit a director gracefully? You’ve become close with them, you don’t want to tell them that it’s not working anymore or the business has changed and you need somebody different. You need to think about that as well. First thing is by-laws. Second thing is you need to determine your board make-up, meaning, how many people do we want, what kinds of people do we want to have on our board. I sat down with one chairman of the board of a bank here locally and we’re talking about diversity and things like that and he says, “Wow, that’s really a good point, Jim. We’ve got seven people on our board and we’re all guys over the age of 55. More than 50% of our customers are women, more than 50% of our employees are women. We don’t have a single woman on our board.” That’s crazy. You need to think about that and know what exactly can fill the gap. It’s more of where the company is going. One of the things that we always look at is if you’re a billion-dollar company, “Let’s get people with $2 billion worth of experience because they’ve been there, done that and so they will have known where the pop holes are along the way.” Or say you’re a $100 billion company on your way to $500 billion. “Let’s get somebody who’s gone from hundred to five hundred.” Determining that board makeup is important. Ryan:               If I can interrupt for a second, because I think what’s interesting about this and the whole concept of having a board of directors for your company in the mid-market is most often I see people try to hire these people. If you’re a $20 million business and you want to get to $200 million, you go hire the person from Cisco and then you realize that they don’t know how to actually work inside your company. You’re getting the expertise but you don’t have to have a million dollars worth of payroll with people that aren’t actually executing correctly. Jim:                  The other mistake they make when we’re looking at the board make-up, they say, “Well, I’ll get the board, I’ll get my banker. I like him. He’s a good guy. The lawyer, she’s really helpful, she’s helped us a lot.” The problem with that is there’s no independence there. Because if I’m already getting paid to be your banker or your lawyer or whatever it is, or your brother-in-law, guess what? I’m not going to be independent, I’m not going to be objective because I have to continue that relationship with you outside of the board room. Ryan:               Isn’t there crazy conflicts with that? Putting your banker on there who wants to make sure that you have deposits, loans, specific things, you’re never going to get you advice anyway, the fiduciary or the prudent responsibility of the board of directors—there’s just too much conflict there isn’t there? Jim:                  There absolutely is. The third point is director recruitment and onboarding. They both are important. Recruitment, we had somebody who we built a board from scratch and the main owner of the business said, “Oh, I know some really good people. I’m really well-connected.” We said, “No Mike, you can’t go there because those people already have a relationship with you. We need to find people that are of the highest value that could come and bring independence and objectiveness to it.” That’s really what we bring a lot of. Every time it’s happened, every time we’ve got a board search, the person we get is 2x of what they thought they could attract. It takes some skill to go and be able to talk to other people, to show them the opportunity and what the value is. The big mistake that comes is when they don’t onboard the person correctly. There’s a whole process of onboarding of the board of directors member that’s not dissimilar to employee but it’s not the same as employee. You don’t want them coming to the first meeting and feeling like they don’t know what to say to you. “Wow, this person is not much value.” Because the first three meetings they didn’t say anything. You probably didn’t onboard them correctly. Ryan:               What’s an example of how you would actually go about onboarding someone? Jim:                  I have them come as an observer for the first meeting or two. You can’t say a word, you just got to sit down and listen. I have them go to the production facility, wherever they are, it could be a warehouse, it could be a manufacturing company, it could be distribution. I have them actually go there and spend a day and see how they make money. I would have them go and I would give them the last two or three board books to have them study to see about the topics and the financials so they know what they’re talking about when they get there. Those are some of the things that you might do on top of just shaking their hands and saying welcome aboard. Ryan:               Even if you’re the other board members, I couldn’t imagine if I’m the other member and all of a sudden a new individual is sitting in there and just giving advice with zero background. You either have someone where you get that kind of tension or like you said, you don’t know why because they’ve no context to give advice on. No matter what, there’s not a good fit there then. Jim:                  The point then is board meeting execution, as important to setting everything up, is you need to have a plan for every board meeting, you need to put together the board book, you need to get them in the hands of the board members at least a week in advance so at least they can study it, so they’re prepared when they get to the meeting. Then in the meeting you need to execute it, have that meeting, and you need to move it along. It needs to have a rhythm to it because otherwise, you can take a left turn in how we’re valuing inventory and spend an hour on that and you don’t get to the important topics. You need to have a real plan and execute that over and over again in the board meeting. The last piece is repeat. Just because you go through this whole process once, you’re good. Just keep always going through this process to keep it fresh and going. Ryan:               Before we continue, I think the one question I think everybody always thinks about is how much do these people cost and what is your obligation to them? Jim:                  There is a cost. There’s always a cost even if you don’t pay them something. There’s the cost of time, the cost of materials and things like that. You want to understand what those costs are. You do need to pay your board members to be able to get—it varies with every company, it varies vastly. I’ll use the example, there’s two multi-billion dollar public companies here in Minnesota and one pays their board members 2x of what the other one does. The one that pays their board members less has 2x the valuation in the market. Why is that? It just is. But you do have to pay them and you do have to value. Then there’s time. You may have an off-site board meeting. Once a year, a lot of times what they do is they go to an off-site, it may be in a remote manufacturing facility and see their facility in Mexico, see their facility in Kansas, whatever it might be just to mix it up or we may have a board summit, we may have a three-day board summit where we get together and talk about the strategy with the executives. There’s lots of time and there’s some dollars involved, not as much as you’d think. I would say that the commitment that you make to those board members is that you’re going to talk about how to be successful, what makes a good or great board. You’re part of a zero commitment to be prepared. It’s all about being prepared. When we’re together, because we’re busy people, let’s make the most of our time. Ryan:               I think that’s a great segway into what does make a successful operating board. I think one of the things that I think people struggle with is what is it that we have to be prepared for, what kind of information are we giving the board members prior, and how do you pick the topics, do you run your board on a traction or some sort of EOS kind of deal? How are you picking the hot topics to discuss or are the board members actually flushing us? Maybe shed some light on that. Jim:                  What makes a good/great board? First off, it’s a two-side relationship between the CEO and his management and the board. Word be said, I think it’s a good adage, think of it as a ten-year marriage. Go in that commitment that this relationship is a ten-year marriage. I’ve been married for 34 years and the similarities are striking between this quote, I sent this to my wife the other day and it’s really true, it’s “marriage is two imperfect people who refuse to give up on each other.” That’s so true about the board as well because it doesn’t go good every time. You can’t give up on each other. The second thing to have a good board is it’s all about the stakeholders. It’s not about just the shareholders. There’s a handful, there’s five main people that are stakeholders, maybe a sixth at a time. One is the shareholders, very importantly, you have to think about the shareholders. When I say a stakeholder, it’s who doesn’t want to see the company fail, who wants to see the company to succeed. The shareholders want to see it succeed. Your employees want to see it succeed. Your customers want to see it succeed. Your suppliers want to see it succeed. Your community wants to see it succeed. The sixth one is government because there’s some businesses that we’re in that are so severely or heavily government regulated. Having somebody on your board that understands how the government thinks can be a real benefit like health care and things like that. But if you keep your focus on the stakeholders, not any one of them, but the full gamut, you’re going to have a pretty good operating board. Ryan:               I think you laid that out beautifully. How do you then figure out the expertise that you need in order to make sure that all of those people have a voice or some sort of representation. You’ve got a combination of how do you count for the voices and all those six categories and then how do you also balance that with the skill sets that you want to help bring you in the company forward? Jim:                  It’s not easy. That’s for sure. Just by the question, you could tell that it’s not easy. Ryan:               Right. I feel like you’re going to have a hard time even formulating the topic because there’s so many things that you have to accomplish with these select people that you’re bringing on board. Jim:                  I guess my point is it’s awareness. You have that awareness. Some companies do it from a standpoint of making health committees. We have an audit committee for example. An audit committee helps us with our government regulations of filing taxes and things. There’s a compensation committee. You’re thinking about the compensation of not just the CEO but the whole company compensation which addresses the employees. You might have a cyber security issue which has to do with your customers for example. You think about – if [00:33:56] didn’t have a cyber security, they do now, it does matter. Often times, you solve those by committees. Ryan:               When you’re saying committee, because I’ve been on a board of a non-profit, I think I know what you’re talking about. Let’s say you’ve got eight people on your board of directors but three of them might be really skilled with compensations. Those three would be responsible for the compensation topic or subject. Correct? Jim:                  Exactly. They go off to a study, it might be CEO compensation, it might be executive, it might be bonuses, and things like that. They’re going to make recommendations. These are strategic issues that they’re dealing with. You don’t want to spend a lot of time in the official board meeting recorder, you want to have a report on to make sure that people are paying attention to you. Ryan:               That’s a huge point because instead of getting eight people’s opinion when some people don’t have the backgrounds and actually trying to solve the problem in the meeting so it’s not just about—in the meeting, you should be giving recommendations and giving the updates and all of that stuff should be going behind the scenes. Correct? Jim:                  Yes, absolutely. Ryan:               How do you determine whether it’s the committees or subjects that you’re trying to address? Jim:                  That’s a really good question. You look at your business today and your strategy says here’s the business where we want to be going towards the future and you say, “We’re going to need some help getting there. We can see where it’s going.” Or you might say, “Here’s the hole we have today.” Some of them become very self-evident in what it is that we need to find. Remember, you always want to find collaborative people. There’s a phrase around boards, “nose in, fingers out”. They’re not running the company but they’re really involved with the company. You want to be able to make sure that they get along together as well. Ryan:               I just think about some of the stuff that we—I think a lot of people try and use it, call it the five million to a couple hundred million, they’re trying to do this in their peer groups and I think that’s where the frustration of the peer groups come because you want to solve all of these problems. We redid our compensation structure because we’re in the copier IT services and the margins disappeared in the hardware and we needed to redo our whole camp plan and we’re just alone trying to do this and trying to figure out what worked and there’s so much failure that you have to go through because you have no one to bounce it across. Being able to find and have people that you can talk to that don’t have a vested interest or that have a vested interest but not an actual motive to bring you one way or another, it’s just invaluable. Jim:                  Yup, exactly. If you look at, Ryan, the keys to maximize board effectiveness, you have a board, I want to make it really efficient, it really starts with a strong chairman. I’m not a fan of having the CEO be the chairman because I want an independent be the chairman that can really hold people accountable which is the second one, accountability. Honest and timely communications, you hear about this a lot. You don’t want to be surprised when you get the board book over here or when you walk into the meeting, “We lost our biggest customer. It’s been going on for three months.” No surprises, honest communication. Really, a good board is strategy first, reporting is second. Really you’re thinking, strategy is the most important topic of the day. Reporting on the numbers and things, you can spend a lot of time going through the minutia detail but that should really be secondary. You should have done that beforehand and just hit the high points. Then, there should be a mutual commitment but with the ability to disagree. A little contention in the boardroom is not a problem because you’re challenging the conventional wisdom which is good because if you just take conventional wisdom, you may go off the cliff because you didn’t see something coming. You’ve got to be [00:44:44] all the time. A really good board doesn’t always get along in every subject but they respect each other, they can come together easily. Ryan:               I think it’s fantastic. Are you familiar, Jim, with the book Principles by Ray Dalio that just came out? Jim:                  Yeah. I’m interested in getting it. Ryan:               It’s seriously amazing. He calls his big thing, his radical truth, fullness, and radical transparency but in the context, and I’m going to so butcher the word because I can never pronounce it, it’s called an Idea Meritocracy. Everybody that brings ideas can argue because everybody’s got credibility but somehow, a decision is still made based on the believability or the credibility of the people that are voicing their opinions. What makes that work is it’s pretty much what you just described. It’s everybody’s there, different backgrounds, different experiences and are processing this strategy together. But what is the process to actually make that decision? Is it the actual business owner or is it the chairman or the CEO? How does that final decision get made after all of the input is given? Jim:                  There’s a reason why there’s odd number of people on boards. It comes down to a vote. Ryan:               Got it. When you say that you got the ten-year marriage, obviously you’re bringing on these board members to be able to be there for ten years with all things going well. How do you upgrade your board and how do you get rid of them and how do you determine that you’re not at the right level that you should be? Jim:                  The one thing is in the by-law, you have something it might be a term limit, like you had a three-year term to be renewed and you can be on board a maximum number of ten years for example or 12 years or something like that. That’s a pretty easy way but you also have some other safety valves. For example, if you retire from your current position or you leave your current position, because there’s some reason why we came and got you in the position that you’re at today. You tend your resignation, we may not accept it but you should tend your resignation so that way, it’s an easy way for you to make a separation happen. How do you determine what is it that you need to make a change or add a board member? It’s really going back there and say, exercise we do it, companies call it the Board Gap Analysis. We look at the board members, their experiences, what experiences are important for the company, average age, you want to have the average age of the board members be in the low 50s, not the high 60s for example. You want to be able to look at that and say, “Where are some gaps? Where’s the future coming?” I have one client, a large private company here in the Twin Cities. You may see their industries changing drastically, they realize that there’s going to be labor charge in the future and there’s other challenges coming and they don’t have somebody on their board that’s really one of those progressive thinkers that’s facing that stuff today. They have to bring somebody in that will help them guide the waters of change that’s going to become in their industry. A lot of times, it’s really looking to the future. Look at what we got and look into our future and see where’s the gap in between and try to fill in that gap. Ryan:               How often do you do that? Jim:                  You should probably be doing it every two or three years. The thing with 360 reviews in new board members is a smart thing to do as well because you might think you’re doing well but your board members don’t. You never say anything, you don’t add anything of value. The chairman needs to hear that. He needs to see what other board members think of him. It’s not a popularity contest but it’s about making sure that we’re holding each other accountable. Ryan:               Okay. Let’s say I’m the CEO or owner of a business, that’s $27 million, $30 million, whatever that might be. I want to create a board of directors. Obviously we’ve talked about a lot of the different ways you can start, some of the by-laws and all that. How do you determine—the gap analysis that you would be doing for someone that doesn’t have a board is obviously very big. How do you determine what positions, where they’re coming from? Explain your recruitment process because I think filling in those gaps and how you do that is very interesting. Jim:                  First of all, you use the example, the $27 million company. You look at what business are you in. We need some expertise around the business that you are in. Then we look at it and say, “What challenges do you have that if you have some more senior management oversight, you could probably help that with?” The third thing is, “What are your future challenges or what future directions you want to go so we could pick up some of that expertise?” We’re trying to take care of today’s world and tomorrow’s world and build that bridge of tomorrow effectively. Once again, you’re hiring senior executives that have been there and done that so you should be able to go off and find that. What I find interesting is that many people want to serve on boards. Finding the board member, if you’re diligent about it, it’s going to happen. It’s going to be a great experience. Because you’re not asking that person to leave their current job, you’re asking to take on another responsibility that’s mutually beneficial to their business because you’re going to learn some things and you can give to that other business some of your expertise. Ryan:               That’s one of my questions. I think there’s probably a lot of these frequency notions of these board members have to be someone that sold a business or an executive that retired that are just looking for something to do. That’s obviously not what you just alluded to. Are these people that are currently at, like current executive, business owners, how do you go about finding these people? Jim:                  First off, we have an incredibly large network and we’ve talked to so many owners and executives. But you do some really old-fashion research and networking to be able to find the person. Often times, this person knows that person. I’m not going to be a good fit with this person over. I’m in a middle of a board search right now, I just kicked off. There’s somebody that I was really impressed with that I think I’m going to have a good fit. Which then comes to, “Hey, would you consider being on this board?” “I’m passive this time, I don’t have the bandwidth, but here’s somebody I think is pretty good.” Didn’t know that person so I reached out and connected with him. We’ll see if he’s the right kind of fit and has an interest. It’s fit and an interest because you’re making a ten-year commitment. Ryan:               I’m just kind of curious, how do you sell the company that you’re trying to create the board for? Is it compensation, is it the vision of the business, is it the personality and culture? How do you actually make that sales percentage candidates? Jim:                  Companies with strong brands are pretty easy to sell. You guys have got some incredible appliance here. You just mention their name and they go, “Oh, I think that company is so wonderful. I’d love to be able to get involved with it.” That’s the easy part. But the other end of the spectrum is, “Oh, I never heard of them. What are they all about?” You’ve got a billion dollar plus companies but sometimes they’re just under the radar. People are predisposed to want to serve on boards, that’s a positive thing that you’ve got going for you. But you really have to explain to them what the business is like, what the challenges they’re having, and what kind of expertise they’re looking for to bring in. Anybody who asks you for some help with something you’re good at, you’re probably going to be predisposed to want to do that. Compensation comes in, definitely, compensation comes in. It’s about fourth or fifth on most people’s list. Time commitment comes in because it could be a really remote place that’s hard to get to and it takes some time. Every board needs a three-day event and they can’t take three days out of their quarter. Those come into play. But the second thing I would say that’s most important is the executive says, “What can I get back from this? What will I learn?” A lot of times, what they think is different than what they get but they always get something bad. But you have to remind them of that these are the value you get back for your business you’ll be able to see. Ryan:               Is there like an interview process that you guys go through or is it just like hiring a normal executive? Jim:                  It’s a lot like hiring a normal executive I would say, but it’s a different kind of an interview because it’s not just functional. You’re not just saying, “Oh, so you manage 5,000 people? Oh, that’s good,” we check that box. You want to look at it, because remember, the board is a very strategic piece of the business so we need to find people that have really good strategy background combined with good execution with some relevant experience and have a personality that fits really well with that board is and what the company is. We do this a lot like an executive search but the way we approach it is going to be completely different because once again, we’re not asking to leave the company and join. Compensation and location mean a lot more if you’re asking somebody to move across country to take on a position. But if you’re looking for the boards, that’s less important. It’s more about the cultural and experiential fit. Ryan:               Do you find it a hard gem to find people that don’t have egos because you’ve got to have just a whole altruistic perspective on the world, because to throw a bunch of people’s egos, there’s going to be miserable obviously, for a lot of different reasons. How do you filter through that main variable? Jim:                  We spend time with them. One of the things that I learned over the years of executive search is the more touches I have with somebody, the more I get to know who they are. I talk with them late in the day, I talk with them early in the day, I talk to them face to face, scheduling things and see how flexible they are. One of the things that’s on our radar, because often times—we’re doing Minnesota or Mid-west companies are pretty family driven. GE people, sometimes you’ve got to be pretty aware because GEs have high testosterone. They come with that already. Now, that doesn’t mean that’s what the person is. But a lot of people, if they got far in GE, they move that kind of way. Obviously, your radar is off and you go, “I just want to make sure that that’s not going to happen.” That’s an easy one to filter out. Different companies have different cultures that you know about and so you want to filter that out to make sure it’s not going to come through. Ryan:               You’ve got the personality fit, and then the expertise fit, trying to bridge the gap between today and tomorrow’s world. Is there a typical set of pillars or subjects that you try and find as you blend all of this together? Whether it’s finance, marketing, security, governance? What are some of the main subject pillars that you’re trying to find in a blend of all these people? Jim:                  That’s a really good question and one of the last subjects that I want to talk about with you today is I get contacted all the time by people who want to be on boards. What I try to tell them is, “I can’t put you on the board. I can’t find one.” But at the same time, there’s a list of things that a great board member will have. I suggest that they make sure that they all fit. The first thing is everybody that gets on the board needs to be a financial star. They need to understand how to read a P&L, a balance sheet, and a cash flow statement, all of those things. It doesn’t matter what the business is, they all have financials. The second thing is what’s your functional expertise? Functionally, I’m in manufacturing, or I’m in sales and marketing, I’m a financier, or I’m a CEO but there’s a functional inside of a company, the expertise that they bring. There is an industry expertise so they might be in the software industry or they may be on the consumer package goods industry. That’s important. The next thing is leadership skills. We need leaders to be on board because they understand the challenges of running the business. There’s a, what I call an “it factor/” An it factor is something beyond all that. It could be their personality. The it factor might be where they’re located. We’ve done board searches where we need to find somebody but not here or but not in Michigan or we want somebody that’s located in the southwest because we have a big growth there in the southwest. Some of those its could be tangible. One of the searches I’m doing right now, it’s the woman, the leading candidate’s 35 years old. She’s bringing age diversity. She’s got the age diversity. In the opposite direction, that’s a good thing because she’d be on there for her technology expertise. That it factor comes into play. Readiness is an important place as well. Are you ready to serve on a board? A lot of people say they are but when it comes down to it, they won’t commit the time. The podcast about boards the other day, the person had a really good point, he said, “Are you somebody that people will listen to?” Ryan:               Nope. Jim:                  He’s going to preach? “Or are you somebody that brings such great value that others want to hear you speak?” That is a really important thing to people. Ryan:               Does it mean something when you speak versus just rambling all these ideas without actually listening to everybody else? Jim:                  That’s right. Ryan:               You brought in that age diversity. I’ve heard a couple of cool things that I’ve read in some of the main publications like Forbes, Inc., Entrepreneur, and such. How are people blending the baby boomers and the millennials and the next generation? Is there any cool takeaways that you’ve seen of how people have embraced that? Jim:                  I have not seen it. Something’s going to happen here in the next number of years. There’s going to be what we talked about, diversity on boards. There’s going to be a tsunami of women going on boards in the next ten years. I have three daughters so I’m all for this. The reason is because if you look at the average board, it’s pretty much guys in their 60s that are on boards that are CEOs. There’s definitely big, public companies, they’ve brought some diversity into as well. But you’re seeing more and more companies look at the board, like this 35-year old gal we’re talking about, and say, “Well, they can bring some things quick to the table that we don’t have.” I know they specifically seek out gen x or the millennials but if they’re presenting where they’re a little bit more—I think especially as we get this generation of board members retiring, the next generation will be much more open to it. But remember, one of the things about being an effective board member is these leadership skills. How do you get leadership skills? You get leadership skills by leading people. Often times, you don’t get that chance until you’re late 30s, early 40s, late 40s, to be a diverse leader. Sometimes it tends people, we want people to go to experience. Ryan:               That’s just the nature of years built up on experience. Jim:                  Exactly. That’s what it tends out to be. Ryan:               As we’re wrapping up here Jim, is there something that you want to highlight that we’ve talked about or something that you want to leave our listeners with? Jim:                  The one thing is that I was at a meeting about three months ago. I’ve been on this search for division of a public company here in Minnesota. I was presenting to the CFO of the public company the findings. I’ve been on a week-long tour of the country reviewing board candidates. I went through the book, the board book I put together. I’m going through it, and I’m half-way through it and the CFO says, “Jim, stop.” He says, “You really like what you do, don’t you?” I said, “I just love it. This is awesome.” It was so fulfilling for me because I am passionate about it and it’s a passionate subject that I like. It’s not for everybody. But I’m so glad that it showed through to him that I cared that much about it. I think that’s one of the things that the clients that we work with and the board members that we recruit deal that way. In this world, this little world that we created, it’s something to be very passionate about because you can help companies become more successful. Ryan:               That is so important because I’ve used recruiters in the past. They have to understand you. You really, really have to understand me, where I want to go, what I want to do, because how else are you going to be able to surround people with me, around me, that are going to be able to do that if you aren’t passionate about it and don’t understand the whole situation. Jim:                  Absolutely. Ryan:               Jim, what’s the best way for our listeners to get in touch with you? Jim:                  The easiest way is just go to our website which is www.cardinalboardservices.com. We’ve got resources that you can download and we’ve got our contact information on there as well for both myself and my partner. That’s probably the easiest. Got our phone numbers, email addresses, everything. Ryan:               Jim, thank you so much for coming on the show today. Jim:                  Take care, Ryan. I really appreciate the time. I hope you enjoyed the interview with Jim. Here are some of my main takeaways. The top three that I had were the first being the real clear definition and the clarity that Jim brought to what an actual board of directors is and the roles that they play, how that’s different from a board of advisors which are just people that are giving you advice but not actually voting or holding you accountable without the by-laws and the governance, and then understanding the difference of a board of directors compared to a CEO peer advisory group. Because I think that everybody needs some variations but the board of directors is really the one thing that you need to surround yourself with the top talent and its expertise that can hold you and your company accountable, to take you to the level that you need to go because being alone is so daunting and being able to have a committee that understands some specific topics that you’re trying to address is absolutely amazing. The second main takeaway I had was that if you have a family business or if you’ve got a business with a very crucial CEO that is running the business and most of the day-to-day, having a board of directors that can help govern and help strategize with the multiple parties to be the sound and voice of reason and then can actually push you forward without all the political bs that comes with having multiple parties that have a vested interest in a specific subject. The last takeaway and the third takeaway that I had was the qualities of a great board member. The seven different things that Jim listed are fantastic. Making sure that you’re not just bringing your family member, your banker, or anybody that knows you and has this preconceived notions or perspective of you and the company, finding the expertise that you actually need to bring you to the next level is huge and making sure that you’re not just sacrificing that because it’s too much work. I really hope you enjoyed the interview with Jim. Lots of great takeaways. Always remember if you want any of the links, they’re in the shownotes.

Today on the Life After Business podcast, we’re going to be talking to Ken Sanginario. Ken is the founder of the Corporate Value Metrics and the creator of the Value Opportunity Profile and the Certified Value Growth Advisor. He’s got a lot of experience and he has developed a system that shows business-owners how to develop and implement a strategic plan. He’s going to give us some background on the work he’s done and some tips on how to fund your growth through your process. Sit back and relax; you won’t want to miss this episode! In This Episode You’ll 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. Today’s podcast centers on the concept of value: value today, and value enduring. We have no greater asset than ourselves when we start a business, this is true. But we need to grow our businesses into stand-alone, fully functioning organizations that do not require our constant input and upkeep. The issue is: how do we get from here to there? Categorize Your Business Value Prioritize Ken Sanginario has identified 8 key points that all business owners need to consider. These are as follows: planning, leadership, sales, marketing, people, operations, finance and legal—and these breakdown further into 47 subcategories. Ken developed his role as a turnaround consultant with these points in mind and has successfully saved business and business owners alike from bankruptcy time and time again. These categories are not, of course, the alpha and omega of successful businesses—but they are pretty darn close. Ken has implemented his working business valuation model into a software program, as well, to aid struggling business owners on a wider plain. Every company is underperforming to some degree, even ones which are strong and profitable. This makes a turnaround consultant a vital part of your advisory team. Where a consultant adds value is by providing measurable ideas. If you’ve had a consultant approach your business in the past with lots of big ideas, but zero ways to measure these ideas, then you have not experienced a real consultant. True advisors are able to provide points (or, in this case, categories) to you which you can measure and evaluate over time so there are real progress points to show your increased business value. What Business Value is Valuable? Your best and truest valuation—the value of future cash flows—depends on sustainability, transferability and predictability. If your company isn’t sustainable, it isn’t valuable—period. You can’t sell it, and you can’t upkeep it. No one wants a company that will not last past their initial investment! And at what point do you, the owner, stop funneling funds into something that won’t give you a positive return on investment in the long run? What about transferability? Let’s use Ken’s example, since it’s so good: When you think about transferability of value, think about a crane reaching into a company, lifting out the current owner, plopping them 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. If all of the expertise is now out in the parking lot, there is not a lot of value to that company. Predictability is a little trickier since markets can change rapidly. However, this is still an excellent unit of measurement because it follows logically from sustainability: if your business is currently making you money and running well, and you have the accounts and cash flow that suggests it should continue to do so for the foreseeable future, you can be fairly certain this business will continue to be a going concern. Based on what Ken has found to be the key factors in what the true value of a company is, compiled a list of about 400 questions. Each of these questions asks for a 0-10 response where zero is not at all and 10 is perfect. Ken prefers to ask the management team that is directly involved in the company’s day-to-day operations to answer as a group since no single person will know every detail about every part of the business. As clients go through these questions with him, he gets a comprehensive look at what the company’s value truly is, where this value comes from and where companies can still improve in order to increase future cash flows. How many questions have you asked yourself about the value of your business? Where do you rate yourself on the questions you have asked yourself? Implementing Your Plan Once a valuation is complete and there is a proper turnaround plan that tackles your weak areas and those areas that can stand some improvement, it’s time to implement it. People invest money where they’re comfortable; we all do what we know! However, your plan might require you to branch out in a whole new direction. If so, consider hiring out the manpower needed to implement the change until someone is fully trained to handle it from within. Keep as much of this knowledge in your business as possible so that when it comes time to sell, you are able to transfer this new wealth as well. As every business has a unique marketable aspect to it, so too should each plan be unique in its approach and specific in its delivery. While this might take some time, you should have things you can measure your success with as you go. Sales or receivables, success scores, feedback… whatever your company thrives off of. If you’ve hired a consultant, Ken says the process goes something like this: 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. The questions asked during the assessment really get the ball rolling. Let’s use Ken’s example and talk about strategic planning. The question is: On a scale of 0 to 10, does your company have a fully developed, written strategic business plan? You say, “7” and the follow-up becomes, “Can we see the plan?” And often the real answer—and therefore the real score—comes out that the plan isn’t actually written. Sometimes it’s more of an idea, a smattering of projections, maybe some sales goals. We all do it; we all self-report higher than we really are when we take out our bias. However, after the first few questions, the learning curve settles down. You’ll start seeing your ranking in a much more neutral way. This is where the real changes start to be made. Once you’ve stopped trying to put a good face on every aspect of your business—remember, this isn’t a sales pitch—you can really dive in there and make realistic and actionable plans for improvement. Now you’ve got a semblance of an idea of how to start fixing your company. It really does come down to being specific and honest, particularly about sustainability, transferability and predictability Takeaways: Value is your cash flow and your future sustainability. Anything you’re doing today should make your business more sustainable, more transferable, and more predictable. That’s how you build value. It’s vital to have a plan that’s measurable. With today’s technology, it’s not necessary or acceptable to fly by the seat of your pants without a measurable plan. Every private company is underperforming to some degree. Have an open mind to determine what you can do to increase your private company’s value. Links and Resources: Email Ken The Trust Edge About Ken Sanginario 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.  

Today we are talking to Jim Sulciner. Jim bought his business, RTD, a decade after becoming an engineer and after having a career in marketing. He experienced double-digit growth for over 12 years before selling to a very large company. He sold for a multiple of EBITA that is nearly unheard of and gave himself some great options. He’s going to talk to us about all of his business milestones. In This Episode You’ll Learn: How Jim started his career and what caused him to take the leap into entrepreneurship. How Jim managed to purchase RTD after only having purchased a home – how he structured the deal and what the transition looked like. Jim’s thoughts on the difference between a founder and an entrepreneur and how he strove to have an entrepreneurial strategy when it came to growth. What Jim’s goals were and how he measured his benchmarks when it came to reaching those goals. Details on how they balanced cash and handled employees. Where Jim got the ideas for his excellent practices that ultimately allowed him to sell for so much. What triggered Jim to want to sell. How Jim managed two offers, how the would-be buyers valued the company, and how he ended up structuring the eventual deal. How Jim transformed his life after his exit. Takeaways: Jim had experience as a buyer and a seller. This was invaluable because he already understood the buyer’s mindset when it was time to sell. Jim implemented value-building techniques that ended up being extremely beneficial to him when the time came to exit. He had profit-sharing with his key executives and was very specific with his AP and AR. Jim had patents that raised his company’s value over and above the business profits and growth. This combination really boosted his buyer’s confidence. Links and Resources: The Value Advantage Email Jim Jim on LinkedIn About Jim Sulciner Jim Sulciner, a sales & marketing executive and entrepreneur, is highly experienced in growth and leadership of startups to midsize companies with an emphasis in recruiting, sales, and customer relations. Most recently as CEO,, Jim guided RTD Company through an acquisition by Measurement Specialties (NASDAQ MEAS) at seven times EBITA. This culminates 25 years of experience in a variety of sales channels — direct, manufacturing representatives, and distribution. His technical experience includes project management, ISo 9001, and lean manufacturing. Jim was educated with a double major in Chemistry from the University of Minnesota, Deluth and Metallurgical Engineering from the University of Wisconsin, Madison. He also completed additional coursework at Harvard University in marketing, organizational behavior, and operational management. His personal interests include traveling, boating, and sailing. Full Transcription: 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, and I hope you enjoy this episode. Welcome back to the Life After Business Podcast. Today’s guest name is Jim Sulciner. Jim and I have an awesome conversation and I really enjoyed the interview because he did so many things right and it allowed him to sell for a multiple of EBITA that is really unheard of and put himself in a position with lots of options. Jim became an entrepreneur when he bought his business, RTD, after a little over a decade of becoming an engineer and working in marketing in the temperature control engaged industry. When Jim bought the business, he learned a lot. Then he had double-digit growth for over 12 years before he eventually sold it to a very large company. Jim walks us through all the different monumental milestones that helped him grow the value of the business, technical things that he did to do so, and then how it helped him with the exit and the dollar amount the he got afterwards. Jim’s story really wraps together a lot of different philosophies from exit planning, value building, and the underlying benefits that preparation gives you on the eventual exit from your business. Without further ado, here’s my interview with Jim. 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 could thrive without you while putting an exit plan in place so you have the option to sell when you want to who you want for how much you want. You’re able to manage the business by the 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 want to know more, check out the show notes or the website. Good morning, Jim. How are you doing? Jim:     Good morning, Ryan. I’m doing well. Ryan:   I’m excited to have you on the show because you and I saw each other at the Club Entrepreneur Event, Club E, in Minneapolis. You were on a panel explaining. You’re actually with a couple other gentlemen. I give you lots of props for getting up there and being able to do that because it took us a while to jump in and reflect. I wanted to have you on the show because you’ve got a really cool story that I want to dive into. For our listeners, maybe just give us a backdrop of where you started your career and where did you have that entrepreneur seizure that all of a sudden just made you decide to the entrepreneurship world. Jim:     Sure. First of all, thanks for having me on. I’m more than thrilled to tell my story. It’s interesting, my career really started in my education, I went up to UMD. I was premed. I spent four years out there getting my Chemistry degree. In the fourth year, I realized that I wasn’t going to get into medical school. I decided to take a turn into engineering and ended up going to the University of Wisconsin, Madison and then I got my engineering degree. I came back to Minneapolis and started working for a [00:03:33] manufacturer. Then from there, I started to realize that every job I had, as I progressed, I always was in the frame of mind that I could do it better. What I decided at that point in time is that I would build a foundation and that foundation was going to be technology, and then I was going to build a foundation in business, and then at some point, I was going to venture off on my own. That journey brought me to Boston and I ended up getting mentored with a gentleman, a GTE, that was on the business side of GTE. He taught me the ropes on the business. Then, when I decided to come back to Minneapolis, which I was originally from, I ended up going to a company called Rosemount which turned into Emerson, and then got into the pressure and temperature business. I spent about five years there. Ryan:   You’re in engineering the whole time doing this, right? Jim:     I was in engineering/project management during this period of time. I learned the engineering part of it which was the technology which to me, meant manufacturing, then to the vendor approval, then to processes, SOPs, learning drawings and at that time they were CAD drawings. I really, really spent the first 10 years of my career really building the technology foundation of my experience. About third year into working at Rosemount, I was running an engineering group there, and I decided, I was the oldest one in the group, I said, “Where do old engineers go?” At that time I was nearly 33 years old and everyone in my group was somewhat younger that I was. I looked around and sure enough, older guys like me at that time got into marketing. I made my way into a marketing role at Rosemount and spent about a year and a half doing that. Then I got to know the engineering part of that business and the marketing side of that business. I got to know the pressure and temperature business quite well, all the aspects of it, from manufacturing to marketing. Then I started getting involved with customs. In the fifth year at Rosemount, I looked around again and I said, “Well, where do the old marketing people go?” Fair enough, they get into sales. I decided that that would be my next stop. I started to look around, and at that time of course, there was no internet and there were just recruiters. I contacted a recruiter and told him what I was looking for. He ended up placing me in a small family business that was specific in temperature. They were kind enough to give me a crack and they hired me. For the next five years, I learned the sales side of technology. During that time, I was able to double that business and in that period of time, I said, “Clearly, the next step is getting my own business.” I stepped aside from that business and a year later, I had purchased my company which was the RTD Company that was up in Cambridge, Minnesota at that time. It was a family-run business, probably less than $2.5 million in sales. I got them to eventually sell me the business. It was a process to learn that because I had never bought a business. The biggest thing I ever bought was a house. I learned the ins and outs of working with the banks and with family-run businesses as RTD was, and I took it from there. That was June of 2001, when I purchased that business. Ryan:   What I love about your story is that you bought a business and you learned so much through that process and you ended up exiting your RTD Company that you ended up growing. I want to focus maybe more on the end part of it, out of all the things you learned but I do want to tackle on how you went through the purchase process of this. What are some of the things that you learned, as you said you only bought a house at this point… How did you structure the deal and what did the transition look like as you were going in there? Jim:     I had a neighbor at the time that was a general manager on one of the big Cargill divisions. Cargill was growing their business through acquisitions. He gave me a piece of advice that I used when I purchased this business. He said, “Whatever you do, get the longest terms you can to buy that business.” Which meant don’t put all the money down at once, don’t borrow all the money at once. What it really came down to is I ended up buying this business with no money down, I borrowed 1/3 of the purchase price from the bank and I got the seller to sell finance the other 2/3 at a 5% interest rate over a 15-year time table. Ryan:   Good negotiation. Jim:     I did not realize how valuable that was because at the end of the day, the thing that everybody will tell you when they own a business and they run a business, big or small, it’s cashflow. That was one of the biggest debts we had, obviously, going into the business. We were able to cashflow it with good revenue coming in and not eat into our cash because we were way under capital but we overcame that by bringing in revenue and minimizing our output. Ryan:   When you are doing that, obviously because you are a buyer, I’m sure it’ll flush later in your story, but when you are doing that, did you ever once think how you didn’t want to be them with those terms, like you really want that opposite? Jim:     100%. I certainly wouldn’t have sold my company in that realm but, that person I bought it from was up a bit north of the Twin Cities which is roughly 50 miles north. The question I asked him is, “If you don’t sell it to me, what’s your exit strategy? How are you going to get out of this business? Who is going to buy this business at this price?” I was able to give him a little bit of a premium in buying the business because of the terms and because I knew the industry. By knowing the industry, I knew I could grow that business quickly and make up for any of the deficits I had inherited which was undercapitalized and which was the first one. Ryan:   I think there’s a lot of different ways we could go with that because I think it’s important because you didn’t have options from a lot of things that he didn’t do correctly. Were you able to see some of the things that pigeon holed him to the situation that he was in selling it to you? Jim:     I did. As I had worked for a family business prior to this, family businesses don’t always have exit strategies that include outside family members. The other thing family businesses are at a deficit at is accessing advisers outside of their business that they have met through other acquaintances as I had obviously working at Emerson and working at GTE and so forth, and learning the ropes through big company ways. You’ll get very insulated when you’re in a small business. You’ll get even more insulated when you’re in a small family business, when you have family members associated to that business. You rely very heavily on people that you can advise with on the outside but you’re also limited to access to them other than a recommendation and so forth. I had just the opposite. I had access to those people through relationships and experience. Those two things were a big difference between myself and that family-run business. Ryan:   What I think is interesting, I can’t remember if it was at the panel where you had said something or it was on a phone call—because you bought a business, correct me if I get this wrong but the difference between a business owner and an entrepreneur, is that how you phrased it? Jim:     No. I actually phrased it as a difference between a founder and an entrepreneur is strikingly different. Founders are just beat to a different drum. Founders are very creative, they’re very focused, and they believe that everything revolves around their world and their product. Entrepreneurs are ones who can come into a business and their focus is on growth. There’s a disconnect somehow between a founder and an entrepreneur when it comes to how to grow the business in just different ways. My philosophy as an entrepreneur, as I come from large companies before, is heavy on the sales and on the marketing side of the business. Founders may think they do but until they have experienced it at a large company level, they get a bit shoved aside. Ryan:   How did you implement that? Let’s say that you’ve got in about RTD, did you have a plan, did you buckle down, what were some of the first things you did to address and hit this growth strategy that you knew you wanted to do because you have the vision from being at a bigger company and then how did you implement it? Jim:     That’s a great question. I’ll tell you, it’s great to look back 15 years ago and say, “How did we get there?” It was a couple of things. One, I came out of the temperature business so I knew where some of the golden eggs were and I knew that my relationship had the ability to bring them over to us. I rapidly transitioned them to our business. The second one was small businesses are minimized in their marketing capabilities. Marketing to me really were the tools for salespeople. And since I was going to be the key sales guy at RTD company, the first thing I did was I took a look at the existing—at that time, even 15, 16 years ago, the internet wasn’t quite what it is today, not even close. Marketing literature was really, really important. An importance of it was that was the first impression you leave with the customer. The catalogue that I had inherited was a 6×4, 20-page catalogue that was black and white and had pretty fundamental drawings and schemes in there to present to the customer. That wasn’t going to come close to what we needed to have done. One of the things that I did is I went out and got all our competitors’ catalogues and certainly competitors that were far bigger than us. We put them on the table, we hired a CAD guy to spend the next 12 months putting together our catalogue. We ended up with a 200-page 8×10 glossy catalogue. 90% of the contents were things we never made before. Ryan:   How [00:16:35] employees that you went on? Jim:     It was a very calculated risk to say the least. It didn’t sit well but I had enough confidence in our folks. I had two partners that really did a good job. One of them was on the operation side and one of them was on the engineering side. Between the two of them, I knew we could get the products that we needed out the door. I knew I could sell ahead of them and get what we needed to our customer. Sure enough, we did. To say that I created chaos would probably put light on it. But what we did do is we started seeing double-digit growth very, very quickly. We were able to keep up with the growth and sustain that growth and get us ahead of our capital needs and make us very cash positive within the very first year. Ryan:   Let’s peel that apart because I think I’m probably more in the spectrum where I would do what you did which is sell the unknown and then figure it out. I do know that it takes a special blend of people to actually make that executable. As you’re doing this, one of the couple of questions I’ve got is what was your goal? Was it a financial goal or was it just to become cash positive because I think a lot of entrepreneurs get stuck with this growth for growth’s sake just to beat your rivals or to show that you could do it just as well as Emerson could do it? How did you judge yourself and what were some of the benchmarks that allowed you to get the feedback of how well you were doing? Jim:     That’s a great question to reflect back on. My goals were very self-imposed. I felt that if we weren’t double-digit growing, we were going to go backwards. By that I meant that if you aren’t bringing on new customers that land in your top 10, you have to be in the frame of mind you’re going to lose one or two customers in that top 10. I knew I had to keep that pace up. I didn’t necessarily have an ultimate goal or an ultimate revenue mark for us. I just knew that each year, we would approach it with a minimum of 10% growth and we would continue to be cash positive and profitable and continue to grow by volume and by the types of work we ended up ultimately getting. We did that for almost 12 years other than ’08, ‘09. Ryan:   Was there any major ripple effects for that for you guys? Jim:     It was. It’s very interesting, one of the philosophies I had and I held it very close to myself, was that we were going to have a steady stream of cash so we would self-fund ourselves from the very, very beginning. I think one of the things business owners that I have met along the way, once they see this stream of cash, they pull it out and they bonus themselves out. I didn’t do that. What I did, I did it pretty conservatively over the first five years and continue that philosophy moving forward. I held a strong cash basis in the business. In ’08, ’09, instead of divesting the business, I reinvested in the business and we shot out by the middle of ’09 because we were putting money back into the business because we had it. That also gave us the ability to never, never dip into our credit line. We never did from the beginning to the end. Ryan:   That’s amazing. I think a lot of entrepreneurs can’t say the same. I’m curious Jim, what is the growth strategy that you have? Because you had an idea of the value of the business because you bought it, you had a baseline for when you bought the business, as you’re doing these things, did you ever—the reason I’m asking this is because I think a lot of the entrepreneurs get stuck with the annual returns other than just overall value of the business because what you were doing, whether you knew it or not, with the cash flow, you’re making your business that much more valuable, how did you track that and did you track that? Jim:     I did. Ryan:   What was the method in order to keep that base line? Jim:     Well what we did is—I was fortunate enough to have two outside advisers. One we would have in on a six-month basis that really came from an operations frame of mind and then the other one was another adviser that had more of an accounting frame of mind. It was that adviser that really gave me a key metric that I would keep. That is what I would call my Tuesday numbers. My Tuesday numbers was really the ultimate goal. Tuesday numbers, what did I really have cash on hand every Tuesday of every month. I would watch that metric and it would include our accounts payable, our accounts receivable, cash on hand, and those three numbers really gave me a metric to the health of the business at that point in time. I would watch that cash on hand increase or decrease. The other thing that we did which I didn’t realize at the time but really appreciate it later on is we had, to the best of our ability, we had 30-day terms with our customers and 60-day terms with our suppliers. Ryan:   Beautiful. Jim:     We could balance that cash coming in. What that also enabled us to do was to grow the business on our own cash rather than dipping into the credit line and give us the metrics of what we had coming in and what we had on hand. Those were wonderful metrics certainly starting out and became very, very valuable as the business grew. Then we really got a sense of what this business cash flowed and what the value of it was. Ryan:   I love those 30-day terms and 60-day terms. That’s just beautiful. Did you implement that? Was it already there and then you realized how good it was? Where and how did that system come to be? Jim:     We brought it. The thing that we did and again—most of the people that we brought in came in from our past history which was Rosemount and our largest competitor. The combination of those people coming in from larger companies brought in those types of corporate metrics that the original RTD Company didn’t have. They didn’t have access to those types of people and type of processes. Ryan:   I’m curious on the employee size as you kind of went through at the beginning, the middle, and the end, so we can have some benchmarks. Did you have any issue of bringing in the big box of employees and having them being in a small business? Jim:     We didn’t because we were a small business run like a big business. Although we were a small business, we had the ability to maneuver and to do things that would thimble, that would give us the ability to be flexible. We didn’t have to follow a hiring criteria. One of the philosophies I had and as well as my other partners was if somebody good came available that we knew along the way, even if we didn’t need them at the time, we would still bring them in. We would grow into them and sure enough, we did. We really, really stopped looking like a small company within the first year. That helped us grow. Ryan:   I’m curious, because in our old business, it took us a long time to figure that out. Because you’re hiring up, that elevates your entire operations and you’ve already given a couple ridiculous and good examples to prove that. Measuring your Tuesday numbers and you’re tracking the investments of these people. I think there’s an assumption of ‘I don’t want to pay the money because it comes out of my pocket’ for these kind of people. How did you weigh the value of hiring these people versus how would it affect your cashflow and what you’re dealing with on a day-to-day basis? Jim:     That’s a good question. Again, I didn’t realize the value of it until we certainly got further into the business and more experienced. What I would typically do is I would hire these people at equal or less than they were making in the past but what we did is we did profit share. Profit sharing was really related to the health of the company at the end of the year. On occasion, we did it twice a year. Anything they lost by coming in, if we continue to be profitable, they gained in profit share. We did that within the first six months of owning the business just to show that we were serious about the philosophy of sharing the profits. What that did is it got everybody engaged. Everybody knew that if they worked hard, the company grew and if they gave that extra effort, they would see that in a 6 to 12-month space. Each and every year, we gave more and more money. Ryan:   How did you structure that? How did you determine what the base line was for the company and what you’re willing to divy up and how did you end up divvying it up? Jim:     It was based on what EBITA ended up. After taxes, we would see what our profit numbers were and we would give a percentage of that back to the employees and that was our reinvestment into the employees. Each year, we increase that percentage by points or couple tenths of a point. Each year, people saw that we were growing and much of it we shared with our employees. We were a very, very transparent company. I had no problem sharing those numbers on a monthly basis with our employees which is what I did. We would share where we’re at every month whether we were up or down. People really got a sense of the direction we were going. There wasn’t anything hidden. Ryan:   There’s the open book management philosophy now. I’m just curious Jim, you’ve got a lot of really, really good practices that you’ve applied, other than some of these advices, were there books, resources, people, or was it just the fact that you worked with a big company, where did you bounce and get these ideas? Jim:     No. It came internal. One of the things that I realized early on is that when I was looking to buy this business, I knew I couldn’t do it alone. I brought in two minority partners. Between the three of us, we had enough insight to figure out what the right things were to do to treat employees with. Certainly, everyone values their paychecks and there’s nothing more valuable than people working hard and rewarding them for it. The three of us had that same philosophy. A lot of it came from just the three of us discussing it. We didn’t always agree but I believe we always ended up doing the right thing. The other is because I have stayed in touch with enough people outside of our doors to not be insulated. I would pick their brains on different venues and different activities. One of the advices I got, I’ll never forget it to this day, this was one of our solid advisers on the outside, was that when you have functions, make sure they’re memorable. We would have great Christmas parties, we would have our monthly meetings where we’re intended to be knowledgeable but interactive so we would do things. One thing that I’ll never forget as well is in ’08, ’09, when we got that deep recession, instead of spending significant dollars on Christmas parties, we chose to do an in house lunch party. Instead of funding a Christmas party, we brought in people from the food shelf and gave them the check that we would have used for a Christmas party. Those are the things that went long ways. Those ideas came from different folks. We would have, internally, what we call fun committees. They would plan these events and those ideas would come out of that. Really, at the end of the day, it was a team effort and it was a combination of outside resources and inside resources and people’s thoughts and ideas. Ryan:   It’s so fun isn’t it? The question I’ve got for you Jim, because I love—everything you just said was a lot of our philosophies too. You’re working and you’re building this life of all these friends, family, you’re building this culture that is engrained in your personality as a reflection of who you are. Did you still continue to think about when and how the business was going to transition to someone else or were you living in the moment of how much fun you’re having with all these stuff because the question I’ve got on top of this is where and how did the triggering happen for you to sell because it sounds like you were having a blast? I can just hear it in the passion while you’re talking about it. What was the identity difference between you and the business and how did all of a sudden the triggering event happen? Jim:     That’s an appropriate question. The answer to that is I had always known that this wasn’t going to be a family business. There was not going to be a transitioning from myself to my daughters. It had the opportunity of transitioning from myself to my partners. But I always kept my options open. My time table came faster than I had anticipated. That being said, I was trying to learn and talk to people of how one goes about selling a business. I got to know some private equity people. They certainly lent me their ear. I got to know people who had sold their business and I listened to what they had to say. I always had my ears open of what that next step would be. But what ultimately happened was one of the other things that we brought into this business is we believe that creating a patent portfolio of our technology was really, really important, protecting what we did and giving more value to the company. What ended up happening is one of our sensors that we use in the medical catheter business became infringed on. That infringer was starting to take some of our business away. But rather than starting litigation against him, I decided to meet with them and see where they were at, made sure that they understood what that next step would be and that conversation, rather than getting into litigation, would you ever consider selling the business. At the end of the day, they offered a price that I couldn’t turn down. Coincidentally, at the same time, I was working with a private equity firm to look at a mutual acquisition we could make to grow our business and to broaden our product offering. When they found out that I was looking to sell the business, they started making offers as well so I played the two of them against one another, I leveraged it and got a multiple, and the timing couldn’t have been any better at the time. I ended up selling it in 2012. Ryan:   What was the time frame from the patent infringement and working with the PE to the eventual sale and actual signing of the documents? Jim:     Six months. Ryan:   Wow. Jim:     Yeah. Six months. I never would have anticipated it. Typically, even if you’re outright selling a company, it’s not going to go that quickly. Ryan:   Right. What are some of the things that as you’re going through, bouncing with two buyers back and forth, how did you navigate those waters? Were you using advisers? How did you play the field like you should have? Jim:     I did two things. One of the things that I did is I had both bidders come in and sit down with our outside attorneys and my two partners. We listened to their offer. They made their presentation. Coincidentally, they both upped their offer. We continued down that path maybe two to four weeks. But the other thing I did is I was also able to tap into my outside advisers of what was the best path as well as our outside accountants, of what was the best financial benefit to all of us and which path to take. Ryan:   That’s interesting. What you have here is a very unique set of circumstances. You’ve got a PE firm that is very financially driven. They’re probably looking at discounted cash flow, multiples of EBITA, growth projections, or the role of whatever you guys are going to do. Now, you’ve got someone that needs your patent. Two different completely methods of valuing of what is that you have. How do you deal with the financial situation of how they were valuing the business? Maybe let’s start with that and I’ve got a follow-up question. Jim:     Sure. They both value the business within 5% of one another. Their ultimate bid was about—again, we leveraged one against the other. Once they got into a certain point which—we just never thought we would get that kind of multiple—once they got to that multiple, The PE, the private equity deal, actually was probably a few percentages higher but the deal structure was a little bit different. The strategic buyer was going to be all cash, all up front, and had the ability and had the desire to grow the business and knew the market. At the end of the day, we took less but we took less for a higher security for us and for the employees. The lesser amount was more appealing because the company would be kept intact, it wouldn’t be resold again like the PE company would. Ryan:   I think you hit on a couple of huge things here because the deal structure I think is so ambiguous to people that have never gone through the sale because it’s the wild, wild, west. It’s complete negotiation on how you structure your deal. You’ve got two different buyers that have different types of organizations. How did you get to the deal structure and how did you get to your objectives on what was important to you like keeping employees and all that kind of stuff. What kind of questions did you ask them to derive to your understanding of what it is that was actually going to happen? Jim:     One of the things that I wanted to make sure on certainly with the strategic buyer, they were a 500 million-dollar buyer, a sector of their business, about a third of this sector was temperature. Their intention was to do temperature company acquisitions and we were one of them. One of the things that came out in those discussions is that we would be the company site for temperature. If anything moved, things would move to us not move to them. That was really important because one of the things I recognize as well as my partners did as well was that keeping the company intact in Minneapolis and keeping our employees employed through this transition, not just through the transition but their future was very important to us. Because we believe that our growth and our success really had a lot to do with these folks. The decision became easier and easier the more we thought through that. The PE company would buy for five years, sell it, and then you don’t know what would happen. There’s a lot of ambiguity out there. It didn’t feel right for our company and for the industry we were in. Ultimately, we ended up going with a lesser price with a strategic buyer. Ryan:   It was for a lesser price but it was all cash up front, right? Versus the PE where they were doing a leverage buyout. How was the payment terms on each of the two? Jim:     The payment terms were slightly different although the PE firm was ready to do all cash as they realized it was going to be very competitive. But the problem with the PE firm is they didn’t have the leverage that the 500 million-dollar firm had in the sense that they didn’t know the industry, they couldn’t put the same kind of cash back into the business if we hit a down turn that the strategic buyer could. Ryan:   As you’re going through this, in your mind, where did your role fit and where did you want to play a part in the future of the business once the deal went down? Jim:     At the time, I was 54 years old, 53 years old. I wanted to stay on. In each case, I negotiated an employment contract for four years for myself. I didn’t really understand what that role would be. What I ended up finding out is that my four-year contract, while it was paid out, should have been a six-month contract with three and a half years paid out. Because all you do once you sell your business is, the best you can do is provide continuity and the reality is that’s all they really want. They want continuity. You have an obligation to give that continuity to your employees, to your customers, and to your suppliers. I ended up staying a year and a half which I said was probably a year too long. I was not in any decision-making capacity. The minute I sold it, I lost my decision capacity. Ryan:   Was it different or close to what you thought that was going to be like? Jim:     Very. The last time I was able to make those kinds of decisions that they give me power to do was when I was 16. I had none. I had to have everything authorized, from buying a pencil to taking a day of vacation. I hadn’t been in that kind of relationship in a very, very long time. Ryan:   It just gave me a stomach ache thinking about it. Jim:     It gave me one too. Ryan:   Other than the decision making, well the decision making ripples into it, I want to go back to when you were talking about all the very unique things that you did from your events and how you were the chief culture officer, as would a lot of entrepreneurs are, how did you emotionally deal with the fact that they were now driving the culture of your business? How did you process that? Jim:     I didn’t deal it well at all. It was really the hardest year of working I had. I had to stay on, I didn’t enjoy doing what I did any longer. I had to think of what that ultimate exit would be for me. I finally came to terms with them of an exit which I said was a year and a half later. I moved on. It was not a productive year for me, to say the least. Ryan:   I went through the same thing. It was not as long as you were. How did you stay positive with your employees and all the people you were supposed to ride continuity to. Did you distance yourself? How did you actually tactically deal with that where you can’t make the decisions when everybody’s going to you or you want to and you’re dealing with this internal conflict? Jim:     Employees are pretty smart people. They caught on. The strategic buyer had a contract with me and they felt they had to keep it. But the employees started to realize they had to go to the fallback people and slowly started to do that. The transition from having responsibility to none became very evident through our employees, maybe less evident to our strategic buyer which I said we ultimately parted ways. Ryan:   As you’re working through your exit, as you said there’s a lot of technical stuff that you’ve got to get figured out with your employment and stuff like that but where was your head at and were you planning your next journey of what you’re going to be doing next or were you just trying to get the immediate stuff accomplished? Because it’s been a few years, how did you transition into your life afterwards? Jim:     What I did is after I left, I’d taken some time off to do the things around my house that I’ve been meaning to do. I did that for a few months but then I reverted back to what I really enjoyed and thought I did pretty well at and that was reconnecting with as many people as I could and seeing what they were up to and seeing what kind of opportunities lie ahead for myself. Those included anything from buying another business to advising businesses, to being on boards of businesses. It didn’t take me long to engage in all three of those. I quickly realized that I had a lot to offer still and I still had a lot of energy in me so I explored all three of those avenues. Ryan:   How did you make your decisions on what you want to do? Is it who you want to spend your time with, financial rewards, was there causes, or did you just kind of go with the flow? What was the decision making criteria? Jim:     It’s interesting, since I was fortunate enough to sell the business at the price we did, I wasn’t looking for financial rewards any longer. Although I still was in the mind frame that it’s good to make money. The financial criteria wasn’t the driving force. What really was the driving force was what I enjoy working with this people, it’s the part of technology that I’m interested in. Sure enough, I was able to get involved in all three of those different things. I did that and I did it without any financial pursuit. Some of it was volunteering my time. Much of it was at certainly no pay. I eventually ran into a business that I just exited out of a couple of weeks ago. I ended up being the interim president for about ten months. Ryan:   I think exploring, it’s kind of a new journey. One of the things that I’ve seen people struggle with or we’ve had conversations about is how do you now gauge yourself? Have you had a new life vision of what’s important because you no longer have Tuesday’s numbers to see how well you’re doing and double-digit growth so there has to be this new intrinsic way on how you value and measure yourself. Have you found a new system that’s worked for you? Is there still a process that you’re going through for that? Jim:     As I said, I still have enough energy in me and the desire to do this again but I don’t gauge myself against that. I really, really gauge myself with the ability to connect with the right people, climbing the right thing, and I enjoyed enough that financial pursuit is not the number one criteria. It really has come down to just doing what I’ve enjoyed best and that’s getting out there and meeting people, finding what makes those people tick and seeing if I have the ability to help them as people had helped me. Some of it is gauged on the ability to get back. The other one is gauged on interest. The last one would certainly be a financial criteria. I don’t know if I’m comfortable with it as much as I should be but at least a part of it I still enjoy. I enjoy doing all those things. Ryan:   That’s awesome. I love it. As we’re wrapping up here, where are you at today and what is the best place for our listeners to get in touch with you? Jim:     They’re welcome to certainly email me at sulciner@gmail.com. They can start with my email address. I’m not on Facebook but I am on LinkedIn. They can certainly access me through LinkedIn. I would love to hear from those. I’m happy to help. Ryan:   Jim, thank you so much for coming on the show. Jim:     You’re very welcome. Thanks a lot. Ryan:   I hope you enjoyed the interview with Jim. He had a ton of good information there. He did a lot things right and I want to highlight three of the main takeaways that I had. The first one was how he went about buying the business really shows what it’s like from the buyer’s perspective because Jim was able to be a buyer but then also a seller throughout his entire journey. How he words it when he said that you need to take as long as you possibly can to buy the business and he had a mentor tell him that, shows you that that’s the buyer’s mentality which is push all of the risks onto the seller. If you’re the seller, knowing that this is the case, how can you build the value and how can you mitigate that? The fact that Jim was able to actually do that and push all of the payment terms over time shows you that the person who he bought it from didn’t do a lot of things to grow the value and derisk it because Jim was able to look at him and say, “If you don’t sell it to me, what’s your exit strategy?” The person he bought it from didn’t have options and had to carry all the risk because he didn’t do the right things. That shows that Jim, when he walked into his business, knew exactly what he needed to do to not be in that position when he exited. He had a lot of key metrics that he measured and the three that I really love which he called his Tuesday’s numbers which is measuring AP, AR, and cash. It’s just really measuring the vitals and the health of the business. But aside from just those key metrics, he did value building techniques that were extremely beneficial for him throughout his exit because he had a profit sharing with his key executives. He was really specific with his AP and AR, making sure that he could use his own float to fund the business instead of becoming the bank like most of our customers and suppliers want us to become. Then he had a ton of patents that allowed him to have a leg up and have extreme value besides just the profit of the business and his ridiculous growth that he had here over the year, all of those reasons gave the buyer the confidence to give him the multiple that he wanted and put most of the cash up front. Tons of great takeaways from this episode, I hope you enjoyed it and until next week.

Today’s guest is Dan Zugell. Dan is the ESOP guy. Dan works for Business Transition Advisors and has been doing ESOPs for 19 years. The reason I wanted to have Dan on the show is because there are a lot of different messages about ESOPs out there. I wanted to get the full ESOP 101. Dan explains law changes, previous failures, how to value the business, payouts, finance structure and more. He totally demystifies the process including what life is like before and after ESOPs. In This Episode You’ll Learn: Dan shares how he got involved working with ESOPs by accident. He was helping a business owner exit and discovered that ESOPs were a great way to exit. He ended up starting and running the ESOP department at MetLife. Employee Stock Ownership Plan is a qualified retirement plan. The primary investment is the stock of the company. There are a lot of tax benefits for everyone involved. Employees get shares with no out of pocket costs. Good candidates for ESOPs need a company worth 5 million or more with 20 or more employees and about a million in payroll. They are also an excellent vehicle for passing a business from one generation to another. Dan shares concerns that may rise when looking into ESOPs, and how they are an internal sale with no outside buyer or influence. Tax advantages include deferred capital gains tax, the company gets to write off the sale over a period of years, the company becomes an S Corporation and the profits aren’t taxed by federal or state bodies, and estate planning advantages. The ESOP borrows money from a bank and buys the company stock. The company uses the tax savings to make ESOP contributions that pay off the loan. Dan’s company takes the ESOPs to the banks. Financing is a combination of a bank loan and the seller taking back a portion of the note at market rate interest. What life is like before and after an ESOP. The company owner can still sit on the board and run the company after establishing the ESOP. They even get board fees, salaries, and perks, but they can’t take money out of the company for personal use.   How to pick a trustee and how they ask for the financials.   The importance of preparing for liability and paying employees when they retire by making sure the company knows their numbers and plans properly. Share allocation. The shares are given out over time. An example would be 5 shares a year over 30 years. Takeaways: The amount of control you have over the process of an ESOP with the structure and financing enables you to reverse engineer your goals into the actual structure.   You still have control over running the business after a properly structured ESOP sale. The tax advantages and the four tax strategies that Dan laid out are an opportunity to maximize tax situations.   Links and Resources: Business Transition Advisors Daniel Zugell on LinkedIn (724)766-3998 About Dan Zugell: Dan is Senior Vice President of the national consulting firm, Business Transition Advisors, Inc. (BTA) and oversees the Central U.S division. BTA is a nationally recognized firm dedicated to assisting owners of closely held businesses with their business succession and liquidity planning with nationally recognized expertise in the education, design and implementation of Employee Stock Ownership Plans (ESOPs). Dan joined BTA with experiences spanning many financial service disciplines including investments, insurance, fee-based financial planning, executive benefits and ESOP implementation and repurchase liability financing as Regional Director-Central U.S. for MetLife Group’s Institutional Specialized Benefit Resources and Guardian Insurance Company. Previously, Dan held several positions with General American/MetLife where as Executive Director of Sales, managed the largest financial producer group relationships and oversaw the implementation of complex cases and strategic marketing concepts and sales initiatives. Dan had risen to a nationally recognized thought leader in numerous aspects of ESOP related topics with special expertise in forecasting and managing the corporate repurchase liability inherent to privately held ESOP companies while Executive Director of GenAmerica’s and MetLife’s ESOP Departments. While the head of MetLife’s ESOP Department, he designed, implemented and successfully marketed innovative financing methods to address the legal and fiduciary obligation to “buy back” stock from exiting plan participants. Dan continues to be a sought after speaker and author throughout the country including numerous local and national financial, legal and accounting industry meetings and symposiums (SFSP, FPA, EPC, NAIFA, CLE, CPE). Dan and BTA are also frequent speakers and consultants to the some of the nation’s largest insurance companies, broker dealers, banks and insurance producer groups. Dan has authored pieces in numerous publications including the prestigious Journal of Financial Service Professionals with his article titled “Executive Benefits for ESOP-Owned S Corporations” and Wealth Counsel Magazine as well as being quoted in TD Ameritrade’s Institutional Advisor Solutions and Employee Benefit Advisor magazines and others. Dan holds a B.A. from Grove City College and has earned advanced financial designations from The American College including Chartered Financial Consultant, Chartered Life Underwriter and Life Underwriter Training Council Fellow. Dan and BTA are also proud Industry Partners of Forum 400. Dan is Past President of the Society of Financial Service Professionals-Pittsburgh Chapter, Past-Chair of the Pittsburgh Business Ethics Awards, Member: National Association of Estate Planners, The ESOP Association, The National Center for Employee Ownership, Ambassador/Strategic Planner for the Pennsylvania Center for Employee Ownership and Northway Christian Community Church. Full Transcription: 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, and I hope you enjoy this episode. Welcome back to the Life After Business podcast. Today’s guest name is Dan Zugell. Dan is the ESOP guy. We had the SPA guy on, and now we’ve got the ESOP guy. Dan works for Business Transition Advisors and has been doing ESOPs for 19 years. The reason I wanted to have Dan on is because we have talked about ESOPs in some previous episodes. We’ve had Nina Hale on, who described her ESOP journey. But I wanted to start back and actually get the full one-on-one of ESOPs because I think there’s a lot of different messages out there about ESOPs and when it’s right. You hear a lot of bad horror stories about ESOPs that have failed, and Dan does a really good job at explaining what has changed and some laws that might have impacted some of the previous failures. But we wanted to totally demystify ESOPs, understanding how you value the business, how the payment structures are paid out with a combination of bank financing and seller financing. We talked about what life was like before an ESOP and then also what it’s like afterwards, and whether your perks change – your control changes or not – and then what kind of employee structure – divesting structure looks like with the shares. Really just top down of what it looks like in order to accomplish an ESOP. He talks about the four tax strategies and tax benefits that an ESOP just knocks out of the park. I can tell you what – it is amazing really having him clarify because of the tax advantages of this. The stories and the complications that come with an ESOP. The potential return on investment is like something I’ve never seen before. Dan’s got a ton of credibility because he started at MetLife, built up their ESOP Division, and then worked on switching over to Business Transition Advisors and has been doing that for 8 years with them. If you’ve ever had any thought about whether an ESOP was right for you, or you want to know a bunch more, we get a little technical and we went a little long, but I really hope that this gets you the information that you need to start to visualize if whether this is something that makes sense for you or not. Without further ado, I hope you enjoy the episode with Dan. 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 option to sell when you want to who you want for how much you want. You’re able to manage the business by the 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. Good afternoon, Dan. How are you doing? Dan:                 I’m fine. Thank you. Ryan:               Looking forward to having you on the show. We have had a couple other episodes in the past about ESOPs, a story that Nina gave about her exit to an ESOP, and a couple other brief ones that I think the topic is one that we should really dive into, and that’s why I was excited when I met you at the BEI Exit Planning Summit because of your experience and how many transactions you’ve done. You challenged my thought process in a couple of things, so now that you’re here, can you just maybe start at the beginning with – how did you get into the ESOP world and started working for Business Transition Advisors? Dan:                 Certainly. Thanks for having me. I do appreciate it. I started doing ESOPs about 19 years ago – kind of by accident. I worked for an insurance company, and we had business owners, who were looking to exit and looking for different methods of doing so. Somebody came to us and said, “Have you heard of this thing called an ESOP?” We said, “What is that?” Then we did some research on it and said, “Well, heck. This is a really, really great way for a business owner to potentially exit their business. Very tax advantaged, and it helps with family transitions. Just a lot of positive aspects to it, and we should explore it more.” We ended up making a whole department, and that insurance company was MetLife. I ran the ESOP Department for MetLife for many years for the purpose of helping our clients with an exit strategy that perhaps they have not heard about that might be – net the most after-tax dollars in their pocket. An ESOP can provide the most after-tax dollars of any other method, and so at MetLife, we took that and ran with that because not a lot of folks were talking about it. Therefore we created quite a niche, and I’ve been doing it ever since, for a total of 19 years. Ryan:               Is Business Transition Advisors part of MetLife then? Dan:                 No. The Business Transition Advisors is the firm that MetLife outsourced the actual heavy lifting to. Ryan:               How long have you been at Business Transition Advisors then? Dan:                 About 8 years. The owners of Business Transition Advisors said, “Hey! You’ve been working inside of MetLife for many years with the high-end advisors there, but there’s a lot of folks out there that could use your advice on where an ESOP makes sense, what are the tax advantages, and how does it work with families. Why don’t you come work for us? You can spread the gospel many different ways as opposed to just through one particular company.” I jumped at the chance, and I loved it ever since. Ryan:               You’ve got so much experience. Even on your website – all the deals that you guys have done. I want to tap into that experience today, just having this, let’s cover all the different pieces of it as much as we can, without getting too far down one technical rabbit hole or another. But why don’t we just – let’s start at the beginning. What is an ESOP? Can you give us a brief overview? Dan:                 I definitely will do that. I think any overview should not be technical to the point, where you’re talking about every tax change since ERISA was formed in 1974, which is a lot of ESOP presentations that I hear. I like to keep it more practical. Where does it fit? What type companies does it fit? What are the tax advantages? What’s the practical aspects of it that you don’t read in a textbook? That’s what I thought we could cover today, if that’s okay with you. Ryan:               Yeah. I think it’s a good – the reason I wanted to have that because you hear there’s so many good things about it, but then I think there’s so much bad gossip around it from failed ESOPs that business owners have a lot of fear around it. There’s a lot of ambiguity, so I think, yeah, to your point, let’s go over the practical fits and everything. Yeah, I’ll just let you kick it off, going what is the main structure of ESOP and the general concept. Dan:                 Right. Let’s do that. I like to start with – I believe Vince Lombardi said, “Gentlemen, this is a football.” I like to say, “Ladies and gentlemen, this is an ESOP.” The reason I do it that way is people confuse ESOPs with stock options. ESOP stands for Employee Stock Ownership Plan, not stock options that the Chairman of GE gets $10 million of stock options next year. An ESOP (employee stock ownership plan) actually means something to the Department of Labor, the IRS, and the financial professionals around the country. An ESOP is a qualified retirement plan, Ryan. It’s like a 401K, like a profit-sharing plan. It’s literally covered under the same code section as 401Ks, profit sharing plans, and pensions plans. The big difference is an ESOP has one primary investment, and that’s the stock of the sponsoring company; whereas a 401K, another type of qualified retirement plans – they get money, they get deferrals, they get matches, and they go out and reinvest and help other company raise capital – IBM, Ford, whatever the mutual fund companies purchased – you’re helping them with their capital needs. An ESOP was designed to help the selling shareholder with their capital needs, namely an exit strategy and a purchaser of stock. But being a retirement plan, there’s some pros and cons there. A retirement plan has rules and regulations. As we know, the Department of Labor oversees retirement plans because it’s for the benefit of the employees. We have to follow discrimination rules, testing rules, contribution limits, things of that sort. That’s where somebody like myself comes in. We make sure we cross those t’s and dot those i’s, but the flipside is because it’s qualified retirement plan, there is a lot of tax benefits to the selling shareholder, the company, and the employees that come along with doing an ESOP through this qualified plan. The reason the government encourages this – they do. In fact, people say, “Boy. Dan, you talk about all these tax advantages (that I’m gonna go through in a minute). Why does the government allow this? When are they gonna close these loopholes?” My answer is, “They don’t consider these loopholes at all. They encourage ESOPs.” As I mentioned, a qualified plan is a plan that’s designed for the benefit of the employees. If the ESOP, the qualified plan, buys stock of the company, and the shares are allocated to the rank and file and the workers and the employees of that company, the shares of the company are ending up in the hands of the folks that are helping to build this company. You can see where perhaps one political party might like the term “redistribution of wealth” – employees are getting shares through no out-of-pocket cost of their own in the company in which they work. That serves a social purpose. The government says, “Hey. The more people that have independent wealth at the company in which they work,” in theory, that’s less they’re gonna have people on the government safety net later on. So one party really liked that. The other party really like the idea of, “Heck. I agree with the social policy there – more people with independent wealth and taking care of themselves, so we’re willing to give incredible tax breaks in order to accomplish this goal.” Both parties have come together in a real kumbaya moment, Ryan, to promote ESOPs. In fact, there’s pending legislation to even promote and give even more tax advantages to ESOP companies to encourage them to do ESOPs. They’re not looking to close any loopholes; they’re actually looking to increase the availability and the participation in employee on plans. Ryan:               I love it. I wanna hear more about those potential benefits that are coming down the road, but before – because I think the taxes is something that everybody wants to dive right into, but before we’re gonna get into that, let’s tee it up to – who are ideal candidates? Are there employee thresholds, valuation thresholds? Who is a good candidate? Because I think there’s probably two different ways to answer this – the financial avenue, but also there’s cultural things too – that I wanna maybe tackle both of those. Dan:                 No, that’s a good point. It’s a good time to bring this up, before we delve into some of the other issues. Well, from just a fact pattern standpoint, the size and shape of a company. Typically, we need a company worth about $5 million of value or more, which equates to maybe a $1 million of net earnings, or for those financially sophisticated, a million of EBIDA. About a million of net earnings equals about 5 million dollar-company on an average. About 20 or more employees and about a million of payroll. The reason I say that is when we talk about the pros and cons of ESOPs, people say, “Well, I hear ESOPs are expensive and complicated.” I say, “Yeah. They are.” That’s why we need a threshold of about $5 million of value and payroll numbers and cashflow to be able to make the ESOP work, but when you get to those thresholds, generally the benefits far outweigh the costs of doing it in the first place. That’s kind of the threshold. That’s uniform. That’s not just me and my firm. That’s across the ESOP industry. It’s about the level there. But when you say, “What does an ESOP company look like? Who looks at an ESOP?” Well, I have a generic example I’ve used for many years. I call it Joe’s and Mary’s Cement Company. Joe and Mary have had the cement company that they started 35-40 years ago with a wheelbarrow and a bag of Quikrete. They paid off the wheelbarrow, bought a truck, bought their building, paid off their building, bought a competitor or two, bought some additional buildings, bought additional competitors, put their kids through college, put a few bucks in their retirement plan. Lo and behold, 30 or 40 years later, Joe and Mary have a nice business worth $10, $20, $30 million. The vast majority of their net worth is tied up in this business. Their kid maybe just graduated college, or maybe is thinking about getting into the business. Or forget the kid. Maybe it’s key managers they have working there, that have been beside them for a long time, and now a rub comes, the key managers or the children says, “I want the business.” Mom and Pop say, “I can’t afford to give it to you. You can buy it.” But the kid’s and key manager say, “I’d like the business, but I don’t have any money. I can’t afford to buy it. The bank’s not gonna loan me what I need to buy this,” so we’re kind of stuck. Where do we go? Well, that’s where an ESOP may really come into play. An ESOP’s an excellent vehicle to facilitate the transfer of power and management from one generation to another, yet providing the senior generation with the cash and the cashflow they need for a successful retirement. That’s where we see a lot of our initial inquiries come from – are situations like that, but that is by far, not the only scenario. But that’s a very common scenario that we see, Ryan. Ryan:               That was us in our previous business. I think most internet marketer entrepreneurs – just whether it’s Joe and Mary – I mean, I think that transfers into almost any scenarios that I run through. I like this story. Let’s take Joe and Mary. How do you – let’s walk through the process and then figure out the benefits that they would actually have, having structured this. What are the questions that they start asking? How does the process begin? Dan:                 Right. The first couple of questions – we’re gonna get questions of “What’s my value? How much do I get for an ESOP? If I let the ESOP buy my shares, am I getting more or less than somebody else from the outside? What happens to my favorite employees and my kid that works in the business? Are they out of work? What happens to my employees? Are they gonna take my patent and shut down my plant and fire my workers that have been here for 30 years? Is my picture on the front entryway – is that gonna be taken down and Acme company logo put there instead?” These are the kind of questions I hear every day, when we’re talking about ESOP or other methods of selling a business. Where an ESOP comes into play, obviously, I’m painting a picture here. An ESOP is an internal sale, and so owners generally like it and say, “Look, I can still stick around, even if I sell more than 51% of my company. I can still be Chair, CEO, President of the company for as long as I want – still take salary and benefits. I just happened to sell some of the equity – or even all of my equity, but I don’t have an outside buyer. I don’t have outside influences that says, ‘We’re gonna wear ties on Fridays now.’” Maybe the receptionist who’s been there for 30 years – getting a 4% raise every year, even in down years – generally that person, with an outside sale, they’re gonna be replaced with somebody that work for half the amount. I don’t think Junior’s car lease is gonna be renewed either, quite frankly, because people buy businesses – they like to trim costs, especially ones they can replace with maybe something more market driven and disregard the culture and the fabric in that community that this company has developed. Moreover, many times, the business owner doesn’t want to sell their business to some outside buyer. By the way, the ESOP’s not necessarily a low bidder. Generally ESOP’s one of the highest prices you’re gonna get for the business, except for some strategic sales. But that owner doesn’t want to show up to church in this small town, where he and she were the largest employer – show up on Sunday in the brand-new Cadillac, and they’re looking at the faces of all those employees that just got laid off because the new employer just laid off the whole manufacturing division and shipped the manufacturing to some other town or another state altogether. Kind of that concern about the family feeling and the fabric of that communication and donating to the Qantas Club and having their company name on the t-shirts of the little league team. That stuff really matters, and ESOPs can really solve those kind of issues. Ryan:               I love it. I think the biggest concern a lot of people have is the legacy. It’s the legacy of – like you just said – paying your receptionist above market rate because they’re a family friend. That’s why a lot of these entrepreneurs and – it’s so intertwined to your life. How do you accomplish all of that while getting the highest bid? Let’s dive into the valuation. How can your company afford to put that, and how does that work for the financial structure in order to be able to get the highest bid but yet accomplish all that stuff that they’ve built for years? Dan:                 Well, this might be a good time to backtrack a little bit. Let me go through the four tax advantages. Ryan:               Yeah. Dan:                 Then we can layer on a typical transaction. Does that work? Ryan:               Yeah, I love it. Dan:                 Okay. The four major tax advantages. I’m not gonna get into the specific details of what type of entity – C Corp, S Corp, whatnot. We can delve into that later if we want to, but for purposes of right now, there are four major tax advantages. One is – this is the oldest ESOP tax benefit. It says if a business owner sells their business to their own company’s ESOP – remember, it’s a retirement plan – so they sell their business to their own retirement plan. The seller can indefinitely defer and even eliminate the capital gains taxes that are normally due on a sale of a business. They potentially cannot pay capital gains tax on the sale. It’s one of the few scenarios in the tax code that allow this. One is – people may be familiar with the 1031 real estate exchange. You have an old family piece of property by the river. You sell it. You buy a new piece of property. You don’t have to recognize and pay a tax on that gain. You take your basis of the old property by the river, which is practically zero, and you transfer it to this new property we just bought for $2 million. Now this $2 million property still has a zero basis, but you didn’t have to recognize a gain on it. 1035’s a provision on life insurance. We had an old policy. A better one came along. You sell it and buy a new one. You don’t have to recognize a gain on maybe any cash value increase that may have been generated. Well, that’s 1031, 1035. 1042 is the tax code which is basically the same thing, but only for ESOPs, that says, if you sell your stock to an ESOP, you can defer the capital gains. There’s ways you can eliminate the capital gains taxes altogether. That’s the first big tax advantage and the oldest tax advantage of an ESOP. Ryan:               Before we go into the other three, Dan, it’s because you’re doing a stock sale, right? Because we’ve talked a lot about asset and stock sales on the show, but it’s because when you’re selling to an ESOP, it is a stock sale, which is why there is – capital gains is the biggest concern, correct? Dan:                 Right. Even if you pay the capital gains tax in an ESOP sale, you are getting capital gains tax treatment because it is a stock sale. An asset sale, as you probably discussed, could be a combination of – recapture it – it might be some combination of ordinary income and stock sale. Then we have the issues of liability and why you want a stock sale versus an asset sale. But even beyond that – even though an ESOP would be taxed as capital gains, which is a preferable way of being taxed, ESOPs take it a step further. It says you may not even have to pay that on the sale. Maybe never. Ryan:               It’s a big deal. Dan:                 Joe and Mary may have started this business, like I said, with a wheelbarrow and bag of Quikrete. Their basis is $25 in this business. They sell it for $20 million. Normally you have to pay capital gains on the difference between $20 million and $25. In an ESOP, potentially, all that gain – basically $25 million could go to Joe and Mary capital gains tax-free, if structured properly. I don’t know of any other way of selling a business that gets you that tax saving. Ryan:               I don’t either. Let’s go into the – what’s the second one then? Dan:                 Second tax advantage is if Joe and Mary sell $25 million of stock to the ESOP, they potentially don’t pay capital gains on the sale, but also the company would get at least a $25 million income tax deduction for that sale. Joe and Mary get $25 million. The company gets to write off $25 million to lower their taxable income, and thus lower their taxes by the tax they would have paid on $25 million. Big deduction. Ryan:               Yes. How long can you deduct that? Is there a certain schedule that they go for? Dan:                 There is. We’re getting into some technicalities, but it’s over a period of years. The company will ultimately deduct the entire sales price. Maybe over a 20-year period. Annual – they get a big old deduction, and over time, it will equal and generally exceed the sale price. That’s a nice big deduction you get. But with that being said, the third tax advantage is kind of the big one these days. This has changed about 18 years ago – about a little after I started in the ESOP business, where when S corporations were allowed to get involved in ESOPs. The third tax advantage is this: to the extent you’re an ESOP-owned company – and the trend is going 100% ESOP-owned company – you become an S corporation. And therefore because it’s a flow-through entity, to the extent you’re an ESOP-owned company (say, 100%), the profits of the company are now no longer subject to federal or state income tax on any level. I said, the profits of the company – I’m gonna repeat that, because people don’t believe me sometimes. If you’re a 100% ESOP-owned S corporation, the profits of the company aren’t taxed ever again by a federal or state body, to any individual – the ESOP nor the company. Nobody’s paying tax on the profits. We’re literally driving 35%, 45%, 50%, depending on the state, additional cash flow to the bottom line of the company that they’re not – Ryan:               You throw those no taxes and the deduction on top of each other. The amount of room in your cash flow goes through the roof. Dan:                 Yeah. The interesting thing is there – I was just gonna say – you kind of alluded to it. If that third tax advantage of not paying an income tax is true, it makes that second tax advantage of the deduction irrelevant. Ryan:               Oh yeah. Dan:                 Even though you might have a $25 million deduction, it doesn’t matter because you’re not paying tax anyway. As great as that advantage is, it’s irrelevant if number three is true, and you’re… Ryan:               That’s only for the 100%. Do you have to have 100% sale to the ESOP in order to get that? Dan:                 To be 100% tax free. If you’re less than 100% – you’re at 50% ESOP, then that number two deduction, the second tax advantage, is still very valuable. Ryan:               Yeah. Dan:                 Even though only half the business is taxable, we’re gonna drive down that taxable income because we get that huge deduction. If you’re less 100%, that deduction still is very, very important. But if you’re 100%, which is the trend – we talk about trends here. This is the current ESOP presentation. About 75% of all new ESOPs are going 100% so they could be 100% tax-free. It’s just – cashflow’s a lot better. Ryan:               Because what’s happening is the government is just taxing the employees as they retire and take the distribution, so it’s just like a normal retirement plan. Dan:                 That’s right. When the employees leave, die, retire, become disabled, they have a stock balance. They say, “Look, I have 73 shares of Joe’s cement company. I have a balance of $72,000.” The company has a legal liability and legal responsibility to buy back those shares, when the employees leave, so the employees get the value of those shares. The company has to buy back those shares. The employees get that value. Then they generally roll that into an individual IRA because it’s qualified plan money, just like a 401K. They roll it in IRA, and then when they use that money when they retire and they tap into that IRA, then it is taxable to them just like an IRA money would be. But they’re paying tax on something they were given, so yes, they are paying tax. They’re the only people who are paying tax here, but it’s on a huge gift that they were given. Most people believe it’s a fair tradeoff, and typically for the employees, Ryan – the employee’s retirement benefit, when an ESOP is in place, is generally two-and-a-half to three times the retirement benefit per employee than a 401K plan alone. Ryan:               Wow. That’s a huge number. Dan:                 Right. I didn’t say that very clearly. When you add an ESOP to a 401K plan – you have both in place – the average employee gets two-and-a-half to three times greater retirement benefit than a 401K alone. Ryan:               Yeah. We can go over – I wanna go into the employees and the liquidation in a little bit, but let’s wrap the four. What’s the fourth tax advantage? Dan:                 I’m gonna defer the fourth until we get to it later, but some very significant estate tax planning opportunities. It’s a great time to do personal estate planning for the selling shareholder when they do an ESOP, and it won’t make sense now, but when we get into that part later, I will remind us of number four (will still be an open topic) and we’ll touch on it then. Ryan:               Okay. Perfect. Then let’s go into – how is this structured then? If the business owner is selling to the ESOP, how is it actually structured? What kind of notes are – who’s paying the seller the actual money? Dan:                 Here’s how it works. We’ll just run through Joe and Mary here. Joe and Mary have this business. They create an ESOP. They have an additional retirement plan. They keep the 401K. They add another retirement plan called an ESOP. The ESOP goes out and usually borrows some money from a bank. It borrows as much as they can from the bank, and the bank lends the ESOP money. The ESOP takes the money they borrowed and buys the stock from Joe and Mary. I didn’t say that very clearly. Let me repeat that. The ESOP borrows money from a bank. The ESOP now has money. It uses that money to buy Joe and Mary’s stock. The company now uses the tax savings that we were talking about before, which is we’re not paying tax anymore. We use all the tax savings we generated, and the company makes contributions to its ESOP, its retirement plan every year. The retirement plan says, “Thanks. What do I do with this? Oh, I know, I’m gonna pay off the bank loan that I took out to buy Joe and Mary’s stock.” Every year, the company uses some of the tax savings that it’s generating that year, contributes it to its retirement plan. That’s why you get a deduction, because it’s a corporate contribution to a retirement plan. The retirement plan gets the money and says, “I gotta pay off the loan.” It takes the contribution it got and pays off the loan it incurred to buy out Joe and Mary in the first place. That just continues until the loan’s paid. Ryan:               I love it because there’s so many tax advantages there. The ESOP, being an entity – how does it go find a bank? What kind of banks specialize in lending to ESOPs? Is there a certain – because I’ve gone through bank bidding processes and stuff like that. How do you find the bank in order to do this? Dan:                 My company’s role – our role in the whole process is just to assist with the education, do the cashflow feasibility analysis – things of that sort, but then when we decide to do an ESOP, we help and assist with the financing. We write a financing memorandum and take it to banks. Now we will take it to banks and get letters of interest. Some of the known national banks that we have relationships in – believe it or not, behind the scenes, there’s a lot of ESOP departments in all the major banks. We’ll go to those folks. I’ll tell you. A lot of the local banks and regional banks – they don’t wanna lose a customer, so they’re more than willing often to take a look at it and offer some lending on a local or regional level. They are out there. There’s no lack of ESOP lenders out there. In fact, it’s a good loan to them. Speaking of the financing, can I take that another step? Unless you have another question, Ryan? Ryan:               Let’s dive in. Dan:                 Because in my example, you might have heard me hesitating a little bit because I didn’t know how I wanted to address it. But if we’re buying 100% of Joe and Mary’s business, many people listening to this might say, “Yeah, but there’s not a bank in the world that’s gonna lend 100% of the value of Joe and Mary’s business.” They’re not gonna lend all of it. They’re gonna lend maybe 30%, 40%, or 50% of the value of the business – maybe a couple multiples of their earnings basically, so that leaves a gap. Now, because we’re not paying income tax anymore, we have virtually all the cash flow we need to finance 100% sale. The problem is the bank’s not lending us all we need, so what do we do? It’s short ball. What do we do? Well, typically what we do is we say to the seller, “Hey look, Seller. The bank lent 40% or 50%. Why don’t you take an installment note for anything above – for the remaining 50%? We’re gonna pay you so much a year for the next 10 years.” We have a combination of a big upfront payment from whatever the bank lends at 4% or 4.5%, and then the seller takes back a note for maybe 10 years – subordinate note behind the bank and gets periodic payments until they’re paid off 100% of the sale price. Yeah, people are saying, “Heck! I’m on the hook then.” Well, in a way, because you still have a seller note. That’s true. If the company has some financial problems, and they owe you money, there might be a delay or may not even get it in a certain year. That rarely happens in the plans we do. Ryan:               Yeah, but it’s the same thing with any kind of internal management transition, or even if you’re to sell to your kids anyways, you’re still carrying a lot of risk. Dan:                 That’s exactly right. That’s exactly right, but there is some good news. If we did this podcast, Ryan, six years ago, I would have said to the listeners, “Hey look. The bank’s charging 4.5%. You’re taking a seller note. You’re entitled to market rate of interest. The bank’s charging 4%, while your market rate’s 4%.” We’d go happily on our way. We do 100% sale, be tax-free. The bank would get 4%, and the seller would get 4%. But in the last four or five or six years, people started saying, “Wait a minute. Is that really market rate?” If the seller is sitting behind the bank and people are scratching their heads, “Well, what would another lender – what would a mezzanine lender or private equity – if they were coming in here and they were subordinate to a bank, maybe interest only, until the bank’s repaid. They don’t get paid until the bank gets paid off. Would they charge 4%?” Heck no! Ryan:               No way. Dan:                 [inaudible 0:31:23] charge 8%, 10%, 12%. To take that risk, they deserve that rate of return. Why the heck shouldn’t Joe and Mary get that same market rate of interest? Finally, 4, 5, 6 years ago, all the courts and the Department of Labor and IRS said, “Yeah. They’re taking the same risk as that secondary lender would. They deserve the same market rate of return.” Therefore Joe and Mary can get a total rate of return 8%, 10%, 12% in some scenarios, should they want to. Now, there are some problems with that. The problem is the bank hates it. The bank doesn’t like anybody making more interest than they do. Sorry, bankers listening to this. They don’t. Second of all, the seller – that interest portion – remember the principal portion – may be taxable as capital gains or may not be taxable at all, depending if we structure it upfront. That was the first tax advantage – was potentially you’re not paying any capital gains at all on the principal. However, if you’re taking 8% interest or even 4% interest, the interest portion is gonna be taxable no matter what, at ordinary income rates, because it’s not the principal you’re selling – you’re getting money. That’s the interest you’re getting. That’s taxable ordinary income. If you’re getting 12% interest on half the company, that’s a lot of taxable income. It’s gonna bump you up in your personal rates. You’re probably gonna lose almost half of that to ordinary income tax, so the modern method, which my firm specializes in, as well as other top planners out there – this is right down Main Street – will say to the seller, “Look. You could take 8%, 10%, 12%, but how about this? Let’s do something different. Why don’t you take 4% like the bank? We’re gonna lower your current taxation. The bank’s happier, and we’re helping the cashflow of the company because they’re not paying 8%, 10%, 12% out the door. They’re only paying 4%.” But the seller should be rewarded for taking 4% instead of 8% or 10% or 12%. What we do is we say, “Look Sir. Take 4%. Lower your tax rate. But because you did that, we’re gonna reward you with a payment in kind. We’re gonna give you something else.” Often it’s in the form of – we call them – warrants, which is basically only a future equity stake in the company, as a reward. We can generally, in a financing package, because that seller took 4% instead of 12%, we can give them 20 or 20% of the future equity value of the company, even though they already sold 100%. They get another second bite at the apple up to 20-25% of the future equity value of the company. When the bank loan and that seller note at 4% is paid off, they get another check or note for up to 25% of the future value of the company, and that’s taxed as capital gains, not taxed as ordinary income, as that interest would have been. Ryan:               In that time horizon, if we’re back into that, that’s roughly 10 years down the road, when that actually happens? Dan:                 Eight to twelve years generally. Ryan:               Okay. Dan:                 Sometimes a lot sooner because the company’s not paying tax. They can pay off the bank note a lot faster than 5 years, and they can pay off the seller note a lot faster than 5 years. It could happen fairly quickly, however, we have a lot of owners who say, “That second bite of the apple – the 20-25% is payable when the other notes are paid off? I love the fact that my value (25% of the future value) is growing every year. I don’t want to pay off those notes. I’m sticking around. I’m still President, CEO. I might be in the ESOP. I’m getting salary, perks, benefits, healthcare, cars. I’m happy working here, even though I don’t own it anymore. I’m an employee making more money than anybody. I love sitting here. I’m happy to have these notes not paid off because I want my future 20% to be worth as much as it possibly can, so I might delay that 20 years, if I want.” It’s all back to the circumstances of what the owners – what they’re looking to do. They want out and go fishing? Or do they want to stay busy, as a lot of business owners do? They want an office to go to. They don’t want to be kicked out the day they sell to somebody. That’s another [0:35:16] with ESOPs. Ryan:               I like that topic because what is life like before and after an ESOP? Obviously before – maybe I can tee this up, so I think we’ve referred to it on the show before, The Great Game of Business by Jack Stack, where he refers to his ESOP strategy. There’s this open-book management, so there’s a lot of stuff that has to happen in your culture and the way you manage it before. Just like us and every other entrepreneur, there’s a lot of perks that come with owning a business, so what is the relationship – what do you gotta do to clean it up? How does the relationship with your business and the perks change afterwards? The perks and the control – what is the before and after look like? Dan:                 That’s very important. I’m glad you brought it up. In general, control really doesn’t have to change. The ESOP buys the stock, but however, it’s important to note the employees never actually own a share of stock. They have a beneficial interest in the trust that owns stock on their behalf. They don’t have minority shareholder rights. I’m getting a little nerdy. They don’t have minority shareholder rights that are granted by the states. That means they don’t have a right to see confidential financial information. Ryan, if you own one share of my company, you’d have a right to certain financial information. State law would say, “You have a right to see what’s going on in this company so you’re not being taken advantage of.” In an ESOP, the employees don’t have those same rights because they don’t have actual shares. However, the trustee, who owns the stock on their behalf, will get to see some financial information. But that trustee has no interest in running the company, nor do they control the board. So in an ESOP company, Mom and Pop can still control the board, be President, CEO, and have majority control on the board, and the trustee doesn’t even sit on the board. Mom and Pop still control the board, and they direct the trustee how to vote the shares many times. They say, “Trustee, show up at the next board meeting and vote for me and my wife and my kid for the next term of the board.” Trustees – directed trustee – they don’t have discretion, unless the owners are telling them to break the law or take advantage of the employees. That trustee will show up at the next board meeting and vote for the Mom and Pop and the kid to be on the board for the next term. Because Mom and Pop are on the board, they may get some board fees. In our example, if Pop is still the President and CEO and still driving sales, Pop is still getting commissions, President and CEO salaries, gets the perks, the cars, the phones, whatever’s ordinary and customary for somebody in that position of a company that size. We may have to clean up the cousin who’s on the payroll that’s not actually working there anymore. We’re all laughing, but we know about that. That boat down in the port that’s for customer use, we have to clean some of that stuff up. You actually have to have board meetings now because right now, board meetings are at the breakfast table. We’re gonna actually have to have some board meetings and have maybe an attorney. We know some good attorneys that could do that. They’ll sit down and have a board meeting once or twice a year, just documented, because if the Department of Labor comes in, because it’s a retirement plan, they wanna see that this company is being run properly. One other thing that might change post-transaction – I say this tongue in cheek. I’m kind of smiling when I say it. But the seller loses their thieving rights. Because right now, if there’s an extra million bucks sitting in there – right now, the owner could say, “Well, it’s my company, I could just go grab that if I want to. I want to buy a vacation. I want to take that million bucks.” But once you sell it to the ESOP, you lose that right. You’re an employee. You’re getting fair market value for your stock. You’re getting a future equity stake potentially. You’re getting the market rate of salary, board fees. You don’t have a right to still go in and grab that million bucks that’s sitting there because you don’t technically own the company. You’d be taking that from the employees’ pockets, and that’s where the trustee has to say, “Hey, look. It’s not your money anymore. It’s the ESOP’s value – it’s part of the company value.” Now, we can use that money to go buy a competitor to drive value. We can do it to launch a new product. That’s different. You just can’t take it to go buy that house wherever you want to buy it. Ryan:               With the trustee, how do you pick the trustee? Then when do they actually ask for the financials? Is it an actual cordial relationship, or is it kind of just like for show? Or is there actually more strict limitations to it? What’s the relationship look like? Dan:                 It’s a very friendly relationship. But the trustee – for the transaction itself, when the ESOP’s buying the stock – I kind of glossed over that, but that’s a true-blue sale of stock with due diligence. There will even be an independent trustee that doesn’t know the company that’s gonna negotiate the sale with the seller. With that being said, it’s probably the most friendly negotiation you’ve ever seen. The trustee wants to buy the stock. The seller wants to sell the stock, so it’s a very friendly negotiation, however, it’s got to be a negotiation. They can’t be too out of whack. The trustee gets their own valuation. My firm generally serves as the valuation firm for the seller. I don’t see their valuation. They don’t see ours. We negotiate for a fair sales price. That’s for the transaction itself. Ryan:               Let’s take a pause there. I’m curious on how are you guys valuing the business. Is it a discounted cash flow? Is it a multiple of EBITA? Do you do market rates? How do you guys actually come to that conclusion? Dan:                 All of that. It’s whatever’s ordinary and customary for that type of business. It’s usually a blended value of all those different methods. Ryan:               Got it. Dan:                 Then we weigh things differently: 25% for the discounted cash flow method, maybe 50%, whatever. Then we blend those together, fair market based on what other companies that are in that similar market and similar size, how they’re valued. Ryan:               How do you take in unique circumstances… We’re familiar with the value builder system, John Warrillow’s key drivers or any kind of value building approach where there might be something outside of just the EBITA or the cash flow that’s important. How do you take some of those intrinsic values and factor that into your valuation? Dan:                 Just like any valuation, you look at anything extraordinary. You look at one-time expenses, you look at adding back some of those things we talked about. Patents, excess cash on the books, signed contracts that maybe aren’t realized yet, the revenues. We have iron clad contracts with these six companies. Here’s the revenue that we project coming in. The ESOP’s look a lot more forward at projections than generally any other type of sale. Yes we look at trailing 12 months but the ESOP really looks a lot more forward to what’s coming down the pipe. As long as it’s realistic and could be justified like with signed contracts and things of that sort. Those type of things really enhance the value of ESOP which is why I say the ESOP value other than outright strategic sale that says I have to have you and I’m paying a 30% premium for you. All things being equal, in a financial sale, ESOP will be either at the same price or maybe even a little above. Ryan:               Those are kind of like a tipping point where you want to get full value. Yes you’ve got a combination of seller notes and bank financing. But is there a certain ratio of where you don’t want to load too much to suffocate in the actual business even though you are getting those types of advantages? Dan:                 Yeah, definitely. You read my mind. Yes. I say cash flow is to an ESOP is to location is to real estate. It’s all about the cash flow. The good news is we just found a lot of cash flow without paying tax. We found a lot of cash flow. But even with that being said, we have to make sure we’re not chewing up too much cash flow that the business can’t operate their business. The good side of the seller financing is that’s extremely flexible. The bank is not extremely flexible. They want their payments. Seller could say, “Hey, look. I’m having some trouble this year. Don’t pay me this year, just pay me interest. I’ll pick up a principal payment on the back end.” Or it might be more positive than that. It might be, “Hey. There’s a competitor down the road. I’d rather use the million you owe me and go buy that competitor for $1 million.” A lot more flexibility on the seller financing side of things than there is on the bank financing. In fact some people say, “I don’t want the bank at all. I’ll do it all on seller financing.” Ryan:               Got it. Dan:                 In addition to that, just something we didn’t talk about but you said you might want to bring up. At the end of the day, the company has the legal requirement to buy that share of stock. I think it’s absolutely vital that the company use some of their tax savings to squirrel away into some kind of a corporate sinking fund, corporate assets to grow money so when the company has to buy back these shares down the line, they have some assets to do that and some savings to do it. The CFO 20 years from now will be very appreciative. Upfront, the more highly leveraged the stocks are not worth much if they’re highly leveraged because of the vesting schedule. The stock takes 20, 30 years to be allocated to employee accounts. Upfront, the first 5, 7 years, it’s hardly any liability to buy the stock back. Later on if it comes bigger, I think it’s absolutely vital that the company puts some money away now. It’s like saving for college. You start when your kid’s born, I won’t say you might pay for it all but you might make a dent in that college tuition. Same thing here when your liability is low, you have all the tax savings. Now’s the time to squirrel some money away to prepare for that future liability. I’ve written some articles on this because I think I take this very seriously. Any ESOP or if anybody’s considering ESOP should bake this into their calculations because you need to be prepared. Otherwise there might be some nasty surprises down the line and some consequences you don’t really want. Ryan:               Do you run those in your financial models where you’re saying okay, out of 100 employees, you’ve got 30 that are 50 and they’re going to retire at this. You just kind of figure out how much you’re going to have to pay them, or are there liquidation events? Dan:                 Yes. With every ESOP we do, we give our clients. It’s baked into our everything fee, our normal fee, a 20-year projection of what that liability and that out-of-pocket cost is going to be. Then we’ll work with their financial advisor or with the company themselves and help them develop some strategies that are prudent to finance that future liability and even make suggestions of how much and what type of vehicles. Ryan:               I’m sure you’ve heard the horror stories, Dan. There’s a company around here, I won’t name it, but they’re very large. They grew extremely fast from a couple of hundred like a thousand. I believe that the key management personnel there – the company was going to owe like $60 million because all of these people were leaving and they didn’t have enough. They ended up selling to a financial buyer because that was the only way to get the money out. Dan:                 When you hear stories like that, when I hear ESOP companies that are in trouble, like you mentioned earlier, the horror stories of ESOPs – I would bet 95% of them revolve around two issues. One of them has been solved because of a certain institution got their hand slapped really hard. It changed the ESOP industry completely. We’re already there. I’m happy to say we have no issues whatsoever. But one of the issues revolves around valuation. I said that the trustee gets the valuation, we do a valuation. We don’t see each other’s valuation. We negotiate. It used to be you got one valuation, you threw it on the table then you negotiate it from that. What Zoe would do, Joe and Mary would get their brother-in-law to do the valuation. Ryan:               It’s kind of like the financial crisis when you say, “Hey. I need a new mortgage on my house. Why don’t we just figure out what this is worth and then go get a loan?” Dan:                 That’s exactly right. That’s what was happening. A large majority of the ESOP lawsuits and the ESOPs get in trouble revolved around valuation. It wasn’t an arm’s length transaction. Remember I said the ESOPs look at projections. This company, the cement company could be a 2% per year growth. All of a sudden they’re going to do an ESOP and the projections are a hockey stick. People used to get away with this. A lot of the lawsuits were around that. That problem has pretty much been solved. That’s good for the industry. I’m glad that came about. I was very supportive of that. The second thing is the repurchase liability, the obligation of the company to buy back the shares when employees eventually die, become disabled or retire. When I was at MetLife, they did a very important study. They spent millions of millions of dollars. They figured out that everybody dies. Point is one way or the other, the employees are going to cash out. You’re going to owe them some money somehow. You just put your head in the sand and say, “We’re going to do that by cash flow because the timing is always going to be good.” That’s very silly. That’s when the seller of the company gets sued. In fact the company’s board of directors could get potentially sued. There was a lawsuit that said to the board, “You knew about this liability. It’s an off the balance sheet liability.” But they knew about it nonetheless, it’s in the footnotes. You did not prepare for it. The company tanked and the ESOP value tanked because the company could have the cash flow. Therefore we’re potentially suing you personally for not managing that liability. Not to be scared of you buddy but those cases are very, very rare. But it shows the importance of preparing for that eventual liability. We think whoever’s in ESOP should be very conscious of that and prepare for that. Even though it may be down the road and that certain advisor may no longer be in the business or even around but the consequences of that to the company could be drastic. Ryan:               This is where it comes down to knowing your numbers. Do you find that it’s easier? Or there’s that certain smoothness with the financial maturity of certain companies if they’ve got clean books and they kind of know their numbers where they’re able to surface these kind of situations a lot easier? Dan:                 Of course. Yes, of course. Proper planning is everything. I made a big deal of this repurchase but the companies I’ve been working with for 19 years now, nobody’s had a problem. Because we’ve set them up, they’ve put a systematic plan in place. In fact there’s even – I’m not going to push insurance anyway because I don’t sell insurance or investments. But there are actually insurance projects that are used to finance these long-term liabilities. Once again, MetLife did a study, everybody dies. You could buy some policies on key executives and those death benefits could flow into the company tax-free later to help pay for these future liabilities. Or the company could just put money in some mutual funds or some CDs or they could put money in a tin can in their backyard. It doesn’t matter. I just think they really need to save for it one way or the other. Ryan:               Let’s go back to the structure. How do you prioritize? If it’s 100%, then how much the bank finances versus the seller? I’m assuming they’re kind of leveraged at all or pull and push in various directions. Do you see what I’m saying? As much as you possibly can, the bank will do a certain, let’s say 50%, then you’ve got the seller wiggle room. Does that also balance in with how much you actually sell to the ESOP? Dan:                 Generally not. Generally we’re backing into. Generally when you talk with the financing, it’s kind of the tail of the dog. Ryan:               Got it. Dan:                 We know when we’re getting some bank financing, we know we’re going to have to sell our finance somehow, what the exact number’s going to be. We can give you a pretty good guess. But at the end of the day, the bank’s going to lend two times your EBITA, that’s two and a half times your EBITA, your earnings. Maybe a little bit more in certain scenarios. Anything else is going to be seller finance. If they’re a six times multiple company, the bank lends, two times, we know the seller’s going to finance four times their earnings, which is what it is. We have a pretty good idea what that’s going to be. Ryan:               Got it. As we’re kind of just wrapping up the financing, the notes and stuff, you have to have very big considerations on the industry. I mean obviously the company needs to be sustainable for the next foreseeable future. But also thinking about the industry, do you guys really dive into that? The reason I asked the question is I’ve talked to some people that were heavy in the online space and did an ESOP. It’s interesting because you’re placing a very large bet on an ever-changing industry. Where does the industry fit into you guys’s analysis? Dan:                 That means that it matters a lot. I should say, because people always ask me. You didn’t ask the question but I’m going to answer it anyway. People say, “What are the industries that do the most of ESOPs?” Then I’ll go into what you’re saying. Ryan:               Okay. Dan:                 Manufacturing is number one. Construction is number two. Then, third is something a lot different, the technical industries – the engineering, architectural and financial industries. That rounds up the top three. Then every other industry falls behind that somewhere but it is across the board all over the place. But industry doesn’t matter as far as obviously valuation goes, as what the bank wants to finance. In fact sometimes the really high multiple industries are really tough to do. Ryan:               Yeah. Dan:                 We have an 11 times multiple on some fancy tech company and just because they’re worth that it doesn’t mean they can cash flow it. Remember, the cash flow might be what a normal 5-time multiple company would be. If you’re doubling the value, you’re doubling the cash flow requirement. Even though we might not be paying tax anymore, we still might be tuning up more cash than we have. Yes, it does matter when we’re doing our planning. That case it might be a partial ESOP instead of a full ESOP because we just tanked cash flows in our own bank. Ryan:               Okay. As you just mentioned, growth. You and I had a conversation with a friend of mine who has been thinking ESOP. He’s got a very long runway. When in the growth cycle of the business is a good time? I had this misperception that you should do an ESOP because you can have tax-free growth where if someone’s in heavy acquisition mode, which I’ve seen in the past, where they’re essentially buying their competitors tax-free because of the structured ESOP, but you had said that depending on the structure, you should use that growth for yourself. Then as it plateaus… why don’t you answer that, fill in the gaps there? Dan:                 Yeah, certainly. As we discussed, it just depends on what the person’s trying to do. I have found that more often than not, the business owners start their business, they’re running their business, they’re on hyper growth mode pursuing the American dream. I’m trying to grow this business so I could cash out for me and my family. That’s not selfish. That’s just business owners. That’s why people start businesses. They’re growing at taking risks and they want to sell it at a higher value than which they bought it. If you sell to an ESOP today, yes it may be tax-free. You’ll be using tax-free dollars to buy other people. But you don’t own the stock anymore. The employees are getting all that benefit. Because when they cash out, they’re getting the advantage of all this growth you have and they’re getting the wealth out of that. The seller might only have that future equity stake they got from the financing piece. If they’re buying this business, they’re growing this business so they can grow individual wealth so they can roll that over into another business or to donate to charity or whatever their objectives are – more often than not when they’re younger, they don’t want to give away that future growth because that’s why they started the business in the first place. With that being said, these entities, there are a lot of industries for example the brewing industry, the beer industry. It’s more of a hey, we’re a big hog. Ryan:               That’s awesome. Dan:                 Let’s have a beer, a beard and a hug. We want to share this thing. We want the employees to share in all of the wealth that we’re growing here. Let’s do it now. We want to do all of it right now. We’re all on the same boat. We’re all doing this together. The hybrid of that is I do love my employees, I do want to keep them all but I do want my future equity. Maybe we do a 30% ESOP, maybe we do a partial ESOP. They have an employment stake unit, they have an ownership stake unit. They act as owners, they grow value as owners. They appreciate it, they stick around. Retention goes up, worker’s comp goes down. You have all these positive things, you have a lot of tax breaks. But you have the seller still retains the majority of the future equity. Then later on, they can sell the balance to the ESOP and they are ready to step out. But I do say that the whole financing process and the payout – I would say allow 5 to 10 years lead time before you want to walk away completely. Because if there’s banknotes out there that the seller might be putting personal guarantees on them and if they’re seller financing, they want to stick at that company at least as chair of the board until those notes are off. They don’t want to sell to ESOP, they want to just hope that the management you left behind can meet all the financial requirements. You want to stick around at least as chair to make sure that it’s all taken care of. I’d give a 5 to10 year glide path to that. Ryan:               That just shows the model and the scenario, and how important it is. You can’t just punch out today so you got to have a little bit of runway but you don’t to be putting a rocket field to it while you’re doing that runway at the same time unless you calculated the risk of the equity that you’re giving up. Dan:                 Exactly. Ryan:               Just one more thought on this. Let’s say you’re to do 100% ESOP, how does the distribution of the shares go with all the employees and the management? Maybe this kind of ties back into the fourth and we’ll wrap it all together. How does the share distribution happen? How do you get the management and family members? What does the whole structure look like after the fact? Dan:                 Yeah. You read my mind. One item left on my list that I didn’t cross off is share allocation. As I mentioned earlier, the ESOP may buy – even 100%, I’m not forcing people into that. It just tends to be the popular thing right now. You don’t have to do 100%. But in any scenario, when the ESOP buys shares, the shares are not allocated and put into employee accounts the day the ESOP buys them. Because what happens if you hire somebody tomorrow? The shares are out, “Sorry, you weren’t here yesterday.” The ESOP buys shares day one but the company has to decide how long do we want to allocate these, how long do we want to be handing these out. This is our employee benefit. We want to figure out what’s too much, what’s too little, what percent of pay we want to be giving out every year because we’re buying substantial assets here. Generally, the company says, “We’re buying 100 shares. We’re giving you out 5 shares a year for 20 years.” Or multiply it by how many shares there are. Generally it’s a 20 or 30 year period that the company says, “Look. We bought them all day one. ESOP bought them all day one. But we’re going to hand them out over the next 30 years.” We can recruit to that. We could say, “Look. Hire your friend, call your friends and your hardworking family and buddies. Work here, stay, become more vested. Every year you’re here you get more shares. Every year you’re here you get more vested. That’s a good reason to have it over a longer period of time, keeps people involved. If they leave any time before 30 years, they’re leaving chips on the table. They’re leaving future allocations and future value on the table. Let’s say it does take 20 years to allocate the shares. That means every year for 20 years, 5% of the shares are being allocated every year. 5 years for 20 years, 100%. Year 1, the first 5% is going to be allocated. That’s subdivided to the employees based on that any individual workers, their compensation relative to total payroll. If Suzy makes 3% of payroll, Suzy’s going to get 3% of that 5% that’s being handed out that year. Hopefully that made sense. Ryan:               Yeah. Dan:                 Next year Suzy gets a raise, Suzy makes 4% of the payroll. Suzy gets 4% year 2 of the 5% that’s being allocated. Ryan:               Which is why you’re doing all the compliance waiting and discriminatory modeling. Do you figure out payroll and salaries and all that stuff in accordance to making sure everything’s fair? Dan:                 I don’t know if I got the question exactly. Ryan:               Okay. If you got $1 million of payroll, you got the whole top heavy that risk is always looking at. How do you figure out who’s getting paid in accordance to making sure that you got your executive bench all nailed down and topnotch getting paid when they should be? Does that make sense? How do you structure all that? Dan:                 Yeah. I’m going to cop that out. We recommend a topnotch third party administrator. Post ESOP – the administrator, the third party, just if you might have a 401(k) administrator. But in ESOPs I would say it’s even more important. They keep track of compensation, who’s eligible, who gets a payout in any given year, who’s vested, they fill up the forms, the 5500 reporting forms. They would help keep track of all of that stuff. The burden on the company is I wouldn’t say light but not heavy. They just have to give some reports to the third party administrator. They kind of track all that stuff. They’ll tell you if somebody leaves, they know how many shares they get at any given year, they quick die or become disabled and how much they’re owed and tell the company you owe this person this amount of money. That’s the ESOP shares. In addition to that, generally for team managers in the top, top inner circle, we generally want to do a little something extra for them too. Some kind of phantom stock or synthetic equity, generally something tied to the stock value. Even if the stock is all in the ESOP, we may say to the management, “We really like you guys. I want you to stick around. You’re the future manager of this company when I’m paid off. We’re also going to assume you have 200 shares outside the ESOP. You don’t really but we’re going to have a legal binding contract that says you are owed the value of 200 shares. You get that in 15 years. If you stick around, you get the value of 200 shares. If you don’t stick around, you lose it.” Ryan:               I didn’t know you could layer a phantom stock right on top of the ESOPs. It’s just the typical however you structure – whether it’s some key retention or whatever performance, whatever it is. Dan:                 Exactly right. I don’t want to gloss over. There’s some testing – take away the value of the company and leave nothing left with the rank and file. But when you’re done in conjunction you can certainly do it. Now we could look at the overall picture. We have the rank and file that has a future equity stake at the company. They stay for 20, 30 years. They’re getting shares every year for the next 30 years. You have a management that have the ESOP shares. They also have other compensation that’s driven off of the equity value and these phantom shares or something else like stock appreciation rights or something. Then you have the seller who sold the stock but still has a future equity stake because of the financing package. Remember the future 20% or 25% that they may be getting off the company. They’re trying to drive stock value growth. They’re smiling like a butcher’s dog because every single person in the company is driving stock value. It’s very successful. ESOP companies drastically outperform their peers. This is a large part of it due to the current structuring when we do some of these structuring techniques that we just talked about. Ryan:               Because everybody’s driving in the same direction. Just to finalize some thoughts on that. Can you put a deferred compensation structure in place? Or is it just phantom because it has to be very clean? Dan:                 It certainly could be either. One of the drawbacks of doing it through a deferred comp… Ryan:               Have insurance and all that stuff because you want to be careful. Dan:                 Yeah, that’s true. I was also going to say many owners would have liked to have done phantom stock or stock appreciation rights but they wouldn’t have the value to stock all the time. We’re already getting the valuation done every year. Ryan:               Yup. Dan:                 The ESOP requires that. We already have evaluation being performed every year. The addition of phantom stock and stock appreciation rights, we’re not acquiring an additional cost because it’s already being valued every year. You can give them a statement telling what it’s worth every year because you’re already doing it anyway. Ryan:               Yup. Dan:                 I think it makes sense to have their compensation tied to corporate performance or the stock market. You could, if you want to – I have no problem. I’m a big fan of deferred compensation plans and the supplemental objective of retirement plan, I’m a big fan. In conjunction with the ESOP when you’re trying to drive value for everybody, I personally feel that maybe the stock appreciation rights and phantom stocks might be a little more appropriate. Ryan:               Then you’ve got the whole foundation laid like you said. Dan:                 Right. Ryan:               How does that tie into family and gifting estate planning? As you’re kind of restructuring the whole family estate with this, the ripple effect touches everybody that the estate touches. How does that get integrated in everything? Dan:                 Let’s talk about the fourth tax advantage that I deferred. You nailed it on the head. Here’s what it is. As soon as the seller does the ESOP, that’s the time to do personal estate planning. Let’s talk about a couple of things. First of all, remember that future equity stake we’ve talked about – the warrants, the future equity stake. The day you get that future equity stake of the company, it’s of a company that it was just 100% leveraged potentially. What’s the value of the stock that they get? $0, right? Ryan:               Yup. Dan:                 If the company’s worth $20 million and we just borrowed $20 million, the equity value’s practically $0. You have a 25% equity stake 15 years from now that’s worth $0 today. That’s hardly worth anything. That future equity stake is hardly worth anything. That’s the time to gift that away into family, partnerships and future generations because it’s hardly worth anything. Knowing darn well when the debt is repaid, the company is going to go back to $20 million, maybe $30 million because you’re a tax-free company. You may be giving away 25% of a $30 million company later for a gift tax consequence today of practically $0. It’s a great way to transfer vast amounts of wealth from the seller’s generation to future generations with zero or little gift and estate tax consequence today. It’s a fantastic time to do that. Secondly, you can do that with – I’m not an expert in all this stuff but I know grantor-retained trusts. You can retain an income stream in the seller and when they die the remaining balance goes to family or you could donate to a charity called a charitable trust. You can say, “I’m donating this when I die. In the meantime I’m taking it as an income. When I die, you get the remaining asset.” The seller gets some incredible tax advantages when you combine it with charity. There’s all kinds of stuff there. As well as the seller note. Remember, the seller note is subordinate to the bank. Remember the reason you got the warrants, the future equity stake, is because you’re getting less than the market rate of interest. It might be interest only until the bank’s paid off. That can be discounted 40%, 50%, 60% in some scenarios. If the seller doesn’t need that portion, the seller note, they can live off the principal and other assets or the down payment that the bank gave them on other assets. They don’t need the seller notes. They can gift that away to family members as well at a very low estate tax planning consequence. There’s all kinds of charitable grantor trust. We can get income streams, the straight-up gifts to charity, moving gift and estate taxes, the future generations. Plus we found the assets to do ILITs for estate planning, for estate tax purposes. We’ve found all the assets we need from the sale proceeds to fund any – it might be insurance policies and all these other gift and estate tax planning. It’s the great time to do all of that. That’s the fourth tax advantage left on the table earlier when we’re talking. Ryan:               It’s one big rubric’s cube. You’re going to see the return on your investment with the work you put into place on this. Dan:                 Right. When people say it’s complicated and expensive back to what I said earlier, yes it is. But look at what we’ve done. Yes you may not be paying capital gains tax on the sale, the company may not pay federal or state income tax ever again on the profits, it’s not going to equate on a $20 million company. That might be a $30 million of tax savings over the next 10 years plus not paying capital gains tax plus gifting away to future generations with virtually $0 gift tax consequence, that might cost you a couple $100,000 to put the ESOP in place. Is that really expensive? Ryan:               Yeah, right. It has a pretty good return. Dan:                 Yeah. Exactly. Ryan:               What’s the time frame from thought process to execution? What are the major key steps? Dan:                 We do five steps. It’s like this. Everybody else has a variation, they may combine steps. I like to do a lot of education. Almost everybody I know in the ESOP community like to preach the gospel. We love to tell the story. How many seminars have we been to with different events by universities or by CPA groups or insurance companies? They talk about business obsession. ESOP’s not even a bullet point. It drives us crazy. I don’t know why. It’s complicated and they’re scared. We like to preach the gospel and talk a lot about it. Education is the key. We do all the education the client would like to hear at no cost. We like to sign a non-disclosure and do a complementary multi-point review. Just to see if the nuts and the bolts, the cash flows were, where the value’s in a range where the owner expects, the value’s in a range that makes an ESOP effective. Do they have enough employees, do they have enough payroll, are they getting the benefit out of it? No cost to that. Just to see – we don’t know their start time or their time, either written or verbal report. Just to see if it makes sense. Then generally after that step – that’s the multi-point review. Generally our first pay step is we call it preliminary evaluation / preliminary analysis. It’s where a couple thousand dollars, we’ll provide a calculation of value, you can hang your hat on for ESOP purposes. Based on that value, we’ll run a model of couple scenarios. Maybe 50% sale or 100% sale. Maybe a C-Corp sale or an S-Corp sale because there’s different tax consequences. We run different models, look at total benefit, tax savings, net proceeds and what affect on cash flow it has, just to see if the company can cash flow based on the value. Like I said, that’s a couple thousand dollars just to see if we’re making sense. Because if you don’t do that, why are you going to spend another $20,000 to figure out how to change your board structure when you can’t get the value in the cash flow right, you might as well stop there. We carve out that little baby step so you can hop off the train if the train’s not going to the direction you want it to go. Then you move into a feasibility study where a lot of people start. If you want the full boat and you want the blueprint from implementation right from the get-go, you can start here. We’re happy to do it. We suggest you take the baby step. But you’re going to a full blueprint from implementation where sharpening all those things we already did plus talking about the financing package, designing the future equity stake, getting letters from the bank to see what they’re willing to do, we’re recommending board additions, recommending stock splits, we’re talking about what are we going to do about the match [01:10:52]. We’re figuring out all the details. At that stage, you’ll know what it’s going to cost to implement the rest of the plan. What are the attorneys going to cost, what are the administrators going to cost, what are the trustees going to cost, what are the valuations going to cost. Kind of figure all that out and give the client and say, “Here’s the blueprint. We talked to all the people that need to be involved. We brought in whatever we need in suiting your scenario, the best attorney for you, the best valuation person in the industry. We’ll bring all these people together and say it’s going to cost x to do what we laid out in this feasibility study.” If they want to go forward, they sign all the contracts including my firm’s. Pull a trigger and we hire everybody and we get the deal done. It’s generally three to six months from beginning to end. A lot of that’s due diligence gathering and waiting on people to do what they’re supposed to do. Ryan:               Yeah. Just the gospel and educating people’s so important. There are so many things where you just jump the gun and you realize you went through all this work and then it’s not worth it. I think that’s the biggest fear that a lot of people have. Honestly, I think Dan ran through everything we did. It was fantastic. Now we understand what kind of project we’re willing to tackle. Because you have to have your head in the game if you want to go down this road. You’re going to be able to reap the rewards. As we wrap it up here, what’s the best way for our listeners to get in touch with you? Dan:                 Happy to just check out our website. You can get my information at esopguy.com. My telephone number is 724-766-3998. We have a lot of white papers we’ve written and articles and the information about our firm and other type of information you might be interested with. We’re happy to send anybody a complementary book put up by the National Center For Employee Ownership that kind of talks about the nuts and the bolts of how ESOPs work. It’s complementary. We’ll send that to you if you like that and answer any other questions. Ryan:               Thanks Dan for coming on the show. I appreciate it very much. Dan:                 Thank you for having me. Ryan:               I hope you enjoyed that episode. That was probably a lot for a lot of people because we got really technical on some of the different areas. But I wanted to do that because I think there’s just too much ambiguity around ESOPs that it painted a bad light when you can see the crazy amounts of benefits that it brings. My three main takeaways from the episode with Dan: One is the structure in the financing. When you’re sitting down and doing a sale to an ESOP, if you can see the amount of control that you have over the process, it’s pretty crazy. If you’re going to go sit down and sell to a strategic buyer or a strategic competitor or even a PE firm, you’re going to be at odds with them because you’re both dealing with the effect that you want the most amount of money and they want the least amount of money to hit their returns. You got the asset stock sale complications. All of the stuff that puts your attention at odds with the buyer and the seller right off the bath if you’re not doing this. Or in this situation, the time it takes to plan to structure the right deal between how much the seller finances, where you get your banking and the relationship of the interest rates tied to the seller financing, and the terms and the conditions that you have and the flexibility you have with the seller financing after the deal that I was actually unaware of. Just realizing that you can almost reverse engineer into your goals because you’re working with yourself and the team of advisors with you. Yes you have to get to that true valuation but then everything comes about optimizing what you currently have. I think the amount of control that we all want as entrepreneurs, ESOP brings a crazy level of control to a sale. You continue to be in that business as much or as little as you want depending on the work you’ve done ahead of time with management and with operations and stability. I just think it’s a very huge opportunity to maintain control over the process. The second takeaway, I was really resonating with the amount of control that you have before and after the deal. I was surprised to hear that you’re still pretty much running the business as is. I know I’ve talked to a lot of other people that say, “You no longer own the company.” Technically yes that is true but how you structure the board of directors and the trustee allows you to have the control over the things that really do matter. On paper you might not own the business because the ESOP now does. But you’re still able to have a lot of control over the fabric, as Dan employed it, of the business and the culture and the people that you hire, why you hire them and the things that you do which I think is mostly the reason we all get in the business anyways. Because we want to help people change their lives. You still have that ability to control that should you set yourself up for that. The third takeaway I just have to say is taxes obviously because those four tax strategies that Dan lays out, he clearly identified all of them. I think he did it in a way that you’re able to articulate and envision what that kind of tax savings does. The biggest thing I think all of us are constantly concerned with is what kind of annual taxes I’m paying today and then what kind of taxes I’m going to pay when I sell my business and give my wealth to my kids. ESOP is a crazy vehicle to be able to maximize and optimize all of those different situations if done correctly. I think that’s even worth looking into if there’s even an option. You’ve heard from my story that the amount of taxes we paid and most people are paying to sell their business is not enjoyable. It’s worth doing to do those and to look into this if it’s a viable option. If you’re still listening, I appreciate you sticking around. Hopefully it was beneficial. Until next week.

Today’s guest is Cathy Demers. Cathy started her career at IBM and Microsoft before developing a startup with her business partner. With a $10,000 investment, they built up their business and eventually went public for $20 million. Today she’s going to share with us the challenges she encountered along the way. In This Episode You’ll Learn: All about the day that Cathy decided to become an entrepreneur, what her business idea was, and how she and her business partner went about gathering up the money needed for them to get started. How Cathy got into using recurring software before it was popular. Why the partnership needed investors and what type they were looking for, as well as why they chose the angel investor that they did. Cathy’s thoughts about the negotiation process. How the growth process went once the company went public, as well as some of the stressors that Cathy didn’t anticipate. Some of the key things that had to be done to prepare for the IPO. What the process was like, Cathy’s emotions, and how her day-to-day role changed. The decision to exit: how Cathy and her partner knew it was the right move. What Cathy did after she exited the company. Takeaways: Start with the end in mind. If you have an IPO goal, you need to start working now to make your company valuable. He who has the money wins. Money and influence will dictate the outcome of your sale. Every business is a game. Being an entrepreneur means playing strategically and knowing what a win entails.   Links and Resources: BusinessSuccess.com The Business Success Cafe Cathy on Facebook Cathy on LinkedIn Cathy on Twitter About Cathy Demers: Founder of BusinessSuccess.com, and host of the Business Success Cafe, Cathy Demers is known for her direct but friendly and supportive style as well as her business savvy and “let’s get ‘er done” approach. She combines the wisdom that comes from her vast business experience with her unique talent for helping business owners get fantastic results by being clear, staying focused, and taking inspired action. When it comes to proven business success, Cathy Demers is not a “wanna be”. In fact, she co-founded a company with a tiny $10K investment and successfully launched an IPO, turning it into a publicly listed company worth over $20M. Winner of the Canadian Woman Entrepreneur for Western Canada and a member of the Forbes Council of Coaches, Cathy is a sought-after expert and has presented keynotes and courses for organizations worldwide, including the Women Presidents’ Organization, Wired Women, and Novice to Advanced Marketing Systems.

Exiting your business with zero regrets is a goal that many of us have. Today’s guest, Troy Schuette, owned a waste disposal business for 23 years. He made his decisions carefully so he knew he’d be able to exit happily without wishing he’d done things differently. He’s going to talk to us today about the process he went through, from creating his valuations to choosing his buyers to finally signing his closing documents. You won’t want to miss Troy’s story! In This Episode You’ll Learn: How and why Troy decided to become an entrepreneur. Where Troy got his passion: Garbage, recycling, and scrap were not actually his passion, but they were the vehicle for his passion. Some of the pitfalls of growing too quickly, as well as what finally clued Troy in that he had lost his passion. How Troy, with the help of his father, decided to sell and how he determined the value. The mental process that Troy went through to choose a buyer. Some of the lifestyle changes that went along with exiting the business. The emotions that Troy went through on the closing date. How Troy told his employees about the sale of the company. What Troy did to let his brain rest after he exited his company. Takeaways: Self-reflection: Troy recognized that he wasn’t happy anymore and he knew himself well enough to make a plan that he would be happy with. Knowing numbers: Troy really had to know what his business was worth in order to take a calculated risk and make a good decision. Retirement: You need to make sure you’re going to spend your days with who you want and do what you love. Make retirement into just having a blast all day, every day. About Troy Schuette: Email Troy

Financing is an important aspect when buying or selling a business. The SBA can play a huge role in this process. An important step in the process is knowing where you are trying to go before knowing what tools you will need to use. When structuring a deal the fundamentals come first before the deal structure. Today we’ll be talking to John Thwing who is known as The SBA Guy. John has closed over 400 SBA financed transactions and is currently at Anchor Bank. Today, John shares a ton of insights about SBA structure, the loans, how they work, and the role the lender plays in relationship to the buyer, seller, and broker. He also provides great insights on all the deals that he has done, and what constitutes a qualified buyer for going into a business and how a seller can use the SBA to exit their business. In This Episode You’ll Learn: John shares how he started at his first bank in the mail department and ended up becoming The SBA Guy today. How the role of the SBA is to guarantee loans for financial institutions. Deal structures and restrictions with SBA financing. How the SBA tool may not be a good fit and how John helps sellers and agents recognize that. How cash flow is the driver of value, and banks want loans that will be repaid. Due diligence, determining value and prequalifying for financing. How SBA lenders validate 3 years of tax records for ecommerce businesses. Marketplaces for matching buyers and sellers. How hiring an appraiser is not always the best first step. Change of ownership is not part of the SBA loan structure. Qualifying buyers and looking at liquidity, transferable skills, background, and expenses. Discuss financial fundamentals and listen to the market and your advisors. Takeaways: The resume and skill sets of the buyer and the seller building themselves out of the company affect the transferability of the business. Going from a technician to an entrepreneur to becoming an investor and replacing yourself. Make sure that your lender understands the structure of the SBA being a tool.    Links and resources: Valued Advantage SBA Anchor Bank About John Thwing: John Thwing is The SBA Guy. John is one of the busiest lenders in Minnesota and has closed over 400 SBA financed transactions. Areas of expertise include owner-user commercial real estate, business acquisitions, expansions, partner buyouts, franchise and construction financing. John regularly speaks on the topic of small business financing, presenting to industry groups, advisors and individuals interested in buying a business or commercial building, and was recognized by C-LEVEL Magazine with a 2016 Champion of Business award. John is a fifteen-year member of the Minnesota Commercial Association of Realtors(MNCAR). He has also volunteered as a business plan judge for the University of St. Thomas MBA program and for BPA-DECA. John has been in banking for 29 years, and is a graduate of the Carlson School of Management at the University of Minnesota. Anchor Bank has funded over $28 million in SBA loans so far in fiscal 2017, and we are currently the #2 SBA 7a lender in MN/WI. The best ways to get in touch with John are through emailing him at Anchor Bank or calling him on his cell phone: Email John (612) 505-9751

The valuation of your life work and business is a direct reflection of the leadership remaining in place after you exit. What does it mean to build a company of leaders? How do you do that? What does it mean to be increasing wealth so everyone profits? Today we’ll be talking to Kevin McCarthy, the Chief Leadership Officer of On-Purpose Partners, a deep strategy and planning business advisory firm. Kevin is also the author of several books, including The On-Purpose Person and The On-Purpose Business Person. Today he’s going to talk to us about how to find your purpose and his multi-decade journey trying to reinvent how an entrepreneur can change his or her business. In This Episode You’ll Learn: Information about Kevin’s background that helped him get where he is now as the CLO of On-Purpose Partners. Where entrepreneurs go off-course when it comes to identifying and sticking to their purposes. What purpose means to Kevin as well as how having purpose minimizes confusion. How the On-Purpose Pal can help you stay aligned with your values, as well why Kevin recommends a two-word purpose statement. How to figure out your purpose without having a tragedy. How an amortization chart can help you get on track with your purpose, as well as what “hellegation” means and how it might apply to you. Tips on how finding your purpose relates to your exit plan. An explanation of the Chief Leadership Officer title. Takeaways: The greatest fear is that of exposure: You don’t have to have it all figured out. Balance vs. integration: Being able to integrate everything in your life is important. Hellegation: It’s the state of not being able to delegate, and it’s vital to get past it.   Links and resources: Valued Advantage CLO Now On Purpose The On-Purpose Person The On-Purpose Business Person I’m OK–You’re OK The E-Myth The On-Purpose Pal More Books by Kevin McCarthy Onpurpose.me About Kevin McCarthy: Kevin McCarthy is a natural entrepreneur with a classic business school education. His MBA is from The Darden School on the grounds of the University of Virginia, and his undergraduate BS business degree is in Business and Economics from Lehigh University. He lives in Winter Park, Florida, which is near Orlando. The best ways to get in touch with Kevin are through OnPurpose.com, by email, and through LinkedIn: Email Kevin Kevin McCarthy on LinkedIn