Latest / MaxValue Podcast / How to get real value out of a valuation Ft. Ted Israel

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How to get real value out of a valuation Ft. Ted Israel · MaxValue Podcast

0:00
SPEAKER_01: What are some things that hold them back from getting good value or maximum value from their business?
0:05
SPEAKER_02: Clean up your practices, get the non-business kirks out of there, clean up the loans, get a good accounting firm, and get three years of reviewed minimum.
0:16
SPEAKER_02: They don't need that 50-page valuation report that they don't understand anyway.
0:21
SPEAKER_02: They just need a little bit of help.
0:22
SPEAKER_01: The higher the risk of the whole company, the lower the value of the whole company.
0:26
SPEAKER_02: Most of the people that didn't need the valuation that were asking for one didn't want to pay for one in the first place.
0:40
SPEAKER_01: Welcome to Max Value, the show for business owners and their trusted advisors who are on a mission to maximize their value with business valuation strategy, exit planning, and maybe even the wisdom to orchestrate your own exit plan.
0:53
SPEAKER_01: I'm your host, Ben Town.
0:54
SPEAKER_01: The valuation community is pretty small, and there are a handful of people whose work you encounter as a practitioner even before you meet them.
1:01
SPEAKER_01: And they show up on your references list and your continuing education material, handouts, that kind of thing.
1:07
SPEAKER_01: And today's guest is one of those people for me.
1:10
SPEAKER_01: And on top of that, he's somebody I'm fortunate enough to call a friend and a mentor.
1:14
SPEAKER_01: Today we are joined by Ted Israel.
1:16
SPEAKER_01: He is the founding and retired partner of Israel Fry Group in San Rafael.
1:20
SPEAKER_01: He spent decades there performing business valuation in some of the most difficult arenas, estate and gift tax, mergers and acquisitions, and especially family law.
1:29
SPEAKER_01: Ted has the ABV and CFF credentials from the AI CPA and the CVA from NACVA.
1:35
SPEAKER_01: He served on the AI CPA Business Valuation Committee.
1:38
SPEAKER_01: And really, he's got a rap sheet, I mean, a resume as long as your arm.
1:42
SPEAKER_01: But at the end of the day, he's one of the most well-heeled professionals out there.
1:45
SPEAKER_01: He's been in court more times than uh most politicians, at least.
1:49
SPEAKER_01: So Ted, now that he's retired, is spending a lot of time on two wheels on his bicycle, and he's uh climbing real hills now, uh, instead of the uh metaphorical hills that he's spent climbing over the last 30 years.
2:03
SPEAKER_01: Without saying that uh any of his uh retirement has mellowed him.
2:08
SPEAKER_01: We're gonna hear some of his uh his strong opinions.
2:11
SPEAKER_01: Hey Ted, welcome.
2:12
SPEAKER_02: Thanks, man.
2:13
SPEAKER_02: You know, you rattled off all those great credentials.
2:15
SPEAKER_02: I have to put out there an honestly, I don't have any of those credentials anymore.
2:18
SPEAKER_02: I let them all lapse and go away.
2:20
SPEAKER_02: Okay.
2:21
SPEAKER_02: I didn't need to be paying those dues.
2:23
SPEAKER_02: So I'm I'm just a I'm just a regular old, you know, citizen now, regular old citizen taxpayer.
2:28
SPEAKER_01: Okay, well that that's cool.
2:29
SPEAKER_01: I'll edit it, edit that to say used to have, yeah, and put that in there.
2:33
unknown: Okay.
2:34
SPEAKER_02: I can't get rid of the opinions.
2:35
SPEAKER_02: I still got those opinions, but you know, I just I just I guess they don't mean as much anymore because I don't have the credentials.
2:41
SPEAKER_01: They're they're just not credentialed anymore.
2:42
SPEAKER_01: No credentialed opinions.
2:44
SPEAKER_01: Well, I guess that's the difference, right?
2:45
SPEAKER_01: Is whether you're getting paid for your opinions now compared to what compared to back then.
2:49
SPEAKER_02: Right, right.
2:50
SPEAKER_02: Anyway, that that was that was a wonderful introduction.
2:52
SPEAKER_02: I couldn't have written it better myself.
2:54
SPEAKER_01: Good because you didn't.
2:57
SPEAKER_01: So all right, Ted.
2:59
SPEAKER_01: How how do you wind up doing business evaluations for 30 years?
3:04
SPEAKER_01: How do you get into it?
3:05
SPEAKER_02: You know, short answer, it's just really, really interesting.
3:09
SPEAKER_02: I mean, I started out when I entered the profession in 76, that I was in the audit staff of a of a local firm, and um I did that for quite a while.
3:18
SPEAKER_02: I be I be I became the audit partner of that firm.
3:21
SPEAKER_02: And like business valuation litigation work, you get to snoop around a lot.
3:27
SPEAKER_02: You get to spend a lot of time learning to understand somebody else's business, uh, management styles, all kinds of things like that.
3:34
SPEAKER_02: I mean, it it it's it's fascinating from an economic standpoint.
3:37
SPEAKER_02: It's not very economically rewarding because it's it's a commodity service that you uh goes the low bidder, and um nobody really cares about it.
3:47
SPEAKER_02: I mean, no nobody gets an audit because they want to, it's because somebody's making them do it.
3:51
SPEAKER_02: Uh, somewhere around the late 70s, early 80s, accountants became aware that they could provide this other service valuation analysis.
4:00
SPEAKER_02: And it it so a lot of training courses started popping up, and a lot of people started um spreading the word about doing that.
4:05
SPEAKER_02: And I was in an association of firms, the same one that your old firm was in.
4:10
SPEAKER_02: And there were some pioneers in there, uh, James Allerding being one of them, who kind of brought us all on board and taught us about it in little uh bits and pieces.
4:19
SPEAKER_02: And I found it fascinating.
4:20
SPEAKER_02: I found the litigation arena fascinating and challenging, and because I'm just an argumentative SOB.
4:28
SPEAKER_02: And so I started getting into it little by little and took advantage of the credentials that were being offered by the AI CPA and NACVA and others, uh, and found the Cal CPA's forensic services section, which was called something else back in the day, and they had an evaluation section full of people that were really good at this stuff, that were pioneers and that were very generous with their time and knowledge and helped me uh bumble along into it and hopefully not make too many mistakes the hard way or have too many lessons that were the learned the hard way, you know, because they they they'd already done it.
4:59
SPEAKER_02: And um, they also helped me, you know, find uh business because attorneys don't want to just give you a case to work on if you're not tried and true.
5:08
SPEAKER_02: So they helped me develop that.
5:11
SPEAKER_02: So it's it's a very, at least when I was coming up, it was a very supportive and collegial group.
5:17
SPEAKER_02: I think you probably experienced a good bit of that yourself with your involvement at Cal CPA.
5:21
SPEAKER_02: And the work was just always fascinating.
5:24
SPEAKER_02: There were some technical challenges out there that were that were come up that I found interesting enough to research myself and publish on and investigate, which made it interesting for me.
5:36
SPEAKER_02: It didn't make me money doing it, but it it made me a little bit famous within the community, which was helpful.
5:42
SPEAKER_02: And uh, you know, that's that that's how it kind of worked out.
5:45
SPEAKER_02: And so it it started as something to kind of easy into to where I was just doing it full time and um just was was great.
5:52
SPEAKER_02: I'm just kind of a nosy person and like an argument, and uh and I like charging a higher rate than uh my colleagues at their at their traditional accounting firm.
6:02
SPEAKER_02: And so there you have it.
6:04
SPEAKER_01: Ted, first off, thank you.
6:06
SPEAKER_01: That was really good.
6:07
SPEAKER_01: Of course, we've been hanging out too too much, I think.
6:09
SPEAKER_01: You stole the joke basically.
6:11
SPEAKER_01: I was gonna do basically.
6:12
SPEAKER_01: You know, you love sticking your your nose into other people's businesses and arguing about it.
6:17
SPEAKER_01: Uh no, this is just based off of what you're saying.
6:20
SPEAKER_01: And then uh, well, and and truly though, I mean you you get into you know got into the uh real collegial groups where you got that self-actualization and you know got a little fame and a little fortune and you know, we're able to able to retire, you know.
6:34
SPEAKER_01: Bottom line.
6:34
SPEAKER_01: That's that's the uh that's the story.
6:36
SPEAKER_01: That's a that's a really great story.
6:37
SPEAKER_01: Brought up your kids and still with Lynn and all all good things.
6:40
SPEAKER_02: Yeah, and I didn't retire because I didn't like the work anymore and I or I couldn't do it.
6:47
SPEAKER_02: People were still trying to hire me.
6:48
SPEAKER_02: It's just that I got you know to a certain age where I thought, you know, I I gotta enjoy the rest of my life, I gotta do some other things.
6:53
SPEAKER_02: I have grandchildren now, I want to spend time with them, I want to travel with my wife and whatever.
6:57
SPEAKER_02: So it's been great.
6:58
SPEAKER_02: And I thought it'd be a harder thing to walk away from because of the involvement.
7:01
SPEAKER_02: And you know, you had a lot of ego stroking with it and this, that, and the other.
7:04
SPEAKER_02: But I I I honestly to tell you, I don't miss it at all.
7:08
SPEAKER_02: Retiring was easy.
7:10
SPEAKER_01: That's awesome.
7:11
SPEAKER_01: You know, let's let's go off on that a a little bit.
7:14
SPEAKER_01: I mean, the walk us through that in a little bit more detail.
7:19
SPEAKER_01: I mean, coming coming to you know, a slowdown, you know, intentional, because you did all of this very, very intentional.
7:25
SPEAKER_01: Some of it I had a kind of a front seat for, but you know especially your your mindset and your you know, what was it, was it a flip of the switch mentally?
7:35
SPEAKER_01: Was it just something that was percolating?
7:37
SPEAKER_01: Yeah, talk us through it.
7:38
SPEAKER_02: Well, you know, so my partner and I, you know, you know very well Diddy's Fry, we we broke off from the old uh traditional accounting firm in 2015 and started Israel Fry Group.
7:48
SPEAKER_02: And the notion was, and I was, you know, in my my mid-60s at that time, that uh somewhere around age 70, at age 70, I would slow down, maybe not completely withdraw from the firm, but but slow down and um assuming that she would be ready to take over the practice.
8:04
SPEAKER_02: And um, and then I'd maybe I'd work a little bit, that kind of thing, to make introductions and whatnot.
8:09
SPEAKER_02: And um, so that we were having a thriving, you know, as a small little two-person practice and everything.
8:14
SPEAKER_02: And then she unexpectedly and tragically passed away in 2020, as as you know.
8:19
SPEAKER_02: And that was a real shock to the system because we were very close friends, and something like that will make you sit step back and reevaluate your plans.
8:31
SPEAKER_02: It's it's like, you know, God you know laughs at your plans.
8:34
SPEAKER_02: So if you know, was your your partner is eight years younger than you, passes away unexpectedly.
8:39
SPEAKER_02: And the easiest thing was, okay, well, it was uh kind of trying because you left, you know, a lot of work that I had to finish.
8:44
SPEAKER_02: But then there went the succession plan, there went you know, your good friend who got cheated out of the rest of her life.
8:49
SPEAKER_02: And it makes you really re-evaluate what you're doing in life.
8:53
SPEAKER_02: And you better take the time to stop and sniff the flowers and enjoy something.
8:58
SPEAKER_02: And if you're all financially able to retire, you know, do it.
9:01
SPEAKER_02: I know guys that I competed with and litigated against for the last 25 or 30 years who are a couple of years older than me, even, and they're still working.
9:12
SPEAKER_02: And I don't understand it.
9:14
SPEAKER_02: I don't know whether they don't have a rewarding life outside their practice or or what.
9:18
SPEAKER_02: But people always ask me, hey, what's retirement like?
9:20
SPEAKER_02: It's it's great.
9:22
SPEAKER_02: You know, I before I retired, I was riding, I was cycling a little bit.
9:27
SPEAKER_02: I mean, a lot, yeah, a good bit.
9:29
SPEAKER_02: You know, I was doing some hundred-mile rides and stuff.
9:31
SPEAKER_02: And I was riding one day a week with a club, and there were people in that club that were riding three days a week, you know, Monday, Wednesday, Friday.
9:36
SPEAKER_02: I thought, you know, I retired, that's what I want to do.
9:38
SPEAKER_02: And that's pretty much what I've done.
9:39
SPEAKER_02: I've been most weeks I'm able to do it three days a week.
9:41
SPEAKER_02: And they're my social network and everything, and they were right there, ready to go, you know, for me to just step into so I'd never be bored or, you know, uh socially, you know, without friends, that kind of thing.
9:55
SPEAKER_02: And uh it made retirement a little easier.
9:57
SPEAKER_02: Just clip in and ride.
9:58
SPEAKER_02: Yeah.
9:58
SPEAKER_02: Yeah.
9:59
SPEAKER_02: And you know, COVID was kind of a preview too, you know.
10:02
SPEAKER_02: The first six months of COVID when we were all working from home, you know, I was sitting here in front of this computer screen doing my work and maybe going to the office like one day a week to do a few things.
10:13
SPEAKER_02: And um, I I realized, hey, this is what retirement's gonna be like.
10:16
SPEAKER_02: I'm I'm home.
10:17
SPEAKER_02: I'm not in my wife's way, she's not in my way.
10:20
SPEAKER_02: She's got all her stuff that she's into and doing and involved in.
10:23
SPEAKER_02: And, you know, we we barely saw each other any more than we did, you know, when I was working full-time.
10:28
SPEAKER_02: So uh I thought, well, this is not bad.
10:29
SPEAKER_02: You know, we're not tripping over each other.
10:31
SPEAKER_02: We're, you know, occasionally we have lunch together, that kind of thing.
10:34
SPEAKER_02: And uh, you know, it was just kind of a a promising um preview of what retirement could be like.
10:39
SPEAKER_01: That's uh I aside from uh certain of the tragic aspects, the rest of that actually is kind of very positive.
10:47
SPEAKER_01: I mean, the rest of it, you know, your your specific uh it was intentional on it.
10:53
SPEAKER_01: Yeah, it was very intentional.
10:54
SPEAKER_01: And I love that.
10:55
SPEAKER_01: And you didn't sell the firm.
10:56
SPEAKER_01: That's that's not really something that that happens very much with uh with our types of practices anyway.
11:02
SPEAKER_01: But well, certainly not one.
11:04
SPEAKER_02: There's only one person left, right?
11:06
SPEAKER_01: Yeah, in in particular, but but I think I think being able to wind up very intentionally is not something that people do often.
11:12
SPEAKER_01: I mean, half the time it is, you know, in in professional services, somebody has a you know, somebody has a heart attack, some medical emergency, and they suddenly can't continue, you know, running their own practice, uh their single person practice or whatnot.
11:25
SPEAKER_01: And nobody's benefited by that.
11:27
SPEAKER_01: Um, and certainly not them.
11:29
SPEAKER_01: Thanks for sharing that.
11:30
SPEAKER_01: Let let's bring it all the way back to business valuations specifically.
11:34
SPEAKER_01: You know, I I'm somebody who makes a living doing business valuations and kind of the the the other things around it, including exit planning.
11:42
SPEAKER_01: But you know, when when we've talked, one of the things that you you constantly have have mentioned, and I've really adopted this perspective as well, is this counterintuitive idea that a lot of times you just don't need a business valuation and suggest something that's not that.
11:57
SPEAKER_01: So when a client calls me up call and used to call you up um as a prospective client, you know, really often we'll say that the right answer is, you know, you don't actually need one.
12:06
SPEAKER_01: And that's that's weird because it sounds like you know, the you know, the dentist telling you, nah, you don't really actually need that root canal.
12:12
SPEAKER_01: But maybe you can tell everybody what you've always told me about, you know, why a formal report, you know, business valuation is is not the answer and when it might not be.
12:22
SPEAKER_02: Right.
12:22
SPEAKER_02: Well, I mean, I wasn't completely altruistic in offering an alternative service.
12:27
SPEAKER_02: It's that most of the people that didn't need the valuation that were asking for one didn't want to pay for one in the first place.
12:34
SPEAKER_02: Okay.
12:35
SPEAKER_02: Because as you know, it's it can be very, you know, time intensive and um the fees get up there.
12:40
SPEAKER_02: And the only venue you find that isn't quite as fee sensitive is when you're actually litigating.
12:45
SPEAKER_02: Because those that you know, you're not in control of the time that's get burned up on that thing.
12:49
SPEAKER_02: It's it's it's it's up to the parties, you know, to to to determine what the duration of a litigation is going to be.
12:55
SPEAKER_02: And then, you know, in the skate and state and gift arena, there's very there's requirements, a lot of checks uh boxes you got to check to to comply with uh all those standards.
13:04
SPEAKER_02: So the average person who's thinking about retiring or they've got an opportunity to sell their business or they're evaluating an opportunity to purchase a business, they say, well, I need to have it value.
13:12
SPEAKER_02: Well, you you don't.
13:14
SPEAKER_02: And the reason that's a that question even comes up is because the standards that have to be complied with to use the term valuation.
13:22
SPEAKER_02: If you're a CPA or other valuation professional, those words don't get thrown around.
13:27
SPEAKER_02: Okay.
13:27
SPEAKER_02: There's very specific things that need to be done that are time consuming and expensive.
13:32
SPEAKER_02: And if you can find a way to get away from that word valuation, then um you can do something more economical.
13:38
SPEAKER_02: So I came up with something called a sensitivity analysis a few years back.
13:42
SPEAKER_02: And I think I'm not, I'm not the only one that uses.
13:44
SPEAKER_02: I don't know whether people are copying me or whether they got it, you know, somewhere else or whatever.
13:47
SPEAKER_01: Basically it's copying you.
13:49
SPEAKER_01: That's that's what we'll say.
13:50
SPEAKER_02: Potentially, yeah, because the people that are doing it all sat through a session I did on it.
13:54
SPEAKER_02: But we say, okay, I'm not gonna do engagement lawyers, we're not gonna do evaluation.
13:58
SPEAKER_02: We're gonna help you evaluate a business opportunity, we're gonna help you make an offer.
14:03
SPEAKER_02: We're gonna help you evaluate an offer, which means you're gonna be in receipt of some kind of deal terms or whatever, and help the buyer or owner evaluate them, look at them and and and and counsel them through something.
14:19
SPEAKER_02: And you know, you do that and you're just kind of there charging your hourly rate to sit with them and work through some things.
14:26
SPEAKER_02: And it may get to the point of becoming a calculation, which is a you know a technical thing under the valuation standards that's less in scope than evaluation, but basically, I've got to stop using the term basically, it is the client determines the assumptions and parameters of the inputs to calculating the value.
14:45
SPEAKER_02: So they'll say, okay, well, I assume that the income stream is going to continue this way in perpetuity or for the next three years.
14:53
SPEAKER_02: I can use a three multiple or five multiple.
14:55
SPEAKER_02: They're not gonna come up with that on their own.
14:57
SPEAKER_02: They're gonna have to have a little bit of help with it.
14:58
SPEAKER_02: Then you can help them have a have a range of value.
15:00
SPEAKER_02: So that's as far as it gets as maybe having a calculation, but uh shy of that, you're just kind of working with them to say, well, this is a good offer or bad offer, and maybe this should be the counter-offer without really valuing anything.
15:13
SPEAKER_02: I mean, you can say, well, they're asking for you know$500,000 for this business.
15:17
SPEAKER_02: Yeah, it seems kind of reasonable, but offer them four.
15:19
SPEAKER_02: Now, have you done a valuation that indicates it's$400,000?
15:21
SPEAKER_02: No, but just strategically you're you're you're helping them.
15:24
SPEAKER_02: And so that really frees you up to do some good consulting for a client without charging for something they don't need.
15:31
SPEAKER_02: They don't need that 50-page valuation report that they don't understand anyway, that they paid a lot of money to you for.
15:38
SPEAKER_02: They just need a little bit of help.
15:40
SPEAKER_01: Well, and so so often you'll see that a like a valuation provider will say, Great, I have a hammer here, you know, where's the nail?
15:49
SPEAKER_01: And more, even worse than that, and more than that, it'll be all right, now that I've pounded your the nail in, pounded the nail in, I'm gone because I've done the work.
15:58
SPEAKER_01: You you asked me to do the thing.
16:00
SPEAKER_01: I that's a defined thing.
16:01
SPEAKER_01: I've now done the thing, and that's it.
16:03
SPEAKER_01: So that a lot of times that looks like somebody, you know, that that expert handing over their report, and you know, you you can call them, but they're not all that interested anymore.
16:11
SPEAKER_01: They're off to the next project.
16:13
SPEAKER_01: When you turn it into a consulting engagement, as as you're talking about, it's let's not worry about all of the other extraneous things that don't matter.
16:20
SPEAKER_01: Let's make sure we're focusing on ex answering exactly the questions that the client's asking and and posing the right questions that we know that they should be asking, uh, in order to get to the intermediate phases too.
16:31
SPEAKER_01: Because I mean that's that's another part part of that where a a a deal isn't isn't one point in time.
16:36
SPEAKER_01: You know, it's not a when you sign your name on the on the dotted line, it's it's the months or years ahead of that where you're getting to that point.
16:45
SPEAKER_01: And as like you were saying, if you're evaluating something, maybe you need to just have a really high-level, you know, I I call it a go or no go no go indicator.
16:55
SPEAKER_01: You know, we do our version of this is called a business diagnostic.
16:59
SPEAKER_01: It is but essentially it's that that same kind of idea.
17:02
SPEAKER_01: Let's get you the research and understanding enough where you can make a really high-level decision.
17:07
SPEAKER_01: You're not, you know, you're not signing your life away yet, but should we even be in this discussion?
17:12
SPEAKER_01: Are we even close enough?
17:13
SPEAKER_01: Is there something that makes sense here, or does it not make sense and we should just stop wasting time?
17:18
SPEAKER_01: That's way easier than getting to the the appropriate, the right level of of diligence needed for a bigger result.
17:26
SPEAKER_02: Sure.
17:26
SPEAKER_02: And you can always, you know, it can always become a calculation engagement or evaluation engagement, but the client's going to decide that, you know, and and you can do these things and be in compliance with the standards.
17:36
SPEAKER_02: I did an article on this, oh, I can't remember who it was for years ago.
17:40
SPEAKER_02: And then the AI CPA used to have a little uh valuation insight publication that they did, you know, years ago.
17:45
SPEAKER_02: I think Joe Emanuele was the one that was the editor for it.
17:48
SPEAKER_02: And so I said, Hey, here's an article, you know, you guys might want to run and run it by your technical people.
17:53
SPEAKER_02: And this the AI CPA published this thing, so they vetted it.
17:57
SPEAKER_02: So if they had a problem with it, they sure didn't say anything about it.
18:00
SPEAKER_02: And I was kind of shocked they didn't push back a little bit about it.
18:02
SPEAKER_02: And they were like, No, you haven't broken any rules.
18:04
SPEAKER_02: This is fine.
18:05
SPEAKER_02: This is, you know, you didn't use the word valuation, so it's fine.
18:08
SPEAKER_01: You well, and you helped write those standards, right?
18:10
SPEAKER_02: Uh so I well, I vetted them.
18:14
SPEAKER_02: I vetted them.
18:15
SPEAKER_02: Actually, I know all the people that were on the committee, the the valuations, uh, the business valuation um committee at the AI CPA.
18:22
SPEAKER_02: The guys that wrote it was actually um Hitchner, Alarding, oh, uh Ed Dubke, and uh I think Mike Tarbell and maybe one other person, they they wrote them and then the committee reviewed it and sent them out.
18:35
SPEAKER_02: What I did was I was on Cal CPA's litigation services steering committee, and I was on a uh a task force that evaluated the standards, the the the exposure draft to form Cal CPA's response to it.
18:49
SPEAKER_02: And you know, our response to it was the second draft, the first exposure draft came out was had some problems.
18:55
SPEAKER_02: The the second exposure draft, you know, our take on it was it was fine, go ahead and do it.
19:01
SPEAKER_02: The only thing that we recommended, and that was my bug, was the questions and answers, the the frequently asked questions.
19:09
SPEAKER_02: There's like a hundred of them at the back of the standard, were supposed to sunset after some number of years.
19:14
SPEAKER_02: And I said, no, those are very powerful and illustrative, those have to stay.
19:19
SPEAKER_02: And they said, okay, and they kept them in, and they're still in there.
19:22
SPEAKER_02: And then uh there was a uh small task force within the litigation services section, Cindy Craig headed up to write a checklist for complying with the standards, and Denise Fry was on that committee, and I was a reviewer of that checklist.
19:36
SPEAKER_02: So that was the extent of that, my involvement.
19:38
SPEAKER_02: I think I think it maybe seven years later, but that was about it.
19:41
SPEAKER_01: But you know these standards much better than than most, I'll I'll say.
19:44
SPEAKER_01: I mean, I think that's that's I do know them.
19:47
SPEAKER_01: Yeah, pretty, pretty clear.
19:48
SPEAKER_01: Okay, so m moving on to you know, in real life, a business owner or somebody who wants a business valued usually has a bias, right?
19:59
SPEAKER_01: Because of course they do.
20:00
SPEAKER_01: We're we're designed to be, you know, independent and unbiased, or at least that's our set position.
20:05
SPEAKER_01: But if you're a business owner, of course you, you know, I want to sell it, I want the value to be higher.
20:09
SPEAKER_01: This, this, that, or the other thing.
20:10
SPEAKER_01: So when going into discussions for a deal, what are some of the things that you've seen that maybe a seller, a business owner looking to sell, what are some things that hold them back from getting good value or maximum value from their business?
20:25
SPEAKER_02: Well, you know, with the exception of say they've got a great product and they're profitable and they, you know, know how to build the best widget and all that stuff.
20:35
SPEAKER_02: They frequently, um, if if it's just them and a family, they don't run it like a business or manage it like a business, like say a publicly traded company would be, or just a large private company.
20:45
SPEAKER_02: And so they tend to treat it as their own piggy bank.
20:48
SPEAKER_02: There's perks running through there that don't belong there.
20:51
SPEAKER_02: They're their helter skelter with the with the with the bookkeeping and whatnot, because they have, you know, they they have it, they they do it by the seat of their pants without having, you know, great accounting or anything like that.
21:01
SPEAKER_02: So I think you probably do the same thing that I would do is they come and they're talking about selling it.
21:05
SPEAKER_02: And usually you you'll tell them, this is pretty typical.
21:08
SPEAKER_02: Not now, maybe in three years, if you're if you're if you do what I tell you to do.
21:14
SPEAKER_02: And that is clean up your practices, get the non-business perks out of there, clean up the loans and advances and all of that, and get away from the shabby bookkeeping, get a good accounting firm and get three years of reviewed minimum financial statements, maybe not audits, but get minimum reviewed financial statements so that a buyer can really know what they're looking at, can really evaluate what it is they're purchasing from a fiscal standpoint, and not a bunch of owner representations like, well, you know, we really get a lot of cash sales and that aren't in here.
21:50
SPEAKER_02: I mean, you can count on those.
21:51
SPEAKER_02: Well, you know what?
21:51
SPEAKER_02: I'm not paying you for your cash sales.
21:53
SPEAKER_02: Forget that.
21:53
SPEAKER_02: And by the way, I don't need to have problems with the fran the with the Board of Equalization because you're understating your sales and all.
22:00
SPEAKER_02: these other kinds of things.
22:01
SPEAKER_02: Those those would be the recommendations that that that I would make.
22:04
SPEAKER_02: Clean up the perks, the you know, for lack of a better term, and um clean up the accounting records and get good reliable stuff to cut down on what we call information risk.
22:14
SPEAKER_01: There you go.
22:15
SPEAKER_01: And I think you know all all of what you're talking about is the underlying mechanics of the business might be working fine.
22:23
SPEAKER_01: But if you're not able to translate that to the a buyer in this case or multiple potential buyers in a way that they trust and that they can really rely upon that's injecting risk on top of or you know pulling value away from your otherwise perfectly valuable business.
22:42
SPEAKER_01: I mean I'm gonna assume it's a perfectly valuable business just for you know for this story.
22:46
SPEAKER_01: But but essentially you know you you you hit the nail right on the head the the uh here I go with the hammer talk.
22:51
SPEAKER_01: Reducing risk is huge.
22:54
SPEAKER_01: And you know the things that you were talking about do that reduces the information risk reduces the the risk that they'll find some the buyer will find something in diligence due diligence that they they are surprised about and in a negative way.
23:08
SPEAKER_01: Like a water cutter like a water cutter say that again what do you mean?
23:12
SPEAKER_02: Oh there's a there's a great anecdote out there by one of my colleagues that they were doing an evaluation of a of a business for an acquisition or something and there was something on the fixed asset schedule called a water cutter and they looked in a little bit further and it was it was a 34 foot water cutter.
23:28
SPEAKER_02: It was a 34 foot water cut cutter with you know a V8.
23:31
SPEAKER_02: It was it was a boat.
23:32
SPEAKER_02: Okay so get the water cutter out of there.
23:34
SPEAKER_01: Gotcha yeah okay there we go I love that let's pause here for station identification hey anybody remember that from the days when we were still listening to the radio in this episode Ted and I have been discussing the real life connection between the esoteric idea of quote unquote business value and price in a transaction how does the person across the negotiating table view risks from their point of view when do you even need evaluation and when do you need to be thinking about any of this stuff anyway and Max Value podcasts exists to explore these topics just as no business is the same no sale and no exit are the same either guess what on top of that no business owners or their goals are the same as any other in order to balance this three body problem my firm created the exit builder program.
24:21
SPEAKER_01: We recognize that the journey through the technical and practical desert of creating a business exit that you're actually satisfied with is one that you largely have to build yourself.
24:31
SPEAKER_01: And a lot of owners are hesitant to ever take that first step into the desert how much easier would it be to take that step with the exit builder team as compass and map it's still a journey don't go in blind.
24:44
SPEAKER_01: If you want to check out what this looks like for you start at townadvisory.com or reach out to me directly.
24:48
SPEAKER_01: No assumptions on what you're building towards it just a conversation.
24:52
SPEAKER_01: Alrighty now back to Ted When we do this I like to have a little segment called value vitamins and basically here I just want a prescription for something that'll move the needle in you know in in a particular situation.
25:08
SPEAKER_01: So you know you you've already talked about you know a couple of things that you would generally advise a a business owner things like a review etc.
25:16
SPEAKER_01: Would you do anything different if that was that same company that you were advising was small or you know professional service professional services compared to a larger larger business or do you recommend every business get a review reviewed financial statement?
25:30
SPEAKER_02: Well it might be cost prohibitive for some businesses.
25:33
SPEAKER_02: I would still recommend that they they use good hygiene in their record keeping and accounting though.
25:38
SPEAKER_02: In other words if all they're doing is say a corporate tax return or a partnership tax return or even you know just Schedule C, they have things classified as accurately as they can and that everything is being complete as it can and do the same things of like not having personal stuff in there, but be able to hand over a set of tax returns that could be used as a financial statement and make sure that everything's very consistent from year to year.
26:02
SPEAKER_02: I mean I'm sure you've seen corporate tax returns when you go through that category called other, which is sometimes 75% of the non-cost of sales expenses, it changes every year what's in there?
26:14
SPEAKER_02: Wait a minute postage was in here last year and now it's over here and they were how come compensation you know employee compensation went up so much but cost of sales went down well last year they had their direct cost up the cost of sales and now they're down there.
26:28
SPEAKER_02: They're just not consistent in how they do it.
26:29
SPEAKER_02: Well there goes your information risk out the window and creates work for some analysts to try and sort all that stuff out because that stuff you know it matters it really matters when you're trying to assess the risk.
26:39
SPEAKER_01: Well and when when your risk to bring it right back to you know the value equation when your risk is higher or the perceived risk the buyer is thinking the risk is higher for them then your value goes down and so the price you're going to get out of your business goes down.
26:53
SPEAKER_01: And I think one of the one of the really important things that you know for all the examples that that you've you've had last few minutes here has been a common thread is that it's not about growing top line.
27:02
SPEAKER_01: So it's not like hey you need to grow your business in the next three years so it's more more valuable more marketable.
27:08
SPEAKER_01: Maybe right that's that that's that's a good fine thing to do.
27:13
SPEAKER_01: But the part that you focused on is is the risk.
27:17
SPEAKER_01: Hey what can we do right now with with what we've got right now to maximize the value out of what we've got right now we don't even have to change the actual we don't have to change the pie.
27:27
SPEAKER_01: You know we have to we don't have to grow it we just have to make sure that we're going to get the most out of it as possible.
27:31
SPEAKER_01: You know what do we have already in terms of information?
27:34
SPEAKER_01: How do we make it more credible and documentable and transferable because I mean really a buyer isn't isn't really buying just you know this this concept called a business they're actually buying the future ability to get cash flow out of this collection of business assets that you've got uh hopefully the collection of business assets includes you know SOPs and good accounting and yada yada yada.
27:56
SPEAKER_02: Right right you know and then one of the things that comes up when we're looking at from the buyer side of things is sometimes you have to ask the buyer when they're looking at this business, hey, is there even really a business here?
28:08
SPEAKER_02: Because it it might be so small, you know, it's a sole proprietor or something like that.
28:13
SPEAKER_02: And if you and the sole proprietor is not getting a salary under the tax code they're not getting paid a salary.
28:18
SPEAKER_02: So you're looking at all this wonderful profit and you're going, hey, wait a minute, what is the fair market value of this operator's services?
28:26
SPEAKER_02: This is the person who is the head marketer the head contact the head widget maker this, that, and the other.
28:31
SPEAKER_02: And they may have some staff and stuff but if we tag in there a number that's represents fair compensation to them all the value goes away.
28:38
SPEAKER_02: And this is something that used to come up in family law all the time.
28:40
SPEAKER_02: They'd be saying well you know one spouse has a business and you got to value it and you look at it and go hey wait a minute no they have a job they're self-employed is what they are there's there's there's no uh measurable goodwill here at all they got to pick up truck and and you know and with a with a with a dog in the back and some tools and that's about it.
28:58
SPEAKER_01: Well and kind of a kind of the opposite edge of that sword same same thing though is you know when you when you look at at these people who own a business quote unquote but it's really a sole proprietorship and they're you know they're most of it you know the when you when you look at okay well how hard are they working?
29:14
SPEAKER_01: What are they what are the things that they're doing in order to make this business work once you start you know adding in all those hours and you know divide dividing those hours into the uh into the profit you know that's where you start seeing oh gosh yeah that really looks like that's uh about$12 an hour in terms of their their actual job and you know what there's some things I probably would do for$12 an hour uh and and still love it but uh not most things honestly thank you for that the uh well you know moving on to diving a little bit deeper into risk actually um so the the cool thing about you know all the things that we're talking about as a through line here you know the messy books the owner dependency etc they they hurt value in a negotiation or sometimes just kill a deal because it's there's just not enough that is transferable.
29:59
SPEAKER_01: But you know kind of in you know backing up to I'll say even a more formal or more academic or however the hell you want to say it valuation obviously these factors are accounted for you know these same risk factors and the way the way we see it excuse me the way we say it is you know company specific risk premium basically more risks that we're adding on to identify that these are there's some bad outcomes that could happen because these risks are present.
30:28
SPEAKER_01: And again the higher the risk of the whole company the lower the value of the whole company.
30:32
SPEAKER_01: That's kind of one of the things that I know you've really honed in on you know in in your career it it's it's the hardest part it takes the most correct judgment um and is probably the least how how to say it um the the the least quantifiably referencible I mean there's the the least amount of data I think that could get you to the answer.
30:52
SPEAKER_01: There this is where you know the answer doesn't exist as so much as there's a the answer range is reasonable.
30:58
SPEAKER_01: So when we're talking about small companies in particular and small is can still be very big.
31:04
SPEAKER_01: I mean that could be a hundred million in revenue or or more but when we're talking about a a normal everyday business you know we think about things like size and we think about things like what's specific to that company, company specific risk and what are some things that you know belong in each bucket.
31:21
SPEAKER_02: So not to uh bore everybody too much but I mean what you what you're talking about is the and company specific risk is that kind of little increment of risk we tack on in our capital asset pricing model to where we've already you know we've got our risk free rate and our equity risk premium to get us to a supposed proxy for a rate of return for a company in that industry that we get from public markets.
31:43
SPEAKER_02: But you know what we're looking at is like wait a minute this is not a publicly traded company it's considerably smaller.
31:48
SPEAKER_02: It doesn't have the level of management and competency and access to markets and yada yada yada.
31:54
SPEAKER_02: So there's things that get tacked on there to try and bridge the gap between this model from the public markets to down to a private company which is uh as Demoter says a recipe for disaster you know he likes to throw those kind of clips out there and it kind of is you know I mean we're we're we're trying to we're trying to to to take this thing that was never designed for the valuation of a of a private company in fact another demoter and quip he said to me one day he goes Ted the people that came up with this model didn't even acknowledge the existence of a private company it wasn't even in their orbit.
32:28
SPEAKER_02: So that you know and he's and he's right about that.
32:30
SPEAKER_02: So one of the pieces that's in there is the size premium portfolios depending on what service you're using.
32:37
SPEAKER_02: And then from there you still don't have something that's as tiny and ill managed as as a private company.
32:44
SPEAKER_02: So then that's where we get into having to and I'm retired now so I can use this term we make up a risk premium.
32:52
SPEAKER_02: Okay we create it from whole cloth somehow with a lot of analysis and you know I know you at some point you want to talk about some embarrassing courtroom moment that I've had way back in the day 25 years ago I tend to be very candid and take this work seriously but be very candid.
33:08
SPEAKER_02: And the judge says how do you get that and I said well that's where the real voodoo comes in I said that in court.
33:14
SPEAKER_02: What a schmuck.
33:15
SPEAKER_02: The next three days Israel says this whole process is voodoo and you know I was just being too candid and I said I should have just used the word well it's very subjective Your Honor okay and so that's one of those things if I do then what I knew now.
33:29
SPEAKER_02: I was using the term that I would use in a college class as a presenter rather than what I should have been using in court.
33:34
SPEAKER_02: So there's all these quirky ways that have come about where people have look at the properties and behaviors and attributes of a small private company compared to a large public trading company and then they try to move the needle based upon some kind of subjective point awarding system, you know, like oh uh lack of you know deep management three points you know lack of market access two points you know it's just and there's nothing that links any of yet.
34:06
SPEAKER_02: But you know I I looked at the huge increments to the cost of capital that were coming through in the size premium.
34:14
SPEAKER_02: You know if you look at the difference between the big publicly traded companies and the companies down in the 10th decile of the crisp data or get down into like you know 10 Z, that kind of stuff those those the companies are are are tiny and the risk premiums are huge.
34:28
SPEAKER_02: And Shannon Pratt said years ago an article he says some of that company specific risk is probably buried in there.
34:34
SPEAKER_02: Okay.
34:35
SPEAKER_02: And if you're putting on a premium from 10 Z, you probably you could be double counting.
34:40
SPEAKER_02: He just said that.
34:41
SPEAKER_02: But he didn't do any further analysis on it.
34:43
SPEAKER_02: But it got me thinking about it and I started looking at those companies and I started conversations with um James Harrington who was a time was with he was with Ibotson writing the books for them and then later with Morningstar when they acquired it and then later with Duffin Phelps and then later on with Kroll he's every acquisition has occurred in roll-up he's gone along with them and and you know and I also his his his uh uh boss there Roger Grabowski who became acquainted with him we started these you know conversations and Grabowski told Harrington he said tell Ted to look at the other information about what's in those portfolios in the Duffin Phelps or we'll call Kroll did it now because they don't just give it by size they give portfolios by variability of income and all kinds of things like that.
35:34
SPEAKER_02: Because what I was looking for I said you know what we're really trying to capture is we've got a projection of what the income's going to be.
35:39
SPEAKER_02: We assume it's gonna go on at a certain growth rate or something.
35:42
SPEAKER_02: The risk we're really trying to prevent or or trying to assess is what's the risk that we think the income's going to be up here or up here and it's really down here or way up here.
35:52
SPEAKER_01: We don't know.
35:53
SPEAKER_01: The risk that the estimate is wrong.
35:55
SPEAKER_01: Right correct well in a negative way actually I mean to nobody cares if the estimate goes way high you know if actual goes way higher than our estimate but not but the other way.
36:03
SPEAKER_02: Yeah and my my punk way of looking at it is that in the capital asset pricing model, you know, you're looking at this thing called beta which is a measure of volatility of how much your stock varies in price to the market compared to the whole market.
36:16
SPEAKER_02: And what I said is what we really want to capture is some kind of estimate of the volatility of the earnings themselves.
36:22
SPEAKER_02: Is there some way of you know capturing that risk?
36:24
SPEAKER_02: And that's when Grobowski and Harrington said, hey, look at the risk portfolios where we're we're evaluating the covariance of the income over time and see what it does to the risk premium.
36:36
SPEAKER_02: And sure enough I mean it shouldn't be a shock at all that if a company has a very high volatility of earnings its cost of capital goes up.
36:43
SPEAKER_02: And guess which companies have a concentration of high volatility of earnings the small ones.
36:48
SPEAKER_02: So you are capturing something right there.
36:51
SPEAKER_02: The other thing is some of these tiny companies aren't any better managed than your private company.
36:56
SPEAKER_02: Okay they may have a bunch of roses like like Grobowski says they're not risky because they're small they're small because they're risky and so I devoted a little bit of study to that and did a paper on it in 2011 called a risky business.
37:09
SPEAKER_02: It was in was in you know BV update was a popular article I got to speak at a bot at different conferences because of that and just said look here's what's being captured in here already.
37:17
SPEAKER_02: So you're if you start tacking on a bunch of extra risk premium to try and capture this, you're going to be overstating your cost of capital and you're going to be understating the value.
37:27
SPEAKER_02: So maybe you know back off a little bit.
37:29
SPEAKER_02: That was it.
37:29
SPEAKER_02: And then every evaluation I did after that did a real analysis of trying to figure out where they fit you know in relation to the volatility of earnings um you know in the in the what what is now the the the croll data.
37:40
SPEAKER_02: And then the next argument that comes along is well yeah but you know that size premium doesn't really exist.
37:46
SPEAKER_02: That's something that's out there.
37:47
SPEAKER_02: Which goes all the way basically the other way in a minute and I can debunk that a little bit but I want to bring it back to see if there's anything else you want to say about you know my approach to uh company specific risk.
37:58
SPEAKER_01: No no and we're we're we're very we're very aligned on it.
38:01
SPEAKER_01: I mean as you would expect I mean from you know collaborating for for years.
38:06
SPEAKER_01: But the to kind of bring it to the to the high level for you know for a business owner who who is just waking up from their nap on this if you see a valuation that has a risk rate that you think maybe too high it's probably because they're the the analyst is adding a whole bunch of percentage risk through the company specific risk and maybe also adding a whole bunch through kind of the size adjuster the size premium that that we add on.
38:34
SPEAKER_01: And again when we're saying that the cost of capital is 30% or whatever we say it is that's saying that every single year you should be getting 30% on your investment as a return.
38:45
SPEAKER_01: And that's to justify the price.
38:48
SPEAKER_01: To justify the price right yeah so that's not even necessarily wrong.
38:53
SPEAKER_01: That's just what it's saying.
38:54
SPEAKER_01: And so be aware of what it's saying because you know you you as the business owner have a bias we don't but you know uh or at least I don't if you're a litigation maybe maybe there's a little bit of a different read on it but to that point definitely we should be looking at um you know what are the levers that that make a huge difference in evaluation and this is one of those kind of not easy to pick out places where where value really gets created or destroyed or uh or at least um at least the appearance of created or destroyed.
39:26
SPEAKER_01: Oh and believe me the triers of fact out there are very suspicious of you know doing stuff and so in some of the public published cases you know with the state gift cases and in and the Delaware chancery court um um chancellor strein said I I think I'm quoting this right he says this is just a way that these valuation analysts are smuggling a bias into their estimate of the cost of capital and that's pretty harsh right so especially when our standard to to to meet our to be the real professionals we're supposed to be we're supposed to be unbiased and in independent and if we're getting accused of you know sneakily putting bias and not even just putting it in but putting it in by secret that's that's a bad thing.
40:07
SPEAKER_02: We would never be accused of that however you know people people can be and probably should be yeah um but you were you were gonna talk uh a little bit about the um you know kind of almost the opposite perspective uh you know some there there's a lot of divergence of opinion out there well about everything in in business valuation but on on this particular topic talking about the well there's not really a size there's not an increase in risk because you know due to size itself uh so no size premium how what do you what do you say to that well so the guy that originally started compiling that data Roger Ibotson is gone on other things now said that you know if I'd wrote those books now I wouldn't have called it a size premium I would have called it something else because they've they've looked at some of what the cause is and and it's not just it's not just uh risk of volatility of earnings and this that and the other that's that's baked into that there's also liquidity baked into it too okay those companies those small companies trade at a much lower turnover in the stock market than their larger peers and Ashok Abbott is a professor of finance at University of Virginia I think it is he's done a couple of papers on that where he's where he's quantified it and and show that these small companies have lower turnover and it takes longer for their stocks to to to trade out there in in the market.
41:28
SPEAKER_02: So when you're looking at that size premium and tacking it on you're also tacking on you know some some discount for lack of liquidity so which means when you get around it like you've if you're trying to look at a uh marketability or liquidity discount on a company be careful because you've already got some of that in there if you're using that size premium.
41:45
SPEAKER_02: Now the whether or not it exists it certainly existed in the data up through the early 80s and after that it tends to kind of go away and come back as Harrington says it it kind of waxes and wanes.
42:02
SPEAKER_02: It's it's it's not quite as consistent.
42:05
SPEAKER_02: So to say that well it doesn't really exist anymore is a little problematic because if you're using the data from 1926 to the present which is what you're doing when you're using the CRISP data it's in there.
42:21
SPEAKER_02: It's in there.
42:22
SPEAKER_02: So you know then fine then use your equity risk premium that's only you know computed in the like the the last five years.
42:29
SPEAKER_02: But it does come back and so even one of the um uh naysayers of the size premium like uh Dr.
42:36
SPEAKER_02: De Motoran he'll he'll in public you know uh venues say oh it's a bunch of junk and you know this that and the other and don't worry about it but in his own paper that he does every year on the it's SSRM which I think Society for Scientific Research Network which is a subscription thing going and get these amazing yeah amazing papers he publishes every year a paper on the equity was premium and he's got a section in there on the size premium where he looks at it and he and he says unquote he goes it is robust and persistent I think it's necessarily due to the size.
43:09
SPEAKER_02: And I agree with that.
43:10
SPEAKER_02: So just call it something else.
43:12
SPEAKER_02: It it's not a size premium it's a risk of lack of liquidity and squirrely earnings whatever you want to call it that happens to be associated with smaller companies.
43:24
SPEAKER_02: One way to clean it up a little bit is I prefer and I can say it here because I'm not going to get any trouble because I've I've I've I've spoken well of the crisp data I've spoken well of business valuation resources cost to capital model which Mike Crane puts together for them I think they're they're they're great models and also the um the crawl data I like the portfolios and the crawl data better because they scrub out the real junk.
43:51
SPEAKER_02: Okay if you look at what's in portfolio 10Z and even some of the other slightly bigger portfolios that that that's in the crisp data there's companies That haven't had earnings in the last five years.
44:02
SPEAKER_02: There's companies that don't even have sales.
44:04
SPEAKER_02: They just happen to be publicly traded.
44:06
SPEAKER_02: They're garbage companies.
44:08
SPEAKER_02: Duffin Phelps, what are you going to call them?
44:10
SPEAKER_02: Kroll, they scrub that stuff out.
44:12
SPEAKER_02: They get rid of it.
44:13
SPEAKER_02: And the companies in Portfolio 25, which are actually a little bigger than Dessile 10, that stuff's not in there.
44:20
SPEAKER_02: So what you're really looking at is a company that's got a history of earnings consistently, and you're able to get a little bit better data.
44:28
SPEAKER_02: Some people will say, smart people, that I don't want somebody curating that that data for me.
44:32
SPEAKER_02: I want to uh just have it the way it is.
44:34
SPEAKER_02: Well, that's fine.
44:35
SPEAKER_02: That's you.
44:36
SPEAKER_02: I'm fine with them scrubbing that stuff out because it doesn't match my subject company.
44:40
SPEAKER_02: Okay.
44:41
SPEAKER_02: My subject company has earnings.
44:43
SPEAKER_02: My subject company doesn't have no sales.
44:46
SPEAKER_01: My subject company hasn't been using must have been working on on businesses that are better than some of our client businesses.
44:51
SPEAKER_01: Um to say that.
44:52
SPEAKER_01: But but but but no, you're you're you're right too.
44:55
SPEAKER_01: That with you know, do you don't want to be comparing a distress company to a non-distress company, for example, or a you know, a spec waiting to happen, you know, spec sponsor waiting to happen kind of thing to your repair shop, whatever, whatever the hell it is.
45:09
SPEAKER_01: Makes no sense.
45:10
SPEAKER_01: Um and and I think the uh a big component here is you know, which which pocket are we are we putting this risk in or pulling it from or whatever, because it's you cannot be double counting.
45:22
SPEAKER_01: I mean that's that's really the the huge argument.
45:25
SPEAKER_01: I mean, I I don't know if you can really say, hey, the this, you know, uh this company's risk must be 22% and not 24, right?
45:35
SPEAKER_01: That's cutting that's slicing the onion too fine and making us all cry.
45:39
SPEAKER_01: Uh on this on the flip side of that is you know it's not 28, and you know it's not 28 because that would be double counting the you know all the things that you're talking about within the size, uh currently what's what's counted in the in the size premiums, and saying that, oh yeah, well, we're an illiquid company or we're you know, we're we're uh we're we're small.
45:59
SPEAKER_01: Okay, well, you just said you were small.
46:02
SPEAKER_01: We already accounted for that over here.
46:03
SPEAKER_01: You know, we we have uh you know less access to capital again.
46:06
SPEAKER_01: You know, we're counting all this stuff.
46:08
SPEAKER_01: And so the the company specific risk, being the most judgmental piece, generally speaking, needs to reflect only those things, only those risks that truly are, if not unique, at least endemic to that company.
46:21
SPEAKER_01: Specific to that company.
46:23
SPEAKER_01: Specific to that.
46:23
SPEAKER_01: I mean, it's right in the name, yeah.
46:25
SPEAKER_01: Right, right in that name to uh talk about that company, that situation, not the industry, not even necessarily the fact that it's a small company because a lot of those same things are already incorporated.
46:35
SPEAKER_01: Like a small company probably doesn't have layers and layers of you know, really top talent management necessarily.
46:41
SPEAKER_01: Not throwing stones at anybody, but you can't afford, you know, your Harvard MBA to come in as your third layer of management kind of thing.
46:48
SPEAKER_01: That's so bottom line is you know, I think the I really is coming back to that.
46:53
SPEAKER_01: Make sure that those aren't just unnaturally large numbers for no no particular reason.
46:57
SPEAKER_01: Or if somebody has a really good reason, make them explain it.
46:59
SPEAKER_01: That that's what business valuation is all about.
47:01
SPEAKER_01: If you don't understand it, smart business owner, who doesn't understand you don't know business valuation like we do.
47:07
SPEAKER_01: That's fine.
47:08
SPEAKER_01: And we're not gonna know your business like you do.
47:09
SPEAKER_01: On the flip side, our job, and and you know, in your in your long litigation career, your job in particular was to explain these things, these technical subjects, to people who don't have the same technical background, such that it makes sense to them.
47:24
SPEAKER_01: And I think if you're talking to a valuation analyst and they aren't making themselves understood to you, that's on them and not you.
47:33
SPEAKER_01: If you're of average intelligence and average education and average everything, there's nothing that that we say that really is voodoo.
47:41
SPEAKER_01: And at the at the I'm I'm I don't want to undercut your uh uh your your your your voodoo talk because I mean there is a piece that is judgmental.
47:49
SPEAKER_01: We want to make sure that that piece is as small as possible, exact so that when we're making it up, we're at least gonna be directionally right.
47:55
SPEAKER_01: We want to make sure we're we're limiting the our own ability to screw it up to get the wrong answer.
48:02
SPEAKER_02: I think a lot of oversized company-specific risk increments are the result of bias because I know a lot of people, including me, when I'm working up the cost of capital for a private company, anytime it's under 20%, I start getting a little concerned, like really, you know, that kind of there's like it it it it's because for years we've been looking at them, you know, where it's you know 20 or 25 or whatever.
48:26
SPEAKER_02: But the thing is, if you have a company that's well run, has consistent earnings, and whatever, there's no reason why it's cost of capital and with plenty of risk built into it, can't be 18% or 16 and a half percent.
48:38
SPEAKER_01: So and you know, we we do a lot of businesses in in that size range that are you know that are professionally run, uh truly.
48:47
SPEAKER_01: And so you know, you get past you know double digit millions of revenue just to pick a a line.
48:54
SPEAKER_01: And more and more often you'll you'll start seeing companies that meet that profile and are gonna be in the tens in terms of risk profile.
49:01
SPEAKER_01: Also, guess what?
49:02
SPEAKER_01: No surprise, that's when private equity starts getting really interested in in those companies.
49:07
SPEAKER_01: They know what they're getting.
49:08
SPEAKER_01: There, they there's not, you know, a there's not a time bomb, you know, in that as often usually, or at least they can find it.
49:16
SPEAKER_01: That sort of thing.
49:17
SPEAKER_01: Well, Ted, thank you very much.
49:19
SPEAKER_01: It's it's been a uh a really great conversation, but let me ask you a couple couple lighter things before we before we wrap up here.
49:26
SPEAKER_01: Sure.
49:26
SPEAKER_01: We've talked about a couple things about about you and your grandkids and cycling and Lynn and everything.
49:36
SPEAKER_01: Can you tell us something about yourself that's not on your LinkedIn?
49:40
SPEAKER_02: I don't think there's much of anything on my LinkedIn.
49:43
SPEAKER_02: In fact, I'm thinking about I'm thinking about taking that thing down because all I do is get little annoying announcements every day and about podcast episodes coming out, that kind of thing.
49:50
SPEAKER_02: Yeah, podcast episodes coming out.
49:52
SPEAKER_02: Some something that's something that's about me that's not on my my CV or anything like that.
49:56
SPEAKER_02: I well, we already talked about how inquisitive I am.
49:59
SPEAKER_02: And um, I I tend to be inquisitive about things I don't I don't know that much about.
50:03
SPEAKER_02: And uh like all people of a certain or males of a certain age, I'm I get to be a little bit of a history buff, you know, where something would have put me to sleep in high school and middle school.
50:13
SPEAKER_02: I'm a voracious reader of history, you know, mostly US history.
50:17
SPEAKER_02: But recently, my wife and I were down in Mexico in February, and we've been to Mexico a number of times, but to resort towns.
50:24
SPEAKER_02: This time we went to Mexico City specifically to just look at cultural and historical things.
50:30
SPEAKER_02: And it's it's it's a fantastic city.
50:33
SPEAKER_02: It's maybe it might be the biggest city in the world in terms of square miles and population.
50:37
SPEAKER_02: It's it's huge.
50:38
SPEAKER_02: And we say stayed in the historic center, which is built on top of the old ruins of the Aztec town of Tenequilan.
50:47
SPEAKER_01: Tidochilan.
50:48
SPEAKER_02: Tenequan, yeah.
50:49
SPEAKER_02: And so you can go and look in the middle of old buildings that are built over where they've excavated some of them, and you can see this stuff, and there's a lot of old stuff built on top of old stuff.
50:58
SPEAKER_02: And then we took a tour, a guided tour out outside the city that's about 40, 40 kilometers outside of town, to the ancient um city of Teotiuquan, which they excavated.
51:07
SPEAKER_02: And there's these huge pyramids that they don't specifically know who built.
51:12
SPEAKER_02: It wasn't the Aztecs.
51:14
SPEAKER_02: The Aztecs inhabited it for a while and were amazed by it, but they they didn't build it.
51:18
SPEAKER_02: So it's it's got an interesting history.
51:20
SPEAKER_02: And then there's a number of other things um that were there, and I became fascinated with with their history.
51:25
SPEAKER_02: And so when I came back, I went to the library and I got myself a uh a book on Mexico's history that's ostensibly a college textbook, and I'm working my way way through it because their their history is is is fascinating.
51:36
SPEAKER_02: And, you know, we tend to kind of North Americans just kind of think of them as a this place down south where you go for a resort and they try to get into our you know country to find work and this, that, and the other.
51:46
SPEAKER_02: But they have this a very robust and fascinating history in people, and I'm really enjoying that.
51:52
SPEAKER_02: So I think that's something about me.
51:53
SPEAKER_02: I'm I'm inquisitive about history and I like to travel, and uh, you know, so there's that.
51:58
SPEAKER_01: It is nice to know that as a geek myself, that I've I've always got plenty of company.
52:03
SPEAKER_01: Yeah, but that that is yeah, that's cool.
52:05
SPEAKER_01: Actually, I'll have to check that out someday.
52:07
SPEAKER_01: I'll have to check out Mexico City.
52:08
SPEAKER_01: Yeah.
52:09
SPEAKER_02: What there's plenty of history, there's plenty of history to read.
52:11
SPEAKER_02: You'll never run out of it.
52:12
SPEAKER_02: You know, just go by countr country by country.
52:14
SPEAKER_01: Very true.
52:15
SPEAKER_01: So are there any any funny stories uh that you want to share about your career?
52:20
SPEAKER_02: Oh my gosh.
52:21
SPEAKER_02: Well, you know, sometimes when you're involved in litigation, you're a consulting expert, which means they're not going to use your testimony.
52:29
SPEAKER_02: In fact, they don't even want you in there.
52:31
SPEAKER_02: And so I was, you know, helping some attorneys with a uh a business dissolution a number of years ago, and I was supposed to be valuing the business they were fighting over.
52:41
SPEAKER_02: And I was I was working for the attorneys for the owners, and it became very clear that they weren't going to like my opinion about the value and the fairness of it.
52:51
SPEAKER_02: And they said, you know what?
52:52
SPEAKER_02: And my in my my engagement letter was only a consulting agreement that would turn into an expert testimony agreement when they designated me.
52:58
SPEAKER_02: They said, We're not going to designate you as an expert because you're just not going to be able to help our case very much.
53:02
SPEAKER_02: But we'd like to keep you on as a consulting expert, which means you're going to evaluate the other side's work, you're going to accompany counsel to trial in this case and be sitting at counsel's table helping with cross-examination and things like that.
53:15
SPEAKER_02: And I did so, and um, it was pretty hilarious because the expert on the other side knew who I was and was apparently terrified.
53:22
SPEAKER_02: And they made our counsel swear up and down that I was never going to testify.
53:25
SPEAKER_02: And Judge said, he's not designated, and they're just worried, so worried about this.
53:29
SPEAKER_02: And it's like, okay, fine, don't worry about it.
53:31
SPEAKER_02: And so then during you know, the experts, opposing experts' testimony, you know, I was feeding notes over to the counsel, you know, to object to this and that.
53:41
SPEAKER_02: And finally, at one point, the guy said something that was just, you know, outlandish.
53:44
SPEAKER_02: And I, you know, I elbowed counsel, I said, object.
53:46
SPEAKER_02: And he stood, I object.
53:47
SPEAKER_02: Then he's looked down, he says, What am I objecting about?
53:50
SPEAKER_02: You know, and I told him, There's no way he can know that, right?
53:53
SPEAKER_02: Just your honor, there's no way that he could know this.
53:55
SPEAKER_02: And they'll be fine.
53:56
SPEAKER_02: Jackson sustained.
53:57
SPEAKER_02: And so that that was a humorous moment because the guy stood up, he didn't know what he was objecting about, just because I said so was hilarious.
54:03
SPEAKER_01: And playing nice playing attorney for a day.
54:06
SPEAKER_01: That's cool.
54:07
SPEAKER_02: Yeah.
54:07
SPEAKER_02: And so then at the end of the whole thing, it was was settled and wrapped up and everything.
54:12
SPEAKER_02: I'm the way out of the courtroom, the judge said, just a minute to me, and she said, I hope to see you back here someday and to hear actually hear you testify about something.
54:23
SPEAKER_02: Okay, you know, whatever.
54:25
SPEAKER_02: Just hilarious.
54:26
SPEAKER_01: That sounds like a loaded statement.
54:28
SPEAKER_02: Yeah, yeah.
54:29
SPEAKER_02: No, I mean, she's wanted to know what the hubbub was about because she didn't know who I was.
54:32
SPEAKER_02: And this this other guy just read some papers by me or something and was just like scared to death.
54:37
SPEAKER_02: And I mean, it was just like really weird.
54:39
SPEAKER_02: I don't know.
54:40
SPEAKER_01: Well, I I don't I don't know.
54:41
SPEAKER_01: I mean, do you do you think it's better to be feared than loved?
54:44
SPEAKER_02: And sometimes I'll okay, I'll tell you another really funny one, and then we'll then we'll be done.
54:48
SPEAKER_02: Um, I was you've you've probably never been in the in the Marin Superior Court building.
54:52
SPEAKER_02: It says Frank Lloyd Wright building, the Civic Center.
54:54
SPEAKER_02: It's a beautiful historic building, a long corridor with open windows on the left and then courtrooms on the right.
55:02
SPEAKER_02: And I was just walking through there one day, towing my trial bag behind me and scrolling through my BlackBerry.
55:09
SPEAKER_02: This is what I had at the time, oblivious to everything else.
55:12
SPEAKER_02: And as I'm rolling down the courtroom, the row of courtrooms, there's other experts and lawyers are sitting up there, and some of them know me.
55:19
SPEAKER_02: I start hearing this faint humming, and they're going, da the Darth Vader music, right?
55:27
SPEAKER_02: Because I'm just cruising through there and I'm like, crap, is that my reputation?
55:31
SPEAKER_02: It's just it was funny.
55:33
SPEAKER_01: That is really funny because I mean, I don't know.
55:35
SPEAKER_01: You because I'm kind of a I'm known as a nice guy, you know.
55:39
SPEAKER_01: Yeah, exactly.
55:40
SPEAKER_01: I was I was I was trying to try to just put in a way that you know wasn't gonna be you know blown smoke, but yeah, you're a really nice guy, and everybody I know uh you know has that opinion of you.
55:50
SPEAKER_01: Just you know, that's part your your reputation is as a nice person and uh and very factually based, yeah.
55:58
SPEAKER_01: And sometimes facts aren't nice, but you you will deliver them nicely.
56:02
SPEAKER_01: So I think I think that's the definition of nice.
56:05
SPEAKER_02: The the people that I've worked against the most, that's the rep when we get into settlement conferences and stuff like that.
56:10
SPEAKER_02: It was everyone's like, you know, we don't really like him very much, you know.
56:14
SPEAKER_02: We don't think he's the brightest guy around, but he's a straight shooter, you know.
56:18
SPEAKER_02: And so they're happy when I get into a case because they know there isn't gonna be a lot of BS.
56:22
SPEAKER_02: It's just gonna, you know, tell tell it like it is.
56:24
SPEAKER_02: And you know, that's and that's that's a pretty nice reputation to have.
56:27
SPEAKER_02: Absolutely, absolutely.
56:28
SPEAKER_01: All right.
56:29
SPEAKER_01: Well, Ted, if you want to be found these days, now that you're retired, email banner.
56:36
SPEAKER_01: That's a good one.
56:37
SPEAKER_02: You're gonna screen them for me.
56:40
SPEAKER_01: We were just going through how nice of a guy you are.
56:42
SPEAKER_01: Now you're like, no, no, no, screen my calls.
56:44
SPEAKER_02: Uh no, I mean you can you can you can you can you can publish my email with this.
56:49
SPEAKER_02: Um no, no, if somebody has a has a follow-up or a question or or or wants to find an expert in something or wants to if they've been trying to track down an article of mine or an article by somebody else, I have a pretty good collection uh on certain subjects, then you know I'm I'm I'm I'm happy to help.
57:03
SPEAKER_01: Because you're such a nice guy, exactly.
57:05
SPEAKER_02: If I'm just not if I don't happen to be out riding my bike or taking a nap.
57:08
SPEAKER_01: Just don't do them both at the same time.
57:09
SPEAKER_02: No, God, no.
57:11
SPEAKER_01: All right, Ted.
57:12
SPEAKER_01: Well, thanks very much.
57:13
SPEAKER_01: Uh you know, you've thank you, Ben.
57:14
SPEAKER_01: You've been awesome in my career, and you've been a big uh just a big supporter of of mine, and I'm a huge fan of yours.
57:24
SPEAKER_01: Uh, and I just genuinely thank you for being on the podcast and just um being my friend too.
57:29
SPEAKER_02: I've been a big supporter of yours, Ben, because you're a straight shooter.
57:32
SPEAKER_01: Appreciate it.
57:33
SPEAKER_01: Alrighty, thank you very much.
57:35
SPEAKER_01: That's a wrap.
57:36
SPEAKER_01: You've been listening to Max Value Podcast.
57:38
SPEAKER_01: And if this episode provided any interesting information, hit that subscribe button, smash like, and drop a comment below.
57:44
SPEAKER_01: I'm Ben Town with Town Advisory, and I'll catch you next time.