Can You Build a Business for Both Cash Flow and a Big Exit?

0:00Yeah, and I agree. And I think the first thing that you said is a really important distinction. that if you're bootstrapped, you have a lot more flexibility than if you're funded, particularly if you're funded by investors as opposed to maybe friends and family and things like that. But in those bootstrapped businesses, some businesses are considered lifestyle businesses, which basically is, I just want the business to produce enough cash for me to live the way that I want to live now.

0:35Hey, everybody. Welcome to another episode of Business Lunch with Ryan Dice and me, Roland Frazier. We are happy to be here with you sharing fun things. We just finished an event and a couple of people asked some really cool questions that we thought might be good podcast topics because we figured if they had them, then you might have them too. Ryan, you want to kick us off? Yeah. So this particular question was posed and really came down to the difference between building a business that you intend to sell versus building a business for cash flow, right? And are the two mutually exclusive? And if you're building a business and you're pulling a lot of money out of this business, because I mean, that seems to be, it's almost treated at least out there in the media world as two different things.

1:20Like there's one path where whether you raise money or not, right? You're putting all the money back. You're constantly investing money back into the business. You're investing for growth, investing for growth, investing for growth. And then you're going to make this big payday at the end. And then the other one is you're taking money out, you're taking money out, you're taking money out. And maybe you sell one day, maybe you don't, but you're basically optimizing for today instead of optimizing for tomorrow. And the question really is, can you do both? Is there a way to balance? What do you think?

1:51And so that's the question, Roland. Can we have our cake and wait for it, eat it too? what uh i'd love to hear your thoughts on it well i would i think for if you you it comes down to what is the path that you picked from an in from an investor and fundraising perspective number one if you went the vc route you raised a bunch of money then you are on a particular path and that path you you just walk through a one-way door so if you raise money through venture capital then it is kind of big exit or bust. And creating a cashflow business is not going to be good for anybody. And so, yeah, everything's got to get reinvested and you basically better get it generated 10X return for your investors.

2:37They're going to be miserable and that's at a bare minimum. So that's if you took the VC check. If you didn't take the VC check and you're bootstrapped, then not only do I think you can both take money out and generate cash flow today and have a large exit value, I think you should. I mean, we have experienced this, but I think the ultimate sign of a healthy business is, you know, not just a high NPS score or even a really large revenue number. I think the ultimate sign of a healthy business is that business's ability to kick out large amounts of distributable cash each and every month or quarter.

3:25So, yes, I think if you do want to sell, then having an ability to make big distributions is not only something you can do. I think it's something that you should do. Now, coming up with a balance so that you're not sending out so much money that there's not enough fuel for growth is definitely a balance that you need to keep in mind. But yes, I do think you can have both. Yeah, and I agree. And I think the first thing that you said is a really important distinction that if you're bootstrapped, you have a lot more flexibility than if you're funded, particularly if you're funded by investors as opposed to maybe friends and family and things like that.

4:01Um, but in those bootstrapped businesses, there's, uh, some businesses are considered lifestyle businesses, which basically is, I just want the business to produce enough cash for me to live the way that I want to live now. And I'm not really concerned about, uh, it building significant value or even growing because I'm happy with where I am and I don't, which, which is may sound a little anathematic, right? It's, it's, it's what you don't want to grow. You don't want to scale. Well, you, you advise somebody one time, uh, uh, a friend of ours on Facebook, I remember long ago, actually. And, um, you said, yeah, I think they were talking about, uh, scaling the business to 10 million.

4:46And you said, well, before you do that, ask if you want what that brings, because it brings a whole host of different things. Um, but that's, that's a different conversation. I think the answer is that you can do both. And the confusion arises out of the advice that you're given that you want to do things differently a couple years before you sell. And a lot of people believe that it's mutually exclusive, that you're either building a business to sell or you're building a business for cash flow and that you have to flip that switch but it's not completely true. There are things that you will do typically as an entrepreneur who doesn't have to answer to other investors that will minimize your taxes.

5:38Like you'll write off everything that you possibly can. You'll take maybe trips that would not be tax deductible and you'll take all of your employees to some fun place that you would otherwise have a non-tax deductible vacation. You'll maybe pay for cell phones or automobiles or other expenses that the business doesn't need, or maybe you'll lease properties or things like that that the business doesn't necessarily have to have, but they are tax deductible because they are ordinary and necessary or basically helpful to the business. That reduces profitability. And because most businesses sell based as a function of profit, anything that takes the profit down is arguably something that will inhibit your ability to get a higher sales price.

6:28Now, that's typically addressed through restated financials where we go through an exercise to say, hey, over the last couple of years, what are all the things that were one-time expenses like masterminds or consults or training programs or all those family type expenses or other things like that that will not be ongoing required expenses of the business to achieve profit going forward in the hands of the new buyer. That can also include the excess salary. Maybe you're paying yourself a million dollars a year, but you could be replaced with somebody that only costs$200 ,000 a year. We'd add that$800 back.

7:06So I don't find it to be bad to take a lot of cash out of the business. And we've gone through recently in a couple of the businesses having this out with high-level people that were C-suite people that we brought in because their argument was, well, you're taking money out of the business that's hurting my future potential exit value. And the answer to that is kind of a combination between, well, what do you think we need to put that money in to do? What would we be doing that would dramatically increase the value of the company. And in this case, the answer was, well, acquisitions, you should put that money towards acquisitions.

7:48And our answer was, we don't really need money for acquisitions. We have a line of credit for$10 million, and we've got a process for identifying and absorbing acquisitions that don't require a lot of cash to start with in the first place. And if we were to go heavy into acquisitions, we know that more than 80 % of those fail to realize their value, we could end up with a bunch of debt and a bunch of extra investors and no cash distributed and a bunch of losers, right? So if we have a process that's continuing to add value and we don't need that cash for the business, then I think we should probably take it out.

8:28And now you may get, as you start to bring in professionals and professionalized people that say, well, you need to have a reserve. And that's good, solid advice, you know, because a lot of bootstrapped entrepreneurs will pay refunds and other expenses like, you know, equipment that's depreciating, they'll just pay it out of cash flow and they won't set money aside for it. So having some set aside makes sense. And other than that, I just, I think that they are not mutually exclusive. And then if you're building a solid business that is a wealth asset, you can take the money out and fund the growth that you need and add back anything you need through restated financials.

9:13And you're not giving anything up in the exit and you're getting to have, you're getting to eat your cake and have it too. Yeah. Funny enough, I've seen excess cash left in companies lead to bloat, which actually caused businesses to slow down, not grow. I would argue, I remember personally a couple of those things that you would have done. Yeah, ones that we owned and one in particular that I ran. So yeah, it is absolutely, I believe that we have this idea that money is fuel and it can be, it absolutely can be, but it's not always fuel. I mean, a better way to think about it is sugar, right? And so it's sugar and it can be fuel for a little bit directed in the right direction, but there can also be a sugar crash.

10:01So if money and cash in a business is directed, if there's a plan for it, then absolutely positively, it makes sense. If it's just left there though, it turns to fat, it turns to bloat and it slows the business down. So what I would say is have a budget, decide ahead of time where this cash is going to go and decide ahead of time that at least some of it is going to show up in the form of profit and that those profits are going to be distributed. We make sure we create a cashflow waterfall so that the cash, when it goes through, it's going to flow through the excess cash, we're going to leave a certain amount in operating.

10:43Typically, it's one month is going to be in the operating account. However much one month OPEX is going to stay in that operating account, everything over and above that is going to get swept out at the end of every month. And it's just a really healthy way of saying, okay, like this business now has everything that needs to operate for the next month. That is going to then stay in basically kind of that sweep account. And out of there, we can then put it into different accounts, perhaps for future investment and or for distribution. The nice thing about it, if you distribute money out to the stakeholders, that money can't always be reinvested back in.

11:20So if there's a significant enough investment opportunity, the investors can all decide at that time to buy back in. And the ones who believe can do that. But it keeps everybody honest. I think that's a good way to look at it too, because really that it comes down to who can get a higher return on the money. Are you like, you know, number one, do you have all the money that you want to maintain your personal living style? Uh, if you do and don't need to take any more, then it's a, it's a pretty cut and dry decision to me. It's, can the company earn a higher rate of return on that money than I can earn on the things I'm going to put it in?

11:59And if, if the company can earn a higher rate of return, why wouldn't I from a financial perspective, leave it in there. But if it can't, and it's just accumulating the money, and I would argue this about Apple and several of the other companies that probably shouldn't have billions or trillions of dollars in cash, they should probably distribute money out to the shareholders and let them decide what they want to do. Because if you've been holding that much cash for five years or more, you don't have a plan for it. Yeah. Right. Yeah. You clearly don't have a plan for it. Yeah. So I would say again, to the person that asked this question, if you're VC backed, then they're not mutually exclusive.

12:43When you took the money, you picked your path. And that path is basically scale and exit or bust like that. That's kind of the only path you got. If you're bootstrapped, which is why we love bootstrap businesses, it's why we want to stay bootstrapped for as long as possible, then you do have options. But the option of are you going to have a business that kicks out a lot of cash or are you going to have a business that that can exit for a lot of money? They're definitely, definitely not mutually exclusive. In fact, the businesses that we've had that exited for the most also just happen to be the businesses that kicked out the most cash because businesses are going to exit based on their profitability.

13:22And profitability should at some point show up in the form of cash. If you're worried about distributing out too much and not leaving enough in for reinvestment, just plan and budget for that. But what we do from a cash flow management perspective, leave one month operating expenses in an OPEX, in the operating account. I believe we keep between three and six months in an emergency fund in cash so that it has that at the company level. And then everything else is going to get either distributed out or it's going to get put in a specific directed savings fund that is going to be used for a specific directed savings purpose.

14:03And beyond that, yeah, get it the heck out of the business. The only other thing that I would say is if you have a material, either in terms of percentage or dollars, refund rate that you know exists, that you can kind of consider that part of the money, not yours, that you're taking in. So you may have a separate refund account as well, like a refund reserve. So if you know that you've got, you know, I'm going to use a high percentage just because you would want to look into this, but it's easy to do the math. If you had a 10 % refund rate and you're doing significant money, let's say you're doing a million dollars a month, then you know that roughly a hundred thousand dollars a month of the money that you bring in is not going to stay in the company.

14:55So you would be wise to, through whatever the cycle of refunds is, have that$100 ,000 a month times the number of months in the cycle to give as a refund. And that you got to put aside because otherwise it's either coming out of your reserve or it's coming out of your cashflow, right? It's coming out of your emergency thing that, but, but you shouldn't just have the refund thing. You should also have kind of an emergency refund, excuse me, not refund, emergency fund, like you talked about. So that's the only thing I would add to that, that, that I think is, is nice just because then you're not, Hey Ryan, I took$50 ,000 out of your, your personal account this month to put back in the company to cover refunds.

15:39Not that we've ever had that happen. Yeah. And that's especially if If you're in retail or you do any type of e-commerce, especially if you do sizing, somebody's going to order a medium and a large and send back the one that didn't fit. It's pretty typical and common. But yes. So keeping that in mind, I think the greater theme here is that if you're bootstrapped, the two are definitely not mutually exclusive. We encourage all of the businesses that we own, including the ones where we are investors in. We encourage them to take out lots of money. It's the ultimate sign of a healthy, successful business.

16:14So do it. It's also a lot more fun than waiting 20 years and hoping that you're going to get a payday at the end. It is. You and I have friends who sold businesses after owning them and running them for 10 years, and they had a really big payday at the end of it. But I remember doing the math, had one buddy doing the math and realizing that I had generated more in distributions over that same period of time from one of the companies than they made from that one exit. And we still own that one business. Yeah. And you got the time value of money, right? As an annuity, you had an annuity that was paying constantly as opposed to that end thing.

16:51So if you think about you put in a compound interest rate on that, it becomes pretty significant. Yep. And I would also argue that exits are not always, to kind of supplement what you said about your friend, they're not always what you anticipate them to be. And so when you hear somebody had a$60 million,$100 million,$300 million exit, they may have gotten very little out of that because they were constantly reinvesting, but also they were getting investors and they were getting diluted and creditors had warrants and things like that. And after all of those things happened, they didn't really end up with that much money.

17:32I know that happened to the - Yeah, they had a pro stack six levels deep. It's like everybody else got their thing. That happened to the guy that founded UGG. I remember listening to him and talking with him about it. And Rand Fishkin wrote a book, I think, about it. Do you remember what the title was? Lost and Founder. Yeah. Lost and Founder, where he talks about that whole thing. So it's like when you hear that somebody had an exit, it's also when you're thinking about who to take advice from, just because somebody had a big exit doesn't mean that they're an expert in exiting. Right. They like they had a big exit.

18:03Maybe they got lucky if they've done it two or three times. It's less luck. They're good founders and they build good companies. But did they actually get the full value that they could have gotten? you don't know that, right? You don't know if they know all the things that you can do to make companies more valuable, or if they're just basically flipping a wholesale, like a wholesale real estate person who's buying market up and then let somebody else take it. Let the private equity company take the lion's share of the profits. That happens a lot too. And it's funny when we're talking to people, when we're helping people with exits and they're like, yeah, so-and-so did this, this, and this.

18:38And we're like, do you know what they got for it? You know, who helped them negotiate the deal? You know, let's, let's dive into it. Cause there's a lot of points, you know, there's 62 profit points. There's 50 exit, you know, valuation amplifiers. There's 196 sales accelerators, right? Are they aware of all those things? And then did they tax structure properly? So it's, it's a lot to think about as you, as you get into that world. Yeah. That's my rant. I'll let you close it out. well no I mean I think I think we can I think we can leave it there awesome well hope you guys enjoyed this if you found it valuable please share it with a friend we love uh we love having the business lunch podcast expand and uh if you have got thoughts questions feelings or emotions about any of this stuff then we'd love for you to share them with either us individually or on the business lunch channels we're on youtube and all of your normal podcast places so thanks guys and we'll see you next time

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