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The business coaching lesson teaches entrepreneurs how to determine the value of a business.

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Featured Coaching Excerpt - Notes & Transcript, Part 1
  • Definition Magician: Angel Investor - provides financial backing for small startups or entrepreneurs.
  • Lesson Nugget: Angel Investors look to invest in companies that have the right team, a strong industry, a great value proposition, and a history of success.
  • Lesson Nugget: A business plan must be a fluid document, not a concrete document.
  • Ask Yourself: Do I surround myself with a network of smart and successful people?
  • Notable Quotable: "The strongest oak of the forest is not the one that is protected from the storm and hidden from the sun. It's the one that stands in the open where it is compelled to struggle for its existence against the winds and rains and the scorching sun." - Napoleon Hill

digitaltutors for capital, start a business

-What's up, Thrivers? Dan Mckenna here, and today we are here with the incredible David Nilssen, and we are talking about after you start a business, how do I value my business? Don't know who David Nilssen is? David Nilssen is the co-founder and CEO of Guidant Financial. Guidant Financial has helped to connect small business owners into over $4 billion of capital that has been used to create over 60,000 jobs throughout the United States. He's kind of a big deal.

Today you'll learn how to value your business and everything you need to look at to determine the value of your business. You will also learn what you can do to increase that value. Now we're not going to tell you how to decrease it. Then we'd have to change the name of our company to Thrive 15, and the paperwork just isn't worth it.

-David, I appreciate letting me harass you, my friend. How are you doing?

-I'm doing great.

-I am very excited to be here in Seattle and in Bellevue specifically. But before we get going about this idea of how do I value my business, I have a question I think the Thrivers all around the world want to know. Is the food at the Space Needle any good? As a Seattle resident as you are here, just objectively, I guess, or subjectively, is the food at the Space Needle any good?

-So I've been to the Space Needle one time. It's OK. It's OK. I think it's more of a tourist trap. I think people go there because they get to spin in the circle once an hour. I wouldn't say it's fantastic, though.

-OK, well that's fair enough. But we should still go up there to check out the view.

-I would for sure.

-OK, I want to ask this because you are actually an active angel investor. There's a lot of books and articles about angel investors, and they've become kind of mythological, but we caught one in action, and that's you.

-Yeah.

-And so how do you actually value a business pre-revenue. Before there's any money coming in, probably there's a lot of money going out. How do you pre-value a business?

-Yeah, typically you lick your thumb and throw it into the wind. Candidly, there's really no formula for it. At the end of the day, you're betting on someone's ability to be successful. So as an angel investor, what you're looking for is do they have the right team? Do you think the industry a strong? Do they have great value proposition? A history of success? All of those things.

-So let me just rehash these and make sure we're on the same page. You're looking for a great team. You're saying does this guy or gal have a good team? Are they in an industry that makes sense? Do they have a value proposition that make sense? And then do they have a good history?

So let's talk about the team just for a second. What do you look for? Let's just say I came in today and I've got this idea for this new widget that I believe is going to change the way people work. When you say, "a good team," what are you looking for?

-Well, my belief is that you build a business around a great entrepreneur. And all of us have strengths, all this have weaknesses. So the question is have they built a team that allows them to play to their strengths and then also has a team that supplements where they're maybe not so strong? So that's one thing.

And the second thing is we want to make sure that they're strategic. So you can have the greatest widget in the world, but do you have the right strategy to go to market with? The team itself also needs to be resilient, because the one thing that I know for sure is that once you write a business plan, it's wrong. So we want to make sure that they have the intelligence and the resilience to see that plan through, because it is going to evolve over time.

-Once you write the plan it's wrong. It just changes. You can't predict the future exactly. You've got to have that resilient team.

-Yeah, absolutely. And I think that's one of the mistakes that lot of entrepreneurs make is they write this business plan and they think of it as a document that is in concrete. So they write the plan and they put up on the shelf and they just execute to the plan. The reality is once you build a business plan, you go out to the marketplace to validate all those assumptions that you originally made. And inevitably some of them are going to be wrong, and you have to be flexible. You have to evolve. A business plan is a fluid document, not a concrete document.

-Fluid, not concrete. I want to ask about this industry thing. If somebody comes in and says, you know, I've got this idea for this widget, how do you know if the industry's-- if they're just out of their mind and the industry doesn't make sense? Or how do you know that the industry's a good industry? What we mean by that?

-Well, so as an angel investor one of things that I'm not terribly interested in is creating a market, because that's super expensive. It takes tremendous amount of branding. So I want to find people they're interested in new innovations inside of an industry where there's already a track record of exciting growth, where we know the market opportunity is large enough. If I have the greatest widget in the world but only 2,000 people in the entire country want that, that may not be an interesting opportunity. But for someone like myself, we know that about 50,000 SBA transactions happen a year.

-50, 000?

-50,000. So if that's the case, that tells me I have a tremendous opportunity to go out to the marketplace of financing tools.

-What about the history aspect? When you talk about a guy or gal and their history, are you looking to see where they went to school or where they're from or if they've had a couple jobs in a row that didn't work out, or what do you're looking for?

-The sum of all parts right. Certainly if they've got a great education, that's one thing. I don't necessarily put a lot of stock in the fact that they have a degree in a certain area, but more or less somebody that has a network of people, that is around smart people.

One of the things that we look at is how successful they've been in some of the jobs that they've played. Some of them are executives who've led large departments or business units but not necessarily gone out on their own. Another could be someone that this is not their first entrepreneurial venture. They've done it before. They've shown that they can take an interesting idea, take it to market and create value.

-I just want to say I really appreciate your sharing these four different areas because I know that the tenacity aspect of it, I know when I started my first business I had no idea how hard it was going to be. I remember getting to work at 3:00 in the morning. Like today it's dark outside. You get to work it's dark. You leave it's dark. You're going, man, I didn't it was this hard. I thought I'd just-- And the whole resiliency thing is a huge part of it. In your mind, I ultimately you're betting on that entrepreneur. That's what you're doing.

-Absolutely. At the end of the day, if it's pre-revenue, the only thing that's for certain hopefully is that the team that's in place will be there through the end, and that's what you're betting

on.

Learn more about how to start a business on Thrive15.com

Featured Coaching Excerpt - Notes & Transcript, Part 2
  • Lesson Nugget: To find the value of your business, talk to a professional in your industry and ask them to run a comparative market analysis.
  • Action Step: When purchasing an existing business, have a team in place to determine the optimum value to buy that business at.
  • Lesson Nugget: Business owners can find out the value of their business by discovering what similar businesses in the same geographic area have sold for.
  • Lesson Nugget: When purchasing a business, your team should consist of an attorney, a business broker, and a Certified Public Accountant.
  • Capital sources typically don't value the business. They determine if the assumptions of financial growth match the lending opportunity.
  • Action Step: Talk to the broker that helped you get in your industry or business and ask them to run a comparative market analysis on your business.
  • Definition Magician: Enterprise value - The measure of a company's value. Often used as an alternative to straightforward market capitalization.

[MUSIC PLAYING]

-Now, I want to move on now to if I'm somebody who's looking to buy an existing business. So let's say that I am watching this right now and I'm looking to buy a business or I'm looking to sell my business. How do you begin to value an existing business?

-Yeah. So I think you look at it a lot like real estate. Right. I love to use real estate as a term because, while not a ton of people have been entrepreneurs, most people have bought a home, or a lot of people have. So the way that you value a piece of real estate is, you talk to somebody who is a professional in that area and you ask them to run comparative market analysis. Right?

What do homes like this sell for within a mile radius, and use that as a way to benchmark, am I buying this at a good value. And the same thing happens inside of a small business. Now, technically, fair market value under Internal Revenue Code is when two people with adverse economic interests are negotiating transactions and independently come to a value together.

And so technically, the value of the business is whatever you and I as a buyer and seller decide is the value. But the reality is, you still want to understand what the market bears.

-So let me see if I could provide an example, make sure I'm getting it here. So let's say that I have a restaurant, and my restaurant's doing about $2 million a year in gross revenue. It's kind of smaller restaurant. Things are starting to take off. Somebody comes in and makes me an offer and says I want to buy it for x.

It would be wise, if I'm the business owner, to find another restaurant or restaurants that are doing about $2 million in revenue in maybe a similar geographical area and kind of go, what are these guys worth. What am I worth? That kind of thing? Is that what I want to do?

-Yeah. Absolutely. I mean, the idea is to see what other businesses or other like businesses are selling for in that area, and why they got the valuation they did. So for example, some businesses people would value more based on cash flow. How profitable is it? Right? And maybe they would give them a value based on a multiple of that number.

Other businesses, they may say, you know what. It's not as important that they're profitable, but that they're growing at a high clip. So someone that's growing at 25%, 30% per year may get a higher valuation than an individual business that's growing at 5% per year.

CLAY: Makes sense.

-So there are other variables there. So at the end of the day, the most important thing that you can do as an entrepreneur or perspective entrepreneur if you're buying an existing business, is to have a team of people in place that can help you determine the optimum value to buy that business at.

-Do you want an accountant to help you with this? Or who's your team? Who should you have as your team here?

-Yes. I would think you'd want an attorney with business transaction experience. You'd want a CPA, a professional that deals primarily with businesses. And then definitely a business broker. Someone that is working with businesses all over that area, helping them to buy and sell.

-Little ABC action, Attorney, Broker, CPA.

-It wasn't intended that way, but it worked out just fine.

-Beautiful. Now, the next question I'm gonna ask you is that, you know, you obviously fund a lot of business owners. You help business owners become successful by providing them the capital they need to do it appropriately. And I think that, you know, I might have this great valuation in my mind of what my business is worth, and there might be a super motivated guy who wants to buy it, but ultimately, if we can't get the funding to purchase it at that price, it's not going to happen.

So how do lenders value a business? So as a lender, let's say that somebody wants to buy my business for $2 million. How do you, as a lender, determine how much money you can lend or how much money's available for the purchase of this kind of thing?

-Yeah. So just for clarification's sake, we are not a direct lender. We work with capital sources. But those capital sources typically aren't going to value the business directly themselves. Instead what they're going to look at is, do the financial assumptions and the financial wherewithal of the borrower meet the opportunity.

So a lot of times, our business owners, especially with an existing business, are going to get a business valuation. And so that makes it very simple. The lenders typically are not going to refute the valuation, as long as it's coming from a lender where they have the ability to be objective. But at the end of the day, what they're underwriting is, do they believe that this business and this entrepreneur can support the debt load that they're about to take on.

-OK. That's what it comes down to at the end of the day. Now, is it a good idea to have the business evaluated annually, to have evaluation done annually? I mean, is it a good idea for a business owner to do this?

-Yeah. So there are a couple ways you can do it. I'm a big fan of understanding the value of your business. Right? Because as entrepreneurs, what we're trying to do is build enterprise value. There are a couple ways that you can do that. You could go out and pay for a formal business valuation. And that's gonna cost somebody anywhere between $750 to $5,000 annually. That may or may not be an expense that's worthwhile for an individual.

But one thing that someone can do is go out to the marketplace and talk to their broker, the person that helped them get into that business, and have them run a comparative market analysis on their business for that year based on some of the information that they have. And that can start to give them, over time, trends about whether they're building value in business or not.

-This makes a lot of sense. I feel like the whole comp idea, it's somewhat genius in how simple it seems. I think you just-- I think a lot of times as business owners, we get so overwhelmed with, oh my gosh, this might affect my value, or this might affect the value, or this. I feel this way or I feel that way. But really, just having comps is probably the most pragmatic way to--

-Yeah. If your concern is about, you know, what's the value of my business. Because again, the reason people go into business is different. Right? You may be going into business because you want to build a big business with large enterprise value. I may be going into business because I want to provide a nice cash flow for me and my family.

So the reasons we're in it are maybe different, but if enterprise value is the focus, then keeping a pulse on where that is, and how your business is evolving, and how that's affecting the enterprise value is important.

So in a comparative market analysis, if your broker came back to you and said, hey, look, here's A, B, and C companies that sold in the last year that are within this geographic territory, and this one sold for this number, and here's the reason why, and this one sold for this number, and here's the reason why, you may start to see, well, shoot. The way that I'm starting to build my business is more consistent with the lower valuation. There may be some ways that I can start to modify my strategy to help build more value long term.

Featured Coaching Excerpt - Notes & Transcript, Part 3
  • Definition Magician: EBITDA - The earnings before interest, taxes, depreciation, and amortization. It is an approximate measure of a company's operating cash flow based on data from the company's income statement.
  • Action Step: If your comparative market analysis data is not where you want it to be, get a formal evaluation of your business.
  • Lesson Nugget: The most common misconception is that a company's top line revenue translate into value.
  • Notable Quotable: "The smartest business decisions you can make is to hire qualified people. Bringing the right people on board saves you thousands, and your business will run smoothly and efficiently." - Brian Tracy

[MUSIC PLAYING]

-And I know that you are not a direct lender, we are clarifying there. But you guys definitely help connect the business owner to the financial solutions they need there or the-- how many transactions have you guys done or is that even something you would share?

-Oh, yeah. We don't mind sharing. So we, at this point, have helped about 10,000 entrepreneurs across the country--

[EXPLOSION]

--to deploy about $4 billion into small business.

-10,000, $4 billion. So if 10,000, I mean, there's a lot of people who are creating jobs because of the financial tools you've been able to help provide them with. You do this all day, every day. So when you're saying these things, these aren't just-- I mean, I just want to clarify for people watching this. This isn't just I guess, your opinion, this is after years of-- $4 billion of funding. I mean, you've seen this. This is the most pragmatic way to do it.

-Yeah, I mean these are things that we've seen to be successful. Now they're not the only ways.

CLAY CLARK: OK. But we've definitely seen it over a period of time and believe that these are ways that entrepreneurs can help to continue to build value in their businesses.

-Now, having worked with 10,000, you probably start to see some misconceptions. You probably start to see some things where most business owners think this, but really it's this. What's the most common maybe misconception that you see when you sit down with a business owner when it comes to evaluating or coming up with the true value of their business? What's the most common misconceptions that you see?

-Um, that top line revenue somehow translates into value. So, for example, if I made a Subway sandwich store and I am producing a thousand a day in revenues on average, that somehow my business is worth about $350,000.

-So, they're basically are saying, because the top line values is this, I believe my value should be this. And you're saying the top line doesn't even matter.

-The top line, I mean, it certainly plays a part in it. But, again, I think the main things that people look at are 1) what's the gross margins when you take the cost of goods out of the revenue that's being generated. That's an important number. The bottom line number the net income, or EBIDA, those are important numbers. But, at the end of the day, where you really get the, I would say the acceleration on a value, is whether you're growing at fast clip or not.

-Because a lot of people watching this, I feel like, we all come at it from different-- some people watching this maybe know all the terms. Some people don't. Can you explain what EBIDA means to the average person who maybe doesn't know what that term is?

-Yeah, so EBIDA is the earnings before interest, taxes, sorry, depreciation and amortization. So these are different accounting opportunities that small businesses have that will factor into the ultimate net income number. But, the EBIDA is a number that sits right above that.

-OK, so if you're watching this, we'll put the data up on the screen here so you can take some notes on that. That's a term that people throw around quite a bit in the financing world there.

DAVID NILLSEN: Yeah.

-So David, if I'm watching this and I got super motivated and I went out and I said, OK I'm going to do some comps. I'm listening to what David has said. I've got comps. Now I come back and I find out I thought my business was worth a million, and it's only worth a hundred thousand. What are some things I could do-- I know it's a broad question-- but what are some things I could do over a 12-month window of time to really get the value of my business.

-Yeah, so I think if I was to go out to the marketplace and take that CMA, that Comparative Market Analysis, and that data was not what I thought it would be, or where I want it to be. Then, at that point, I would probably be compelled to go out and actually get a formal business valuation. Because the thing with the CMAs it's going to give you very general information.

A business valuation is going to help you understand more about your business and were there are things that are adding value and things that are not. And oftentimes, a business value analyst, or a business valuation expert, will give you ideas as to how you can drive value. Ultimately, it's going to come down to how can I drive more profit or how come I grow at a faster clip. And, hopefully, that individual that you work with will help you identify different strategies to do so.

-So, grow the total amount of the actual rate at which you are growing, and also look to increase the profitability. Now, I know that seems simple. However, and I know a lot of people watch this-- I know I was in that boat for years where I had a business. And I knew there were some tough decisions I needed to make, but I didn't want to make them because of it could be an emotional reason. It could be, I don't know, a psychological reason. It could be whatever. But what are the reasons that you see, a lot of times, with businesses where they don't make the tough decisions? What are some that you see all the time?

-Well, the most common is obviously with labor. When we're talking about small businesses, right, when we started Guidant, it was two guys. It was me and a business partner and a laptop, right. And as we grew, we started bringing in people that we knew, people that we could trust that we thought would do a good job. That worked out very well for us.

But I see oftentimes, the small businesses them hiring family, and friends, and creating this fun environment for them to work together, and be with those people more often. But, unfortunately, it's harder to deal with some of those performance issues. And, oftentimes, the issue isn't that the business model isn't sound, and that it can't grow at a faster clip, or be more profitable, but it's got the wrong people in the wrong roles.

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