Using Customer Lifetime Value (LTV) to Grow Your Business

Customer lifetime value (LTV) is a term you can toss out at cocktail parties to sound smart.

Want to look like Matt Damon in Good Will Hunting? Just say something like this at your next highfalutin business get together:

“Oh yeah? Well this year I focused on getting my CPA below my LTV, I’m highly confident it will boost the ROI on my overall ad spend.”

(On second thought this might just make you look like a pretentious jerk).

Most of us understand the concept of LTV.

But is it actually something you can calculate without a PhD? And if so, is it something you can use to make better decisions?

Dave Bayless joins me to discuss these questions. We also talk about quick-and-dirty methods for calculating LTV, if a “good enough” calculation is good enough and more.

In the second half we shift gears and discuss the idea of building up a portfolio of eCommerce investments and how that might look.

Subscribe: iTunes | Stitcher

(With your host Andrew Youderian of eCommerceFuel.com and Dave Bayless from HumanScaleBusiness.org)

Andrew: Welcome to the eCommerceFuel podcast. The show dedicated to helping high six and seven figure entrepreneurs build amazing online companies and incredible lives. I’m your host and fellow e-commerce entrepreneur, Andrew Youderian.

Hey, guys Andrew here and welcome to the “eCommerceFuel” podcast. Thank you so much for joining me on the episode today. And on the show, I was joined in person who sat down at the ECF headquarter here Bozeman, Montana with Dave Bayless, another local Montanan here from Human Scale Business to talk about a couple different things. We talked about lifetime value. This is somewhat academic term that gets thrown around a lot. I think people know about at a conceptual high level K after a value. It’s, what, you know, the total value of a customer over the life of their interactions with my business.

But we dive into is something that how hard is it to calculate, is it something you’d take a stab at? You know, if you do spend the time to actually do that, what kind of questions should you start asking? And can you, you know, start using to help make changes in your business using that lifetime value data to improve your business? Should you finance growth if you think you have a lifetime value that’s really high in the long-term but you don’t have cash short-term?

We will talk a bunch of these kind of stuff. So that’s something that’s interesting to you and you like most people, you know, myself included, where most of my business career where I had no idea what your lifetime value was, hopefully that’ll be interesting enough.

And then the second part of our discussion, we dive into we talk about investing and not investing in the traditional stock market, S&P 500 sense, but we talk about investing in e-commerce companies. Obviously, if you own your own company you’re heavily invested in e-commerce but we take that approach of is there an opportunity and if so how would that look to invest in e-commerce companies on a broader sense, put together an investment of, you know, put money into multiple e-commerce companies not necessarily as the owner operated but as a strategic partner and investor.

You look at multiples on a lot of these companies that, you know, where they traded, you know, in that seven figure range even go up to $10 million, you know, or someone who’s generating around a million dollars in profit or even up a year, the multiples are still fairly low.

And so, you know, a lot of people, myself included, have looked at that and said “Man, looks like there’s an opportunity there but how do you tap into that? How does that work?” It’s a very unique and there are challenges to being able to do that. So, Dave has got a background of private equity, he’s got a background of investing and also working with, you know, these kinds of companies, you know, really in the trenches so we talk a lot about that.

So, a couple different topics both may or may not appeal to you but hopefully one of them does and you’ll get a lot of value out of this. So, with that I’m gonna play that funky transition music and we’re gonna get into my discussion with Dave.

Dave, welcome back to the show.

Dave: Glad to be back. Thanks for having me.

LTV Meaningful for Small Businesses

Andrew: We’ll get couple of cold beers another one here soon, and glad you’re willing to come talk about lifetime value. I think the lifetime value is one of those things that, academically, gets talked about a lot. I’m guessing almost everyone listening knows what it is. I’m guessing almost everyone listening probably doesn’t know what the actual lifetime value is. So, it sounds great theoretically but is that all it is like I love to get your take because it’s something you’ve had a lot about, worked a lot of companies on.

And then we can start with is lifetime value is something that’s great for big companies like Starbucks and Walmart to make decisions but it actually isn’t very practical for most smaller, you know, say, like six seven figure merchant stores, so is it something that you even a small, you know, medium sized seven figure merchant can actually use that and calculate to inform meaningful decisions in their business?

Dave: It’s a great question and it sounds like your experience has not been too different than mine, in some sense. You know, I learned about customer lifetime value probably back in, you know, eons ago when I went to business school and I came to recognize it always as just a special case of net present value analysis. And, yeah, that’s useful and interesting and then I kind of packed it away and didn’t even think about it for 20 years.

It wasn’t something that really was applicable to my daily existence. What’s been interesting for me is, over last few years, as I’ve come to work with a lot more six and seven figure e-commerce sellers, it’s come back to the floor. So, I think, like any tool it depends on the job at hand, and, I think, for very small companies it’s not a terribly useful or interesting tool because the company is small enough and simple enough that managing by intuition is sufficient.

You, kind of, know what’s going on. There’s not very much additional information customer lifetime value calculation can provide. When you’re a really, really big company, I think, people talk about it a lot but it ultimately sort of boils down, I think, to an academic kind of idea because big companies are so siloed that the core strength of customer lifetime value and that’s it’s, sort of, integrated perspective on value really isn’t something that you can act upon.

You know, if you’re head of customer support, you can’t pull the levers in sales or product design. So you can calculate it all day long, you just can’t do much about it. People with a seven figure store are facing enough complexity that intuition is insufficient, but they’re also in the driver seat. They can make policy decisions, they need to have an integrated view of their business and customer lifetime value becomes a really useful tool in that situation.

How LTV Can Affect Change

Andrew: So before we dive super deep, can you give us maybe a couple of anecdotes or some examples of how you’ve worked with businesses and retailers to calculate or look at their LTV and use that data to be able to make decisions that ideally or hopefully helping long-term trajectory of the business.

Dave: Sure. So one company a maker of their own product which is sold primarily through online but also through a network of wholesale customers and that had grown let’s call it organically, you know, in a very ad hoc manner. And it was a collection of large wholesale buyers. And, over time, lots of very small retailers who bought whole sale from them. And they didn’t have a process around selling to wholesale. So the little guys, the little customers had the same sort of bespoke ordering and pricing and customer service and shipping fulfillment processes that a big customer might impose upon you.

So, in this case, we use the customer lifetime value framework to recognize it, “Hey, there’s a cost associated with this category of customer,” the sort of small ad hoc wholesale, you know, buyers. And it’s really quite expensive to service them. So, we went through the, you know, a reasonable process of estimating valuation, and what became apparent was that the customer lifetime value for that category of customer was zero or negative. And what that spawn was a conversation about what to do about it.

There were lots of things that could be done. You could walk away from that customer base and focus your time and energy in limited financial resources on higher value customer channels. You could rethink pricing for example to make it a function of the volume people bought or the frequency of what they repurchased. I think one of the really important outcomes was rethinking the whole process.

So one of the things I’ve been excited about recently is the emergence of Shopify’s wholesale channel, for instance, to apply those familiar online processes to specialty retail customers. So, they don’t have to be as expensive to serve and all those things change the equation.

The Best Way(s) To Use It

Andrew: So when you think that LTV, does it ever make sense to do just one overarching lifetime value or to really use it effectively? Do you need to split it up to get LTV for all of your different popular types of customer segments? Sounds like I’m guessing the latter.

Dave: You know, my experience isn’t broad enough to have some, sort of, definitive, you know, perspective. Where I found myself applying it is usually about a customer category. And oftentimes, it’s related to a channel or a geography. Sometimes if there’s a distinct enough product category. And remember that most of the people that we work with are making their own product rather than buying lots, you know. So they’re not dealing with a thousand skews, they are dealing with a couple dozen maybe 100 skews overall.

So, in my experience, it hasn’t been so much about product categories, it’s really been about marketing and distribution channels.

Andrew: Can you kinda talk a little bit about thinking through the importance of getting an exact number and using…There are some bunch of different formulas and methods multiple ones for calculate lifetime value, maybe explain your thought process behind if you should. And if it’s really important to use one of those exactly and to get a very concrete exact academic number, or if you can, kind of, do a little bit more of a quick and dirty calculation to get something that’s in the ballpark. Like, how precise you need to be with these kind of calculations?

Dave: Well, getting a pretty good answer fast and cheaply is always a good way to go.

Andrew: That you’ll actually use?

Dave: It can lead some tremendous insights right away without going through a lot of the mental, you know, sort of, brain damage of trying to find a precise number. So, I think, of customer lifetime value is a model as a framework before I think of it as a specific quantity. It’s not to say the quantification doesn’t matter, because having a pretty good sense of whether something positive or negative, that’s really good to know, if you’ve got a pretty good idea of the order of magnitude of value. Is the customer lifetime value in this particular channel $10,000 or is it $10? That’s helpful.

And when you’re comparing, you know, how to spend your time across different categories, it’s useful to have some, sort of, notion of force ranking what category or grouping is your most valuable customer, what’s your least. Those are good places to start you don’t have to get super precise to get that kind of information. At some point, you may conclude you need to go, you know, drill in a little bit deeper, but I would warn against trying to worry too much about precision right out of the gates. You know, try to figure out, “Wow.I wonder what range of pretty good guesses do I have a positive customer lifetime value?”

Is There An Easy Way To Use LTV Results?

Andrew: You know, we were talking about before we had gone on, you know, using sort of four wasn’t discount rates and applying those which are effectively, kind of, like, interest rates in a sense to discount things back. But maybe go on the other aspect, look at really simply, let’s say…I mean, I remember trying to do this for actual radios and just taking a very ghetto approach to, you know, looking at expert in the whole database looking at the email addresses, figuring out, you know, some of the email address was unique for a customer, figuring out how many times they purchased, you know, two or three year period their average purchase size.

And I came up with a rough number of revenue in any times that by a rough number if your profit margin and that’s roughly what, you know, your average customer is gonna be worth over the lifetime of their time with you. Is that the best way to do? What’s probably the best way of someone’s thinking about like, “Hey, I have two approaches like, you know, I have an hour this week that maybe I can dedicate to this.”

What’s the best quick and dirty way for most people to be able to do this where they can get an answer in an hour and get a sense of, “Okay, here is a number overall all I can work with.” And then maybe, you know, maybe apply that same approach to maybe there, you know, three or four different channels down the road to get a little more nuance. But is the approach that I, kind of, took is an okay one or should people be thinking about that a little more sophisticated perhaps?

Dave: You know, it’s interesting, in my own conversations, interviews on entrepreneurs, I ask them, you know, a recurring question about some of the most important things I’ve learned. And a significant proportion of people talk about how they wished they’d just started earlier. So, the application of the tool or customer lifetime value, you know, one of the biggest benefits is just doing it. So, I guess my answer would be whatever gets you off the dime and take 15, 30, you know, 45 minutes to ask these questions in a structured way is the best way.

Whatever that’s gonna get you started. Because it’s one of these things that you think you only got an hour for it, but if you find that it’s starting to yield interesting questions and prompting you think differently about your business, you’re gonna find, you’re gonna put all the energy into it that’s required.

The hard part is people looking, you know, staring blankly at some, sort of, complex summation formula and say, you know, “Screw that. I don’t have the time for that.” So if you just look at, you know, your gross profit make some estimate of what it cost to service a customer over the course of a year to remarket to that customer. You can make some pretty good guess of what the lifetime is gonna be, customer lifetimes aren’t infinite. People die. I mean, at the outer edges, but if you’re buying baby diapers, you can make a pretty good guess their maximum retention is gonna be four, five years. So you can spitball that and you can come up with a, you know, a reasonable discount.

You don’t have to worry about compound interest rate. Just say “Hey, a dollar today is worth more in a dollar in future so I’m gonna apply an 85%, you know, discount to one of my, you know, simple calculation is gonna be.” And then go to, you know, the point, is it positive or negative? Is it $10,000 or $10? And then when you’ve identified some of these components of the calculation that might be drivers of value over time, it inevitably prompts questions like, “What do I do? How can I tweak it? How can I change my business to make the value go up?”

LTV For Young Businesses

Andrew: What do you do if you’re five years old as a business, you’ve got a good amount of data, what do you do if you’re nine months old and you’ve got data, but, I mean, really for repeat customers especially let’s say your repeat customer cycle is, you know, gonna be about six or 12-month period you don’t have the data. Is it even worth doing this calculation if you’re that young?

Dave: Oh yeah. I mean you can still make pretty good guesses and you can make a range. You know, one thing I would advise is don’t get hung up on point forecast you’re gonna be wrong. Even if you have not gone into business, depending on your product and your market, you can at least come up with an educated guess about what your average customer relationship duration is gonna be. And have confidence and you can say at least, you know, “I’m 80% confident it’s gonna be within, you know, 18 months to 48 months.”

Run your calculations and figure out, you know, is tweaking the parameters gonna change the conclusion? Is it gonna change your behavior? If the answer is no, move on. You don’t need to worry about dig in deeper. If you find that that customer, you know, value is really strongly driven by your retention rate, you might want to take a closer look and start thinking about how you might capture information over time.

One of the nice things about e-commerce companies, for example, is you can measure effectively back into a duration calculation, you know, way that brick and mortar sellers would find very, very difficult. You know, out of scope of our conversation here but, you know, if it’s important it can be done even if you don’t have lots and lots of hard data.

You’ve Got Data. Now What?

Andrew: Let’s say somebody calculates their LTV or their multiple LTVs for different types of either customer types or channels, and they’ve got these numbers and they’re looking at them, what kind of, question should they be asking themselves about what they should do with this information? And how should this information inform…You touched it on a little bit at the beginning, but maybe if you could kinda could go through some of those different areas where they should think what should we be doing differently given that we know that this is our LTV for customers?

Dave: Well, if you go through the process of looking at the framework and understanding that there are multiple drivers of customer lifetime value, so it’s not just the customer acquisition cost, it’s not just the contribution margin, it’s also the duration of the relationship. It’s the cost and the perspective benefits of customer service and the marketing efforts, you know, the investments you make in upselling, cross-selling, spurring repeat purchases. Recognizing those in relationships is really powerful thing because then you can start asking questions about if I move one of these dials, how might it affect other things?

For example, there is a tendency in business to view customer support, customer success as a cost of doing business because we see that the cost of paying people to do customer support is salient. And the benefits are sometimes ambiguous. But to go through the customer lifetime value process, you start realizing that, “Wow, if I’ve got people on the phone doing customer support, that’s an opportunity to do cross-sells and upsells. If not that, it’s a way to help ensure that my customer retention might go from 24 months to 36 months on average over time. If I find a way to capture that information providing really great service, I may be able to use that on the front end marketing and actually lower my customer acquisition cost.”

So, recognizing the interdependencies of these variables rather than looking at an isolation is just a cost, you know, burden, or a source of revenue, it is really enabling and it helps you think about your business in a much more dynamic way and gives you a lot more combinations and permutations to draw upon to actually increase your value over time because that’s the ultimate objective is to increase your customer lifetime value.

Deciding on LTV As an Investment

Andrew: Let me give you hypothetical situation, and, obviously, that your decision on this would vary, I’m sure, on the number of variables and so I’m not expecting exact answer, more of a high level answer. But let’s say you had somebody who came to you and said, “You know, Dave, I’ve got a business and I figured out that my customer lifetime value is $500. I’d like to start advertising growing the business much more quickly. I’m capital constrained but I’m able to get some financing in order to pour into marketing. And, I think, that I can acquire customers at let’s say $300, $350 per pop for that lifetime value. The lifetime value recoups over let’s say two or three-year period, I think, I’m going to I’m strongly considering taking a financing to invest in marketing because, I think, my lifetime values longer.”

Do you think it’s a good decision? Like, do you think it’s good to finance growth even if your lifetime value, if it’s there but it will take multiple years to recoup?

Dave: The short answer is yes. The longer answer is it depends. And the person that came in to me that, sort of, our scenario, first, I got to want to do is I’ll, sort of, unpack where the number come from. What assumptions did you make? How confident are you in those assumptions? I mean, one of the experience I’ve had as a business analyst is creating very complex models and calculations and going through each of the assumptions and agonizing over it and then saying, “Yes, I’m pretty confident in this assumption.” And you add all those pretty confidence together can sometimes lead to a really absurd outcome.

So, I’d wanna say, “Okay, how confident are you?” And also go into their risk tolerance. I mean, different people…the answer is gonna be different for different people because, of course, you have special leverage and debt financing to your business amplifies the underlying risk. So, you may wanna phase how you do that, you know.

For example, before you mortgage the farm to go raise all that money to pour into advertising, you might wanna think about doing it in stages and finding a way to see if you can measure the effect and test whether your guesses about the drivers of customer lifetime value have validity in that scenario.

I’d also want to talk about what alternatives are there to increasing value? Is advertising the only investment you should make, or maybe it’s investments and customer success? One of the relative, you know, contributors to those different levers is make sense to do just one or maybe, you know a couple levers in concert.

Visual Framework For Getting Started

Andrew: You’ve put together some resource for people in how to think about this and even compute LTV for themselves at ecf.hsb.online. So, ECF for e-commerce field, HSB, humanscalebusiness.online. And can you just maybe quickly mention what those are if people who go there what they’ll find?

Dave: You know, there’s a PDF download that actually something I created for myself. It’s just a, sort of, visual framework for customer lifetime value. So if you’re not interested doing any calculations whatsoever, I think, there’s value in just seeing how, you know, sort of, the underpinning assumptions of this model, this framework. And second is a pretty standard Excel-based calculator that I put together that, you know, if you’re interested in taking that step, it can save your couple hours from putting the model together.

What Dave Does at Human Scale Business

Andrew: In human scale business,can you quickly remind people what it is? What Human Scale Business is and how or if you can help versus listen to this if they’re really interested in doing a deep dive on, you know, figuring out LTV and how it applies to their business, if that’s something you get if you help merchants with.

Dave: Absolutely. So, Human Scale Business is a consulting in business education firm that Laura Black and I own and run are, sort of, the bull’s eye of our target market, our founders of growing companies that design and make their own products and that are sold direct to consumer online. So, they tend to be small but inherently complex businesses. And we’re wonks. Were business egg heads. Where we can help is when people’s businesses are outgrowing their intuition and they need to take a little bit more systematic view of strategy in particular. So we can help do things like customer lifetime value and help translate that back into real decisions about marketing, sourcing, fulfillment, financing strategy.

Andrew: Right, thanks, humanscalebusiness.org. Again, the website for the LTV resources was ecf.hsb.online. And, Dave, you;re also a member of the forum, so if you’re in the community and you wanna ping him about any questions about any of this, feel free to. I’m sure he wouldn’t mind at all.

Dave: Absolutely.

Andrew: Let’s shift gears a little bit, and if you’re listening, we’re gonna move away from LTV a little bit to something that, to be totally honestly, is kinda, selfishly, something I wanted to ask you about. It’s something that’s been on my mind…Not sure how applicable it will be to everyone listening but might be interesting just from the e-commerce standpoint, and that’s, kind of, some questions I had about investing in e-commerce businesses.

I was hanging out with some good friends in the e-commerce space this summer and the topic turned to investing and investing in e-commerce businesses. And a number of them…They, kind of, really urge me to seriously think about trying to put together some kind of fund or systematically invest in e-commerce businesses.

If you look at ecommerce businesses, you know, up until a million dollars in cash flow, or even though I haven’t really look at it, a lot of times you’re only seeing multiple of 3x which, you know, 30% return even if you account for a salary in there for the owner, you’re still looking at returns that are much better than what you can get lot of times in the other market.

Flip side to that is you’ve got obviously much more risk, it’s a more opaque market. It’s much smaller, a lot of these different things. But the idea was to look for businesses in that, you know, let’s say, you know, $3 to $5 million range maybe up to $20, $25, $30 million in revenue and come to them, and not private equity in the sense of trying to invest in a company lever it up, improve it and flip it within five to six years.

But really with an investment strategy more focused on cash flow, on not permanent equity investment from people, but definitely much a longer-term, you know, not 5 years more like in the 10 to 20 year horizon, with the idea of being to try to come into those companies keep the management in place, you know, let’s say maybe take a 30% to 50% stake in the business and be able to provide capital, one, of course, but also, secondly, advisory services and connections which would something be something I try to do as well given my unique experience.

So, I wanna to get your thoughts on that. Is that something that you think…I mean, you’ve got a lot of experience in the private equity space, working with a lot of these small businesses. And, I think, as I found through it, I think, a couple of other things that success would hinge on would be, one, looking for companies with great management teams that had solid products that wanted to be able to take some money off the table to sell a portion of their business but still wanted to stay involved.

And then secondly, either that or companies in that range that needed financing and expertise but weren’t able to get that other places because, I think, it’s really the only two ways where I was running a company like that would make sense for me to be on the other side of that deal. Anyway, I, kind of, throw a lot at you there, but broadly speaking, do you think that’s a feasible…do you think it could work?

Investment Opportunities via eCommerce

Dave: I think it will work because the opportunities going to continue to grow. And given the need and the global scope, it’s going to attract capital. There are lots of people asking similar questions because it’s different. I mean, it’s not the same kind of situation that, you know, I and my colleagues faced years ago in doing, you know, roll ups. But businesses that are doing, you know, specialty retail or what we call human scale businesses that are niche producers of product are becoming a larger and larger component of our economy and there are some inherent tensions in the business models.

What founders of these companies tend to be good at is part development in innovation and developing a really keen sense of who their customers are in their niche usually because they came from that niche. They know it because they’re really a part of it and most of that how they can compete against larger companies with scale and scope. That said they, run into the issue of having to manage operational complexity and fulfillment, and ultimately financing. And those are all things that benefit from economies of scale and scope.

And the diseconomies of scale and economies of scale have a hard time living under the same roof. So, I think, it’s very likely that we’re going to see emerging forms of investment private equity that focus on that market and try to somehow bridge these incompatible worlds.

How that’s gonna be done…I think, people who hit on several of the issues, it’s gonna be fraught with danger for everybody involved, it’s how you marry that sensitivity to the customer and the innovation and product development comes from that with some of the demands of scale and scope.

Investor Stakes

Andrew: Do you think it’s possible to do that effectively to come in a traditional lesson sense and say, “We’re gonna be advisors for you. We’re gonna give you a large cash infusion units to help grow the business or to take money off the table for yourself,” if you wanna take, you know, maybe half of it, it’s like you bringing the business? Or do you think you have to come in with something more nuanced that could address the problem perhaps, say, you mentioned fulfillment, some of these other issues, where you have one umbrella, maybe you don’t own the company but maybe you have part of your value add would be saying, “Fulfillments are paying for you.”

We’ve got a huge 30,000 square foot warehouse here. Five of our other companies, they work out of them, we lease it to them at a very favorable rates. It’s got a photo studio, it’s got a filming studio. We have, you know, accountants on staff that you can talk to. We’ve got fulfillment. Of course, we’re housing all these kind of stuff. From a purely selfish investor standpoint, that sounds less attractive but obviously it adds more value. Do you think something like that would be necessary to make this work?

Dave: I suspect so. You know, I, too, you know, just naturally given my background, I’ve thought about there seem to be some interesting investment opportunities. But applying some of those, sort of, familiar investment techniques to a $3 million revenue niche producer, just starts to look afraid, you know, really quickly. To get some scope, to get some breath, to get some of the benefits of portfolio diversification without diluting a hell out of your focus, probably requires some element of operations platform, where the people on the product and the marketing are living and breathing, you know, their niche but they’re benefiting from an optimized fulfillment operation.

You know, you don’t have to reinvent that wheel. That can be done. You don’t have to find out where you’re gonna make your product videos. So, I suspect your intuition is right, that it’s gonna look a little bit like an old-school conglomerate. It’s hard for me to say because there are so much hair that comes with that, you know, concept but having an operating and finance platform and somehow marrying that to a dynamic portfolio of laser-focused product and marketing, you know, notes. It sounds hard but it sounds, you know, certainly plausible and maybe even interesting.

Headed to No Man’s Land

Andrew: If I was a 10…I’m not. I wish I was, so if I owned a $10 million-business, say, it has generated $2 million in, you know, leap it to up per year. And I wanted to continue running the business but I also wanted to take some chips off the table, I wanted to be able to let’s say cash out a little bit, take some money out of the business on the equity side maybe bring in some partners who could help out with a few things. Would I have a lot of good options? Is that a place where there are private equity firms right now or investment people looking to invest that would be interested and eager and take an investment in that stance for, let’s say, a 4-ish-x multiple? Or is that, kind of, a no man’s land?

Dave: I think it’s a no man’s land. In my experience, it’s more likely that somebody would just want to buy you and, you know, have you hit the beach. It’s tough to with that small level company to use that as an investment platform or a standalone investment. You really are increasingly in, kind of, a no man’s land somewhere north of the long tail of the distribution but well south of the fat head. So you’ve got the worst of all worlds in some respects.

Bringing In Investors Vs. Maintaining Control

Andrew: Are there many people like that? Like, I just used myself as example as a hypothetical but is that a scenario? Is that a common scenario? Or is it much more likely, in your experience, as you see founders, who either say, “I wanna keep bringing this 100%. I don’t want someone else coming in and tell me what to do.” Or they say, “I’m done. I wanna cash out.” Do you have many founders that are interested at that scale in selling it let’s say 30% to, you know, 49% stake in the business assuming they could maintain control?

Dave: Most of our clients are smaller than that. They’re in the below seven figures so they’re very much in the mindset of, “Wow. This is this is cool, you know. My years of hard work are paying off. And now, I’ve got the money to be able to do some things.” But they tend to be really energized about the business themselves and then what they struggle with is, “Do I wanna make a run across the no man’s land and build a $50 or $100 million business?” Or, they’re thinking “Well, this has been fun, but now I’m saddled with all sorts of managerial responsibilities that I don’t really enjoy and that I’m not very well equipped for. I really love product development. The operational headache of running fulfillment is just not my cup of tea, you know, is there any way I can get out of this?”

So, they tend to be looking to either, you know, lock down for the next 20 years or, you know, find a way to sell it while the revenue and cash flow ramp is still open to the right.

Andrew: And I’m kinda gonna be dipping back to your private equity days is that something you saw very often with owners on the larger side of the scale, you know, whether that’s…I don’t know exactly where that is, but I wanna say $50 million-ish. Do owners…I guess what I’m getting at is do you think there’s any opportunities or very many opportunities to be able to come in, take a meaningful stake but still have a management team and ownership team that’s still very much invested in the long-term success of the business? Or do you think that’s rare that people usually either all in or they’re ready to make an exit?

Dave: It’s hard as an investor to go in and just take a stake. You know, the work that I did in the past years ago was really I’m, you know, buying a platform doing a roll up. So there was one entrepreneur that fit that bill, but we would acquire the vast majority of the equity stake and provide the capital to go acquire, tuck in and grow the business that way. And there was enough financial return for the CEO, sort of, the keystone founder to make that game interested in an opportunity to really grow the scope of their operations and their experiences in a relatively small percentage of the business could translate into really meaningful value over time.

I have never really participated in an investment of a company in the eight or nine figures where it would be, you know, more of a, sort of, a venture minority stake. That’s hard for me to get my mind around, quite honestly.

Andrew: So, you go in, and the CEO or the owner would…You’d buy a majority stake as the investors, as a CEO, they would have a percentage plus a smaller percentage and they would still…Okay, the big difference would be you would take…it wouldn’t be minority stake, it would be majority stake that would be taking. And in those cases, would you…I’m guessing, how much would you and the firm you were working with, how much would you get in and really get your hands dirty in terms of the operations, bring people in, where were you mostly taking ownership making sure the leader had a really good set of structure and obviously advising but you weren’t, you know, the one really driving the ship? Was that more of an investment stake? Or, was it you were really in there, getting your hands dirty?

Dave: Well, I can only share my personal experiences which obviously are limited. When thing worked, I wasn’t that involved. In one particular case, it’s way back, our best bet for that managing CEO didn’t work out. And I found myself way above my head, you know, knee-deep in the operations of the business. And my role, at that point, was to cure our original sin by finding the right CEO and making that acquisition which we were able to do, we were very, very fortunate. But typically not. I mean, investors do investing. And while they have connections and know-how in personal experience, they wouldn’t be the people I’d turn to run my business.

Helping Big Companies From The Backend

Andrew: I had a friend this week, one of the same friends that we were, kind of, spitballing this back and forth with, you know, kind of, tongue-in-cheek said, “Hey, you know, Andrew, you should just find $50 million-companies that don’t have help desks and get them set up on that and you’ll instantly, you know, add a lot of value to some companies that are just enormous and atrociously unsophisticated behind the curtain.”

You, as partially being tongue-in-cheek, you partially being serious based on experience you’ve had. I’d love to be able to think that there’s a bunch of right opportunities out there to take companies at scale who don’t have great systems on the backend, swoop in for 18 months as the advisory or even get your hands dirty. Bring them back in, you know, into 2017 and be able have a graceful exit with, you know, a nice little return. But, I think, that, for some reason, that just sounds to clean and tidy and then I guess I’m suspect it was that many opportunities like that.

That was my intuition or my gut feeling. Would you share the same thing? Or, do you think there’s actually a lot of businesses in the mid-eight figure range that are just running on systems from 1960?

Dave: Man, it’s just two-fold. One ism I suspect that there are businesses out there…I know of some who have developed an interesting business but are in significant need of a rethink in terms of their process or systems to modernize and then to adapt to a very rapidly changing competitive environment. If you’re not using e-commerce automation today and making that a course out of your expertise, you really should.

That said, I think, your skepticism is warranted, you know, to come in and contribute how can you get fair value for that? And, I think, that’s a lot tougher I think you could probably help create value. But getting compensated appropriately, I think, is another thing. I mean, one of the things we’re just guilty of as human beings is we tend to internalize value very. very quickly.

So, the truth is that you can’t add value to a platform business without the platform being there. So, it’s very difficult to really discern how much value you contribute. I started, you know, early in my banking career I was working for Citicorp and I thought I was creating a lot of value. It was only until after I left Citicorp and put up my own shingle that I fully appreciate the leverage of that brand. Maybe my value contribution wasn’t as big as I thought it was, at the end of the day.

So, I don’t know. I’m more interested, I guess, personally, my bias has become find opportunities that are really worth a lot of effort, and then go execute on that, and put yourself in the position of getting an appropriate return. I have never found a way and it maybe just be my shortcomings to kind of find those clever finesses. It usually, you know, great ideas tend to devolve into a lot of hard work.

So, I guess I’ve become more sensitive to the question, “If this isn’t a good idea and it does devolve into really hard work, I might gonna be willing to do it for however long it takes.” It just tends to narrow down the range of things I’m focused on.

How to Split an Increase in Value

Andrew: It’s a great quote. I love that. Great ideas tend to devolve to, you know, lots of hard work. It’s funny you mentioned that being able to certain value and where that comes from there was someone who has a really interesting business that I chatted with last year. On a couple different occasions, we had serious talks to try to figure out where I could either invest in the business or come in for a period of time and really help, or do my best to try to take the business to the next level especially on the marketing side. And, I think, there was a lot of opportunity there for us both to be able to create something that was more than the sum of the parts, but the problem we ran into both times was kill the deal was we could not agree upon a way to be able to split that increase in value.

On my side, I wanted to come in and work for 18 months, two years at the most, and then be able to step away and have a long-term equity stake in the business. And, I think, for the owner it was very difficult for them to be able to see someone come in for two years and then be able to take money out of the business doing nothing going forward, which if I was in his shoes I probably would have a similar approach, but if in my shoes I’m thinking, Well, I’m more or less buying my equity, you know, with those two years.”

So anyway, the bottom line, I think, neither of us was right or wrong, but what I learned from that was it is…it’s very difficult to try to be able to set up. And this is from the outside, this wasn’t a year down the road had we done it, where there was resentment or people feeling like they got the wrong end of the stick and then you’re a business partner with them, you know. So it was interesting because that was a very, very tricky thing to do. And we didn’t do it obviously it’s what made it not happen, so…

Dave: You know, it’s mostly very difficult to do. I mean, it’s one thing to, you know, all pretend we’re economists and we’re gonna make rational decisions about value creation and splitting the baby. But when you’re a founder of a business, as you know, it’s really hard to see somebody…you know, it doesn’t matter how smart and talented you think they are to come waltzing in at your eight and talk about adding value. And you can still remember the sleepless nights when the wheels on the bus were awfully shaky and, you know, you were driving a 20-year-old car to make ends meet. It’s just, you know, maybe we shouldn’t, you know, let our emotions cloud our judgments in situations, but it’s naive to think what they won’t. They do.

Andrew: Dave, it has been a lot of fun. Dave Bayless, humanscalebusiness.org. Make sure to check out his work. He’s got a lot of interesting posts and information about, you know, just thinking about how to grow your business, how to optimize it. Rally cool stuff. And, of course, he and his partner, Laura Black, offer advisory services. If you enjoyed what we’ve been talking about and would love to know going deeper on some of these issues, not the ones that actually per se about investing but, some of the other ones we talked about, lifetime value, previously, or just getting help strategizing with your business to be able to take it to the next level, especially if you are a creator and someone who’s making unique individual products, Dave is a great guy to take to. So, Dave, thanks for coming back.

Dave: My pleasure. Thanks for having me.

Andrew: Want to connect with and learn from other proven e-commerce entrepreneurs? Join us in the eCommerceFuel private community. It’s our tight-knit embedded group for store owners with at least a quarter million dollars in annual sales. You can learn more and apply for membership at ecommercefuel.com. Thanks so much for listening and I’m looking forward to seeing you again next time.

 

What Was Mentioned

Photo: Flickr/Paul Townsend

Post tagged in: Lifestyle & Growth, Podcast

Speak Your Mind

Your email address will not be published. Required fields are marked *