Building a valuable business

From: alexhormozi

Building and growing a successful business can be likened to creating a masterpiece, like the Mona Lisa, where every piece must be in the right place to achieve perfection [00:00:00]. A key aim is to transform a business from merely generating money into an incredibly valuable asset that can financially change one’s life and family’s future [01:20:00]. This concept is explored through the “Value Acceleration Method,” developed by acquisition.com [01:30:00].

The value of a company, or its Enterprise Value, is primarily affected by three variables:

1. Increasing the number of customers [02:02:00]
2. Increasing the Lifetime Gross Profit per customer [02:09:00]
3. Decreasing risk, which refers to the likelihood of the business continuing its performance in the future [02:30:00]

The following 10 elements are crucial for building a valuable business, each unlocking a new level of Enterprise Value [02:47:00].

Key Elements of a Masterpiece Business

1. Leadership Team in Place Running the Day-to-Day

A valuable business can not only maintain but also grow even in the absence of its owner [03:10:00]. Many small businesses are essentially well-paying jobs for the owner, not true assets [03:40:00]. True wealth is generated from owning assets, not just earning a paycheck [03:58:00].

• Experienced vs. Inexperienced Operators: Bringing in a seasoned operator significantly reduces risk and can dramatically increase profitability, even leading to periods focused solely on profit expansion rather than growth [03:38:00]. An inexperienced operator can lead to plateaued growth, rising costs, and a decline in profitability [05:18:00].
• Qualities of a Good Operator: An operator is someone who can truly lead the business, someone the owner and team admire and aspire to be like [06:36:00]. They should increase the owner’s time and bandwidth [06:56:00]. A good operator aims to decrease work globally across the entire company using minimal systems, whereas a bad operator tends to add tasks without removing others [07:41:00].
• Hiring for Purpose: Hire someone with a clear goal or problem to solve [09:17:00]. Look at their track record and relevant experience as the primary predictor of success, rather than just compatibility [09:50:00].
• Value of A-Players: A-players cost about 25% more but produce five times more than B-players [11:10:00]. Top talent knows their value and may negotiate, which is a sign of their capability [11:45:00].
• Equity and Growth: Founders who build very wealthy companies often own a smaller percentage (e.g., 12% on average at IPO) because they prioritize growing the overall “pie” rather than retaining 100% of a smaller one [11:51:00]. Incentivizing others to grow the business is key [12:15:00].

2. Marketing Without the Founder

When the founder is central to marketing efforts (e.g., appearing in all ads), the business becomes a job, not a sellable asset [13:03:00].

• Transitioning Marketing Presence: Transitioning the founder’s marketing role to someone else takes time, potentially around 12 months [14:52:00]. This involves joint appearances, gradually increasing the exposure of the new person until they can carry the brand independently [14:18:00].
• Separating Personal Brand from Business: It’s possible to separate a personal brand from a business brand, allowing the company to be sold without being tied to the founder’s ongoing presence [15:02:00].

3. Delivery Without the Face of the Founder

If the founder is key to service delivery or customer relationships, this presents a risk factor for potential buyers [16:00:00].

• Delegating Delivery: Instead of finding one person to replace the founder, it’s easier to find multiple people (a “Hydra” of experts) who can fulfill different portions of the founder’s role [16:56:00].
• Edification and Equity: Edify these individuals as subject matter experts in their respective areas [17:21:00]. Granting small amounts of equity (e.g., 0.1% to 0.5%) can incentivize them and ensure non-compete agreements hold weight [17:52:00].
• Impact on Risk: Removing the founder from day-to-day delivery significantly decreases risk for an investor, making the business more valuable [18:40:00].

4. Multiple Reliable Acquisition Channels

Reliance on a single customer acquisition channel poses significant risk [19:54:00]. Having diverse, reliable channels reduces the risk of sudden business collapse if one channel fails (e.g., a platform ban) [20:28:00].

• Diversification Strategy: Identify and build out new acquisition channels, even if they start small. A common strategy is to first optimize existing channels by doing “more and better” before adding new ones [24:30:00].
• Timing for New Channels: It’s generally advised to stick to one offer, one avatar, and one channel until the business reaches at least $1 million per year [23:47:00]. New channels should be introduced when the business is stable and growing [24:06:00].
• Patience and Progress: Building new channels takes time and resources. Focus on tracking progress metrics (e.g., clicks, opt-ins, show rates) rather than solely on immediate outcomes [25:21:00].
• Leveraging Others: It’s often more effective to bring in someone else to own and develop a new channel while the founder maintains focus on the primary channel [26:50:00].
• Market Research: Look at where competitors in your industry successfully acquire customers [27:22:00].

5. Reliable Recurring Revenue

Businesses with reliable recurring revenue streams compound over time, leading to significantly higher value compared to those relying on one-off sales [28:34:00].

• Net Negative Churn: The ideal scenario is “net negative churn,” where even without new customers, revenue still increases each month due to existing customers increasing their value (e.g., Salesforce adding seats or services) [30:07:00]. This allows for nearly unlimited customer acquisition spending due to high customer lifetime value [30:56:00].
• Multiples on Earnings: Public companies with reliable, growing recurring revenue (like Netflix or Amazon) command much higher multiples on their earnings (Price-to-Earnings ratios) because investors anticipate continued future growth [31:48:00]. Amazon, for example, has an extremely high multiple due to its slim margins (reinvesting in growth) and vast expansion opportunities, making it highly defensible [32:30:30].
• The Nine C’s of Recurring Revenue (Increasing Stickiness):
  1. Consumption: Customers actively using the product/service [34:28:00].
  2. Collateral: The business holding something valuable to the customer (e.g., data, physical items) [34:41:00].
  3. Cost of Switching: High effort or loss of benefits if a customer leaves [35:00:00].
  4. Choice: Limited or unique options available outside of your offering (e.g., patents, trade secrets) [35:19:00].
  5. Control: The ability to control the customer’s money flow (e.g., payment processing) [35:32:00].
  6. Cause: Alignment with a mission, charity, or movement [35:53:00].
  7. Community: A strong community around the product or service [36:05:00].
  8. Contracts: Commitments like 12-month memberships [36:30:00].
  9. Communication: Regular engagement with customers, providing things to look forward to [36:42:00].

6. Diverse Customer Base

A diverse customer base minimizes risk. Relying heavily on one large “whale” customer can make the business vulnerable if that customer leaves [37:22:00].

• Risk Mitigation: Ideally, no single customer should account for more than 20% of revenue, and for more conservative approaches, less than 5% is preferred [39:06:00].
• Profit Vulnerability: A single large customer, even if they represent 20% of revenue, could account for 100% of profit, making their departure catastrophic [39:51:00].
• Strategic Choices: If a business chooses to pursue large “whale” clients, the strategy should be to acquire many such clients to maintain diversity among high-value customers [38:31:00]. Focus is key: either serve many small customers or many large customers, but avoid being dependent on one large client [40:40:00].

7. Automated Metric Tracking

Data is crucial for making informed decisions and significantly enhances perceived value to an investor [41:17:00].

• Real-time Insights: Automated dashboards allow for real-time tracking of key metrics (e.g., registrations, affiliate numbers), preventing manual, time-consuming data collection [42:25:00].
• Decision Making: Lack of data leads to guessing in decision-making [42:54:00].
• Impact on Value Drivers: Automated metrics provide insights into customer acquisition, Lifetime Gross Profit, and overall business risk [43:27:00].
• Implementation Steps:
  1. Pick a platform: Integrate a CRM like Salesforce or HubSpot [43:08:00].
  2. Select key data (KPIs): Determine what specific metrics to track [47:12:00].
  3. Assign ownership: Designate a person to own the implementation and management of the tracking function [47:18:00].
  4. Develop a game plan (Theory of Constraints): Identify the biggest bottlenecks or smallest numbers in the business (e.g., lowest conversion rate) and focus improvements there for the highest impact [47:28:00].

8. High Cash Flow, Profitable, Growing with a Good Story

Investors prefer businesses that are already in motion (growing) because they are more likely to continue to grow [48:44:00].

• Key Characteristics:
  • High Cash Flow: Generates cash in excess of what’s needed for reinvestment [48:58:00].
  • Profitable: Generates profit [49:04:00] (note: profitability doesn’t always equal cash flow if payments are delayed) [49:09:00].
  • Growing: Consistently increasing in size (revenue/customers) month-over-month or year-over-year [49:26:00].
  • Good Story: A compelling narrative that aligns with trends (e.g., AI integration or AI resistance) to demonstrate continued growth potential [49:27:00].
• Focus on Cash Flow (for self-funded businesses): Unlike venture-backed companies (like HubSpot), most self-funded businesses should prioritize strong cash flow and profitability to de-risk the founder and ensure sustainability [50:00:00]. This may mean sacrificing some growth for the ability to take regular paychecks [51:00:00].
• Product Suite Optimization: Analyze products/services based on absolute gross profit and gross margin, and reorganize the sales process to emphasize those that yield the most profit and margin [54:22:00].

9. Audit-Ready Financials

Having verifiable, transparent financials reduces risk for potential buyers [55:46:00]. An “audit-ready financial” means a third party can validate the stated profit numbers [55:56:00].

• Levels of Financial Sophistication:
  1. Basic Financials: Outsourcing to a bookkeeper [56:33:00].
  2. Accountant with GAAP: Upgrading to an accountant who prepares financials according to Generally Accepted Accounting Principles (GAAP), which recognizes revenue over time and accrues costs, smoothing out financials for easier analysis [56:47:00].
  3. Audit-Ready/Quality of Earnings (QoE): Having books ready for a third-party audit or obtaining a Quality of Earnings report, which provides a “blue check mark” of validation [57:34:00].
• Importance of Finance Function: A well-developed finance function provides clarity on cash flow and investment capacity, alleviating uncertainty for the business owner [58:50:00]. Without it, selling the business for a material amount is nearly impossible [59:24:00].

10. 5 Million Plus in EBITDA

This is a size requirement for most institutional investors, as companies of this scale typically already possess a professional management team and infrastructure, reducing the effort required to grow them [59:33:00].

• Valuation Multiples: Larger businesses command higher multiples on their earnings. For example, S&P 500 companies trade at 23x earnings, while small businesses (under $10M/year)mighttradeat1-4xearnings,increasingto5+xforbusinessesover$10M/year and $2M/year in profit [01:00:19].
• Time to Growth: With the right tools, systems, and plan, businesses can see significant growth in revenue (e.g., 1.8x in 12 months) and profit (e.g., 3.01x in 12 months) [01:01:04].
• Targeting Acquisitions: Many investors, including Acquisition.com, target businesses in the $2-6millionEBITDArangebecausetheirexisting[[framework{s}_{a}n{d}_{l}esson{s}_i{n}_{b}uildin{g}_{s}uccessfu{l}_{b}usinesses|playbooksandchecklists]]canquicklyplugholesandunlocksubstantialvalue(e.g.,takinga$2M profit business to $9.4MEBITDAintwoyears,increasingitsvaluefrom$6M to $63M) [01:01:40].
• Focus on Bottlenecks: The key is to identify and address the specific bottlenecks within the business, rather than expending effort on non-critical areas [01:02:44].

By addressing each of these 10 points, a business can transform into a valuable asset, creating generational wealth [01:03:31]. It’s about ensuring that customer acquisition and value generation continue reliably, regardless of the business’s current size or stage [01:03:38]. The goal is to identify and fill the “holes in the painting” to complete the masterpiece [01:03:57].