Welcome to the itsp magazine Podcast Network. You're listening to a new episode of the founder pack podcast with your host, Brendon rot, bring startup stories from experienced founders and other functional experts to help current and future founders get inspired and grow their knowledge with quick tactical insights. Knowledge is power. Now, more than ever.
Hey, Chris, welcome to the show.
Thanks so much. Appreciate you having me, Brendan,
thank you for giving up your time to chat with us on founder pack podcast today. So how is your week going? So far? Anything interesting, you'd like to share with the audience?
Oh, it's been a busy week where it's even in a relatively down market for m&a. We've been really busy. So we're grateful for it.
That's a great segue to our topic today. I would love to hear your thoughts for a few minutes about the current market ecosystem.
Yeah, it's not dissimilar to what we saw in other markets where either there was a recession or maybe a fear of recession, which is, is still a fair amount of deal activity. But it's focused on high quality companies, and companies that generally perform well during recessions. From a from our vantage, we've been very busy. We've got some great companies that we've been taking to market. And so we've, like I said, we've been very busy. And what we saw was, I would say q4 was probably the worst of the deal environment. And I think that's when lots of buyers were still reconciling to higher interest rates, and dealing with what that meant for their financing and for their valuations. And on the flip side, sellers expectations, when valuations are going down, never adjust as fast as buyers expectations. But we're starting to see those come together more or at least start to meet. And our expectation is that we'll see a lot more deal activity over the next 12 months, certainly than we saw in the last 12 months. It's we're excited for it.
And just to give our audience a little bit of context about you and your background, would you mind sharing a quick introduction and overview about you and what you're up to?
Sure, sure. So I am one of the founders along with my co founder, David Tolson of class, six partners. We're an investment bank, primarily. But we also have a family office where we work with about 90 families, most of whom we've represented in the sale of their company or are representing in the sale of their company. And then we have a group called Pathfinder, which is our consulting group or advisory group that helps businesses get ready a year to five years before they're going to go to market. We've learned a lot we've done over 100 transactions. And so we've learned a lot about what makes for a great company and a good valuation and a good deal. And we've tried to use that knowledge to help give companies advice and counsel before they're going to go down the transaction path on things that they could do to make their business more valuable or a deal easier to get done. And we've been doing that for over 13 or 14 years, we've had our investment bank about 20 years. And all of our work is with entrepreneurs and we love it. And it just personally I don't hold it against me. I started out as an attorney. As I like to joke that I've been through all the 12 steps of recovery from being a being an attorney and my wife accuses me of lapsing every once in a while, but and then I did a roll up in the communications sector where I did. I was the lead deal negotiator. And we did about 27 deals, acquisitions of companies, and then became the president of that business and the CFO. And then we sold that business to Avaya, which was a big communications company been in and around mergers and acquisitions, and kind of corporate growth plans for a long time. And I said really love what we do because we get to work with entrepreneurs every day.
That's awesome. appreciate you sharing all that. And I'm excited to get into your advice on what makes for a scalable company. What are the key components to building and scaling a business? I believe you outlined four steps or four key components. You mentioned team business model, the addressable market and the risk factor There's, why is teams so important? And what can you share?
Yeah, look for an entrepreneur, they can usually take a business to a certain level. And at some point, they're going to spin out, right, they're going to have too much work to do, they're going to burn out, they're going to start to exceed their own personal capacities, whether that's just the laws of physics in terms of time available, or they're starting to do a lot of things that they may not be the best at. And that will, that'll put a ceiling on how fast that company can grow or beyond what revenue level or employee level they can grow. And the only solution to that is to be very intentional about hiring a team that hopefully complements the entrepreneurs strengths and weaknesses, but also can basically take a lot of the workload off of the entrepreneur and help that business scale faster. Too many times, I think entrepreneurs are afraid to make those investments in key personnel, because they may not have the cash flow to do it, or may not think they have the cash flow to do it, they may think that they can do the job the best, just simply because they've been doing it for so many years. And sometimes they just have a hard time delegating in all of that if you don't build the team, that will put a ceiling on where that company can go. And one of the first things that we encourage entrepreneurs to do before they need it, is to start designing and then recruiting for the team and the specific roles that they're going to need. Too many businesses are just so dependent on the owner for sales or product development or operations. And in order to scale, you've got to build a team around you that can manage those functions, and hopefully do it better than you can that's that's the perfect world.
And what happens, have you seen in like successful teams versus unsuccessful teams? Where have you ever had to step in and advise about how to build a high performing team?
Yeah, I'm a big believer that if you're starting to build that team, you need to get aligned around what the vision and mission of the business is. And you also need to be aligned as it relates to core values. I, I was trained by a Catholic priest, ex Catholic priest on how to interview and what he described was the three elements to evaluating an individual for a particular position, there's talent, which is just their raw capabilities, are they smart enough and talented enough to do what you're going to ask them to do? And then there's experience have they done the job before or something like it, and then there's chemistry, which is a are they aligned with the culture of the business, the values of the business, most people hire principally based on experience, which, if you don't have the raw talent, or if you don't have the chemistry or the alignment, is going to be a mistake. And so I'd much rather, if I'm going to miss one of those three elements in hiring, I'm okay, missing experience, because we can train them and give them that experience. If they've got the raw horsepower, and they're aligned from a values perspective, then we're in a great spot, we can train them up and get them into that role. I think the mistake that too many people make is sacrificing culture or core values, alignment, that chemistry piece, in order to get the experience. And if you've got a team that's misaligned, from a values perspective, they won't be very successful. That will, as my old mentor used to say, that'll cause sand in the gearbox. And at some point, that's going to stop the car. And so getting alignment on the core values is is so important. And it's one of the things that, again, we're big advocates of both for our business as well as our clients businesses is to make sure you're hiring folks to sign up to the core values of your business.
So I would love to drill down a little more into the topic of core values. I think it's really interesting and haven't really expanded on it in previous conversations, what makes core values unique? How unique can you make your core values? Because it seems like most companies have the same generic core values of they're just very cliche?
Oh, for sure. For sure. Yeah, it's I don't know that core values necessarily need to be that unique for a business, I think what they need to be as well aligned with what you're trying to accomplish as a business. And while aligned with what's important to you as as the entrepreneur, the founder, again, you'll see integrity or honesty or hustle or whatever the core values are. They don't necessarily need to be unique, but they do need to be something that you as an owner are going to be a great example of, and that whole fully serve, the business that you are running and the mission that you're trying to deliver on. So I'd probably be less focused on whether they're unique or something different, I'd be a lot more focused on, are they aligned with what I adhere to personally, and I'm going to be a great example of, and is that going to support the mission and the vision of the organization?
Yeah, it's a good point, I think, perhaps, what I think perhaps where things fall, or lack clarity is actually in explaining what the core values are, to the company, if you just present Oh, these are our core values, and then you move on. Okay, big deal. It goes in one year, it goes out the other. But if you actually explain why these core values mean a lot to the business, and why we chose each of those core values, perhaps it would be more powerful and instrumental in like how people felt about them and understood them the way I see it. And correct me if I'm wrong core values, it's how the company can bring like minded people and collective chemistry. So for example, if you're a startup, you're gonna want people that can grind it out, that can handle pressure that never give up. Those are core values that you need in a startup, which may not be needed in a more established company. So I think, if the founder or HR went to maybe do a better job of explaining why these are our core values, perhaps they would have more meaning.
I'm look, I think core values are significant insofar as they impact behaviors. That's how you see what the core values of a business are, is, what are the behaviors that we're seeing in this business? One of the things we do in our business is every Monday, we have hero stories. And hero stories are basically, hey, what examples did we see this week or last week of our team? Being examples of our core values? And if you do that over and over again, people catch on pretty quickly as to what are the behaviors that are encouraged in the business? What are the behaviors that are not tolerated in the business? And you also, it helps people make that link between core values, and it What are you trying to accomplish as a business. And that's really, that's the leaders responsibility is to be able to help the team understand, hey, that here are the three quorum. And I'm a big believer in having a limited number of core values. We have three hustle, humility and relationships. But in order to be able to explain to the team, hey, here's why this core values important, not just to how we operate with one another, but how we deliver to our clients, and then give them examples. That's the best stories are a great way to share what core values really mean in practice,
yeah, like you reflect your internal behavior to the outside world slash your customers.
Yeah, all that stuff has to line up and be aligned. Otherwise, if your core values are not serving your customers,
for example, your one of your core values, relationships, that's going to be an internal and external facing core value. So the relationships would be between your co workers. And I guess, you need to read between the lines a little bit because it's quite broad. And then for external, it's going to be your customer facing relationships,
it's really for us with the core value of relationships is about is required to make a healthy long term relationship. And that shows up in trying to always do the right thing for one another, trying to make sure we're supportive of one another, trying to make sure that we're there for our clients when they need us. And you're going to end up making decisions which may cost you in the short run, but are very beneficial in the long run in terms of having a good relationship. If you're in a healthy marriage, you're making sacrifices every day in advance to advance the health of that relationship. And we view that no differently internally and externally.
To wrap up on this topic, who typically owns this isn't always the founder. Look, I
think the founder is going to have a pretty significant impact on what the core values of the business are because they've, it's their DNA that has really started this business. But that said, that senior team needs to buy into and be aligned with those core values as well. And so it's always a good exercise. I think like to revisit those core values with the team from time to time. And, hey, is this still serving us as an organization? One of the things that's not in our three core values, but it's very important to us is innovation, constantly looking at our processes to figure out how we can do things better? Again, that's one of those things that we always revisit and think through, Hey, how did how does that reflect itself? In most likely our hustle core value, hey, we never want to take for granted. And that's our humility, core value, we never want to take for granted that our processes are the best that they can be, because that's likely not true. We can always improve on them and and we want people to take risks in coming up with new processes and testing those to see hey, could we do things better?
If we will move on to the second component of scaling your business? How does the business model affect growth? And what do you want to share specifically about the business model terms of scaling?
Yeah, this is really, when you think about a business model, there's lots of ones you can compare and contrast, take one that's highly people dependent, maybe a construction business, something where the primary deliverable to the client is based on hours of work. Again, a contractor or construction company, or even a consulting firm, that business can only scale as fast as they can hire, train, retain key talent. And those businesses are going to be inherently less scalable, than a business where the product is much easier to scale. For example, software, I'm sure you've got a lot of listeners out there who are working on developing software products, once that product is developed. Generally, the cost of delivery is relatively small. And generally, the ability to scale, the sales of that product is much, much higher, because now I the only thing I have to do is Grant somebody else a new license, obviously, you've got to maintain the software and improve it and do all those things. But that business is going to be much more scalable, and will be able to grow faster than a business where in order to grow, I've got to add people, people are generally one of the more limiting characteristics of the growth of a business. Likewise, businesses that are highly capital intensive, ones that need an a contractor or construction company is a great example where in order to grow, I've got to add a bunch of equipment, that's expensive, that takes capital and a lot of small and mid sized businesses are capital constrained. So that puts them in a position where if they don't have the capital, that's going to put a ceiling on how fast they can grow. So it's really that whole business model understanding what is the level of effort and cost and complexity of adding that incremental sale, that gives you a good understanding of how scalable that business is going to be.
Have you seen any new upcoming innovative business models in the last couple of years?
Yeah, I don't know if I've seen any new ones. We've certainly seen some models, business models that were very popular for a while, I think reality has set in one of the most significant that we've seen is companies that are selling products directly to the consumer. And the there were a lot of those businesses that were acquired or investments were made. Because they were growing very quickly, they were spending a lot of money on sales and marketing, with the change in iOS 14. And some of the changes with Facebook and Apple in particular, that the cost to acquire those customers has gotten a lot higher. And so those business models are a lot less attractive than they were historically because that whole relationship between the value of that customer over whatever period of time they're going to do business with the company, that relationship of that benefit to the cost of acquiring them has gotten upside down in a lot of cases. And so those business models we've seen, not nearly as attractive to investors, the traditional SAS models we think are still very attractive. Those are, if you've got a software product, you've got 85% Plus gross margins, and your cost of acquisition is reasonable. Those are going to be really healthy businesses and will be very saleable, when and if the time comes for that entrepreneur.
So if we're continued down this path of business models and acquisition, like other than the founder led sales initial model, once you've surpassed that what sort of business models go to market approaches are using successful for fairly early The stage startups Yeah, I
would say it all comes down to the product name, particularly for software. If you have a great product that's in demand, you're going to be able to sell it. Conversely, if you've got a product, that's not great, even your best salespeople are not going to be able to sell it very well. And so it really it does come down to do we have the right product for the market? And what evidence do we have of that to, you know, in terms of customer acceptance and ease of sales, if it's only a product that can be sold by the entrepreneur, because they're really good at sales. But hey, if they hire a salesperson, and they can't sell it, that business is not going to grow very fast. If it's a product that, hey, your new salespeople can sell fairly easily, then that business is going to have, they're going to be in a position to be able to grow very quickly.
Having said all that, there's like 1000s of new software companies coming onto the market, what channels and models? Have you seen working post COVID? Everybody went online and started investing more and more in digital? Do you still think those are the best channels? Or do you see more hybrid approach is working better?
Yeah, a lot depends on the product itself? What margins do you have to play with in terms of hey, how much can I invest in customer acquisition? Obviously, digital customer acquisition is likely going to be less expensive than having an in person salesperson may be less expensive than using particular channels as well. But I think any business, and we certainly do this with clients, you have to analyze each one of the channels that you're selling, and understand, hey, what is the margin contribution for the investment that we're making? In that particular channel. One of the things that we're seeing in consumer products, companies, as an example is having a kind of an omni channel approach where I'm selling on Amazon, I'm selling in retail, I'm selling in different types of retail, I'm selling online, having that multiple channel approach gives that that business insulation against revenue disruption, because, hey, if a retailer decides not to restock your product, and that's a significant customer for you, that's, that's gonna be a problem. But if you've got a great strategy online, you've got a great strategy through Amazon, that's going to give you some protection against that. And I think investors are seeing that and paying for that type of omni channel sales approach. Whereas before, I think they were much more focused on DTC. And, again, I think that model has come back to burn some folks.
And I want to throw in pricing here for a few minutes. I'm curious to hear from you, on how companies price and do companies actually invest enough time and research and outsource this as a service to price their products and services accurately. And not just looking at other vendors are using the market only as a resource for pricing. I would
say most entrepreneurs that we see are likely have underpriced their product in the effort to get sales and then in the effort to really move their business forward. They probably have underpriced it. It's interesting, one of the first things that most private equity firms do when they acquire a company is to go do a pricing study. Because they I think they understand and appreciate that most entrepreneurs have underpriced the product. And so they see opportunity to raise prices, and hopefully not lose customers. One of the things that we always ask our clients before they go to market is have you raised prices in the past? And if so, how many customers? Did you lose? In essence, we're trying to test to see has that company optimize their pricing in the market? But I would think I think most entrepreneurs do it by gut by feel looking at competitors, pricing the way that they think they need to price in order to get business. And they're probably much more opportunistic than they are disciplined about the price of their products. At least that's been what we've seen it it makes sense, right? They're not didn't necessarily have the resources to hire an outside firm to do a professional pricing study, which might be helpful to them, but they probably, again, they may not have the resources to make that type of investment.
So if we will take the use case of acquiring your first 1020 customers, what would your approach be finding that glass ceiling for like your price point, like how would you go about doing a pricing experiment?
Great question. And I think, again, absent the ability to actually go out and do a study. The best strategy, I think, is to experiment. Here's we've priced this particular product this way, let's see how it works. We're going to price it differently now and see how that works. Or we're going to bid this way in this particular project and see how that works. because you just, you want the feedback, right? You want the feedback from the market and from potential prospects. And that hopefully allows you to dial it in a little bit. But I don't know that it's a it's certainly not easy. And it's certainly not quick to figure out exactly what the right price should be.
Yeah, me too, as you're always going to be felt pushed back on price. You have multiple markets, multiple segments, verticals, trees, like all those things are quite complex to find your sweet spot across the board. But I guess you could segment it down to control tests per Aegir, vertical, etc. But I know that this is a much bigger topic. So it's a whole nother podcast, maybe five, for sure. But I appreciate like your insights, regardless and moving on to the third component addressable market, also known as Tam, total addressable market, what did you want to share about this specific component,
ultimately, the market and which a business plays determines how fast it can grow and what the opportunity is for maxing out revenues. If you're a $50 million business, and your market is a $200 million market, that's going to put a pretty significant ceiling on how much you can grow, taking market share from 25%, even 50%. Is, would be a Herculean task. So part of it is just understanding where's the ceiling, in terms of where this business can grow? Most professional investors, they don't want to invest in a business unless there's a billion dollar tam or addressable market, so that they feel like I can grow this company, I can grow this investment. And the market is big enough to accommodate that growth without having to do anything unnatural to be able to in order to be able to grow to that level. And so the market size just sets the ceiling for pay work in this business go ultimately,
what's your opinion on crossing those chasms of markets as a startup natural instinct is to try and shoot everywhere to get customers does that work? Or do you prefer to be brave and choose a more targeted niche market and try to slowly progress through the chasms versus that sort of spray and pray approach?
Yeah, it'll vary by business and by entrepreneur, and what's the right strategy. Obviously, if you pick a niche, it's going to be a little bit easier to get penetration, because there may not be as many competitors there. But unless you demonstrate that you can expand beyond that niche, then you're basically you've put a ceiling on how much your company can grow. Again, for conversely, if you're a startup and you're picked a giant market, you may not be able to get any traction, because you're such a small player. It's such a small piece of that, and you're competing against way too many competitors. So I don't know that there's a right answer, necessarily, I do think that they're very lots and lots of very successful, small to medium sized software companies, for example, who have created a great niche for themselves. My advice to them is, hey, if you've penetrated your niche really well and you've been successful, in order, if you're going to go sell your company, at some point, make sure that you can demonstrate that you can get into adjacent markets, and be successful in those with your core product or with a variation of your core product. Because that will help give credence to your story that hey, I can grow beyond just this niche that I'm currently in.
Yeah, and I should have elaborated more on that TAM questions. Maybe it's not a niche, but you're crossing like mid market to enterprise chasms, lots of companies will try to tackle all companies from zero to 10,000. At once,
I think it's gonna be easier for them, as long as they've picked the right niche or the right vertical or subset of that vertical. It'll be easier for them to sell, if they it makes the message clearer makes the message cleaner, it makes it more focused. So you want to, you know, obviously, you got to spend some time trying to define what that ideal customer profile looks like. But if you've done that, it will make your sales efforts a little bit more focused and a little bit easier. And so I think that makes complete sense. Versus if you've got a small staff and you're trying to sell into a really crowded market. That's pretty challenging.
So moving on to the last component of scaling the business and it ties nicely into what we were just speaking about risk factors and how that affects evaluation. So what did you want to share with us around that?
Yeah, it when you think about how you value a business, it really comes down to how credible is the growth plan meaning for an investor? How believable are the is the forecast that a company is? Or a selling company is presenting to that investor? And then the flip side of that is how risky is that forecast? For example, if that growth is coming from just a couple of customers, that's really risky, right? There's odds are you're going to have a lot of volatility in that, or the team is not deep enough to support that growth, that's going to be really risky, or, Hey, this business has litigation issues, or environmental issues, or labor issues or regulatory issues that are going to get in the way of it's that company's ability to grow. Those are all the things that I mean, that's one of the things we built internally for ourselves as a health assessment of a business that lasts about 150 questions. But it's designed to uncover what of the 100 risks that we've seen in businesses could this business have, and every business has risk, every business has potential exposures. The key is to identify those, resolve them if you can before going out to market, but also to if you can't resolve them to be able to build your story around them, because investors, they're going to have concerns over it. And so the ability to anticipate what those objections are just like in sales, right? If you're selling a big account, you want to try to anticipate, what am I going to hear, as to reasons why this customer is not going to buy let's the same for buyers of a company? What are the things that I'm going to hear from the buying community that could potentially get in the way of them wanting to buy my company. And so understanding what those risks are addressing them, if you can build the story around them, if you can't solve them, that's critical to driving value in the eyes of a buyer.
So specifically to sass companies, could you list the top five major risks that investors are really concerned about? Yeah, for sure.
And we wrote a white paper on SAS companies that what investors look for, I'd be happy to send out to anybody that wants one. But it's for SAS businesses, the specific elements to a SaaS business are going to be, how fast is the AR growing, right? Or Mr. annual recurring revenue? Or monthly recurring revenue? How fast is that growing? What are the gross margins on that growth? How expensive? Is it for me to get a new customer? How much churn do I have in that business? How many customers Am I losing? And why? And then what's the value of that customer over the long term? Do I have enough data to tell me how much a customer is worth? And how does that relate to how much it cost me to get that customer? And then, of course, for any business, you're going to have questions around team and around strategy and protect the protective moat around the business that insulates it from competition. Its customers how, how concentrated is the revenue or how diverse is the revenue? how creditworthy are those customers? What's the nature of the relationship with those customers? So for SAS businesses, you're really trying to understand, at root, how fast can I grow the business? Which comes back to what's the return on the investment that I make in acquiring a customer with the ultimate margin that's coming out of that customer over the lifetime of its of the relationship with the company? Where do
you see companies falling short, the most out of those top five?
That's tricky, right? The biggest one that we see usually is just the team is not deep enough or experienced enough. And that's, there's not a lot of explaining around that one
isn't? You did not make the argument like yeah, if we got more investment, we could deepen the team, for sure.
Yeah, that's the only argument you can make, I think in order for, for an investor to buy that story. Hopefully, you've made some successful hires in the past that have been a rockstar team members. So you've demonstrated a capability of attracting and recruiting and retaining really high powered talent, you just may not have enough of it. But if you haven't done any of that, you're asking the investor to take on that job, which is I think, as most people can appreciate, pretty risky.
So that was actually a question I wanted to ask you earlier on in the episode as a startup, how would you go about building your executive team? If you have limited budget? Should you take that risk and hire because you've mentioned if certain core values are missing, you'd rather have someone with less experience but with talent and hustle, but then could that come to bite you in the butt later on with the investors or if the company's if all is going well in the company then do the investors really care about the team as long as the results are there? because it's a bit of a double edged sword for at least for startups, I would say.
Yeah, I think look for most investors, if the company is generating great results, that tells you a lot about the quality and the performance of that team. So that's going to give you more confidence in the capabilities of the team. If the business is not performing well, you're going to have a hard time persuading an investor that your team is competent and capable. And so obviously, results are a huge driver. And in terms of the perception of the team, the where it becomes trickier is if there's the founder, or maybe just a few people that are working 80 to 100 hour weeks, in order to generate those results. That's not scalable. And at some point, folks are going to break down.
Yeah, no, it makes perfect sense. I know. We're running up on time. But thank you so much for the time you've spent with us today. Before we really wrap up. Is there anything we missed that you would like to share? Before we go?
No, you've asked great questions. And thanks for doing what you're doing for entrepreneurs and founders that they need all the support we can give them they're really important to our communities. And like I said, I think it's great, what you're doing for him and always happy to be be helpful.
Thanks. I appreciate it. It's a passion of mine startups and giving back to the community. So if anyone would like to reach out and connect with you, where's the best place to catch you? Yeah,
they can reach me at Chris CHR is at class six partners.com. That's Class VI partners.com. You can certainly go to our website as well. www dot class six partners.com.
Awesome. All right. So for real this time. Thank you. So it's been a pleasure, and hopefully we get to chat with you again in the future.
Thanks so much for having me.
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