I Reverse Engineered the Perfect Business Ep 614

In this comprehensive discussion, the host of "The Game" podcast, who is also the founder of acquisition.com, shares his entrepreneurial journey, from starting Gym Launch to building a billion-dollar business. He emphasizes the importance of having the right tools, systems, and plans to scale a business effectively. Key themes include the importance of a leadership team capable of running day-to-day operations, the value acceleration method, the three variables determining company worth (number of customers, lifetime gross profit, and risk), and the significance of reliable recurring revenue and diverse customer bases. He also highlights the necessity of automated metric tracking, audit-ready financials, and reaching an EBITDA of $5 million plus to attract institutional investors. The episode encapsulates a strategic approach to business growth, focusing on increasing customer numbers and lifetime value while reducing risk, all leading to a masterpiece business capable of generational wealth creation.

• Alex Hormozi emphasizes that with the right tools, systems, plan, and people, business improvements can happen quickly.
• The "right who, the what, and the how" are crucial for achieving desired outcomes.

"Well, if you have the right tools and systems and the right plan, the right who, the what, and the how, you can get the right outcome pretty quickly."

This quote highlights the importance of having a comprehensive strategy and the right resources to expedite business growth and improvements.

• Hormozi is documenting his journey with acquisition.com to build a billion-dollar business.
• He wishes that prominent entrepreneurs like Jeff Bezos, Elon Musk, and Warren Buffett had documented their journeys.

"I'm trying to build a billion dollar thing with acquisition.com. I wished Bezos, Musk and Buffett had documented their journey. So I'm doing it for the rest of us."

The relevance of this quote is Hormozi's intent to provide a documented blueprint of his business journey for others to learn from, which is not commonly available from other major entrepreneurs.

• Hormozi shares the rapid growth of Gym Launch, which expanded to licensing over 5000 locations.
• He discusses the challenges of managing rapid growth, including being overwhelmed with operational tasks and emotional rollercoasters.

"We went from month in 20 months, and it also sucked."

This quote conveys the dual nature of business growth: significant expansion can come with substantial challenges and stress.

• Hormozi considered shutting down his business but realized its potential value after consulting an investment banking friend.
• He learned that to sell a business for a good price, it needs to be desirable to institutional investors.

"So I called an investment banking friend of mine and I said, hey, if I were to sell my business, do you think I could get anything for it? And he's like, oh, you could get millions of dollars for this business."

The quote is significant as it marks the beginning of Hormozi's journey to transform his business from merely profitable to a valuable asset for potential investors.

• Hormozi introduces the value acceleration method developed at acquisition.com.
• The method focuses on increasing the number of customers, lifetime gross profit, and reducing risk to enhance enterprise value.

"Now, you've probably heard of big companies like Netflix and Amazon and Microsoft being worth 2 trillion, 5,000,000,000,001 gazillion dollars."

This quote sets the stage for discussing the valuation of large companies and the factors that contribute to their high enterprise values.

• A leadership team capable of running the day-to-day operations can significantly increase a business's value.
• Hormozi explains that without a capable leadership team, a business may not survive the departure of its owner, making it essentially worthless to buyers.

"Leadership team in place, running the day to day means that the person who owns the business can leave the business, and the business can not only maintain, but also grow in their absence."

The quote stresses the importance of having a leadership team that can operate independently of the business owner, which is crucial for increasing the company's value.

• Hormozi clarifies that an operator is not just someone who manages systems but someone who can lead the business.
• He discusses the importance of hiring operators who can reduce the overall workload of the company, as opposed to increasing it.

"An operator is somebody who can lead the business. It has to be someone that you aspire to be like, that you admire in different ways, and it should be people that everyone on your team could look up to."

This quote defines what an operator should be within a business and highlights the leadership qualities necessary for this role.

• When hiring, it is important to have a clear goal or problem that the new hire will address.
• Hormozi emphasizes the importance of hiring based on the ability to solve specific business problems rather than personal compatibility.

"So you should have a clear idea of why this person is coming in. You want someone to come in with a clear goal or a clear problem to solve."

The relevance of this quote is in its advice for business owners on how to approach the hiring process strategically, focusing on candidates' problem-solving abilities.

• A players may cost more but can produce significantly higher returns than B players.
• Hormozi advises being willing to pay more for top talent and to expect them to negotiate for their value.

"An a player costs 25% more than a b player, but a players produce five times more than b players."

This quote highlights the business wisdom of investing in high-quality talent, as A players can significantly outperform average employees, justifying their higher costs.

• Hormozi stresses that the founder's involvement in marketing should not be necessary for a business to be considered an asset.
• He shares his experience of transitioning the marketing role from himself to his general manager to ensure the business could continue to attract customers without his direct involvement.

"So this is me marketing thy business. And sometimes even being in the ads and the videos and making the content, whatever it is, that is not an asset. That is a job."

The quote distinguishes between the founder's job and the business as an asset, highlighting the need for the business to operate independently of the founder's personal brand for it to be valuable to investors.

• Alex Hormozi emphasizes the importance of keeping one's personal brand separate from their primary source of income, especially if there's an intention to sell the business in the future.
• A personal brand stays with an individual for life, and intertwining it with the business can complicate potential sales.
• If there's no desire to sell, intertwining personal brand and business is less of an issue.

"You should want to make sure that it's not intertwined with your primary source of making money. Mind you, that's if you want to sell."

The quote highlights the strategic consideration of keeping personal branding distinct from business operations to facilitate future business transactions.

• The concept of "delivery without the face of the founder" is critical for increasing a business's value.
• Being the face of the business or integral to service delivery can be a risk if someone else needs to take over.
• Alex suggests replacing oneself with a team of individuals who can collectively cover all aspects of the founder's role, rather than looking for one person with the same experience.
• Subject matter experts are introduced in different areas to gradually transfer the founder's responsibilities and maintain service quality.
• Equity and noncompetes can be given to key employees to ensure commitment and protect the business.
• Alex shares his own experience with Gym Launch, where he phased himself out of client interactions over 24 months to demonstrate the company's value independent of his involvement.

"But it's much easier to find two or three people or five people who've lived portions of your life in different areas."

This quote explains the strategy of dividing the founder's responsibilities among several individuals to ensure continuity and reduce dependency on the founder.

• Diversifying customer acquisition channels is crucial for reducing the risk of business failure.
• Alex discusses the importance of having multiple and reliable channels to ensure stability and avoid sudden loss of income.
• He shares his experience of how relying solely on Facebook and Instagram ads posed a risk during COVID, and how he diversified by incorporating outbound strategies.
• The addition of outbound methods led to significant revenue growth and made the business more attractive to buyers.
• Alex advises focusing on one channel until the business reaches $1 million per year before considering adding more channels.
• It's important to grow existing channels ("more and better") before expanding to new ones.
• The process of establishing new acquisition channels is time-consuming and should be approached with patience and careful resource allocation.

"The more of them you have that are consistently getting customers, the less likely an investor is going to think, wow, this can go from 100 to zero overnight."

The quote underlines the advantage of having diversified acquisition channels in reducing perceived investment risk.

• Alex explains how recurring revenue models can significantly increase the value of a business.
• He contrasts traditional one-time sales with a recurring revenue model that compounds over time, resulting in exponential growth.
• The concept of net negative churn, where the value of existing customers grows over time, is introduced as an ideal scenario for a business.
• Businesses with recurring revenue are more attractive to investors because they provide more predictable and potentially increasing future earnings.
• Alex uses examples like Salesforce to illustrate how businesses with strong recurring revenue models can afford to invest heavily in customer acquisition.

"Every single month, if you acquired no new customers, you would still make more money."

This quote encapsulates the essence of net negative churn and its impact on business growth and valuation.

• Valuation multiples vary significantly between large tech companies and smaller businesses.
• Netflix trades at 44 times earnings, Microsoft at 29 times, and Amazon at 310 times.
• Amazon's high multiple is due to its slim margins and reinvestment strategy for growth.
• Small businesses typically see multiples ranging from one to four times earnings, with the potential for higher multiples if the business is larger and more profitable.
• The value of a business is influenced by factors such as profitability, growth potential, and market opportunities.

"So Netflix right now trades at 44 times earnings. [...] Good old Jeffy B is getting 310 times earnings." "Realistically, you're probably looking at one to four times earnings."

These quotes illustrate the disparity in valuation multiples between large companies like Netflix and Amazon and the more modest multiples typically seen by smaller businesses.

• Amazon's high valuation is partly due to its vast expansion opportunities, such as AWS and Prime Video.
• Netflix has fewer expansion opportunities, impacting its valuation.
• The defensibility of a business model is crucial; Amazon has a competitive moat making it hard to replicate.
• Competitive moats and expansion opportunities can significantly increase a company's valuation.

"Amazon has a lot more expansion opportunities. [...] Whereas Amazon, it's virtually impossible to recreate what Amazon's done."

The quote emphasizes the value of expansion opportunities and a defensible business model as key factors in Amazon's high valuation multiple.

• Consumption: Customers must use the product or service they are paying for to justify the expense.
• Collateral: Holding customer assets (e.g., storage units holding personal items) can ensure continued payment.
• Cost of Switching: Creating a superior product or service can make it difficult for customers to leave.
• Choice: Having a unique offering with patents or trade secrets limits customer alternatives.
• Control the Money Flow: Controlling how money is transacted in the business increases leverage and customer retention.
• Cause: Aligning with charities or movements can attract customers who share similar values.
• Community: Fostering a community around a product or service can increase customer stickiness.
• Contractual Commitment: Having customers sign contracts for a set period can ensure more stable revenue.
• Communication: Regularly engaging with customers and providing events or updates can reduce churn.

"There are nine c's of recurring revenue. [...] So I give you nine ways to do recurring revenue."

This quote outlines the nine strategies to enhance the recurring revenue model, which is critical for business valuation and customer retention.

• Relying on a single large customer (a "whale") can be risky and change business strategy.
• A diverse customer base mitigates the risk of losing a significant portion of revenue if one customer leaves.
• Ideally, no single customer should account for more than 20% of revenue; personal preference may dictate an even lower percentage.
• The decision to take on a large client should be weighed against the potential need to diversify further.

"So having a diverse customer base, let's imagine that this is your customer base. [...] Ideally, for me, I don't like anyone more than 5% of my revenue."

The quote stresses the importance of having a diverse customer base to reduce dependency on any single customer and maintain business stability.

• Data-driven decision-making is crucial for business growth and attracting investors.
• Automated metric tracking allows for real-time business insights and performance monitoring.
• The lack of data collection can lead to guesswork and poor decision-making.
• Implementing a CRM or similar system can help small businesses scale and improve operational efficiency.
• Key metrics to track include customer acquisition costs, lifetime gross profit per customer, and churn rates.

"Automated metric tracking affects how many customers you get, lifetime gross profit per customer and the risk associated with everything." "You can tell how skilled someone is at anything based on the number and quality of the metrics."

These quotes highlight the significance of automated metric tracking in understanding business performance and making informed decisions to drive growth.

• High cash flow indicates a business generates more cash than needed for reinvestment and competition.
• Profitability alone does not guarantee high cash flow, as seen in service delivery businesses.
• A growing business is more likely to continue growing compared to a stagnant one, as it requires less force to maintain momentum.
• The story of a business, including its trajectory and potential, is vital for attracting investment and achieving a higher valuation.

"A business that has high cash flow means that it kicks off cash in excess of what it needs to reinvest in the business to remain competitive and grow."

This quote underscores the importance of having a business that not only is profitable but also generates significant cash flow to be attractive to investors and for its long-term sustainability.

• Cash flow is crucial for a business's ability to sustain operations and grow.
• Businesses profitable on paper may still struggle with cash flow, especially if payment terms delay cash receipt.
• Continuous growth in liabilities can outpace the cash flow, leading to potential financial strain.
• Investors, like customers, are drawn to compelling stories that illustrate a company's growth potential.

"Because by the time that cash hits, I have new liabilities that I'm incurring and growing is that a business gets bigger every month or every year, right?"

This quote emphasizes the challenge businesses face when their growth in liabilities outpaces their cash flow, which can happen even as the business grows in size. It highlights the importance of managing cash flow to ensure liabilities do not become unmanageable.

• Not all valuable companies have high net free cash or profitability; HubSpot is an example.
• Most business owners are not like Netflix or HubSpot and are self-funded or have limited investment from friends and family.
• The focus on stories of successful companies often overshadows the many that fail to generate cash flow and ultimately provide no return for the founders.

"HubSpot, for example, I'm pretty sure isn't profitable. And it's a public traded company worth hundreds of billions of dollars."

Alex Hormozi points out that profitability isn't the only indicator of a company's value, using HubSpot as an example of a highly valued but not necessarily profitable company.

• Alex Hormozi is a cash flow investor, prioritizing businesses that generate significant cash after reinvestment to stay competitive.
• Even businesses with high returns on capital should ensure founders take a fixed amount out of the business to minimize personal financial risk.
• Alex Hormozi shares a personal story of reinvesting profits and later selling his gyms for less than their potential value, exemplifying the importance of balancing growth with personal financial security.

"I'm a cash flow investor. I want to see how much money does this thing kick off after we have to reinvest in the business to keep it competitive."

This quote explains Alex Hormozi's investment strategy, which focuses on the cash flow a business generates after necessary reinvestments, highlighting the importance of sustainable growth and profitability.

• We Whiten, a teeth whitening chain, was attractive for investment due to its high cash flow, profitability, growth, and compelling story.
• The ability to quickly pay off new locations and compound returns made it a lucrative investment opportunity.
• Aligning a company's story with current trends can enhance its attractiveness to investors.

"They had 32 locations by the time we actually ended up closing the deal. I think this is probably like four months end to end, which is actually pretty decent in terms of timelines."

Alex Hormozi uses We Whiten as a case study to illustrate a successful investment opportunity due to the company's rapid growth and ability to expand while maintaining high cash flow and profitability.

• Analyzing a company's product suite involves examining gross profit and gross margin for each product or service.
• Reorganizing the sales process to emphasize products with higher gross profits and margins can significantly enhance profitability and cash flow.
• Understanding and optimizing the product mix is a key strategy for improving a company's financial performance.

"How can I recombine these things so that it becomes the first thing that we sell, most commonly in the highest volume?"

This quote highlights the strategy of reorganizing the sales process to focus on the most profitable products, which can lead to a substantial increase in a company's profitability and cash flow.

• Having audit-ready financials reduces risk for buyers and validates the company's reported profits.
• Transitioning from cash-based accounting to GAAP (Generally Accepted Accounting Principles) provides a more accurate financial picture over time.
• The level of financial sophistication required depends on the business's needs, with more complex businesses requiring stronger financial functions.

"If you have an audit ready financial, it means that a third party will come in and go through all your numbers."

Alex Hormozi stresses the importance of third-party validation of a company's financials, which provides credibility and assurance to potential investors or buyers.

• Institutional investors typically seek businesses with at least $5 million in EBITDA due to the presence of professional management teams.
• Larger businesses command higher valuations because they consolidate profit and are more attractive to investors with larger capital to allocate.
• The effort to grow a business is similar regardless of its size, but larger businesses offer more infrastructure and potential for value creation.

"Most institutional investors do not want to buy companies that are smaller than this."

The quote explains why institutional investors prefer larger companies, as they are generally more established and have the management infrastructure to operate independently of the owner.

• With the right tools, systems, and plans, businesses can significantly increase revenue and profit within a short timeframe.
• Alex Hormozi provides real data on how his portfolio companies have grown revenue and profit after twelve and twenty-four months.
• The goal is to make a business more valuable by ensuring it can continue to sell more, increase customer value, and operate without the owner's involvement.

"So our portfolio company, on average, within the first twelve months, we increase revenue by 1.8 x on average."

This quote demonstrates the impact of strategic interventions on a company's growth, showcasing Alex Hormozi's success in significantly increasing portfolio companies' revenue within the first year.

• A successful business is like a masterpiece painting, with each element contributing to its overall value.
• Understanding the gaps in a business and addressing them strategically can unlock significant value.
• The process of enhancing a business's value is systematic and can be replicated across different businesses.

"And it doesn't matter if your business looks like this or like this or like this, because what we look at is it's like paint by numbers."

Alex Hormozi compares the process of increasing a business's value to painting by numbers, suggesting a methodical approach to identifying and filling gaps to create a valuable enterprise.