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| Tom Swartz Contributing Editor |
It's the classic problem for remodelers: what is your company worth beyond the trucks, equipment and tools? Brand recognition and a good reputation, you hope. That doesn't always translate into money in the bank, though, especially for a remodeler looking for a loan or hoping to sell the business. This month, Tom Swartz talks with Bill Asdal and Geno Benvenuti about different types of business equity and how to go about creating it.
Tom: What does equity mean, and what does it mean for your company?
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| Geno Benvenuti Benvenuti and Stein Inc. |
Geno: Equity to me means a lot of different things. We have a cabinet shop, and I have invested heavily in tooling an entire shop with modern equipment so that we can produce our cabinets quickly and efficiently. We have 12 vehicles for all of our lead people and some for office people with our name on it. It keeps our people happy. Rather then giving them more money, I gave them trucks, and in return, we got great advertising and it helped us build our brand name. We have a heavy pool of repeat business. I think those are things that are intangible and add a lot of equity to a company.
Bill: Can you put a value on that list of things you just said?
Geno: Absolutely. We tend to average at least a 20 percent higher markup on each repeat client than we do on an initial client. Having our cabinet shop produce cabinets for the rest of the company is very strategic as well.
Tom: Let's talk about what equity means to Bill Asdal.
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| Bill Asdal Asdal Builders LLC |
Bill: By definition, equity is assets minus debt. Equity to me, beyond the formula, means net worth. Personal net worth might include the business plus a number of other assets, whether they are cash, bonds, stocks, trucks or a vacation home. The measurement for any company, in terms of business value, is how much cash that company can produce. A resale formula is generally two, three or four times net income. Historically, remodeling businesses have very little resale value because their sum total of assets are hard goods (being tools and trucks) and maybe some valuation for goodwill and brand recognition. That, however, is not often recognized in the marketplace, because it takes the sole proprietor to run it and create that cash flow stream. Our remodeling business is a cash-generating vehicle, and equity or net worth is all done outside of that business with the money that the remodeling company generates.
Geno: I feel that the founder in a remodeling business very often is the business. When that person is able to step away from the day-to-day and pass on the responsibilities of running it to a management team — that is the key to a strong organization. I consider that an intangible equity. I consider human capital as strong equity. The other key ingredient is having minimal turnover. In our organization, 35 percent of the employees have been here over ten years, 43 percent three to ten years, and 22 percent less than three years.
Tom: Geno, how would you determine the value on your business to sell it?
Geno: We have an architectural department, a construction department and a cabinet shop. We also have a maintenance department. We are also now doing spec building. All of these practices support themselves, and they are all capitalizing on our brand name. This is enabling me to achieve my goal of having a steady stream of income. I also have invested in the housing of all of these departments in the building. Having a rental income provides many advantages to supplement my income as an owner, and there are a lot of tax advantages as well.
Tom: Bill, what I think you were alluding to is that without Bill Asdal on the Asdal Builders, the value might not be as high, because you make a lot of the decisions. So talk to me about the equity that you have.
Bill: Well, we are creating a passive income stream. There are two types of income. Passive income will come every day whether you're there or not. Real estate income, bond income, stock income at times, is passive. Active income comes because you run a business. Owning a business, even if you have it managed by others, is still active income. I am a strong advocate of building a passive income stream. We did that early in our career. It was buying wrecked houses, fixing them and putting a tenant in them. If you sell it, if you do spec building, that's still active income. But if you keep it, and you create a rent role, it's passive income. There are many tax advantages to that, not the least of which is that there is no self-employment tax on passive income. That is 15.6 percent.
If you buy under market, the minute you buy, you've created equity because the market recognizes a value above what you've got. As soon as you fix a property, you should add value, based on market value, what you've put in, plus the recognition in the marketplace. A rental property should generate positive cash flow — rent should exceed your carrying expenses. Inflation in value creates a growth in equity. Escalation in rents builds equity. Principal buy-down with the mortgage payments creates additional equity. Because of depreciation, every year you can write off some portion of the core asset against active income, hence lowering taxes. If you've got one of these things firing on eight cylinders creating lots of money and paying the bills, and you choose to take some capital out of it and make it liquid, there's no tax on that refinance. Lastly, you're paying capital gains tax as opposed to regular income tax, and that's 20 percent versus 31 to 39 percent.
Tom: Geno, would you consider most of the income that you have generated active cash and active effort to gain equity?
Geno: That's absolutely correct. I do own the property that houses all of our businesses and I am generating equity and income in that respect. I will agree with Bill that we are investing in speculative remodeling, new home construction and creating new businesses, new LLCs for each of them and we hope to grow in that area. I definitely feel real estate is a great way to build equity for my future and certainly for the people in the organization as well.
Tom: Does your leadership team actually have ownership in the real estate investments that you do?
Geno: No, they don't. I have other partners that are involved in those. Certainly the people that are involved from within my organization will benefit from the results of our successes. There is certainly a carrot there for them as well.
Tom: How would you put a value on a business if you were to sell it to a non-family member down the line? Can you put a value on a remodeling company?
Geno: There are basic formulas that accountants use such as five times the net profit, or whatever sort of system or numbers that someone might want to come up with. Personally, I feel that the value certainly will be in the brand name. I really feel that the intangibles, goodwill, that sort of thing, they're hard to measure so it's much more difficult. However, we've been approached many times by people who are interested in getting involved in our company, and I have no interest in doing that. Our cabinet shop is a manufacturing plant. It would be much easier to value because we can see what the production capabilities are. Everything is measurable. If it's measurable, you can put a dollar figure on it.
Bill: The simple answer is in the liquidation value: sell all the trucks, sell the brand, sell the hard assets. I have seen literally thousands of businesses, and I can't count five that have actually been sold on forward cash flow. Very clever people have tried to hand off their companies to a management team and retain a piece of forward cash flow, and invariably after a year or two the energy and entrepreneurial spirit tends to deteriorate with people who are probably excellent managers, but may not have the entrepreneurial spirit.
The epicenter of the U.S building industry is relationships. The value of those relationships can be turned into cash by working them, meaning that you hire subs that trust you, you create value for consumers out of relationships with subs who perform well or employees who perform well, or a management team that performs well. Geno and I have wonderful relationships that carry us forward in business because we can make money with them. The prime way to carry these forward is a multi-generational business, where the relationships are transferable.
The contractor you spoke about — someone who has spent 30 to 40 years toiling at a privately owned business and ends up finding they have no equity — is a clarion call for remodelers to plan for equity. Recognize that your company makes money. Take some out, save it, build a pension, build some equity elsewhere. It's very easy to keep investing for growth in a business, but growth alone may not equate to increased equity.
Tom: Geno, have you known anyone that has actually bought or sold the actual remodeling company?
Geno: I am familiar with one very, very large organization that has been purchased by a national firm. However, most remodelers are small guys. The biggest problem we have is the inability to let go and that is what keeps the value and the company limited only to the existence of the entrepreneur. Once he is gone, there is no company.
Bill: Fear is a very big barrier. Not only of letting go, but also fear of failure. Fear of the reputation deteriorating. Health is a barrier. Health of the family is a barrier. Lack of recognition of what resources you have. Rather than bemoaning the fact that they've worked 20 years and they've got $10,000 in the bank, they need to start tomorrow on looking at what assets they have, whether they be emotional, physical, monetary. Mine those, and put those all into a plan that will create passive income for decades to come. And then a barrier is willpower. Do you have the firepower internally to just sit down and figure this out?
Tom: Geno, is there a percentage that you would like to see taken out and put into equity outside your remodeling company? Is there a dollar amount?
Geno: I really don't have a good answer for that. It really depends on the situation. I will say this: The way to build equity is to take whatever profits you can, invest them in things like insurance policies that accumulate over time, invest them in 401(k)s. There are all sorts of strategies that one can use to put money aside for the future. Most remodelers struggle in our day-to-day. We have a hard time pulling ourselves out of the mire. We are creative people, we love what we do, and we're stuck in it. Therefore, it is very important that we listen to what Bill has to say.
Tom: I am a remodeler who is saying, "I've got to make payroll and I've got accounts payable this week and you're saying you want me to take some of that and go buy an apartment? What do I do? Where do I start?"
Bill: I would ask a company owner, "What does it take for you to live?" If that number is $50,000, $100,000 or $250,000, do you have a company that can generate 150 percent of what it costs you to live? If you don't, you have to build one. Every company needs a leader to chart the path not only for themselves, but also for everyone in the company to enjoy a well-rounded, fulfilling, financially rewarding work experience. I've asked audiences of remodelers, "How many of you have a personal budget, and know what it costs you to live on a month-to-month basis?" Consistently, less then 10 percent answer that they know that number.
Geno: It starts with some fundamental basics. The first question that one should ask is, "How much time does one spend working in the company rather then on it?" If an owner says that he spends more time working in the company, rather then on it, he's not building any equity. Secondly, budgeting is very critical. To be able to project what you're doing gives you a target. To do a thorough budget at the beginning of a fiscal year so you can budget what your profit is going to be allows for you to do the things that Bill is suggesting. You've got to get the basics right — budgeting, controlling your costs, measuring your results — in order to build a platform to build equity. You have to have the platform first.
Bill: I use personal, professional, financial and spiritual buckets. Each of these has equity, some of which is monetized, some of which is not monetized, but still needs to be measured. Do a little assessment of where you are, right now, in whatever buckets you want to measure. Once you understand where you are, it's important to chart where you want to be. How much do you need when you retire? The rule of thumb used to be 70 percent of your active income. I think that has turned on its head, and now you need 125 percent of what you made while you were working because you have more time to travel, to do things and to spend money. Professionally, I want the respect of my peers in my chosen industry or profession. How do you get that? Geno talked about branding, brand recognition — all of that is a very satisfying and measurable piece of professional equity. Personal equity, maybe it's more time with their kids and you can measure that. If you're not taking enough vacation time, in a year you can measure it. By dissecting the problem and counting the resources and blessings you have today, you'll figure out how you get to where you want to be.
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Creating value means measuring more than hard assets