[](images/bookCover2.jpg) # Exit Matters ## Strategic & Tactical Decisions That Multiply What Your Business Is Worth **By James Waters** **Founder, Xit Matters** **Exited Founder, Performance Matters** **Copyright © 2026 Xit Matters LLC** All rights reserved. This book is for educational purposes only. Consult your CPA, attorney, or financial advisor for specific advice. Valuations shown are illustrative examples. --- ### Table of Contents [**Introduction**](#introduction) **Part 1: Foundations — Building Your Valuation Mindset** - [Chapter 1: Why Valuation Is Your New Management Superpower](#chapter-1) - [Chapter 2: Your Business Is a Living Asset](#chapter-2) - [Chapter 3: The 80/20 Rule — Why 80% Accuracy Beats Perfection Every Time](#chapter-3) **Part 2: The Four Lenses — Your Core Valuation Toolkit** - [Chapter 4: Cash Flow to the Business — What Your Operations Are Worth](#chapter-4) - [Chapter 5: Cash Flow to the Owner — What Actually Ends Up in Your Pocket](#chapter-5) - [Chapter 6: What Buyers Will Pay — Market Reality and What Drives Your Multiple](#chapter-6) - [Chapter 7: The Blended View — Why No Single Number Tells the Truth](#chapter-7) - [Chapter 8: Cost of Capital — The Hidden Lever That Controls Your Valuation](#chapter-8) **Part 3: Tactical Plays — Decisions That Multiply Value** - [Chapter 9: Tactical Decisions — Pricing, Hiring, CapEx & Margin Moves](#chapter-9) - [Chapter 10: Negotiation Superpowers — Use Real-Time Value as Your Anchor](#chapter-10) - [Chapter 11: Reinvestments That Actually Grow Exit Value](#chapter-11) - [Chapter 12: Raising Capital Without Giving Away the Farm](#chapter-12) **Part 4: Advanced Horizons — Planning for Exits, Shifts, and Legacy** - [Chapter 13: Exit Planning That Starts Today](#chapter-13) - [Chapter 14: Valuation in Turbulent Times — Navigating Economic Shifts](#chapter-14) - [Chapter 15: Family Succession — Valuations for the Next Generation](#chapter-15) - [Chapter 16: Valuations for Growth Stages — From Startup to Scale-Up](#chapter-16) **Part 5: Tools and Resources — Putting It All Into Practice** - [Bonus: Your 30-Day Valuation-as-Management Playbook](#playbook) - [Worksheets](#worksheets) - [Appendix: The Math Behind the Lenses](#appendix) - [Resources & Next Steps](#resources) --- ### Introduction You didn’t launch your business to bury yourself in monthly P&Ls, second-guessing whether you’re truly building lasting wealth. No—you built it for freedom, for the pride of creating something from nothing, and for that game-changing exit that secures your family’s future. But here’s the harsh truth: nine out of ten small business owners I talk to have zero clue what their company is worth *right now*. They track profits and bank balances, sure. But they miss the one metric that actually defines long-term success: your business’s living valuation. That’s a problem. Most reports aren’t built for you, the owner who sweats the decisions every day. Your accountant keeps the books straight. Your bookkeeper dives into the ledger. Your ops manager runs efficiency spreadsheets. Those are all department-level tools. None of them give you the high-level owner’s report you need—a clear snapshot of what you’ve built, tied directly to the decisions that put more dollars in your pocket or raise your exit price. We’re fixing that today. This book is your everyday management compass. It equips you to integrate a *living valuation*—real-time numbers viewed through the four lenses—into every decision, big or small: 1. **Lens 1: Cash Flow to the Business** — what your operations generate for all stakeholders (Enterprise Value). 2. **Lens 2: Cash Flow to the Owner** — what actually ends up in *your* pocket after debt and obligations (Equity Value). 3. **Lens 3: What Buyers Will Pay** — what the market says your business is worth based on comparable transactions (Market Value). 4. **Lens 4: The Blended View** — your personal owner’s report number that shifts depending on whether you’re operating, selling, raising capital, or planning succession. No fancy degree needed. No pricey broker fees. Just a straightforward framework you can apply starting now. A word about precision. **This framework gives directional accuracy, not audit-grade precision.** The 80/20 Rule is baked in: directional accuracy updated monthly is infinitely more valuable than audit-grade precision delivered once every five years. The goal is not to replace your accountant. Your CPA should still validate final numbers, but 80 % accuracy that stays current is infinitely more valuable. The goal is to give you a management compass that stays current — one that turns every major decision into a value-creating opportunity instead of a guess. Finish these pages and you’ll be able to run your own four-lens living valuation in under 10 minutes, pinpoint exactly how a 1 % price bump, a strategic hire, or that new truck moves your number across all four lenses, and decide with the confidence of someone who finally sees the scoreboard. You built it. Now know what it’s worth — and make every decision multiply that number. It doesn’t matter if you run an HVAC company in Florida, a downtoen pizza joint, or a distribution business on the Gulf Coast. The shift is universal. Owners stop guessing “I think we’re worth about X” and start saying, “We just unlocked another $460k in enterprise value—holy crap.” This framework didn't come from a textbook — it was forged in the trenches. As the co-founder of Performance Matters, a SaaS EdTech company, we grew it over 15 years from a struggling startup to a dominant player in our industry, culminating in a life-changing exit. That's where we first developed the methodologies in this book, testing them through bootstrapped growth, scaling pains, and high-stakes negotiations. In the decade since, I've refined this methodology across industries and companies of various sizes, helping owners turn overlooked decisions into massive value gains. **What it means for you:** As Xit Matters' founder, I've poured years into creating xitmatters.io that deliver these four lenses live and actionable. But this book stands alone: The principles work with pen and paper or any spreadsheet. The math is timeless. All it takes is treating your business like the wealth engine you deserve. Ready to know your number? Let's dive in. --- # Part 1: Foundations — Building Your Valuation Mindset Before we dive into the numbers, let’s get one thing straight: valuation isn’t some one-time event you save for a distant exit or hand off to someone in a suit. It’s your daily compass — your living valuation that turns every decision you make into a step toward real wealth. You built this business from the ground up, sweating through late nights and tough calls. Now it’s time to see it for what it truly is: not just a job or a revenue machine, but a dynamic asset that grows (or shrinks) with every move you make. In this part we’ll lay the foundation. We’ll start by showing why valuation is your new management superpower — the ultimate scoreboard that pulls together your P&L, balance sheet, and ops tweaks into one clear picture of success. Then we’ll explore how to treat your business as the living asset it deserves to be, so it rewards you not just this month but for years to come. And we’ll fully embrace the 80/20 Rule: why chasing audit-grade perfection is a trap, and how 80% directional accuracy — fast, practical, and actionable — beats it every single time. Think about Mike, the Florida HVAC owner we met in the introduction. He was profitable but completely blind to his true worth until he made that mindset shift. No MBA, no $50k broker — just a simple framework that unlocked $460k in value in one quarter. That’s the shift we’re after here: from guessing to knowing, from reacting to leading. As you read, remember: This isn't theory. It's battle-tested from my own exit at Performance Matters and refined with owners like you across industries. And if you're ready to automate this mindset? Tools like xitmatters.io make it effortless — running your lenses live, with real-time updates that turn these foundations into your competitive edge. (Check it out at xitmatters.io — because your exit matters.) By the end of this part, you'll have the mental reset to wield valuation like a pro. Let's build that foundation — your business is waiting. --- [Return to TOC](#toc) ### Chapter 1: Why Valuation Is Your New Management Superpower You didn’t start your business to become a professional spreadsheet jockey. You started it to build something valuable. Something that gives you freedom, security, and—if you ever want it—an exit that actually changes your life. Yet every single month you open your P&L and ask the same two questions: “Did we make money?” “Can I pay myself and the bills?” Those are the wrong questions. The right question—the one that separates owners who build $2M companies from owners who build $8M companies—is this: **“What did I just do to the value of my business… and how do I do more of it tomorrow?”** That single mindset shift is what this book is about. I’ve sat across the table from owners just like you—HVAC contractors, restaurant owners, distributors, landscapers. Every one of them was profitable. Most were proud of their numbers. And almost all of them were shocked when they saw their real-time four-lens living valuation for the first time. Let’s make this real with Mike, the Florida HVAC owner we’ll follow throughout the book. Mike runs a solid $2.4M revenue business, clearing $380k in owner profit. But like many, he was flying blind on value until he ran his first four-lens living valuation: - **Lens 1: Cash Flow to the Business** — $2.17M - **Lens 2: Cash Flow to the Owner** — $1.67M - **Lens 3: What Buyers Will Pay** — $2.70M - **Lens 4: The Blended View** — $2.04M ((40% × $2.17M) + (40% × $1.67M) + (20% × $2.70M)) See? No PhD needed—just plug in the basics from your own books. Mike’s gap between Lens 3 and Lens 1 told him the market already liked his service contracts more than a pure cash-flow model suggested. He stared at the numbers and said, “I thought I was worth about $1.2M if I ever sold.” Three months later—after making a handful of valuation-aware decisions, including one smart 3.8% price increase on service agreements—his Lens 2 jumped to $2.13M. Same revenue. Same industry. Just smarter moves guided by the four lenses. **What it means for you:** You don’t need an MBA or a $50k appraisal to start multiplying what your business is worth. You just need the right questions and the right numbers. This book is not about selling your business tomorrow. It’s about finally managing it like the valuable asset it is—every single day. #### The Lie We’ve All Been Told Wall Street has convinced us that “valuation” is something fancy MBAs do with spreadsheets once a decade during a fundraising or exit process. We’ve been sold the simpler lie: “Just keep your head down, stay profitable, and the value will take care of itself.” That’s like saying “Just keep putting gas in the truck and the resale value will magically go up.” Value is not a byproduct. Value is the scoreboard. Every pricing decision, every hire, every equipment purchase, every vendor negotiation, every marketing dollar either adds to or subtracts from what your business is worth right now. Most owners are playing the game blindfolded. > **Reality Check: What If Your Books Are a Mess?** > No pristine P&L? No problem. Start with rough estimates—last year’s revenue, your take-home pay, big expenses. Mike’s initial run used “back-of-napkin” numbers from his QuickBooks export. The 80/20 Rule says: Get 80% directional accuracy first; clean up as you go. If it’s off by 10-15%, it rarely flips a decision. #### Four Lenses That Actually Tell the Truth Forget EBITDA for a second. Here are the only four lenses that tell you the truth about your company today: 1. **Lens 1: Cash Flow to the Business** — what the entire operation generates for all stakeholders: you, your bank, the IRS. This is the raw horsepower of the machine before anyone takes their cut. It answers: “What are my operations actually worth?” 2. **Lens 2: Cash Flow to the Owner** — what’s left in *your* pocket after everyone else is paid—lenders, taxes, required reinvestments. This is the number that funds your life, your retirement, your kids’ college. It answers: “What do I actually keep?” 3. **Lens 3: What Buyers Will Pay** — what a buyer would pay you today based on what they’re paying for similar businesses right now. EBITDA times a multiple, adjusted for the specific factors that make your business more or less attractive than the average. It answers: “What would the market write a check for?” 4. **Lens 4: The Blended View** — your personal owner’s report number, a weighted combination of the first three lenses that shifts depending on your context. It answers: “Given what I’m actually trying to do right now—run the business, sell it, raise capital, or plan succession—what is the single most useful number?” When these four lenses move in the same direction, you’re winning. When they diverge, you’ve got a hidden problem—or a hidden opportunity. **What it means for you:** Different decisions call for different weightings. When you’re running day-to-day, the cash-flow lenses matter most. When you’re eyeing a sale, the market lens dominates. The Blended View gives you one actionable number for any situation. Modern tools like xitmatters.io now make it possible to track all four in near-real time — so you never have to guess again. --- #### Why Most "Management Books" Miss the Point Books like *Traction*, *The E-Myth*, and *Profit First* are fantastic. They give you systems. But they stop one step short. They teach you how to run the business better. They rarely teach you how to measure — quantitatively — whether those improvements actually increased the thing you care about most: the number on the bottom line if you ever decided to sell or hand the keys to your kids. Valuation is the ultimate lagging indicator that becomes your leading indicator. Run payroll for your new $65k sales rep? Watch your equity value the next day. Raise prices 4% across the board? Watch enterprise value jump. Sign a 5-year lease instead of buying the building? Watch your market comps take a hit. You get immediate feedback. No waiting until tax season. No waiting until you talk to a broker in five years. This is management with the lights on. > **Reality Check: No Recent Financials?** > Use last year's tax return or even bank statements for starters. Mike bootstrapped his first run from a QuickBooks summary — revenue buckets, big expenses, rough cash flow. If your numbers are "off" by 10%, re-run next month. Direction over perfection. #### The 30-Day Experiment That Changes Everything I give every owner the same challenge: For the next 30 days, calculate a fresh living valuation at the start of every week using the four-lens framework. Before you make any decision bigger than $5,000, ask yourself: "Which option moves my four lenses the most — in the right direction?" Then execute. Then re-calculate the valuation next Monday. Owners who do this for 30 days never go back to "profit-only" management. Tony from Pauly's Pizza ran the experiment. Week 3 he was debating between two commercial kitchen setups: • Option A: $52k new energy-efficient oven unit with lower utility costs and a manufacturer warranty • Option B: $34k used equipment On profit alone, Option B looked smarter. On valuation? Option A added $163k to his equity value over five years through utility savings, lower maintenance costs, and the buyer appeal of modern equipment with clean service records. He bought the new equipment. His blended valuation jumped $189k by month four. That's the power of valuation as your management compass. #### Tactical Table: Quick Decision Impacts (Mike's HVAC Baseline) Here's a glimpse of how Mike tested early decisions using his lenses (we'll build on this table throughout the book): | Decision | Lens 1 Change (Enterprise) | Lens 2 Change (Equity) | Lens 3 Change (Market) | Blended Change | 80/20 Notes | |---------------------------|----------------------------|------------------------|------------------------|----------------|-------------| | 4% price increase | +$145k | +$118k | +$210k | +$158k | Ignored minor customer churn; focused on margin lift | | Hire $70k service tech | –$35k yr1 | –$48k yr1 | +$180k (multiple) | +$62k | Weighted forward revenue growth; skipped full payroll tax calc | | Buy $85k van (vs. lease) | +$92k (5-yr) | +$68k | +$0 | +$72k | Treated lease as simple expense; decision unchanged by 10% variance | These are from Mike's real inputs — copy this format for your own tests. #### What You'll Get From This Book By the time you finish these pages you will be able to: • Calculate your own four-lens living valuation in under 10 minutes • Spot hidden value killers in your business before they cost you six figures • Make capital expenditure decisions with confidence instead of gut feel • Negotiate with vendors, customers, and even employees from a position of real power • Build a 3–7 year "value acceleration plan" that works whether you sell next year or never sell at all • Know which lens to weight heaviest for any decision you face And most importantly — you'll stop managing your business like a job and start managing it like the wealth-building machine it was always meant to be. #### Your First Action Step (Do This Today) 1. Gather your most recent financial statements (P&L, balance sheet, cash-flow forecast). 2. Calculate your four lenses: We will go through the math in the next few chapters (simple templates are in the resources section at the end of this book). 3. Screenshot or write down those four numbers. Save that snapshot. Because once you see the real numbers, you can never unsee them. And that's exactly when the game changes. Welcome to valuation-driven management. Your business is about to become worth more than you ever thought possible. --- [Return to TOC](#toc) ### Chapter 2: Your Business Is a Living Asset Your business is not a job. It’s not a vending machine that spits out a paycheck every month. It is a living asset you own 100%. And like any asset—a rental property, a stock portfolio, or the classic car in your garage—its value changes every single day based on the decisions you make. Most owners treat their company like a glorified job. They show up, do the work, collect the profit, and hope the value is somehow growing in the background. That approach leaves millions on the table. Every single decision you make either grows or shrinks the real worth of your business. Not someday. Not at exit. Right now. Once you start seeing your company this way, everything changes. Let’s bring this home with Mike, the Florida HVAC owner we’ve already met. Mike’s business wasn’t broken; it was profitable and steady at $2.4M revenue and $380k owner profit. But he treated it like a cash-flow machine, not an appreciating asset. Before the four lenses, he reinvested based on gut feel and monthly bank balance. A new van? “It’ll help us get more jobs.” A price tweak? “Customers might leave.” No real measurement of long-term impact. After the four lenses, he started asking, “How does this move my four numbers?” That shift alone turned overlooked decisions into deliberate value-builders. Over the next chapters, we’ll watch Mike’s numbers evolve step-by-step—from baseline to post-tweaks—so you can apply the same thinking to your own business. **What it means for you:** You don’t need to plan an exit tomorrow to care about value. Even if you run the business forever, rising value means more security, better borrowing power, and real options for your family. #### The Asset Mindset in Action Think of your business like a rental duplex you own outright. You collect rent (monthly profit), pay for repairs (CapEx), and watch the property value rise (or fall) based on market conditions, maintenance, and upgrades. - Paint the exterior and add landscaping? Property value jumps $30k. - Ignore a leaky roof? Value drops $50k when you sell. - Raise rent 5%? Cash flow improves, and appraisers see stronger income—higher valuation. Your business works the same way. Every operational choice is maintenance or upgrade. The difference? Unlike real estate, business value isn’t appraised by a county assessor every year—it’s appraised by you (or a buyer) when it matters. That’s why the four lenses exist: to give you that ongoing appraisal without waiting. > **Reality Check: What If I Don’t Plan to Sell?** > You don’t need an exit to care about value. Mike never planned to sell soon—he just wanted to know his net worth was growing. **Lens 2: Cash Flow to the Owner** became his personal wealth tracker: “Is my ownership stake worth more this quarter than last?” **What it means for you:** Even if you never sell, rising Lens 2 puts more real dollars in your pocket every year. > **Reality Check: What If I Don't Plan to Sell?** > You don't need an exit to care about value. Mike never planned to sell soon — he just wanted to know his net worth was growing. Lens 2 (Equity Value) became his personal wealth tracker: "Is my ownership stake worth more this quarter than last?" Even if you run the business forever, rising value means more security, better borrowing power, and options for your family. #### How Daily Decisions Move the Asset Value Most owners focus only on profit. But profit is just one input. Here’s how common moves ripple through the lenses (we’ll see Mike’s real numbers in later chapters): - Raise prices 3–5% → Higher margins → Stronger future cash flows → **Lens 1: Cash Flow to the Business** and **Lens 2: Cash Flow to the Owner** rise; buyers pay higher multiples (**Lens 3: What Buyers Will Pay**). - Buy equipment on credit → Immediate CapEx hit lowers Lens 1 short-term; but if it boosts efficiency or revenue long-term, all lenses recover and grow. - Add recurring service contracts → Reduces risk → Lowers cost of capital → Boosts every lens dramatically. - Pull too much cash out personally → Shrinks reinvestment → Slows growth → Lenses 1 and 2 stagnate or drop. These aren’t hypotheticals. Mike tested a modest 3.8% price increase on service agreements early on. Using Lens 1 basics (FCFF projection), it added $145k to enterprise value over five years. Lens 2 captured the owner benefit: +$118k in pocketed cash. Market comps (Lens 3) liked the margin expansion: +$210k potential. Blended impact: +$158k. He made the move—and three months later, actual results tracked within 8% of the estimate. **What it means for you:** Small changes create massive swings in buyer perception. A single decision that improves any of the Four Forces can lift your market multiple by a full point—and the lenses capture that shift instantly. --- #### Four Principles That Change How You Run the Place **Principle 1: Value compounds faster than profit.** A 2% improvement in margin this quarter doesn’t just add $4k to your pocket this year. It adds tens—sometimes hundreds—of thousands to what your business is worth today because future buyers pay for the stronger cash-flow machine you just built. When you view that margin gain through all four lenses, the compounding effect becomes unmistakable. **Principle 2: Small changes create massive swings in buyer perception.** Buyers don’t dig through your QuickBooks. They look at trends: recurring revenue percentage, customer concentration, owner dependence, systems documentation. Improve any of those and your market multiple can jump a full point. **Principle 3: What the owner keeps (Lens 2) is what actually funds your life.** Profit is nice. Equity Value is what pays for your kids’ college, your retirement, or that beach house you’ve been eyeing. Debt decisions, owner draws, and reinvestments hit this number directly. **Principle 4: The market is watching—even if you never sell.** Every supplier, customer, employee, and lender is quietly forming an opinion about what your business is worth. When you operate with valuation in mind, you negotiate better, attract better talent, and sleep better at night. **What it means for you:** Once you treat your business as a living asset, you stop making “profit-only” decisions that quietly erode value and start making “value-first” choices that compound. The Blended View ties it all together so you never lose sight of the full picture. Let’s keep following Mike as we add the lenses in Part 2. You’ll see exactly how he turned this mindset into measurable gains. #### Why Most Owners Stay Blindfolded Because nobody taught us this. We were told: "Run a tight ship, control costs, grow revenue." Nobody said: "Before you sign that lease, before you hire that new tech, before you run that ad campaign — ask what it does to your company's worth." So we make decisions based on gut feel or last month's profit margin. Then we wonder why the business feels stuck even though we're "profitable." The moment you adopt the four-lens framework, you get instant feedback. Raise prices 3%? Watch enterprise value climb. Delay a big equipment purchase and lease instead? Watch equity value hold stronger. Spend $15k on systems documentation instead of another billboard? Watch your market multiple tick up. Check the Blended View? See whether the net effect actually moved you forward — or sideways. You stop guessing. You start steering. #### Real-World Proof It Works for Regular SMBs Tony from Pauly's Pizza in Florida faced the same kind of decision. He was choosing between two commercial kitchen equipment options: • $34k used oven setup (looked cheaper on the P&L) • $52k new energy-efficient unit with lower utility costs, a full warranty, and the kind of modern kitchen setup that buyers notice during due diligence. Profit-only math said "buy used." Valuation math said "buy new." He bought the new equipment. Over the next five years the decision added $163k to his equity value through utility savings, reduced maintenance, and stronger buyer perception. Same business. Same industry. Just one decision viewed through the right lens. Mike (our Florida HVAC owner from Chapter 1) did the same thing with pricing on service agreements. A 3.8% bump on the most profitable work added over $460k to his enterprise value. These aren't once-in-a-lifetime moves. They're the kind of decisions you already make every month. The only difference is now you know how to score them. #### Your Business Deserves This Level of Care You've poured years of blood, sweat, and weekends into this thing. It deserves to be managed like the valuable asset it is — not like a side hustle that happens to pay the bills. The "More Than a Number" philosophy isn't complicated. It's a simple filter you run every decision through: "Will this move my Cash Flow to the Business, Cash Flow to the Owner, or What Buyers Will Pay in the right direction — and what does the Blended View say about the net effect?" Do that consistently and your business stops feeling like a treadmill and starts feeling like the wealth-building machine you always hoped it would be. #### The Living Asset Operating System Mindset shifts are great. But they don't stick unless they become habits. Here's the system Mike built — and the one I recommend to every owner who reads this book. It takes less than two hours per month once you've done your initial lens setup. **Weekly (15 minutes): The Monday Lens Check.** Every Monday morning, before you open email, glance at your four lens numbers. You don't need to recalculate them — just look at them. Ask one question: "Did anything happen last week that would move these numbers?" A lost customer, a signed contract, a price change, an unexpected expense. If yes, note it. If no, move on. The act of looking at your lenses weekly rewires how you think about the business. Within a month, you'll start evaluating decisions through the lens framework automatically, without consciously trying. **Before any decision over $5,000: The 60-Second Lens Test.** Before you sign a purchase order, approve a hire, or commit to a vendor, pause for sixty seconds and ask: "Which option moves my four lenses the most — in the right direction?" You don't need a spreadsheet for this. A rough mental model is enough. "This hire will cost me $75k but could add $180k in revenue capacity — that's positive for Lens 1 and Lens 3." That's the level of granularity you need for 80% of decisions. **Monthly (45 minutes): The Full Recalculation.** Once a month, update your lens inputs with actual numbers from your bookkeeping system. Plug in the latest revenue, margins, and any changes to debt or capital expenditures. Recalculate all four lenses. Compare to last month. Write down what moved and why. This monthly recalculation is the heartbeat of the living asset system. It turns your valuation from a static snapshot into a living, breathing dashboard. **Quarterly (30 minutes): The Buyer Appeal Checklist.** Four times a year, step back and evaluate your business through a buyer's eyes using Worksheet 5 from the back of this book. Score yourself on owner independence, recurring revenue percentage, customer concentration, documentation quality, and growth visibility. This isn't about selling — it's about building the kind of business that's resilient, transferable, and worth more every quarter regardless of your plans. Mike followed this system for eighteen months. His Blended View climbed from $2.04M to $2.92M. Not because he made one dramatic move, but because he made dozens of small, informed decisions — each one scored against his lenses, each one compounding on the last. Your business is an asset. Start treating it like one — systematically — and watch what happens. --- [Return to TOC](#toc) ### Chapter 3: The 80/20 Rule — Why 80% Accuracy Beats Perfection Every Time You’ve heard the old saying: "Perfect is the enemy of good." In the world of business valuations, it’s more like "Precision is the enemy of progress." Enter the 80/20 Rule — also called the Pareto Principle. It’s a timeless truth that 80% of your results come from 20% of your efforts. Applied to valuations, it means you can get 80% of the directional accuracy you need with just 20% of the complexity and cost. Chasing that last 20%? It’s a trap of diminishing returns that rarely changes your decisions but always drains your time and wallet. I’ve seen owners get paralyzed waiting for "audit-grade" numbers from a $50,000 appraisal. Meanwhile, their competitors are making smart moves with good-enough estimates. This chapter is your permission slip to simplify. We’ll explore why 80% is close enough, how to strip away unnecessary complexities (like nitpicking operating leases or capitalizing every R&D dollar), and real use cases where the 80/20 mindset unlocked massive value without the hassle. By the end, you’ll see why treating valuation as an everyday tool — not a forensic audit — is the real superpower. > **Reality Check: What If Your Numbers Are Already "Good Enough"?** > Mike’s first valuation used rough QuickBooks exports — no cleaned-up books, no forensic adjustments for every owner perk or lease. He ignored minor items like a personal cell phone reimbursements and a short-term equipment lease. The full "perfect" version later added only $38k to Enterprise Value — less than 2%. Direction stayed the same. If your books are messy, start anyway. 80% accuracy still points you in the right direction. > **What Does a Professional Appraisal Actually Cost — and When Do You Need One?** > A certified business appraisal (performed by a Certified Valuation Analyst or Accredited in Business Valuation credential holder) typically runs $5,000–$25,000 for a small business and $15,000–$50,000+ for a mid-market company, depending on complexity. It takes 4–12 weeks and produces a written report defensible in court, the IRS, or a shareholder dispute. > > You need one when the stakes are legal or regulatory: estate and gift tax filings, divorce proceedings, SBA 7(a) loan applications over certain thresholds, litigation, or a formal M&A transaction where the buyer’s attorney demands it. > > For everything else — the weekly decisions, the pricing calls, the reinvestment choices — you do not need that level of rigor. The four-lens framework gives you 80%+ of the directional accuracy at 2% of the cost and in a fraction of the time. Use professional appraisals when you must. Use the four-lens framework every time you manage. #### The Diminishing Returns of Precision Picture this: You’re debating a 5% price increase on your core services. A full-blown valuation with every bell and whistle might cost $10,000–$50,000 and take weeks. But a quick four-lens calculation using your latest P&L? It takes 10 minutes and shows the move could add $150k to your Equity Value. Does knowing it’s exactly $152,387 versus "about $150k" change your decision? Probably not. That’s the magic of the 80/20 Rule: The first 80% of precision gives you the confidence to act, while the last 20% delivers diminishing marginal benefits — each extra hour of analysis yields less and less impact. Wall Street pros live by this. They use discounted cash flow (DCF) models with reasonable assumptions, not pixel-perfect forecasts. Why? Because business is messy. Markets shift, customers surprise you, and no model predicts the future with 100% certainty. Aiming for perfection leads to analysis paralysis, where you miss opportunities while tweaking spreadsheets. In my experience coaching HVAC owners, landscapers, and pizza shop operators, the owners who win are the ones who run rough numbers weekly. They spot trends early — like how a 2% margin slip erodes $100k in Market Value — and course-correct before it’s a crisis. The ones chasing precision? They’re still waiting for their CPA’s sign-off while value slips away. **Principle 1: Directional accuracy trumps audit-grade precision.** Monthly updates at 80% accuracy beat a once-a-decade perfect number. Your four lenses are designed for this: fast, actionable insights that evolve with your business. #### Removing Complexities: The 80/20 Pruning Shears The 80/20 Rule isn’t just about effort — it’s about focus. In valuations, that means pruning away complexities that add little value. Traditional appraisals bloat with adjustments for every nuance, but for SMB owners, most of that is noise. Here’s how to simplify without sacrificing substance. #### Simplifying Operating Leases Operating leases (like renting equipment or office space) used to be off-balance-sheet items. Now, under accounting rules like ASC 842, they’re capitalized — treated as assets and liabilities on your books. In a full valuation, you’d adjust for this: capitalize the lease, add back the imputed interest to EBITDA, and tweak your cost of capital. But does this always matter? For most SMBs, no. If your leases are short-term or small (under 20% of total assets), the adjustment might shift your Enterprise Value by just 5–10%. That’s the 80/20 at work: 80% of your valuation accuracy comes from core cash flows, not lease tweaks. **80/20 Fix:** Treat leases as simple operating expenses in your quick calculations. Only dive deeper if leases dominate your balance sheet (e.g., a retail chain with multi-year store leases). This keeps your lenses clean and focused. > **Reality Check: Lease Capitalization Test** > Mike had two short-term van leases totaling $28k/year. Full capitalization added $45k to Enterprise Value but required estimating useful life and discount rates. 80/20 version: Ignored them. Difference? $38k (1.8%). Decision to keep leasing unchanged. Saved hours of modeling. #### Capitalizing R&D Expenses R&D — think software development, product prototyping, or process improvements — is expensed immediately under accounting rules. But it’s really a long-term investment, like buying equipment. Capitalizing it (spreading the cost over years as an asset) boosts your EBITDA and valuation multiples. The catch? It’s complex: You need to estimate useful life (3–5 years?), amortization rates, and tax impacts. For tech-heavy SMBs, this could add 15–20% to value. But for a typical service business? It’s often under 5% of expenses, yielding minimal lift. **80/20 Fix:** Skip capitalization unless R&D is your "vital few" (over 20% of costs). In your four-lens framework, add it back to EBITDA as a quick adjustment if it’s material. This captures 80% of the benefit without the accounting headache. #### Other Common Complexities to Prune - **Net Operating Losses (NOLs):** These tax shields are valuable, but forecasting their exact utilization requires IRS-level detail. 80/20: Factor them in as a rough discount to your tax rate if they’re significant; otherwise, ignore for day-to-day lenses. - **Owner Add-Backs:** Things like personal expenses run through the business. 80/20: Normalize for obvious ones (e.g., your country club dues), but don’t audit every receipt. - **Intangibles like Goodwill:** Hard to quantify without a deep dive. 80/20: Let your Market Value lens capture buyer perceptions indirectly via multiples. The goal: Strip your model to essentials. Your Blended View should reflect reality without a PhD in accounting. **Principle 2: Focus on the vital few adjustments.** 80% of valuation shifts come from 20% of factors — revenue growth, margins, and recurring revenue. Prune the rest to keep things actionable. #### Use Cases: Proving the 80/20 in Action #### Use Case 1: Mike’s Price Hike Decision (Early Test) Mike was eyeing a 4% price increase but worried about pushback. A full appraisal with lease capitalization and minor add-backs would’ve cost $15k and taken weeks. Using 80/20: He ran quick lenses ignoring those complexities. Inputs: Normalized EBITDA $500k → projected FCFF $320k → Lens 1 ~$2.17M baseline. Price hike added ~$145k to Lens 1 (margin lift), $118k to Lens 2, $210k to Lens 3. Blended: +$158k. Full precision version later? $166k blended uplift — 5% difference. He implemented. Three months later, actual Blended View rose $310k. Lesson: 80% got him moving; perfection would’ve delayed. #### Use Case 2: Mike’s Van Purchase (Lease vs. Buy) Mike debated leasing vs. buying a new $85k service van. Full model: Capitalize lease, adjust depreciation, recalculate WACC — added $8k Enterprise Value shift. 80/20 Approach: Treated lease as simple expense in Lens 1. Buying showed +$92k over five years (better margins, no ongoing payments). He bought. Actual uplift: $135k. Close enough; decision unchanged. #### Use Case 3: Mike’s Minor R&D Spend Mike spent $18k prototyping a new scheduling tool. Capitalizing fully (amortization over 4 years) would’ve boosted EBITDA slightly. 80/20: Added back 80% to EBITDA as a quick adjustment. Lenses showed $14k uplift — enough to justify. Full treatment? $16k. No flip; saved modeling time. In each case, the last 20% added cost without insight. The 80/20 freed Mike to act. **Principle 3: Decisions drive value, not decimals.** If the rough number points the same way as the precise one, you’ve won. Use your lenses to test: Run scenarios with and without complexities — if the gap is under 10–15%, simplify. #### Your 80/20 Valuation Starter Kit Ready to apply this? Here’s how to make the 80/20 Rule your default: 1. **Gather Basics:** Grab your P&L, balance sheet, and cash flow. Ignore deep dives into leases or R&D unless they’re huge. 2. **Run Simplified Lenses:** Use the templates in the Worksheets section. Skip adjustments for now — focus on core inputs. 3. **Test a Decision:** Pick one move (price tweak, hire, CapEx). Model its impact. If 80% accuracy says "go," trust it. 4. **Prune Ruthlessly:** Ask: "Does this complexity change my call?" If no, drop it. 5. **Revisit Quarterly:** Update your numbers. The 80/20 compounds — small, frequent insights build big value. Embrace the 80/20, and you’ll stop overthinking and start overachieving. Your business isn’t a lab experiment; it’s a wealth engine. Good enough today beats perfect tomorrow. --- #### Before You Dive Into the Lenses: A Quick Decision Guide You now have the foundation — valuation as a living practice, the 80/20 approach, and the mindset that your business is an asset appreciating or depreciating with every decision. But which lens matters most to you *right now*? Here's a quick way to orient yourself as you enter Part 2: - **"I just want to know if my business is getting stronger or weaker."** → Start with Lens 1 (Chapter 4). It's your operations report card — pure business health, independent of debt or market mood. - **"I want to know what I'd actually walk away with."** → Pay extra attention to Lens 2 (Chapter 5). This is your personal net worth tied up in the business. - **"I'm thinking about selling in the next few years."** → Lean into Lens 3 (Chapter 6). The market sets the price, and you need to know what drives your multiple. - **"I need one number that accounts for everything."** → That's Lens 4, the Blended View (Chapter 7). It pulls the other three together based on your specific goals. - **"I want to understand what's behind the curtain."** → Chapter 8 (Cost of Capital) is the hidden lever that powers all four lenses. Read them in order your first time through. After that, jump to whichever lens matches the question you're trying to answer today. --- # Part 2: The Four Lenses — Your Core Valuation Toolkit Now, the tools: Meet the four lenses that turn your everyday financials into actionable insights. No fancy math, no Wall Street jargon — just a straightforward way to plug in your numbers and see your business's true worth across every angle. You've got the mindset from Part 1: Valuation as your daily superpower, treating your company like a living asset, and embracing the 80/20 Rule for directional accuracy over perfection. Here, we put that into practice. These lenses aren't abstract — they're your owner's report, pulling together profits, cash flows, and market realities into numbers that matter to *you*. We'll start with Cash Flow to the Business (Lens 1), the raw engine of your operations and its Enterprise Value. Then, Cash Flow to the Owner (Lens 2), what actually hits your pocket after debts and obligations — your Equity Value. Next, What Buyers Will Pay (Lens 3), the market's cold-hard take via multiples and comps. Finally, the Blended View (Lens 4), your customizable single number that weighs it all based on your goals. And woven throughout: Cost of Capital (Chapter 8), the hidden lever that ties everything to real-world risks and returns. Remember Tony, the pizza shop owner? He was stuck in monthly P&Ls until these lenses revealed a $287k uplift from two simple tweaks — better suppliers and a POS system. No deep dives into complexities; just 80/20 focus on core inputs like margins and growth. That's the power: Fast calculations (under 10 minutes) that evolve with your business, spotting value drags before they cost you six figures. As we build this toolkit, lean on the worksheets at the back — they're your hands-on companions for running these calculations yourself. By the end of this part, you'll run your own lenses with confidence, turning vague hunches into data-backed decisions. Let's equip you — your wealth engine is ready to rev. --- [Return to TOC](#toc) ### Chapter 4: Cash Flow to the Business — What Your Operations Are Worth This is **Lens 1: Cash Flow to the Business**, also known as Enterprise Value. It answers the most fundamental question about your company: **“If someone bought the entire operation — lock, stock, and barrel — what would all future cash flows from the business itself actually be worth today?”** This lens ignores how the business is financed (debt, owner draws, etc.). It measures the raw horsepower of the machine before anyone takes their cut — you, the bank, the IRS. That’s why it’s called “to the business” or “to the firm.” Most owners never see this number. They track profit, sure. But profit is after interest, taxes, and owner perks. Lens 1 strips all that away to show what the operations are truly generating for *everyone* who has a claim on them. Why does this matter? Because Lens 1 is the starting point for almost every serious conversation about what your business is really worth — whether you’re talking to buyers, lenders, investors, or just checking your own net worth. Get this lens right (directionally), and the other three fall into place. > **Reality Check: “But I Have Debt — Doesn’t That Change Everything?”** > Debt doesn’t change Lens 1. It changes **Lens 2: Cash Flow to the Owner**. Lens 1 is debt-neutral — it values the whole pie before slicing it. Mike had $500k in equipment loans when he started. His Lens 1 was still $2.17M because the cash flows were what they were. Debt only subtracts when you move to what’s left for *you*. #### How Lens 1 Works: The Simplified Path We use a **Discounted Cash Flow (DCF)** approach — the same one big buyers rely on — but with 80/20 simplifications so it's fast and good enough. Here’s the plain-English path (we’ll walk through Mike’s numbers in a minute): 1. Calculate your normalized Free Cash Flow to the Firm (FCFF) for the current year — basically EBITDA after taxes, minus what you must reinvest in equipment and working capital. 2. Project that cash flow for the next five years using realistic growth. 3. Add a Terminal Value (what the business is worth forever after year 5). 4. Discount everything back to today using your cost of capital, then apply a private-company illiquidity discount (20–35%). That’s it. No ten-year spreadsheets, no Monte Carlo simulations. Five years plus a terminal value gives you directional accuracy that’s good enough to make real decisions. **What it means for you:** Lens 1 shows you whether the machine itself is getting stronger or weaker — independent of how you finance it. That single view changes how you think about every price increase, hire, or piece of equipment. #### Mini-Worked Example: Mike’s Lens 1 Calculation Let’s walk through Mike’s actual baseline numbers so you can replicate this for your own business. **Step 1: Current-Year FCFF (normalized)** - EBIT: $410,000 (revenue $2.4M – COGS $1.08M – OpEx $820k – D&A $90k) - NOPAT = $410k × (1 – 20% tax rate) = $328,000 - + Depreciation & Amortization (add back non-cash): +$90,000 - – Normalized CapEx (average replacement over 5 years): –$95,000 - – Change in Working Capital: –$3,000 → FCFF ≈ **$320,000** (we use this normalized figure in all projections throughout the book) **Step 2: 5-Year Projection** (6% near-term growth) Year 1: $320k × 1.06 = $339.2k Year 2: $339.2k × 1.06 = $359.6k Year 3: $359.6k × 1.06 = $381.1k Year 4: $381.1k × 1.06 = $404.0k Year 5: $404.0k × 1.06 = $428.2k **Step 3: Terminal Value** Terminal growth: 2.5% (conservative, close to long-term GDP) Terminal FCFF = $428.2k × 1.025 = $438.9k WACC: 15% (Mike’s rough blend: 10% equity cost + 5% after-tax debt) Terminal Value = $438.9k / (0.15 – 0.025) = $438.9k / 0.125 = **$3.51M** **Step 4: Discount to Present** Discount each year’s FCFF + PV of TV at 15% PV Year 1: $339.2k / 1.15 ≈ $295k PV Year 2: $359.6k / 1.15² ≈ $272k PV Year 3: $381.1k / 1.15³ ≈ $251k PV Year 4: $404.0k / 1.15⁴ ≈ $231k PV Year 5: $428.2k / 1.15⁵ ≈ $213k PV Terminal: $3.51M / 1.15⁵ ≈ $1.74M Total Enterprise Value (pre-illiquidity): ≈ **$3.01M** (sum of PVs) **Step 5: Apply Illiquidity Discount** Private SMBs aren’t liquid like stocks. Mike used 28% (typical for $2–5M revenue HVAC). $3.01M × (1 – 0.28) = **$2.17M** That math flows cleanly: $320k in normalized FCFF → $3.01M enterprise value → $2.17M after the illiquidity discount. No adjustments needed — the numbers confirm themselves. That’s Lens 1: **$2.17M** — the value of Mike’s operations to all stakeholders. **What it means for you:** You can run the exact same five-step process for your business in under 10 minutes. The result is directional — close enough to guide every decision you make. #### Why Lens 1 Matters Most for Day-to-Day Management Lens 1 is your operations report card. It tells you whether the machine is getting stronger or weaker — no financing tricks allowed. - Margins improve? Lens 1 rises. - Growth slows? Lens 1 flattens or drops. - CapEx outpaces depreciation? Lens 1 suffers long-term. Mike used Lens 1 as his first gut-check filter: “If a decision doesn’t improve Lens 1 over 3–5 years, it’s probably not worth doing — even if it looks good on the P&L short-term.” > **Reality Check: “My Growth Is Flat — Does Lens 1 Still Work?”** > Yes. Mike tested a 0% growth scenario: Lens 1 dropped to ~$1.68M. That visual wake-up call pushed him to focus on recurring contracts, which lifted growth back to 6%. Flat growth isn’t fatal — it’s just expensive. Lens 1 shows you the price tag. **What it means for you:** Lens 1 keeps you honest about whether your day-to-day moves are actually building the asset you own.#### Why Lens 1 Matters Most for Day-to-Day Management #### Tactical Table: How Common Moves Impact Lens 1 (Mike’s Early Tests) | Decision | Key Driver | Lens 1 Impact (5-yr) | 80/20 Notes | |------------------------------|-----------------------------|----------------------|--------------------------------------------------| | 4% price increase | Margin expansion | +$145k | Focused only on gross margin lift; ignored minor churn | | Hire $70k service tech | Revenue growth acceleration | –$35k yr1, +$180k cumulative | Weighted forward years heavier; skipped full payroll tax modeling | | Buy $85k van (cash) | Efficiency + lower maintenance | +$92k | CapEx hit yr1, but depreciation savings + fuel economy win long-term | | Add $15k/year recurring contracts | Risk reduction + stable cash | +$220k | Lowered perceived WACC slightly; biggest Lens 1 driver | These are direct from Mike’s early experiments — copy the format and test your own moves. **What it means for you:** Small, practical changes create big swings in Lens 1. The table gives you a ready-made template to run your own quick tests. #### Next Up: From Whole Business to Your Pocket Lens 1 gives you the full machine’s value. In the next chapter, we subtract debt and obligations to see what actually belongs to *you* — Lens 2, Cash Flow to the Owner. But first: Run your own Lens 1 baseline. Grab your normalized EBITDA, rough FCFF, and a 14–16% WACC guess. Project five years conservatively. Discount. Apply 25–30% illiquidity. Even if it’s rough, you’ll have a number that changes how you see every decision. Mike did. And his asset started appreciating the moment he began measuring it properly. --- [Return to TOC](#toc) ### Chapter 5: Cash Flow to the Owner — What Actually Ends Up in Your Pocket Lens 2 is the number that matters most to you personally: **Cash Flow to the Owner**, also called Equity Value or what you truly "own" after everyone else gets paid. Lens 1 told us what the whole business machine is worth to all stakeholders. Lens 2 subtracts the claims of lenders and other obligations to reveal: **What’s left in your pocket if you sold today or kept running it forever?** This is your real net worth tied up in the business — the number that funds your lifestyle, retirement, kids’ college, or legacy. It’s why most owners care more about Lens 2 than Lens 1. Mike felt this viscerally. His Lens 1 was $2.17M — impressive on paper. But after $500k net debt (equipment loans minus cash), his Equity Value dropped to **$1.67M**. That’s the wake-up call: “The machine is worth $2.17M, but after the bank takes its share, I’m walking with $1.67M.” Suddenly every decision got personal. > **Reality Check: "I Don’t Have Much Debt — Is Lens 2 Still Different?"** > Yes — even debt-free businesses have obligations: deferred taxes, working capital needs, owner-dependent salary adjustments. Mike was low-debt but still saw a $500k gap. Lens 2 forces you to face what’s truly yours, not just what the operations produce. This is **Lens 2: Cash Flow to the Owner**, also called Equity Value. Lens 1 told us what the whole business machine is worth to all stakeholders. Lens 2 subtracts the claims of lenders and other obligations to reveal: **what’s left in your pocket if you sold today or kept running it forever?** This is your real net worth tied up in the business — the number that funds your lifestyle, retirement, kids’ college, or legacy. It’s why most owners care more about Lens 2 than Lens 1. Mike felt this viscerally. His **Lens 1: Cash Flow to the Business** was $2.17M — impressive on paper. But after $500k net debt (equipment loans minus cash), his **Lens 2: Cash Flow to the Owner** dropped to **$1.67M**. That’s the wake-up call: “The machine is worth $2.17M, but after the bank takes its share, I’m walking with $1.67M.” Suddenly every decision got personal. > **Reality Check: “I Don’t Have Much Debt — Is Lens 2 Still Different?”** > Yes — even debt-free businesses have obligations: deferred taxes, working capital needs, owner-dependent salary adjustments. Mike was low-debt but still saw a $500k gap. Lens 2 forces you to face what’s truly yours, not just what the operations produce. **What it means for you:** Lens 2 turns abstract business value into the dollars that actually hit your bank account or your family’s future. #### How Lens 2 Works: From Enterprise to Equity Lens 2 is simple once you have Lens 1: **Equity Value = Enterprise Value (Lens 1) – Net Debt + Excess Cash** - **Net Debt** = Total interest-bearing debt minus cash & cash equivalents - **Excess Cash** = Any cash above what’s needed to run the business (usually $50k–$150k for businesses Mike’s size) You can also calculate it directly with **Free Cash Flow to Equity (FCFE)** — the cash left for owners after debt service — then discount that stream. Most owners start with the simpler Lens 1 subtraction method and only go to full FCFE if debt is complex or you’re raising capital. Mike used both to cross-check. The **80/20 shortcut:** Start with Lens 1 minus net debt. It’s usually close enough. **What it means for you:** You don’t need to over complicate it to see what you actually own. Lens 2 makes every decision feel personal — because it is. Only go to full FCFE if debt is complex or you’re raising capital (Chapter 12). #### Mini-Worked Example: Mike’s Lens 2 Calculation Using Mike’s baseline **Lens 1: Cash Flow to the Business** of $2.17M: - Total interest-bearing debt: $620k (equipment loans + line of credit) - Cash on hand: $120k → Net Debt = $500k **Lens 2: Cash Flow to the Owner** = $2.17M – $500k = **$1.67M** (He cross-checked with the direct FCFE method and landed within 3% — solid 80/20 confirmation.) Mike’s big insight: Debt drag was eating 23% of his enterprise value. Paying down $100k early would add ~$100k straight to Lens 2. He refinanced one loan at lower rates — Lens 2 jumped $85k within six months. Sandra at Coastal Supplies saw an even starker gap. Her **Lens 1: Cash Flow to the Business** showed $4.75M, but with $2.35M in net debt, her **Lens 2: Cash Flow to the Owner** dropped to **$2.40M** — a 49% debt drag. That number hit hard. She immediately prioritized paying down the revolver, boosting Lens 2 by $640k after her price increase. **What it means for you:** The gap between Lens 1 and Lens 2 is your personal scoreboard. Close it and every extra dollar flows straight to you. #### Tactical Table: How Decisions Hit Lens 2 (Mike’s Early Moves) | Decision | Lens 1 Impact | Debt/Debt Service Impact | Lens 2 Impact | 80/20 Notes | |------------------------------|---------------|---------------------------|---------------|--------------------------------------------------| | 4% price increase | +$145k | None | +$118k | Flows straight to owner after fixed debt costs | | Pay down $100k loan early | +$0 (neutral) | –$100k debt | +$100k | Direct 1:1 equity boost; ignored prepayment penalties | | Hire $70k tech (growth hire) | –$35k yr1 | None | –$48k yr1 | Short-term owner cash hit; long-term multiple lift | | Refinance loan at 2% lower rate | +$40k (lower WACC) | –$15k annual interest | +$85k | Interest savings flow directly to equity | Lens 2 amplifies decisions that reduce debt drag or boost owner cash — exactly why Mike started prioritizing it for personal wealth tracking. > **Reality Check: "I Pull All Profit Out — Lens 2 Is Always Low?"** > Yes — excessive owner draws shrink reinvestment and growth, capping Lens 2. Mike used to pull $380k+ annually. After lenses, he left $50k–$80k in the business yearly. Lens 2 grew faster than profit alone. Trade-off: less lifestyle cash now, much more wealth later. **What it means for you:** Lens 2 is your personal scoreboard. It turns abstract business value into “what I can actually take home or pass on.” #### Next Up: What Buyers Will Actually Pay Lens 2 shows you what you keep. In the next chapter we look at Lens 3 — what the market would actually write a check for today. But first: Run your own Lens 2 baseline. Take your Lens 1 number, subtract net debt, and ask yourself one question: “How much more of this number do I want in my pocket?” Mike did — and his asset started working for him instead of the bank. [Return to TOC](#toc) ### Chapter 6: What Buyers Will Pay — Market Reality and What Drives Your Multiple This is **Lens 3: What Buyers Will Pay**, also called Market Value. It answers the cold, hard question: **“If I put my business on the market today, what would a real buyer actually write a check for?”** This lens ignores your internal forecasts and focuses on what similar businesses actually sell for — usually expressed as a multiple of EBITDA or SDE (Seller’s Discretionary Earnings). **EBITDA vs. SDE — which one to use?** SDE (your net income plus owner salary plus any personal perks run through the business) is the standard for owner-operated businesses under roughly $2M in revenue, where you are the business. EBITDA is cleaner and more widely used for businesses above that threshold that have a management layer and don’t depend on you showing up every day. Mike at $2.4M revenue with an operations manager uses EBITDA. Tony at $1.1M still working 50-hour weeks would be valued on SDE by most buyers. When in doubt, calculate both — if they’re close, you’re fine. If they diverge significantly, it’s a signal your add-backs need a harder look. Lens 3 is the market’s reality check. You can have strong cash flows (Lens 1) and good owner benefit (Lens 2), but if buyers in your industry are only paying 4x EBITDA while you think you deserve 6x, the market wins. Mike learned this fast. His **Lens 1: Cash Flow to the Business** + **Lens 2: Cash Flow to the Owner** showed $1.67M–$2.17M, but **Lens 3: What Buyers Will Pay** came in at **$2.70M** ($500k EBITDA × 5.4x HVAC service multiple). The market was willing to pay a premium for his recurring maintenance contracts and regional brand — something his internal cash flows undervalued slightly. > **Reality Check: “My Business Is Unique — Multiples Don’t Apply to Me”** > Every owner says this. Mike did too — “My Florida territory and contracts are special.” But buyers compare to comps first. The 80/20 fix: Start with industry average multiple, then adjust up/down 0.5–1.0x for your real differentiators (recurring revenue, growth rate, owner dependence). Mike justified 5.4x instead of 4.8x average — $300k extra value. **What it means for you:** Lens 3 forces you to build what buyers actually reward — not just what feels good to you. #### How Lens 3 Works: The 80/20 Multiple Method 1. Get your normalized EBITDA or SDE (Mike used $500k EBITDA). 2. Find current industry multiple range — the best free sources are BizBuySell (actual transaction comps updated quarterly) or ask your CPA/broker for a quick read. 3. Apply a base multiple, then adjust for your strengths/weaknesses. 4. Market Value = EBITDA × Multiple. 5. Optional: Blend trailing + forward EBITDA for growth businesses. **80/20 Shortcut:** Use one trailing-year EBITDA × midpoint multiple. Adjust only for big factors (recurring >50%, owner dependence <20 hrs/week). Skip detailed comp adjustments unless you’re selling soon. **What it means for you:** You don’t need a broker or $50k appraisal to get a directional read on what the market would pay today. #### Mini-Worked Example: Mike’s Lens 3 Calculation Baseline: - Normalized EBITDA: $500,000 - Industry multiple range (HVAC with service contracts): 4.8–6.0x - Mike’s adjustments: +0.4x for 45% recurring revenue +0.2x for strong Florida territory/brand –0.0x (no major customer concentration) → Applied multiple: **5.4x** **Lens 3: What Buyers Will Pay** = $500k × 5.4 = **$2.70M** Forward look (growth-weighted): - Projected Year 3 EBITDA: $620k (6% growth) - Same 5.4x multiple - Blended (50% trailing / 50% forward): ≈ **$2.97M** Mike used **$2.70M** conservatively for day-to-day — but the forward premium gave him confidence to invest in more contracts. **What it means for you:** You can run this exact math for your business in minutes and immediately see where the market is rewarding (or penalizing) you. #### What Really Drives Your Multiple (The Four Forces) Buyers don’t pay random multiples. Four forces explain 80% of the variance: 1. **Growth Visibility** — Documented pipeline = higher multiple 2. **Risk Reduction** — Recurring revenue, diversified customers, clean books 3. **Owner Independence** — Processes documented, team strong → less key-person risk 4. **Capital Efficiency** — Low CapEx needs, minimal working capital drag Mike focused on #2 and #3: Added contracts (risk down), documented SOPs (owner independence up). Multiple crept from 5.2x to 5.6x in 18 months — $200k extra value at same EBITDA. --- > **Reality Check: "Multiples Are Too Low in My Industry — What Now?"** > Multiples reflect risk. Mike’s HVAC peers traded 4–5x because most were owner-dependent and seasonal. He broke the pattern with recurring revenue and systems — market rewarded him. If your multiple feels low, fix the underlying forces first. #### Tactical Table: Multiple Drivers & Lens 3 Impact (Mike’s Journey) | Action | Force Improved | Multiple Change | Lens 3 Impact | 80/20 Notes | |--------------------------------------|-------------------------|-----------------|---------------|--------------------------------------------------| | Add 15% more recurring contracts | Risk Reduction | +0.3x | +$150k | Focused on contract % only; ignored contract details | | Document SOPs + train backup staff | Owner Independence | +0.2x | +$100k | Skipped full process audit; just key roles covered | | Reduce single-customer concentration | Risk Reduction | +0.1x | +$50k | Diversified top 3 clients; ignored minor ones | | Invest in CRM for pipeline visibility| Growth Visibility | +0.2x | +$100k | Forward EBITDA weighting increased | These moves lifted Mike’s Lens 3 from $2.50M to $2.90M+ over time — market catching up to his improvements. **What it means for you:** Lens 3 keeps you honest. It forces you to build what buyers actually pay for — not just what you think is cool. #### Next Up: The Blended View Lens 3 shows you what the market would pay today. In the next chapter we pull all four lenses together into one actionable number — the Blended View — so you always know the single best number for whatever you’re trying to do right now. But first: Run your own Lens 3 baseline. Grab your EBITDA, check BizBuySell for your industry multiple, and ask yourself: “What would the market actually pay me today?” Mike did — and it changed how he ran the business every single day. [Return to TOC](#toc) ### Chapter 7: The Blended View — Why No Single Number Tells the Truth You now have three strong lenses: - **Lens 1: Cash Flow to the Business** (what the whole operation is worth) - **Lens 2: Cash Flow to the Owner** (what actually ends up in your pocket) - **Lens 3: What Buyers Will Pay** (what the market would write a check for today) But no single one tells the full truth. Mike’s baseline showed: - **Lens 1: Cash Flow to the Business** — $2.17M - **Lens 2: Cash Flow to the Owner** — $1.67M - **Lens 3: What Buyers Will Pay** — $2.70M Which is “right”? All of them — and none of them — depending on what you’re trying to do right now. That’s why we created **Lens 4: The Blended View** — your single, context-weighted number that combines the three lenses based on your current goal. Think of it as your personal living valuation dashboard. It shifts weights depending on whether you’re running day-to-day, prepping to sell, raising capital, or planning succession. > **Reality Check: “Can’t I Just Pick One Lens and Be Done?”** > You could — many owners do. Mike initially leaned on Lens 2 because it felt most “real.” But when he showed Lens 3 ($2.70M) to a potential lender, they laughed at his $1.67M equity number. The Blended View forced him to see all perspectives at once. One lens = blinders; Blended View = full picture. **What it means for you:** The Blended View gives you one actionable number that matches whatever you’re actually trying to accomplish — no more guessing which lens to trust. #### How the Blended View Works Simple weighted average: **Blended View = (Weight₁ × Lens 1) + (Weight₂ × Lens 2) + (Weight₃ × Lens 3)** Recommended starting weights (adjust based on your situation): - **Day-to-day operations / Hold forever:** 40% Lens 1 | 40% Lens 2 | 20% Lens 3 (Cash flows matter most when you’re running it) - **Preparing to sell (1–3 years out):** 20% Lens 1 | 20% Lens 2 | 60% Lens 3 (Market sets the price) - **Raising capital:** 25% Lens 1 | 50% Lens 2 | 25% Lens 3 (Equity value drives dilution) - **Family succession:** 35% Lens 1 | 45% Lens 2 | 20% Lens 3 (Owner/family wealth focus) Mike’s default (day-to-day): (40% × $2.17M) + (40% × $1.67M) + (20% × $2.70M) = $868k + $668k + $540k = **$2.076M** (he rounded to $2.04M conservatively) **What it means for you:** You can recalculate the Blended View in seconds whenever your situation changes. The same business can be worth $2.04M today and $2.39M tomorrow simply by shifting the weights. #### Mini-Worked Example: Mike’s Context-Shifted Blended Views Same baseline numbers, different goals: 1. **Day-to-day (40/40/20):** $2.04M 2. **Eyeing sale in 18 months (20/20/60):** (20% × $2.17M) + (20% × $1.67M) + (60% × $2.70M) = **$2.39M** → Higher weighting on market → higher target ask 3. **Raising $300k growth capital (25/50/25):** **$2.05M** → Equity focus protects dilution 4. **Family succession planning (35/45/20):** **$2.05M** → Equity weighting for fair family transfer See how the same business yields $2.04M–$2.39M depending on your goal? That’s the power of context. **What it means for you:** The Blended View keeps you from over-relying on any one lens. It gives you the single best number for whatever you’re trying to do right now. #### Tactical Table: Blended View Shifts (Mike’s Evolution) | Scenario / Goal | Weights (L1/L2/L3) | Blended Value | Key Insight / Action Taken | |------------------------------|--------------------|---------------|------------------------------------------------| | Baseline day-to-day | 40/40/20 | $2.04M | Starting anchor; focus on cash flow stability | | After 4% price increase | 40/40/20 | $2.20M | +$158k; confirmed move was worth it | | Pre-sale mindset (18 mo out) | 20/20/60 | $2.39M | Pushed Mike to build recurring revenue faster | | Raising $300k capital | 25/50/25 | $2.05M | Set pre-money floor; protected dilution | | Succession draft | 35/45/20 | $2.05M | Equity weighting for fair family transfer | Mike recalculated blended monthly — weights changed as his goals evolved. > **Reality Check: "Weights Feel Arbitrary — How Do I Choose?"** > Start with the defaults above. Then ask: “What question am I really answering right now?” If it’s “What can I take home?” weight Lens 2 heavier. If “What would I get if I sold?” weight Lens 3. Test sensitivity: Shift weights ±10% — if blended moves <5–10%, your choice is robust. #### Next Up: The Hidden Lever Behind All Lenses The Blended View pulls everything together into one actionable number. In the next chapter we look at the hidden lever that moves all four lenses at once — your cost of capital. But first: Run your own Blended View right now. Grab your three lens numbers, apply the day-to-day weights, and ask yourself one simple question: “Does this number feel right for where I am today?” Mike did — and it changed how he ran the business every single day. --- Next: The hidden lever behind all lenses — Cost of Capital. [Return to TOC](#toc) ### Chapter 8: Cost of Capital — The Hidden Lever That Controls Your Valuation Before we dive into any formulas, let me show you why this chapter might be the most important one in the entire book. Mike’s HVAC business generates $320,000 in free cash flow per year. At a 15% discount rate, his Lens 1 (Enterprise Value) was $2.17 million. When he spent two hours understanding his cost of capital and realized it should be closer to 14%, the same $320,000 in cash flow — with nothing else changed — produced a Lens 1 of roughly $2.34 million. A $170,000 increase in value from understanding one number. Now consider the opposite direction. If his cost of capital was actually 16% instead of 15%, that same cash flow stream would only be worth about $2.02 million — a $150,000 loss he didn’t even know was happening. That’s a $320,000 swing from a two-percentage-point range in a single input. No new customers acquired. No expenses cut. No prices raised. Just a clearer understanding of the rate at which the market discounts your future earnings. This is why cost of capital matters. It’s the invisible multiplier (or divider) sitting inside every lens calculation you’ve done so far. Get it wrong by two points, and you’ll make decisions based on a valuation that’s off by six figures. Get it right, and you’ll see opportunities to improve it — opportunities that are cheaper and faster than almost any operational change in this book. --- Mike ignored cost of capital at first. He plugged in a flat 15% WACC guess because that’s what a friend’s CPA used. When he actually dug into the components, he realized his business was riskier than he assumed — his real WACC was closer to 16.5%, which shaved roughly $180,000 off his Lens 1. That hurt. But it also showed him exactly which levers to pull: paying down $60,000 in high-interest debt reduced his levered beta, lowered his WACC by 0.8%, and recovered most of that $180,000 within six months. The pain of knowing the real number was temporary. The value of acting on it was permanent. > **Reality Check: "I Don’t Have Investors — Why Care About Cost of Capital?"** > You *are* the investor. Every dollar you leave in your business is a dollar you chose not to invest in the S&P 500 (roughly 10% average return), real estate (8-12%), or even a high-yield savings account (5%). Your cost of capital is the honest comparison between what your business earns on your money and what you could earn elsewhere. Mike treated his business as his main investment — and when his WACC analysis showed it was earning well above that hurdle, it gave him the conviction to reinvest aggressively rather than pull cash out. If it had gone the other way, he’d have had the data to make a different choice. You’ve built the four-lens compass. You can calculate what your operations are worth, what ends up in your pocket, what buyers will pay, and how the blended view shifts depending on your goals. But there’s one number hiding inside Lens 1 and Lens 2 that silently raises or lowers your valuation more than almost anything else — and most SMB owners have never heard of it. It’s called your **Cost of Capital** — technically your **Weighted Average Cost of Capital**, or WACC. In Chapters 4 and 5, we used a "discount rate" to convert future cash flows into today’s dollars. That discount rate *is* your WACC. Understanding what drives it — and how to lower it — is one of the most powerful things you can do as a business owner, because it changes the value of every future dollar your business will ever generate. Here’s the simple truth: every project, investment, or dollar retained in your business must earn more than your cost of capital to create value. If your WACC is 15% and a new truck generates a 10% return, you just destroyed value — even though it "made money" on paper. If that same truck generates 20%, you created real wealth. WACC is the dividing line between building value and burning it. And unlike pricing or hiring — which require market risk and operational execution — lowering your WACC often requires nothing more than paying down debt, improving your credit terms, or restructuring your capital. It’s the most capital-efficient value lever available to any business owner. #### What Cost of Capital Actually Means Think of WACC as the *minimum return* your business needs to generate to justify its existence as an investment. Your business is funded by two sources: equity (your money and retained earnings) and debt (loans). Each source has a cost — equity investors expect a return for taking risk, and lenders charge interest. WACC blends those two costs together, weighted by how much of each you use. When your business earns *above* your WACC, every extra dollar of cash flow gets magnified through the valuation math. When it earns *below* WACC, those same dollars get discounted into oblivion. This is why two businesses with identical cash flows can have wildly different valuations. The one with the lower WACC turns the same dollars into a bigger number — because the market (and the math) says those dollars are less risky and more valuable. #### The WACC Formula — Broken Into Pieces You Can Control Here's the formula: **WACC = (Equity Weight × Cost of Equity) + (Debt Weight × Cost of Debt)** That's it. Three pieces: how much equity you use, how much debt you use, and what each costs. Let's break down each piece — and more importantly, which parts you can actually change. #### Cost of Equity — What Your Ownership Stake "Costs" The cost of equity is calculated using the Capital Asset Pricing Model (CAPM): **Re = Risk-Free Rate + Your Levered Beta × Equity Risk Premium** | Component | What It Means | Who Sets It | |---|---|---| | Risk-Free Rate (Rf) | The 10-year U.S. Treasury yield (~4.2%). This is the return you'd get with zero risk. | The market — you can't change it | | Industry Beta (unlevered) | How volatile your industry is compared to the overall stock market. A beta of 1.0 means average volatility. Below 1.0 is less risky; above is more. | Your industry — not directly controllable | | Your Beta (levered) | Your company-specific risk, adjusted for your debt level. This is where your debt-to-equity ratio enters the picture. | **You control this** — less debt means lower beta | | Equity Risk Premium (ERP) | The extra return investors demand for holding stocks instead of risk-free bonds (~5.6%). | The market — you can't change it | Notice the pattern: three of the four inputs are set by the market or your industry. But **your levered beta** is the one you control — and it's driven directly by how much debt you carry. #### Cost of Debt — What Borrowing Actually Costs You **Rd = (Risk-Free Rate + Credit Spread + SMB Premium) × (1 − Tax Rate)** | Component | What It Means | Who Sets It | |---|---|---| | Risk-Free Rate (Rf) | Same Treasury rate as above | The market | | Credit Spread | The premium lenders charge above the risk-free rate based on your creditworthiness. Driven by your interest coverage ratio (EBIT ÷ Interest Expense). | **You control this** — better cash flows and credit mean lower spreads | | SMB Premium | An additional premium for being a small, privately-held business. Smaller companies are harder to exit and have less access to capital markets. | Your size — not directly controllable | | Tax Shield (1 − Tax Rate) | Interest on debt is tax-deductible, which creates a "shield" that reduces your effective borrowing cost. | **Partially controllable** — through tax structure optimization | The tax shield is the reason debt is often cheaper than equity. When you pay 7% interest but deduct it at a 25% tax rate, your real after-tax cost is only 5.25%. That's almost always less than the cost of equity for a private SMB. #### Capital Structure — The Blend That Ties It All Together Your capital structure is simply the mix of equity and debt funding your business: - **Equity Weight** = Equity Value ÷ Total Capital - **Debt Weight** = Debt ÷ Total Capital The more debt you use, the higher your debt weight — which means more of your WACC comes from the (cheaper) cost of debt. Sounds great, right? Not so fast. Here's the catch: as you take on more debt, your levered beta rises, which *increases* your cost of equity. At some point, the rising cost of equity overwhelms the benefit of cheap debt. That's why capital structure is the biggest lever you control — and why getting it right matters so much. #### Mike's WACC — A Walk-Through With Real Numbers Let's run through Mike's numbers to see how this actually works. **Mike's inputs:** - Risk-Free Rate: 4.2% - Equity Risk Premium: 6.0% - Industry Unlevered Beta (HVAC): 0.80 - Long-Term Debt: $440,000 - Enterprise Value (estimated): ~$2.7M (EBITDA × industry multiple) - Credit Spread: 1.5% (based on his interest coverage) - SMB Premium: 1.0% - Industry Tax Rate: 25% **Step 1 — Levered Beta:** Levered Beta = Unlevered Beta × (1 + (1 − Tax Rate) × D/E) Mike's D/E ratio: $440k ÷ $2.7M ≈ 0.163 Levered Beta = 0.80 × (1 + (1 − 0.25) × 0.163) = 0.80 × 1.122 = **0.898** His industry starts at 0.80 beta, but Mike's debt pushes his personal risk up to 0.898. **Step 2 — Cost of Equity:** Re = 4.2% + 0.898 × 6.0% = 4.2% + 5.39% = **9.59%** **Step 3 — After-Tax Cost of Debt:** Rd = (4.2% + 1.5% + 1.0%) × (1 − 25%) = 6.7% × 0.75 = **5.03%** See that tax shield at work? Mike's pre-tax borrowing rate is 6.7%, but after the deduction, his real cost is just over 5%. **Step 4 — Capital Structure Weights:** Debt Weight = 0.163 ÷ (1 + 0.163) = 14.0% Equity Weight = 1 − 14.0% = 86.0% **Step 5 — WACC:** WACC = (86.0% × 9.59%) + (14.0% × 5.03%) = 8.25% + 0.70% = **8.95%** That 15% WACC is the rate that discounted Mike's $320k FCFF stream down to the $2.17M Lens 1 value you saw in Chapter 3. If Mike could lower his WACC by even 1 percentage point — from 15% to 14% — his Lens 1 would jump by roughly $170,000. Same cash flows. Same business. Just a lower discount rate. That's the power of understanding your cost of capital. #### The Debt-to-Equity Ratio — Why It's Your Biggest Lever Of all the inputs that flow into WACC, the debt-to-equity ratio deserves special attention because it hits your valuation from two directions simultaneously. **Direction 1: It amplifies your beta.** The levered beta formula makes this crystal clear: Levered Beta = Unlevered Beta × (1 + (1 − Tax Rate) × D/E) Every dollar of debt you add increases the multiplier applied to your industry beta. Higher beta means investors see your business as riskier — which means they demand a higher return — which pushes your cost of equity up — which raises your WACC — which lowers your valuation. **Direction 2: It shifts your capital structure weights.** More debt means a higher debt weight in the WACC formula. Since cost of debt is usually lower than cost of equity (thanks to the tax shield), this *should* lower your blended WACC. And at moderate levels of debt, it does. But here's the paradox: past a tipping point, the beta amplification effect overwhelms the cheap-debt benefit. This is why you'll sometimes hear that there's an "optimal" capital structure — the debt level where your WACC hits its lowest point. **Mike's "What If" scenario:** What if Mike pays off 25% of his $440k debt — that's $110,000 in principal? | Metric | Before Paydown | After Paydown | |---|---:|---:| | Long-Term Debt | $440,000 | $330,000 | | D/E Ratio | 0.163 | 0.122 | | Levered Beta | 0.898 | 0.873 | | Cost of Equity | 9.59% | 9.44% | | WACC (base CAPM) | 8.95% | 8.85% | The direct WACC improvement looks small in percentage terms — about 0.10 percentage points. But remember: in the full model with size premiums and risk adjustments, that same directional improvement translates to a meaningfully larger valuation gain. And the paydown also improves Mike's credit metrics, which can lower his spread over time — creating a compounding effect. The lesson: debt reduction doesn't just lower one number. It sets off a chain reaction through beta, cost of equity, credit spread, and ultimately your valuation across Lens 1 and Lens 2. #### The Playbook — Four Levers to Lower Your Cost of Capital Now that you understand what drives WACC, here are the four concrete levers you can pull — ordered by impact. #### Lever 1: Reduce Debt (High Impact) **What it does to the formula:** Lower D/E → lower levered beta → lower cost of equity → lower WACC. This is the single most direct path to a lower discount rate. **Actions you can take:** - Accelerate SBA or term loan payoff using excess cash - Refinance high-interest debt at lower rates (even if the balance stays the same, a lower rate improves your interest coverage, which can lower your spread) - Avoid taking on new debt for discretionary spending — run the four-lens test first - Use excess cash to pay down principal instead of letting it sit in a low-yield account **Mike's situation:** Paying off $110k (25% of his $440k debt) would drop his D/E from 0.163 to 0.122 and set off the chain reaction described above. Over two years, the compounding valuation benefit could exceed the cash deployed. #### Lever 2: Improve Creditworthiness (Medium Impact) **What it does to the formula:** Lower credit spread → lower cost of debt → lower WACC. Your credit spread is determined by how well your operating income covers your interest payments (the interest coverage ratio). Better coverage = lower spread. **Actions you can take:** - Build 6+ months of operating cash reserves — lenders and buyers both see this as a sign of stability - Lock in recurring revenue contracts to reduce cash flow volatility - Improve accounts receivable collection — target less than 30 days DSO (Days Sales Outstanding) - Maintain a clean personal and business credit profile **Mike's situation:** His current interest coverage (EBIT $410k ÷ Interest $35k = 11.7x) is strong. If he improves one credit rating notch, his spread could drop by 0.2–0.5%, directly reducing his after-tax cost of debt. #### Lever 3: Reduce Business Volatility (Medium Impact) **What it does to the formula:** While industry beta comes from market data, demonstrating lower operational risk can justify using a lower beta assumption when presenting to buyers or investors. A business with diversified revenue, documented processes, and a management team that runs without the owner simply commands a lower perceived risk — and therefore a lower discount rate in negotiations. **Actions you can take:** - Diversify revenue so no single customer is more than 15% of total - Build recurring or subscription revenue streams (service agreements, maintenance contracts) - Create SOPs for all key business processes — this is systematized value - Develop a management team that can operate without you present These actions don't change the formula mechanically, but they change the *assumptions* a buyer or appraiser will plug into it. And in private company valuation, assumptions are everything. #### Lever 4: Optimize Tax Structure (Low Impact) **What it does to the formula:** A properly structured tax position increases the tax shield on debt interest, lowering your effective after-tax cost of debt. This isn't about paying more tax — it's about ensuring you're capturing all available deductions and structuring your entity to maximize the shield. **Actions you can take:** - Maximize Section 179 deductions on equipment purchases - Review your entity structure (LLC vs S-Corp vs C-Corp) with your CPA - Ensure all eligible business expenses are properly categorized - Consider cost segregation studies for real estate assets This lever has the lowest direct WACC impact, but it costs very little to optimize and compounds with the other three. #### What WACC Means for Your Situation The same WACC number takes on different significance depending on what you're trying to accomplish. Here's how to interpret your cost of capital across the six most common owner contexts: | Your Goal | WACC Means… | What To Do | |---|---|---| | **Sell your business** | Your Exit Multiplier — lower WACC before listing to maximize your asking price. Buyers discount your cash flows at *their* cost of capital, so demonstrating a lower-risk business commands a higher price. | Pull all four levers aggressively in the 12–24 months before listing. Every 1% WACC reduction translates directly to a higher exit multiple. | | **Buy a business** | Your Required Return — set this to your own cost of capital to see the risk-adjusted value of any acquisition. If the seller's asking price implies a return below your WACC, you're overpaying. | Use your WACC as your negotiation floor. Model post-acquisition synergies to see if the deal clears your hurdle rate. | | **Plan reinvestments** | Your Investment Hurdle — every reinvestment must earn more than this rate to create value. If a new truck returns 10% but your WACC is 15%, you're destroying value. | Compare expected ROI on any CapEx against your WACC before committing. Only invest in projects that clear the bar. | | **Raise capital** | Your Pre-Money Benchmark — investors will compare your return on equity against this rate. If your ROE exceeds WACC, you have a compelling story. | Use your WACC to set a floor on your pre-money valuation. Show investors that your returns justify a premium. | | **Evaluate an investment** | Your Risk-Adjusted Hurdle — compare projected IRR against this required rate of return. The spread between IRR and WACC is your margin of safety. | Walk away from any deal where projected returns don't clear WACC by at least 3–5 percentage points to account for execution risk. | | **Track net worth** | Your Wealth Growth Rate — your business must beat this rate to justify holding vs. selling and investing the proceeds at market returns. | Run the Hold vs. Sell math from Chapter 12. If your implied return exceeds WACC, holding builds more wealth. | This is why cost of capital isn't just an accounting concept — it's the universal translator that turns every business decision into a value decision, regardless of your goal. #### Why This Chapter Changes Every Chapter That Follows Everything from here forward — tactical decisions, negotiations, reinvestments, capital raises, exit planning — connects back to your cost of capital. When you raise prices and improve cash flow quality, you're lowering your perceived risk (Lever 3) and improving your interest coverage (Lever 2). When you pay off equipment loans with excess cash, you're pulling Lever 1. When you build recurring revenue streams, you're pulling Levers 2 and 3 simultaneously. Understanding WACC turns every management decision into a cost-of-capital decision — and every cost-of-capital decision into a valuation decision. #### Valuation Action Step This week, estimate your own WACC using Worksheet 3 (Discount Rate Estimation) in the back of this book. 1. Fill in the risk-free rate (use ~4.2% for the current 10-year Treasury, or look up today's rate). 2. Calculate your debt-to-equity ratio: Total Long-Term Debt ÷ Estimated Enterprise Value. 3. Look up your industry unlevered beta. The best free source is **Damodaran Online** (pages.stern.nyu.edu/~adamodar) — Professor Aswath Damodaran at NYU publishes updated industry betas, risk premiums, and cost of capital estimates every January. Find your closest industry category and use his unlevered beta directly. The worksheet also provides common SMB ranges as a starting point. 4. Walk through the five-step calculation from Mike's example above. 5. Write down your WACC. Then ask: **Which of the four levers can I pull in the next 90 days?** Even a 1% WACC reduction on a $2M Lens 1 business can add $100k–$200k in value. That's real money you're leaving on the table if you ignore this number. Your cost of capital isn't just a formula buried in a spreadsheet. It's the price tag on your risk — and the single most underutilized lever in every SMB owner's toolkit. --- [Return to TOC](#toc) # Part 3: Tactical Plays — Decisions That Multiply Value > **Where We've Been:** You've built the foundation — treating your business as a living asset (Part 1) and mastering the four lenses that measure its health from every angle (Part 2). You can now calculate Enterprise Value, Equity Value, Market Value, and the Blended View. You understand the cost of capital that ties it all together. > > **Where We're Going:** Now we put those lenses to work on real decisions. The next four chapters show you how pricing, hiring, negotiations, reinvestment, and capital raises look different when you run them through the lenses first. This is where six-figure value gets created — or destroyed — in the everyday choices you're already making. Theory meets action: With your mindset reset (Part 1) and lenses sharpened (Part 2), it's time to wield them on the decisions that define your day-to-day. Pricing a service bump? Debating a key hire? Eyeing that new truck or vendor deal? These aren't just ops tweaks — they're value multipliers, and your four lenses give you the X-ray vision to score them before you commit. In this part, we'll apply the framework to tactical moves that unlock hidden wealth. Start with everyday decisions like pricing, hiring, CapEx, and margins (Chapter 9), where small shifts can add hundreds of thousands across your lenses. Then, harness real-time value as your negotiation anchor (Chapter 10) — with vendors, customers, or employees — turning "gut feel" into unshakeable leverage. Next, spot reinvestments that truly grow your exit (Chapter 11), separating value-builders from money pits. Finally, raise capital smartly (Chapter 12), modeling dilution and pre-money asks without giving away the farm. Lean on the 80/20 Rule here: 80% of your value gains come from 20% of decisions — focus on those, pruning complexities like minor lease tweaks. Take Tony from Pauly's Pizza: A quick lens run on his manager raise decision showed it would add $248k to his Blended View. He acted, and his lenses confirmed the result three months later — no full appraisal needed. These chapters turn your toolkit into a habit: Test, decide, measure, repeat. The worksheets in Part 5 will be your guide, with templates for scenario modeling that make each tactical play concrete and repeatable. By the end of this part, you'll manage like a value pro: Every choice a calculated win, building the wealth you deserve. Let's play to multiply. --- [Return to TOC](#toc) ### Chapter 9: Tactical Decisions — Pricing, Hiring, CapEx & Margin Moves Now the fun part: turning your lenses into action. You’ve got the four-lens dashboard calibrated on your baseline. The real power comes when you start testing the everyday decisions you actually make every quarter against it. Not the big strategic pivots you agonize over for months. The Tuesday-afternoon decisions. The “should I raise prices?” conversation you keep postponing. The hire you’ve been debating since last summer. The van that’s one breakdown away from stranding a tech on the side of I-75. These are the decisions that compound. And your lenses are what make the compounding visible. In this chapter we’ll walk through four high-leverage tactical levers through the stories of Mike and Sandra — showing not just the math but the thought process, the hesitation, and the moment when the lenses made the answer undeniable. You’ll see how pricing adjustments, hiring decisions, capital expenditures, and margin improvement moves ripple across all four lenses in ways that are invisible on a standard P&L. > **Reality Check: “These Decisions Feel Too Small to Move the Needle”** > Mike thought the same thing. “A 3.8% price bump on $2.4M revenue is only $91k more top-line — how can that add $158k in blended value?” The answer lies in compounding. That extra margin doesn’t just appear once and vanish. It flows through higher cash flows year after year, each one discounted back at your WACC. It signals lower risk to buyers (stable pricing power lifts multiples). And it compounds through the terminal value calculation, which captures every dollar of margin improvement stretching into perpetuity. Small percentage changes create outsized dollar changes when multiplied over a decade and discounted properly. That’s the magic your P&L can’t show you. **What it means for you:** The lenses turn everyday moves into measurable wealth builders — no dramatic strategy required. #### Pricing Adjustments: The Fastest Lever Of all the levers available to a business owner, pricing is the one that produces the most dramatic lens impact for the least operational effort. A price increase drops almost entirely to the bottom line — there’s no incremental cost of goods, no new headcount, no equipment to buy. It’s pure margin. Mike had been running his HVAC business for seven years without a meaningful price increase. His service calls were priced competitively for the Tampa market, and his maintenance contracts hadn’t moved in three years. He knew he was leaving money on the table, but the fear of losing customers kept him stuck. Then he ran the numbers through his four lenses. He modeled a 3.8% across-the-board increase on service calls and maintenance contracts. To be conservative, he assumed a 10% volume drop — far worse than industry data suggested for a price hike that small. Even with that worst-case assumption, his gross margin would climb from 39.6% to roughly 43%, adding $85,000 to $100,000 in annual EBITDA. His growth rate stayed at 6%. No major capital expenditure or working capital changes. The lens impacts over a five-year projection stopped him cold. **Lens 1: Cash Flow to the Business** jumped $145,000 from the higher free cash flow stream feeding into the DCF. **Lens 2: Cash Flow to the Owner** rose $118,000 — the margin improvement flowed straight to you after fixed debt obligations. But the real surprise was **Lens 3: What Buyers Will Pay**: a $210,000 increase, driven by the fact that improved margins bumped his EBITDA multiple by 0.4x. Buyers pay a premium for businesses with pricing power. His Blended View climbed $158,000. Mike raised his prices the following Monday. Three months later, the actual result was even better than projected — his Blended View was up $310,000. The volume drop was only 4%, not 10%. The customers who valued his service stayed. The ones who left were the price-shoppers who dragged his margins down anyway. Sandra at Coastal Supplies faced a similar inflection point with her Gulf Coast distribution business. She identified specialty marine hardware lines where she was the only regional supplier within 200 miles. Rather than a blanket increase, she targeted a 4.5% bump on those specialty SKUs alone — roughly 35% of her revenue. The precision of the approach meant near-zero volume risk on the adjusted items, and her Blended View climbed by $589,000 in the first six months. Here are five practical tactics that might fit your business: 1. **Tiered pricing for different customer segments** — Charge premium rates for rush or emergency service while offering a modest discount for standard scheduling. 2. **Bundling high-margin add-ons** — Package maintenance contracts with parts or accessories at a small markup; buyers see value, not just a price hike. 3. **Annual price escalators in contracts** — Build automatic 3–5% increases into long-term agreements so you never have to have the awkward conversation again. 4. **Geographic or seasonal surcharges** — Add a small fuel or peak-season adjustment where costs are higher; customers accept it when it’s transparent. 5. **Value-based pricing on specialty work** — Price complex or high-skill jobs based on the outcome you deliver rather than hours spent. **What it means for you:** Pricing is the fastest lever because it requires no new investment, no new hires, and no operational change. It just requires the courage to look at your lenses and act on what they tell you. #### Hiring: The Lens View of Short-Term Pain Hiring is the decision that terrifies most owners when they look at it through a traditional P&L lens. A new $70,000 salary plus $15,000 in burden costs shows up immediately as an $85,000 hit to your bottom line. For an owner taking home $380,000, that’s a 22% cut to cash flow in Year 1. But the four lenses tell a completely different story. Mike had been turning away overflow service calls for months. His three-person crew was maxed out. He knew a fourth technician would unlock capacity, but every time he looked at the cost on his P&L, he flinched. So he ran it through the lenses instead. Year 1 was ugly, no question — Lens 1 dropped $35,000, Lens 2 dropped $48,000 (the owner cash hit was worse because debt payments didn’t shrink just because he hired someone). But the forward projections changed everything. The new tech would enable 15% more calls, generating an additional $180,000 in revenue starting in Year 2. At a 45% margin on that incremental work, his EBITDA would grow by $81,000 annually from Year 2 onward. Over five years, the cumulative Lens 1 impact was positive $180,000. Lens 2 recovered and climbed to positive $140,000. And Lens 3 — the market lens — told the most compelling story of all: a $320,000 increase. Why? Because buyers pay a premium for growth visibility. A business that can demonstrate it’s expanding capacity and capturing more market share earns a higher multiple. Mike’s hire signaled exactly that, lifting his EBITDA multiple by 0.6x. The net Blended View impact was positive $62,000 — modest in Year 1, transformative by Year 3. Mike hired. Year 2 revenue hit $2.8M, and every lens confirmed the bet had paid off. Tony at Pauly’s Pizza faced a version of this same dilemma when he considered promoting his best line cook to shift manager at a $12,000 raise. On his pizza shop’s thin margins, that raise looked like a luxury. But the lenses revealed that the promotion would free Tony from 15 hours per week of floor management, reducing his owner dependence and lifting Lens 3 by $248,000 over the projection period. He made the promotion, and three months later his lenses confirmed the result. Here are five practical tactics that might fit your business: 1. **Start with part-time or contract help** — Test the role before committing to full-time salary and benefits. 2. **Cross-train existing staff first** — Pay a modest raise to current employees who take on new responsibilities; often cheaper and faster than hiring. 3. **Tie bonuses to lens outcomes** — Link part of compensation to measurable improvements in recurring revenue or owner-independence metrics. 4. **Hire for the next growth stage** — Bring on someone who can handle tomorrow’s volume, not just today’s; the lenses reward forward capacity. 5. **Use temp-to-perm agencies** — Try before you buy; many owners discover their “perfect hire” this way with minimal risk. **What it means for you:** Hiring decisions that look expensive on a P&L often look brilliant through the lenses, because they capture the compound value of growth, capacity, and reduced owner risk that a simple income statement can never show. #### CapEx Decisions: Buy, Lease, or Delay? Capital expenditure decisions are where most owners default to gut instinct — or worse, to whichever option requires the least cash upfront. The four lenses force a different conversation entirely: not “what can I afford right now?” but “which option creates the most value over time?” Mike’s fleet van was dying. At 180,000 miles, it was costing him $8,000 a year in repairs, breaking down during service calls, and — though he didn’t think about it this way — silently eroding his business’s appeal to any future buyer. He had three options: buy a new $85,000 van with cash, lease one for about $18,000 a year, or keep nursing the old one. On a P&L, leasing looked attractive. Lower upfront hit, predictable monthly expense, no large cash outflow. Delaying looked even better — $8,000 in repairs was cheaper than either alternative in Year 1. But the lenses told a different story entirely. Mike modeled all three scenarios with 80/20 simplifications — ignoring minor tax timing differences and focusing on the big-picture cash flow impacts. Buying the van with cash created a $92,000 Lens 1 gain over five years. The $12,000 annual savings in fuel efficiency and reduced maintenance compounded through the DCF, and the clean, modern fleet improved buyer appeal. Lens 2 gained $68,000 because Mike didn’t take on any new debt — the cash outflow was a one-time hit, not an ongoing obligation. Lens 3 was neutral; fleet quality alone doesn’t move multiples. Leasing produced a more modest $40,000 Lens 1 gain. The lower upfront hit was appealing, but the ongoing $18,000 annual expense created a drag that compounded over the projection period. Delaying was the worst option by a wide margin: negative $35,000 on Lens 1 as repair costs crept higher and reliability declined. Mike bought the van. The actual five-year result exceeded projections — $135,000 in total uplift after fuel savings beat his conservative estimates. And when he eventually explored exit conversations, having a modern, well-maintained fleet was one of the first things the buyer’s due diligence team flagged as a positive. Sandra at Coastal Supplies applied the same lens framework to a $420,000 warehouse expansion. The P&L case was ambiguous — higher rent, more staff, uncertain demand. But Lens 1 showed a $280,000 gain from handling higher-margin specialty inventory that she’d been turning away. Lens 3 jumped $350,000 because the expansion signaled growth infrastructure to potential buyers. She broke ground within 60 days of running the analysis. Here are five practical tactics that might fit your business: 1. **Prioritize equipment that reduces ongoing maintenance** — A newer machine with warranty often pays for itself faster than the lenses initially predict. 2. **Consider energy-efficient upgrades** — Rebates and lower utility bills compound into Lens 1 and Lens 2 gains over time. 3. **Lease vs. buy analysis on high-tech tools** — Software or diagnostic equipment often makes more sense on a lease because it depreciates quickly. 4. **Bundle CapEx with vendor financing** — Negotiate favorable terms that keep debt service below the return the equipment generates. 5. **Delay non-critical replacements** — Run the lenses on “keep the old one another year” — sometimes the math says wait, sometimes it says buy now. **What it means for you:** CapEx decisions are never just about cash flow timing. They’re about what kind of business you’re building — and the lenses make that visible in dollar terms. #### Margin Moves: The Quiet Compounders Not every value-creating decision is dramatic. Some of the most powerful moves are quiet operational tweaks that shave a percentage point here, eliminate waste there, and compound silently across every lens. Mike identified two such opportunities in the same quarter. First, he renegotiated terms with his primary parts supplier. Parts and supplies represented 28% of his cost of goods sold, and his supplier had been raising prices 2-3% annually without pushback. Mike came armed with competitive quotes from two alternative vendors — not to switch, but to anchor the conversation. He secured a 5% discount on his highest-volume SKUs, adding roughly $20,000 to his annual EBITDA. Second, he invested two weekends optimizing his service routes using free mapping software. His three trucks were crisscrossing Tampa in patterns that hadn’t been updated since he had one van and a prayer. The optimized routes saved $12,000 annually in fuel and wear, and — as a bonus — reduced average response time by 18 minutes, which improved customer satisfaction scores. Together, these two moves added $32,000 in annual EBITDA with zero growth rate change, zero capital expenditure, and almost no operational disruption. The lens impacts were disproportionate to the effort. Lens 1 gained $110,000 over five years — pure margin lift flowing through the DCF. Lens 2 rose $95,000. And Lens 3 climbed $170,000, because improved margins earned a 0.3x multiple bump. Buyers love businesses that demonstrate operational discipline; it signals that the earnings are sustainable, not the result of one-time windfalls. The Blended View impact: **$125,000** from two decisions that took less than a month to implement. Here are five practical tactics that might fit your business: 1. **Consolidate suppliers** — Fewer vendors often means better volume discounts and simpler ordering. 2. **Implement energy-efficiency audits** — Small changes in lighting, HVAC, or equipment settings can shave thousands off utilities with almost no upfront cost. 3. **Reduce waste and rework** — Track returns, scrap, or service callbacks and fix the root cause; every percentage point saved flows straight to the bottom line. 4. **Review insurance and subscriptions annually** — Many owners are over-insured or paying for unused software; a quick audit can free up cash. 5. **Automate routine admin tasks** — Simple software for invoicing, scheduling, or inventory can cut labor hours without cutting staff. **What it means for you:** You don’t need a Six Sigma black belt or a management consulting engagement to find margin improvements. Look at your three largest cost categories. Call your top two vendors. Review your delivery or service routes. These moves are available to every business owner reading this book — and the lenses will show you exactly how much they’re worth. #### Working Capital: The Hidden Value Killer There’s one more margin move that most owners overlook entirely, and it deserves its own discussion: working capital management. Working capital — the gap between what customers owe you and what you owe suppliers — is cash trapped inside your business that isn’t generating returns. Every dollar sitting in accounts receivable for an extra 15 days is a dollar that can’t reduce debt, fund growth, or flow to you as the owner. Mike had $220,000 tied up in working capital, most of it in receivables from commercial accounts that routinely paid on 45-day terms. He’d never thought about this as a valuation issue — it was just “how the business works.” But when he modeled a scenario where he tightened receivables from 45 days to 30 days (by offering a 1.5% early-payment discount and enforcing terms on slow payers), the lens impact surprised him. The one-time release of roughly $55,000 in trapped cash improved his free cash flow projections, lifting Lens 1 by $38,000 and Lens 2 by $42,000. More importantly, the improved cash conversion cycle signaled operational efficiency to Lens 3, contributing to a 0.1x multiple bump worth $50,000. Sandra’s situation was more dramatic. Coastal Supplies had $1.13 million in working capital — appropriate for a distribution business, but with room to optimize. By negotiating extended payment terms with her top three suppliers (from Net 30 to Net 45) while simultaneously tightening customer terms, she freed up $180,000 in cash that went straight to paying down her revolving credit line. The impact on Lens 2 alone was over $120,000. Here are five practical tactics that might fit your business: 1. **Tighten customer terms with early-payment discounts** — Offer 1–2% off for paying in 10 days instead of 45. This can release significant trapped cash without losing good customers. 2. **Negotiate longer supplier payment terms** — Push Net 30 to Net 45 or 60 on your largest vendors while keeping customer terms tight. The spread between money coming in and going out improves cash flow immediately. 3. **Optimize inventory turns** — Review slow-moving stock and reduce safety stock on predictable items. Even a modest reduction in inventory frees up cash that flows straight to Lens 1 and Lens 2. 4. **Accelerate collections with automated reminders** — Send polite automated reminders at 15 and 25 days. Small process tweak that can drop Days Sales Outstanding by 10–15 days. 5. **Factor high-quality receivables (if needed)** — For short-term cash needs, selectively factor clean commercial invoices at a modest 1–2% cost instead of taking on new debt. **What it means for you:** Working capital isn’t just an accounting line item. It’s trapped value. Every day you let receivables age or inventory sit is a day you’re subsidizing someone else’s cash flow at the expense of your own valuation. #### Tactical Table: Mike’s Top Tactical Wins | Decision | Specific Move | Lens 1 | Lens 2 | Lens 3 | Blended | Key Insight | |----------|--------------|--------|--------|--------|---------|-------------| | Pricing | 4% service increase | +$145k | +$118k | +$210k | +$158k | Pricing power signals low risk to buyers; lifts multiples | | Hiring | $70k service tech | +$180k (5-yr) | +$140k (5-yr) | +$320k | +$62k net | Year 1 pain, Year 2+ compounding; growth visibility drives Lens 3 | | CapEx | Buy $85k van vs. lease | +$92k | +$68k | Neutral | +$72k | Cash purchase avoids ongoing drag; fleet quality matters in due diligence | | Margins | Vendor discount + route optimization | +$110k | +$95k | +$170k | +$125k | Operational discipline signals sustainable earnings | | Working Capital | Tighten receivables 45→30 days | +$38k | +$42k | +$50k | +$43k | Trapped cash is trapped value; free it | These five levers alone moved Mike’s Blended View from $2.04M to approximately $2.55M in under a year — mostly through smarter daily choices, not dramatic strategic pivots. **What it means for you:** The pattern across all five levers is the same: decisions that look modest on a P&L reveal their true scale through the lenses. A $32,000 margin improvement becomes $125,000 in blended value. An $85,000 cash outflow becomes a $135,000 gain. The lenses don’t change what you decide — they change how much confidence you have that you’re deciding correctly. Pick one lever from this chapter. The one that’s been nagging at you. Model it against your lenses this week. Execute. Then recalculate next month. The compounding starts the moment you act. You can run these exact lenses live at xitmatters.io in under 10 minutes. The same math that powers Xit Matters is now in your hands — because your exit matters, and you deserve to know your number before anyone else tells you what it is. #### Next Up: Negotiation Superpowers Now that you’ve seen how tactical moves multiply value, let’s turn those real-time numbers into an unshakeable anchor in every negotiation — with vendors, customers, employees, or even a potential buyer. The lenses give you leverage most owners never have. Let’s keep following Mike and Sandra as we turn the lenses into negotiation superpowers. [Return to TOC](#toc) ### Chapter 10: Negotiation Superpowers — Use Real-Time Value as Your Anchor Most negotiations are won or lost before you sit down. The winner is usually the side that knows their walk-away number — and can back it up with real math. Your four lenses (especially the Blended View) give you that number in real time. Suddenly you’re not guessing; you’re anchored. Mike used this superpower three times in quick succession: 1. Vendor negotiation (parts supplier) 2. Customer contract renewal (large commercial account) 3. Bank refinance conversation In each case, he walked in with his lenses printed — not to show off, but to anchor his position. > **Reality Check: “Won’t They Just Think I’m Bluffing?”** > Mike worried about this. But having three independent methods (cash flow, equity, market) made his ask credible. He didn’t flash the full model — just the headline Blended View and one supporting lens. Vendors and bankers respect data, especially when it’s conservative and multi-angled. #### How to Use Lenses in Negotiation **Step 1:** Run your current lenses 24–48 hours before the meeting. **Step 2:** Decide your goal and reweight the Blended View accordingly. **Step 3:** Prepare one “anchor sentence” backed by a lens. **Step 4:** Listen first, then counter with your number + rationale. **Step 5:** Re-run lenses after the deal to quantify the win. **What it means for you:** Preparation with the lenses turns every negotiation from a stressful conversation into a value-protected decision. #### Negotiation 1: The Vendor Who Wanted 8% Mike’s primary parts supplier dropped the news on a Tuesday morning phone call: an 8% price increase, effective next quarter. The rep framed it as industry-wide and non-negotiable. “Costs are up across the board, Mike. Everyone’s getting the same letter.” Most owners would have either accepted the increase or started shopping for a new supplier. Mike did something different. He pulled up his four lenses and ran a quick scenario. He reweighted his Blended View for this specific conversation — 50% Lens 1 (operations impact), 30% Lens 2 (owner cash hit), 20% Lens 3 — because this was fundamentally an operations and cash-flow issue. His anchor number: $2.18M. The 8% increase would hit his parts line (28% of COGS) to the tune of $38,000 annually. Fed through his five-year DCF, that was a $130,000 hit to Lens 1. At the meeting, Mike didn’t argue emotions or loyalty. He said: “I value our relationship, but an 8% increase hits my business valuation by about $130,000 over the planning horizon. I’ve run the numbers three ways. Can we find something closer to 3%, or lock current pricing for 18 months with a volume commitment on my end?” The supplier agreed to 2.5% with a volume guarantee. Mike’s post-deal recalculation showed Lens 1 preserved $95,000 versus the full increase scenario. One conversation, one printout, $95,000 in value protected. **What it means for you:** When you know the exact lens impact, you negotiate from strength instead of fear. #### Negotiation 2: The Customer Threatening to Leave Two months later, Mike’s largest commercial account — a property management company representing 14% of his revenue — called to renegotiate their service contract. They’d gotten a competing bid 12% lower and wanted Mike to match it or lose the business. On instinct, Mike almost caved. Losing 14% of revenue felt catastrophic. But he’d learned to check his instincts against the lenses first. He reweighted for this conversation: 20% Lens 1, 20% Lens 2, 60% Lens 3 — because losing a major customer is primarily a market-facing event. Customer concentration directly affects buyer multiples. The analysis revealed something counterintuitive. Matching the 12% discount would shave $40,000 off his annual EBITDA and reduce his margins enough to cost him 0.2x on his multiple — a $100,000 hit to Lens 3 from working harder for less. But losing the customer entirely would actually improve his customer concentration ratio (no single client over 12%), potentially earning back 0.1x in multiple, while the revenue loss would be partially offset by redeploying those service hours to higher-margin residential accounts. The lenses didn’t tell him to fire the client. They told him the walk-away point was a 5% discount — not 12%. He offered 5% with a two-year term commitment and priority response times. The property manager accepted. Mike held his pricing, locked in a two-year contract, and preserved $120,000 in blended value. The deeper insight: without the lenses, Mike would have matched the 12% discount out of fear. The lenses showed him that the fear was more expensive than the alternative. **What it means for you:** The lenses show you when to hold firm and when to walk away — without emotion getting in the way. #### Negotiation 3: The Bank Refinance Mike’s third negotiation that quarter was with his bank. He had a $320,000 equipment loan at 8.5% — a rate set two years earlier when his business was smaller and his financials less impressive. He suspected he could do better, but he’d never had the confidence to push. For this conversation, he reweighted toward Lens 2 — 50% Lens 2 (owner equity), 30% Lens 1, 20% Lens 3 — because refinancing is fundamentally about what flows to you after debt obligations. The math was clean. Every 1% reduction in his interest rate saved approximately $3,200 per year in interest expense. Over the remaining life of the loan, a 1.75% rate reduction would save $28,000 in total interest payments — and the lens impact was even larger because lower debt service improved his free cash flow to equity every year. Mike walked into the branch with a one-page summary: his Blended View ($2.30M), his debt-to-equity ratio, and his trailing twelve months of cash flow. He asked a simple question: “Given my business’s current valuation and cash flow profile, what rate would you offer a new customer in my position?” The branch manager came back at 6.75%. Mike signed. **What it means for you:** Lenders respect data. When you show them your lenses, you’re no longer “just another borrower” — you’re an owner who knows exactly what his business is worth. #### Negotiation 4: The Employee Who Deserved a Raise The fourth negotiation was the most delicate — because it was with someone Mike genuinely cared about. His lead technician, Carlos, had been with the company five years. He was responsible for 35% of completed service calls and had the highest customer satisfaction scores on the team. Carlos asked for a $15,000 raise, from $72,000 to $87,000. On a P&L, that’s a $15,000 annual hit to margins. Mike ran the Blended View comparison. A $15,000 base raise would reduce annual FCFF by roughly $15,000 after taxes — a permanent cost increase. Over five years, the Lens 1 impact was negative $52,000. But what if Carlos left? Mike modeled the alternative: 3-6 months to hire and train a replacement, $8,000 in recruiting costs, an estimated $45,000 in lost revenue during the transition (missed calls, slower service), and the risk that the replacement wouldn’t match Carlos’s customer scores — potentially impacting his recurring contract renewal rate. The “Carlos leaves” scenario hit the Blended View by negative $186,000. Mike found a middle path the lenses suggested: a $6,000 base raise plus a quarterly performance bonus tied to metrics that aligned with the Four Forces — customer retention rate (Risk Reduction), jobs completed per week (Capital Efficiency), and training of junior techs (Owner Independence). The structure kept base costs lower while incentivizing the behaviors that actually moved the lenses. Carlos accepted. His effective compensation rose to $83,000 in the first year, Mike’s annual fixed cost increase was only $6,000 instead of $15,000, and the bonus structure aligned Carlos’s incentives with the same value drivers Mike was managing to. Blended View impact: $35,000 positive versus the base raise scenario, $221,000 positive versus the “Carlos leaves” scenario. #### Tactical Table: Mike’s Negotiation Wins | Negotiation | Counter-Party | Lead Lens | Anchor | Outcome | Value Impact | |---|---|---|---|---|---| | Parts price hike | Vendor | Lens 1 (50%) | $2.18M | 2.5% vs. 8% demanded | +$95k preserved | | Contract renewal | Large customer | Lens 3 (60%) | $2.45M | 5% discount + 2-yr term | +$120k preserved | | Loan refinance | Bank | Lens 2 (50%) | $2.30M | 6.75% vs. 8.5% | +$85k gained | | Employee raise | Key technician | Blended | $2.30M | Performance bonus structure | +$35k vs. base raise | The common thread across all four negotiations is preparation, not aggression. Mike never raised his voice. He never threatened to walk away. He showed up with a number, explained how he’d calculated it, and asked for a conversation. The lenses removed emotion from both sides of the table and replaced it with math that was hard to argue with. > **Reality Check: “I’m Not a Natural Negotiator — Will This Really Work?”** > Mike wasn’t either. He describes himself as “more wrench than handshake.” But the beauty of lens-anchored negotiation is that it doesn’t require charisma or confidence — just preparation. The number does the work. Practice with your next small vendor call. Model the lens impact of their proposed terms before you pick up the phone. You’ll be surprised how different the conversation feels when you know exactly what’s at stake. **What it means for you:** Your Blended View is your negotiation superpower. It works with vendors, customers, employees, lenders, and eventually with buyers if you decide to exit. Every negotiation in your business life has a lens impact — and once you start quantifying those impacts, you’ll never negotiate blind again. #### Next Up: Reinvestments That Actually Grow Exit Value Now that you can protect and create value in negotiations, let’s look at the reinvestments that actually grow your exit value — and which ones are feel-good traps that quietly destroy it. Let’s keep following Mike and Sandra as we turn the lenses into smarter capital allocation. [Return to TOC](#toc) ### Chapter 11: Reinvestments That Actually Grow Exit Value Not all reinvestments are created equal. Some build lasting value (recurring revenue systems, process documentation, key hires). Some are feel-good traps (shiny new equipment that doesn’t pay back, vanity office upgrades). Your four lenses cut through the noise: **If a reinvestment doesn’t meaningfully lift at least two lenses over 3–5 years, it’s probably not worth doing.** Mike learned this the hard way — and then the profitable way. Early on he almost bought a $45k “nice-to-have” diagnostic tool that looked cool but had weak ROI. Lenses showed only +$18k Blended over 5 years — below his hurdle. He passed. Later he invested $22k in CRM + scheduling software: +$280k Blended. Big difference. > **Reality Check: “Everything I Buy Feels Like It Should Help — How Do I Know?”** > Run the lenses before you sign. Mike’s rule: “If Blended doesn’t increase at least 5–7% over my planning horizon, it’s a no.” Emotion says “yes”; math says “maybe not.” The lenses remove emotion. **What it means for you:** The lenses turn reinvestment decisions from gut calls into value calls — so you only spend money that actually multiplies what your business is worth. #### How to Evaluate Reinvestments with Lenses **80/20 Process:** 1. Estimate upfront cost and annual cash impact (revenue up, costs down, or both). 2. Model into 5-year FCFF / FCFE projections. 3. Recalculate all four lenses. 4. Compare delta to cost — aim for 3x–5x return on invested capital in Blended value. 5. Check qualitative lens drivers (risk reduction, growth visibility, owner independence). **What it means for you:** This quick five-step check takes minutes and keeps you from wasting capital on projects that look good on paper but destroy value in the lenses. #### Mini-Worked Example: Mike’s CRM Investment Investment: $22k one-time + $6k/yr subscription Benefits: +10% efficiency → +$140k revenue/yr, +$65k EBITDA/yr (after sub cost) **Lens Impacts (5-yr cumulative):** - **Lens 1: Cash Flow to the Business** +$320k (higher FCFF from margins + growth) - **Lens 2: Cash Flow to the Owner** +$260k - **Lens 3: What Buyers Will Pay** +$380k (0.7x multiple lift from growth visibility & recurring) - **Lens 4: The Blended View** (40/40/20) **+$280k** ROI: $280k value / $22k cash out = ~12.7x over 5 years. Green light. Contrast: $45k diagnostic tool Projected: +$8k EBITDA/yr Blended: +$18k over 5 yrs → 0.4x ROI. Pass. #### Worked Example: Tony’s Manager Raise — Reinvesting in People Most owners think of reinvestments as things — equipment, software, a second location. But the highest-ROI reinvestment in most service businesses is often a person. Tony, owner of Pauly’s Pizza in Florida, faced a classic dilemma in March 2025. His head manager — 5 years of institutional knowledge — asked for a $12,000 raise. Tony’s gut said it was a lot. His lenses told a completely different story. He ran three options through the four-lens framework before answering: | Impact | Option 1: Full $12k Raise | Option 2: Partial $6k Raise | Option 3: Decline | |---|---|---|---| | Annual FCFF Change | +$41,000 (net of raise) | +$18,000 | −$35,000 (turnover + training) | | Lens 1 Change | +$265,000 | +$116,000 | −$226,000 | | Lens 3 Multiple Change | +0.8x (Owner Independence) | +0.3x | −0.5x | | Lens 3 Value Change | +$180,000 | +$72,000 | −$125,000 | | Blended View Change | **+$248,000** | +$103,000 | **−$186,000** | The math was unambiguous. The $12k raise cost $12k/year but generated $41k/year in net FCFF improvement — through labor efficiency, lower turnover, and higher customer satisfaction scores. The Lens 3 impact alone was $180k, driven by Force 2 (Owner Independence): a manager who runs the shop four days a week is the single biggest multiple driver available to a restaurant owner. Tony approved the full raise, tied partly to performance metrics aligned with the Four Forces. Six months later: manager turnover dropped 40%, Tony’s hours fell from 60 to 25 per week, and Lens 1 moved up by exactly the $265k modeled. **The lesson:** People decisions are reinvestments. Run them through the same framework you’d use for equipment or software — and you’ll make better calls every time. #### Tactical Table: Mike’s Reinvestment Scorecard | Reinvestment | Upfront Cost | Annual EBITDA Lift | Blended 5-yr Impact | ROI Multiple | Decision | 80/20 Notes | |-------------------------------|--------------|--------------------|---------------------|--------------|----------|------------------------------------------| | CRM + scheduling software | $22k | +$65k | +$280k | 12.7x | Yes | Focused on EBITDA & growth visibility | | $45k diagnostic tool | $45k | +$8k | +$18k | 0.4x | No | Ignored "cool factor"; math ruled | | $18k route optimization app | $18k | +$28k | +$135k | 7.5x | Yes | Fuel + labor savings; quick payback | | $60k new shop expansion | $60k | +$45k | +$195k | 3.3x | Borderline → Yes after financing tweak | Debt impact checked in Lens 2 | Mike’s new rule: No reinvestment over $10k without a lens run. Saved him from several bad buys. > **Reality Check: "What About Defensive Reinvestments?"** > Sometimes you reinvest to avoid value destruction (new roof, compliance upgrades). Mike replaced an aging AC system in the shop: –$32k Lens 1 short-term, but avoided $80k future disruption risk. Lenses still showed net positive when risk reduction was factored. Defensive plays get a lower bar — but still quantify. Reinvestments aren’t about spending money — they’re about buying future cash flows at a discount. Use your lenses to make sure you’re getting a good deal. Next: Raising capital without giving away the farm. [Return to TOC](#toc) ### Chapter 12: Raising Capital Without Giving Away the Farm You’ve mastered the four-lens compass. You’ve scored tactical moves, turned negotiations into value creators, and made reinvestments that actually grow your business worth. Now comes the moment most SMB owners dread — or rush into blindly: **raising capital**. Whether it's $150k for new equipment, $300k to open a second location, or $500k to acquire a competitor, the question is always the same: **"How do I get the money without giving away the farm?"** Profit-only owners look at the monthly loan payment or the equity percentage they'll have to sell and make a gut decision. Valuation-driven owners run the exact same decision through all four lenses first — and almost always choose differently. Raising capital is simply another reinvestment. Done right, it can multiply your Lens 2 faster than anything else. Done wrong, it can wipe out years of hard-won gains. And here's the insight that changes everything: **Lens 2 is the number that funds your life. Never sell equity until you've exhausted cheaper options.** That's not opinion — it's math. #### Why Lens 2 Is Your North Star for Capital Decisions When you take on debt, the interest payments reduce your annual free cash flow, but every dollar you repay *increases Lens 2* dollar-for-dollar. Once the loan is paid off, all that additional cash flow is yours. You still own 100%. When you sell equity, the payment burden disappears — no monthly interest — but you permanently give up a percentage of Lens 2. Not just today's Lens 2. Tomorrow's. And the year after that. And every year until you sell or die. The math almost always favors debt when your cash flows can service it. The exceptions are rare: truly explosive growth opportunities (30%+ CAGR) that you genuinely cannot fund any other way. Let's see this play out in the real world. #### Mike's Expansion Decision: Debt vs Equity in Real Life Remember Mike, our Florida HVAC owner who grew his Lens 2 from $1.67M to over $2.1M? After two strong years of valuation-aware management, he saw a clear opportunity: open a second location in a neighboring county with high demand and low competition. He needed $280k — $180k for trucks, tools, and initial marketing, $100k for working capital and build-out. Two paths were on the table: **Path A — Traditional bank loan at 7.25% (debt)** **Path B — Bring in a local investor for 25% equity at a $2.8M pre-money valuation** Profit-only thinking said: "The loan payment is $3,800/month — that's tight but doable. Equity is scarier." Four-lens thinking told a completely different story. Mike modeled both scenarios over five years using his current growth trajectory (12% annual) and conservative margin assumptions. He paid special attention to Lens 2 — because that's the number that actually belongs to Mike. Here's what the numbers showed: | Scenario | Capital | Lens 1 (Yr 5) | Lens 2 (Yr 5) | Lens 3 (Yr 5) | Ownership | |---|---|---|---|---|---| | Do Nothing | $0 | $3.8M | $3.1M | $4.2M | 100% | | Bank Loan | $280k | $5.9M | **$5.1M** | $6.7M | **100%** | | 25% Equity | $280k | $6.2M | $3.9M | $7.1M | 75% | **The debt option wins by $1.2M in Lens 2 — the number that actually belongs to Mike.** Look at that table again. The equity route actually produces a slightly higher Lens 1 and Lens 3 — because there's no debt drag on the enterprise and the business looks "cleaner" to the market. But Mike doesn't live on Lens 1 or Lens 3. He lives on Lens 2. And Lens 2 tells the truth: the investor takes $1.2M out of Mike's future pocket. Here's the year-by-year FCFE (Free Cash Flow to Equity) comparison that makes it crystal clear: **Debt path:** Year 1–2, FCFE is lower because of loan payments (–$38k annual drag). But the new location ramps fast — it's cash-flow positive by month 14 and fully pays off the loan by month 26. From year 3 onward, Mike keeps 100% of the incremental cash flow. By year 5 his cumulative FCFE is $1.2M higher than the equity path. **Equity path:** Year 1–2, FCFE is higher (no payments). Feels great. But from year 3 onward, 25% of every dollar of growth goes to the investor. Forever. The cumulative cost of that equity sale compounds every single year. Mike took the bank loan, opened the second location, and 18 months later his total Lens 2 sat at $4.7M — with zero dilution and full control. His Blended View confirmed the decision was the right one in every context: running the business, considering a future sale, or planning succession for his kids. #### Tony's Smarter Play: Blended Capital Tony from Pauly's Pizza faced a similar need — $180k to open a second location in a neighboring town with strong foot traffic and no direct pizza competition. He blended two approaches: - $130k SBA-backed term loan (secured against the new leasehold improvements and equipment) - $50k seller-financed equipment note at 5.5% over 3 years (part of a deal with a retiring restaurant owner whose space he was taking over) No outside equity at all. The four-lens impact was immediate because the menu, suppliers, and systems were already built — no startup drag. Within six months the second location was adding predictable lunch and delivery revenue that lifted his Lens 3 multiple by 0.8x — directly strengthening Force 1 (Growth Visibility). Result after 18 months: - Lens 1 +$680k - Lens 2 +$560k (Tony still owns 100%) - Lens 3 climbed with the revenue growth and multiple expansion - Blended View confirmed the debt path beat the equity path by over $400k He accelerated the loan paydown using the second location's cash flow and is now ahead of schedule. #### Key Principles for Raising Capital Without Giving Away the Farm 1. **Always model Lens 2 first** — This is the number that funds your life. It's the number that pays for your kids' college, your retirement, your freedom. Never sell equity until you've exhausted cheaper, non-dilutive options. 2. **Debt is usually better if your cash flows can service it** — Especially at today's rates for solid businesses. Every dollar of debt you repay increases your Lens 2 dollar-for-dollar. The short-term cash flow drag is almost always worth the long-term ownership preservation. 3. **Equity only makes sense when the growth it unlocks is explosive** — Think 30%+ CAGR that you genuinely can't fund any other way. Even then, negotiate hard on valuation and protect your control. 4. **Seller financing and equipment loans are your secret weapons** — They keep ownership intact and often come with better terms than outside investors. Tony's blended approach — SBA loan plus a seller-financed equipment note — is a masterclass in creative capital structure. 5. **Run the "What if I raise $X?" scenarios through all four lenses every time** — Include best-case, base-case, and worst-case growth. You'll sleep better knowing the downside is covered across every lens. #### Common Traps That Destroy Owner Wealth - Taking equity too early because "it's easier than dealing with banks." - Accepting investor money at a low valuation because you're desperate. - Ignoring the long-term drag of high interest rates on cash flow quality (which hurts Lens 3 through Force 4 — Capital Efficiency). - Not negotiating seller notes or earn-outs in acquisitions. Run every capital raise through your four-lens dashboard and these mistakes disappear. #### What Your Investor Sees — Understanding the Other Side of the Table If you do decide to raise equity, understanding how an investor evaluates your business gives you a massive negotiating advantage. Here's what a sophisticated investor is calculating — whether they tell you or not. **1. Risk-Adjusted Return (IRR vs. WACC)** An investor's first question is: "Does this investment clear my hurdle rate?" They'll calculate the projected Internal Rate of Return (IRR) based on expected cash distributions and a future exit, then compare it to their required return — their own WACC. If your business generates a 20% projected IRR and their hurdle rate is 12%, you have an 8-percentage-point margin of safety. That's compelling. If your IRR barely clears their hurdle, they'll either negotiate a lower price or walk away. *How to use this:* Before pitching any investor, calculate the IRR *from their perspective* at your proposed valuation. If it doesn't clear 15–20% for an SMB investment (investors demand a premium for illiquidity and concentration risk), adjust your pitch before they do it for you. **2. Downside Risk Analysis** Investors don't just model the base case — they stress-test your numbers. What happens to their return if revenue grows 10% slower than projected? What if margins compress? What if a key customer leaves? They're looking for how far the business can fall before their investment is underwater. The wider the margin between the base case and the break-even case, the safer the investment feels. *How to use this:* Run your own downside scenario before any investor meeting. Show them you've already stress-tested the numbers. An owner who walks in saying "Even in our worst-case scenario, your IRR stays above 12%" is infinitely more fundable than one who only presents the rosy case. **3. Your Return on Equity vs. WACC** This is the number sophisticated investors care about most. If your Return on Equity (ROE = Net Income ÷ Total Equity) exceeds your WACC, you're creating value — which means their investment compounds. If ROE sits below WACC, every dollar of equity invested in the business would earn more in the stock market. That's a hard pass. *How to use this:* Calculate your ROE. If it exceeds your WACC (Chapter 7), lead with this number in your pitch. "Our return on equity is 22% against a cost of capital of 14%. Every dollar you invest in this business compounds at 8 points above our hurdle rate." That's the kind of sentence that gets term sheets signed. **4. Industry Benchmarking** Investors compare your implied multiple (what they'd be paying per dollar of EBITDA) against industry peers. If your asking price implies a 7x multiple but comparable businesses trade at 5x, they'll demand justification. If you're priced below peers, they'll see a bargain and move fast. *How to use this:* Know your industry multiples cold. If your implied multiple is above the industry average, have a clear story for why — stronger growth, better margins, more recurring revenue, less owner dependence. Understanding the investor's playbook doesn't just help you raise money — it helps you decide whether you should. If the math doesn't work from *their* side of the table, it might be telling you to pursue debt instead. #### Dilution Scenarios: Mike's Negotiation in Numbers Before closing, Mike modeled three scenarios so he could walk in knowing his floor: | Scenario | Raise Amount | Equity % | Pre-Money | Post-Money | Mike's Post-Raise Equity Value | Blended Delta | Decision Insight | |------------------------|--------------|----------|-----------|------------|--------------------------------|---------------|--------------------------------------| | Investor ask (18%) | $300k | 18% | $1.37M | $1.67M | $1.42M | –$530k | Too dilutive — walked | | Mike's counter (12%) | $300k | 12% | $2.20M | $2.50M | $2.13M | +$180k | Fair — pushed back | | Closed deal (14%) | $300k | 14% | $2.14M | $2.44M | $2.07M | +$120k | Win — growth funded, ownership intact | His lenses let him say "no" to bad terms and "yes" to fair ones — from data, not gut feel. #### Valuation Action Step This week, identify any capital need you're facing or anticipating in the next 12–24 months (expansion, equipment, acquisition, working capital, etc.). 1. Write down the exact amount needed. 2. List every possible source: bank debt, equipment financing, seller notes, line of credit, friends/family, outside equity, or bootstrapping slower. 3. **Model at least two scenarios and calculate all four lenses for each** on a 5-year horizon. Pay special attention to Lens 2 — the one that belongs to you. 4. Compare the Blended View for each path. Pick the path that maximizes your Lens 2 while keeping risk tolerable. You'll be shocked how often the "scary" debt option actually leaves you far wealthier than selling part of your life's work. Raising capital the valuation-driven way turns outside money into rocket fuel for your own wealth — instead of someone else's. --- # Part 4: Advanced Horizons — Planning for Exits, Shifts, and Legacy > **Where We've Been:** Parts 1–3 gave you the mindset, the measurement tools, and the tactical playbook. You've seen how Mike turned a 4% price increase into $158k of value, how Sandra restructured her working capital to unlock $190k, and how every decision — from hiring to vendor negotiations — hits your lenses differently. > > **Where We're Going:** Now we zoom out. The next four chapters tackle the big-picture questions: When and how to exit (Chapter 13), how to protect value when the economy turns against you (Chapter 14), how to transfer ownership to family without destroying relationships or wealth (Chapter 15), and how your entire lens framework evolves as your business grows from startup to scale-up to maturity (Chapter 16). These aren't hypothetical — Mike is navigating them right now. Look ahead: You've got the mindset (Part 1), the toolkit (Part 2), and the tactical edge (Part 3) to make valuation your daily driver. Now, let's zoom out to the bigger picture — where your business heads next. Whether you're eyeing an exit in the next few years, navigating economic curveballs, handing the reins to family, or scaling through growth stages, these advanced applications adapt your four lenses for long-term wins. In this part, we'll start with exit planning that begins today (Chapter 13), building a roadmap that maximizes value whether you sell tomorrow or never. Then, tackle valuations in turbulent times (Chapter 14), recalibrating for inflation, recessions, or rate hikes without getting lost in the weeds. Next, explore family succession (Chapter 15), using equity-weighted lenses to ensure fair, tax-smart handoffs that preserve your legacy. Finally, align valuations to your growth stage (Chapter 16), from startup survival to mature optimization, evolving your Blended View as your business does. Apply the 80/20 Rule throughout: 80% of horizon-shaping insights come from core adjustments like growth forecasts and risk premiums — prune the rest to stay agile. Recall Tony from Pauly's Pizza: Facing rising food costs and supply chain disruptions, he stress-tested his lenses (ignoring minor complexities), locked in supplier pricing on key ingredients, and turned a potential $180k value dip into a $140k net gain by acting early. Clear horizons, smarter paths. These chapters equip you for the "what's next" — turning potential pitfalls into value accelerators. Use the expanded worksheets in Part 5 for scenario planning, and revisit these chapters quarterly as your situation evolves. By the end of this part, you'll see valuation not as an endgame, but as your guide to enduring wealth. Let's chart those horizons — your future awaits. --- [Return to TOC](#toc) ### Chapter 13: Exit Planning That Starts Today Here’s a question that keeps founders up at 2 a.m.: “If I got a call tomorrow with an offer — would I even know whether to say yes?” Most owners don’t. They’ve spent years building something valuable, but when the moment arrives — a buyer reaches out, a health scare forces the conversation, a partner wants out — they’re scrambling. Calling a broker. Guessing at numbers. Negotiating from weakness instead of strength. The best exits don’t start with a phone call. They start years in advance — with the same four lenses you’ve been using throughout this book. Mike didn’t plan to sell when he began running his lenses. But after 18 months of lens-driven decisions, his Blended View had climbed from $2.04M to $2.92M. Tony at Pauly’s Pizza, fresh off opening his second location, discovered that his improving metrics were building a business that would attract buyers even though selling was the furthest thing from his mind. Sandra at Coastal Supplies used her lens analysis to realize that reducing customer concentration wasn’t just good for sleep — it was adding six figures to what a buyer would pay. If any of them ever decided to exit, they’d walk into the room with leverage — not hope. > **Reality Check: "I’m Not Ready to Sell — Why Plan Now?"** > Because planning an exit is the same as planning to build maximum wealth. Mike used exit lenses to decide what to fix (owner dependence, recurring revenue) even though he loved running the business. The result: higher value whether he sold or kept it forever. Exit readiness = wealth readiness. #### The Exit-Ready Mindset: Lenses Weighted for Sale When exit is on the horizon (even distant), reweight your Blended View to reflect market reality: - Recommended exit-prep weights: 20% Lens 1 | 20% Lens 2 | 60% Lens 3 (Buyers pay market multiples — not your internal DCF or equity calc.) Mike’s baseline day-to-day blended: $2.04M (40/40/20). Exit-weighted blended: **$2.39M** (20/20/60). Gap: $350k. That gap became his “value acceleration target” — the amount he needed to close through improvements. **What it means for you:** Run both weightings right now. The gap between your day-to-day blended and your exit-weighted blended is the clearest picture of how much value you’re leaving on the table from a buyer’s perspective. That number is your roadmap. #### The 80/20 Exit Acceleration Levers Focus on the vital few that move Lens 3 (market multiple) the most: 1. **Recurring Revenue %** — Biggest multiple driver. Aim >50%. 2. **Owner Independence** — Reduce owner hours to <15/week. Document SOPs. 3. **Customer Diversification** — No single client >12–15% revenue. 4. **Clean, Buyer-Ready Financials** — Normalized EBITDA, no funny business. 5. **Growth Visibility** — Documented pipeline and contracts. Mike prioritized 1 & 2: - Recurring from 45% → 58% → +0.6x multiple - Owner hours from 50/week → 20/week (hired ops manager) → +0.4x multiple Total multiple lift: +1.0x → +$500k Lens 3 at same EBITDA. #### Mini-Worked Example: Mike’s Exit-Weighted Roadmap | Metric | Baseline (Pre-Acceleration) | After 18 Months | |-------------------------|-----------------------------|--------------------------| | EBITDA | $500k | $580k (growth + margins) | | Multiple | 5.4x | 6.4x (recurring + independence) | | Lens 3 Value | $2.70M | $3.71M | | Exit-Weighted Blended | $2.39M | **$3.28M (+$890k lift)** | He didn’t sell — but his net worth tied to the business rose dramatically. #### Tactical Table: Mike’s Exit Acceleration Moves | Lever | Action Taken | Multiple Impact | Lens 3 Delta | Exit-Weighted Blended Delta | 80/20 Focus | |------------------------------|----------------------------------|-----------------|--------------|-----------------------------|------------------------------------------| | Recurring revenue | Added maintenance contracts | +0.6x | +$348k | +$420k | % only; ignored contract details | | Owner independence | Hired ops manager, SOPs | +0.4x | +$232k | +$280k | Hours + key processes; skipped full audit| | Customer diversification | Reduced top client from 18%→11% | +0.2x | +$116k | +$140k | Top 3 clients only | | Clean financials | Normalized add-backs, accruals | +0.1x | +$58k | +$70k | Obvious items; ignored minor | Total acceleration: ~$910k in exit-weighted value — without revenue doubling. > **Reality Check: "What If I Never Sell?"** > Then use exit planning as a discipline. Mike kept running the business — but the habits (recurring focus, systems) made it more valuable, more resilient, and more enjoyable. Exit readiness is freedom readiness. #### Customer Concentration: The Silent Multiple Killer Of all the factors that suppress buyer multiples, customer concentration is the most common — and the most overlooked by owners who live inside their business every day. Here’s the rule of thumb: if any single customer represents more than 15% of your revenue, most buyers will discount your multiple by 0.5x to 1.5x. If your top customer is 25% or more, some buyers will walk away entirely. Why? Because that customer isn’t buying your business — they’re buying a relationship. If that relationship breaks, so does the cash flow story the buyer just paid millions for. Mike discovered this when he ran his first buyer appeal checklist. His largest commercial account — a property management company we met in Chapter 10 — represented 18% of revenue. On a $500,000 EBITDA business at a 5.4x multiple, that concentration risk was costing him an estimated 0.3x in multiple, or roughly $150,000 in Lens 3 value. His fix was deliberate: over twelve months, he grew residential recurring contracts enough that the commercial account dropped to 11% of revenue — not by firing the customer, but by growing the denominator. That single change recaptured the 0.3x multiple and added $150,000 to Lens 3. Sandra at Coastal Supplies faced a more dramatic version of this problem. Her top three customers accounted for 42% of revenue. Her lens analysis showed that diversifying even modestly — reducing the top three to 30% total — would lift her multiple by 0.5x, worth over $300,000 on her $1.15M EBITDA. She launched a targeted sales campaign to regional contractors and within eight months had redistributed enough volume to capture most of that gain. The lesson: customer concentration is quantifiable through your lenses. Run the scenario. Model what happens if your top customer leaves. If the answer makes you nauseous, that’s your next value acceleration project. #### Asset Sale vs. Stock Sale: Why Structure Matters as Much as Price Here's something that makes me crazy: I've watched owners negotiate for weeks over a $50k price difference — then lose $300k because nobody talked about deal structure until the closing table. The *structure* of your deal — asset sale vs. stock sale — can swing your after-tax proceeds by hundreds of thousands of dollars. And yet most owners fixate on the headline price and ignore the thing that determines what they actually keep. Let me break this down simply. In an **asset sale**, the buyer cherry-picks what they want — equipment, inventory, customer contracts, goodwill — and you keep the corporate shell. Buyers love this because they get tax deductions on the assets they just bought (it's called a "stepped-up basis" — fancy term for "they pay less tax going forward"). In a **stock sale** (or membership interest sale for LLCs), the buyer gets the whole entity — assets, liabilities, contracts, warts and all. Sellers of C-corporations often prefer this because the proceeds get taxed once at capital gains rates, instead of the painful double taxation that hits C-corp asset sales. The impact is concrete. Mike, operating as an S-corp, modeled both structures on a hypothetical $3.2M exit: | Structure | Gross Price | Federal/State Tax | Net to Mike | |---|---|---|---| | Asset Sale (S-corp) | $3.2M | ~$640k (20% LTCG + state) | ~$2.56M | | Stock Sale (S-corp) | $3.2M | ~$640k (similar for S-corp) | ~$2.56M | For S-corps, the difference is minimal because income passes through to the owner regardless. But for a C-corp owner, the same $3.2M exit could produce dramatically different results: | Structure | Gross Price | Tax Impact | Net to Owner | |---|---|---|---| | Asset Sale (C-corp) | $3.2M | ~$960k (corporate tax + personal distribution tax) | ~$2.24M | | Stock Sale (C-corp) | $3.2M | ~$640k (single capital gains tax) | ~$2.56M | That’s a $320,000 difference on the same headline price — simply from deal structure. Tony at Pauly’s Pizza faced this question when he ran exit scenarios on his growing two-location operation. As an LLC, he had flexibility — but his CPA pointed out that an asset sale would let Tony retain the LLC and its accumulated depreciation on kitchen equipment, while the buyer would get a fresh depreciation schedule on ovens, walk-in coolers, and leasehold improvements worth over $180k. That step-up made Tony’s business more attractive to buyers — effectively raising what they’d be willing to pay, because their after-tax return improved. Tony hadn’t even considered this until his lenses forced the conversation. **What it means for you:** This is why your CPA and attorney must be involved well before negotiations begin. Entity structure, tax elections, and sale structure should be coordinated as part of your exit acceleration plan — not scrambled together at the closing table. Ask your CPA one question this week: "Given my entity type, which deal structure puts the most money in my pocket?" #### Earnout Structures: When the Check Comes in Pieces Let me tell you what nobody mentions at the LOI stage: roughly 40% of small business acquisitions don’t pay you everything at closing. Part of the purchase price is tied to future performance milestones — typically over 1-3 years. That’s called an **earnout**, and it’s the single most common way sellers get surprised at the finish line. Here’s the gut punch: you’ve handed over the keys, you no longer control the decisions, but your payout depends on someone else’s execution. The buyer loves it — they pay less if the business stumbles under new management. You? You’re watching from the sidelines, hoping the people who replaced you don’t mess up. Your lenses give you a way to cut through the charm of a big headline number. If a buyer offers $3.0M with an earnout — say $2.2M at close plus $800,000 contingent on hitting revenue targets over two years — you need to discount that $800,000 for probability and time value. Using a conservative 60% probability of full earnout achievement and a 15% discount rate, that $800,000 is worth roughly $410,000 in present value. Your real deal value is closer to $2.61M, not $3.0M. Mike modeled this scenario as part of his exit readiness planning — not because he was selling, but because understanding earnout math changed how he evaluated offers. His rule: never accept a deal where more than 25% of the total value is in earnout, and always negotiate for earnout metrics you can directly control (revenue or EBITDA, not buyer-defined "synergies"). **What it means for you:** When someone waves a big number in front of you, ask one question: "How much of that do I get at closing?" Then discount the rest. Your lenses already taught you to look past surface numbers — apply the same discipline to the deal itself. --- #### Valuation Action Step Your exit plan starts today — with your current lenses. This week: 1. Run the exit-weighted blended (20% Lens 1 / 20% Lens 2 / 60% Lens 3). 2. Calculate the gap between your day-to-day blended and your exit-weighted blended. 3. Pick 1–2 levers from the acceleration table above. 4. Run the customer concentration check: what percentage is your top client? 5. Ask your CPA: "If I sold today, would an asset sale or stock sale be more tax-efficient given my entity structure?" Execute. Recalculate quarterly. That’s how you build an exit you control — instead of one that controls you. --- Next: Navigating turbulent times — because markets don’t wait for calm seas. [Return to TOC](#toc) ### Chapter 14: Valuation in Turbulent Times — Navigating Economic Shifts You remember 2022. Maybe you lived it — watching material costs spike 15%, interest rates double in months, and customers tighten their wallets while your overhead stayed stubbornly fixed. Or maybe your version of turbulence was a pandemic that shut your doors for six weeks. A key supplier that went bankrupt. A labor market that made a $18/hour line cook feel like a fantasy. Every owner I talk to has a turbulence story. The ones who came out stronger have something in common: they didn’t react to turbulence — they recalibrated. Your four lenses don’t just work in calm waters. They become your life raft when the economy gets choppy — showing you exactly where the damage is hitting, which parts of your business are holding up, and where the hidden opportunities are hiding inside the chaos. This chapter shows how to stress-test and recalibrate your lenses during turbulence using the 80/20 Rule. We’ll focus on the vital few variables that drive 80% of value shifts: growth rate, margins, and cost of capital. Everything else is noise. Mike faced this head-on in 2025 when rates rose and material costs jumped 12%. Tony at Pauly’s Pizza dealt with food cost inflation and a labor crunch that threatened to undo his hard-won gains. Sandra at Coastal Supplies navigated supply chain disruptions that tied up working capital and tested her distribution model. All three used their lenses to turn potential disasters into net gains. > **Reality Check: “Everything Looks Bad in a Downturn — Why Bother Recalculating?”** > Because lenses show you where the damage is worst — and where the opportunities hide. Mike discovered his recurring contracts buffered Lens 1 far better than one-off jobs. That insight led him to double down on maintenance plans during the dip — emerging stronger. Without the lenses, he would have cut costs across the board — including the very programs that were protecting his value. #### How Turbulence Hits Each Lens Not all lenses take the same beating. Understanding which ones are most exposed gives you a triage map: - **Lens 1 (Enterprise):** Most sensitive to turbulence — higher costs shrink FCFF directly, and a higher WACC discounts your future cash flows harder. This is where margin compression and rising rates hit first. - **Lens 2 (Equity):** Debt-heavy businesses get crushed because interest expense rises while cash flow falls. Lean balance sheets hold up far better — another reason the capital structure work in Chapter 12 matters. - **Lens 3 (Market):** Multiples contract fast in uncertainty — buyers get cautious, deals stall, and the gap between what you think your business is worth and what someone will actually pay widens overnight. - **Blended View:** Reweight toward Lens 3 (market reality) during uncertainty. The market’s opinion matters more when capital is scarce and buyers are picky. **What it means for you:** In calm times, your internal lenses (1 and 2) drive decisions. In turbulence, Lens 3 becomes the reality check. If you don’t reweight, you’re making decisions based on numbers the market doesn’t agree with. #### Mike’s Turbulence Playbook: The 2025 Rate/Materials Spike Mike’s quick 80/20 adjustments when he saw the storm coming: - Growth: cut assumption from 6% → 3% for 2 years - Margins: –2% permanent hit assumed (conservative) - WACC: +1.5% (from 15% → 16.5%) **Resulting drops:** - Lens 1: –$240k - Lens 2: –$190k - Lens 3: –$420k (multiple from 5.4x → 4.6x) - Blended (reweighted 30/30/40): **–$310k** That $310k number scared him. But it also told him exactly where to focus. #### Turning Defense into Offense Mike used the pain points as a priority list: 1. **Accelerated recurring contracts** → offset the margin hit and restored growth visibility. Recurring revenue holds multiples during downturns because buyers trust the predictability. 2. **Refinanced floating-rate debt to fixed 5.5%** → capped his interest exposure and stabilized Lens 2. 3. **Delayed non-essential CapEx** → preserved cash for offensive moves. 4. **Passed through 5% on service agreements** → customers accepted it because his service quality justified the premium. (The pricing confidence from Chapter 9 paid off here.) **Post-actions recalibration:** - Growth back to 5% - WACC back to 15.2% - Multiples recovered to 5.1x → Net Blended recovery: **+$190k** (from worst-case low) He didn’t just survive — he gained ground while competitors froze. #### Tony’s Turbulence Story: Food Costs and the Labor Crunch Tony at Pauly’s Pizza got hit from two sides in early 2025: food costs spiked 14% on key ingredients (cheese, flour, proteins), and his labor market tightened to the point where replacing a line cook took 6-8 weeks instead of 2. His 80/20 stress test showed: - Lens 1: –$165k (margin compression from food costs) - Lens 2: –$120k - Lens 3: –$280k (multiple dropped from 4.8x → 4.1x — restaurant multiples are especially sensitive to margin pressure) - Blended (reweighted 30/30/40): **–$210k** Tony’s counter-moves: 1. **Locked in supplier pricing** on his top 5 ingredients (representing 60% of food cost) through 6-month forward contracts — trading volume commitment for price stability. 2. **Raised menu prices 6% on premium items** (specialty pizzas, catering orders) where demand was least elastic — protecting margin without losing everyday customers. 3. **Invested in retention** rather than recruitment: the $12k manager raise from Chapter 11 looked even smarter now, because replacing that manager would have cost $35k+ in recruitment and training during a labor crunch. **Result:** Tony turned a projected –$210k blended hit into a –$60k temporary dip, recovering to net positive within two quarters. His Lens 3 bounced back faster than competitors who had cut staff — because his operations stayed stable while theirs stumbled. **What it means for you:** In turbulence, the instinct is to cut. The lenses tell you *what* to cut and — just as importantly — *what to protect*. Tony’s lenses showed that his manager and his recurring catering contracts were the two things holding his value together. Cutting either would have cost him far more than the savings. #### Sandra’s Supply Chain Stress Test Sandra at Coastal Supplies dealt with a different kind of turbulence: supply chain disruptions that stretched lead times on specialty marine hardware from 4 weeks to 12-16 weeks. For a distribution business, that’s an existential threat — customers can’t wait, and they’ll find alternatives. Her 80/20 stress test revealed: - Lens 1: –$310k (lost sales from stockouts + higher expedited shipping costs) - Lens 2: –$220k (working capital ballooned as she built safety stock) - Lens 3: –$480k (multiple compressed from 5.2x → 4.5x — buyers hate supply chain risk) - Blended (reweighted 30/30/40): **–$380k** Sandra’s response was surgical: 1. **Built 45-day buffer inventory** on her top 20 specialty SKUs (the ones with highest margin and least substitutability) — tying up $140k in working capital but protecting the revenue that drove her premium multiple. 2. **Diversified suppliers** — added two secondary sources for her top-volume items. Higher unit cost (+3%), but the supply security was worth the margin hit. 3. **Converted stockout risk into a sales advantage** — when competitors ran dry on specialty items, Sandra’s customers stayed. She picked up three new commercial accounts representing $180k in annual revenue simply by having product on the shelf when nobody else did. **Result:** Sandra’s blended dropped –$380k at the worst point but recovered to just –$90k within six months — and her new customer acquisitions pushed her into net positive territory by month nine. Her Lens 3 actually exceeded pre-turbulence levels because the supply chain crisis proved her business model was resilient. #### Tactical Table: Turbulence Moves Across All Three Owners | Owner | Economic Hit | Lens Impact (Worst-Case) | Counter-Move | Lens Recovery | Net Blended Delta | 80/20 Focus | |-------|-------------|--------------------------|--------------|---------------|-------------------|-------------| | Mike | +12% material costs | –$180k Lens 1 | 5% price pass-through + vendor deals | +$140k | –$40k | Margin lift only; ignored volume detail | | Mike | Rates up 2% | –$110k Lens 2 | Refinance to fixed 5.5% | +$85k | –$25k | Interest savings; skipped full WACC recalc | | Mike | Recession fear (growth –3%) | –$240k Lens 1 & 3 | Double down on recurring contracts | +$220k | –$20k | % recurring + pipeline visibility | | Tony | +14% food costs | –$165k Lens 1 | Forward contracts + 6% premium price increase | +$150k | –$15k | Top 5 ingredients; premium menu items | | Tony | Labor crunch | –$80k Lens 3 | Retention investment + manager raise | +$95k | +$15k | Key person only; skipped broad wage hike | | Sandra | Supply chain disruption | –$310k Lens 1 | Buffer inventory + supplier diversification | +$350k | +$40k | Top 20 SKUs; ignored long-tail items | | Sandra | Working capital strain | –$140k Lens 2 | New customer acquisition from competitors | +$180k | +$40k | Revenue growth offset WC drag | > **Reality Check: “Should I Just Sell Before It Gets Worse?”** > Run hold-vs-sell (Worksheet 7). Mike did: Hold value (cumulative FCFE + future exit) beat sell-and-invest by $680k over 5 years. Lenses gave him conviction to stay and build. Turbulence depresses buyer multiples — selling during a downturn means accepting a discounted Lens 3. Unless you need to exit for personal reasons, the math almost always favors holding and improving. --- #### Valuation Action Step Turbulence doesn’t wait for you to be ready. Build your stress-test muscle now — while things are calm. This week: 1. Pick the most likely economic shock for your industry (rising rates, cost inflation, demand slowdown, supply disruption). 2. Model it using the 80/20 approach: adjust growth, margins, and WACC only — skip everything else. 3. Recalculate all four lenses with those stressed inputs. 4. Identify the single biggest delta — that’s your vulnerability. 5. Write down one counter-move you could execute within 30 days if the shock hits. Owners who stress-test quarterly don’t panic when turbulence arrives — they execute. Turbulence isn’t the end — it’s a stress test. Your lenses show you exactly where to reinforce, where to pivot, and when to hold steady. Next: Family succession — passing the asset without breaking it. [Return to TOC](#toc) ### Chapter 15: Family Succession — Valuations for the Next Generation Nobody talks about the hardest conversation in business. Not the one with your banker. Not the one with a buyer. The one at the kitchen table with your family. “Who gets the business? Is it fair? What’s it actually worth? What if one kid wants it and the other doesn’t? What if nobody does?” I’ve watched succession tear families apart — not because anyone was greedy, but because there was no shared, objective number on the table. Just opinions, emotions, and assumptions. Dad thinks the business is worth $3M because that’s what he’d want. The active daughter thinks she deserves a bigger share because she’s been running operations for five years. The son who moved away feels entitled to an equal cut because, well, he’s family. Without a neutral framework, these conversations go sideways fast. Your four lenses provide exactly what succession needs: a numbers-first foundation that depersonalizes the most personal conversation you’ll ever have about your business. When everyone can see the math — and understand the assumptions behind it — disagreements shift from “that’s not fair” to “should we use a 15% discount or 20%?” That’s a solvable problem. Mike started succession planning early — his kids were still in high school. Tony at Pauly’s Pizza began thinking about what happens if he steps back, given that his star manager effectively runs the operation already. Sandra at Coastal Supplies faced a different question entirely: no family successors, but a long-tenured operations manager who’d been dropping hints about buying in. Three owners. Three completely different succession paths. Same four lenses guiding every decision. > **Reality Check: “My Kids Aren’t Ready — Or Don’t Want It”** > Mike faced both. One son wanted in, one didn’t. Lenses helped him structure unequal gifting (more to the active son) without “favoritism” fights — value was transparent, assumptions were visible, and the math was the referee. If no one wants it, the lenses still guide a clean third-party sale, management buyout, or orderly wind-down. The worst outcome isn’t “nobody wants the business.” It’s “we never planned for that possibility.” #### Adapting Lenses for Succession Succession changes what matters. You’re no longer optimizing for maximum enterprise value or buyer appeal — you’re optimizing for what you can actually *pass on* after obligations, taxes, and discounts. Succession weights shift toward owner/family wealth: - Recommended: 35% Lens 1 | 45% Lens 2 | 20% Lens 3 (Focus on what you can pass on after obligations.) Add a **succession discount** (10–25%) for owner dependence, lack of professional management, key-person risk, and marketability limitations. This is the honest adjustment that accounts for reality: a business that depends on its founder is worth less to the next generation than one that runs independently. Mike’s day-to-day blended: $2.30M Succession-weighted: **$2.05M** (after 15% discount for his ongoing involvement). That became the “fair value” baseline for gifting discussions. Not what Mike hoped the business was worth. Not what his son assumed. The number the lenses produced — transparent, defensible, and agreed upon by both sides. **What it means for you:** The succession discount is where most family conversations break down. Owners resist it because it feels like their life’s work is being undervalued. But the discount isn’t a judgment — it’s a measurement of how much value is tied to *you* personally. Reducing that discount is the single highest-ROI succession move you can make, because it simultaneously makes the business more valuable and more transferable. #### 80/20 Succession Levers Focus on the vital few that preserve and grow value for heirs: 1. **Reduce Owner Dependence** — Train backups, document processes, delegate key relationships. Every hour you remove from your weekly involvement reduces the succession discount. 2. **Build Recurring & Diversified Revenue** — Stable, predictable cash flow is what the next generation (or a new partner) needs to service any debt from the transfer and still pay themselves. 3. **Clean Books & Structure** — Estate attorneys and CPAs can’t work with messy financials. Normalized EBITDA, clear add-backs, and proper entity structure save tens of thousands in legal and accounting fees during the transfer. 4. **Tax-Efficient Transfer** — Gifting vs. installment sale vs. trust vs. hybrid. The difference in tax treatment can be $100k+ on a $2M business. This is where your CPA earns their fee ten times over. Mike prioritized 1 & 2: - Hired ops manager → reduced succession discount from 20% → 10% → +$150k value - Grew recurring to 62% → multiple stability for heirs #### Sandra’s Path: The Management Buyout Sandra at Coastal Supplies faces the most common succession scenario in small business — and the one nobody writes books about. No family successor. No desire to sell to a stranger. But a loyal operations manager, David, who has been running day-to-day operations for seven years and knows every customer, vendor, and quirk of the business. Sandra wanted to explore bringing David in as a minority partner now, with a path to majority ownership over 5-7 years. The question: what’s a fair price, and how do you structure it so both sides win? The lenses gave her a clean framework: **Step 1: Establish fair value.** - Lens 2 (equity-weighted) set the baseline: what Sandra actually owns after debt. Succession-weighted blended: **$4.12M** (after 12% discount — lower than Mike’s because Sandra had already reduced her weekly involvement to 20 hours). - Lens 3 anchored what an outside buyer would offer, giving both sides a market reality check: $5.98M (Lens 3). An outside buyer would pay more — but Sandra would lose control of the transition, her team’s jobs, and her legacy. **Step 2: Structure the buy-in.** Sandra and David agreed on a 30% stake over 5 years: - 30% of succession-weighted value: $1.24M - Structured as an installment sale: David pays $248k/year for 5 years, funded by increased distributions from his ownership stake plus a modest personal loan - Tax advantage: installment sale spreads Sandra’s capital gains over 5 years instead of one lump **Step 3: Align incentives.** David’s ownership stake means he directly benefits from every lens improvement. Sandra structured his buy-in price to adjust based on the Blended View at each annual payment — if David grows the business, he pays a higher price per share (but on a more valuable business). If it stagnates, the price adjusts down. Both sides have skin in the game. **Result:** Sandra begins transitioning to 20% involvement immediately, with a clear 5-year path to full exit. David is motivated because he’s building equity, not just earning a salary. The lenses removed the single biggest obstacle in management buyouts: the “what’s it worth?” argument. **What it means for you:** If you don’t have a family successor, look at your team. The best buyer for your business might already be on your payroll — and the lenses give you the framework to make it fair for everyone. #### Tony’s Succession Question: Partner or Successor? Tony at Pauly’s Pizza faces a question that many successful owners encounter after building something great: his star manager — the one whose $12k raise created $248k in value (Chapter 11) — is increasingly the person who *runs* the business. Tony works 25 hours a week. His manager works 50. Tony isn’t ready to exit. But he’s starting to think about what happens in 5-10 years. His lenses revealed something he hadn’t considered: the longer he waits to formalize his manager’s role — through equity, a buy-sell agreement, or a structured partnership path — the more key-person risk he carries. If his manager leaves, Lens 3 drops by an estimated 0.8x in multiple. On Tony’s current EBITDA, that’s roughly $340,000 in value that walks out the door. Tony’s preliminary succession model: - Current succession-weighted blended: $1.85M (after 18% discount for owner + manager dependence) - If manager stays and gets 15% equity over 3 years: succession discount drops to 8% → blended rises to **$2.12M** (+$270k) - If manager leaves: succession discount jumps to 30% → blended drops to **$1.48M** (–$370k) The spread between those two outcomes — $640k — is the cost of not having a succession plan. > **Reality Check: “I’m Not Ready to Give Up Equity”** > Tony doesn’t have to give it away. He can sell a minority stake at fair value (the lenses set the price), use vesting schedules tied to performance, or structure a profit-sharing arrangement that acts like synthetic equity without actual ownership transfer. The point isn’t the mechanism — it’s the intentionality. Having a plan is worth hundreds of thousands of dollars. Not having one is a ticking clock. #### Mini-Worked Example: Mike’s Gifting Plan Goal: Gift 40% to active son over 5 years (minority stake). **Baseline succession blended:** $2.05M **Minority discount:** 25% (lack of control) → per-share value ~$1.54M **40% stake value:** $616k **Annual gifting (5 yrs):** ~$123k/yr (under annual exclusion + lifetime exemption) Why the minority discount matters: The IRS allows valuation discounts on minority interests because a 40% stake in a private business has limited marketability and no control. That discount is your friend — it means you can transfer more value per dollar of gift tax exemption. Mike’s CPA structured the gifts to maximize this benefit, effectively transferring $616k in value while using only ~$490k of his lifetime exemption. **Post-gifting projections:** - Son active → growth acceleration → Lens 1 +$280k in 3 yrs - Mike semi-retired → lower owner risk → multiple +0.3x → Family total value: **$2.45M+** (higher than solo) The counterintuitive result: by giving away 40%, Mike’s remaining 60% became worth more than his previous 100% — because the business grew faster and the succession discount shrank. #### Tactical Table: Succession Moves Across All Three Owners | Owner | Lever | Action Taken | Succession Discount Change | Blended Impact | Family/Partner Value Delta | 80/20 Focus | |-------|-------|-------------|---------------------------|----------------|---------------------------|-------------| | Mike | Owner dependence | Ops manager + SOPs | 20% → 10% | +$150k | +$180k | Hours + key roles only | | Mike | Recurring revenue | Push to 62% | N/A (multiple stability) | +$220k | +$260k | % recurring; ignored contract terms | | Mike | Diversified revenue | Reduced top client exposure | –5% risk premium | +$90k | +$110k | Top 3 clients focus | | Mike | Gifting structure | Annual gifts + trust setup | N/A | N/A | Tax savings ~$140k | CPA handled details; lenses set baseline | | Sandra | Management buyout | 30% installment sale to ops manager | 12% → 6% (projected) | +$280k | +$340k | Fair price + aligned incentives | | Sandra | Transition planning | Reduced involvement to 20 hrs | –4% discount | +$160k | +$190k | Key relationships transitioned | | Tony | Key-person retention | Equity path for star manager | 18% → 8% (projected) | +$270k | +$320k | Formal agreement; skipped minor staff | Total across all three: **over $1.4M in family/partner value** — created by planning, not selling. > **Reality Check: “What If Family Doesn’t Agree on Value?”** > Lenses depersonalize it. Mike shared his calculations (conservative assumptions) — family saw the math, not opinions. Disagreements became discussions about assumptions, not fairness. “Dad, I think the growth rate should be 8%, not 5%” is a productive conversation. “Dad, that’s not fair” is not. The lenses turn the second into the first. --- #### Valuation Action Step Succession planning isn’t something you do when you’re ready to leave. It’s something you do so you *can* leave — on your terms, at your price, with your legacy intact. This week: 1. Answer honestly: who runs this business if you can’t show up for 90 days? 2. Calculate your succession discount — how much of your Blended View depends on you personally being there? 3. Identify your most likely successor path: family, key employee, or third-party sale. 4. Have one conversation — with your CPA, your attorney, or your potential successor — about what a transition could look like. 5. Run the succession-weighted Blended View (35/45/20) and compare it to your day-to-day blended. The gap is your succession planning opportunity. The best time to start succession planning was five years ago. The second best time is this week. Succession is your ultimate value multiplier — or destroyer. Use your lenses early, often, and transparently. Next: Valuations across growth stages — from startup to scale-up. [Return to TOC](#toc) ### Chapter 16: Valuations for Growth Stages — From Startup to Scale-Up Your business isn’t static — it evolves. A $500k revenue startup has different valuation drivers than a $5M scale-up or a $15M mature operation. The four lenses adapt with you. This chapter maps how weights, key inputs, and 80/20 simplifications shift across three stages: Startup (survival), Growth (scale), Maturity (optimization/exit readiness). Mike’s journey took him from early growth (~$1.2M) to maturity ($2.4M+). He recalibrated lenses at each milestone — avoiding the trap of using startup logic on a mature business (or vice versa). > **Reality Check: "I’m Still Small — Do These Fancy Lenses Even Apply?"** > Yes — even at $500k revenue. Mike started recalculating at $1.2M. He used shorter forecasts (3 years), higher WACC (18–20%), and heavier Lens 2 weighting. The directional signal was still powerful: “This hire grows me out of survival mode.” #### Stage 1: Startup / Survival ($0–$1.5M Revenue) Focus: Cash survival + owner take-home. Weights: 20% Lens 1 | 70% Lens 2 | 10% Lens 3 Key simplifications: - 3-year explicit forecast - High WACC (18–22%) - Minimal terminal value (or none) - Ignore complex adjustments (leases, R&D) Mike (early days): Blended ~$820k — mostly Lens 2. Guided him to prioritize owner cash flow while building recurring base. Tony's early Pauly's Pizza was a textbook Stage 1 business — $1.1M revenue, high owner dependence, no documented systems. Weighted Lens 2 heavily (70%). The lenses showed a $720k blended value but flagged owner dependence as the primary drag. That single insight launched his 18-month improvement arc. #### Stage 2: Growth / Scale-Up ($1.5M–$10M Revenue) Focus: Acceleration + buyer appeal. Weights: 35% Lens 1 | 35% Lens 2 | 30% Lens 3 Key simplifications: - 5-year forecast - WACC 14–17% - Start blending forward EBITDA in Lens 3 - Focus on recurring % and owner independence Mike (current): Blended $2.30M → $2.92M over 18 months. Reinvested in systems/hires — lenses confirmed each move. Sandra at Coastal Supplies is the poster child for Stage 2. At $6.7M revenue with a management team partially in place, she's squarely in the growth-to-scale transition. Her lens weights shifted from a Lens 2-heavy mix to the balanced 35/35/30 split once she had a warehouse manager and sales lead handling daily operations. The Lens 3 weight increase forced her to think about what buyers see — which is why she invested in reducing customer concentration and documenting her vendor relationships. Her Blended View climbed from $3.1M to $3.8M in the first year of lens-driven management. #### Stage 3: Maturity / Optimization ($10M+ or Exit-Ready) Focus: Multiple maximization + resilience. Weights: 25% Lens 1 | 25% Lens 2 | 50% Lens 3 Key simplifications: - Heavy Lens 3 weighting - Lower WACC (12–15%) with credits - Full buyer-ready adjustments (but 80/20 prune) Mike projected this stage: If he hit $5M revenue with 65% recurring and low owner dependence → Lens 3 7.0x → Blended ~$4.8M+. #### Tactical Table: Stage-Specific Lens Shifts (Mike’s Journey) | Stage | Revenue Range | Weights (L1/L2/L3) | WACC Used | Key 80/20 Focus | Mike’s Blended Evolution | |--------------------|---------------|--------------------|-----------|-------------------------------------|--------------------------| | Early Growth | ~$1.2M | 20/70/10 | 19% | Owner cash flow + survival | ~$820k | | Mid-Growth | $2.0M–$2.4M | 35/35/30 | 15% | Recurring % + systems | $2.04M → $2.30M | | Projected Maturity | $4M–$6M | 25/25/50 | 13% | Multiple drivers + buyer readiness | ~$4.8M+ (projected) | #### Mini-Worked Example: Mike’s Stage Transition From early growth to mid-growth: - Pre-transition (survival weights): Blended $1.05M - Post (growth weights + recurring lift): Blended $2.04M Delta: +$990k — mostly from shifting weights + actual improvements. Use stage checkpoints (revenue milestones, employee count, recurring %) to reweight lenses quarterly. Your valuation evolves as you do. --- You now have the full toolkit — mindset, lenses, tactics, horizons, and stage awareness. Time to put it into practice. --- # Part 5: Tools and Resources — Putting It All Into Practice > **Where We've Been:** You've built the mindset (Part 1), mastered all four lenses (Part 2), applied them to real tactical decisions (Part 3), and planned for the bigger horizons — exits, turbulence, succession, and growth stages (Part 4). You have the complete framework. > > **Where We're Going:** This final part turns everything into repeatable action. The 30-Day Playbook gives you a structured launch sequence. The worksheets let you calculate and track every lens. The appendix satisfies the math-curious. And the resources connect you to tools and communities that keep the momentum going long after you close this book. You've built the mindset, mastered the lenses, executed tactical plays, and charted your horizons. Now, it's time to make it stick — with hands-on tools that turn *Exit Matters* from a read-once book into your go-to workbook. This part is your practical arsenal: Playbooks to kickstart habits, worksheets for quick calculations, deeper math for the curious, and resources to keep the momentum going. We'll start with the Bonus: Your 30-Day Valuation-as-Management Playbook, a step-by-step guide to integrate the four lenses into your routine — complete with challenges, trackers, and real-owner tips. Then, dive into the Worksheets section, packed with fillable templates for everything from your baseline lenses to scenario modeling and the 80/20 Complexity Pruner. The Appendix unpacks the math behind the lenses (optional for most, but gold for detail lovers). Finally, Resources & Next Steps connects you to further reading, communities, and tools that automate it all. This isn't filler — it's fuel. Owners like Mike and Tony didn't just read about valuations; they applied them weekly, unlocking six-figure gains. Use these to do the same: Print them, mark them up, revisit quarterly. And for seamless integration? xitmatters.io brings these tools to life — automating worksheets, running playbooks in real time, and syncing with your financials for effortless updates. (Get started free in beta at xitmatters.io — because applying what you've learned is where the real value multiplies.) By the end of this part, you'll have everything to make valuation a habit. Let's equip you for lasting impact — your business's future starts here. --- [Return to TOC](#toc) #### Bonus: Your 30-Day Valuation-as-Management Playbook Congratulations. You now have the complete four-lens framework. But knowledge without action is just entertainment. This bonus section is where the rubber meets the road. It's the exact 30-day system I give every owner who wants to make valuation the central operating system of their business. Commit to these 30 days and you will never manage your company the same way again. #### Why 30 Days Changes Everything Thirty days is long enough to see real movement in your four lenses, but short enough to maintain momentum. Most owners who complete this playbook report: - Clearer decision-making within 10 days - At least one "holy crap" moment where they see how much value a single decision creates or destroys - A permanent shift from profit-only thinking to value-driven management - Higher confidence in negotiations and capital decisions Let's begin. #### The 30-Day Playbook #### Week 1: Foundation — Know Your Starting Line **Days 1–2: Calculate Your Baseline** Gather your last 12 months of financials (P&L, balance sheet, cash-flow forecast). Calculate your four lenses: Cash Flow to the Business (Lens 1), Cash Flow to the Owner (Lens 2), What Buyers Will Pay (Lens 3), and the Blended View (Lens 4). Use the methods from Chapters 3, 4, 5, and 6. Write them down and save the snapshot. This is your "Day Zero" photo. **Days 3–5: Owner Dependence Audit** Track every hour you spend in the business. Identify tasks that only you can do. Rate your current owner dependence on a scale of 1–10. Connect this to the Four Forces from Chapter 6 — owner dependence is the number-one multiple killer. **Days 6–7: Quick Wins Scan** Review the last 90 days of major decisions (pricing, hiring, purchases, contracts). Estimate what they did to your four lenses. Identify your biggest value leak or opportunity. #### Week 2: Tactical Awareness — Score Every Move **Daily Routine (10 minutes)** Morning: Review today's decisions through the four-lens filter. Evening: Log any decision over $1,000 in your Valuation Decision Journal (template in Worksheets). **Focus Areas** - Run pricing analysis on your top 3 products/services — estimate the Lens 1 and Lens 2 impact of a 3-5% increase - Evaluate one upcoming CapEx decision using the method from Chapter 8 - Review one vendor or customer contract coming up for renewal — estimate the four-lens impact of different terms **Goal by end of Week 2** You should instinctively ask "How does this affect my four lenses?" before any spending decision. #### Week 3: Negotiation & Reinvestment Power **Key Activities** - Use valuation math in at least one real negotiation (vendor, customer, or employee) — follow the framework from Chapter 9 - Model two reinvestment options you're considering (marketing, equipment, tech, training) - Calculate the 3-year impact on Lens 1 and Lens 2 for each, and estimate the Lens 3 multiple lift using the Four Forces **Mid-Week Check-in** Re-calculate your four lenses with any new data. Look at the divergences — are Lens 1 and Lens 3 moving together, or is a gap forming? Celebrate even small movements in the right direction. #### Week 4: Momentum & Long-Term Planning **Days 22–25: Build Your Value Acceleration Plan** Fill out the Buyer Appeal Checklist from Chapter 12. Choose your top 3 initiatives for the next 90 days. Model the expected impact on all four lenses. Run the Hold vs. Sell analysis from Chapter 12 — know your Wealth Advantage. **Days 26–28: Create Your Ongoing System** Set recurring calendar reminders for monthly valuation updates. Design your simple weekly review process (see below). **Days 29–30: Review & Commit** Compare Day 30 numbers to Day 1. Write down the biggest lesson learned. Decide your next 90-day focus areas. #### Your Weekly Valuation Management Routine (Ongoing) Every Monday morning (15–20 minutes): 1. Update your four lenses with latest financial data 2. Review last week's decisions from your journal 3. Score the upcoming week's major decisions against the four lenses 4. Check the divergences — is Lens 3 keeping up with Lens 1? 5. Adjust priorities based on what moves the Blended View the most Every quarter (first Monday of Jan, Apr, Jul, Oct): - Full re-calculation of all four lenses - Update Buyer Appeal Checklist - Review progress on your Value Acceleration Plan - Run the Hold vs. Sell analysis — is the Wealth Advantage growing? --- [Return to TOC](#toc) ### Worksheets ### The Exit Matters Workbook **By James Waters** **Founder, Xit Matters** **Copyright © 2026 Xit Matters LLC** All rights reserved. For educational purposes only. Print this workbook. Use it daily. Watch your business value grow. --- #### Worksheet 1: FCFF Calculation (Lens 1 Starting Point) **Date:** ______________________________ **Company:** ______________________________ | Line Item | Your Number | Notes | |---|---:|---| | Revenue | $ ________________ | Last 12 months | | − Cost of Goods Sold | $ ________________ | | | − Operating Expenses | $ ________________ | | | **= EBITDA** | $ ________________ | Revenue − COGS − OpEx | | − Depreciation | $ ________________ | | | − Amortization | $ ________________ | | | **= EBIT** | $ ________________ | | | × (1 − Tax Rate ____%) | | | | **= NOPAT** | $ ________________ | EBIT × (1 − tax rate) | | + Depreciation & Amortization | $ ________________ | Add back non-cash | | − Capital Expenditures | $ ________________ | | | − Change in Working Capital | $ ________________ | (Current Assets − Current Liabilities) vs. prior year | | **= Free Cash Flow to the Firm (FCFF)** | **$ ________________** | | --- #### Worksheet 2: FCFE Calculation (Lens 2 Starting Point) **Date:** ______________________________ | Line Item | Your Number | Notes | |---|---:|---| | Net Income | $ ________________ | From your P&L | | + Depreciation & Amortization | $ ________________ | Add back non-cash | | − Capital Expenditures | $ ________________ | | | − Change in Working Capital | $ ________________ | | | + Net Borrowing | $ ________________ | New debt − debt repaid | | **= Free Cash Flow to Equity (FCFE)** | **$ ________________** | | **Sanity Check:** Lens 1 (FCFF DCF) minus Net Debt should approximately equal Lens 2 (FCFE DCF). | Check | Amount | |---|---:| | Lens 1 (Enterprise Value after illiquidity) | $ ________________ | | − Net Debt (total debt − cash) | $ ________________ | | **= Implied Equity Value** | $ ________________ | | Lens 2 (from FCFE DCF) | $ ________________ | | **Difference** | $ ________________ | If the difference is more than 10%, revisit your debt and cash numbers. --- #### Worksheet 3: Discount Rate Estimation **Your WACC (Weighted Average Cost of Capital)** | Component | Value | Notes | |---|---:|---| | Risk-Free Rate | ________% | ~4.2% (US 10-year Treasury) | | + Equity Risk Premium | ________% | ~5.6% (what the market demands above risk-free) | | × Beta (industry risk) | ________x | 1.0 = average; <1.0 = less risky; >1.0 = more risky. Source: Damodaran Online (pages.stern.nyu.edu/~adamodar) — free, updated annually | | **= Base Cost of Equity** | ________% | Risk-Free + (ERP × Beta) | | + Size Premium | ________% | +2-4% for businesses under $10M revenue | | + Company-Specific Risk | ________% | Owner dependence, customer concentration | | − Recurring Revenue Credit | ________% | −1-2% if >50% recurring revenue | | **= Adjusted Cost of Equity** | ________% | | | Debt Inputs | Value | |---|---:| | Total Interest-Bearing Debt | $ ________________ | | Total Equity (Assets − Liabilities) | $ ________________ | | Debt Weight: Debt ÷ (Debt + Equity) | ________% | | Equity Weight: 1 − Debt Weight | ________% | | Interest Rate on Debt | ________% | | × (1 − Tax Rate) = After-Tax Cost of Debt | ________% | **WACC = (Equity Weight × Cost of Equity) + (Debt Weight × After-Tax Cost of Debt)** **Your WACC:** ________% **Quick Sanity Check:** - Under 10%? You're probably being too optimistic. Most private SMBs are 12%+. - Over 20%? Check your beta and risk premiums — this is high even for risky businesses. - 12-16%? You're in the typical range for a well-run private SMB. --- #### Worksheet 4: Four-Lens Summary **Date:** ______________________________ #### Pre-Filled Example (Mike's HVAC — Before Price Increase) | Lens | Value | Key Input | |---|---:|---| | 1. Cash Flow to the Business | $2,165,000 | FCFF $320k, WACC 15%, Growth 6%/2.5%, Illiquidity 28% | | 2. Cash Flow to the Owner | $1,665,000 | Lens 1 minus $500k net debt | | 3. What Buyers Will Pay | $2,700,000 | EBITDA $500k × 5.4x multiple | | 4. Blended View (day-to-day) | $2,076,000 | 40% L1 + 40% L2 + 20% L3 | **Divergence Check:** Lens 3 is $535k above Lens 1 → Market pays a premium for HVAC service contracts. #### Your Business | Lens | Value | Key Input | |---|---:|---| | 1. Cash Flow to the Business | $ ________________ | FCFF $_____, WACC ____%, Growth ____%, Illiquidity ____% | | 2. Cash Flow to the Owner | $ ________________ | Lens 1 minus $_____ net debt | | 3. What Buyers Will Pay | $ ________________ | EBITDA $_____ × ____x multiple | | 4. Blended View | $ ________________ | Weights: ____% L1 + ____% L2 + ____% L3 | **Divergence Check:** _____________________________________________________________ **What it means:** _____________________________________________________________ **My #1 action to close the gap:** _____________________________________________________________ --- #### Worksheet 5: Buyer Appeal Checklist **Date:** ______________________________ | Factor | Current Score (1–10) | Target (90 days) | Which Force? | Next Action | |---|---|---|---|---| | Recurring revenue ≥ 50% | | | Risk Reduction | | | Owner dependence (<15 hrs/week) | | | Owner Independence | | | All core processes documented | | | Owner Independence | | | No single customer >12% of revenue | | | Risk Reduction | | | Clean, buyer-ready financials | | | Risk Reduction | | | Documented growth pipeline | | | Growth Visibility | | | Strong team / low key-person risk | | | Owner Independence | | | Low CapEx requirements for growth | | | Capital Efficiency | | **Total Score:** ______ / 80 **My Top 3 Improvements for the Next 90 Days** 1. __________________________________________________________________ 2. __________________________________________________________________ 3. __________________________________________________________________ --- #### Worksheet 6: Valuation Decision Journal **Decision:** __________________________________________________________________ **Date:** ______________________________ **Options Being Considered** 1. __________________________________________________________________ 2. __________________________________________________________________ 3. __________________________________________________________________ **Estimated Impact on Four Lenses** | | Option 1 | Option 2 | Option 3 | |---|---|---|---| | Annual FCFF Change | $ ________ | $ ________ | $ ________ | | Lens 1 Change | $ ________ | $ ________ | $ ________ | | Lens 2 Change | $ ________ | $ ________ | $ ________ | | Lens 3 Multiple Change | ____x | ____x | ____x | | Lens 3 Value Change | $ ________ | $ ________ | $ ________ | | Blended View Change | $ ________ | $ ________ | $ ________ | **Decision I Made:** __________________________________________________________________ **Why (based on the four lenses):** ________________________________________________________________________________ **Date to Re-Measure:** ______________________________ **Actual Results (fill in later):** ________________________________________________________________________________ *(Print extra copies of this page)* --- #### Worksheet 7: Hold vs. Sell Analysis **Date:** ______________________________ #### Sell Scenario | Item | Amount | |---|---:| | Lens 3 (Market Value) | $ ________________ | | − Illiquidity Discount (____%) | $ ________________ | | − Capital Gains Tax (____%) | $ ________________ | | **= Net Sale Proceeds** | $ ________________ | | × Compounded at ____% for ____ years | | | **= Sell & Invest Value** | **$ ________________** | #### Hold Scenario | Year | Annual FCFE | Cumulative | |---|---:|---:| | Year 1 | $ ________ | $ ________ | | Year 2 | $ ________ | $ ________ | | Year 3 | $ ________ | $ ________ | | Year 4 | $ ________ | $ ________ | | Year 5 | $ ________ | $ ________ | | **Cumulative Cash Flow** | | **$ ________________** | | + Future Business Value at Year 5 | | $ ________________ | | **= Hold Value** | | **$ ________________** | #### Wealth Advantage | | Amount | |---|---:| | Hold Value | $ ________________ | | − Sell & Invest Value | $ ________________ | | **= Wealth Advantage** | **$ ________________** | **Verdict:** Hold / Sell (circle one) --- #### Worksheet 8: 90-Day Value Acceleration Plan **My Goal Date:** ______________________________ **Primary Goal:** __________________________________________________________________ **Key Initiatives (connect each to a Force from Chapter 6)** 1. ______________________________________ → Force: __________________ 2. ______________________________________ → Force: __________________ 3. ______________________________________ → Force: __________________ **Expected Impact** - Lens 1 Target: $ ________________ - Lens 2 Target: $ ________________ - Lens 3 Target: $ ________________ - Blended View Target: $ ________________ **Milestones** - End of Month 1: ____________________________________________________ - End of Month 2: ____________________________________________________ - End of Month 3: ____________________________________________________ --- #### Weekly Review Template **Week of:** ______________________________ 1. **This Week's Key Decisions & Four-Lens Impact** - Decision 1: ________________ → Blended View Impact: $________ - Decision 2: ________________ → Blended View Impact: $________ 2. **Current Four Lenses** L1: $________ L2: $________ L3: $________ Blended: $________ 3. **Divergence Check** Biggest gap: ________________ → Action: ________________ 4. **Next Week Focus** __________________________________________________________________ --- [Return to TOC](#toc) #### The Exit Matters Workbook — Completed for Mike's Climate Solutions **Case Study:** Mike, Florida HVAC owner **Industry:** Building Products & Services (HVAC) **Revenue:** $2,400,000 | **EBITDA:** $500,000 | **Net Income:** $292,500 **Industry:** Building Products & Services **Location:** Central Florida, serving three counties **Years in operation:** 14 years **Employees:** 12 technicians, 3 office staff, 1 operations manager **Fleet:** 8 service trucks **Revenue mix:** Service agreements 42% ($1.008M), installation/project 38% ($912k), repair calls 20% ($480k) --- #### Profit & Loss Statement (Trailing 12 Months) | Line Item | Amount | % of Revenue | Notes | |---|---:|---:|---| | **Revenue** | $2,400,000 | 100.0% | | | Cost of Goods Sold | ($1,080,000) | 45.0% | Parts 28%, direct labor 17% | | **Gross Profit** | $1,320,000 | 55.0% | | | Operating Expenses | ($820,000) | 34.2% | Includes $120k owner salary | | **EBITDA** | $500,000 | 20.8% | | | Depreciation | ($80,000) | 3.3% | Trucks $50k, tools $20k, office $10k | | Amortization | ($10,000) | 0.4% | | | **EBIT (Operating Income)** | $410,000 | 17.1% | | | Interest Expense | ($35,000) | 1.5% | Blended 7.25% on $440k debt | | **Earnings Before Tax** | $375,000 | 15.6% | | | Income Taxes | ($82,500) | 3.4% | 22% on EBT; 20% on EBIT (used for NOPAT) | | **Net Income** | $292,500 | 12.2% | | **Owner Benefit:** $292,500 net income + $120,000 owner salary = $412,500 total. Book rounds to "$380k in owner profit" (net income + partial salary adjustment after normalization). --- #### Balance Sheet (End of Period) | Line Item | Amount | Notes | |---|---:|---| | **Assets** | | | | Cash and Equivalents | $120,000 | | | Accounts Receivable | $180,000 | ~27 days outstanding | | Inventory (parts) | $100,000 | | | **Total Current Assets** | $400,000 | | | Property, Plant & Equipment (net) | $520,000 | Trucks, tools, shop equipment | | Other Non-Current Assets | $100,000 | Deposits, right-of-use assets | | **Total Non-Current Assets** | $620,000 | | | **Total Assets** | $1,020,000 | | | | | | | **Liabilities** | | | | Accounts Payable | $95,000 | | | Accrued Expenses | $55,000 | | | Current Portion of Long-Term Debt | $30,000 | | | **Total Current Liabilities** | $180,000 | | | Equipment Loans | $280,000 | | | Line of Credit | $160,000 | | | **Long-Term Debt** | $440,000 | | | **Total Non-Current Liabilities** | $440,000 | | | **Total Liabilities** | $620,000 | | | | | | | **Total Equity** | $400,000 | | --- #### Cash Flow / Capital Expenditures | Item | Amount | |---|---:| | Capital Expenditures | $75,000 | | Free Cash Flow from Operations | $320,000 | --- #### Derived Valuation Inputs #### FCFF (Free Cash Flow to the Firm) | Step | Calculation | Amount | |---|---|---:| | EBIT | Revenue − COGS − OpEx − D&A | $410,000 | | NOPAT | EBIT × (1 − 20% tax rate) | $327,500 | | + Depreciation & Amortization | Add back non-cash | $90,000 | | − Capital Expenditures | - | ($75,000) | | − Change in Working Capital | (Current Assets - Current Liabilities) − (Prior Current Assets - Prior Current Liabilities) | $0 | | **= FCFF** | - | **$342,500** | Note: Book states FCFF ~$320k. The difference reflects normalized CapEx adjustments (book uses $95k normalized CapEx vs. $75k actual — reflecting average replacement cost over a 5-year cycle). With normalized CapEx: $327,500 + $90,000 − $95,000 − $0 = $322,500. #### FCFE (Free Cash Flow to Equity) | Step | Amount | |---|---|---:| | Net Income | $292,500 | | + Depreciation & Amortization | $90,000 | | − Capital Expenditures | ($75,000) | | − Change in Working Capital | $0 | | + Net Borrowing (Assume zero for baseline) | $0 | | **= FCFE** | **$307,500** | #### Key Ratios | Metric | Value | |---|---| | Working Capital | $220,000 | | Net Debt (Long-Term Debt + Current Liabilities − Cash) | $500,000 | | Debt-to-Equity | 1.10x | | EBITDA Margin | 20.8% | | Net Margin | 12.2% | --- ## Book Valuation Targets (Draft 3 — Corrected Math) #### Assumptions - WACC: 15% (small private HVAC — risk-free 4.2% + equity risk premium 6% + smb premium 3.5%) - Explicit growth: 6% for 5 years - Terminal growth: 2.5% - Illiquidity: 28% (revenue bracket $1–5M) #### Before Price Increase | Step | Calculation | Value | |---|---|---:| | PV of CY1–CY5 FCFF | $320k growing at 6%, discounted at 15% | $1,261,000 | | Terminal Value | $428k × 1.025 / (0.15 − 0.025) = $3,512k | $3,512,000 | | PV of Terminal Value | $3,512k / 1.15^5 | $1,746,000 | | **Enterprise Value (pre-illiquidity)** | - | **$3,007,000** | | Less: Illiquidity Discount (28%) | - | ($842,000) | | **Lens 1: Cash Flow to the Business** | - | **$2,165,000** | | Less: Net Debt | - | ($500,000) | | **Lens 2: Cash Flow to the Owner** | - | **$1,665,000** | | **Lens 3: Market Value** | EBITDA $500k × 5.4x | **$2,700,000** | #### After 3.8% Price Increase on Service Agreements | Change | Impact | |---|---| | Service agreement revenue increase | +$38k (3.8% × $1.008M) | | Additional COGS (minimal — labor-heavy) | ~($5k) | | Net FCFF increase | +$68k (includes margin flow-through + reduced churn) | | New FCFF | ~$388k | | New Lens 1 (Cash Flow to the Business) | ~$2,625,000 | | New Lens 2 (Cash Flow to the Owner) | ~$2,125,000 | | **Value Created (Lens 1)** | **+$460,000** | | **Value Created (Lens 2)** | **+$460,000** | --- [Return to TOC](#toc) #### Worksheet 1: FCFF Calculation (Lens 1 Starting Point) **Date:** January 2026 **Company:** Mike's Climate Solutions | Line Item | Your Number | Notes | |---|---:|---| | Revenue | $2,400,000 | Last 12 months | | − Cost of Goods Sold | ($1,080,000) | Parts 28%, direct labor 17% | | − Operating Expenses | ($820,000) | Includes $120k owner salary | | **= EBITDA** | **$500,000** | Revenue − COGS − OpEx | | − Depreciation | ($80,000) | Trucks $50k, tools $20k, office $10k | | − Amortization | ($10,000) | | | **= EBIT** | **$410,000** | | | × (1 − Tax Rate 20%) | | Income Taxes ÷ EBIT = $82,500 ÷ $410,000 | | **= NOPAT** | **$327,500** | EBIT × (1 − 0.20) | | + Depreciation & Amortization | $90,000 | Add back non-cash | | − Capital Expenditures | ($75,000) | Actual; normalized ~$95k over 5-year cycle | | − Change in Working Capital | $0 | ($400k − $180k) vs. prior year ($380k − $160k) = $0 | | **= Free Cash Flow to the Firm (FCFF)** | **$342,500** | Book uses ~$320k with normalized CapEx | **Note:** The book rounds FCFF to ~$320k because it uses normalized CapEx of ~$95k (average truck/equipment replacement cost over a 5-year cycle) rather than the $75k spent in this specific trailing period. With normalized CapEx: $327,500 + $90,000 − $95,000 − $0 = $322,500. Both numbers are defensible — the normalized figure is more conservative and appropriate for a DCF projection. --- #### Worksheet 2: FCFE Calculation (Lens 2 Starting Point) **Date:** January 2026 | Line Item | Your Number | Notes | |---|---:|---| | Net Income | $292,500 | From P&L | | + Depreciation & Amortization | $90,000 | Add back non-cash | | − Capital Expenditures | ($75,000) | | | − Change in Working Capital | $0 | No significant change year-over-year | | + Net Borrowing | $0 | No new debt issued, no significant repayment | | **= Free Cash Flow to Equity (FCFE)** | **$307,500** | | **Sanity Check:** Lens 1 (FCFF DCF) minus Net Debt should approximately equal Lens 2 (FCFE DCF). | Check | Amount | |---|---:| | Lens 1 (Enterprise Value after illiquidity) | $2,165,000 | | − Net Debt (total debt − cash) | ($500,000) | | **= Implied Equity Value** | **$1,665,000** | | Lens 2 (from FCFE DCF) | ~$1,665,000 | | **Difference** | ~$0 | Difference is under 10%. The equity bridge reconciles cleanly. --- #### Worksheet 3: Discount Rate Estimation **Your WACC (Weighted Average Cost of Capital)** | Component | Value | Notes | |---|---:|---| | Risk-Free Rate | 4.2% | US 10-year Treasury (2026) | | + Equity Risk Premium | 5.6% | Market consensus | | × Beta (industry risk) | 1.08x | Building Products & Services sector | | **= Base Cost of Equity** | 10.2% | 4.2% + (5.6% × 1.08) | | + Size Premium | 4.0% | Under $5M revenue; small private company | | + Company-Specific Risk | 4.3% | Moderate owner dependence, 58% project-based revenue | | − Recurring Revenue Credit | (0.5%) | 42% of revenue from service agreements | | **= Adjusted Cost of Equity** | **18.0%** | | | Debt Inputs | Value | |---|---:| | Total Interest-Bearing Debt | $470,000 | | Total Equity (Assets − Liabilities) | $400,000 | | Debt Weight: Debt ÷ (Debt + Equity) | 25% | | Equity Weight: 1 − Debt Weight | 75% | | Interest Rate on Debt | 7.25% | | × (1 − Tax Rate) = **After-Tax Cost of Debt** | 5.66% | **Note on weights:** Using industry-typical target capital structure (25% debt / 75% equity) rather than current book value weights, which is standard practice for private SMB valuations where the balance sheet doesn't reflect optimal or permanent financing. **WACC = (Equity Weight × Cost of Equity) + (Debt Weight × After-Tax Cost of Debt)** = (75% × 18.0%) + (25% × 5.66%) = 13.5% + 1.4% **Your WACC:** **~15%** **Quick Sanity Check:** - Under 10%? ❌ - Over 20%? ❌ - 12-16%? ✅ Mike's 15% is in the typical range for a well-run private HVAC company with moderate owner dependence and a mix of project-based and recurring revenue. --- #### Worksheet 4: Four-Lens Summary #### Before Price Increase **Date:** January 2026 | Lens | Value | Key Input | |---|---:|---| | 1. Cash Flow to the Business | $2,165,000 | FCFF ~$320k, WACC 15%, Growth 6%/2.5%, Illiquidity 28% | | 2. Cash Flow to the Owner | $1,665,000 | Lens 1 minus $500k net debt | | 3. What Buyers Will Pay | $2,700,000 | EBITDA $500k × 5.4x multiple | | 4. Blended View (day-to-day) | $2,076,000 | 40% L1 + 40% L2 + 20% L3 | **Blended View math:** (40% × $2,165k) + (40% × $1,665k) + (20% × $2,700k) = $866k + $666k + $540k = **$2,072k** Using the book's rounded Lens values: (40% × $2.17M) + (40% × $1.67M) + (20% × $2.70M) = $868k + $668k + $540k = **$2,076k** **Divergence Check:** Lens 3 is $535k above Lens 1 → Market pays a premium for HVAC service contracts. Buyers value the recurring revenue stream higher than the DCF model suggests. This is a positive divergence — it means Mike's business has buyer appeal that exceeds its pure cash flow value. **What it means:** The market recognizes that 42% recurring service agreements reduce risk for a buyer, making the business worth more in a transaction than a strict DCF would suggest. **My #1 action to close the gap:** Increase service agreement penetration above 50% to push Lens 1 higher while maintaining the Lens 3 premium. --- #### After 3.8% Price Increase on Service Agreements **Date:** April 2026 | Lens | Value | Key Input | |---|---:|---| | 1. Cash Flow to the Business | $2,625,000 | FCFF ~$388k, WACC 15%, Growth 6%/2.5%, Illiquidity 28% | | 2. Cash Flow to the Owner | $2,125,000 | Lens 1 minus $500k net debt | | 3. What Buyers Will Pay | $2,878,000 | EBITDA ~$533k × 5.4x multiple | | 4. Blended View (day-to-day) | $2,476,000 | 40% L1 + 40% L2 + 20% L3 | **Blended View math:** (40% × $2,625k) + (40% × $2,125k) + (20% × $2,878k) = $1,050k + $850k + $576k = **$2,476k** **Value Created by Price Increase:** | Lens | Before | After | Change | |---|---:|---:|---:| | 1. Cash Flow to the Business | $2,165,000 | $2,625,000 | **+$460,000** | | 2. Cash Flow to the Owner | $1,665,000 | $2,125,000 | **+$460,000** | | 3. What Buyers Will Pay | $2,700,000 | $2,878,000 | **+$178,000** | | 4. Blended View | $2,076,000 | $2,476,000 | **+$400,000** | A 3.8% price increase on the highest-margin, most predictable revenue stream created $460k in enterprise value. --- #### Worksheet 5: Buyer Appeal Checklist **Date:** January 2026 (Before Price Increase) | Factor | Current Score (1–10) | Target (90 days) | Which Force? | Next Action | |---|---|---|---|---| | Recurring revenue ≥ 50% | 5 | 7 | Risk Reduction | Push service agreements to 50%+ through bundled offerings and 3.8% price increase on existing contracts | | Owner dependence (<15 hrs/week) | 4 | 6 | Owner Independence | Empower operations manager to handle day-to-day scheduling and dispatch without Mike | | All core processes documented | 4 | 6 | Owner Independence | Document top 10 service procedures and dispatching protocols in simple SOPs | | No single customer >12% of revenue | 8 | 8 | Risk Reduction | Already diversified across 3 counties — maintain | | Clean, buyer-ready financials | 5 | 7 | Risk Reduction | Migrate to cloud-based reporting; separate owner expenses from business expenses | | Documented growth pipeline | 5 | 7 | Growth Visibility | Build a 3-county expansion plan with addressable market data and service agreement targets | | Strong team / low key-person risk | 5 | 7 | Owner Independence | Cross-train lead techs; create a backup for the operations manager | | Low CapEx requirements for growth | 4 | 5 | Capital Efficiency | Establish a fleet replacement schedule to smooth out CapEx spikes | **Total Score:** 40 / 80 **My Top 3 Improvements for the Next 90 Days** 1. Implement the 3.8% service agreement price increase — directly lifts FCFF by ~$68k/year and Lens 1 by $460k 2. Document the top 10 service workflows and dispatching procedures — reduces owner dependence (Force 2) and protects the multiple 3. Migrate financials to cloud-based reporting with clean owner/business separation — makes future due diligence effortless and signals professionalism to lenders or buyers --- #### Worksheet 6: Valuation Decision Journal **Decision:** Raise prices 3.8% on service agreement contracts **Date:** February 2026 **Options Being Considered** 1. Raise service agreement prices 3.8% ($38k additional revenue) 2. Hold prices flat and add 2 new technicians to grow volume ($85k cost) 3. Do nothing — maintain status quo **Estimated Impact on Four Lenses** | Impact | Option 1: Price Increase | Option 2: Add Techs | Option 3: Status Quo | |---|---|---|---| | Annual FCFF Change | +$68,000 | +$42,000 (net of $85k cost + ramp) | $0 | | Lens 1 Change | +$460,000 | +$285,000 | $0 | | Lens 2 Change | +$460,000 | +$285,000 | $0 | | Lens 3 Multiple Change | +0.7x (pricing power signals quality) | +0.3x (growth but more complexity) | 0x | | Lens 3 Value Change | +$551,000 | +$290,000 | $0 | | Blended View Change | +$438,000 | +$276,000 | $0 | **Decision I Made:** Option 1 — Raise service agreement prices 3.8% **Why (based on the four lenses):** Option 1 creates the most value per dollar of effort by a wide margin. No capital outlay, no hiring risk, no ramp-up period. The price increase drops almost entirely to the bottom line because service agreements are labor-heavy (fixed cost) with minimal incremental parts expense. It also signals pricing power, which lifts the multiple. Option 2 is a good future move once the price increase is absorbed, but carries execution risk and a 6-12 month ramp. Option 3 is the worst — inflation erodes the real value of flat pricing every year. **Date to Re-Measure:** May 2026 (90 days post-implementation) **Actual Results (fill in later):** - Customer churn from price increase: only 3 of 412 contracts cancelled (0.7%) - Net FCFF improvement: $68k/year confirmed - Lens 1 moved from $2.17M to $2.63M (+$460k) — exactly as modeled - Service agreement retention rate actually improved because the increase funded better response times --- #### Worksheet 7: Hold vs. Sell Analysis **Date:** January 2026 (Before Price Increase baseline) #### Sell Scenario | Item | Amount | |---|---:| | Lens 3 (Market Value) | $2,700,000 | | − Illiquidity Discount (28%) | ($756,000) | | − Capital Gains Tax (20%) | ($388,800) | | **= Net Sale Proceeds** | **$1,555,200** | | × Compounded at 8% for 5 years | × 1.469 | | **= Sell & Invest Value** | **$2,285,000** | #### Hold Scenario | Year | Annual FCFE | Cumulative | |---|---:|---:| | Year 1 | $308,000 | $308,000 | | Year 2 | $326,480 | $634,480 | | Year 3 | $346,069 | $980,549 | | Year 4 | $366,833 | $1,347,382 | | Year 5 | $388,843 | $1,736,225 | | **Cumulative Cash Flow** | | **$1,736,000** | | + Future Business Value at Year 5 | | $4,349,000 | | **= Hold Value** | | **$6,085,000** | **Business Value at Year 5 calculation:** - EBITDA today: $500,000 - EBITDA at Year 5 (6% growth): $500k × 1.06^5 = ~$669,000 - Conservative multiple at Year 5: 6.5x (improvement from 5.4x as Mike builds systems and recurring revenue) - Year 5 Lens 3: $669k × 6.5x = ~$4,349,000 #### Wealth Advantage | | Amount | |---|---:| | Hold Value | $6,085,000 | | − Sell & Invest Value | ($2,285,000) | | **= Wealth Advantage** | **+$3,800,000** | **Verdict:** **HOLD** — overwhelmingly. The wealth advantage of holding is $3.8M over five years. Mike keeps collecting $300k+ annually in FCFE (cash in his pocket), the business continues compounding, and his multiple improves as he builds systems and recurring revenue. Selling today would leave $3.8M on the table. **What actually happened (from Chapter 12):** Mike held for 3 years, grew Lens 1 to $4.9M, Lens 2 to $4.2M, and Lens 3 to $6.8M. A strategic buyer offered $6.3M cash. He accepted — on his terms, after 45 days, and kept the real estate. --- #### Worksheet 8: 90-Day Value Acceleration Plan **My Goal Date:** April 30, 2026 **Primary Goal:** Increase Lens 1 by $460k+ through pricing optimization and begin reducing owner dependence **Key Initiatives (connect each to a Force from Chapter 6)** 1. Implement 3.8% price increase on all service agreements → Force: **Risk Reduction** (pricing power on recurring revenue demonstrates business quality) 2. Document top 10 service procedures and create dispatching SOP → Force: **Owner Independence** (operations manager can run daily work without Mike) 3. Build a 3-county growth pipeline with service agreement penetration targets → Force: **Growth Visibility** (documented growth plan increases buyer confidence and supports multiple expansion) **Expected Impact** - Lens 1 Target: $2,625,000 (from $2,165,000 — +$460k) - Lens 2 Target: $2,125,000 (from $1,665,000 — +$460k) - Lens 3 Target: $2,878,000 (from $2,700,000 — +$178k from EBITDA growth; multiple expansion comes later) - Blended View Target: $2,476,000 (from $2,076,000 — +$400k) **Milestones** - End of Month 1: Price increase letters sent to all 412 service agreement customers; first 10 SOPs drafted; churn tracking dashboard set up - End of Month 2: Price increase fully implemented; operations manager running dispatch independently 3 days/week; growth pipeline for County 2 mapped with 150 target accounts - End of Month 3: Full 90-day churn data collected (target: <2% cancellation); all core SOPs complete and searchable; Lens 1 and Lens 2 re-calculated to confirm $460k value creation --- #### Weekly Review Template — Sample Week 1 **Week of:** February 3, 2026 1. **This Week's Key Decisions & Four-Lens Impact** - Decision 1: Sent price increase letters to first 100 service agreement customers (cohort A) → Blended View Impact: +$112,000 (proportional — 100 of 412 contracts) - Decision 2: Promoted lead tech to "field supervisor" role with dispatching authority → Blended View Impact: +$45,000 (estimated from reduced owner hours) 2. **Current Four Lenses** L1: $2,165,000 L2: $1,665,000 L3: $2,700,000 Blended: $2,076,000 3. **Divergence Check** Biggest gap: Lens 3 ($2.70M) vs. Lens 1 ($2.17M) — $535k gap → Action: Continue building recurring revenue to lift Lens 1 toward Lens 3 4. **Next Week Focus** Send price increase letters to remaining 312 contracts (cohorts B and C). Begin drafting SOP #1 (emergency AC repair protocol) with operations manager. --- [Return to ](#toc) # The Living Valuations Workbook — Completed for Coastal Supplies Co **Case Study:** Sandra, Florida Gulf Coast distribution owner **Industry:** Wholesale Distribution (Marine & Coastal Products) **Revenue:** $6,700,000 | **EBITDA:** $1,150,000 | **Net Income:** $540,000 --- # Coastal Supplies Co — Financial Reference - **Case study character:** Sandra, Florida Gulf Coast distribution owner - **Book chapters:** 3, 4, 5, 7, 9, 11, 12 - **App industry:** Wholesale Distribution - **Location:** Gulf Coast Florida, serving five coastal counties - **Years in operation:** 11 years - **Employees:** 8 warehouse/logistics staff, 6 outside sales, 5 office/admin, 2 managers - **Fleet:** 5 delivery trucks, 2 sales vehicles - **Revenue mix:** Commercial contractors & marinas 55% ($3,685,000), wholesale resellers 30% ($2,010,000), direct consumer/retail 15% ($1,005,000) --- ## Profit & Loss Statement (Trailing 12 Months) | Line Item | Amount | % of Revenue | Notes | |---|---:|---:|---| | **Revenue** | $6,700,000 | 100.0% | | | Cost of Goods Sold | ($4,800,000) | 71.6% | Product cost 62%, inbound freight 5%, direct labor 4.6% | | **Gross Profit** | $1,900,000 | 28.4% | | | Operating Expenses | ($750,000) | 11.2% | Includes $160k owner salary | | **EBITDA** | $1,150,000 | 17.2% | | | Depreciation | ($205,000) | 3.1% | Warehouse equipment $110k, trucks $75k, fixtures $20k | | Amortization | ($35,000) | 0.5% | | | **EBIT (Operating Income)** | $910,000 | 13.6% | | | Interest Expense | ($115,000) | 1.7% | Blended rate on $3.5M debt (LTD incl. real estate) | | **Earnings Before Tax** | $795,000 | 11.9% | | | Income Taxes | ($255,000) | 3.8% | 24% effective rate on EBIT (used for NOPAT) | | **Net Income** | $540,000 | 8.1% | | **NOPAT:** $910,000 × (1 − 0.24) = **$691,600** (as provided; 24% tax rate on EBIT) --- ## Balance Sheet (End of Period) | Line Item | Amount | Notes | |---|---:|---| | **Assets** | | | | Cash and Equivalents | $1,250,000 | | | Accounts Receivable & Other Current | $330,000 | ~18 days outstanding | | **Total Current Assets** | $1,580,000 | | | Property, Plant & Equipment (net) | $4,800,000 | Warehouse/real estate, equipment, fleet | | Other Non-Current Assets | $700,000 | Deposits, right-of-use assets, intangibles | | **Total Non-Current Assets** | $5,500,000 | | | **Total Assets** | $7,080,000 | | | | | | | **Liabilities** | | | | Accounts Payable & Accrued Expenses | $350,000 | | | Current Portion of Long-Term Debt | $100,000 | | | **Total Current Liabilities** | $450,000 | | | Long-Term Debt | $3,500,000 | Real estate mortgage $2.1M + equipment $1.4M | | Other Non-Current Liabilities | $250,000 | Deferred revenue, lease obligations | | **Total Non-Current Liabilities** | $3,750,000 | | | **Total Liabilities** | $4,200,000 | | | | | | | **Total Equity** | $2,880,000 | | --- ## Cash Flow / Capital Expenditures | Item | Amount | |---|---:| | Capital Expenditures | $350,000 | | Free Cash Flow from Operations | $550,000 | | Working Capital | $1,130,000 | --- ## Derived Valuation Inputs ### FCFF (Free Cash Flow to the Firm) | Step | Calculation | Amount | |---|---|---:| | EBIT | Revenue − COGS − OpEx − D&A | $910,000 | | NOPAT | EBIT × (1 − 24% tax rate) | $691,600 | | + Depreciation & Amortization | Add back non-cash ($205k + $35k) | $240,000 | | − Capital Expenditures | | ($350,000) | | − Change in Working Capital | ~$32k increase in WC year-over-year | ($31,600) | | **= FCFF** | | **$550,000** | Note: Matches the provided Free Cash Flow from Operations of $550,000. ### FCFE (Free Cash Flow to Equity) | Step | Amount | |---|---:| | Net Income | $540,000 | | + Depreciation & Amortization | $240,000 | | − Capital Expenditures | ($350,000) | | − Change in Working Capital | ($31,600) | | + Net Borrowing (Assume zero for baseline) | $0 | | **= FCFE** | **$398,400** | ### Key Ratios | Metric | Value | |---|---| | Working Capital | $1,130,000 | | Total Interest-Bearing Debt | $3,600,000 (LTD $3.5M + current portion $100k) | | Net Debt (Interest-Bearing Debt − Cash) | $2,350,000 | | Debt-to-Equity | 1.46x | | Gross Margin | 28.4% | | EBITDA Margin | 17.2% | | Net Margin | 8.1% | --- ## Book Valuation Targets ### Assumptions - WACC: 13% (distribution company, high leverage, real estate-backed — see Worksheet 3) - Explicit growth: 5% for 5 years - Terminal growth: 2.5% - Illiquidity: 20% (revenue bracket $5–10M) - Industry EV/EBITDA multiple: 5.2x (wholesale distribution, SMB) - Net Debt used in Lens 2 bridge: $2,350,000 ### Baseline Valuation | Step | Calculation | Value | |---|---|---:| | PV of CY1–CY5 FCFF | $550k growing at 5%, discounted at 13% | $2,218,000 | | Terminal Value | $702k × 1.025 / (0.13 − 0.025) = $6,852k | $6,852,000 | | PV of Terminal Value | $6,852k / 1.13^5 | $3,719,000 | | **Enterprise Value (pre-illiquidity)** | | **$5,937,000** | | Less: Illiquidity Discount (20%) | | ($1,187,000) | | **Lens 1: Cash Flow to the Business** | | **$4,750,000** | | Less: Net Debt | | ($2,350,000) | | **Lens 2: Cash Flow to the Owner** | | **$2,400,000** | | **Lens 3: What Buyers Will Pay** | EBITDA $1,150k × 5.2x | **$5,980,000** | | **Lens 4: Blended View** | 40% L1 + 40% L2 + 20% L3 | **$4,056,000** | Blended math: (40% × $4,750k) + (40% × $2,400k) + (20% × $5,980k) = $1,900k + $960k + $1,196k = **$4,056k** ### After 4.5% Price Increase on Specialty Coastal Products Specialty/premium products represent 35% of revenue ($2,345,000). A 4.5% increase adds $106,000 in revenue with ~70% flow-through to FCFF (distribution: minimal incremental variable cost on existing SKUs). | Change | Impact | |---|---| | Revenue increase | +$106,000 (4.5% × $2,345,000) | | FCFF increase (70% flow-through) | +$74,000 | | New FCFF | ~$624,000 | | New Lens 1 (Cash Flow to the Business) | ~$5,390,000 | | New Lens 2 (Cash Flow to the Owner) | ~$3,040,000 | | New Lens 3 (EBITDA $1,224k × 5.2x) | ~$6,365,000 | | New Blended View | ~$4,645,000 | | **Value Created (Lens 1)** | **+$640,000** | | **Value Created (Lens 2)** | **+$640,000** | --- ## Xit Matters Loading Instructions 1. Select industry: **Wholesale Distribution** 2. Enter P&L values from the table above (7 user-entered fields) 3. Enter Balance Sheet values (8 user-entered fields) 4. Growth sliders: Revenue 5%, COGS 5%, OpEx 3% 5. The app will calculate EBITDA ($1,150k), FCFF, FCFE, and all four valuation lenses 6. To reproduce the "after price increase" scenario: adjust Revenue slider to reflect the $106k increase impact on FCFF --- ## Worksheet 1: FCFF Calculation (Lens 1 Starting Point) **Date:** January 2026 **Company:** Coastal Supplies Co | Line Item | Your Number | Notes | |---|---:|---| | Revenue | $6,700,000 | Last 12 months | | − Cost of Goods Sold | ($4,800,000) | Product cost 62%, inbound freight 5%, direct labor 4.6% | | − Operating Expenses | ($750,000) | Includes $160k owner salary | | **= EBITDA** | **$1,150,000** | Revenue − COGS − OpEx | | − Depreciation | ($205,000) | Warehouse equipment $110k, trucks $75k, fixtures $20k | | − Amortization | ($35,000) | | | **= EBIT** | **$910,000** | | | × (1 − Tax Rate 24%) | | Income Taxes ÷ EBIT = $218,400 ÷ $910,000 | | **= NOPAT** | **$691,600** | EBIT × (1 − 0.24) | | + Depreciation & Amortization | $240,000 | Add back non-cash ($205k + $35k) | | − Capital Expenditures | ($350,000) | Equipment refresh and fleet vehicle replacement | | − Change in Working Capital | ($31,600) | ~$32k increase year-over-year as revenue grew | | **= Free Cash Flow to the Firm (FCFF)** | **$550,000** | Matches provided FCF from Operations | **Note:** The tax rate applied to EBIT for NOPAT (24%) differs from the effective book tax rate on EBT (32%). This is intentional — NOPAT strips out the interest tax shield to measure the unlevered operating cash return. The 24% rate is applied to EBIT as the effective marginal rate on operating income. --- ## Worksheet 2: FCFE Calculation (Lens 2 Starting Point) **Date:** January 2026 | Line Item | Your Number | Notes | |---|---:|---| | Net Income | $540,000 | From P&L | | + Depreciation & Amortization | $240,000 | Add back non-cash | | − Capital Expenditures | ($350,000) | | | − Change in Working Capital | ($31,600) | Consistent with FCFF calculation | | + Net Borrowing | $0 | No new debt issued; no material repayment in period | | **= Free Cash Flow to Equity (FCFE)** | **$398,400** | | **Sanity Check:** Lens 1 (FCFF DCF) minus Net Debt should approximately equal Lens 2 (FCFE DCF). | Check | Amount | |---|---:| | Lens 1 (Enterprise Value after illiquidity) | $4,750,000 | | − Net Debt (interest-bearing debt − cash) | ($2,350,000) | | **= Implied Equity Value** | **$2,400,000** | | Lens 2 (from FCFE DCF) | ~$2,400,000 | | **Difference** | ~$0 | Difference is under 2%. The equity bridge reconciles cleanly — a strong signal the FCFF and FCFE are internally consistent. --- ## Worksheet 3: Discount Rate Estimation **Your WACC (Weighted Average Cost of Capital)** | Component | Value | Notes | |---|---:|---| | Risk-Free Rate | 4.2% | US 10-year Treasury (2026) | | + Equity Risk Premium | 5.6% | Market consensus | | × Beta (industry risk) | 0.92x | Wholesale distribution sector | | **= Base Cost of Equity** | 9.4% | 4.2% + (5.6% × 0.92) | | + Size Premium | 3.5% | Revenue $5–10M bracket | | + Company-Specific Risk | 5.1% | High leverage, seasonal coastal demand, weather exposure, moderate owner dependence | | **= Adjusted Cost of Equity** | **18.0%** | | | Debt Inputs | Value | |---|---:| | Total Interest-Bearing Debt | $3,600,000 (LTD $3.5M + current portion $100k) | | Total Equity (Assets − Liabilities) | $2,880,000 | | Debt Weight (target structure) | 40% | | Equity Weight (target structure) | 60% | | Interest Rate on Debt | 6.5% (market rate; current blended rate understates due to legacy low-rate real estate debt) | | × (1 − Tax Rate) = **After-Tax Cost of Debt** | 4.94% | **Note on weights:** Using a target capital structure of 40% debt / 60% equity rather than current book weights (55% / 45%). The current high leverage reflects a strategic real estate purchase — a deliberate long-term asset, not a signal of permanent leverage. Target structure reflects where the business is headed as the mortgage amortizes. **WACC = (Equity Weight × Cost of Equity) + (Debt Weight × After-Tax Cost of Debt)** = (60% × 18.0%) + (40% × 4.94%) = 10.80% + 1.98% **Your WACC:** **~13%** **Quick Sanity Check:** - Under 10%? ❌ - Over 20%? ❌ - 10–16%? ✅ Coastal Supplies Co's 13% is in the appropriate range for a well-run distribution company with significant real estate debt, strong asset coverage, and moderate owner dependence. --- ## Worksheet 4: Four-Lens Summary ### Baseline (Before Price Increase) **Date:** January 2026 | Lens | Value | Key Input | |---|---:|---| | 1. Cash Flow to the Business | $4,750,000 | FCFF $550k, WACC 13%, Growth 5%/2.5%, Illiquidity 20% | | 2. Cash Flow to the Owner | $2,400,000 | Lens 1 minus $2,350k net debt | | 3. What Buyers Will Pay | $5,980,000 | EBITDA $1,150k × 5.2x multiple | | 4. Blended View (day-to-day) | $4,056,000 | 40% L1 + 40% L2 + 20% L3 | **Blended View math:** (40% × $4,750k) + (40% × $2,400k) + (20% × $5,980k) = $1,900k + $960k + $1,196k = **$4,056k** **Divergence Check:** Lens 3 ($5,980k) is $1,230k above Lens 1 ($4,750k) — a 26% premium. This is a positive divergence. The market is valuing Coastal Supplies Co's physical asset base and reliable commercial account relationships higher than a pure cash flow model suggests. Buyers are paying for the warehouse real estate and the predictable contractor customer base, not just the FCFF. **What it means for Sandra:** The 5.2x EBITDA multiple reflects the market's appetite for asset-backed distribution businesses with commercial client concentration. If Sandra can reduce the net debt burden — accelerating the mortgage paydown or refinancing at lower rates — the gap between Lens 2 and Lens 3 closes fast. **My #1 action to close the Lens 1 / Lens 3 gap:** Raise prices on specialty/premium SKUs where Coastal Supplies has limited direct competition. Even a 4–5% increase on high-margin coastal product lines flows almost entirely to FCFF and lifts Lens 1 toward the market's view. --- ### After 4.5% Price Increase on Specialty Coastal Products **Date:** April 2026 | Lens | Value | Key Input | |---|---:|---| | 1. Cash Flow to the Business | $5,390,000 | FCFF ~$624k, WACC 13%, Growth 5%/2.5%, Illiquidity 20% | | 2. Cash Flow to the Owner | $3,040,000 | Lens 1 minus $2,350k net debt | | 3. What Buyers Will Pay | $6,365,000 | EBITDA ~$1,224k × 5.2x multiple | | 4. Blended View (day-to-day) | $4,645,000 | 40% L1 + 40% L2 + 20% L3 | **Blended View math:** (40% × $5,390k) + (40% × $3,040k) + (20% × $6,365k) = $2,156k + $1,216k + $1,273k = **$4,645k** **Value Created by Price Increase:** | Lens | Before | After | Change | |---|---:|---:|---:| | 1. Cash Flow to the Business | $4,750,000 | $5,390,000 | **+$640,000** | | 2. Cash Flow to the Owner | $2,400,000 | $3,040,000 | **+$640,000** | | 3. What Buyers Will Pay | $5,980,000 | $6,365,000 | **+$385,000** | | 4. Blended View | $4,056,000 | $4,645,000 | **+$589,000** | A 4.5% price increase on 35% of revenue — the specialty coastal product segment where Coastal Supplies holds the strongest competitive position — created $640,000 in enterprise value and $589,000 in blended value. No additional headcount. No capital outlay. The price increase works because specialty coastal SKUs have limited local substitutes, and Sandra's commercial accounts prioritize reliability over price on these lines. --- ## Worksheet 5: Buyer Appeal Checklist **Date:** January 2026 (Baseline) | Factor | Current Score (1–10) | Target (90 days) | Which Force? | Next Action | |---|---|---|---|---| | Recurring revenue ≥ 50% | 4 | 6 | Risk Reduction | Convert top 20 commercial accounts to annual supply agreements with locked pricing | | Owner dependence (<15 hrs/week) | 5 | 7 | Owner Independence | Empower operations manager to handle vendor negotiations and daily order fulfillment without Sandra | | All core processes documented | 3 | 6 | Owner Independence | Document the top 10 fulfillment, receiving, and client reorder procedures | | No single customer >12% of revenue | 6 | 7 | Risk Reduction | Current top customer is ~14% — develop two new commercial accounts to dilute concentration | | Clean, buyer-ready financials | 6 | 8 | Risk Reduction | Financials are solid; separate owner compensation cleanly from operating expenses | | Documented growth pipeline | 4 | 6 | Growth Visibility | Map two adjacent coastal counties as expansion markets with addressable volume | | Strong team / low key-person risk | 5 | 7 | Owner Independence | Cross-train warehouse supervisor and senior sales rep; document customer relationships | | Low CapEx requirements for growth | 5 | 6 | Capital Efficiency | Existing warehouse has capacity for 25% volume growth; no near-term facility CapEx needed | **Total Score:** 38 / 80 **My Top 3 Improvements for the Next 90 Days** 1. Implement the 4.5% price increase on specialty coastal product lines — directly lifts FCFF by ~$74k/year and Lens 1 by $640k with zero capital outlay 2. Convert top 20 commercial accounts to annual supply agreements — shifts revenue from transactional to recurring, expands the EBITDA multiple, and reduces buyer risk perception 3. Document the top 10 fulfillment and reorder workflows with the operations manager — reduces owner dependence (Force 2) and is the single biggest gap holding the Buyer Appeal score below 50 --- ## Worksheet 6: Valuation Decision Journal **Decision:** Raise prices 4.5% on specialty coastal product categories **Date:** February 2026 **Options Being Considered** 1. Raise specialty product prices 4.5% ($106k additional revenue) 2. Add a sales rep and territory vehicle to pursue two new coastal counties ($135k all-in cost) 3. Do nothing — maintain status quo through peak season **Estimated Impact on Four Lenses** | Impact | Option 1: Price Increase | Option 2: Add Sales Rep | Option 3: Status Quo | |---|---|---|---| | Annual FCFF Change | +$74,000 | +$38,000 (net of $135k cost + 9-month ramp) | $0 | | Lens 1 Change | +$640,000 | +$328,000 | $0 | | Lens 2 Change | +$640,000 | +$328,000 | $0 | | Lens 3 Multiple Change | +0.5x (pricing power on specialty lines signals defensibility) | +0.2x (growth but higher complexity and ramp risk) | 0x | | Lens 3 Value Change | +$578,000 | +$292,000 | $0 | | Blended View Change | +$589,000 | +$305,000 | $0 | **Decision I Made:** Option 1 — Raise specialty product prices 4.5% **Why (based on the four lenses):** Option 1 creates $640k in enterprise value with no capital outlay, no hiring risk, and no ramp time. The specialty coastal product segment — marine hardware, weatherproofing systems, coastal construction materials — is one Sandra sources from suppliers with long lead times, giving her a natural pricing moat. These aren't commodity SKUs that commercial accounts cross-shop on price. Option 2 is a strong long-term move, but the 9-month ramp to profitability and the execution risk of a new territory don't compete with the immediate, high-certainty payoff of Option 1. Option 3 leaves $640k on the table and lets inflation erode margins silently. **Date to Re-Measure:** May 2026 (90 days post-implementation) **Actual Results (fill in later):** - Customer pushback on price increase: 2 of 47 specialty accounts requested a hold; 1 reduced order volume temporarily - Net FCFF improvement: $72k/year (slightly below $74k target — one account reduction) - Lens 1 moved from $4.75M to $5.37M (+$620k) — within 3% of model - Three commercial accounts mentioned the increase confirmed Coastal Supplies' premium positioning; none moved to competitors --- ## Worksheet 7: Hold vs. Sell Analysis **Date:** January 2026 (Baseline) ### Sell Scenario | Item | Amount | |---|---:| | Lens 3 (Market Value) | $5,980,000 | | − Illiquidity Discount (20%) | ($1,196,000) | | − Capital Gains Tax (20%) | ($956,800) | | **= Net Sale Proceeds** | **$3,827,200** | | × Compounded at 8% for 5 years | × 1.469 | | **= Sell & Invest Value** | **$5,622,000** | ### Hold Scenario | Year | Annual FCFE | Cumulative | |---|---:|---:| | Year 1 | $398,400 | $398,400 | | Year 2 | $418,320 | $816,720 | | Year 3 | $439,236 | $1,255,956 | | Year 4 | $461,198 | $1,717,154 | | Year 5 | $484,258 | $2,201,412 | | **Cumulative Cash Flow** | | **$2,201,000** | | + Future Business Value at Year 5 | | $9,102,000 | | **= Hold Value** | | **$11,303,000** | **Business Value at Year 5 calculation:** - EBITDA today: $1,150,000 - EBITDA at Year 5 (5% growth): $1,150,000 × 1.05^5 = ~$1,468,000 - Conservative multiple at Year 5: 6.2x (improvement from 5.2x as Sandra builds annual supply agreements, reduces owner dependence, and mortgage amortizes) - Year 5 Lens 3: $1,468,000 × 6.2x = ~$9,102,000 ### Wealth Advantage | | Amount | |---|---:| | Hold Value | $11,303,000 | | − Sell & Invest Value | ($5,622,000) | | **= Wealth Advantage** | **+$5,681,000** | **Verdict:** **HOLD** — decisively. Selling today nets Sandra $3.83M after taxes, which compounds to $5.62M over five years in a passive 8% portfolio. Holding delivers $11.3M — $5.68M more. Every year Sandra holds and executes, the gap grows. The real estate component of the business (estimated $2.1M mortgage against likely $3.5M+ market value) is an often-overlooked wealth multiplier. Selling the business without the real estate, or selling the whole package at a premium to a strategic buyer, are both options worth modelling in year 4 or 5. **What to watch:** The biggest risk to the Hold scenario is debt service. With $3.5M in LTD, any revenue disruption (major hurricane damage, supply chain disruption) compresses FCFE quickly. The $1.25M cash reserve is strong protection — Sandra has over 2 years of debt service in cash. --- ## Worksheet 8: 90-Day Value Acceleration Plan **My Goal Date:** April 30, 2026 **Primary Goal:** Increase Lens 1 by $640k+ through specialty pricing and begin converting commercial accounts to annual supply agreements **Key Initiatives (connect each to a Force from Chapter 5)** 1. Implement 4.5% price increase on specialty coastal product lines → Force: **Risk Reduction** (pricing power on hard-to-substitute SKUs demonstrates competitive defensibility and supports multiple expansion) 2. Convert top 20 commercial accounts to annual supply agreements with locked pricing → Force: **Risk Reduction** (recurring revenue reduces buyer risk perception and directly expands the EBITDA multiple) 3. Document top 10 fulfillment, receiving, and client reorder procedures with operations manager → Force: **Owner Independence** (warehouse and sales ops can run without Sandra; reduces the single biggest buyer objection in due diligence) **Expected Impact** - Lens 1 Target: $5,390,000 (from $4,750,000 — +$640k) - Lens 2 Target: $3,040,000 (from $2,400,000 — +$640k) - Lens 3 Target: $6,365,000 (from $5,980,000 — +$385k from EBITDA growth; multiple expansion comes later as recurring revenue builds) - Blended View Target: $4,645,000 (from $4,056,000 — +$589k) **Milestones** - End of Month 1: Price increase letters sent to all specialty account customers; top 20 commercial accounts contacted about annual supply agreements; SOP drafting begun for receiving and fulfillment - End of Month 2: Price increase fully active; first 8 annual supply agreements signed; operations manager handling 80% of vendor calls and daily order approvals independently; 5 core SOPs completed - End of Month 3: Full 90-day price increase data collected (target: <5% account attrition on specialty lines); 15+ annual supply agreements signed; all core SOPs documented and in shared drive; Lens 1 and Lens 2 re-calculated to confirm $640k value creation --- ## Weekly Review Template — Sample Week 1 **Week of:** February 3, 2026 1. **This Week's Key Decisions & Four-Lens Impact** - Decision 1: Notified all specialty coastal product accounts of the 4.5% price increase effective March 1 → Blended View Impact: +$589,000 (full impact when implemented; currently $0 until March 1) - Decision 2: Personally called the top 5 commercial accounts to walk them through the pricing rationale before the letter arrived → Blended View Impact: ~+$85,000 (estimated from customer retention protection — these 5 accounts = 22% of specialty revenue) 2. **Current Four Lenses** L1: $4,750,000 L2: $2,400,000 L3: $5,980,000 Blended: $4,056,000 3. **Divergence Check** Biggest gap: Lens 3 ($5,980k) vs. Lens 2 ($2,400k) — $3,580k gap → The net debt load ($2,350k) accounts for $2,350k of this gap. The remaining $1,230k Lens 3 / Lens 1 divergence reflects the market's asset and relationship premium. Action: accelerate annual supply agreement conversions to close the Lens 1 / Lens 3 gap by lifting the FCFF and expanding the multiple. 4. **Next Week Focus** Follow up with top 5 accounts on annual supply agreement proposals. Begin SOP #1 (standard receiving and inventory intake procedure) with warehouse supervisor. Pull list of all specialty SKUs to confirm 4.5% increase applies consistently across the full category. --- [Return to TOC](#toc) ### Appendix: The Math Behind the Lenses You don't need this appendix to use the four-lens framework. Everything in the main chapters gives you enough to calculate, compare, and make smarter decisions. But if you want to understand exactly what's happening under the hood — or if your CPA, financial advisor, or a prospective buyer asks how you arrived at your numbers — this is your reference. #### 1. Free Cash Flow to the Firm (FCFF) FCFF is the cash generated by the business for ALL stakeholders — equity holders, debt holders, and the tax man. **Formula:** FCFF = NOPAT + D&A − CapEx − ΔWC Where: - **NOPAT** (Net Operating Profit After Tax) = EBIT × (1 − tax rate) - **EBIT** = Revenue − COGS − Operating Expenses − Depreciation − Amortization - **D&A** = Depreciation + Amortization (added back because they're non-cash charges) - **CapEx** = Capital Expenditures (cash spent on equipment, vehicles, facilities) - **ΔWC** = Change in Working Capital = (Current Assets − Current Liabilities) this year minus last year **Why NOPAT, not Net Income?** Because NOPAT removes the effect of how the business is financed (interest expense). FCFF measures the cash the *operations* generate, regardless of whether you have debt or not. #### 2. Free Cash Flow to Equity (FCFE) FCFE is the cash available to the OWNER after all obligations are met. There are two mathematically equivalent ways to calculate FCFE. Both arrive at the same destination — what's left for the equity holder — but they take different routes. **Method A: The Owner's Method (used throughout this book)** FCFE = Net Income + D&A − CapEx − ΔWC + Net Borrowing Where: - **Net Income** = Revenue − all expenses including interest and taxes - **D&A** = Depreciation + Amortization (non-cash charges added back) - **CapEx** = Capital Expenditures - **ΔWC** = Change in Working Capital - **Net Borrowing** = New debt issued − debt repaid during the period **Why this works:** You start with what the owner actually earns (net income already subtracts interest), add back non-cash charges, subtract reinvestment, and adjust for the fact that borrowing puts cash in the owner's pocket today (even though it creates future obligations). This is the most intuitive method — every term maps directly to something you can see on your financial statements. **80/20 Shortcut:** For most SMBs with stable or declining debt, Net Borrowing is zero or slightly negative. If that's your situation, simplify to: FCFE ≈ Net Income + D&A − CapEx − ΔWC. **Method B: The Capital Structure Adjusted Method (used by the XIT engine)** FCFE = Net Income − (1 − δ) × (CapEx − Depreciation) − (1 − δ) × ΔWC Where: - **δ** (delta) = Debt / (Debt + Equity) — the proportion of the business funded by debt - **(1 − δ)** = the equity fraction of total capital **Why this works:** Instead of explicitly tracking net borrowing, this method recognizes that only the *equity portion* of reinvestment (CapEx and working capital) comes out of equity holders' pockets. The debt-funded portion is implicitly accounted for through the δ adjustment. When the company reinvests $100K and 30% is debt-funded, only $70K (the equity fraction) reduces FCFE. **When do the two methods differ?** They are mathematically equivalent when debt-to-equity ratios are stable and balance sheet ratios track consistently with growth. In practice, small rounding differences can appear because Method A uses actual borrowing flows while Method B uses the capital structure ratio. For most SMBs, the difference is well within the 80/20 accuracy threshold. **Which should you use?** - **Method A** if you're doing quick pen-and-paper analysis, explaining your valuation to a non-financial buyer, or when your debt changes are lumpy (e.g., took a big loan this year, paying it off next year) - **Method B** when projecting FCFE over 5–10 years where the capital structure ratio is more stable than individual borrowing decisions — this is why the XIT engine uses it for multi-year DCF projections **Important — Discount Rate:** Regardless of which method you use, FCFE must be discounted at the **cost of equity** (Re), NOT at WACC. Equity cash flows carry more risk than firm-level flows (equity holders get paid last). Using WACC to discount FCFE would overstate your Lens 2 value. For Mike, his WACC was ~12–14% but his cost of equity was ~18% — a significant difference that compounds over a 5-year projection plus terminal value. #### 3. Discounted Cash Flow (DCF) Both FCFF and FCFE are projected forward and discounted back to today. **Formula (for each projected year):** Present Value = Future Cash Flow ÷ (1 + discount rate)^year **Example:** $340,000 in Year 1, discounted at 15%: PV = $340,000 ÷ 1.15 = $295,652 For a 5-year projection, you sum the present values of all five years plus the present value of the terminal value. #### 4. Terminal Value (Gordon Growth Model) Terminal value captures the value of all cash flows beyond the explicit forecast period, assuming the business grows at a stable rate forever. **Formula:** TV = Last Year's FCF × (1 + g) ÷ (r − g) Where: - **g** = long-term growth rate (typically 2–3%, roughly matching GDP growth) - **r** = discount rate (WACC for FCFF, cost of equity for FCFE) **Critical constraint:** g must ALWAYS be less than r. If g ≥ r, the formula produces infinity — which means your growth assumption is unrealistic. **Present Value of Terminal Value:** PV of TV = TV ÷ (1 + r)^n Where n = number of years in the explicit forecast period. **Important:** Terminal value typically represents 55–75% of total Enterprise Value for SMBs. This means your assumptions about long-term growth and discount rate have enormous impact on the final number. Always use conservative estimates. #### 5. Weighted Average Cost of Capital (WACC) WACC blends the cost of equity and the cost of debt, weighted by how much of each the company uses. **Formula:** WACC = (E / V) × Re + (D / V) × Rd × (1 − T) Where: - **E** = market value of equity - **D** = market value of debt - **V** = E + D (total capital) - **Re** = cost of equity - **Rd** = cost of debt (interest rate) - **T** = marginal tax rate **Cost of Equity (CAPM):** Re = Rf + β × ERP + Size Premium Where: - **Rf** = risk-free rate (~4.2% — US 10-year Treasury) - **β** (beta) = measure of industry risk relative to the overall market (1.0 = average) - **ERP** = equity risk premium (~5.6% — the extra return investors demand for stocks over bonds) - **Size Premium** = additional risk premium for small companies (2–5% for most SMBs) **After-Tax Cost of Debt:** Rd(after-tax) = Interest Rate × (1 − Tax Rate) **Why after-tax?** Because interest expense is tax-deductible, making debt cheaper than it appears on the surface. **Typical WACC ranges for private SMBs:** - Low risk (recurring revenue, low debt, diversified): 11–13% - Moderate risk (mixed revenue, moderate debt): 13–16% - High risk (project-based, concentrated customers, heavy debt): 16–20% #### 6. Illiquidity Discount Private businesses cannot be sold as quickly or easily as public stocks. This illiquidity reduces their value relative to the theoretical DCF calculation. **Revenue-based brackets (typical for US private companies):** | Annual Revenue | Discount Range | |---|---| | Under $1M | 30–35% | | $1M – $5M | 25–28% | | $5M – $10M | 20–22% | | $10M – $25M | 15–18% | | $25M+ | 12–15% | **Application:** Lens 1 (after illiquidity) = Enterprise Value (DCF) × (1 − illiquidity discount %) The illiquidity discount is applied to the enterprise value from the DCF, BEFORE subtracting net debt to arrive at equity value. #### 7. EV/EBITDA Multiple Decomposition (The Four Forces) Chapter 6 introduced the Four Forces that drive your multiple. Here is the mathematical framework behind them. A company's "fair" EV/EBITDA multiple can be decomposed into four components: **Multiple = Main + Tax Shield − CapEx Drag − Working Capital Drag** Where: **Main Component** = (1 − tax rate) ÷ (cost of capital − growth rate) This is the primary driver. Lower cost of capital or higher growth rate = higher multiple. **Tax Shield** = (depreciation ÷ EBITDA) × (tax rate ÷ (cost of capital − growth rate)) Capital-intensive businesses with significant depreciation get a modest uplift from tax savings. **CapEx Drag** = max(0, (CapEx − depreciation) ÷ EBITDA) ÷ (cost of capital − growth rate) If you spend more on CapEx than you depreciate, you're reinvesting above replacement — and buyers discount for that. **Working Capital Drag** = max(0, ΔWC ÷ EBITDA) ÷ (cost of capital − growth rate) Businesses that tie up increasing cash in receivables or inventory get penalized. **Example — Tony's Pizza (Before):** - Tax rate: 20%, Cost of capital: 18%, Growth: 3% - Main: (1 − 0.20) ÷ (0.18 − 0.03) = 0.80 ÷ 0.15 = 5.33 - CapEx and WC drag reduce this to ~4.2x - After improvements (lower risk → lower CoC at 13%, higher growth at 6%): - Main: 0.80 ÷ (0.13 − 0.06) = 0.80 ÷ 0.07 = 11.4 - After drags: ~6.8x This is why seemingly small changes in risk profile and growth rate produce dramatic swings in multiples. #### 8. Current vs. Forward Relative Valuation Lens 3 uses a blend of current and forward EBITDA: **Current Market Value** = Current EBITDA × Multiple **Forward Market Value** = Projected Year 5 EBITDA × Multiple **Blended Market Value** = (Current × Weight) + (Forward × Weight) Typical weighting: 50% current / 50% forward. Growth businesses may weight forward more heavily (40/60). Mature businesses may weight current more heavily (60/40). #### 9. The Blended View Calculation Lens 4 = (Weight₁ × Lens 1) + (Weight₂ × Lens 2) + (Weight₃ × Lens 3) Weights depend on context and must sum to 100%. **Recommended starting weights:** - Day-to-day operations: 40 / 40 / 20 - Preparing to sell: 20 / 20 / 60 - Raising capital: 25 / 50 / 25 - Family succession: 35 / 45 / 20 #### 10. Hold vs. Sell Analysis **Hold Value** = Σ(FCFE year 1 through N) + Business Value at Year N Where FCFE grows at the expected growth rate each year, and the business value at Year N is estimated using the Blended View grown at the same rate. **Sell & Invest Value** = Net Sale Proceeds × (1 + market return)^N Where Net Sale Proceeds = Market Value × (1 − illiquidity discount) × (1 − capital gains tax rate) **Wealth Advantage** = Hold Value − Sell & Invest Value A positive Wealth Advantage means holding the business creates more wealth. A negative Wealth Advantage means selling and investing the proceeds is the better financial path. --- [Return to TOC](#toc) #### Resources & Next Steps Congratulations. You now have everything you need to manage your business by value instead of just profit. The framework is simple, the math is straightforward, and the results are real. Here are a few resources to help you keep the momentum going: **Printable Tools** - The complete 30-Day Valuation-as-Management Playbook & Worksheets (in this book) - Blank Valuation Decision Journal pages (print as many as you need) **Quick-Start Calculator** A simple spreadsheet to run your four lenses without any fancy software. Download at the Resources section of our website. **Living Valuation Tool** We built Xit Matters to automate everything you just learned — all four lenses, the Blended View, sensitivity analysis, and the divergence diagnostics — in real time, connected to your actual financial data. You can run a free basic valuation at xitmatters.io. **Data Sources for Your Inputs** *Industry Multiples* - **BizBuySell Insight Report** (bizbuysell.com/research) — Quarterly transaction data on small business sales, including median revenue and EBITDA multiples by industry. Free. Updated quarterly. Use this to benchmark your Lens 3 multiple against actual closed transactions in your sector. - **Pratt's Stats / DealStats** (businessvaluation.net) — More granular private-company transaction database used by professional appraisers. Subscription-based; your CPA or business broker may have access. Useful if you want to verify your multiple against a deeper dataset. *Discount Rate Inputs* - **Damodaran Online** (pages.stern.nyu.edu/~adamodar) — Professor Aswath Damodaran at NYU Stern publishes free annual datasets on equity risk premiums, industry betas, and cost of capital by sector. Updated every January. When building your WACC in Worksheet 3, use his industry beta tables as your starting point — search for your sector (e.g., "Restaurants," "Building Products") and pull the unlevered beta. *Financing* - **SBA Lender Match** (lendermatch.sba.gov) — Free tool that connects small business owners with SBA-approved lenders. Relevant when you're modeling debt vs. equity scenarios in Lens 2. SBA 7(a) loans (up to $5M) and SBA 504 loans (equipment and real estate) are the most common instruments for the businesses in this book. *Professional Appraisers* - **NACVA** (nacva.com) — National Association of Certified Valuators and Analysts. Use their directory to find a Certified Valuation Analyst (CVA) if you need a formal appraisal for legal, tax, or transaction purposes. Many owners tell me they run their numbers once a month, watch how decisions move the four lenses, and never go back to profit-only management. If this book helped you see your business differently, I'd love to hear about it. Drop me a note on X (@jamescwaters) or reply to any of my posts with "LIVING VALUATIONS". I read every one. Your business is worth more than a number. Now you know exactly how to prove it. — James Waters Founder, Xit Matters