Mike Michalowicz - Using Profit First to Increase Business Value
In the business world, it is common knowledge that Revenue less Expenses equals Profit. Ed had the opportunity to sit with Mike Michalowicz, author of Profit First. Mike explains a system of Profit First where Revenue less Profit equals Expenses. This system does not only increases business value from an earning standpoint but also forces business owners to look at their operating expenses in a way that they hadn’t ever before.
In this episode, Mike and Ed covered why business owners should take profit first, why carrying the business on their backs is a risky strategy, and why they should stop calling themselves “entrepreneurs”.
1:35 – Who is Mike Michalowicz
5:03 – Mike’s Thoughts on Valuation
8:15 – Why Selling a Business in Desperate Mode Seldom Works
10:00 – Carrying The Business On Your Back – A Risky Strategy
11:53 – How To Transit From Owner to Investor
15:23 – Stop Calling Yourself ‘Entrepreneur’
18:46 – How To Deal With Fear
24:06 – Why Profit First
29:05 – Lifestyle or Legacy
31:25 – Fix This Next
34:35 – How To Work With Mike Michalowicz
36:20 – Mike’s Advice That Would Have The Most Immediate Impact on Business Value
Learn More From This Podcast
Who is Mike Michalowicz
Mike is the author of the books Clockwork, Profit First, Surge, The Pumpkin Plan, and The Toilet Paper Entrepreneur.
He is a former small business columnist for The Wall Street Journal. He is the “Business Rescue” segment host for MSNBC’s Your Business. He hosted a reality television program called Bailout!. And has appeared on CNBC’, NBC, MSNBC, Fox News, ABC News Now, CNBC’s On the Money and Pat Croce’s Down To Business.
He has lectured on entrepreneurship, sales and behavioral marketing techniques at universities, companies, and organizations. And he is the host of his own podcast The Entrepreneurship Elevated.
It was eleven years ago when Mike had an epiphany that even though he has built and sold a couple of companies, he knows nothing about entrepreneurship. When he looked back on the struggles he had, he was never profitable running those businesses. Those were brutal times tearing his hair out trying to cover payroll. And so he endeavored at that particular moment that he would understand what makes an entrepreneur successful and the journey simpler.
Mike created a system for himself and implemented it to his own businesses. Sure enough, he found a solution and tested it eleven years ago, and five years ago started writing it into a book. And that’s how he became an author. For the last 11 years, he has been a full-time author devoted to small business owners and entrepreneurs.
Mike’s Thoughts on Valuation
Mike thinks that the most valuable business in the world is one that you love so much you would never sell it.
If a business gives you joy and satisfaction, then that’s a very valuable business. If you want to have an extraordinary exit, create a business that is extraordinary for you that you love every component of it.
To explain further, Mike shared a story about a conference he joined 15 years ago. It was an invite-only gathering of successful and household businesses. When the speaker of that conference asked the audience if they have sold their business, about 20% of the hands went up. And that is the odd scenario. Most businesses will never sell.
According to Mike, we should not have this pipe dream that “if we build it they will come”. Instead, it should be “we should build it so we want to go there every single day.” If the inevitability comes that you had to cancel your business, and if that business was built around what brings you joy and cash, then you’re still golden. But to have a pipe dream that you can sell a business in desperate mode is super dangerous.
As Ed puts it, holding on to the business is an exit strategy. Build your business for yourself and somebody will view it as a valuable asset when you go to exit.
Why Selling a Business in Desperate Mode Seldom Works
There is only a 25-30% success rate of actually being able to sell a business. The overwhelming desire to sell a business often reverts to shortcuts and ignoring business fundamentals. Sometimes, business owners go all-out to sell their business. They cut costs and even go bare bones just to show the sales trajectory and to prove a trend. They cut down infrastructure as they try to build up the sales number which puts the business in a really precarious situation. Any investor, when they see that in the last year before selling the business you got an improved sales trajectory and growth and you’re cutting cost, they know that they are buying an unhealthy business.
Carrying The Business On Your Back – A Risky Strategy
Mike thinks that one of the craziest risky strategies that owners take is carrying the business on their backs. You see it with small businesses. The owner does everything. They work ridiculous hours, they can answer any situation, and they are the superheroes swooping in to save the business yet again. That is the worst valued business ever. Mike, as an investor, does not want to buy a business that has any dependency on the owner. Because if Mike buys the business and the owner is sick or decides not to show up, Mike will be in trouble. The value is in the business where the owner is ‘just an owner’.
To put this into perspective, Mike shared a research project he’s been doing recently for his future book. In this research project, he goes to McDonald’s when he travels and tells the cashier that he is impressed with the service and wants to talk to the store owner about it. Based on Mike’s experience, he is yet to have that single visit where the cashier says “Oh, yeah, let me grab the owner.” The owner is not in the office, not flipping burgers or cooking fries, not in the cash register. There was one cashier who said she doesn’t know the owner is, and another cashier who said he met the owner a couple of months ago as they came in to pick up the money.
The job of the owner is to create a system so tight that there is no dependency on them. McDonald’s is a franchise model and the systems are already created, but we should all aspire to have a business where our only responsibility is to come in and pick up the money. That is a very valuable business.
How To Transit From Owner to Investor
Don’t work IN the business; work ON the business. This means the owner needs to extract himself from the business.
The relationship between the owner and his business is often treated as a parent-child relationship where the owner nurtures and grows his business until such time that the business can stand on its own and serve the owner. Mike, however, thinks the relationship between the owner and his business is more like that of conjoined twins. The owner and his business share critical organs, they share a heart and a soul. Therefore, just like conjoined twins, the separation of the owner from their business is a very careful critical process.
Entrepreneurship has been equated to a “hustle and grind” mentality which means you have to show up and crank every single day if you want your business to be successful. That is the epitome of growing a business that is of no value because it is fully based on the entrepreneur’s sweat. Entrepreneurship is not an easy job. You have to work for it. But the goal is to be smart about it and not just muscle your way through the business growth. You need to choreograph the resources around you, organize your people, system, and clients to move you to a common outcome which is your vision for the business.
Stop Calling Yourself ‘Entrepreneur’
The first step in the transition is to change your title. Stop calling yourself ‘entrepreneur’ because that translates internally to “I work my tail off”. Instead, call yourself a ‘shareholder’. Shareholder means you render a vote in your business, you manage the business, but you don’t work in the business. When you say that you are a shareholder, it puts you in the mentality of acting like a shareholder – giving strategic directions, voting for or maybe even sitting on the board, but not doing the work.
A micro business needs all the resources it can get and you may be that resource, but realize that you are serving a temporary role. Your role, first and foremost, is to be acting as a shareholder and you can fill that role, as long as it’s healthy for the business, by hiring other people and putting other people to the position. That is a simple thing that you can do immediately and will have a major mind shift for you. Extracting yourself from a business that you are ingrained in can be done, in most businesses, in under two years. And as you do this, you will be relying more and more on the systematization of the business.
Mike shared a story about his interview with one business owner. The owner ran an electrical contracting company that he sold last year for $28M cash. This guy started with just one van. When Mike asked what was one of the most strategic things the owner did, the owner answered that he woke up one day, after working 12 hours installing electric panels, and realized that instead of asking “how will I get the work done tomorrow?” he changed the question to “who is going to get the work done tomorrow?” And this started a shift in the empowering of the labor force.
The second strategic thing that the owner did was a decision NOT to make an office at his office because every day that he is in the office, people come to him for help and rely on him like he is a knowledge base. By not having an office, his people became more self-reliant.
Those two elements move him to the pathway of a business that runs itself. And a business that runs itself is very valuable.
How To Deal With Fear
Business owners can get their arms around the concept of “this is what I need to do”, but the fear associated with doing it is the challenge. To deal with that fear, Mike explains the use of humans’ cognitive bias called the “primacy effect”.
The primacy effect is that we put more value on things that are immediately in front of us than when those things are placed at a faraway distance. For example, if we are to choose between receiving $5,000 right now versus receiving $10,000 next year, we are more likely to choose the $5,000 than wait for the $10,000 next year even though, based on interest rates, $10,000 is the better choice. We are very oriented towards immediate gain.
One way to get past the fear is to look at your history. If you have a mentality of “If I will just grind it out for the day then my business will finally grow”, ask yourself how long have you been grinding out. And if you’ve been grinding out for more than a year you’ve proven that you can’t grow your business by just grinding.
The 2nd thing is to do a compression of roadworks. The mentality of Profit First system is to ‘pay yourself first’ simply applied to business. With the Profit First system, every time revenue comes into Mike’s business they immediately take their cash profit and reserve it away. So Mike has been keeping profit all the time in an account. Every quarter, Mike goes into that account and take a portion of it. He is rewarding himself quarterly. But he does not take all the profit. He makes sure that the business is at strength and position and position that in the next quarter the profit is bigger.
So what Mike did was that instead of requiring himself to defer the benefit for so long by disciplining himself almost in a negative way, he gave himself a trickle effect that’s growing and every time it made him more and more excited. This compression of time where you are dripping out rewards to yourself, it builds a positive behavior towards what you want to achieve.
Why Profit First
When a business takes its profit first it forces the business to chain around the things that make profitability. You take your profit first, there’s less money spent on expenses, so you have to cut expenses de-risking the business. You have to focus on separating true value. You start cutting cost, but you start becoming selective in what cost have a true ROI.
When you take your profit first, you have to run the business more efficiently to maintain the profit that you already took. You have to build efficiency. And the ultimate way to achieve efficiency is through repeatability. That is why businesses who take profit first focus on a type of client that has repeating problems, and therefore they need a smaller set of solutions to solve it. They have mastered the process because they repeat the same process. They become specialists and clients are willing to pay the premium price.
Businesses that take profit first build the most important asset in the world which is cash in the bank. That gives you such power and flexibility to grasp the opportunity. It positions you to high valuation.
Lifestyle or Legacy
When asked if today’s business owners are more interested in lifestyle or in legacy, Mike hopes that more people are interested in the lifestyle. As someone who has experienced being very wealthy and being very broke, for Mike, lifestyle equates to joy. Money is only an asset if you’re in a joyous state. You can be living a miserable life and make tons of money. Your life will not become better. Mike finds money an amplifier of your state. If you are miserable, more money can bring more miserable.
Many entrepreneurs go into business not to make tons of money but are making a business that brings them internal satisfaction. They can see the impact they are having. It brings them wealth, but it is rooted in joy. And that translates to legacy. Mike defines legacy as that we are leaving a long-lasting impact, perhaps something that can live decades or centuries past our own existence on this planet. That is the state Mike believes he is fully in now. He built businesses that bring him joy, he loves working, he sees the impact he’s having, and he is positioning now that when he leaves this planet the businesses and the work he’s done can leave behind him. Living joyfully puts us in a position to have a long-lasting legacy.
Fix This Next
The biggest challenge facing entrepreneurs is that they don’t know what their biggest challenge is. Identification of problem. Fix This Next is a tool Mike developed to pinpoint where the next vital need is in your business that must be resolved. Where that next roadblock and bust through it. And then you go to this process again to identify the next need. It’s a way to really put in order the things you need to do next.
The challenge Mike found with this arbitrary approach in growing business is that entrepreneurs are overly reliant on instinct. Our instincts are very valuable to self-preservation. We are neurologically wired to ourselves. However, we are NOT neurologically wired to our business yet we behave like we are and so our instincts can misfire or misdirect. What we need is some kind of validation of the way we analyze our data. Some compass that can complement our instinct.
The book Fix This Next, which will come out in April 2020, is the compass to complement our instinct and navigate through the journey of entrepreneurship.
How To Work With Mike Michalowicz
You can visit Mike’s website www.mikemichalowicz.com.
There’s a nice easy trick for those who have trouble spelling Mike’s last name. You can use Mike’s high school nickname – Mike Motorbike. Simply go to www.mikemotorbike.com and it will redirect you to the main website.
Feel free to explore the site to get started.
Mike’s Advice That Would Have The Most Immediate Impact on Business Value
If you want to increase the value of your business, it should be profitability first. It is the first stage of getting you extracted from the business.
Go to your bank and work with them.
Set up a savings account at that bank and name it Profit.
Start allocating a small percentage (1% or 2%) of your income and put it in your Profit account.
When you start with a small percentage, there is no negative impact on how you currently operate the business. But the serious consequence now is you have cash profit accumulating. And when it comes to the valuation of your business, if your business keeps accumulating profit, you have a far far more valuable business. Start establishing this habit. Start small. And start it today.