Critical Advice for Businesses Making Less Than $10M | Ep 824
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Welcome back to the game. Business owners making less than $10 million per year cannot afford to make this mistake. And it's a problem that limited me and my ability to sell my company. And there's four parts to this mistake. And it starts with something that I like to call key man risk.

if a single person is vital to how your business operates and if they were gone the business would cease to be able to exist or be able to be as profitable as it is with that person and so this key man risk can exist at the founder level so it might be you like if your business if you leave for for two months which by the way is a great test of this

If the business cannot sustain its level of productivity, like if all of a sudden the sales go to zero or they cut in half because you're the only good closer, or all of a sudden you're not even getting leads because you're the only good marketer, or because the product can't be delivered because you're the only person who knows how to do it, right? In each of these situations, there's key man risk.

And that can be, of course, you, the owner. In the beginning, it's more common that it's you. And then over time, that key man risk can be an employee who works for you. It's just as dangerous for a public company that has an employee who has zero stock in the business, who happens

happens to own all the passwords, for example, to every single dedicated system. Like if that person leaves, it could do material damage to the business. You've got these functions that occur in the business on a regular basis, and there may be multiple people that can do

these functions. And so the opposite of key man risk is redundancy, meaning if one of these people disappear, we still have a flow for, let's say, dollars to go across this bridge. It can still keep, kind of make its way through. All right, so let me tell you a story. So,

One of the key man risks that existed in gym lunch, and we had multiple. So the thing is, is that this can happen at any function. So this could happen on the marketing side. If only one guy knows how to generate leads, or if that person left, you would get half the leads or a third of the leads. That would be key man risk. If only one guy knows how to sell like you, and that guy closes 80% and no one else can close 20, that would be material. That

would be key man risk. If only one person can do the delivery, that would be key man risk. And so I'll give you an example of the delivery. And so when I had Gym Launch, I was kind of the innovator of the product and the service. I came up with the solutions for the gyms. And so for an acquirer or a private equity firm who wants to buy this business, or whoever else you might want to sell a business to, having one person, especially if it's the person who's going to leave,

when the business is sold is a huge, massive red flag for them because they're like, wait, we're buying this production, but it's with this key cog in the machine and you want to have us buy this thing and remove the cog. Now, in a situation where you raise money, for example, it's not as much of an issue because those people, those pieces, those cogs are still in the machine.

If you wanted to sell a company and you own the company and you leave and all the people who are still key man remain within the business, then what they're going to do is try and incentivize those people to stay, but it still makes the company sellable. So this just counts double if it's the owner or somebody who's going to leave as a result of a transaction. Is the key man risking any of the functions of the business?

So I was key man in the delivery. And so I did a couple things to solve the problem. So number one is that I created a department called the R&D department.

And so the way it worked was simple. I thought about the process that I would go through when I wanted to innovate the product. So I'd say, okay, what can we do for our gym owners that will help them generate more leads, make more sales, whatever the issue was. And so the first thing that I did was that I would say, okay, I have a way of identifying problems. I would ask the customers. And the nice thing is if you listen to your customers, they will shout at you and they will tell you exactly what their problems are.

And so I'd say, okay, number one is that I had these problems. Now I have to solve those problems. And so I'd have them rank the problems. They say, okay, this month lead generation is the biggest issue. They want more leads. And I'd say, all right. Now the next thing that I would do is I would deploy resources. So this would be time.

and money that ideally my customers couldn't deploy, but I could fractionalize that cost between all of my customers to create a much bigger individual investment than any one of them could afford. Let's say they pay $3,000 or $4,000 a month. I would spend $50,000 a month on this test. And so I'd say, okay, go hire a bunch of models, go out to a really good gym,

film some great ads, then test those ads. So number three, I would test the ads in representative markets. So I'd have 20 markets or so that would represent different demographics. So black, white, Asian, Hispanic, poor markets, rich markets, large markets, small markets, with good operators, with poor operators, with mediocre operators. That way I had a true sampling rather than just saying, I'm just going to send this to my favorite customers because that's not going to work.

And so we test it. And then what I would do is hand off winners. And so what that meant was I would say, okay, these ads of the 30 that we ran and we spent $50,000 on this whole thing, these two or three were the ones that generated the highest returns. And then I would give all of those to the gyms in our distribution base so that they could run those ads. They just wanted the inputs to feed the system.

and those inputs were required on a regular basis. In order for me to hand this off to someone, I said, "This is fundamentally the way I do it." I look at the problems that they have, in this instance it was lead generation, I would dedicate time and money to solving this problem in a way that they couldn't do it so that I could create a better solution that they could do it on their own. I would test to validate that the solution that I had was superior,

And then we roll it out. And I followed this process for my R&D so that I could replicate the person with a system. Why this matters is that if you have key man risk, you don't have an asset, you have a high paying job. And I don't say that to insult you. I say that so that you can be aware of it so that you can actually fix it.

And to be clear, if you are fine just working and not necessarily owning an asset, that's great. There's nothing wrong with trading time for money.

Big fan. It's just like, ideally, just trade it for lots of money, right? But if you do want to solve it, you will get more leverage on your time because then you don't have to do this thing. This thing occurs without you. And then you can take the remainder of your time and shuttle it to the things that make even more money. And so typically, key man risk will occur in three primary areas. So number one is that it can occur in marketing. So how do we get leads in the door?

The second big place that it can occur is sales or conversion. How do we get prospects to hand us money for our goods and services? And then third is the actual goods and services themselves, which you can consider product, etc.,

And so this happens at any level. So if you're a service and you just happen to be the best plumber, the best electrician, or you're the best coder, or you're the best advertiser. Now, with marketing, for example, if you own a marketing agency, you probably are key man on marketing for yourself and marketing for your customers, right? Like it can happen in multiple places, even if it's one person. And the more places one person is key man, the riskier the business is overall.

Now, I want to be clear. Key man risk is a double-edged sword because the more valuable you become, the more of a key man you are. And so the idea is that as soon as you learn a very valuable skill, the most valuable thing that you can do next is learn how to transfer that skill to another person.

And I think this is a skill that I've spent a tremendous amount of time trying to hone so that I can build companies, and I think about it like this, assemble companies, assemble people, and then transfer the skills around whatever area has some sort of bottleneck where there's too few people who know how to do the thing. And this is so important because

whether you want to sell a business or not, making a business that is sellable makes it better for anyone. Here's the best analogy I have, which is say that you've bought a house. Now, if you've never bought a house before, then this may be news. But when you buy a house, what happens is that after a certain amount of time, and the average American's like three to five years, they change where they live.

All right, so you buy a house. Now over time, you got some wear and tear on the house and the house kind of degrades in your mind, right? Like you get a little crack on the front porch, this door kind of squeaks a little bit. And when you go to sell, what do you do? You fix the little path in front of the house. You put some oil on the little hinges here. You know, you're like, you know what, maybe I'll put a little patio out back. I feel like that would increase our home value, right? And then all of a sudden, and this is the crazy thing, right when you're about to sell the house and you fixed all the things that are wrong with it, you're like, you know,

This house ain't so bad, right? And so the same exact thing happens with the business. If all of a sudden you remove yourself as key man in marketing and sales and product, all of a sudden you're like, huh, this business almost runs without me. This ain't so bad. Now, the last area that you can have key man risk that can occur, and this is kind of like the glue between all of these, is operations.

So, if you have a key leader, for example, who has tremendous influence over the entire team,

then the operations connects the people to their functions. And so think of that as kind of the glue that runs the organization. If Layla were to leave, she would leave a huge vacuum at Acquisition.com. Now, she's not specifically over marketing, sales, or products. She just has all of these leaders that are rolling into her. And so if the leadership was gone, that in and of itself would also be somebody who's key man.

So if you're thinking to yourself, "Okay, this is me. I'm definitely key man or there's somebody in my business who's key man on marketing, sales, operations, product," then there are two major ways that you can solve this.

So the first is through process and people, just like I walked through earlier where I said, "Okay, what are the actual steps that I do in order to solve this marketing problem? What are the actual steps that I use to think through creating new products? What are the actual steps that I use to think through creating sales process, driving sales results, etc.?" So it's process and the people who will then do those processes within the business.

The second way, and this really only applies if it's not you who is the person who's key man, is incentives. And so if it's you, you only have option one. If it's somebody else, other people, you have option one and option two.

to solve the problem. And so, for example, if I said, hey, I will incentivize you to stay in this business by giving you some vesting of shares over a three or five year period, then that would make it less likely that the person's going to leave and disrupt the business. I think through it in both of these. Now, which of these is the most valuable, like most valuable to the business to do? Well, the most valuable to do is this one.

But the higher up the skill set is, the more unique the individual. Like think about Elon Musk. He's key man in almost all of his businesses. But the reason that it's okay is that he has no desire to sell them.

And so people bet on Elon and the companies because they are inseparable entities. Like they go one together and no one's leaving, right? They go public and all of their shares are still theirs and they're still incentivized to continue to grow it. Now, if you're watching this and wondering, well, okay, process and people, what does that actually mean? So inside of $100 million leads, I break this down in the employee section, which is a chapter in the book in terms of how to help, how to get people to get you more customers.

You have the functions that an employee would do. And so there's two aspects. One is like, how do I get these people? You can use warm outreach to ask your network. You can do cold outreach, which is basically recruiting. You can post content, which is basically posting job openings that you have available. Doing paid ads, so promoting job postings on like a Craigslist or an Indeed or a Monster or a Ladder. Getting employee referrals, right? So rather than customer referrals, you're getting employee referrals.

Affiliates would be like associations, guilds, listservs that already have a huge amount of people who want this specific type of role or job. Agencies, so think like staffing firms. And then, obviously, employees themselves could be the solution. Now, how do you get them to actually do this? And so the step one is that you document, which is basically saying, hey, here's our checklist of things that must occur in order for this process to be deemed complete or sufficient.

The second D here is demonstrate, which is that you do it in front of them. So you do it on your own and you create the checklist. Then you do that checklist in front of them. And you only stick with that checklist because if you do anything off the checklist, then you have to add to it. And then finally, they do it in front of you. So they duplicate it. So you document checklist, you demonstrate it in front of them, then they demonstrate it in front of you, which is basically duplication.

And so that three-step process is fundamentally how you can teach anyone to do anything. And in order to make a process more teachable, you simply have to break it down to more and more steps based on the skill of the person you're teaching it to. If I wanted to teach an advanced marketer how to do email marketing, for example, I wouldn't say, "Hey, turn on your computer."

Step two, pull up Internet Explorer. Step three, sign up for a Gmail account. I wouldn't have to go through all those steps because there's an assumed level of proficiency. This is why when you go to college or whatever education system you went through, there are prerequisites for moving on to the next level so that they don't have to teach you arithmetic and then teach you calculus later. They just assume you know it.

And so your checklist that you create is going to depend on the level of the person that you're teaching the skill to. And the lower the level, the more checks you're going to be on the list, the more you need to regress it. And so let's say you brought on somebody for sales, right? Who's going to be a director of sales. This might be a higher level role. You would still follow the same thing as, hey, these are the activities that I spend my time on. This is what I actually do.

then they're going to watch you do it. You probably are running teams, you're probably doing one-on-ones, you're probably looking at data to look for key out points so that you can

address them and solve them within the team. And then they are going to take over those responsibilities, do them in front of you, and then when they have done them to the satisfactory level, you can then delegate it. And so the easy litmus test for good delegation is that after you've given the responsibility away and someone else is actually doing the actions,

then the performance of the department or function either remains neutral or goes up. That is when you have successfully delegated. It's not that you give something to someone that makes it delegation.

You can give something to someone and completely abdicate or basically get rid of responsibility but with no feedback loop to determine whether or not you did a good job or that they're doing a good job. And so it has to be the performance of the function after you've handed off that determines whether or not you have successfully delegated. And sometimes you have to repeat the cycle multiple times with the same person and that's okay because you need to learn too on how to teach better. And quick pro tip, if you're a smaller business

And let's say that you do some sort of service and it's just you or just you and a couple people. There are three options that you can do when you have too much demand and very fixed amount of supply. Like you can't, you're completely maxed out. You can't take on any more customers. You barely can. So option one is that you can simply raise your prices.

And if you do that, you'll absolutely make more money. So you'll get paid more for the same thing, which is my favorite way of getting paid. Now, the second thing that you can do is you can increase the service ratio. And so that means instead of doing one-on-one, for example, I would do one-on-five or one-on-ten.

Now, alternatively, you can think of it with a team the same way, which is, let's say I have four people who work in my agency and they do different functions to serve one type of customer. Then if I can change it from those four people together can handle 20 clients, I can have those four people together handling 40 clients. And so the ratio still shifts towards us. So you get more efficient, which is either process or some sort of technology or training that allows you to get more from your existing talent.

The third, and this is the most valuable one, process in people is that you actually get somebody else to do the work for you, which typically means you have to organize this stuff, make sure they did it successfully, and you can hand it off. And if I had to do this in sequence, meaning in what order would I do this? First is I would raise prices because that requires the least amount of work and can immediately make money if I'm supply constrained.

Second, I would say, "Okay, well, people are saying yes to these higher prices. Well, I don't want to raise prices again," which you obviously still can. "I can shift my service ratio at this current price to fundamentally dilute down the service that I have because it's so good. And as long as my value still exceeds my price without raising the price with this second implementation, I would still have people who want to give me money."

Now, if I've done as much of these two things as I can, I can then say, you know what? I want to not have to do any of these things at all. I want someone else to do them. And then that transforms this particular job that you have, because as an entrepreneur, you'll have more than one job. It takes this job, takes the hat off your head and puts it on someone else's. And then that shifts you towards ownership.

owning an asset rather than owning a job. And to be clear, I'm all for maximizing the amount of money that you're making. And some businesses lend themselves more to kind of the people and process stuff than others do. Taylor Swift, for example, is going to have a hard time being like, hey, this is my blonde double and she's going to sing for you guys today because look, I've delegated the responsibilities.

Now, it's very unlikely that that would happen. And so there are situations where you just have unicorns in a business. And so that's where you just have to align incentives like crazy and try and take it all the way. Right. Which is either you're just getting a paid a ton of money, which, you know, Taylor Swift does, or you create liquidity, meaning you get paid for the equity shares that you have.

via a different vehicle than selling. So when you go public, you sell a little bit of the company, but the vast majority of the wealth that most of those founders have is that they have shares that they can take loans against. And the bigger a business gets, if you don't have any desire to sell, you can take debt or other instruments where people will lend you and you can collateralize or back it up

with the stock that you have in the business. And so if you don't pay them back, they get to own shares in the company. And so you can see with Keyman, it's all about risk. And so when we successfully bridge this gap, what we avoid is the risk pitfalls here at the bottom where we could just die a fiery death in our business. And so we just keep building our little bridge, the next brick in our bridge to our big money pile over here.

is single channel risk. Now that's just a fancy word, so let me tell you what it means. Very simple. If more than half of your customers or leads come from one place, you have single channel risk. And the concept behind this is that if that were to stop, it would materially affect your business on a long time horizon. So quick illustration. One of our portfolio companies, which is the teeth whiting chain, got a lot of business from outbound.

meaning they had a team in the Philippines that would reach out to prospects in a specific geographic so that we could give them an offer to get them to come in and get their teeth whitened. Very simple business. Almost all customers were coming from that specific source. All of a sudden, the rules on that platform changed based on the way that we could message. Almost overnight, we had 50% to 70% fewer sales coming in from that primary channel.

Now, that is single channel risk. Can you imagine as a business owner overnight? You're like, oh my God, this will change. Now, this has happened for if you're ads dependent. Let's say all of your ads, the way that you get customers is on meta ads. And then you lose your account, boom. All of a sudden, your business almost goes to zero. Or if you have an organic content following and you're only on one platform, for example, and that platform bans you or restricts you or shadow bans, whatever. And then boom, all of your lead flow disappears.

Or you have, let's say, a domain or a server that you send your emails from. When you do outbound and all of a sudden that gets whacked with some sort of, you go into the promotions tab on email, all of a sudden all your response rates from your domain go to almost nothing. In each of those scenarios, you have single channel risk.

Now, thankfully for this particular business, I had spent the last six months or more building out a recurring revenue stream. And I detailed that in a different video where we went from like 5% of revenue being recurring revenue to over 60% of revenue being recurring revenue.

And so even though we decreased the amount of new sales coming in by over half, it didn't actually change our overall revenue because we had so much compounding that had started to become unlocked, which is why there are multiple ways to stabilize a business. But for the purpose of this video, if you have only one way to get customers, then you have one way to lose them. So first off, who needs to worry about this? Well,

The bigger your business gets, the more important this is. And let me explain tactically how this works. Because let's say even volatility from a single channel is something that could rock the boat, figuratively. Well, if you have a small business and let's say the channel goes down by 20%, then let's say you've got one sales guy and his calendar goes from 100% filled to 80% filled. Not a huge deal.

Now, if you have 100 sales guys and their calendars go from 100% to all of a sudden 20 of the guys have completely empty calendars, that level of volatility that can occur when you only have one channel makes it much more difficult to do business on a regular basis.

And so there's a variety of solutions that I will walk you through. So number one is that if you're a tiny business, you don't need to worry about this yet. But my biggest advocate for being a small business is that you're going to have one primary method for getting cold people, which is usually going to be outbound, number one, which is you're reaching out to prospects who don't know who you are. Two is going to be affiliates. So again, you've got third parties that are sending you traffic.

Three, you've got ads that are ways that people are coming into the business. And you've got organic. So this is going to be likely how you're going to be getting customers. This may seem like a little bit of a departure from some of the things I've talked before with one channel, one avatar, one product up to a million dollars a year. And that's true. It's just that I've seen like...

so many people be able to manage this and I think it's it's such high return for such low effort that the organic that you put here is not really to acquire customers it actually functions more to Amplify what you're doing with these other channels if you are doing outbound and then people google you and then they can find a little bit of content then it's like oh this is got this guy has a Paul so this is a real business someone is an affiliate or affiliates are sending you customers or you're trying to sell affiliates or

then just knowing that if some sort of precedence increases, likely they do business with you. And same thing with ads. And so if you're a small business, this is going to be one of the big ones that you're probably going to use, but the organic is just something that you can do even one post a week. It doesn't have to be a ton, just to look like you have a pulse. So if you're a bigger business, the way that we solve this is a standardized process that I've now had to jump through with a lot of companies.

So the first thing we do is we shore up long-term nurture. And you're like, how does this have to do, what does this have to do with getting a second channel? Wait. So the reason we shore up the long-term nurture is because

We want to get more out of what we're already doing. And if we get more, that's going to increase our cash flow without adding cost basis to the business. So it's basically, think about it as like decreasing risk and increasing our ability to make bets. So long-term nurture means a combination of making more content and

Hey guys, real quick. This podcast only grows from word of mouth, quite literally. There's no other way to grow a podcast than word of mouth. If there's some element of this that you think somebody else should hear or would be relevant to them, it would mean the world to me if you shared this via text, via Instagram, via DM, via whatever way you like to share stuff with the people you love. Thank you.

Email specifically follow-up because a lot of people, a lot of businesses don't do a good job following up with leads. And so they have this list of 10,000 or 20,000 or 1,000 people that have done business with them over a long period of time, or at least given them their information. And so if we create a cadence or some sort of schedule,

around reaching out to those people, providing value, and then occasionally presenting offers, we're going to have another stream of customers that's coming in. So think of this as, in a way, another customer stream, but it's an incredibly low-risk customer stream that is the most profitable of all streams. And so email marketing, for example, has, depending on the source, a 42 to 1 to 36 to 1 return on dollars.

And so it's like, oh my God, why would we not do that? So we do this to decrease our risk, increase our cash flow in the short term to get that engine going. The next engine that I like to make sure is very strong is my referral engine. And so if I haven't put a strong referral system in place to get customers to send me more customers and

made sure that I'm asking multiple times in different and creative ways throughout the customer journey, then I implement that next. Again, we're getting more for what we put in. And so after we've got the long-term nurture firing and we've got the referral system going, this should give us a little bit of padding to then invest in the second channel. Now, when I say invest,

The way that it typically works is that you will see no outcome for an extended period and then all of a sudden it will start working. And you may get frustrated in the short term that you're not seeing immediate results, but welcome to business. You have to think long-term about the value of what a second acquisition channel or third acquisition channel means to you. So number one is that when you do the second acquisition channel, you can't immediately double sales or more. And if you double revenue, you typically far more than double profit. So that's number one.

Number two is that the business itself becomes less risky. So not only are we adding revenue and profit to the business, the revenue and profits itself

is more likely to continue and so the business itself becomes more valuable and you can sleep much better at night knowing that if one of these things goes down, my team is still fed. And so when we make this investment, here's one of the big no-no's, is you don't do two no's. Like what's two no's? So you don't want to have two no's. So what does that mean? Well, if you're going to start a new channel, that's one no.

What you don't want to do is put a new person on a new channel because then you don't know which new is the problem. Because even if you take you and maybe you're really good or your best person and you put them on the new channel, well, there's already the newness of the new channel and you won't know. But if it's somebody you know who's really good, then at least we're working through the channel itself. Otherwise, you could be stuck paying lots of money for a long period of time not knowing if you're solving the right problem.

which is why I'm such an advocate for founders to have deep understanding of the core processes of the business, which for me are understand how you get customers, which is going to be marketing and sales, and understand how you deliver value. Now, if you wanted to outsource IT, if you wanted to outsource accounting, if you wanted to outsource HR or payroll processing, those are things that I don't see as core to the business. You can, of course, bring them in-house when the cost makes sense. But in terms of the core processes

economic engine of the business. Those are the things that you, the founder, the entrepreneur, want to understand intimately. If I am going to start a new channel, I do these two things first in order to give myself some breathing room. I get a little more cash flow. I get a little bit more from what I'm already doing. And then I have one new

which is the new channel, and then old person. Now, it doesn't actually have to be old, but it's somebody that I know. This can be tough because you're like, wait, wait, I don't want my original channel to go down, which is the most common thing that happens in this situation. My recommendation is transfer the skill on the first channel first to someone else. Make sure that they can handle that without decreasing performance. Ideally, it goes up.

Then and only then you can then make the investment into the second channel where you're the old guy and the channels the new thing now if you want to bring somebody in to help you with this I think that's a great idea like if you're a larger business and you're like I can't actually just like figure out cold outbound That's fine But you basically have a thought partner and you guys are working through it together because you'll have more context on the business overall and maybe they have more context

on the methodology that you're going to use for the second channel. But that merger, those things coming together where you learn a lot about the method, they learn a lot about the context of the business, both people get better. And this is how I've seen, this is how I've been able to successfully use all of these different methods of getting customers in different companies.

If any customer or associated customers left tomorrow, would your revenue drop by 20% or more? Now, the reason 20% is kind of the number I choose is that most businesses run at 10%, 20%, 30%, 40% margins. And so if you had even a 40% margin, which would be a great margin, you'd lose half your profit. This would be material to the business itself and its value. So I'll give you a real business story. So I had a business owner come out to Acquisition.com who was an agency owner.

And he had 10 customers. And nine of his customers were small, like tech, SEO, like agency customers. And then one customer was Google itself. And it was a massive percentage of his revenue. So for him, for this example,

example, this was actually 70% of his revenue. So if you actually look at the meat of this fish and you added all these little pieces of meat in between together, this is definitely the fish that has all the money. If I'm this owner, I'm like, oh my God, if I lose this whale, it's going to kill my business. I won't be able to, I have to let go of half my staff. I would certainly lose all my profit. And so this is a huge risk to the business. Now, there are thousands

four ways that you can solve this problem. So there are four proven ways to solve this problem.

So when this business owner came out, I said, we're going to go through all four and you're going to pick the one that you think you have the highest likelihood of achieving. And so this is you. This is how you solve it. So the first way you can do it, all of a sudden you get a bunch more minnows. And then all of a sudden, by percentage, man, these are ugly fish. By percentage, you know what? This whale isn't 70% of my business anymore. So you just keep adding minnows to your boat. And then all of a sudden you're like, you know what? My minnows way outweigh my whale. And so I don't have key customer risk anymore.

The second way is that you lock this whale in to a long-term contract. So just think about this whale as signing his life away. But you get Google or whatever this customer is to sign a three-year, a five-year, a seven-year commitment. And you can add some bonuses in there and say you're going to have some dedicated reps or you're going to have some sort of discount that might be associated with that kind of commitment. But when they do that, then it makes it more stable because it's

unlikely that they're going to leave. And if you want to be smart about this, just a little pro tip, add a little breakup fee because some people are still going to back out on their agreement and you don't want to get into a legal battle. So you want to just give them some way in the future. But just knowing that there's this nut that they're going to have to pay will prolong how long they'll stay with you.

And so I would probably charge somewhere in the neighborhood of 10 to 20% of the contract. Now all of this stuff's negotiable as a breakup fee. So if someone has a five-year deal, then I might say you ought to pay a year if you're going to break up beforehand.

Another way of thinking about it is saying whatever discount I gave you, you're going to have to pay to make up that discount for the entirety of the contract in order to leave the contract. Another one is that they have to give you six or 12 months of heads up. So there's a lot of ways that you can write terms around this with the whale to decrease the likelihood that they leave and disrupt the business. Now that's path number two.

The third path is, and this is my preferred path, is you just get more damn whales. And then all of a sudden you realize, you know what? Dude, I'm in the whale business, right? Why was I hunting minnows? Look at the meat on these guys, right? And so all of a sudden you don't try to

outnumber with minnows, you make all of a sudden, you just go get five, six more whales, and this isn't 10% or 20% of your business. So path four is a nasty one. And for many of you, if this is your situation, it may actually be the right path. And I'll tell you a story to illustrate it. So there was a recruiting firm that I was talking to, and they had grown a decent amount

and they had this Mondo contract that was on the horizon. And so they staffed for very specific types of engineering roles that were difficult to find. So they definitely had a niche that they had found. And they had some big whale come to them and say, "Hey, we want you to staff us with 20 new employees a month," which was a big contract for this firm. So this firm was probably doing $600,000, $700,000 a month, and so this would be like an additional $200,000 a month that they were going to be able to contract through this new whale.

And when they were asking, you know, how should we negotiate this deal? What pricing should we put in there? I thought about it for a long time and I was like, you know what, guys? I think the actual best move is to not do this deal.

because they were going to have to basically change the fundamentals of their business, their pricing, their delivery. The whale demanded so many custom things that were only going to be a use case for them and were not going to service the rest of their customers. And they had no way of reliably acquiring the whale. So I'll explain the difference. So if...

the whale comes in through a tried and true channel, then this might make a ton of sense. But if you just get a random referral or you just meet somebody or you work from your network, building your entire business around an unsustainable or unpredictable way of getting this type of customer is probably not smart. Now, if that

recruiting firm and said, hey, we just got our first whale, but we have a new way of getting whales, then I say, oh, this is the first whale of many. This makes sense. But if this is just a random lottery ticket that falls into your lap, you have to make the decision of what business do I really want to be in and what customer do I really want to serve? And so I think that this entrepreneur just saw dollar signs in his eyes, but didn't calculate the cost of what it would mean to his business and the disruption of the

the main economic engine that he had spent years putting together. And so path four is you just realize that this whale might be someone else's customer and you let it swim on. And the fourth one, and this one is a crazy one that I've got a story for you, is single vendor risk.

All right, so the first example of this that I had, like, unfortunately, I've had this happen a lot. All right, so with Prestige Labs, I had one manufacturer who made our products. And it turned out, we found out that he ended up stealing about $400,000 in cash that I had sent. And he kept asking for early and earlier payment on stuff.

to lock in greater discounts. And in general, if I have cash and I can guarantee a 10% or 20% return on that money, then it's almost like I could put it in the stock market, but I know for sure I'm going to get a 20% discount for sure that it's like getting a 20% return on the money guaranteed. So I'll take those deals when they come. But I kept asking for it earlier and earlier and earlier. And

When we just said, "Hey, you know what?" It had been enough times that we were like, "Why don't you just send us what you owe us in terms of product?" All of a sudden, he couldn't because what he had used is he was using our cash to run his business rather than use it as an account for the products and raw materials that he needed to purchase for our account.

And so obviously that was a big no-no and we were able to thankfully like bridge to another provider and not really create a disruption. But for probably a period of six months, we were running out of product on a regular basis and had like three month lead times where we had to basically make this transition and we lost a serious amount of revenue. And that was a big hit both to the revenue but also just reputation because Prestige Labs sold through affiliates. It still does sell through affiliates.

And during that period, affiliates were like, "Dude, we can't sell half the products we normally do because you don't have them in stock." And so that was very tough. And I learned that lesson. Prestige Labs, which is a supplement company that I owned at about 20 million bucks a year. And I ended up selling that in that $46 million sale to American Pacific Group in 2021.

Allen was the third company that I started and sold in 2021, which was a company that helped brick and mortar businesses work their leads through automated messaging. And I didn't understand how software worked at the time. And so I just said, "Cool, I know this problem. I'm going to go hire an outsourced dev team to go build me this software stack." And they

they did. And lo and behold, here's the crazy thing, no one on my team was any bit technological or a developer. And so 100% of the development was happening in this outside shop. Now, what do you think the outside shop owner did when all of a sudden this thing that he built's doing $500,000, $800,000, $1,000,000, $1.2, $1.5, $1.7 million in sales? All of a sudden, magically,

What was once $100,000 a month in development became $200,000, $300,000, $500,000 a month in development because he could see how much money we were making.

which is why I'm such an advocate of if you are gonna start a software company, you want that person to be in-house. At least it'd be key man risk that you can control, right? But instead, I had a key vendor who literally designed and built the entire product that I was selling. And so this guy had me by the balls. There was nothing I could do. And so I had to start building an in-house team

in parallel without trying to let him know that I'm doing this because obviously he could see the writing on the wall and then he was difficult to work with and transferring the knowledge over and it was a nightmare. And so that was my second big experience with this.

The third, you're like, "You should learn this lesson." You know what? Sometimes it takes me a while. So in my first book, "100 Million Dollar Offers," I talk about how I lost my payment processor and it was this terrible experience for me because it was the only problem I'd ever encountered in my life that I couldn't save with sales because no one would process the money.

TLDR, I was running a national business out of a brick and mortar store that I had in Southern California. So I'm processing payments out of Canada, I'm processing payments out of Mexico, I'm processing payments out of the United States, all over the country. And they're like, "Wait, how is this happening out of a little brick and mortar store in California?" I didn't know how this worked. I was 25 years old. And so I broke the rules and was unaware of it. And so they held my processing.

After that happened, and you only need it to happen once, for every single business that I've had afterwards, I always have redundancies in processing, meaning I have multiple processors that are approved, spun up, and can handle the entirety of my monthly volume at a moment's notice.

Because I only had one payment processor, I had no ability to negotiate anything in terms of my fees as well. And so having multiple there that are approved gave me leverage with the relationship, I got better service, and if for whatever reason something goes down, I can switch it over in a heartbeat and not even miss anything.

Now, I had a second occurrence with this later on in my career where we did have redundancies. And here was the issue. I had a recurring revenue business and the payment processor acted a little bit shady, which is why I decided to shift away from that specific processor. And they said, "Oh, if you want to transfer away from us, that's going to cost $150,000." And I was like, "What?"

And they're like, "Yeah, it's just a lot of work to transfer all those things over." I was like, "I'm pretty sure it's a button that you click export." But the thing is, is what was I going to do? I had multiple millions a month in recurring revenue across thousands of customers.

There was nothing I could do. It was basically extortion. And so I paid the bill and then I got all my customer information and I transferred it to a more ethical provider. And so I bring these stories up because I hope that you don't have to live through each of these. And so let's get to the tactics for how to actually solve against key vendor risk. And I think this one can be so nasty because it's one of the only times where like the person on the other side of the table says,

has leverage. And if you don't have a good person on the other side, they may use it and they may try to put you out of business or put you just as close to getting out of business as they possibly, I mean, they basically can just blackmail you for your own business. And the amount they can blackmail you for is proportional to how much money you got or at least how much money they think you got.

Alright, so number one rule: always have backups for just about everything that's important. So you want to think about this in terms of acquisition, conversion, product, and then the layer on top of this obviously is processing, banking, anything that you do that facilitates transactions with customers. And so the big solution, and we're going to put this in big green letters, so solution number one is redundancy, right? Now, I want to be clear about redundancy.

Sometimes redundancy looks like waste, but is actually insurance the day you need it. And so think about it this way. If I pay for fire insurance and my house never catches on fire, if I knew for a fact that my house would never catch on fire, then 100% of that money is completely wasted. I literally just flushed the money down the toilet because I didn't get anything for it. If my house does catch on fire, the day it catches on fire, every one of those payments was 100% worth it.

And so I see redundancy the same way, which is that it is insurance against existential threats to the business. And these are the things that I'm telling you when I, now that I have these things in place, it's like one, I have leverage in negotiations, which is probably the more reasonable thing that you get in terms of short-term benefits of having redundancy. The second is that you sleep great at night knowing that your business can't get taken down, at least from the things that you know about. Like, listen, you can't control the unknown unknowns, but at least control the knowns. And if,

if the chickens do come home to roost and you do have that bad day and the bill is due, then you will be grateful that you had this redundancy in place. The second way of doing this is having mutually insured destruction. So what does that even mean? So it basically means that the bigger you get, the bigger

you are as a percentage of their business, the more they need to keep your business and not let you go. Because basically you shift from them being a key vendor risk to you becoming key customer risk for them.

And so it's the shift in power, basically the bigger you get, the more important you are to them. And so there's this saying in the finance world where it's like, if you owe a bank a million dollars, they own you. If you owe a bank a billion dollars, you own them, right? Now, obviously it depends on the size of the bank and things like that, but the saying kind of carries.

Right? And so you want to understand what percentage of the business their business you are. And that way, if they fuck you, they get fucked too. So this is where the size of the person that you're working with can be kind of a double-edged sword. The small guys are probably the guys that are most likely to do the shady stuff. On the other hand, if you become a huge percentage of their business, you have some leverage back towards them.

And so redundancy number one, mutually insured destruction number two, and here's a big one, covenants and terms, which are just fancy ways of saying, what do we agree to? Now, kind of like key customers, because key customer and key vendor are kind of opposite sides of the same coin. So all the terms that we asked from our customers before in the last section for mistakes, we also can ask now as the customer of the vendor. So we say, hey, if you

If you want to stop doing business with us, you have to give us a six or 12 month lead time to letting us know that that's going to occur so that we can find another vendor. So that's number one is lead time. Number two is you can have a breakup fee associated. Now you can imagine on the other side as a vendor, you're like, this guy wants to put a breakup fee on me. My God, this guy's going to be sticky. But at this point, when you have...

Key components of the business that are outsourced, which I fundamentally don't do this anymore because I have been screwed so many times, which is why I think that marketing, sales, delivery should be in-house to a business because it's just too important. Payment processing, it's unlikely you're going to start a payment processing business just to be able to process your own payments, right? There are some things that are going to be outsourced and you have to have trust. Now, one is give the heads up. Two is the breakup fee.

Third is that you have fees or fines associated with service level agreements, meaning you're going to respond to us on this timeline. You're going to ship to us

or raw materials on this schedule. You're going to get us, Leezer, run this amount of ads on this cadence. And when we think about it that way, that allows us to say, if you don't do those things, then you hedge the amount of money that you would have lost as a result of them not doing the work with the fine associates. It's basically a hedge. Now, if you have a vendor, they're going to try and decrease what that amount of money is. But,

them also having transparency into understanding how important their role is, is again, a double-edged sword. One is to understand leverage. On the other hand, if you get the term inside the deal in terms of the cash required from them to make sure that they're doing their job, you cover your downside.

And finally, and this is a bit of like a advanced move, but if you become significantly bigger than they are or you're a huge percentage of their business and they're still important to you, that's where things like aqua hires and acquisitions can be very,

strategic. So you say, Hey, under what circumstances would you like to do what you do inside of our company? Right? Is there a way that we could work together more permanently? And then you permanently align the incentives if they're doing a good job. Now, if they're doing a terrible job, then you have someone to do that. But this is how I think through reducing risk with key vendors who are core to how we make money. And if they were to disappear, so too would our business.

Real quick guys, I have a special special gift for you for being loyal listeners of the podcast.

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