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The Shotgun Breakup

September 3, 2021 |  

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Back in 2006, Michael Kaplan and his partners bought into a Zerorez Carpet and Living Surfaces Care franchise. The business was generating $300,000 in revenue and losing $40,000 a year.

By 2019, the company was generating $17 million in revenue when Kaplan and his partner had an irreconcilable dust-up which led to Kaplan triggering their shotgun partnership agreement. In the end, Kaplan sold for around four times EBITDA.

This story has some fantastic twists and turns, and through it all, you’ll discover:

  • Why Kaplan refers to the “no man’s land” between a start-up and a mid-sized business as “the awkward teenage years.”
  • How to leverage word of mouth to grow your business.
  • The Price vs. Value equation and why getting it right is the key to increasing your Net Promoter Score.
  • The danger of “aspirational” core values.
  • A definition for a “waterfall” distribution.
  • Why it may be time to sell if you feel as if you are “trading misery for dollars.”
  • How a shotgun agreement works and how that’s different from an operating agreement (and why you need both if you have partners).

About Our Guest

Michael Kaplan spent most of his 20s thinking he would go into some sort of law practice. However, he found himself partnering with a friend to purchase Zerorez. After a few stumbles and lucky economic breaks, Michael and his partners were able to scale the carpet cleaning business to 18 million dollars.

Michael Kaplan is now a private equity and angel investor who was part owner and president of the wildly successful carpet cleaning franchise called Zerorez. He is now associated with Red Hook Investments and is actively finding new ways to help small service companies grow.

Michael grew up in Minneapolis, moved to Maine (undergrad) then to Atlanta (for barbeque and bourbon) then to Boston (pondering a Jimmy John’s franchise) then to Minneapolis (law school), where help to turn around the troubled carpet cleaning business.

Over the last few years, he’s been focused on investing in small home service companies, by purchasing a minority interest in their company, providing capital and expertise along the way, and guiding the business to success. He also loves to buy distressed or “stuck” companies, within the home service space in order to unlock their value.

 

Connect with Michael:

Watch the interview

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Transcript

Disclaimer: Transcripts may contain a few typos. With most episodes lasting 60+ minutes, it can be difficult to catch some minor errors.

John Warrillow:

Hey there it’s John Warrillow. If you’re brand new to Built to Sell Radio, welcome. It’s good to have you along for the ride. We’ve been doing this show now for five years. I’ve interviewed literally a different entrepreneur every week for the past five years, and I’ve taken some of their best practices, their tips, and tricks, and negotiation hacks, and distilled them all into a field guide. It’s a book called The Art of Selling Your Business, and it is a little bit of a recipe card for you to punch above your weight when it comes to negotiating with an acquirer. You can get it at BuiltToSell.com/Selling.

Welcome to another edition of Built to Sell Radio, where we help you punch above your weight in negotiation to sell your business. I’m your host, John Warrillow. And today on the show, we’re going to hear from Michael Kaplan. Hey, Michael built a great business. Zerorez Carpet Cleaning and Living Surfaces Care, was a franchise organization that he brought into it 300 grand in revenue, ultimately sold out at $17 million in annual revenue. But that’s not the cool part of this story. Michael had a shotgun agreement with his partner and as he will describe, he had to trigger that shotgun agreement. And he’ll talk you through what’s involved in a shotgun agreement and how you need to structure it to ensure that both you and your partner are protected. And more importantly, the company you built is protected and will live on, past any dispute between you and your partner. So if you’ve ever had partnerships in a business, or you’ve been curious about a shotgun agreement, today’s episode will demystify the whole process for you.

He’ll also talk about the awkward teenage years, which I really related to, in any company where it’s too small to be big and too big to be small. It’s where profits get shrunk. And it can be difficult to get out of. He’ll talk about how they got out of it. He’ll talk about how to create word of mouth for your company and the important role net promoter score played for their business. He’ll talk about the danger of aspirational core values. What are those? Well, Michael will define them for you. He’ll talk about the danger of trading misery for dollars, and when to know the right time to sell your company. Here to tell you the entire story is Michael Kaplan. Michael Kaplan, welcome to Built to Sell Radio.

Michael Kaplan:

Thank you.

John Warrillow:

Zerorez Carpet Cleaning, I think I know what this company does. It cleans carpets, but tell me the story. How did you get involved in this business?

Michael Kaplan:

Right. Largely by mistake. So through a handful of miscues and misturns and proper decisions, I ended up in grad school and didn’t want to practice law, wanted to start or buy the business. And I wrote these lofty big business plans, huge ideas, I’m going to change the world. I realized that was really hard, and that I probably wasn’t qualified to do it. And the first business opportunity I came across that really resonated, where I was like, I can do this, I could wrap my arms around it, was local service. It was a carpet cleaning company I stumbled upon with some friends and we decided we were going to buy it and fix it, and I’d spend three years in operations and then I’d go on and start a private equity firm and try to do turnarounds on a bigger scale.

John Warrillow:

So the plan was to buy this business, Zerorez Carpet Cleaning, and improve it and then potentially sell it down the road?

Michael Kaplan:

Keep it or flip it, didn’t really have that vision, but it was doing about $300,000 a year. It was losing probably 40,000 bucks a year. So the thought was scale it a little bit, bring in some efficiency while figuring out how the business really worked. I didn’t want to be one of those investment banker, private equity types who was just a spreadsheet jockey, and didn’t really know what made a business work, how to work with the people, how to engage with the P and L in a meaningful way. I didn’t want it to just be academic. But it turned out home service can be a lot harder than one thinks. And there were a lot more moving parts than we ever anticipated for sure.

John Warrillow:

So 300 grand in revenue, losing 40 grand a year on the bottom line, what did you find when you got in there? What was the state of the business?

Michael Kaplan:

Well, it’s a franchise. Typically, when one buys a franchise… Say you go out and you buy a Papa John’s, you can rest assured that Papa made a whole lot of pizzas and had opened a whole lot of stores and worked with vendors, and done the media, and done scouting and all that stuff before you shell out the big bucks. Well, this franchise was more of a startup. They had a great concept for how to clean a carpet but some of the details were a little bit fuzzy like how do you maintain the equipment, how you source the product, how do you acquire the customers. So the business model was just a little bit missing. So we came in…

John Warrillow:

To be clear, you bought a franchise, not the franchise [or 00:05:54], but you bought a franchise.

Michael Kaplan:

Yes. Yep.

John Warrillow:

Is that right? And did that come with a geographic exclusivity where you had a patch to work?

Michael Kaplan:

We had negotiated and paid for the State of Minnesota and Western Wisconsin. Turns out that there was a nuance to that, and we ended up reworking our deal a little bit. The franchise sales guy, who was in charge of delegating territories, was also the guy who owned one zip code in Minnesota. So he sold this one zip code in Minnesota while packaging it as this breadth of territory. So it was a little bit a tomfoolery, but we worked it out first couple months, once it became clear.

John Warrillow:

Got it. So you buy this business. How did you come up with the cash? 300 grand is… You’re just coming out of school. You got a bunch of debt I’m guessing. Maybe you did have 300 grand sitting around, but…

Michael Kaplan:

Yes.

John Warrillow:

… I’d imagine it was a tough nut. How did you come up with money?

Michael Kaplan:

Yeah. So I did have a little bit of cash. I was not the lead investor and I wasn’t the person who found the deal. One of three business partners was in real estate development. He had a local or a handful of real estate retail firms, like brokerage companies. He had a flipping company and a title company. So he was the real estate baron. Mind you, it was 2006. So the tide shifted a little bit, come away don’t I? But he was the big boss.

John Warrillow:

So he put in money. Does that mean he… Did you guys split the equity equally, or did he get a lion’s share because he put the cash up, or did… How did you guys divvy up the equity in the beginning?

Michael Kaplan:

We were about 60-40. I think I was 43 and a half when we ended things. But we had a couple of sweat equity partners, and I took a little bit of discount on my cash upfront because I didn’t personally guarantee anything. Again, ’08, ’09 shifted that and equity shifted back. But he was flipping houses and selling houses and moving and shaking, and he’d come by the shop, he’d drink a beer once in a while but the intention was not that the lead investor would have been active in the business.

John Warrillow:

Got it. How did 2008 changed that?

Michael Kaplan:

Well, two things happened. Well, a lot of things happened, but the two meaningful for me were one, our business started blowing up and just going gangbusters, and we got some great press. We had hunted down a newspaper guy, [inaudible 00:08:39] business section in Minneapolis and got some good press. And we did a couple of customers. We had all the phones lit up for about 10 weeks. We just went gangbusters because we were a green cleaning company and was the local feel good story and it really opened our eyes. The other thing, the world fell apart and everything related to housing, mortgages, et cetera, became a dumpster fire. And my business partner was joint in several liability on 20, 25 million of real estate development that was 70, 80% pre-sold, 708, and it went down to 0% pre-sold and he handed the keys back and filed [inaudible 00:09:25].

John Warrillow:

Wow. When you say filed, you mean filed for bankruptcy?

Michael Kaplan:

Mm-hmm (affirmative). And so he was the guarantor on all this stuff. I literally took a discount on how far my dollars went so that I didn’t have to be, but all of a sudden we’ve got no line of credit, we’ve got no ability to buy equipment. Our credit cards get shut down, bank accounts frozen, as we’re doing more business than we’ve ever seen. So we had to start over, do a bunch of RFPs with banks and just run like crazy, trying to convince someone that, “Okay, the balance sheet is not super strong, but look at the trajectory and look at the story,” which, as most small businesses know, is not an easy feat.

John Warrillow:

Why did you need capital? You were up and going. I’m assuming customers paid you. Was it a negative cash flow cycle? How did you get paid and why did you need the banks to fund your growth?

Michael Kaplan:

Well, first and foremost, we weren’t smart enough to have a subscription model. So that was our big… No. That was a plug for you.

John Warrillow:

Yeah, no. I’d take it anytime.

Michael Kaplan:

So carpet cleaning is $300 transactions and you can be a Chuck in his truck and make great money and your margins are better than if you add employees, but you don’t have any scale. Where the awkward teenage years, where you’ve got 3, 4, 5, 6 trucks, the math just doesn’t work really well because to support those trucks, you’ve got enough infrastructure that will suck all your profits. And then once you get to 8, 10, 30, 40 trucks, start scaling all of this on the margins, you come back and you’re just printing money. So at the end of ’08, we had five trucks. We had business booked out about two months, which is not typical [inaudible 00:11:19].

A healthy business cycle would have us booked out about five days where we can really communicate and handle screw ups and surprises. But being booked out weeks was really challenging. So we had plans and capabilities to double the business overnight. We just didn’t have any capital to throw our trucks. Meanwhile, it’s a goofy franchise system where they bring all their water with them. They use electrolyzed oxidative water rather than the typical chemistry and surfactants used in carpet cleaning. So it’s specialized equipment and we were reworking it with new vendors because the franchise or model of building their own trucks, that cost three times the industry norm, was not sustainable.

John Warrillow:

So what do these trucks cost for the special water?

Michael Kaplan:

The franchise or trucks that they were building, they were about 130,000. We reworked them with a company called HydraMaster where all the parts were stainless steel, and it was a little bit overkill, but the water would eat brass and copper. So we said better safe than sorry. We worked them down to about 72,000 with a brand new Chevy included. So all the equipment, all the stickers, wraps, ready to roll.

John Warrillow:

Got it. So was that area of conflict with the franchise war that you weren’t buying their trucks, that you were going outside to buy gear?

Michael Kaplan:

So when we bought the franchise in ’06, like three weeks later, there was a mutiny where franchisees got out their pitchforks. They said, “We’re mad as hell. We’re not going to take any more,” and they’re ready to storm the castle. And we’re like, “Whoa. We just bought this thing. Let’s not burn it down just yet.” So we helped quell the rebellion. We joined all the committees, got on the marketing committee, technology committee, ops committee and donated our time to try and fix this thing in collaboration with other franchisees and the franchisor. So after 18 months of begging, crying, and pleading, we had their blessing to work with HydraMaster to redesign the vehicles and we had the permission to buy one. And HydraMaster had the right to redesign the vehicle for us as long as we bought 20. So there was a little bit of tomfoolery and a little bit of, “Yeah, we’ll figure this out together.” They knew they could sell us a ton of vehicles and we knew we could buy a ton. We just didn’t officially get on the same page for a couple of years.

John Warrillow:

Got it. So where does it go from there? You’re in these teenage years where you got five trucks, not making any money, 2008, your partner files. So what happened to… Is it a guy, your partner, who had 60% of your business? Does he ask for check to cover some of his debts or how did he get out of your business if you will?

Michael Kaplan:

So he didn’t get out, he got in. So he was a majority partner. He was not active, didn’t have a desk, didn’t have the job. Eventually in 2009, he realized, “Well, crap, I got to pay some bills and it’s not going to be through selling real estate.” And so he came in and he hopped on a truck and earned a cleaning commission for a minute. Then he got on a small salary, brilliant business guy, great leader, probably 20, 25 years, my senior, and I’m 26 at the time. I guess, ’09, I had three years. And we were just crappy together, trying to figure out how can we make the most of this thing where we had… So we got that little bit of good press on… We started running really hard and invested in marketing at the beginning of ’09, that started taking off in March of ’09.

And before we know it, business is just continually flowing and as he filed, we had a conversation and we were great friends and just said, “Listen, I’ve got the biggest chunk outside of your chunk. If the government comes for it or the bankruptcy court comes for it, I’m going to make sure nobody wants to buy it.” Because nobody’s going to take on a partnership with a really disgruntled partner. And I said, “I’ll be that disgruntled partner for you.” So it gave him a little bit of security. As far as helping figure things out, we guaranteed a mortgage with him. Nobody wants to touch a person going through bankruptcy and let them buy a house. We figured that out, and it was really collaborative. In spite of the age difference, in spite of the equity difference, we had a great collaboration.

John Warrillow:

Got it. And so to be clear, when he files for bankruptcy, as I understand the process, the bankruptcy court says, “Okay, what are your assets?” And he would’ve had to say, “Well, I own a share more than a half of this thing called Zerorez Carpet Cleaning Minneapolis.” And presumably the bankruptcy court would have said, “Okay, we’ll liquidate that, sell that, so you can pay off some of these other debts to these homeowners,” et cetera. Am I getting it right? Is that what happened?

Michael Kaplan:

Nobody called. I think he put down that it was worth about 20,000 bucks and nobody touched it.

John Warrillow:

Okay. Got it. And so was it worth 20,000 bucks? Was it worth more than that in your mind?

Michael Kaplan:

It was. I mean, we in ’06, the business cleaned about 300,000. We did about 700,000 in ’07. ’08, it was about 1,000,002. And at the beginning of ’09, when things started rolling on the bankruptcy, we were pasting two and a half million that year. So it wasn’t-

John Warrillow:

In revenue?

Michael Kaplan:

Revenue… printing money, but it had legs and had a story that one could tell. So I’d say most definitely, I mean, we had assets worth more than 20,000 bucks for sure. But I think it had enough hair on it that nobody thought to do anything with it. Meanwhile, you think back then, it wasn’t the only bankruptcy in town. There were a whole lot of [inaudible 00:18:20], and I think the courts were strapped, and the bankruptcy supervisors or whatever they’re called, had plenty of play balls in the air that… I don’t know. It was a mess, but it was a pleasant surprise for us.

John Warrillow:

Yeah. So where does it go from there? So you’ve got a couple million in top-line revenue, business is picking up and going well, what happens next?

Michael Kaplan:

We just ran like hell. We tried to figure out how do we stay out of our own way? How do we hire everybody we can and make sure… Carpet cleaning is just that it’s a wonderful, terrible business. I mean, you go into any individual house. You’ve got a residential customer, so they’re, by definition, a pathological liar. They’re asking you to clean something that hasn’t been cleaned, but has been locked down in laundry [inaudible 00:19:20] for 10 years straight. And it looks uniformly bad. It all looks the same. Then you’re going to go in and you’re going to extract the dirt and show them all the problems, because there are traffic patterns where the fibers used to be super tightly wound. Now, they look like that. So they look darker.

You’ve got the areas where the dog used to pee, so that’s discolored, and the spaghetti got thrown, so that same. So now it looks totally different. It looks a lot worse a lot of times. And you do that time, and time, and time again. With labor that’s, a 20 year old millennial, it’s pretty challenging, I think. So we had to learn quite a bit about how to communicate very well in advance of finding problems, how to sell aggressively well, having people still hug us and love us, to make sure that the value exceeded the price while maximizing the price that we could. And doing this while trying to figure out how do we leverage the hell out of ourselves and buy 10 trucks a year without really knowing do the customers like us, will they call us back?

So it had a handful of gaps in the system that we had to figure out. So we had to really learn, on the employee side, how to define what the box was that a great employee would fit in and really make sure that we only hired people that fit in that box. At the beginning of ’09, there were doctors and lawyers and professors that were out of work and we hired all thinking, “Well, he’s a PhD. He’d be great on our truck. He’s a great communicator.” Meanwhile, he hates every minute of it and lothes going into work. He’s not going to offer great customer service. You need like a former landscaper who’s just great with people and loves not working in the snow. That’s a great employee. So we had that [running 00:21:23].

We found a company called Listen360 that did net promoter score surveys that helped to answer the, do our customers like us, question. And we’re spending 720,000 bucks a year buying 10 trucks a year without really knowing is our crazy scheme of, okay. We pay too much for customer acquisition today, on the hopes that we can really engage them for a 50 cent postcard tomorrow. We didn’t really know, do they like us. But Listen360 and net promoter score helped us identify, okay, we do have room for improvement, but they do like us, and they probably will call us back. And the business got a whole lot easier, a handful of years down the road as those masses started to cycle back through [inaudible 00:22:08].

John Warrillow:

Yeah. So net promoter score, I’ll just define that for our audience. For those that don’t know, Fred Reichheld developed it, wrote a book about it, wrote a number of books about a scale zero to 10, how likely are you to recommend this company, your friend, or colleague is the question you ask your customers, you bucket your customers into a nine or 10. Those are your promoters, that gives you a nine and 10 on that question. The sevens and eights are called passives [inaudible 00:22:31] detractors. And I believe a world-class score is 50% or greater.

Average is 15% net promoter score when you subtract your detractors from your promoters. And the average is 15% across all companies, all industries. And I think world-class is 50% plus. So when you first got your NPS, what did you find? Where were you at?

Michael Kaplan:

72.

John Warrillow:

Wow. So amazing. And so what Rakel would tell you is that two things are going to happen when you have a net promoter score of that high. One is people will repeat purchase, they’ll come back to you, and second, they will refer you. So did those two things happen for you?

Michael Kaplan:

It was a wonderful and amazing blessing. We had no idea what to expect, but we had probably 35% give or take of a past… or customers that just had service taking the survey. So we felt like we were getting a good sample and we had an amazing score. We always subscribed to the notion that good’s the enemy of great. And so, we obsessed about it. We used it to be a significant portion of our pay plan for our service technicians and just dove into the data. The cool thing, not that this is a Listen360 commercial, but that particular software would let you dive in behind the numbers and say, “Okay, under these circumstances, or from these referral sources, or from these technicians, you have these variables.”

And it really chopped up the data in some interesting ways where, when people bought more, you got higher customer service scores, when people bought the minimum, we had the worst customer service score… net promoter score. Because in theory, people were… We took the approach, if they’re not buying, I’m flying. There’s just no communication. They judge the house, or judge the people, or were in a rush. They did a service minimum, and it was tough to have value exceed price. But if you’ve got price exceeding value, it’s really tough to have somebody say, “Boy, that was a great experience.” They say, “Damn, I didn’t buy a lot, but that was expensive.” But when you flip that equation, no matter how much people buy, if they got love and care and really felt that you did a great job it becomes more memorable and easier to give you a higher score.

John Warrillow:

Yeah. Great point. So many questions around net promoter score. So you mentioned you tied your employee compensation to NPS. How did you avoid employees gaming the system? We’ve all been on the other end of that, where someone says, “Look, I’m going to send you a survey. And if you like me, make sure you score me a 10 because my bonus is contingent on it.” So you run the risk of getting gamed. How did you avoid that?

Michael Kaplan:

And we run into this. Before I left, we had six locations, and our Omaha location had like a 93 or 94% net promoter score, and who knows what they were doing. We worked on it. We tried to de-incentivize it, we tried to prioritize and spiff around other elements of quality. And it was a little bit out of sight out of mind, because it was in Omaha. And it was really tricky, but in our primary location, we really tried to talk to customers, we really tried to have close communication with the technicians and make sure that they had, not just a pay plan and not just incentives, but really they had a why for what they were doing and our core values reign supreme for the most part. So it just required lots of communication. And any time you smelled something funny you had to dig in, or have somebody make sure that they really wrapped their arms around it.

John Warrillow:

How do you come up with a why, cleaning carpets? I mean, all due respect, it’s not a sexy business, right? You’re cleaning carpets. So how do you get people excited about cleaning people’s carpets?

Michael Kaplan:

So we had a really cool set of core values. And one of the speeches I was asked to give at a new employee orientation was about the core value called live deliberately. And what I would say is, listen, we’re not crazy. We understand that most of you, many of you, may not be here 10 years from now, and that’s perfectly okay. This can be a launching pad. For those who are here 10 years from now, that’s awesome. We hope that it’s very fulfilling, but it’s not about the act of cleaning. It’s not about the sales, but if you want to be a professional guitarist, you want to be a writer, you want to be a salesman for Medtronic, that’s great.

Utilize your opportunity here and your time, garner some skills, and learn how to talk to people, learn how to be in new environments, and how to sell some stuff, and make some money to support the things you’re wanting to be doing. Wake up every day with purpose and say, “I’m going to be the person I want to be today,” and build yourself up and follow the golden rule. And that kind of language and mentality beat into their heads day after day, helped provide a why. And we gave our team members, great autonomy, people in the field and people on the phone, to make their own decisions and that empowerment.

They could call up the office and say, “Hey, this lady, she has emphysema and the reason she’s getting her carpets cleaned is for better indoor air quality, what can we do for her?”, “Well, let’s clean her air ducts for free, or let’s clean her carpet for free, or let’s tell her the next one’s free.” And finding ways where they can do good in spite of it just being carpet clean.

John Warrillow:

Mm-hmm (affirmative). Got it.

Michael Kaplan:

And a huge part of most people’s enjoyment of work is culture and community. And you can’t spell culture without the word cult. And we really focused on… It wasn’t necessarily mission-driven, but we were really obsessive about presenting themes to the team. And we were providing a service, so it was really helping people. We were saving the world, one carpet at a time. We were obsessing about growth for good. That was another of our core values where we weren’t just growing bigger and acquiring more customers or more locations for profit. Yes, profit is a requirement of every healthy company and we ingrain that in our team, but growth for Goodman that we’re trying to find more customers and spread more happy, so that Rick, who’s in the phone room, someday might run a phone room in Poughkeepsie, or Sally who’s on a truck, cleaning carpet, might be running a team of people who runs trucks in Omaha. We got people fired up and they felt like they were part of something.

John Warrillow:

What impact do you think codifying your values had on the growth of your company?

Michael Kaplan:

I think it’s huge. And honestly, my belief in those values is why I blew up my life and sold my business. And I’m sure we’ll get to that, but I think it was a massive part because it gave everyone a compass, and not just a moral compass, but it helped them figure out how to do what the job they were being asked to do really meant. I mean, you can have a robot sit there and answer phone calls, but you can do it more efficiently online.

John Warrillow:

But how [inaudible 00:30:57] each people…

Michael Kaplan:

Oh, go ahead.

John Warrillow:

No, I was just going to say, how did you make it real? I’ll come clean. I’m heavily skeptical of values. I’ve read Jim Collins work. And I know that vision and values are critical, et cetera, yet I see so many bad examples of execution, right? People have got the teamwork poster with the rowers in their boardroom and trustworthy, and I see so many terrible executions of this concept that I become jaded about it. So I’d be curious like how did you make it real for people and actually work?

Michael Kaplan:

Well, I think you’re absolutely right. Aspirational values are so destructive. And Patrick Lencioni has a couple of great articles about it. If you’re a team of accountants and you’re not a fun workplace, and you have a core value of work hard, play hard, it’s grown worthy and it’s destructive. But if you can really teach people and champion people around values that really describe what the team is, it has an amplification effect because people have the vernacular and the language to be able to talk about the things that are already important to the team. And so when you bring Sam, the new guy, in, all of a sudden, the people have the language to be able to say, “Hey, here’s how we do what we do and this is why.” And so it gives them the tools to express the things that they already believe. So aspirational values [inaudible 00:32:46], values that are guiding principles and describe a team that everyone can champion because it’s at the core of how you’re already operating. Those can be really powerful. I don’t know if I used any words that made any sense, but…

John Warrillow:

Yeah. I know. I think you did. I think it’s a great distinction between… Again, and you said eloquently, aspirational values, which are things you hope to be versus what you are and just articulating what you are for good or for bad. I love that.

Michael Kaplan:

One quick anecdote, we had guys at one of our shops who would… You got six trucks out, five of them come back, they’d hang around, they play basketball, and they drink a little bit of beer and when the last guy would come home, they’d help him break his truck down, or someone would go out and help them finish his job. And they’d come back and one of the managers would say, “Oh, thank you.” And they’d give a high five and they’d say, “Team is family bro, of course.” And it’s just like, team is family. That’s one of our core values, but they’re living it because no man left behind, was the concept.

John Warrillow:

Love it. Good. So where are you at, in your journey here? So how big is the company when you start to turn your attention to selling it? How many employees, how many trucks, revenue? Any proxy for size, it would be helpful.

Michael Kaplan:

We peaked at six locations. We had probably 180ish employees and probably 17, 18 million in top-line revenue.

John Warrillow:

Wow. This is a long way from where you were with five or six trucks. That’s incredible.

Michael Kaplan:

Oh, we created all kinds of problems along the way, but it happened by accident that we opened up Omaha. We had employee who said he had a ton of money through an inheritance and he was going to go out there and asked us to be a tiny investor and help him along the way. Turned out that we were the lead investors and we helped him along the way. But that was fine. And that vetted the model and we realized, “Well, crap, the things we thought we understood, we might actually understand.” So then we hired a company called Diedrich RPM, and they went out and did surveys.

They did online and phone call surveys of thousands of people in 10 different markets that we said, “Well, we think these might be the right markets. And we think this might be what the magic in Minnesota is.” And we weren’t really sure. So we surveyed Minnesota and still it turned out that we were able to quantify what the mojo was and we found markets that aligned with the psychographics and demographics in Minnesota. So we ended up moving the business into St. Louis and Pittsburgh, and had options on a couple other markets as well. We bought Charlotte and Savannah as well.

John Warrillow:

What did the research tell you about the psychographics you were… You were looking at homeowners in these markets and trying to understand how they think, is that what the research was?

Michael Kaplan:

Yeah. As well as, do the major metropolitan areas have basements, more basement, more carpet, more square footage. So colder markets, we’re good. We liked greener markets, educated markets. We wanted markets that were big enough, but small enough. So our magic media outlet was radio as weird as that is, but we bought a ton of radio and having markets that outside of that survey, we went out and met with radio reps, set a bunch of stations that really understand how efficiently can we buy. Are there good programming? Things that align with the things that we believe make a good radio buy, as well as just the… In Minnesota, there’s that Scandinavian tendency toward clean where your mother-in-law’s going to yell at you if your house isn’t clean. And we looked for a little bit of that, how do people prioritize their home? And…

John Warrillow:

That’s fascinating. So you got to 17 million revenue, again, what’s the ownership structure at this point? So is your former real estate buddy still the majority shareholder, or owner, or where’s the equity at, at this point?

Michael Kaplan:

We liked partnerships, we liked strategic partnerships with the right people. One, because it’s really fun and two, because you bring the right people into the room and magic can happen. And if they know what they’re doing in their area of expertise you can lean on them to better yourself in the organization. So in Omaha, we had a diverse investment group where franchisee from Des Moines joined because of proximity and whatnot. And he was interested and we brought along our general manager. When we opened up Pittsburgh and St. Louis, we actually negotiated with the franchisor. They were looking to raise some money and the capital markets and debt markets were not kind to them. And we said, “Hey, give us more equity in what we’re doing and we’ll be your lender.”

So we gave them a little over a million bucks. They stopped charging us royalties, and they gave us the right to open a handful of locations without paying a royalty. So we went to a handful of investors and raised some money. We kept 50% of the equity between me and my partner in Minnesota. And we charged them royalty to pay off the loan that we borrowed money to give to the franchisor. So convoluted circumstances, but everyone was tied in. The lead investor in the Pittsburgh, St. Louis expansion was my business partner’s son, which had all kinds of complications. One of the roles-

John Warrillow:

You have [crosstalk 00:39:06] for punishment, man.

Michael Kaplan:

Oh, man. Eyes wide open, right? Now. But we said, no friends, no family, no waterfall distributions, no repayment of invested capital. We’re going to be 50% partners up front and here’s the deal. And then my business partner’s son gets involved and all those rules go out the window and we start negotiating who has what, and the waterfall distributions going to look like.

John Warrillow:

Sorry. Can you just explain what a waterfall distribution is?

Michael Kaplan:

So typically if we’re 50-50 partners you and I, in this business we just started, the distributions come out 50-50. A waterfall distribution would prioritize certain payments over others. So if you put in $10 and I put in $0 into the business, a waterfall distribution may say the first $10 that comes out of the business goes to repay the money that you put in. We said, “Well, we’re not going to do anything like that because we’re putting in our acumen, our time. We’re making the thing happen and we think that the market will provide an equity investment on those terms.”

Well, when family got involved those priorities shifted. My partner said, “Well, we got to be fair.” And I had enough going with my business partner that it just… I won’t say I caved, but I didn’t negotiate hard and said, “Okay. It’s more important keeping our relationship healthy than it is getting a couple extra points or a couple hundred thousand dollars on this distribution scale.”

John Warrillow:

I mean, in the early days, the business was thirsty for cash and you were buying these trucks and taking on debt to do that. As you grew, were you ever able to get to the point where you were taking distributions out of the company?

Michael Kaplan:

Oh, for sure. Come 2009, we started making a decent wage. It was not a good wage, but it started to grow. In 2010, we really started being able to, on a monthly basis, pull money out. And the value of depreciating assets really can help the balance sheet and a tax return. So because we’re buying all these trucks, and we’re leveraging it, and we’re cash flowing decent on top of that, we made, I would say, pretty good money along the way.

John Warrillow:

Got it. Okay. So you’re growing, you’re at 17 million in revenue. Did you have a sense of what the company might be worth? Did you do any back of a napkin sort of calculation as to what you thought the thing was worth?

Michael Kaplan:

We had conversations, we bantered about it. We had gone to a handful of seminars about exit strategies and things like that put on by investment bankers, you want to find middle-market companies that they can charge exorbitant fees too. And I spent enough time that I had a sense of value and-

John Warrillow:

What’d you think it was worth?

Michael Kaplan:

I assumed that it was worth somewhere between either three to five times EBITDA or one times revenue minus debt. Those were the two metrics that I had in mind. And when I exited, I ended up probably about four times EBITDA.

John Warrillow:

Got it. Okay. That’s helpful for sure. So where does it go from there? You’re going gangbusters, you alluded to this notion that you blew up your life and sold your company. So what triggered that?

Michael Kaplan:

So we had these values that were near and dear and really impactful on how we operated the business, how we trained people, who we brought in. We were subscribers to the ELS or traction model in running our business. And one of the key principles there is a people analyzer. And you look at, is the person the right butt in the right seat? And you look at, do they get it, do they want it to have the capacity to do the job, GWC? And then you look at their alignment with core values. So we’re assessing our people every day based on core values. And there was a shift. And I can’t pinpoint the moment exactly, I can pinpoint moments where my relationships started breaking down with my partner, but I don’t know the exact moment or whether there was a catalyst, but the theme that kept coming up with my partner and misalignment with our leadership team was that… And the old joke was that, that he subscribed to our core values, but there was always an [asterix 00:44:27].

There was but if. And I’m not a purist that says, “Well, the core values can only be read one way, but when team is family, applies most of the time, unless it’s one of my drinking buddies or a commitment to wow, unless we can make more money by screwing that customer, it starts becoming a problem. So I had a handful of really frank conversations. We beat it up plenty of times on some bad behavior and misalignment with core values, happened at the end of ’16. And I finally said, “Listen, this is really hard for me, but I feel like I’ve coached and I’ve brought this to the table as many times and as many ways as I can. I’m going to do the best thing I know how to do that isn’t blowing up the business, because I don’t think that’s productive for anyone. I’m going to step out of operations. I’m going to let you run the business. I will still play a pivotal role on the marketing team on the finance team and we’ll still have our EOS meetings with the COO and the owners, but I’ll stop coming in.”

And it was phase one of blowing my world up. I was raising this child. I had the business before I had babies and it really was my first born and I sent it to foster care to try and do what was best for the company and do what was best for the relationship. And it was really tough doing that and I was confident that we could make it work or that it was at least worth trying. And things got worse because I think my partner felt abandoned, then things got better as we rekindled and started making good progress and fighting for things. Then at the beginning of ’18, there was a handful of events stemming around a Christmas party that…

We always did our Christmas party a little bit late, after the holidays and whatnot. Did in January and shit hit the fan at that point. And leadership team wrote a letter saying, “Listen, we’re not behind this guy anymore.” I had frank conversations about it and it said, “Listen, we’re going to lose people if we don’t do the right thing. You got to see it from the other perspective.” And without getting in the details, it was just important behavior that was, not by my partner, but backed up by my partner, and the perspective he took was, “Well, if people don’t like it they’ll leave. I don’t have a problem, what’s their problem?”

And I started reflecting and realized I had asked myself plenty of times, “Is he a good person who does some bad things or is he a bad person acting accordingly?” And I won’t say a bad thing about him. He’s a brilliant guy, does a whole lot of good, but I think the misalignment with the core values, the misalignment with the leadership team, and the realization that I was treating misery for dollars, and probably we should have broken up years prior, that just became at the forefront of my thinking. And I thought, “You know what? I’ll leave money on the table, but there’s a million ways to make a million dollars. I’m not worried about it. I want to be able to hold my head high and process matters,” how you do it matters.

And so I had the tough conversation and said, “Listen, our operating agreement is structured with a shotgun clause. And it allows me, when we’re at an impasse, to say, “I think we’re at an impasse. We’ve got 30 days to remedy it. Otherwise, I’m going to give you a number and that’s the valuation of the company, and you can be a buyer or a seller.” And I got, [inaudible 00:48:42] for going that direction and set up plenty of meetings, some of which were skipped and some of which were just not productive.

I didn’t get a single piece of feedback that would have remedied the situation. There wasn’t a creative idea presented by him. And so I gave him a number. And honestly, I thought I’d be a buyer. I didn’t put the number purposely higher or purposely low. I put it at a point where I thought there was fair value exchange and enough leeway that the company would survive because it’s my legacy and his legacy. But in hindsight, it makes perfect sense that he was a buyer because at a certain age, kids are out of the house and most of your friends are at work and you drink in the shop after work every day, and it’s just your buddies. I don’t know what a bunch of money would have changed, but not having the environment, and the friends, and the drinking buddies definitely would have been a change for my partner. So it made a lot of sense that he was a buyer.

John Warrillow:

Okay. So for folks who don’t know what a shotgun agreement is, effectively, you triggered the 30 day window where you attempt to make… you try to remedy the situation, but in the event that doesn’t happen, you, the person who triggered the shotgun, needs to put a value on the company, and then the other person needs to decide whether they are willing to accept that amount or buy the company for that amount. Have I got that about right?

Michael Kaplan:

Absolutely. It’s a really fair way to manage a breakup that is not amicable because it’s the negotiation of what things are worth, who’s going to buy, who’s going to sell. It takes it off the table and it puts the burden on the person causing the breakup, or it’s triggering the breakup to put a value that they’d be willing to buy it and willing to sell it. And then it puts the decision in the other person’s hands.

John Warrillow:

Yeah, this is great. I’m glad we’re here. So you arrived at this number of around four times EBITDA, is that right?

Michael Kaplan:

I did. Yeah.

John Warrillow:

Got it. And so where did you get that number from? Why did you choose that?

Michael Kaplan:

Well, it struck me as reasonable, it struck me as something I could live with as a buyer or as a seller. I think that he would have been a buyer at a higher number. I think I extracted fair value at that number. And it was something that I thought that he could take too. He didn’t have millions of dollars just sitting in his piggy bank. So I thought he could get loans, I thought he could find strategic investors or retail investors and it’s something he could sell. My goal was not to cripple the company, to stick a knife in anyone’s back, or to give the screw you. It was something that struck me as really fair and that… I didn’t have the million sitting in my bank account. I would have been getting loans, I would have been looking at strategic investors. It was a story that could be sold at that valuation.

John Warrillow:

Mm-hmm (affirmative). Yeah. Shotgun deals, what I’ve come to learn about them is that they can be really fair if both partners that are at similar stage in wealth, if you will, and can be less fair if one partner is poor and the other partner is rich, because they can take advantage of the fact that the poor partner won’t be able to raise the money unless the business itself is bankable. And your case, it sounded like the business was to some extent bankable. So your partner could raise and get debt.

Michael Kaplan:

And there was an expectation that there would be a willingness of either party to carry some debt, and we had that conversation, and that was in the context of my partner saying, “Well, the people who don’t like it we’ll pick their shit up and go.” And when that was said, I said, “Well, you’ve expressed a willingness to buy. If that’s the approach you’re going to take, I’m not going to carry any debt because that’s just so inconsistent with how we operate and my money is at risk if I’m carrying debt and that’s how you’re leaving.” And he said, “Okay,” which was just fine for me. I got paid sooner.

John Warrillow:

Mm-hmm (affirmative). That was going to be my next question. You arrived at it at what you thought was a fair offer. Did part of that include structuring by which time you would get the money? Was it 100% four times EBITDA upfront, or did you agree to take some of that money over time?

Michael Kaplan:

So with that conversation that we had about the lack of recognition of the issues and the lack of willingness to trying to do the right thing for the employees, it was clear that I was a seller at that point and the conversation was very straight forward that I wasn’t going to carry any debt, and I’d be paid upfront. The nuance and the challenge in this deal was less about structure of payments. It was about all the ancillary stuff. When I finally left, there were five [inaudible 00:54:38] left. We had sold a Savannah a little bit prior and we had a real estate firm, or a real estate investment, that was an 87,000 square foot building that the Minneapolis location lived in with a below market rental rate and that’s great when we’re both benefiting as partners in the operating business, but as a real estate holding, it’s crappy to have something that doesn’t make much money because the operating company is sucking out if you’re not involved in the operating company.

The other nuance was we had a company that scrapes our royalty off a handful of locations, and it’s got no employees, it’s got no customers, but it prints money. And so, negotiations around those two types of things were tricky and confrontational, and were the bulk of the challenge. Once we came up with a number, or I came up with a number on the Minnesota sale, the Pittsburgh, St. Louis, Charlotte sale, that number I picked out of a valuation we did by a firm called Redpath. A handful of years prior, it was an extremely low number, but it was a decent placeholder and absolutely could extracted more money but at that point I was just done. It was easier to say, “All right, this is not close to fair, it’s low and it’ll get approved.” And there was no conversation about it. It was, “Yeah, sure. I’ll take that number.”

But I didn’t have any level of comfort of being a silent minority in businesses out of state where I had no influence. So that part of the conversation is not a great lesson for the the podcast folks. Don’t just blow things off and say, “I’m sick of this. I’ll take a low number.” But it wasn’t a number that was going to move the needle relative to the other sale. It had to get done and I was able to extract value relative to having put $10,000 into growing a business. I got hundreds of thousands from selling that business line, but it was ancillary to the bigger deal and not a throw away, but it didn’t get a lot of attention because we had enough sticking points that were bigger numbers that I had to get figured out. So for me it felt like an easy give.

John Warrillow:

Michael, one of the things that I’m curious about is you sound like someone who is a very principled individual for whom your core values, in your own admission, were central to the success of your company. And when your partners basically said, “Okay, I’ll be the buyer and you are going to have to leave,” you knew you were leaving the company in someone’s hands for whom the values were, at times, less important to him. What was that like? To know you were getting paid, which must have felt great, yet at the same time, no, you’re leaving your baby in the hands of someone that may not feel quite as passionately about the values as you did?

Michael Kaplan:

It was really bittersweet, or… I don’t know if sweet is the right word. It was hard. The team that we had built up, I knew that my legacy would live on and those who were going to judge me had proudly judged me a long time ago, and those that were really ingrained in the culture and were really running the business, I wouldn’t say they were disciples of mine, but I think they bought into the values. And so, I knew that many of them would live on, but over time, those people are going to cycle out and you’re going to have a new set of values, or maybe a diluted set of values, or…. It’ll be different by definition because I’m not there. And it was pretty hard. And seeing 50 trucks drive by…

My daycare was three blocks from the office. And so, I would be driving by as the trucks are leaving and I see a parade of these Zerorez tracks, and that was tricky. It stung for a fair amount of time, but the benefit of exiting and focusing on doing things my way… I started a private equity firm, I invest in turnarounds, I invest in home service companies as well as buying home service companies outright. And I’m having a ton of fun. Exiting was fantastic for my PFS, it was fantastic for my sanity and my family and-

John Warrillow:

Sorry. PFS stands for personal financial statement?

Michael Kaplan:

Yes. Yeah. So I’ve done very well and been blessed in many ways. It’s the one that got away. It’s the girl you dated in high school kind of thing, but it stopped. But at the same time, all things happen for a reason. I’m just thrilled with where things have gone. And on my next rodeo, I’m better informed. I’m picking up on, choose about personality traits quicker and finding the right partnerships. So there’s a whole lot of benefit and I think, I definitely would have… If I were doing it again, I would have done it sooner, and then probably left more money on the table.

John Warrillow:

Why do you say that?

Michael Kaplan:

The part about doing it sooner or about leaving more money on the table?

John Warrillow:

No. [crosstalk 01:01:25] both really, but I’m just curious as to why you would have done it sooner.

Michael Kaplan:

Well, the thing that had me delaying was twofold. One, doing an assessment of the character that people I’m working with. And hindsight, I think I’ve assessed that character and it’s not people I want to be in business with. And so acting on that quicker would have been better. And secondly, the trading misery for dollars and saying, “Okay, well, it’s too messy to break up. Even though this isn’t fun, even though this is really challenging, and there’s all this interpersonal crap and high school drama going on, I’ll stick it out because it pays for my kid’s daycare.”

That financial entanglement and saying, “I’m going to actively not make a decision,” is a decision to stay put. And I think that I’ve evolved. I’m more mature and would say, “You know what? I can figure this out. It’s going to be painful and take a little bit of time, but waking up, thrilled to do what you do every day, is the most important thing you can strive for, and I have the opportunity to do that. I just have to go through some crap to get there.” And I probably would have pulled the trigger in 2016 if I were rewriting the script.

John Warrillow:

I’m glad you mentioned rewriting it because I want to make sure, before we close, that I ask you a simple question around structuring a shotgun clause, because I think we’re going to have a lot of listeners listening to this saying, “I’ve got a shotgun agreement. I’m thinking of going into business with a partner. I should have a shotgun agreement.” You’re also someone who’s gone through law school. So I’d be curious, from your perspective as having lived through this as well as understanding the theory and the academic side of it, what should people be thinking about if they’re going to structure a shotgun agreement as part of an operating agreement?

Michael Kaplan:

Well, I wouldn’t structure the operating agreement around that clause, but what I’d really think about is, all right. So often I hear the story of, “Oh, we’re best friends. We’re going to get into business together. Oh, we’re husband and wife, we’re going to get in business together.” Think about what happens when you disagree, what happens when you’re not best friends, what happens when you’re at each other’s throats? With your cooler heads today prevailing, what would be a fair way to resolve that conflict? And be sure to have an operating agreement, for sure. Operating agreements, the rules of the game, and I always use this terrible analogy, but I can’t help myself. So growing up, we played the heck out of the monopoly and we always would take 500 bucks and put it in the middle. And whoever landed on free parking first would get that 500 bucks, and all the taxes, and luxury tax, and property tax, and all that stuff went in the middle.

Before you know it, there’s a thousand bucks in the middle and most people don’t play that way. Some people do some people don’t. But if you don’t work that out before you start rolling the dice and moving around the board, you’re getting out of a conflict, right? You’ve got to work those rules out about how the business is operated before you start operating the business. Otherwise, you’re going to run into a challenge and you’re going to say, “Well, we’ve got $5000 in the bank. Should we distribute it? Well, let’s fight about it.” Maybe one person thinks you need 50 grand in the bank before you start distributing. I mean, what is the mechanism for that type of decision? What’s the mechanism for figuring out how do we define who gets paid what? How do we define what happens if there’s irreconcilable differences? Those sorts of things.

So the operating agreement is an invaluable tool to map things out before you’re in, over your head, how you would resolve a bulk of categories of conflict, including breaking up. So thinking specifically about that shotgun clause, just making sure that you’ve got… It’s not about trying to put the pressure on someone to break up, it’s really about trying to not break up. And the key element of the shotgun clause for us was, there’s a 30 day cool off period that says, “Hey, I’m really serious and I have rights if we don’t figure it out.”

And my partner lacked the willingness to engage in that conversation about figuring it out. He said, “You got a problem. I don’t.” That was my answer that this is absolutely the way we should be going. And under better circumstances he would have said, “Okay, I will take one of the five options that you’ve laid out, or I will present new options about how we resolve this conflict, because clearly it’s important to you, Michael.” But yeah, came up short of that. So it was time to go.

John Warrillow:

Got it. That’s super helpful. And certainly, for my own, the difference between an operating agreement and a shotgun agreement, well, what I’m hearing you say is that a shotgun agreement is part of an operating agreement. It’s the area where you’re talking about, “Okay, if all else breaks down, here’s our remedy for breakup.” But there’s lots of other things that should happen as part of an operating agreement, including how you handle distributions, how you handle conflict, et cetera. So hopefully you don’t have to trigger the shotgun in the first place.

Michael Kaplan:

Absolutely.

John Warrillow:

Well, see, given free legal advice. Nothing in this episode should be considered as legal advice. Call your lawyer, call your dentist, call your doctor or whoever you go to for advice, but don’t consider this legal advice.

Michael Kaplan:

Exactly. My friends often ask me why I didn’t take the bar. And I said, I don’t want to be accused of being a lawyer, like, [crosstalk 01:07:30]. But no, talk to your attorney, but plan in advance, and plan for the blue sky, but plan for the cloudy sky as well. And I think that’s the value of an operating agreement.

John Warrillow:

Well, this has been a fun experience for me, and I really appreciate you sharing in such candor. Michael, where can people learn about you? If they wanted to reach out and say hi on… I’m assuming LinkedIn is the best place. Just give us a sense of where people can go to find you.

Michael Kaplan:

You can find me on LinkedIn. It’s Michael Kaplan and I’m in Minneapolis. You can also check us out. We’ve got a company called RedHookInvestments.com. And RedHookInvestments.com talks about some workshops we put on, talks about our turnaround business, where we all fix businesses. It’s not so much consulting as we look to fix broken things, buy things, or find ways to collaborate, or bring people into our network and jam about small business. So it’s a whole lot of fun. You can find us at RedHookInvestments.com.

John Warrillow:

Awesome. And we’ll put that in the show notes at Built to Sell Radio, well, builttosell.com. Michael, thanks for doing this.

Michael Kaplan:

I really appreciate it. It’s been a ton of fun.

John Warrillow:

Hey, if you liked today’s episode, you’re going to love my new book, The Art of Selling Your Business. The book was inspired by the cohort of my guests over the years, who’ve been able to negotiate an exit far better than the benchmark in their industry sometimes two or three times more than I would have expected. I was curious to understand the tactics and strategy of these entrepreneurs and what they do differently from average performers. The result is a playbook for punching above your weight when it comes to selling your business. To learn more, go to BuiltToSell.com/Selling, where we put together a collection of gifts for listeners who order the book. Just go to BuiltToSell.com/Selling. Built to Sell Radio is produced by Haley Parkhill. Our audio and video engineer is Denis Labattaglia. If you liked what you’ve just heard, subscribe to get a new episode delivered to your inbox each week. Just go to BuiltToSell.com.

Outro:

Thanks for listening to Built to Sell Radio with John Warrillow. For complete show notes, with links to additional resources, visit BuiltToSell.com/Blog. John is the founder of The Value Builder System™. To find out how to improve the value of your business by 71%, visit ValueBuilderSystem.com. John is also the author of Built to Sell: Creating a Business That Can Thrive Without You, and The Automatic Customer: Creating a Subscription Business in Any Industry. Connect with John at Facebook.com/BuiltToSell, or on Twitter @JohnWarrillow, W-A-R-R-I-L-L-O-W. Thanks for listening.

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