What is the purpose of the company? What is the goal?
Dumb question. It’s to make money, right? Unsurprisingly, how you answer this question determines your strategy which largely determines your outcome. If we are being honest with ourselves, how many of us have asked this question let alone really thought of the answer?
Make money. Generate wealth. Tomatoes, tomatohs. What’s the difference? The difference is subtle but super important. If we agree that the goal is generating wealth, then we can do that by
1/ maximizing cash flow for distributions
2/ maximize valuation for an exit or
3/ some combination of both.
The goal of ‘making money’ often leads to maximizing cash flows. And while there is nothing wrong with that, the issue is whether you are maximizing cash flows at the expense of maximizing valuation.
Just as not all customers are equal, not all cash flows are equal. Cash flows are valued differently by investors. By investors I mean acquirers and minority investors.
Steady, secure, durable = good.
Lumpy, sporadic, volatile = bad
Controllable, manageable, forecastable = good
Reliant on other entities, hard to forecast and manage = bad
Growing = good
Stagnant or declining = bad
So, in thinking about how to generate wealth, you have to think about the balance between distributions and valuation increases based on how your cash flows will be judged by investors.
Q: What about realizing my vision and making the world better? I am not doing this just for money or wealth, I want to…
A: You can’t do good when you’re bankrupt. The better your company does, the more of your mission and vision you can achieve. So mission has to come second.
Home Depot and Nardelli
In his book, I Love Capitalism, Ken Langone, one of the co-founders of Home Depot, describes what happened to the company’s stock price during the tenure of Robert Nardelli. He doubled revenues, massively cut costs and more than doubled earnings. But investors didn’t care judging by the stock price. As you can see in the table below, Lowe’s was able to double their share price over the Nardelli tenure while Home Depot shares performed far worse.
So earnings dramatically increased, but investors perceived the value of those earnings to be much lower and stock performance stagnated. For reference, HD closed May 8, 2024 at $345.
Let’s look at Ferrari. As Benedetto Vigna, the CEO recently said, Ferrari is really a luxury brand. And they have played luxury as well or better than anyone. It’s simply incredible how much they make from selling so few units.
Ferrari shipped 6,000 more cars last year than it did in 2015, the year it went public. While that was a 78% increase in units and a 113% increase in revenue, it was an impressive 342% increase in Net Income. How did investors like those cash flows? They increased the share price 555%.
So, how do you think investors view cash flows powered by lots of META ad spend fueled by expensive short term debt?
My goal here isn’t to disparage customer acquisition or paid social. I am not saying to ditch paid customer acquisition! My goal is to help founders and leaders who want to generate wealth through building a brand to re-think how they are doing it.
The argument I am making is:
Finding this balance requires important changes in thinking, new metrics and new processes. It will require discarding (or at least de-emphasizing) metrics like ROAS and MER and analytical tools like cohort analysis.
Preston Rutherford formerly of Chubbies has a masterclass on this. His posts are fantastic insights and examples of lived experience in how he and the team came around to this balance.
Changing will be hard. Inertia is STRONG.
But the benefits are massive because you will be building a machine that is not only more efficient and stable, but also able to grow sustainably. And ultimately, this will be valued more by investors.
Q: Is it one or the other?
A: No. But I do think building a brand and specifically focusing on your high value customers (future posts) is a very different mindset than ad spend fueled growth. Balancing the tension between these personalities and processes will be a challenge.
Q: Can’t I start high growth, scale past my OpEX and then switch to more of a brand building focus?
A: Yes. And I think Preston would agree based on his experience. I think he would also say it took a lot of work inside a super high trust environment and team to make that switch successful.
Q: Don’t I have to get big enough to get the attention of potential acquirers? What’s the point of a great brand if no one knows who we are?
A: Great brands seem to have a way of funding their initial fans very quickly. This story among DTC founders is common place. I think the answer here really comes down to time and ego. How quickly do you want to exit and how important is it to your ego to talk about revenue? There isn’t a single luxury brand that grew quickly. So, I think what you are really asking is, can’t I crank a lot of paid acquisition growth but also get valued as a brand? I think the answer to that is maybe. You might hit some great timing in the market where multiples start expanding as competition among buyers heats up. If you are lucky enough to be exiting in that type of market, I would posit that multiple expansion (i.e. higher value placed on your cash flows) will be more important than increasing the notional amount of the cash flows, but it will be academic at that point as you count your millions.
Previous posts:
Making the Capital → Sales → Capital cycle efficient
https://elephantherdconsulting.com/blog/blog-database/capital-cash-and-growth-tuning-the-machine
Building compounding into your business by understanding not all customers are equal
https://elephantherdconsulting.com/blog/blog-database/compounding-drives-success
Future posts:
Defining brand
Customers are your greatest asset. The accounting treatment is misleading (and wrong).
ROAS and MER are not your guiding metrics for brand building advertising.
Cohort analysis is a sub optimal tool. Focus on the brand pyramid.
The Paradox of Product Expansion
What I do:
I’m a gun for hire. I provide financial consulting to premium brands in the form of short term, high ROI projects designed to help teams inflect, reach a new level and maximize their chances of success.
Let me know your thoughts and how to make this better. DM’s are open.