How Your Business Risk Profile Affects Value

In this episode of The Faces of Business, we welcome Mike Blake, Partner, High Score Strategies, as he unravels the intricate relationship between business risk and business valuation.

In this episode of The Faces of Business, we welcome Mike Blake, Partner, High Score Strategies, as he unravels the intricate relationship between business risk and business valuation.

With over two decades of expertise in business advising, appraisals, and venture capital, Mike has mastered identifying unique risk profiles for each company and determining how they affect business value. His non-conventional approach – starting with a “blank screen and a flashing cursor” – ensures that every solution is tailor-made to your business needs, steering clear of one-size-fits-all templates.

Mike’s insight goes beyond the numbers; it’s about crafting a narrative that reflects the true value of your business, considering the risks and opportunities.

Download our free business valuation guide here to understand more about business valuations and view our business valuation FAQs to answer the most common valuation questions.

Whether navigating significant business decisions or aiming for a business breakthrough, this session promises invaluable insights on improving your business risk profile.­

Damon energetically starts the Livestream with Mike. He requests Mike to share his professional background.
Mike shares his intriguing journey, describing himself as a “recovering venture capitalist and investment banker.”

Despite enjoying venture capital, he admits he wasn’t successful in it. On the other hand, he excelled in investment banking but disliked the work. Valuation emerged as a middle ground, blending his skills and instincts. Mike didn’t initially foresee this path, even though his father held a prominent position in business valuation for many years. His father’s practice suffered due to Sarbanes-Oxley forcing him to leave the firm.
Despite resisting following in his father’s footsteps for a long time, Mike eventually recognized valuation as the one thing he was reasonably good at, allowing him to make a good living while doing something he enjoys. On the sidelines, he reveals that he got the job because his wife applied for the post on Mike’s behalf.

Do you want to know if your business is ready for your exit or what you should do to prepare? Learn this and more with our business exit assessment here.

Damon inquires about Mike’s initial interest in venture capital.

Mike is optimistic about venture capital for its focus on building something tangible, contrasting it with other areas of finance that involve mainly moving assets around. Unlike many transactions with minimal profit margins, venture capital allows for creating new businesses and capitalizing fresh ventures.

Mike’s venture into venture capital started in Belarus and Ukraine, where he ran a privatization program after the Fall of the Berlin Wall. In this role, he gained valuable experience by assisting venture capitalists in evaluating companies and, in some cases, participating in investments.

Get the most value for your business by understanding the process and preparing for the sale with information here on our Selling a Business page.

Similarly, on Damon’s request, the guest notes how asking the right questions is essential. He reflects on his early career in his twenties. Despite the initial appeal of being in a position where everyone sought his favor for access to potential funding, he admits to a lack of knowledge and understanding.

Moreover, Mike discusses the unpredictability of successful unicorn companies, citing instances where investors initially passed on now-thriving ventures like Uber and Amazon. He advocates for a “pointy-headed” approach in valuations, keeping the conversation going until potential showstoppers emerge.

Additionally, the guest talks about the current barrier to entry, pointing out challenges related to patents and the risk of larger companies eliminating competition through internal investments. He urges startups to prove their immunity to such difficulties.

Mike addresses the market efficiency issue in valuations as the Livestream progresses, comprising the three key levers: cash flow, growth, and risk. While cash flow and growth are often discussed, risk is overlooked. Mike advocates supporting individuals in organizations who speak the language of risk, acknowledging that risk discussions are historically challenging to quantify.

Agreeing with the guest, Damon notes the difficulty for CFOs to convey qualitative aspects in a quantitative context, making it challenging for others to take such warnings seriously, given the typical expectation for numerical data.

To quantify risks in finance, Mike suggests using tools like Monte Carlo simulation. He encourages clients to make informed decisions, even if they decide to proceed with a deal, stressing the necessity of understanding and acknowledging the associated risks.

Damon asks Mike to share instances where a situation initially appeared favorable but, upon closer examination and analysis, revealed underlying complexities or issues that weren’t apparent at first glance.

In response, Mike shares a memorable simulation assignment early in his career where a long-term client was about to sell their nine-figure company. Despite providing a traditional valuation, the client expressed a specific concern: not wanting to invest more than $3 million in the acquired company over the next five years. This introduced the concept of value at risk, typically considered academic but crucial in decision-making. Mike quickly developed a model, revealing a 30% chance of needing to invest at least $3 million in the next five years.

With a low-risk tolerance, the client decided to walk away from the deal.

Damon invites Mike’s comments on the standard risk assessment practices in various transaction sizes. He questions whether larger transactions, like a $100 million acquisition, commonly involve more thorough risk analysis than smaller deals of $10 million.

Mike says that risk assessment practices vary among companies. Those with a defined strategy for acquisitions, particularly those working with private equity funds, often have processes in place. However, despite their understanding of risk, Mike believes some private equity funds surprisingly underutilize available quantitative tools.

Damon seeks further clarification on the prevalence of comprehensive risk assessment in deals.

To put it more clearly, Mike shares his experience, indicating that risk assessment tends to be predominantly qualitative. He criticizes what he calls a “false quant approach,” where people use sensitivity analysis to give the illusion of accounting for risk. Mike expresses frustration with this method, considering it a waste of time, as analysts often pick random ranges without proper consideration of the risks involved, likening it to blindly shooting an arrow at a distant target.

Damon asks whether or not Mike’s clients start incorporating risk assessment into regular business decisions.

Mike explains that after engaging in risk profiling projects, clients learn the language of risk and understand concepts like standard normal distribution, mean, standard deviation, and more. As they grasp these basics, they start contemplating the application of risk analysis in various areas of their business, such as sales forecasts, supply chain risk, and insurance assessments. Mike introduces the idea of risk analysis as a platform concept and highlights the transformative effect of becoming “risk forward.”

Mike mentions that clients working with him in risk analysis tend to return for additional projects. Those unfamiliar with his work may approach him through referrals or social media, seeking guidance on making risk management a competitive advantage for their business. During conversations like the current one, some find the concept intriguing and valuable, while others may feel apprehensive and choose not to pursue it further.

Mike highlights the ease of changing aspects related to risk in a company compared to challenges in improving sales or cash flow. Using the example of customer concentration, he explains that diversifying customer concentration is achievable through strategies like acquiring companies with similar issues, negotiating better deals, or incentivizing salespeople to bring in new customers. This makes risk management a more controllable factor in the business equation.

Shifting the conversation to AI, Damon questions Mike about its role in risk management. While talking about it, Mike believes “AI is like a firehose that’s turned on full blast. And nobody’s holding the end.” At a personal level, he finds AI, specifically ChatGPT, helpful in generating additional questions to ask about a business. By inputting the basic pattern of the business three times and focusing on questions that consistently arise, he identifies key inquiries while disregarding outliers.

Towards the show’s conclusion, Damon inquires if risk analysis is becoming more prevalent as he observes business trends.

Mike humorously says that despite his wish for increased prevalence, risk analysis isn’t as common as he’d like. He notes a cyclical pattern where the focus on risk alternates with periods of economic vitality and minimal concern for risk. He brings attention to the Boeing 737 Max situation, highlighting it as a compelling case study for risk assessment and management.

Similarly, the guest discusses his interest in Game Theory as a new approach to risk. He notes that traditional business valuation assumes an equilibrium between buyers and sellers, which rarely happens. Game Theory, a new tool for quantifying relative leverage, helps assess risk differentials to buy and sell more realistically.

The show ends with Damon thanking Mike for his time.

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Exit Your Way® provides a structured process and skilled resources to grow business value and allow business owners to leave with 2X+ more money when they are ready.

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48:30
SUMMARY KEYWORDS
risk, company, valuation, business, people, client, years, quantifying, working, deal, put, buy, growth, point, mike, opportunities, talking, pointy headed, ai, conversation
SPEAKERS
Mike Blake, Damon Pistulka

Damon Pistulka 00:02
All right, everyone, welcome once again in the faces of business. I am your host, Damon Pistulka. And I am so excited today, because we’re going to be talking to none other than Mike Blake. If you look at the screen there it says Mike unbreakable, we’re gonna have to ask about that. But Mike from high score strategies, Mike is an expert in helping people gauge risk in buying and selling companies in business risk in general. Thanks for being here today. Mike.

Mike Blake 00:33
Damon, thanks a lot. It’s gonna have a lot of fun the next 45 minutes.

Damon Pistulka 00:38
Oh, yeah, it’s gonna be great. It’s gonna be great, man. So, Les, we always like to start off Mike with you probably didn’t come out of school, thinking that you are going to be helping people quantify risk in business. So how did you get here today? To doing what you’re doing?

Mike Blake 01:00
Yeah, so I have an interesting origin origin story. I’m a recovering venture capitalist and investment banker. I liked being in venture capital, but I sucked at it. I was good at investment banking, but I hated doing it. And so over time, valuation sort of presented itself as a as a happy middle ground and sort of the instinct part of the valuation. So are you talking about nobody, I didn’t necessarily grow up thinking I would do what I was going to do. In fact, I could have because my father ran the valuation practice for NY in North America for about 25 years. Whoa, Sarbanes Oxley killed his practice overnight. And he had to leave the firm basically to survive. So my friend you you can you can attribute this to chest beating if you want, but my father was until he retired. He was at LeBron James of business valuation. Okay. Right. His clients were the New England Patriots. They were Parma law. He was an expert witness on the stand for eight days in the wake of of Enron. Oh, my goodness. And, and for the longest time, I didn’t want to do what he did. So I’d always be my dad’s kin. And nobody knows about him, because he didn’t write books or anything like that he had no interest in the academic part. He just likes to go out there and basically kick people’s asses. But he was no, I had no interest in being a teacher, that sort of thing. But I didn’t want to be my dad’s kid. But it was as what I came to understand over over the years was that being in the valuation space is the only thing that I’m reasonably good at that I can make a legal a good legal living and doing.

Damon Pistulka 02:54
I love it. I love it. That’s a you figured it out at least.

Mike Blake 03:00
And so I fell into it because my wife applied for a job on my behalf. Without my knowledge. I got this interview out of out of nowhere, the firm in Atlanta called Adams capital. And next thing, you know, two months later, I’m working for them. I’m starting a career the exact thing that I didn’t think I’d be doing with my life, but 20 years later, here I am. Yeah.

Damon Pistulka 03:29
So as you started out, so let’s talk a little bit, you said, you really like venture capital being a venture capitalist, but you suck at it. So what did you really like about venture capital?

Mike Blake 03:42
What I like about venture capital is it’s one of the areas in finance where you’re building something. Whereas much of corporate finance, and this is not a criticism, by the way, it’s necessary for the function of our economy. Yeah, but most of them corporate finance, involves moving assets around. Okay. And then people taking your commission off of the work that is required to move those assets from point A to point B to point C. Yep. And now, or being involved in transactions where the profit margin is a 100th of a percent, right, like in currency transactions, something like that. Yeah. And that’s just not something that interested me. What instantly in venture capital was building new businesses, right capitalizing brand new concerns, how does that? How does that work? And I got my start on that. Working in Belarus and Ukraine of all places for about four years, right. I ran a privatization program over there after the fall of the Berlin Wall, and part of a big component of that was basically carrying the briefcases of venture capitalists who came over to evaluate the, the companies that we were putting through the program and in some cases, investing MLW learned a ton about venture capital by just just being around people talking about deals, right? Yeah, better education, I could not have gotten a better education about that in any school in the planet. So I enjoyed it. And I enjoyed that. I enjoyed that, that that facet of it. But at that age, I was not I was not mature enough to distinguish good opportunities from bad opportunities.

Damon Pistulka 05:34
That is such that it’s mad. It’s funny you say that, because I think of my career, I had no idea how to do it early in my career. And now it seems like it’s just, we’re just a just a tad bit Dysart more discerning, add those, ask those two or three questions that that are the ones that you didn’t ask before that would just hold you in the end if you didn’t.

Mike Blake 05:56
That’s cool. That’s right. So much fun. It’s about asking the right questions, right. So as a as a as a 20, something, you know, it felt great. Everybody was kissing my ring, because they wanted me to be the conduit to the general partner that would write the check. So popular a chest out, I feel like I’m all that. But at the end of the day, I just, you know, I just didn’t know, I just didn’t know anything about anything. And everybody want I wanted to be everybody’s best friend. I wanted to fund everything and that, you know, that’s a great way to lose all of your money.

Damon Pistulka 06:34
Yeah, yeah. You have to say no and venture capital, that’s for sure.

Mike Blake 06:38
Yeah, most of the time, right. Your job is to say no. And then you’re pleasantly surprised the time when you say, Well, I’m not gonna say no, yet. I still probably well, but let’s keep talking. Right? And then, yeah, one out of 1000 turns into a yes.

Damon Pistulka 06:55
And, you know, somehow I always I always when you talk about venture capital or or other angel is a little bit smaller deals are obviously but I, every time and this leads right into this that I know, you’re just gonna roll your eyes when I started taking it when you hear someone talking about the valuation of this unicorn company, and somehow they’re comparing their company in some way, shape or form to it. I imagine that has to that has to kind of, I don’t know, just give you. I don’t know what it does. But no applause.

Mike Blake 07:31
I understand what you’re saying. But But I, you know, there are so many unicorn companies that I think a lot of investors passed on, that nobody thought would do anything, right? There are people that turned down Uber, there are people that turned down Amazon, right. So that everybody was so smart. They just knew, yes, knew what the right companies were. Right. So, you know, to me, the way I tend to approach those kinds of valuations is I tend to just sort of keep playing along the conversation until there’s a showstopper. And maybe sometimes it’s not a showstopper. Right? And maybe, because yeah, unicorns do happen. And just as though you need a skeptical eye to weed out the nine unicorns, because that’s the vast majority of the universe. It’s also important to keep an open mind so that when a unicorn presents itself, you can recognize it when you see it. Yeah.

Damon Pistulka 08:37
So if you’re looking at a company today, what would be the one thing that you would be looking for that would say, Now, this isn’t going to be anything? I for it’s gonna be challenging, I should

Mike Blake 08:52
say. Yeah, I think I think it’s barrier to entry. Number one, because, you know, it’s, it’s, especially now with the way the patents are kind of being warped. With with with P tab and the way that people want to challenge patterns. Now to get sort of a second bite of the apple. You got to answer the question. Well, as soon as you start to eat somebody’s lunch, right? What do you start to eat alphabets lunch? Why are they not just going to throw $50 million at it internally, and wipe you out? Right, yeah. Because, because the thesis is, of course, that well, Google’s gonna buy us or alphabets gonna buy us like, they might, but they probably won’t. You know, they do a few deals a year. Right? But they only do those deals because they’re forced to only do those deals because it’s something you’ve got that they’ve decided they either can’t run applicate from a feasibility standpoint, or it’s going to take them so long to do it, they’re going to miss out on a market opportunity. Right? Yeah. And unless you can prove to me that you’ve got one of those two things, then the onus is on you to prove to me that that’s not going to happen.

Damon Pistulka 10:19
That’s a great point. You know, because I can’t tell you how many people you hear that say, Well, I’m gonna develop, and I’m gonna sell it to this big company, and, and it’s in software, it’s in hard goods, all different kinds of places, you see that? But you’re right, most of them won’t do it, if they can do it themselves, and not have to go through that hassle. Or,

Mike Blake 10:40
yeah, and, you know, that comes from early in my career, when I sort of drank too much of that Kool Aid, and and, you know, brought clients up and saw the conversations to companies, you know, the client would say, you know, I want $5 million for this company, and the buyer, and so we can build it for two. Yeah, right. And in fact, we think we’re gonna build it for five and put you out of business. So why don’t you sell it to us? For 400,000? Because we kind of think you’re a nice guy. That that’s, that’s how those conversations go. And they’re not popular. They don’t get written about but those conversations happen much more often, then. Then the big, massive exit, the big massive exit happens because you’ve got overwhelming leverage.

Damon Pistulka 11:35
Yeah. Overwhelming leverage. So write that down. So we’ll ask about that later. So. So as you’re, as you’re coming along, you’re talking about business valuation, you’re working on that. And you’re get into risk, what really pulled you into really learning and understanding and quantifying risk in buying and selling businesses.

Mike Blake 12:02
I think it’s a market efficiency issue. And what I mean by that is, value has three levers, ultimately, cash flow, growth and risk. And everybody loves to talk about cash flow, it’s happy, right? You’re genuine, a lot of cash. That’s how that’s how you get on Tim Ferriss podcast. That’s how you get on Bloomberg, to be interviewed. Right? on CNBC. And then growth, right, it’s that times, and you’re ringing the bell, the New York Stock Exchange, right? Yep. But when was the last time you saw somebody on TV talking about risk? Right, who’s the hero, who’s the hero that stepped in front of the bus, when everybody in the company said, We gotta go buy this company, but that, but the risk person using the CFO, is the person who basically ties themselves to the train track, and say, if we do this deal, I’m telling you, you’re killing the company. Right? When 20 Other people want to get that deal done, because that’s how bonus has happened. advisors get paid more, including myself on deals get done. Okay. There are a lot of reasons that the deals gonna get done off with somebody else’s money. And, and I think about those people, and I’ve worked with them enough, saying, you know, those people need an ally. Those people need somebody that speaks the language of risk, and, and, and, and where people like that, and the organization gets shouted down as that risk is something that’s historically very hard to quantify. So the poor CFO is often left with a very qualitative discussion, which is not where the CFO wants to be. Because the CFO is usually a numbers person, right? Yep. So you’re taking a you’re taking a person who speaks English, and you’re asking them to deliver their argument in French? Yeah, that is difficult. Right? Yeah. And think about, you know, think about how many, how many bad deals would have been averted when somebody listened to that one guy or that one woman in the company? That was right. Right. Think about how economic history would have been rewritten, had somebody anybody listened to the people talking about the fact that the housing market itself was unstable, but it was unstable on steroids because it was so highly leveraged using instruments that even public company auditors didn’t understand because they couldn’t do the math. Yeah. And I you know, I just I just think people like that. People like that need an ally people like that need a champion.

Damon Pistulka 14:52
Yeah, very cool. Very cool. Well, I want to say real quick, I apologize because I didn’t see I didn’t have it flipped over to see the comments, but we’ll get Dale given us the strong arm. Good. Glad to see you here again. Do they awaken sky? No. Well, then we have Dean Dean. He hits some things earlier. This is compared to a $6 trillion industry. This is a deal. I don’t know where that the conversation, I apologize, we weren’t keeping up with it. Because I was I was listening to Mike and enthralled by but oh, he has spelling say. But anyway, we were he was talking about buying the big companies buying them. And it just sounds great conversation. But thanks for being here. Dean. Thanks, Dale, for being here. When you talk about that, that is that is really a great point. Because you know, that is the CFO can intuitively feel it, they may have some indicators to do it to really, though be able to quantify what it is they are walking out into unknown territory for them. And it’s gotta be very hard for to justify what they’re saying. And for others even take it any way seriously, because they’re used to them coming to them with numbers.

Mike Blake 15:58
Yeah, I think that’s right. And that’s why, you know, I think that finance, in general, and my industry, in particular, in business valuation has to adopt more widely risk management and risk specification tools. And they’re out there, but because they’re kind of mathy, they’re often ignored, and they’re very easily dismissed as well. There are Greek letters in here. And so this is just pointy headed academic stuff. But you know, pointy headed academic, a lot of pointy headed academic sound actually made a lot of money on that stuff. Yeah, I might want to listen to him sometimes.

Damon Pistulka 16:43
Yeah, that’s true. That’s true. You’re right, because it’s not simple. But but it is. applicable. And sometimes we overlook it.

Mike Blake 16:55
That’s right. And that’s, you know, it’s gonna take Yeah, it’s gonna take you a little bit to work the numbers out, okay. Monte Carlo simulation. For me, it’s not hard. So I’ve been doing it for 15 years, right. But But for others, it can be challenging, but I can tell you when I kind of when I run those simulations in real time, and I can show the visuals of the of the outcomes that are being drawn in real time. It brings a sense of wonder, to the client, which in finance, you don’t often have the opportunity to do when when you show it as a way to illustrate quantitatively that there’s a there’s a 5% chance if you do this deal, it’s going to kill your company, right? And here, and here’s the numbers to support it. Right? You know, you can still do that deal. If you’re comfortable with the 5% risk of killing your company. Go for it. And I’m not I’m not going to tell you to take the risk or not take the risk. But at a minimum don’t go into the deal, not knowing what the risk looks like. Yeah, that’s my product.

Damon Pistulka 18:03
Yeah. Yeah, that’s a that’s a great point. Because, you know, there’s risks to be comfortable with. But ignoring the risk and not knowing what the risk is, is, I mean, it can kill you just can kill your business really easily if you don’t, don’t understand it well enough. So the tell me about some situations where you gone in and something looks good on the outside. But you start digging in and you start doing your thing, and you go, Oh, this is not quite as pretty as it looks like on the outside. We just got the Carfax maybe. Yeah.

Mike Blake 18:49
So my favorite is actually one of my first simulation assignments. Were a client that has been a client of mine for a long time. They’re about to sell their company for nine figures. But I’ve helped them do a number of acquisitions. And and they asked me to help them evaluate a potential acquisition. And you know, I did what I did, I said, Here’s what I think the value of the company is. And here’s why here’s a narrative. And the client would client sort of paused and said, you know, this is great, and I’m sure you’re right. What I really care about is, if I buy this thing, I don’t want to have to put more than $3 million into this company in the next five years. Right, whatever the price is, that’s my apple plate for potentially covering losses of the company. What is the likelihood that I’m going to have to do that? Oh, yeah. Okay, well, that’s a that’s a concept of value at risk that is not, again, one of those things that is often relegated to pointy headed academia. Right, but it’s a real thing. And it involves a little bit of math, not a tiny little bit of statistics. And within a couple of weeks, I could put together a model, I said, Look, if my model is accurate, if it’s correctly specifying, there’s a 30% chance, you’re gonna have to put in at least that much money in the next five years or more. And the client walked away from the deal. So look, the price may be right, but that’s not a risk tolerance, and I’m not all the risk tolerance they care about. And it was at that point, I discovered, you know, price is is is important. But quantifying risk, and specifying it is so powerful. It instantly made my client a much better decision maker. It was that assignment all those years ago that led me to, you know, it led me to understand risk is where it’s at. Risk is where you find either the underpriced opportunities or the overpriced opportunities. And because the world is conditioned to think about risk purely in qualitative terms. For those of us who can, who can think about risk in a quantitative way, that gives us a lot of information that others don’t have, and information has value.

Damon Pistulka 21:30
Yes. I’m sitting here thinking about what you just said. And it is certainly we should pause and think about that a little bit. And if and if someone’s listening to us now that that is anything to do with buying and selling businesses, you just said something that was, it was pretty, you know, it really rang a bell for me, is you’re looking at that company helping your client do that. And they want to know, hey, what’s the chance I’m gonna put 3 million in over the next X years, and you’re telling them, Hey, this is, this is the chance and it’s too high, they walk away from it, but you then said, spotting an undervalued or overvalued company, because of the quantifying the wrist is a huge thing. Because if you went in and you did the same thing, and you had three different companies you are going to buy, you could do it, okay, what is the the chances that I’m going to have to invest in this company or in this company in this company, or the return I can get? And you just that could be the same price, it could be looked the same on the outside as they’ve cashflow, everything else. But the other things that you put together could could show that one of those companies is significantly better than the other two.

Mike Blake 22:44
Yeah, that’s right. And what it made me realize, again, is that is that value has a limitation in terms of its value. It’s important. But it’s not nearly as it’s not nearly as all encompassing. Right? Yeah. And again, it goes back to there’s so much focus on growth and cash flow, which are important. But because those are so heavily scrutinized, there’s not there’s not a lot of things new to learn there. What isn’t, is heavily scrutinized because many people lack the tools to do so. Is the risk part of the equation? Yeah, and so if I’ve got a pair of binoculars, and the other guy just has the naked eye, right, I’m gonna see a lot more birds I can bag. It’s really just, it’s really that simple.

Damon Pistulka 23:38
Yeah, there’s no doubt. And you’re gonna walk away from the ones that aren’t going to be the right birds. I mean, exactly. People are just shooting them in, you know, blindly and you’re you’re just shooting the ones you want. That’s the thing. And so it goes down a holder of the CIO, how widely when you look at the is there a certain size where you really see size of transaction when you really see people starting to go into the risk? Taking the taking the plunge into it? So if if I’m going to be buying $100 million company, is that where you go at standard practice? Or if you go a $10 million standard practice? Is there really, do you see that some of these groups that are doing these transactions as a standard practice that they’re always going to do? Or is it still kind of one office because they haven’t pulled like you said, the pointy academics into there to really give them that that background?

Mike Blake 24:38
I think it varies company to company. If a company has a defined strategy of making acquisitions or something strategic like that, they’re gonna have processes, especially if they’re if they’re working with a private equity fund. Yeah. Because private equity funds do pay of course, a lot of attention to risks, but many of them again, surprisingly, don’t use a lot of the quantitative tools available to them.

Damon Pistulka 25:07
Yeah, yeah, that’s it. I was wondering because it’s like, is it so common? You go? Oh, yeah, it’s like, it’s, you know, whatever. But you’re saying that there still are a lot of deals done that are sizable deals without it?

Mike Blake 25:19
In my experience, yes. I mean, I don’t have I don’t have a comprehensive view of every deal on the planet. But, you know, I do think that, but my experience is my visibility says that, that risk assessment, generally speaking, is, is a very qualitative approach. And, and there’s what I call sort of a false quant approach, when when people will do what’s called a sensitivity analysis. And this sort of thing drives me crazy, because it’s such a waste of time. But you know, the do of they’ll perform their own analysis and valuation of the company. And they’ll say, well, our cost of capital is is actually plus 1%, or minus 1%. Here’s how the value of the company has impacted earth the terminal growth rate as plus 1% minus 1%. Here’s how the value is impacted. Right. And it, it’s to give the illusion that you’re accounting for risk. When you’re not in most of those cases, the analyst is picking a random is picking a random range. Right? Yeah. Which may or may well be putting on a blindfold, while shooting an arrow in an archery target 50 yards away.

Damon Pistulka 26:45
Yeah, yeah. I mean,

Mike Blake 26:48
if you don’t know the distribution of those potential outcomes, if you don’t know, the mean, truly is if you don’t know what the standard deviation is, then those those sensitivity analyses are meaningless. And they’re so dangerous, because many people are led into thinking they’re meaningful, simply because it exists. And they think that their cover, right, and then they make terrible decisions. Because, again, they don’t know what they don’t know, they don’t even know how to ask the questions that define whether or not the parameters of the sensitivity analysis are irrelevant. Yeah.

Damon Pistulka 27:26
Yeah. Yeah, because as you’re saying quantitative risk is just not discussed very often. In in acquisitions or transactions is just not discussed very often at all. It’s

Mike Blake 27:46
not it’s left to be it’s left to the quant jocks working for hedge funds. And for option traders, that sort of thing. Right. Risk is their business. Yes. Yeah. So they discuss it. But in terms of the m&a world, you know, you just, I at least I haven’t seen it. I haven’t seen it done in a systematic, rigorous way. I’m sure it is that like for Fortune 500. Yeah. I can teach them. Right. They’re not calling me for good reasons. They already know everything I know. And more. Yeah. But the but the impact I can make as somebody that’s, that’s $100 million business. Yeah. And they don’t necessarily have those tools. They haven’t been exposed to it. And just simply putting that tool in front of them.

Damon Pistulka 28:36
Yeah. So as you look at this, and some of the clients that you’ve been working with, you mentioned one working with over the years, do they begin to incorporate looking at risk in normal business decisions? And having you go through some of those things? Or is that really more for just in the buying and selling a business? So

Mike Blake 28:59
they start to what they what happens with what happens with those first couple of projects where I help clients with their risk profiling, is they start to learn the language of risk. Okay, they start to understand things like a standard normal distribution, and a mean, and a standard deviation, okay? And a discrete versus continuous variable, they start to pick up that language and they start to say, Hmm, I wonder if we could do that with our sales forecasts. I wonder if we could do that with our, with our supply chain risk. I wonder if we could do that as we assess whether or not we have the right amount and kind of insurance that these risk analysis tools, you’re familiar with the term of platform technology, risk analysis is a platform concept. Yeah, once you learn once you Learn the basics, you start to your eyes open up, and you just start to see oh, man, we can apply this to every part of our business and become we become risk forward. And here’s the dirty little secret, you know, for if I move my cash flow are my growth up a percentage point that’s 1/10, the impact of decreasing my risk that same percentage point x, think about the value equation, cashflow times growth in the numerator, and then risk is the denominator. What happens when you decrease your risk as a multiplier effect?

Damon Pistulka 30:43
Oh, yeah. That to put the formula on a piece of paper, here’s like, a year, right? That’s, yeah.

Mike Blake 30:54
You think about your valuation, multiple, right? EBIT? A minus g. Yeah. Right. K is your risk variable. You change that a little bit. And all of a sudden, your multiple just explodes. Yeah.

Damon Pistulka 31:07
Yeah. So how many people come to you talking about that? Because if I’m sitting here today, and I’m, I’m looking at doing a large transaction in the next few years, how many company and go okay, let’s do a risk analysis today. So we can go tomorrow, we’ve really made a difference in that.

Mike Blake 31:26
They, they? Well, the ones that have worked with me, once they have that they they’re recidivists, they come back again and again. Okay. Yeah, the ones that don’t sort of, they found me through social media, or somebody’s referred them, and they say, You’re the risk guy, right? You’re the you’re the risk wizard. And the person, I don’t understand exactly how it is that you do what you do. But I want to have a conversation kind of like this. How do you think about risk? How can we make risk a risk management a competitive advantage for our firm? Yeah, and we’ll have a conversation like this, and some people are scared, they’re running, screaming, and that’s fine. But then other people say, Yeah, you know, this, this makes sense. This is a, this is a concept I’ve had, but I haven’t had the vocabulary to express it. And you’ve given me the vocabulary to have these conversations and make these concepts applicable in a real world business context. And then we go and then we go from there.

Damon Pistulka 32:32
Yeah. Yeah. Because if you were, if you were thinking about this ahead of time, and it is, it’s going to affect it greatly. This this could be. And when you look at people that are investing in businesses, to build them to grow their value, or people that are doing that, and they’re they’re nearing an exit, and that risk can be huge, because you’d look at why don’t businesses sell while they don’t sell? Because you know, customer concentration? Or are they going to have all these other problems that are gonna, you know, and the kinds of things and that risk can be changed. And if that risk has changed, it drastically affects the marketability.

Mike Blake 33:14
Again, the other dirty little secret is risk is the easiest thing to change about your company. Right? You’ve worked with, how many companies have you worked with over the decades, and they’re trying to figure out how to move the needle on their sales and their cash flow. And a good salesperson is really hard to find. Yeah. And say, you know, it’s one thing to say I want to increase my sales growth from four to eight, four to 7%. But you know, this, I mean, companies crawl naked over broken glass, the sensitive side down, trying to get that growth number because sales is such an inexact, such an inexact practice. Right? On the other hand, risk, take customer concentration. It’s not that hard to diversify customer concentration, don’t get another customer. Don’t tell your salespeople that, that I’m not gonna give you a commission anymore. For customers who already have or want to lower your commission, you want to make the big bonus, you got to get new customers coming in the door. Or, I’m going to buy another company that’s got a customer concentration issue in the same industry. I’m going to convince them they got to sell to me for less because they’ve got the big scary customer concentration issue. But by buying them now I’ve got two customers accounting for 80% of sales instead of one. And there’s an arbitrage opportunity. Yeah, that happens all the time.

Damon Pistulka 34:46
Yeah, I never even thought of that. But the risk, the change in risk, just because you put those two together like that. And, you know, it’s, it’s very interesting we’ve seen, I mean, and you mentioned one of the thing is, if, if when listeners hear you may, you may think about this, you may scoff at this. But I’m going to tell you one of the things I think, is a real opportunity for business owners right now that are in the situation that you talked about is is doing this is combining with someone else that he could be a could be a friendly competitor could be somebody across the country that you know, because you just absolutely transformed your chances of exiting that business successfully for more money. It’s just it is, without a doubt, you just made some things happen. And and that’s such a great point. I’m just sitting here flabbergasted that because that could help you help you immensely. So as you’re going along, sorry, I didn’t mean to cut you off there. But I’ve gone along now. Ever everybody’s talking about AI. Everybody’s talking about AI in this in that in risk. Are you seeing things where it’s actually helping that? Or is AI really still the tax base not doing the calculations kind of stuff and helping make better decisions there? Or do you see it really starting to be? Because correct me if I’m wrong, but risk is rarely blending a lot of different factors together, right? That’s what you’re trying to do. So is the AI helpful in seeing things that we wouldn’t as humans are? haven’t really seen it been developed yet?

Mike Blake 36:35
So right now, I think AI is and the AI we’re used to be careful, because for people like me, I’m not a computer programmer. Yet. As far as I’m concerned, I showed up when Chad GPT was made available. And chat bots, all that stuff. Right. But in terms of something that I actually use, right, it’s aI started that day that it was made available to me. Yeah, my but we know that it’s there’s been some kind of AI has been a thing really since the mid 1990s. It’s just haven’t been transparent to us.

Damon Pistulka 37:12
Yeah.

Mike Blake 37:14
Now, now AI is is like a firehose that’s turned on full blast. And nobody’s holding the end. Yeah,

Damon Pistulka 37:25
that’s for sure.

Mike Blake 37:27
So you tell me right, sometimes that fire hose is gonna get pointed at the fire. Right. And sometimes we have pointed a chihuahua across the street and knock his head off. And I don’t know which one it is. And 100%. I think that I think for a lot of companies, they don’t know. They don’t know what that is.

Damon Pistulka 37:47
I was just curious if you had seen something. We’re really did anything yet. But that’s overtime. Yeah, I think we can do it. But I were just wondering, because it’s, we, you know, the interesting thing about it doesn’t forget it can consider more variables, and we can and those kinds of things. But if if your risk analysis is already doing that appropriately, it may not be anything and I was just curious, because so much being said about it. But

Mike Blake 38:12
what I found to be helpful, in from my perspective, is it does help make sure you’re it does give you another source of questions to ask, hmm, right. GP, they can I can I can type into chat GPT. Here’s the basic pack pattern of the business. Right, what questions should I be asking? And I do that three times to the three times. And the questions that are that come up or three times the ones I’m going to ask, Oh ones are outliers. I tend to discard.

Damon Pistulka 38:51
Yeah. Yeah. That’s a good, that’s an interesting way to use it. That’s, that’s very cool. That’s very cool. So as you are helping businesses do this, and as you see things coming along, is is this risk analysis becoming more common?

Mike Blake 39:15
No, I don’t think that is I’m still I still wish it were more common. But you know, we have a collectively have a very short memory of when things go bad on us, right? I mean, how many times do we have to lend money to Argentina before he just froze the fall with all due respect from the new president and and I know nothing about him. I guess he’s sort of shaking things up. Right. But But how many times in our lifetime have they defaulted? Three, four, right still gonna happen? Right that that’s the real headline. So you know, I think that so what my observation is that we have a 10 year pendulum? Yeah, this is from my 53 years and the planet. We have we have two years when we start to really care about risk. And we’re emerging from that over the last two years. Okay. But up until then the prior eight years, it’s Punchbowl time. It’s party. Yeah. Yeah. Drink, pass flow. And anybody who’s talking about risk is, you know, why do you got to be like that? Right? Why do you got to be that guy? Yeah, that’s when that’s when the whole world is set. You know, the whole world wants a growth stock. And everybody’s writing the articles that Warren Buffett has lost his touch, he doesn’t know what he’s talking about. Right. And then there’s a market correction. And suddenly, price to book is in fashion. And Warren Buffett is back to being the Oracle of Omaha. And we’re coming out of that, and it’s gonna go, it’s gonna go back to growth and cash flow again. And nobody’s gonna care about risk. Right. But for me, that’s great. Because that’s where the, when nobody’s when nobody’s looking at risk. That’s when you can make money on?

Damon Pistulka 41:18
Yeah, yeah. Sure. Very cool. So interesting. Talking to you, Mike, and learning more about your take and hearing you talk about risk. I mean, just back from talking about your examples of looking at the company and looking at the for helping your client where they’re going to buy a company, but they didn’t want to put more than $3 million in over the next few years. And you’re able to say that they walk away from and then we talk about, wow, that’s a quite a different way to evaluate your acquisition targets, or if your company was a good sale candidate right now, to really understand that risk, to see if you’re, if where you want to buy at is undervalued or overvalued? And then, really, how if you understood risk, and this is the thing that I think hopefully people listening today really take to heart to to understand the risk and sales projections and your supply chain and you know, whatever else you want to think about in your business, because understanding that and making the change to those, the risk factors could be a huge thing for you. I mean, if you’re, if you’re a company and you’re making something like heart valves or you know, your your risk, moving your risk factor down can make a big difference over time.

Mike Blake 42:45
And well, you think you think Boeing stock might do a little bit better if they did different risk modeling, on their fuselage design? And that,

Damon Pistulka 42:56
yes,

Mike Blake 42:59
37 Max and I, it bone doesn’t put a bullet in that I understand what I understand what they’re waiting for, because that thing has been a disaster. Since the day the thing rolled off the assembly line. And it’s yes, it’s it’s fascinating to watch Boeing, how they are Trump how they’re trying to address risk. Right. Yeah. And, and we’ll you know, that story has yet to be written. But But Boeing is a Boeing is an ongoing case study that’s going to launch about 58 Different dissertations in risk assessment and management right now.

Damon Pistulka 43:39
Yes, I agree with you 100%. There, and it’s a great example of, of, you know, high high cost to misjudging risk. And then this the, the aftermath of that is, is just bog mind boggling and the cost, cost and, you know, downstream effects and just things you don’t know, you don’t know. So. So when you’re thinking about risk, though, I got we’re getting close to time here. But I want to ask you one last question. Now, when we talk about risks, we talked about how you’re calculating risk, and we’re talking about math that’s been around a long time, this statistical stuff. What’s new and risks that you’re going wow, this is kind of cool. I’m really this is got me got me kind of excited about it again.

Mike Blake 44:34
What’s what I Well, let me answer it this way. What I’m thinking about that is new to me in terms of risk is Game Theory. Business Valuation assumes, generally speaking, an equilibrium between buyer and sellers having a utility function that meets up and what that means in English is that It is that buyers and sellers have an equal motivation of being the dealer not on the deal. Right? Which is fantastic with the sole exception that that never happens in real life. Right, there’s always a disequilibrium and leverage that sometimes you can overcome that with deal structuring, you can overcome that with superior negotiation. Right? But the fact of the matter is that that equilibrium happens, on average, if you’re average, every deal, sure. But on a micro level, there’s always disequilibrium. And so and so I’m kind of playing around with Game Theory, as a way of quantifying the relative leverage as a risk differential or as a function of risk differential between buyers and sellers, among other things.

Damon Pistulka 45:57
That is really cool. Oh, that’s awesome, man. That’s awesome. I could see from your perspective, I know other people might be less than they don’t understand it. But, man, the just understanding some of these things, right? It’s got to be really exciting to you. Because if it could bring to new discoveries, new discoveries, you could help to develop better solutions for your clients and ultimately help them build and buy more valuable businesses. Yeah,

Mike Blake 46:28
I guess, again, it’s new tools. And the exciting thing for clients is that the, the market for knowledge in this area is not efficient. Which means there are opportunities for arbitrage all over the place. Because Because game theory involves fairly basic calculus, like calculus to maybe a lot of people just sort of run screaming and the easy way out, well, it’s just academic stuff. Right? I’m not but you know, that academic stuff that Nash won a Nobel Prize for a reason, right? Must be somewhat valid. Right. So it’s just a matter of trying to take that and again, equipping clients, and not just clients. I want to equip everybody with the vocabulary to ask the right questions about risk. Yeah.

Damon Pistulka 47:19
That’s awesome, man. Oh, so interesting, Mike. Well, I’ve really appreciate you taking the time and talking about risk with us today. And you know, just how, how risk really affects the value of business, how it affects decision making in the buying and selling of businesses and the other thing you’ve shared today. So if someone wants to get a hold of you, what’s the best way to do that?

Mike Blake 47:48
So I’m not hard to find. On my handle, it says unbreakable. So you can use that as a handle to find me on LinkedIn, Facebook, Instagram, I’m posting there almost every day. Want to go email? It’s Emblica. High score strategies.com. So I’m not hard to find it.

Damon Pistulka 48:07
All right, Mike. Well, thanks so much for being here. And I want to thank all the listeners today for being there. And the people that were commenting, Dale and Dean and, and others. Thank you, Mike. Thanks for being here today and hang out for a minute. We’ll talk after we’re done here.

Mike Blake 48:23
Yeah, thanks so much. That’s so so much fun and good stuff.

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