🔑 Investors, stop giving your money to these types of managers
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🔑 The Teddy Bear Millionaire
June 27, 2024
Here's the story of how we bought a business for $147.5k that will generate $250k in cash flow per year.
In December 2021, Xavier, my business partner sent me a listing he found on BizBuySell for a business in Hawaii.
Owning a business in Hawaii sounds awesome, right?
This business rents motorcycles on the Big Island of Hawaii.
About the company
Tim & David purchased the company from a previous owner. They manage the shop together 7 days a week renting motorcycles, beach gear, and other fun things on wheels.
The business was making $400,000 in annual revenues with $150,000 of cash flow, and it owned $200,000 of equipment that was less than 1 year old.
How we structured the deal
The owners agreed to give us a large seller note, which means we get to pay the owner back from the future cash flow of the business. It's a good way to buy a business with very little money out of pocket.
The deal ($600k total):
We can bonus depreciate the $200,000 in inventory. That means we can subtract that number from our "income". At a 21% corporate tax rate we save $52.5k in taxes. Which means this deal cost us $147.5k in cash and produces approximately $150k of cash flow each year.
In the first year we used all the cash flow to pay back the debt. In Yr 2-5 we get to see a bit of a return on our cash. After year 5, there's no more debt and you get to keep all the cash (besides upgrading equipment).
cash-on-cash return by year
As a comparison, buying US treasuries returns 5% per year. Buying the S&P returns 8% on average over the years. So you can see this is a pretty good deal. But it takes some work.
Here is the MOST IMPORTANT takeaway of this email
Any deal gets much better if you can raise prices after you buy it.
A year after we bought the business we raised all prices by 25% (we waited too long). Revenue jumped by $100k per year.
All of that cash goes to the bottom line (total $250k of cash flow now).
cash on cash returns after price increases
These returns are incredible for any investment.
There are some downsides of this deal, let's talk about those.
What I didn't love about this deal.
What I don't love this business - #1
Everything we commit to is a distraction. No matter how small a business it still takes time and attention. That is time and attention we could be spending on a much larger deal. Therefore I put a premium on my time.
That's why a small business is an opportunity for you. Groups like mine, and other buyers are thinking the same way.
Small = too much work.
That means there is little to no price competition for businesses with less than $1M of EBITDA. So you can get an incredible deal, with a favorable structure like we did here.
why did we buy a tiny business like this? Some things we do to learn.
This deal had low downside for us. It was a small check. We found a good General Manager (GM) to run it.
It was a situation where if things didn't work out we don't lose any money. If things went well, we can make a little money and also learn about the equipment rental business.
Our learnings here almost led us to buy a business that was much larger 18 months later, also in the equipment rental space.
What I don't love this business - #2
To grow this business you need to buy more equipment and motorcycles.
To grow our business from $250k of cash flow into $500k of cash flow, we're going to need to spend another $300k on equipment (at least). This isn't inherently bad. It's a good return on money spent. But there are some businesses that don't require any capital to grow (for example: a marketing agency or an HVAC service company), which I prefer.
We made some simple changes after we bought the business. We bought some electric bicycles electric, which paid us our money back in 5 months. And we've raised prices. The GM was reporting that many of our customers complimented us on our low prices. But we're in the business of making money for a service, so I prefer to be on the other end of the spectrum. I want 1/10 customers tell us our prices are too high
Some learnings for you
We got quite lucky with our GM with this business. Having the GM allows us to spend little to no time on the business.
Here are the qualities you need for a successful GM: entrepreneurial, loves motorcycles, doesn't love his current job, has management and P&L experience, charismatic, willing to "do the work" and not just be a manager.
How to pay a GM for a business like this
A small base pay salary, with most of their economics coming from sharing ownership in cash flow. We want "skin in the game" meaning they need to invest a meaningful part of their net worth into this company alongside of you. No equity with no investment.
Are you interested in these deals?
We buy a few small businesses like this each year (but larger). We're starting to let investors co-invest with us in deals. If you're an accredited investor and you'd like to hear about those deals when they come around sign-up here.
Sieva
ps: what did you think of today's email? did you like the deal breakdown?
pss: I spend a lot of time writing these newsletters. Do me a small favor and forward this email to a few of your friends. Maybe they'll learn something that will help their life.