The biggest mistake in wealth creation
Welcome to The Business Academy with Sieva Kozinsky. Here's what we have in store for you today:
- The dangers of being in a rush to get rich
- Here's how to convince a business owner you're the right buyer
- A $21 million contracting business
🔑 How to Buy a $5 Million Flooring Business for $155k Upfront
Here's a real life example of a flooring business for sale in the Dallas area.
Let me walk you through the numbers.
It does $5 million in revenue, $1.25 million in cash flow, and the owner is asking for $3.3m. Through SBA financing, you could buy this business for just $155k down.
Business buying can be life changing. I've bought 21 businesses over the last 6 years with investors, and I've seen deals like this happen all the time.
🔑 A Mistake that Cost Billions: Being in a Rush to Get Rich
Everyone reading this knows Warren Buffett and Charlie Munger.
But have you heard of Rick Guerin?
Probably not.
Rick was the 3rd partner in Berkshire in the 1970s. If he kept his shares they would be worth $10 Billion today.
Rick Guerin was a meaningful part of Berkshire's early success.
He had the great idea to buy Blue Chip Stamps with Charlie Munger.
Blue Chip Stamps distributed stamps through grocery stores and retailers which customers could collect and exchange for merchandise. Think of this like Starbucks Loyalty rewards today. The more coffee you buy, the more points you get, which you can later redeem for more Starbucks products. Blue Chip was just a paper version of the Starbucks loyalty app.
Here's what made Blue Chip Stamps a great investment:
Rick noticed there was a difference between the volume of stamps purchased and redeemed. This was called the "float".
Blue Chip Stamps kept this money in the bank at the ready for their customers to use. But the beauty of this was only 50% of stamps ever got redeemed.
In 1970 the company market cap was $63.5 million.
The unredeemed stamps were $86mil. Since only half the stamps got redeemed, this $86m had a value of $43m to the company.
And the company also held $72mil of investment securities.
You could buy $115mil of value for $63.5mil. This was the dictionary definition of value investing.
And the Berkshire team only needed 60% of the company ($38mil) to control the investments of the company.
After buying 60% of the company, they used the "float" of Blue Chip Stamps to buy See's Candy with $25mil. Then they bought Wesco Financial for $25mil and the Buffalo Evening Post.
See's Candy alone went on to generate over $2 Billion of income for Berkshire to-date. Wesco Financial has a market cap of $7 Billion. These were three transformative investments for Berkshire Hathaway.
Rick was an important part of the Berkshire Hathaway story. But what happened to Rick?
In a 2013 interview Warren Buffett was asked:
"Are you in touch with Rick Guerin? What happened to him?"
Warren explained:
"Charlie and I knew we were going to be rich. But we weren't in a rush.
Rick Guerin was just as smart as us. But he was in a rush to get rich. He was levered with margin loans, and in the crash of 1973 he had to sell his Berkshire stock to me for $40 a share."
That stock Rick sold for $40 per share?
It's now worth about $702,760 per share.
Ouch.
The learning?
As an investor don't take any actions that benefit you in the short term but massively increase your risk in the long term.
Debt does this.
Don't use debt that can wipe out your portfolio if the market turns. If you do use debt, use it selectively with low leverage.
If you're smart and patient good things will happen to your investment.
Don't be in a rush to get rich.
There's another lesson in this story. But it's hidden a bit deeper.
As you read above See's Candy returned $2 Billion in pre-tax income for Berkshire over the years.
The Buffalo Evening Post returned over $300mil with the sale.
And Blue Chip Stamps eventually withered and died as the business model went away.
The learning for me is that even the world's best investors don' t know exactly how great a company will be over the years. They may aim for a double or triple. Sometimes the company will far exceed their estimations. And it's those outsized returns that can transform your career.
But the most important lesson is you just need to avoid losing money as an investor. Because if you don't lose money, you can keep investing.
And you get more "at bats".
With more at bats, you learn more and you're more likely to see a homerun like the Berkshire's See's Candy investment.
The first rule of investing is "Never lose money". Rule number 2 is never forget rule number 1.-Warren Buffett
🔑 Being the "Right Buyer"
You would think to buy a business, you just offer a price, and if the owner likes the price, they take it. Fortunately or unfortunately buying a business is not like buying a pack of gum at the store.
The owner of a great business, and brand isn't going to sell their business to just anyone. They are proud of their company, legacy, they care about their employees and customers. There are many other factors at play in their decision.
So what does that mean for you as a buyer?
You need a clear value proposition. You need to have a good website and a clear way to communicate why you're unique or special to someone selling their business. If you can do these things well, you will have an opportunity to be at the table where great businesses are sold.
If you don't do this, you're going to be left with scraps of bad businesses...
Think of Warren Buffett. He has spent his whole career working on his reputation as a good buyer of businesses...and it's paid off in spades.
Read this article to understand how sellers think about finding the right buyer for their business:
🔑 One interesting deal
This is one of the larger deals I've featured in the newsletter, but it's a good one.
This contracting company does over $21 million in revenue with more than $6 million in cash flow. Let's take a closer look.
What I like
At first glance, there's a lot to like about this business. It's been around for 12 years, meaning its business model has most likely been proven to work well at this point. It generates a lot of cash, and is selling for a reasonable multiple (3.4x cash flow).
Make sure you always get quality of earnings (QoE) report on a business you're buying...
What I don't like
I'd love to know more about the FF&E figure - this business likely has a lot of equipment, so I'd want to see how that equipment is used, financed, it's age, and wear...etc.
If you've read for a while, you know I distrust the "cash flow" figure in this listing. Sometimes it's EBITDA that brokers falsely label as cash flow.
There's a lot of heavy equipment in this business so cash flow is not close to EBITDA. Whenever you're buying a business you need to understand how much true free cash the business produces. Meaning if you had to pay debt with the money, how much debt could the business service?
One potential downside is that the listing says the largest clients are multi-family apartment construction jobs. Arizona has been a hotbed for development over the last several years, so I'd want to analyze how the business would do if new construction plummeted (which is already happening now thanks to high interest rates). The business hasn't gone through a severe housing crisis, because it was started after the 2008 financial crisis.
Have a great week,
Sieva
P.S. I've been publishing more shorts on YouTube with some of the most interesting moments from my interviews. subscribe on YouTube if you haven't already to check it out.
Disclaimer: nothing here is investment advice. Please do your own research. The information above is just for information and learning.
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