How You Can Buy a Company Right Now

Email agenda:

Estimated read time: 6 minutes 50 seconds

1. How you can buy a company right now

2. Bear market rallies + my portfolio update

Good morning and happy Monday - let's get smarter

How You Can Buy a Company Right Now

Leverage - a tool that amplifies your efforts

One of the biggest misconceptions I had growing up working in mergers and acquisitions was that only big companies can do mergers and acquisitions

My misconceptions: you need a lot of cash, you need to pay a lot of experts, only big companies get access to the best deals, its super complex

The truth is - it’s not

And buying a business can reap HUGE financial rewards due to 2 types of leverage

1. People leverage

2. Financial leverage

Leverage of people

When you work a job your inputs = your outputs

You trade your time in exchange for a paycheck

If you stopped showing up, you’d stop giving them your time, so they’d stop giving you money

When you purchase a business, you can use other people’s money, and leverage employees, so you actually earn while you sleep

Now, you can either buy a job and a business, or find an operator and just be an owner

What’s the difference?

Some businesses, the owner is runs the day to day operations. If you purchase this business, someone has to fill this role

Ideally, you are an expert in the niche and can step in and be the owner and operator

But here - you bought yourself a job 

Buying and Operating

Pro’s: Maybe the owner pays himself $100k in salary and you previously made $56k at your job, so when you buy this business you increased your salary by $44k

Con’s: Although you have equity, you are still managing the operations and trading your time for $ like a job with all of the stress that also comes with owning the business and wanting it to succeed

Option 2 - You can find someone who’s an expert in a field and team up with them, you will buy the business and give them incentives (salary + bonus or equity that vests over time) in exchange for them running the business

Buying and Owning

Pro’s: You don’t have to run the day to day operations (leverage of people). You now have employees who are working to build your business, equity/wealth

Con’s: You need to find a reliable high quality operator and trust them to care about your business the way you do + pay them - not easy

So, what about paying for it? The other type of leverage: financial leverage

Financial Leverage

Example

Flooring business for sale - $200,000 (4x EBITDA)

• Revenue: $150k

• EBITDA: $50k

• 2 employees

You’re probably thinking, well, I don’t have $200k so…

If you don’t have the cash, there are multiple ways to finance this transaction

1. Loan from a regional bank

2. SBA (Small Business Association) Loan

3. Investors

4. Seller Financing

   1. The seller takes let’s say 80% of the money, and in essence loans you 20% at an agreed upon term and interest rate that you will pay with the money the business makes

Now before you go all Dave Ramsey on me that debt is bad, this is different

This is INCOME PRODUCING DEBT

What does this mean? This isn’t taking on a debt to buy a sports car or a boat, taking on debt to buy liabilities that you will owe money on

This is taking on debt that generates income that actively pays down the debt with the income it makes, growing your wealth

So to continue to this example

You could get an SBA Loan for 70% of the business, seller financing for 20%, and put down 10% of your own money (this is financial leverage)

Now you have to put down 10% ($20,000) and have an asset that produces $50k in EBITDA (cash flows) before debt, so potentially $25k after debt (you would make monthly principal payments on the debt, lowering the cash flows of the business after you buy it from $50k to $25k)

In a nutshell, you put $20k down and in your first year made back $25k, and will continue to grow the business, make more EBITDA, driving the value of your business up

Now let’s say in 5 years you want to sell the business

It’s now doing

$300k in revenue

$100k in EBITDA

You’ve paid off the $180k of debt with the income from the business

You’ve pocketed $25k a year for 5 years ($125k)

You sell the business for the same multiple 4x EBITDA

You made $400k on the sale + $125k from the business earnings over the 5 years with $20k down

So through the power of employees growing the business (leverage of people) and using other people's money to finance the transaction (financial leverage)

You 26x your money over the course of 5 years

Bear Market Rallies

Being wrong sucks, but markets are one of the most difficult games to play

When markets move against my expectations, I revert back to some of my favorite quotes from one of the top investors of the past 30 years Howard Marks. Some of my personal favorites:

• “Risk = the probability of bad outcomes”

• “You can’t tell the quality of a decision from the outcome”

• “Improbable things happen all the time and probable things don’t happen all the time because the world is uncertain, and if that wasn’t the case, there would be no risk”

• “A good decision that doesn’t work can look like a bad decision”

• “Basic human psychology shows people care more about not losing money than they do about missing out on making money”

The Data

The US economy in the back half of 2022 and into the first 1-2 quarters of 2023 will have slowing GDP growth 

My favorite risk management firm, Hedgeye’s models has year-over-year GDP slowing from +1.62% to +0.07% in the next 4 quarters

What does this mean?

Companies haven’t had to deal with GDP growth of 0% in quite some time

Remember, the biggest contributor to GDP growth is personal consumption

For households, real income growth is negative, real spending growth is slowing, and excess savings are now negative

For companies, the chart below shows companies “guiding down” aka lowering their earnings expectations in the future

6th grade terms: When we reported earnings last quarter, we told you we'd make $5 per share in Q3 (next quarter) and $6 per share in Q4, now we are reporting Q3, we made $3 per share, and we want to lower how much we think we will make $5 per share in Q4

^ That's revising your estimates and you can see the chart showing the different sectors besides energy are all starting to lower their earnings expectations

As profits and cash flows slow for companies, they invest less in “capital expenditures” - funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology

Capital expenditures drive GDP growth and help companies grow by increasing their output

Households and companies have recessionary data in the back half of 2022

As Michael Burry (Christian Bale's character in the big short who predicted the 2008 financial crisis), bear market rallies can be substantial

But there’s always a sucker who tries to chase the rally

Don’t be that guy  

My core assets right now: $USD (bullish US Dollar), $BAB (bonds), $LQD (bonds)

Tickers I will be adding: $DEF (defensive equities) and $SPLV (low volatility equities)

Why?

Volatility during bear markets can be nasty to the upside and downside

The assets mentioned above are lower volatility asset classes that I want to hold during poor economic times

Math doesn't lie - people do

Don't get sucked into bear market rallies and chase stocks because of FOMO

- Dev

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.