The Fastest Way to $500K Income

i've got an exciting episode for everyone today this week i've discovered through the magic of twitter the quickest way to a 500 000 income and we're gonna dive into it right now i'm david c barnett and you're tuned into small business and deal making the podcast youtube channel and blog where i talk about buying selling financing and managing small and medium-sized businesses while controlling risk so if you're looking to take control of your future through buying a business one day or if you already own a business and you're looking to grow or exit you've come to the right place i talk about interesting things i talk to interesting people and i answer your questions every week right here so be sure to hit like and be sure to hit subscribe and let's get to it [Music] so um on saturday night and i'm recording this on tuesday morning saturday night i was at my favorite brew pub and i was enjoying a nice glass of beer and i was scrolling twitter and i came across it wasn't even someone that i followed it was shared or maybe highlighted to me by the algorithm you know because of the people you follow you might like this and someone was sharing the secret to the fastest way to a half million dollar income and i was like oh that's cool who wouldn't want half a million dollars so i started to read the thread and very quickly realized that there were enormous problems with what this individual was sharing and um so i replied to it and i'll show you my reply and then in turn the author of the thread asked me what i would pay and so this week's question for our video is coming to us from uh from siva kozinski um who has a pretty big twitter following actually uh if i hover over here you can see this and i'll read it for people that are listening to the audio and he says i buy beautiful businesses at enduring.ventures tweeted about business and investments he's got 20 000 uh 20 400 followers and the interesting thing about this tweet is that you can see it's been retweeted almost 1500 times um and 92 people have quoted the tweet and 10 500 people have liked the tweet so the internet loves the tweet i've learned from some younger people that the internet has opinions and the internet obviously likes this tweet so i'm going to read the tweet and we're going to go down and i've built a spreadsheet and we're going to unpack and examine all of the different parts of this thread and we're going to see just whether or not what is being described here is a realistic plan if it makes sense and if it's something that you should do so let's read it so uh buying so so um mr kaczynski says buying businesses is the quickest way to cash flow 500 000 per year here's a five step process for buying your first business highlight the word first this is important okay it says number one find a business to buy here's a landscaping company that looks promising 2.6 million in revenue with 450k in normalized ebitda 70 of revenues from recurring work looks good to me now we need to finance it so let's take a look at this more carefully i've blown up the image here so we can examine it and i did go looking online in some of the big online marketplaces and i found this business brokers website but they didn't have it easily demonstrated where they had businesses for sale so we're just going to look at the information that was available in the tweet so the business broker says they have a landscaping service provider in the mid-atlantic region below are some of the highlights and it says the company generates 2.6 million in revenue with 450 000 k and normalized q1 2021 is 2 000 grand ahead of 2020 so it looks like the trend for last year was to grow was growing says company provides full service landscape services to primarily commercial and utility clients okay that's important approximately 97 revenue is derived from commercial and utility clients and approximately three percent is residential and connected to a corporate account so what does that mean it means that they're doing work for some kind of property management company uh where they have to do some residential properties or it could mean that they've secured the contract for the local mcdonald's franchisee but in order to get the contract they're mowing his lawn at home for free okay that that's pretty common if this is a lawn mowing business right and they're using the word landscaping but let's really dig into this their their biggest customers are utilities approximately 70 of revenues are derived from recurring maintenance work okay so that might create the image in your head that they're going out and mowing lawns regularly multi-year contracts with numerous long-term clients well-known and highly respected name in the marketplace long-standing relationship with a diversified client base and maintains a fleet of approximately 20 trucks another key fact so as we go through the thread i'm going to keep referring back to this listing because we're going to be able to make a couple of uh assumptions i guess um i'm leaning heavily on my own experience because i've helped people buy and sell many lawn maintenance landscaping and other types of companies that are sort of in this space and one of the one of the big questions that we need to figure out when it comes to any business is we have to think about the type of machinery and equipment that is involved so let's get back to the tweet over here the thread um and he says so he talks about the the revenue he talks about the normalized ebitda 70 revenues from recurring work looks good to me now we need to finance it so we get down here and he says let's finance the business we're going to use an sba loan sba is a government program that helps you start and grow a business in the states true through sba you can get outstanding rates of 6.5 over 10 years again great so he's got a summary here revenue 2.6 million ebitda 450 000. he puts in an ebitda multiple of 3.5 times um and that was when we get to my comment we're going to see what i think of that and he puts the value of the business at 1.575 million and then he says he's going to get an sba loan of 1.338 million and then he's going to put in his own investment of 78 000. so it was at this point that i started building a spreadsheet and you can see here i just copied in the information that he had provided because i wanted to follow along in a calculated way being able to you know use cells in excel and you'll notice this sba loan of 1.33 million is only 85 percent of his of his enterprise value that he says that the business is worth and the personal down payment is 5 so this only adds up to 90. so that was the first point i was like huh this this doesn't add up where is the other 10 of your of your purchase coming from let's get back to the twitter thread so he says the down payment is 78 750. we'll either need to save some cash for the down payment or raise it the money from friends okay the multiple we're paying is 3.5 times ebitda so the purchase price is 1.57 mill now we need to structure the deal so he says three structure the deal here's what we propose sixty percent of cash up front thirty five percent seller note paid over five years and five percent seller note on full standby so let's let's take a look at this one no that's the wrong one here let me let me grow this one out here there we go so 60 cash up front but i thought the sba loan was for 80 was for like 85 right and now he's saying there's going to be a 35 seller note and a 5 note on full standby now i'm not sure what he means by full standby but i'm going to assume it's going to be an interest only note that is fully postponed until the end of all other debts are paid maybe to have an offset clause or something like that so that's my assumption so let's go back to my spreadsheet so i went in here and i was like okay so now we're saying he's going to have five percent cash down a 35 percent seller note and 5 uh note on standby this makes the sba loan 866 thousand dollars not the 1.33 right because this this adds up to 100 percent five percent cash down 55 sba no payment 35 seller note and five percent smaller seller note right um but that's not what he's talking about let's let's go back and oops let's go back in here sorry very sensitive so the next tweet says looking at this model you'll see we barely have enough cash flow in year one to cover our debt this means one thing for the purchase to be successful and less risky we must grow the business so i took a look at this and i was like again not quite understanding because now he's saying the e-bit does 450 but the cash flow is 315. what happened to 135 000 right it just kind of disappeared and i wasn't sure what that meant so back over here at the spreadsheet um what i started to do is say okay if the 450 000 cash flow is 135 000 short does that mean he's considering an owner's salary for himself that he's going to take this money out but in the definition of ebitda ebitda includes the salary of a full-time working owner operator manager so if you're going to buy this business and you're going to be the manager then that salary should already be included in the ebitda cash flow unless what he's calling normalized ebitda is in reality sde seller's discretionary earnings and i've seen sde referred to as normalized ebitda more often in the uk not in the united states so so this was a big question for me that never quite got understood um addressed because he has not mentioned anywhere in the twitter thread about where the 135 000 went from went to he just goes from ebitda to cash flow so let's get back into here because the next tweet is the one that reveals what i think is is pretty astounding so he says we're going to grow the business so he's actually admitting under his own calculation that there's not enough cash flow here and so that the only reason it makes sense to buy this business is if you're going to grow it bigger which i think is a pretty big presumption and as we move through here i'm going to reference other videos that i've recorded that i think um are pretty important for people to refer to but um i have a problem with this i have a really big problem with this and and the chief problem is simply that um when you buy a business with a plan to grow it that's great but why would you pay a price based on what you're going to achieve should not you be the person that profits from the growth i mean you're going to do the work you're going to make it grow so you should be the one that that gets the profit from that not the seller right and so the word or the term in in the world of buying and selling businesses for this kind of thing is called blue sky so in fact i probably forgot to mention this already but the one of the prerequisites that i think you should watch is i made a video a little while ago and we'll we'll link it up above here uh why sde is not cash flow which also talks to this ebitda thing so if some of you are confused about the ebitda sde normalized but i think just watch that video it'll explain it all so then what he's saying is that we need to grow the business but he says luckily with the deal structure we proposed we end up with 472 500 of working capital we can use this capital to grow the business hire talent by trucks and invest in marketing and i was like what where how do you end up with the working capital you know and then i realized what this guy was talking about is he's actually talking about um the fact that he's going to buy this business with the full sba loan he originally mentioned the 1.338 million and he's going to ask the seller to finance 40 of it as well so what does that mean it means that he's actually going to buy this business and he's going to have this full debt service amount here of 316 000 which now jives with his cash flow image from from the twitter thread he's essentially going to finance this business with a 125 percent debt so this harkens back to the period of around 2006 where people were using these ninja mortgages to get jumbo loans with a 24-month arm i i think some of us remember how that went down um but let's just say and in my experience if you buy a business and you use an sba loan and you have a reason for working capital like receivables for example um then yes the banker will make some allowances for working capital and they'll either add it to the sba seven day term loan or you'll qualify for some kind of revolving credit facility which in my opinion is the preferred way because you just you use the bank's money excuse me too to revolve and to finance your customers through the way of the receivables so if he were able to actually pull this off this is what would happen he'd have a proposed sba loan of 1.338 million his own money of 78 uh total proceeds 1.417 um it would end up looking like this for a balance sheet so you can see the assets is the total of the purchase and the extra cash so he'd have 2 million 47 500 of assets on his balance sheet he'd then have this full sba loan of 1.338 million first seller note of 551 000 a second seller note of 78 000 for a total of 1.968 in debt and his equity would still only be 78 750. this would create a 25 to 1 debt to equity ratio banks like three to one in general under conventional lending concerns with sba financing under the right circumstances they will stretch to like nine to one because the government is guaranteeing the note right so like and then he's going to take let's get back to the twitter thread so how is he going to use the 472 thousand dollars he's going to use it to grow the business by hiring talent buying more trucks and investing in marketing okay but specifically he's going to spend time and money to grow the business by networking creating flyers creating a honeypot and optimizing the website seo so he's going to spend the money let's look at how it's going to be spent number one he's going to network he's going to drive to local commercial facilities talk to managers about their costs and pain points for landscaping and ask questions uh and ask for their business so what what does this mean costs and pain points right so he's going to offer them an opportunity to reduce their costs so he's going to pay a premium for a business because it has goodwill in the marketplace and it's well known and then he's going to go out there and become a low-cost provider which is going to threaten what margins this business has and we're going to talk about its margins later um and he's going to hand out flyers which are going to have a qr code and a special discount for people who act now and a telephone number that forwards to the cell phone so this kind of strategy works really well maybe in a residential space where we can have a direct response but if you go to a commercial company oftentimes they're going to say well we have a contract let's go back and look at the listing which is on this tab so 70 of revenues are from recurring maintenance work multi-year contracts with numerous long-term clients well do you think that other people also are in multi-year contracts in this market for the type of work these people do i think so um long-standing relationship with diversified client base and again i'm going to highlight this commercial and utility clients utility is key here okay um and only three percent is residential work so i don't necessarily think that even even if he were to make a really great presentation to someone i don't think it can result in business immediately right most of the people he's going to talk to are under contract most of the big companies as far as i know big commercial entities and utilities especially have professional purchasing departments so even the local facilities manager if he could make a decision to switch providers is probably going to have to go to the purchasing department they're probably going to say well you can submit a tender for next year when our contact contract is over right so instant direct response growth in sales is likely not how these contracts are won in my estimation based on my own experience this company is winning its contracts probably through a tendering process and through dealing with professional purchasers professional purchasers in the mind of entrepreneurs should equal one thing controlled margins because just like business owners try to get as much profit as possible big companies hire professional purchasers to counteract that phenomenon right professional purchasers do whatever it takes to make sure costs are lowered within an organization there was a really great example that happened here about three years ago neighboring province nova scotia they were re paving a huge stretch of highway they went out for tender for asphalt and all the quotes that came in were high do you know what the supply and service people did which is the equivalent of government professional purchasers they went and bought their own asphalt plant in the u.s and moved it to nova scotia and they made their own asphalt okay because they understood what it cost they had the time to delve into the bids and to learn at what the margins likely were and they realized we can't accept any of these we can save a lot of money if we do it ourselves that's the kind of stuff that professional purchasers do so number four he's going to make a honey pot but he's going to open a bar event for two hours invite all the property managers in your area collect business cards and set up one-on-ones for those who attend later in the week for a one thousand dollar bar tab you filled your sales schedule for the next couple of weeks and created a list of places where you can submit your tender bid for for next season probably okay now will it result in some work uh it could 2.6 million of revenue what percentage growth is this going to is this going to create are we going to have a 10 increase in sales are you going to be able to do this right now in may when all the landscape contracts have already been initiated for the year and create another 260 000 in revenue for 2022 i don't think so relationships have already been established any work you're doing now is only going to bear fruit next year speaking from my experience in sales particularly business to business sales if you are in the residential market you can convert do-it-yourselfers you can get people who don't have contract obligations etc but i i hesitate on this optimize your website for seo most owners don't understand it if you're selling to utilities they're probably not looking for you on a website you are finding out who makes the purchase decision at the power company and you're going and you're talking to that person so hire a good seo firm so he's going to spend money on that um and to recap network create flyers create a honeypot optimize the website so let's go back to the spreadsheet because i want to i want to uh highlight this so if you take the 472 thousand dollars and you spend 20 of it on the activities that he's highlighted what will happen is your cash will decline and it and it's not going to go into assets that will appear on the balance sheet the cash will decline and will go into expenses seo bar tabs printing flyers labor for a salesman and what will happen is that all of a sudden the cash will be lower the debt will still be there this business will become insolvent within just a couple of months the entire equity position will be wiped out okay now do do i regularly see people go out and figure out how to borrow 125 of the purchase price no i don't i never do um what traditionally happens is that the buyer has some money of their own they borrow some money from a bank and they get a seller note which is subject to offsets which helps them secure the fact that you can't do 100 pure due diligence and i've made all kinds of videos about seller financing and why it's so critical at the beginning of the twitter thread he said this is how you can buy your first business i don't believe that's true you cannot get 125 financing on your first business but this gentleman is in a different position remember his twitter profile says that he has a hold code with 14 businesses and here's the key any acquisition that he does a clever banker is going to figure out how to structure it as an expansion which means that the bank isn't going to just look at the business he's acquiring they're going to look at one of the businesses he owns in conjunction with the new business they're going to combine the balance sheets combine the cash flow of the two and look at them together and so he might be able to pull this off but it's not because of clever structuring it's because of an a strong balance sheet position and good cash flow in another company that he owns which may create the illusion that he's pulling off 125 financing where in reality what the bank is doing is they're financing a combined entity part of which he already owns and this is very common in amongst people who talk about buying a business with no money is they'll talk about how they pull off these deals but they won't get into the nitty-gritty of how they already control an entity which is expanding to include the new acquisition in an asset purchase and so the bankers are looking at an opening balance sheet that includes the existing items of the current company and then adding what's being acquired a 25 to one debt to equity ratio is not going to get financed by any banker in my experience and if you're a banker and you regularly finance these let me know in the comments because i'd love to have you on the show all right so let's get back to the back to the twitter thread so cash flow by providing high quality service and leveraging the previous growth strategies your business will succeed let's dive into the cash flow projections and so he says i'm going to grow the business and so not only you know i questioned whether you could grow at 10 in one year he's saying that by the end of 2022 you're going to grow it to 3.38 million in sales and then by the end of 23 to 4.3 in the end of 24 to 5.2 so this is very aggressive he's going to grow it from a 21 000 cash flow all the way up to 505. right and he's going to do this all with bar tabs and flyers so let's close that and then we're going to scroll down here and he says now you can start paying your debt faster the faster you pay down the debt the more cash you'll make and he talks about you know because if the money's not going to the bank it's going to go into your pocket right and then he summarizes then he says that's it for now if you enjoy this thread please let me know by tweeting and stuff and i'd like to remind everyone that this tweet thread managed to get 10 500 likes okay so people are excited about this this is people are on board they want to do this so i read this and now recall that i had already finished my first beer at the time so this is what troll david looks like on a saturday night so my response was taxes question mark capex question mark and at this point i hadn't done the math i looked at his 21 thousand dollar positive cash flow and i realized ebitda does not include taxes it does include uh depreciation and amortization which is the cost of equipment and we're talking about an equipment intensive business we're talking about landscape services right and i put that price is insane 3.5 times ebitda doesn't make sense for a service business with low barriers to entry saying it's affordable because of growth just makes you complicit in the seller making you pay for blue sky and then i put a link here to a video that i've made before called pay for potential and i'll link it here up above and i put why would you pay for work you were going to do and so my comment got 44 likes right just to give you some perspective of you know the people who are following everyone on twitter and so let's talk about that let's talk about the taxes let's talk about the capex because this is an important part of our conversation let's go back to the spreadsheet so i scroll back over here and then i go down somewhere here yeah i got some more numbers to show you oops okay so we've got this ebitda of 450 000 and like i said he shows a cash flow of 315 and and does not address anywhere about the 135 that goes missing my guess is that he's confusing ebitda with sde or the broker listing added back the owner's salary meaning that this normalized ebitda is actually sde we don't know but i'm going to give him the benefit of the doubt i'm going to assume that ebitda is really ebitda and that already includes a salary for the owner manager so if you bought this business you would take that that owner manager salary okay which is a positive 135 thousand dollars to the example that he put in the twitter thread so i'm giving him a huge advantage here in my calculations so we're going to have a normalized ebitda of 450 and then the debt service is going to be based on his financing structure which is a full sba seller note and a 60 month seller note and we're just going to have the standby note be interest only for the period of this demonstration so that means after his debt service he's going to have 133 000 in cash flow after he pays his different loans and interest it's important to know how much of that is interest why because we also need to pay taxes if um you borrow money from the bank um you get the money it's not taxable it's not income so when you repay money in a loan it's also not a taxable thing so when you are paying a bank loan the interest portion is ta is a tax expense a tax creditable expense that's why on a p l or an income statement interest expense is listed as an item but the principal portion is not an expense the principal portion is paid out of your profits ppp principal portion paid from profits okay and so as such we need to know how much of the debt service is interest because the other part of it is subject to taxation so we've got our interest and then what what what is this capex thing that i mentioned in the tweet well there's another video i want you to watch it's called david and warren buffett duel over depreciation and it'll help you it'll help explain some of this for people who don't know and if you are looking at an ebitda number depreciation and amortization have been added back what are those two things that's how accountants represent the cost of things wearing out right let's go back to the original listing right here remember how i said utility was important and it's a landscaping services provider and they have 20 trucks well let's think about this i don't think these guys mow lawns i really don't i think those 20 trucks look like this i think these guys clean away trees from power right aways i think they go through communities during the good weather months and they cut down trees that are kind of like infringing or encroaching on power lines so that when there are storms hurricanes etc there are fewer power disruptions and this happens here where i live because in wintertime we get a lot of bad winter storms ice storms et cetera so in the summertime these contractors go through the neighborhood and they follow the power lines and any trees that are kind of leaning over or branches that are growing too close they trim them right and and they just move through so that when there's a bad winter storm there are fewer instances of power outages okay and that's what i think these guys do and so look at this this is um this is treetrader.com and we can see here this is a this is a 2012 all-tech mounted on a ford f-450 so this is a 10 year old bucket truck um still worth 50 000 right and so if these guys have 20 trucks my guess is that they're not all 10 years old my guess is that some of them are newer than that so the fleet of equipment here is a significant value and trucks depreciate i know with the recent inflation used trucks have been going up but in normally trucks depreciate over time and every year this company is probably replacing one or two trucks so the capex is important i did a little bit of research and i discovered uh from a source here this is a paid thing that i have access to called business reference guide and the average for the landscaping industry depreciation cost is 3.7 so that's what i ran with i said what if this business had to commit 3.7 percent of its sales every year to replacing the fleet of equipment that would add up to 96 000 which coincidentally would be buying two of these used 10 year old bucket trucks not that maybe someone would want to invest in 10 year old used trucks but that would match up so you this could very well be the capex budget of this company so let's get back and look at the numbers so if i've got a depreciation or capex of 96 200 a year uh also um i forgot to mention up here under the deal structure he proposed the ebitda debt service coverage ratio would be 1.42 which actually would qualify with some lenders but when we consider the total um capex after capex and and i recently had lisa forrest on from live oak bank who said that they'd look at ebitda and they add a maintenance capex depreciation type of expense because they wanted to make sure that capital equipment was replaced and maintained so bankers are keen to this guys they understand that equipment wears out now our debt service coverage ratio is only 1.12 and now our cash flow before taxes is 36.8 so under in the twitter example he showed that his cash flow was only going to be 22 000. i've given him an extra 135 000 of advantage but we're still down to only 36 000 we haven't paid taxes so again i'm assuming that there's already a salary built into that ebitda for the owner manager and i'm assuming all the source deductions and taxation under that salary is going to be paid like on a w-2 okay so the business activity itself is going to have an income of 159 000 and i went to um i just assumed we're going to be talking about a flow-through entity like an s-corp or a um or an llc oh i've lost my page there it is and it said mid-atlantic state in the um in the listing so i just i think i assumed south carolina north carolina so it just gave here a total income tax for someone who lived in that place and obviously if somebody had a base w-2 and then added this income their taxes would be even more so again i'm erring on the side of advantage uh for the story here so after the tax of 48 000 we would be left with a negative so then i put another comment here watch my video pay for potential learn about blue sky we'll link it again uh maybe we've linked too many videos i don't know but um spend time on my youtube channel you learn about this stuff so obviously if you did this deal from day one you'd be losing money you would be underwater and behind you in most cases people who got into this would be cutting their own salary uh because they they would not want to be falling deeper into debt or getting into lines of credit or using credit cards right this would be a really bad situation and it would be a roll of the dice on whether or not any of the suggested marketing methods in the twitter thread would work out to grow the business if you bought a business under these circumstances you are entirely avoiding the advantages of buying a business you might as well just take your money and start a business of your own because this business has to act like a high growth startup in order to get out from under the incredible debt that he's suggesting that you take on the reason you buy a business is because you make a deal to have a successful cash flow from day one that covers everything that like an sde seller's discretionary earnings that does all these things provides you with a living income that is a market can commercial comparison with what it would be if you worked as an employee in the business number two you need to be able to service your debt number three you need to be able to get a return on your cash investment to get your part your cash back out um and return on your equity has to be a lot higher than the overall rate of return on the acquisition of the company um and i've made many videos on the difference between roi and roe and how people get confused and and snooker themselves by that confusion then you have to be able to pay your taxes and then you also have to be able to do capital reinvestment right so when you buy a business you need to be able to do those five things out of the cash flow and if you can't it's not a sensible deal i quite literally have told many many people i would rather see them leave their life savings in a bank even losing money against inflation and if you read headlines about warren buffett he's sitting on like a billion dollars right now even though he knows about inflation because he'd rather lose money against inflation than risk the capital right he wants a winning a winning investment and i want a winning investment for you too so i've told people leave your money in the bank and go get a job somewhere don't do a dumb deal you you need to do a deal that's going to make money from for you from day one or else it doesn't make sense to do the deal so let's get back to the twitter thread so i troll commented that's what i said now let's look at what people replied to me with and so we're going to skip him for a minute we'll go back to him um and then here's genus has have been trying to buy a business for a long time but in my industry this is what i keep running into seller's not willing to sell what the business is actually worth but attempting to sell for potential i will not pay cold hard cash for potential good gina siva says keep looking you'll find one priced right well not if she's looking in the wrong place right and so this is why in my group coaching program business buyer adventure so much time is spent on deal flow not necessarily with a broker channel because the reason sellers go to brokers is because they want the brokers to create competition between buyers to drive up the price the best deals are not often had through a broker channel or you become a known commodity to the brokers where they know that you're a good buyer you can execute you can do deals and they'll bring you motivated sellers immediately before they even advertise them online so someone like mr kaczynski who has multiple companies in his holdco he's probably got that kind of reputation with some brokers where they're bringing him deals before they ever get on to the online marketplaces and so he may get an opportunity to buy things at a reasonable price where gina for example here does not um and then one person says it's just an example um and then this person says honest to god borrowing money from your friends and blowing it all on yeah i can't read that online um and then here's somebody makusu-san who says as a banker i agree this process um doesn't make sense uh of course on twitter there's lots of colorful language but what mr kaczynski says to me in response to my quote is sorry not super clear what would you like to pay for this landscaping business and that lady ladies and gentlemen is this week's question that i'm going to answer next so let's go back over to the spreadsheet so let's scroll down what would david like to pay and i've got a few comments here [Music] and some things have moved sorry okay so steven asks what would david like to pay and my answer is it depends to a great extent on the plant and equipment in any business like this you need to know the actual capex schedule what needs to be put out not rely on averages like we did with the depreciation so if i was going to be actually buying this business i might make an offer subject to due diligence of course but in the due diligence i would be having every piece of equipment looked at and i would build an actual capex replacement schedule going off into the future to know what the expenditures were going to be and then i would either make a plan to spend that money in the future and i would take that out of the cash flow oops or i would use the the method i explained in the um david and warren buffen duel over depreciation video and i would use the leasing tool method where i would just assume certain pieces of equipment were going to be leased and i would use the lease lease payments um because many sellers who plan to exit will stop reinvesting and they'll allow their fleet to age so that they can create more cash flow for themselves in the in a couple years leading up to their proposed sale date you don't want to be caught by that because what ends up happening is you end up catching this big deferred revenue deferred maintenance and maintenance and capex replacement expense i wouldn't want to have a lower than a dscr of two of ebit not ebitda because this is a capital intensive business right if we assume these are bucket trucks and they're worth 50 grand each at 10 years old it means that at a minimum the capital fleet here is worth a million dollars so that means my debt service budget on this acquisition would be 100 177 000 roughly right i then did a little bit of research so i went into some paid online databases i looked at iba appraiser data i looked at biz comp's data and i also looked at deal data and i would like to put them on the screen but i believe the terms of service prevent me from publicly sharing things like that which they're paid databases so so i i'm going to explain to you what i saw i saw that in a lot of these businesses as the earnings and ebitda and sde numbers went down the multiple went up so the lower the ebitda number went the higher the ebitda multiplier went which is counterintuitive why would someone pay more for a business that has a lower cash flow well a few months ago a good friend of mine online here mike finger put a comment about cafes selling for eight times discretionary cash flow and he said that it was unrealistic and i responded it's not unrealistic all you have to have is an espresso machine worth eight times what the sd sd of the business is meaning that if the earnings are low enough the equipment value becomes the main point of consideration for buyers not the cash flow because they're not really buying the business as cash flow they're just buying the equipment right and so that's what was being confirmed with to me in these databases is that there was a certain minimum price that these businesses was hitting now if you looked at that database and you didn't understand that phenomena if you didn't consider the value of the equipment you would believe that these businesses are actually selling for 3.5 times their cash flow and they don't they're selling at a price related to the equipment value so they're really they're going as a bulk liquidation of equipment along with the customers right so when i started to look at this and i just backed up and i said okay if i was going to buy a service business that had a high capital cost of of entry what sort of ballpark numbers would i be looking at and i thought about all the excavation companies that i've helped people buy and sell i thought about other landscaping businesses that have helped people buy or sell i thought about businesses like grocery stores which are also capital intensive with all the shelving and the display coolers and all the leaseholds et cetera and i thought let's just use some general ballpark numbers here so i said about 40 of revenue about 2.2 times sde or about three times ebit and so you can see here in my calculations that gives me just over a million according to the revenue about 1.2 million according to sde and just over a million again for ebitda for the multiple of ebit so i just put a round figure of 1.1 million so at 1.1 million here's my purchase formula um if a buyer put 10 down and then got an sba loan or just a conventional equipment loan from a bank because there's a ton of equipment here if you got a conventional loan for half that price another 550 000 and a seller note for 40 of that for 440 000 what would that do our debt service total would be 178 000 which is pretty close to 177 000 budget that i had proposed okay so with four hundred and fifty thousand dollars uh and and if i go back up here sorry i didn't do the cash flow illustration but if we have 450 000 of ebitda minus a hundred thousand dollars of capex so let's say 350 minus 178 000 um that leaves us with um 315 minus 178 you know a little over 130 so then you're going to pay your taxes out of that and have close to 100 000 income for yourself that's a deal that makes sense okay that's a deal that makes sense so then i'm going to tell you this here's why the seller will not accept this offer because if i owned this business i wouldn't accept this offer would you to walk away with 650 000 of money and a note for 440 000 subject offsets when i've got equipment worth a million bucks no because the equipment is likely worth more than 1.1 million this is an example of a business that likely has negative equity the the person who owns this business has invested more in plant and equipment than the cash flow would dictate how does that happen how does it happen i tell you it happens all the time i see it all the time this business if they don't find somebody ill-informed enough to pay their asking price this business will end up simply liquidating they'll call an auctioneer they'll send the trucks to richie brothers or to a dealer and they'll just liquidate all the equipment there's another video here which is very important called dead capital in a business and it's where i explain how this phenomenon happens how business owners keep reinvesting reinvesting reinvesting thinking that they're building something of value not realizing that it's the cash flow that determines the value if a lot of these business owners looked at their business from the point of view of the way a buyer would and looked at the value of the cash flow they would realize that some of these reinvestments in plant and equipment don't make any sense how can the business not have sufficient cash flow to warrant the investment let's go back over here remember this right where's my magical word here utility clients for most businesses i've ever worked with um who were involved in any way here i'm going to make myself bigger for most uh businesses that i've been involved with who've worked in any way in some kind of construction or subcontractor role or doing sort of of work this company probably charges an hourly rate for a truck with crew for the utility company to do this maintenance of of right-of-ways um anytime i've ever worked with any of these companies they're bidding and because they're bidding and because there are professional purchasers on the other side who know what stuff costs they have difficulty increasing their margins and every time somebody goes and buys one of these trucks at the richie brothers auction with the idea that they're going to get into this business they go right down and they just say hey i'm going to help you solve your cost problem remember that comment let's go find that let's go find that comment because if i back up here mr kaczynski actually said that he's going to go and talk to property managers about their maintenance and cost talk to managers about their costs and pain points for landscaping and that's what the buyers of trucks at auctions are going to do they're saying i'm going to get into this business i'm going to buy this truck cheap and i'm going to go and the purchaser over at the utility is going to tell them what their rate is he's going to say or she's going to say your rate is x per hour and we'll we'll hire you on this season and that's why the cash flow will never be worth enough because they don't have the ability to create a high margin business versus a company that goes and mows lawns you can employ all kinds of marketing strategies sales tactics etc to impress a homeowner and and you know have them create an opinion in their mind that you do a better quality service so it's worth paying you a little bit more than the other guy that's true goodwill built up into a brand let's go back here to the listing once again well known and highly respected name in the marketplace long-standing relationship with diversified client base well so they're well known and they're established that's great but this is not where goodwill is generated goodwill for those of you who are new is the difference between the market value of a cash flow and the tangible value of assets so if i believe this business is worth 1.1 million that's what i'm willing to pay let's say that's a true fact it's worth 1.1 if the trucks are worth more than 1.1 it means the business has no good will if they're worth more than 1.1 it's got negative goodwill the trucks have to be sold at a discount in order for it to make sense for a buyer right so how do you create goodwill let's look at a great example i already mentioned warren buffett he invested in coca-cola coca-cola sells fizzy sugar water with flavor and they sell it at two to three times what the store brand sells for next to it but people still reach for the red labeled bottle why because people perceive it to be of greater value it's both products the store brand and the coca-cola are both fizzy sugar water with flavor right why is coca-cola able to get that price because they really have value in their brand name and reputation and goodwill people are willing to pay that's what creates the goodwill this business doesn't have that opportunity this business is in a tender trade so if if you if you're new to this and and maybe i'll get some new viewers after creating this it went a little bit longer than i thought um i highly recommend if anyone wants to get into buying a business that you you head over to businessbuyeradvantage.com it's where you'll find be able to sign up for my online course and you'll be able to sign a business buyer advantage and you'll be able to learn more about my group coaching program business buyer adventure um please share this message if you're one of the 10 000 people who liked this thread be careful what you read i mean there are people online who will look at this thread and and believe it's real because 10 500 people liked it because the internet agrees that it's a good strategy very few people get down into the comments and a lot of people would see my comment and dismiss it because it only has 48 likes um and you know my apologies and thank you mr kaczynski for for asking me the question because i think it's we need to take a cold hard look at some of these things because a lot of stuff out there on the internet creates a lot of hype and excitement and this cheerleading kind of atmosphere around the idea that you know buying a business is in is a can't lose scenario where it's a slam dunk for easy wealth and a lot of people are detouring themselves from time and effort spent developing themselves learning real skills because they're chasing this dream you know i've been in this business since 2007 2008 helping people buy businesses and the most common sort of um sketch of someone that i help buy a business is a person who's middle-aged who's got experience management experience who has money saved up equity home equity good credit etc and they come to the game with resources and management ability and skills and increasingly what i'm seeing in the marketplace are these very young people who just got out of university who believe they're going to go down this path of pulling off a deal sometimes with none of their own money pooling together investors and all this other kind of stuff and i'm seeing a lot of them making noise i'm seeing a lot of them having discussions and i'm seeing a lot of them you know going through the paces but i have yet to run into a lot of them who've executed and and if you're young develop yourself spend some time in the trenches work for someone else give yourself a chance to make mistakes while you run someone else's company before you end up trying to do a deal potentially putting yourself into a poor situation without resources to fall back on and really shooting yourself in the foot and with that we'll say see you later and if you enjoyed this video please give it a thumbs up and if you think someone else could benefit from this message please share it share it on other media share it on twitter share it on facebook share it on linkedin and with that i'll say see you later thanks for joining me i know it was a long one we'll talk to you soon bye so how can you learn more about buying selling financing and managing small medium-sized businesses easy head over to my blog site davidcbarnett.com where you can learn more about me and how i work with my clients you can learn more about my books and the online courses that i've prepared for you you can find out about how to subscribe to my email list the youtube playlist etc there's literally hundreds of hours of content there all for free and i'd love for you to be my guest special thanks go out to jeff alpog customs for being my tailor men all around the world can look dangerous just like me with the help of jeff alpock customs jeffalpod.com use the code dcb10 to save they handle multiple currencies and ship anywhere you happen to be

Channel: David C Barnett Small Business and Deal Making SME

Views: 51,578

Keywords: business broker, bizbroker, buisness brokers, small business, mergers and acquisitions, m&a, smallbiz, entrepreneurship, entrepreneur, investing, investors, smb, buy a business, startup, ebitda, mergers and inquisitions, buying businesses, business valuations, how to sell my business

Id: K89r4TNebFE

Length: 55min 38sec (3338 seconds)

Published: Wed Jun 01 2022