I don’t frequently do book reviews, but occasionally a book is published that is so closely aligned with the Fundamental Investing Institute’s mission of educating and empowering entrepreneurs and individual investors that I would be remiss not to comment on it. Codie Sanchez’s book, Main Street Millionaire: How to Make Extraordinary Wealth Buying Ordinary Businesses is one such book.
For those who don’t know, Codie Sanchez is a very successful acquisition entrepreneur with a large social media following. She also offers programs and courses to help aspiring entrepreneurs acquire small businesses.
Having been an equity partner and operator in a number of “main street” businesses myself, I can appreciate Ms. Sanchez’s mission of promoting small business ownership through acquisition. And I can more so appreciate Ms. Sanchez not sugar-coating what it takes to be a business owner. As she states, “….there is one common thread: when you own it, you gotta work on it….It is not passive, nor is for the faint of heart.”
Ms. Sanchez has become very wealthy using a seemingly simple formula: buy a cash-flowing business, finance the acquisition with seller financing, increase profits through efficiency improvements and aggressive marketing, and use the cash flows to acquire other businesses. In this book, Ms. Sanchez provides an overview of the process.
The book’s central thesis is “…buying profitable, established, cash-flowing businesses is the most underrated path to wealth.” I couldn’t agree more. For even moderately successful leveraged deals, the economics are very attractive. Consider the following very simple example. You buy a business currently making $300,000 in operating profit and pay a purchase price of $900,000 (three times operating profit). You put down $90,000 and finance the rest. Assuming the note is financed at 7% with a 10-year standard amortization, the yearly debt service will be around $113,000 a year. Install an operator at a $100,000 per year base salary, and your pretax earnings surplus is $87,000 per year. In other words, you’ve almost recovered your entire equity investment in the first year. Add to that the loan amortization, which increases your equity in the business, and you have made a substantial return in the first year. Of course, how much of this is a true return on investment will depend on the amount of time that you have to put into the business.
The above assumes that you can maintain the business’s current earnings. If you can improve the earnings of the business through more efficient operations and more aggressive marketing, you can earn truly impressive returns on your investment and be on a quick path to financial independence. Judging from her record, Ms. Sanchez is expert at improving and scaling small businesses.
The key to these deals is a combination of the low purchase multiple (purchase price divided by earnings) and the use of financial leverage (i.e., borrowed money). The low purchase price is a reality of the market for smaller businesses – companies making less than $500,000 generally sell for three to four times operating profit. These businesses are seldom well-oiled machines, and they pose significant risks to the buyer (staff may leave, customers may leave, etc.). These smaller companies are also generally off the radar of private equity firms and corporate acquisition departments.
Financial leverage, on the other hand, is no free lunch. Ms. Sanchez understands that well and seeks to minimize her risk by using seller financing. In fact, along with improving and scaling small businesses, Ms. Sanchez is expert at negotiating seller financing, which she does not have to personally guarantee. And lest the reader scoff at the idea of taking on debt, Ms. Sanchez offers the following: “The wealthy understand debt. They use it to buy cash flowing businesses that will, in turn, pay off the debt… Average people don’t understand debt, so they do dumb things with it. They use debt to buy liabilities … and then wonder how they’re in such a deep hole.” In other words, leverage used to buy appreciating assets can lead to financial independence, while leverage used to purchase depreciating assets (cars, jet skis, expensive leather boots, etc.) can lead to financial ruin.
I only have one (relatively small) critique of the book. I am more than a little skeptical of the prevalence of full seller financing, especially for inexperienced buyers. A smart buyer is likely to understand that she, not the buyer, is retaining the majority of the risk in such a deal. There are certainly tax benefits to the seller if the deal is structured as an installment, but these benefits may not outweigh the risks of holding the note. And in many cases, private equity firms are backing “platform” companies in industries such as home services. These companies generally acquire smaller firms in their industry in all cash deals, making it harder for individual buyers to compete. Ms. Sanchez’s successful track record is undoubtedly a selling point for her to obtain seller financing that may not be available to the average business acquirer.
That said, partial seller financing is still available for many deals. In fact, it is in the best interest of a buyer to insist on partial seller financing, as having the seller retain a financial interest is likely to make for a more successful transition. A more competitive financing structure is to use a three-tiered model, using bank financing for the hard assets (furniture, equipment, real estate, etc.) and a combination of equity and seller financing for the goodwill. This will give the seller significant cash upfront while limiting the buyer’s risk.
The question of seller financing aside, Main Street Millionaire is the best introduction to small business acquisitions I have ever read. The chapter on hiring a manager is alone worth the price of the book. I only wish this book was available fifteen years ago. It could have saved me from making some costly mistakes.
