Hello folks! I have a special post for you today (…aren’t they all special??). James, a Green Swan reader, is here to share his story on buying a small business and how he hopes it will accelerate financial independence. As it turns out, James and I have quite a few similarities. Not only are we both on the journey toward financial independence, we both bought small businesses on the side of our day jobs, we’ve both experienced a few headwinds with those small businesses…but we’re also both fathers to little boys…James first son was born just over a month ago!! Congrats buddy and welcome to the club!!
James bought his business in January 2017 and has already experienced a bumpy ride. But don’t worry, I won’t spoil the ending to the story…read on to hear his journey, the criteria he used to buy a business and the lessons he learned in year 1. Feel free to leave a question / comment below. Thanks for taking a look!
As a young lad growing up in a solidly middle-class household, the value of a dollar was instilled in me from a very young age. I realized that money, managed wisely, is one of the keys to freedom in life. Freedom to go where I wanted to go, do what I wanted to do – freedom from the shackles of the mundane day to day existence so many Americans experience. I committed early on to saving and immersed myself in personal finance, which eventually led me to the FI community.
My definition of Freedom matured from “having money” to “purchasing appreciating and/or income producing assets that will generate diversified income streams”. That definition of freedom seemed to most often be attained through market investments, real estate, or through being the purveyor of a lucrative online side-hustle. Lacking, however, was information on wealth-building through the purchase of a brick and mortar side business – or “business class” assets. Having worked with successful entrepreneurs, seeking out a struggling business to acquire, add value, and sell seemed like as good a path as any to financial freedom. As many of you house flippers can attest – find a home with good bones, give it a little TLC, profit!
In January of 2017, that opportunity finally came about. I was approached about purchasing an existing business in a subset of home construction. I had zero experience in the field (my background is in accounting & finance), but other individuals in the partnership did have extensive residential & commercial construction experience. That experience coupled with my banking relationships and ability to run a set of books set the stage for a complimentary partnership. The owner of the business had a good reputation for quality work, but seemed to lack the ability to organize and manage. He needed to make a quick exit, so we dove into the details to see if a viable opportunity existed.
At the forefront in my mind was the fact that the venture seemed to be a scalable business model. “Scalable” may mean different things to different people, but I find that to be scalable, a business must have an infrastructure already in place that will allow for revenue growth without incurring significant additional expense. In our case, we identified very quickly that the business had significant excess capacity. If the current employees agreed to remain in the business, we thought good management, organization and marketing could optimize the business quickly and increase output within the first 60 days.
In order to reach capacity quickly, we needed to ensure that the existing employees were on board with the change of ownership. It would be awfully difficult to meet our goals in the specified time period if we had to hire and train new staff. Fortunately, our initial “temperature test” indicated that there was optimism surrounding the business, and the employees seemed to enjoy what they were doing. Considering that each employee had between 5-10 years experience in the industry, we were starting to feel very comfortable with the idea that we could have a smooth transition and ramp up timely.
Good Business Attributes and Local Trends
By this point in our evaluation, we felt like we had an opportunity worth serious consideration. We had a scalable business model with experienced employees, in a market that was right in the middle of a commercial and residential real estate boom. New developments were going up quickly, and our partnership already had well established relationships that would no doubt lead to bid opportunities. In addition, if the previous owner did one thing right, it was his tireless and singular focus on quality. With the personnel remaining with the business, we felt that we could capitalize on that reputation for quality and create a higher priced, but higher quality niche for ourselves.
A Steal of a Deal
That left one area remaining to discuss – how much do we pay for the business? The previous owner was not a businessman by any stretch. The books were in shambles, and most of the business had been conducted in cash. Even after pouring through three years worth of bank statements, it was hard to get a complete picture of the financial health of the business. That difficulty prohibited us from using any sort of EBITDA calculation or multiplier as a basis for our purchase. Ultimately, we decided that the only comfortable path forward for us was to do an asset purchase. With this method, we could bring in outside professionals to appraise the value of the equipment, giving us a comfortable starting point to negotiate. The business owner, having no way to argue our position due to a lack of documentation and needing to make a quick exit, acquiesced rather quickly and we were able to get the deal done. We placed the assets in a newly formed LLC and we were off to the races. Considering the purchase price and growth potential, we thought we could return our initial investment in year 1, so we set out to do just that.
The Joys of Small Business Ownership
Problems arose within the first couple of weeks. We hired a manager, who was a friend of one of our partners, to step in to the shoes left by the owner as each member of our partnership had other full-time careers. We quickly realized that the employees enjoyed their jobs because they had an extraordinary amount of freedom. Freedom to not show up to work at all even, if they happen to be coming off a weekend bender. Not only was showing up optional, so was notifying management as to the absence.
As we tried to ramp up and increase output, the employees balked. They were not interested in working any harder than they had been under the previous ownership. Within two months, all but one employee either quit or was fired. Our manager, we’ll call him Tim, hired green employees who could be trained up to meet our standards. The business plodded along, but we got wind of other problems. As it turned out, our “manager” Tim was not much of a manager at all. There were issues in the shop as well as issues on the job sites – all due to a complete lack of organization and leadership from Tim.
The major mistake I made was allowing this to continue for too long, due to the longstanding friendship Tim had with another owner. Finally the decision was made to fire Tim. Despite all of this, jobs continued to come our way – a benefit of having an established network within the industry from the start. For the most part, thanks to the one employee who stayed on board through it all, the quality of work was there. We still had a viable, albeit chaotic, business model. Learning from that crucial mistake, we went for experience at the management position this time around. The new manager cleaned house, reorganized the shop, hired his own guys and put together a marketing campaign.
Accelerate Financial Independence
We have been in business for one year, and obviously it has been far from the smooth transition we envisioned at the start. Despite the difficulties, I maintain that we made a good purchase. We focused our analysis on three pillars – current local industry trends, scalability and return on investment. Where we fell short was thoroughly vetting existing employees. We also hired a manager because of his preexisting relationship, not because we thought he was capable of doing the job. It has not been easy, especially as a side business, but the efforts this year have paid off. We did meet our goal, barely, of returning our initial investment within the first year. Current management has a team in place that is trustworthy and experienced.
As we gear up for the second year, I am as confident as ever that this business can and will be a great accelerator to financial independence.
Thanks so much for sharing your story, James! You definitely struck a cord with me on the joys of small business ownership. What a ride you’ve been on, but glad to hear it is turning out good. Sounds like you got quite a deal on your acquisition with a full return on your investment in one year!!! No doubt your business will be an accelerator to financial independence. I too hope that 2018 is a turning point for my small business!