How to Fund a Business Acquisition: The Smart Investor's Playbook

It's the same thing that I do. Right. So I lend down payments to students. I take. It's a 10% in and it's 15% back. And there's also a debt on that. So that. That needs to get paid back. And the reason that we do that is because. And I'll go through this experiment so you can, so you. So everybody can see how the fund works. Let's take this deal, for example. The total deal is $1.8 million. Okay. Number one, I want to ask this guy, what's happening in 2024. The Florida market is absolutely getting decimated from estate perspective. I just want to make sure there wasn't a huge precipitous drop. If that's only six months and you annualize that out, they'll actually do better than what they did in 23. I just want to confirm that if they shift it over to commercial, the margins went lower. It's probably right in line just because they're making a smaller. A smaller margin on commercial stuff, which is fine. So a couple of things that you need to consider is your $200,000 is going to go in for a 10% equity injection. We're going to be looking at debt service of, let's call it 180 per million financed times two. So on the high side, it's going to be $360,000 in debt service. Again, that's on the high side. I know that you can shop interest rates. I know that. You know, if you were to look at 10%, it's closer to 13,000 per million financed. Like, we can get nitpicky about it. And it's 1 million 8, not 2 million. But I'm going to use $360,000 in debt, and I'm going to take an average of $500,000 over the last couple of years. Okay, $500,000. If there is 500 minus 360, whoops. 500 minus 360 is 140. So replacement salary. So you have 70,000 in a replacement salary is what they put on their P and L for an adjustment. And then you have this 140 after debt service, which is about $210,000. Okay, so if he's gonna take that $70,000, that leaves that 140 for profit. Sure. Your number out of, out of 1 4. Now, we haven't talked about marketing. We haven't talked about rebranding. Now you guys have. You guys have your bpo. You guys can probably add a ton of value to this thing. You know, from a marketing standpoint, you could probably grow this thing tremendously, but that still costs time, energy, effort, love, money. Right. And so what is the add back gonna be from a marketing perspective? Is there any rebranding that needs to be done? Is there any necessary cleanup that be done? There will be unexpected costs as you move forward and try to clean this business up. You're doing all of that right now for $140,000 before we start to, you know, for, for 10% of 140, which is 14 grand. So if you're, if you're investing $200,000, you know, 14,000. Fourteen thousand divided by 140. Right. You're getting, you're getting your 14,000 divided by 200. You're getting a 7% return on your money. And that's before you have any expenses. And you know, it has to be a fair and equal deal at the end of the day. That's why when we do it, we do the 10% down, we get 15% equity in the company. So then that way, in this case, it's $1.8 million. Your equity position, it would be automatically, you put 200 in, you get 270 on the valuation. Okay. I'm working for equity at the end of the day. And I think that, I think people forget the debt structure and the reasonable comp salary and the working capital that needs to go into a deal. And so then they go, well, Kyle's getting 15% on his money in debt and 15% of my company, like, wrong. Right. My investors are putting the money down for the down payment, which, you know, in your case would be you. So you have to pay, you have to get a premium on that money because you could put your money in the S and p and make 10%. You could put your money in gold and make 10%. You could put YOUR money in anything and make 10% relatively risk free. Right. And so for you to take all the risk in this deal and you know, have to work for the equity only, that is pretty much illiquid and rides and dies on this person's operational skills to build the business is not a fair risk reward scenario for you. Right. And so that's why we do that like that. So it's 15% coupon on the money that we lend into the deal. So in your case would be $200,000. You want a 15% annual return on that. And then for the profit share of the business, we need to figure out what's the reasonable Compensation that's going to go back to the operator, right? Because they got to get paid. They're going to run this business. And you don't want to cut corners here because if your operator is starving and can't make a living and can't do well, like it's like nobody wins, right? Like your whole investment is at risk. And so I always make sure, is this fair? Is this good enough? Are you able to live on this? And within this constraint, if I give you more here and more there and more here and more there. We're working together to build the enterprise, but I need to make sure that you can live off of this 70. So we need to confirm that first and then whatever is left. What's the profit distribution of whatever is left at the end of the day? What? Also who's going to bring more money for marketing? Who's going to bring working capital? Let me show you something really quick. If your working capital is. It was 1945 and I'm just using blocks of four here. 1.9452485 in 23. And if I prorate out that 1335 times two is 2670 to run this business divided by 12, it's going to cost $222,000 a month in gross top line sales. Okay? Now the margins here are 20% profit margins. So I'm going to take that 222 in sales and I'm going to times it by 0.8 because that's my cost to actually run the business. 222 times 0.8. It cost me 177amonth to run this business. Okay? Now you're gonna have to buy materials, you're gonna have to replace materials. You have a local distribution center. You have to buy goods in order to install. You go out and get a commercial job. You bid the job at $25,000. You have to take a deposit for the $25,000, you have to order the product, you have to install the product, you got to pay the subs in order to do the install in order to get the last check to get paid. And so what I'm saying is there's a significant amount of working capital that needs to be had in this deal as well. And so depending on when you know if you're doing commercial work, the cash conversion cycle could be 90 days. So that means I quote the job, I start the job, I take a deposit, I start, I'm in the middle of the project doing the work, I finish the project, I get Paid the final bill, that could take 90 days. And if that takes 90 days, you, you're going to need approximately 25% of whatever the top line sales are in reserves to be able to stomach that type of cash conversion cycle. Now, if they're dealing with residential and you get a Facebook ad today and they quote the customer on Friday and we start on Tuesday and we do the job in 10 days and we get paid in 14 days, your cash conversion cycle might only be 30 days. Then you don't need as much working capital in the deal to run the deal. But because you're doing work, you're doing residential and commercial and you have full time employees on the floor, right? Your annual payroll right now is 150. That's 12,5amonth, that's $4,000 a week in payroll costs. You got rent for a thousand bucks a week. You've got insurance, you got work, right? We have all these expenses that we need to take on. And we need to understand what the cash conversion cycle is going to be in this deal. Because if the operator is coming in and would like you to put the down payment down, the good news is you stay under 20%, you're not personally guaranteed on the SBA loan. That's why we do 15%. Because then I don't have to personally guarantee all of my other companies just to be able to participate in the deal. Right? So you want to stay under the 20%, number one. Number two, you need to get paid an interest premium on your down payment money on top of the equity. Because what I'm trying to suggest is that 140 that's left after all these bills and all the debt and all the things. If you are only reliant on that to pay the interest that your money would normally make risk free, it could get dicey, right, because you might have $200,000 of working capital in addition to your $200,000 into the deal. Now we're $400,000 into a deal of which my equity piece is only worth $200,000, right? And I'm making no cash flow on that money. And so I don't want you to get down the pipe with, you know, something that looks great and then all of a sudden it becomes very, very thin later and now you're stuck in an illiquid asset and it wasn't a good use of your $200,000. That's why I love the SBA so much, is because you can leverage up and use that same 200 and own 100% of the deal on your own. Right. Like you guys could buy something and just bolt it on to what you're doing and own 100% of it. I understand the idea of, I want to bet on maybe some earlier investors that will go and run the deal so I don't have to be in it. But I also want to make sure that that's fair because your time, energy, effort and money is worth a tremendous amount. I don't want you to discount yourself. Like in my deals, for example, I don't even plan to make a return outside of my equity value because I know dang well that especially the first year, there's going to be unexpected expenses, there's going to be value ads that we're going to want to do. You know, the website needs an overhaul, the uniforms need to be updated, the people need to get technology and digitization. This is what you guys are really good at. And I think you'll be able to add a lot of value to anything. And it's good for you to collaborate with other operators within the group. But just understand we got to protect our capital at the end of the day and we don't want to get it, you know, all convoluted where, you know, we're not making any money on our investment. Yes, we got this equity, but you know, it's only, it all rides and dies on that operator. And you know, like I said in the first couple of years of our debt fund, I don't anticipate making a return. I'm strictly working for equity and, and any money that's being generated on that interest. And so for example, if it was $200,000 at 15% interest only, you know, 200,000 times 15%, it'd be a $30,000 interest only payment. So divided by 12, it'd be 2,500 bucks to you. If you did 200,000 and did it like on a 60 month note with a payback, it would be 300 and 33, 33, 33amonth plus the 15%. So the debt service would be negligible. It'd be somewhere between 2,500 interest only and 4,500 principal and interest. But it's paid back over a definitive amount of time. And then they're using the free cash flow of the business to pay that debt. And what happens is after five years, you've made 15% per year for five years, all of your debts paid back and you now own hopefully a business that's been going up 5 to 10% per year for the last five years. You know, you're in a good position. It's grown at least 30 to 50% over five years. And now you own this equity free and outright and you share in the profit share at the end of the day. Was that helpful and insightful though? I mean, I just, I want you to be well prepared and this is for everybody. I want you to be well prepared for what that might look like. You know, when we structure the fund and I agree to pay people's down payments, I think people don't really look at the math to go, oh well, what is, what is he making? There is like, it feels like double dipping. There's debt and there's equity, but really at the end of the day, once there's reasonable comp, there's marketing, there's, there's debt service from the bank, all these other things, there's peanuts in the equity position. You know, the equity value is there, but the cash flow isn't. And so that's why that front end money, which is coming from outside sources, needs to get some preferred return, which is what you would ask for here.

Yeah, I was just had a question when you said that let's say that the business goes crazy and you sell three years before the debt's due.

Yep.

Paid back to fund the equity plus.

Yep.

Hasn't been.

If there was a liquidity event, we would just do where we're at right now. So if I, if I take something not full cycle, not the full five years, I sell in three, their payments would stop and they'd get a return of their capital. That's it. Okay. Yep. You're welcome. And you know, that's a good thing though because investors go, well thanks. Here's your half million dollars back plus your interest over the last, you know, you've enjoyed 12% or 20% over the last three years. And they go, well, what's the next project, Kyle? What do you want? So they're pretty happy at that point, but it's always a good thing.