PROFIT FIRST & IMPROVING CASH w/ RIGQUIPMENT

Hey guys, we tried our darndest to get Facebook livestream to work today. Clayton tried it on his account, I tried it on mine a couple different ways, and it just wasn't working. We were thinking Facebook is down, but we still wanted to record this information for you since Clay and I are right here. Anyway, so it's not live, but we hope you get valuable information from this. Um, why don't you start off, Clay, by telling us just your journey with your business and a little, a little bit about it?

Absolutely, John. And, uh, you know, I had great hopes of kicking this thing off by, you know, really stressing that I think this is a really unique conversation since I'm almost certain that there are not 2 people in the world who have looked at more Microgym financials, bank statements, and tax returns than the two of us. Um, so that was the first thing that I thought was going to be really unique about this conversation, which I would have said a week ago. Um, but today we get to even add that you are now a best-selling author, right, for Profit First for Microgyms, which since arriving on Wednesday has already been read twice right here at Rig Equipment. So, um, congrats to you. Uh, I think, you know, I'll touch more on recruitment here in a second, right? But in addition to being, right, a good friend, you're someone that I respect in the industry and, you know, see as having, you know, very much a same or similar mission to recruitment finance. And that's ultimately, you know, helping the people whose job is helping other people, right? And we both have, you know, found our way into the fitness space through slightly different angles. Um, you know, myself, financial services background, found CrossFit back in 2011. Started coaching, started to learn the business side of, right, running a, right, boutique fitness facility, which later led me into really kind of merging that professional passion, right, or professional experience with personal passion and creating Requiem Finance, which is effectively a non-bank lender that works exclusively in the boutique fitness space. So, we help gyms, right, borrow for equipment purchases, you know, renovations, expansions, ultimately help them accelerate. Right. Their growth plans, right. Both in terms of the facility itself, as well as, right, the path to profitability. Um, and so, you know, super excited to have this conversation with someone else who has gone down a similar path.

Yeah. So let me clarify though, um, the non-bank financing is so critical. Um, I don't want to just gloss over that term. Because a lot of people don't realize, like, yeah, most of the time, if I want to get lending, you think about the banks. I'm going to go to Chase. I'm going to go to Wells Fargo. And with that, you can also imagine red tape, all sorts of stupid, crazy rules. Like in our office, um, just by the nature of what we do with tax returns, we deal with people and, um, our clients and their lending, like almost thousands of times per year. We're talking to underwriters. And I can tell you every single one of those banks is a little bit different and they don't, they don't understand your business. They actually don't understand the tax returns they're using to determine if you're lendable. So the fact that you're a non-banking financing institution to get the opportunity to lend it, you get to work more directly with someone who's going to make the decision. And that's so much, that's so critical, especially with the fact with your background, You understand the gym space where the other banks aren't likely going to do that.

That's absolutely the case. And the other thing that's really unique about our business versus a lot of other non-bank lenders, right, the majority, you know, more often than not actually just function as a broker or a middleman. And so, that's one of the things that I really disliked about, right, the traditional non-bank lending model is that there's really no incentive for the customer to actually succeed, right? It's very transactional-based, you know, it leaves a lot of room for really bad practices. So, when we started Recruitment Finance, it was really important for us to actually function as if the bank. So, every dollar, right, that we lend is a dollar, right, that we are the party that is looking to, you know, collect that back over time. And at the end of the day, right, our success is entirely dependent upon the success of our customers. So, that's the other thing that, you know, really helps differentiate it. And it's also the big, you know, opportunity, you know, opportunity or problem, right, that I saw early on was, you know, banks don't want to lend to small business owners in general, particularly not, you know, the ones that are either getting started or, you know, within the first few years of their operations because it's incredibly risky, right? And so, we had a lot of the same issues, right, that you just described of trying to convince, right, the banks that we get our funding from that, hey, look, you know, not only is it the right decision to lend the right gym owners money, but we can do it, you know, better and more efficiently than you can, right? Because a lot of times, you know, banks, they make their money off of really large transactions, right? And over the course of, you know, the last 7 years, our average finance size is about $25,000. You know, within the bank construct, it's largely economically infeasible for them to devote the time and attention and resources to appropriately underwrite a small business loan at $25,000 and actually make enough money not only to cover those costs, but also to, you know, compensate themselves for the risk they're taking.

So— Well, and I've also found too, in those scenarios, a lot of times the person you're dealing with at the bank, The middleman, if you will, who by the way takes a haircut of your loan, takes some fees that you basically have to pay back with interest. You don't really maybe see that because there's 3 parties involved. They're often trying to convince you, well, with such a small amount, really we should look at like a line of credit, or can't you just pull money from your home equity type of stuff? It's just not— they always try to convince you to do a different product. Because it's such a small amount to them. Well, it's still not a small amount to small business owners, so like, screw you, banks.

They're right behind the IRS, right, on the not friends list.

Yes.

But, you know, and originally, right, as we were, you know, planning to host this live on, you know, RedQuipment's page, To the extent that there wasn't anyone that was familiar with the Profit First concept, right? So, John, as you guys all know that follow Insight, he runs an accounting firm and tax preparation firm that's focused almost exclusively in the financial services, or in the boutique fitness space. In addition to that, he is a gym owner himself. So, he has also a very unique view into the underworkings, both the operations and the finances of a microgym. So, that's why I was really excited to be able to share his perspective. For those out there who may not be familiar with the Profit First concept in general, I was hoping, Jon, you could just give us the— and granted, there's been an entire book written about it and now a second book written to tailor it to the microgym specifically, but if you can give us the 1-minute elevator pitch around Profit First at a high level And then how, um, within Profit First for Microgyms, you've tweaked and changed some of those broader concepts to focus, you know, on the microgym industry specifically.

Yeah. And there's, there's so many different 1-minute spiels I could do on Profit First. Um, from a system concept standpoint, the general idea is we are very used to this formula of sales minus expenses equals profit. Uh, cause that's the financial statements. That's how your tax returns are organized. What happens though, from a behavioral standpoint, is that profit becomes an afterthought. You're hoping something's left over. With Profit First, we take the mindset and say, well, look, as humans, we've been known to be pretty innovative when we have limited resources. How about we arbitrarily limit ourselves On how much money we have to spend on the business by first taking out the cash that we need to benefit us as the owners, whether that's to pay ourselves, to cover our tax burden, or to give us profit distribution. So we just reverse the formula and we say sales minus profit equals expenses. So we take a predetermined amount of profit. And then with what's left over, we'll try to run our business. And more often than not, owners are creative enough that they're able to do that. So that's kind of the overall thing from a, from an actual application standpoint. Um, we know that when a dollar comes in as an owner, that that's not all mine. I have other commitments that I've already made, whether that's to my team members, to my landlord.

We just—

To the taxman, unfortunately, not that we personally made that commitment, but we're, you know, citizens. So we have to do that. So it's the Profit First system says for the commitments that, you know, you have, let's go ahead and set those aside and not leave them in our operating expense account so that we realize it's not available to spend because it's already committed. Um, so yeah, there's, there's an overview for you.

And I appreciate that. And anybody that's not familiar with it, right, obviously you've got a whole book right behind it that'll go into the details, But I did think that was a worthwhile place to start because I think, and you see this on a daily basis, right? I know I do, is that so often gym owners, really probably small business owners in general, right? But gym owners, their passion is not on the financial side of the business and that oftentimes is going to lead them to, ignore is probably too strong of a word, right? But to not focus as heavily as, right, they probably should be, right? And so, you know, when I think about your role as a business owner, right, you're making decisions about, right, what programs to offer, right, what products, right, what services, how to price them, how to staff it, right, how to operate the business. You're making all these decisions, right, with the right concept in mind, but without the understanding of how those decisions translate into financial results, and in turn be able to understand the financial implications of the decision so you can then make more of the good decisions and less of the bad decisions to ultimately grow your business on a sustainable and profitable basis over the long term. So, I mean, it's like, for me, it's like, it should be like right after an L1, right? For a CrossFit owner, should be like the financial L1 of understanding the basic accounting concepts Which would be great, but I think the real beauty of the Profit First model is, you know, that's still important and necessary. But by setting up these bank accounts, now you have, right, kind of taking all of the accounting jargon and some of the, right, more confusing concepts out of it and put it into, right, these very simple categories where you can have a much greater level of insight, a much more frequent, you know, way to review the financial success, right, or struggles of the business, right? And from my perspective, like, the number one thing I do at the start of every day is a quick review of the financial statements as well as my bank statements, because I think it really helps, you know, any kind of business owner to understand, okay, I made these decisions, right? Here's the expenses. Were these worthwhile? Did these move me towards, right, profitability? Were they impactful, right, for the business? Or Or were they not? And if you don't have that sort of like continuous feedback and very regular feedback, right, it's likely that if you wait until April to look back at, you know, the prior year's results, you know, there's just— that's too much time has passed for you to really tie the decision to, right, spend money into the outcome that it generated, right? You never really get better at growing a business or growing your business.

And I think that's one of the reasons why a lot of owners don't— or while they, like you said it the right way, they don't ignore it. But if I have time to do my accounting and anything else in the world pops up that I could do, I'm going to do that instead. I'm going to— I'll get to the accounting later. Then once we— normally it's a tax return. They're like, oh, I got to get my financials ready for my accountant to prepare. Have a tax return. So that's their habit. And yeah, when you're thinking about looking at the last 15 months, because at the point you look at it, you're still a couple months into the new year, it's a gigantic elephant and it's really burdensome. So one of the bread and butters of the Profit First system is sitting down twice a month or once a week and looking at the last transactions that just happened so that it's more fresh and you can make better decisions for sure. Also, what I love about the system too, you kind of mentioned it. Look, bookkeepers are weirdos, right? Accountants are weirdos. Finance people like you and me, we're geeks. And sometimes we use words that the average human is like, I don't even want to know what that means. And so Profit First says, instead of trying to force owners to be more like accountants, why don't we force the accounting system To be more like the owners. And so most owners are bank balance accounting. You were talking about the decisions that owners make. Certainly they're okay. Can I hire a staff person? Can I, do I need to buy more equipment? Should I do another ad campaign? All these things require money. And so whatever the—

Yeah.

The bank balance accounting process typically works is as an owner, I want to make a decision that requires cash. I open up my bank account and I see if there's cash in that account and I spend it. But we kind of already talked about that money that's sitting in the one account. That can be a problem because you have a bunch of other commitments that are in there that if you would have separated it out into other bank accounts for purposes, then when you're looking at the operating expense account, now all of a sudden that's a much smaller amount. Hmm. I know I have payroll due in a week. I'm going to hold off on that decision. So it allows us to use our human behavior and still bank balance account, um, without having to maybe worry about the crazy jargon that accountants throw out.

Absolutely. And then like to that point, right, when we think about, right, some of the timing differences, one, one thing that I always like to recommend to people, I mean, it's 2020, right? Like try to avoid using a paper check wherever possible. Like, almost everywhere, you know, in the world will accept, right, some form of electronic payment that can post on a much quicker basis. So, if you are really relying on, you know, your Profit First accounts to understand what you have to spend and what you have left to allocate, right, remove that uncertainty of, I'm not sure when this is going to post or when that's going to post and actually hit my account. And I'm now nervous of, right, maybe potentially running into an issue because things that I thought was going to post last week now posted this week, and something I thought was going to post next week also posted this week, and now I'm in a big issue, right? So, you know, we live in an age where you can, can do stuff almost instantaneously financially. Um, and I definitely recommend that everyone, you know, moves towards that wherever possible.

Yeah, so, so true. Even as I, as I was closing out last year, there's 2 checks that are 3 months old that I've written and sent out And that person has not cashed them yet. It's like, when are you going to get around to it, man? But yeah, it's, if I look, just look at my bank account balance, I have a floating cash out there. So it would have been preferable to use an electronic method to get immediate feedback. Um, well, I mean, you're the debt guy, so it would be crazy for us not to talk about good debt versus bad debt. What do you, what do you see with your experience with all these financial statements you look at and what owners are requesting they're going to use the money for? Yeah, so advice.

Yeah, no, absolutely. So I think, right, the, the biggest concept and, and is really that— so debt in itself is not bad, right? It's the misunderstanding or the misuse of debt, right, that gets people into trouble and then gives it a bad name, right? If used appropriately and right for the right things, you know, it is a phenomenal tool to go further faster, right? In business or in life, right? If you had to save until you could afford your buying a house in cash, right? That's a pretty unrealistic concept for most people, right? And the same thing kind of applies in business, right? It allows you to, right, generate a, you know, better return on your investment a lot quicker, allows you to grow faster. Again, as long as you use it prudently. So, and we, we chat a little bit about this leading up to the book, right? But I think the biggest, right, categorization I have for good debt versus bad debt is really the, the nature of what it's being used for. And so, in the, in the context of a gym, right, I think, you know, bad debt more often than not is used as a band-aid to cover, right, a shortfall in cash for expenses. Right? It has this really kind of negative, you know, kind of reinforcement loop where you weren't generating enough revenue to cover the expenses. So, now you're borrowing to fill that gap. Well, next month, right, assuming that revenue hasn't changed, you now have those same expenses that prompted the shortfall to begin with, plus now the loan payment, right? And that's going to now create an even bigger shortfall the next month. And that's where people run into a lot of troubles and really accelerates, you know, the downfall or demise of a business that shouldn't be in that situation. Right. On the other hand, good debt, what I think about is really a mechanism to, or can be used for things to help increase revenue and help increase cash flow in the future. Right. And so that could be anything from a building or equipment. Right. But if you are buying an asset that will generate that future cash benefit, right, using debt is a great way to help increase your return on investment, right? Like a very kind of simple high-level example, say you have, you know, $10,000 worth of equipment you want to purchase, right? If you spend the $10,000 in cash, right, on day 1, it's going to take you, right, maybe an extended period of time to recoup not only the $10,000 investment, right, but then generate a return on top of that, right? Whereas by financing it, you now have a fixed stream of monthly payments where instead of investing $10,000 upfront, or maybe you've invested as little as $1,000. And so, right, the next month, if you can generate $1,000 of revenue on a cash-on-cash basis, right, you're already covering that cost. Whereas if you earned $1,000 after spending $10,000, right, that's a A pretty— you're still working your way back to at least covering the initial outflow, right? If you could earn $2,000 in that second month, you now have 100% cash-on-cash return relative to, right, that financing payment versus, again, still being at only 20% of the initial cost. So, right, that's the kind of best way that I think about using debt to your advantage is you're going to accelerate, right, that return on investment or enhance the return on investment. Which over time, and right, if you continue to reinvest in that sort of cycle, ultimately allows you to grow your business and your profitability much faster.

Yeah, and I think about the danger too. Uh, most the time when people are borrowing money for the bad debt, that's living on a credit card. Yeah, and the credit card can be super deceptive because of the minimum payment amount. I can still have good credit and pay the minimum amount. Where every single month now my balance continues to increase.

Right.

Because of those things you mentioned, like, if my cash flow is not there to cover that expense, unless there's a change in my revenue, it's not going to be there next month to cover the same expenses. Now I have the additional burden. We also, you and I were in an event and there was a panel of gym owners who are doing some really cool big things like expansion, multiple locations, franchising concepts for their own fitness modality. And I remember one of— it was like a panel. So one of the audience attendees asked the question like, well, how do you recommend growing? Like, if I want to open up another location, should I borrow money or should I bring on equity? And it was funny because I thought to myself, it's also kind of in the— in my mind, it's in the same realm of this conversation of good debt versus bad debt.

Mm-hmm.

Also, not to mention, even before the panel answered, with them having told us earlier in the event what each of them had done, I could tell you how each of them was going to respond. Oh, lo and behold, the guy who brought on a partner he recommended doing it through equity. Oh, the guy who borrowed money, lo and behold, he recommended borrowing money. So I would just say also be careful of where you're getting advice from. Most people are just going to tell you what worked for them, and that doesn't necessarily mean it's going to work for you. But when it comes to that, if you're in the point where your business, whether you're physically at a capacity space and you're looking for a new location, or you have the ability to expand with some equipment and bring on some more revenue, still think about this concept with, will borrowing the money increase my revenue? Have I maximized my current space to the full extent possible? Too many times I see owners jumping ship to a much bigger location because one of their 10 classes a day Is at capacity, but the other 9 are still not even fully attended. But because this one class is super full and it's hard to do this one class, I'm going to go ahead and jump. Don't make that mistake. And then equity, just so you know, it's the most expensive way to finance your growth. Now, that being said, if you have a partner who you know has a skill set that you can't touch and they truly are bringing value, that is an awesome play. I mean, I'm a huge fan of Shark Tank, and a lot of times the reason that works out, the reason it's— it's worth it for these business people to bring on a shark is because of what the shark adds to their company, you know. Uh, anyway, so those are just some general ideas that I think people need to be aware of.

Yeah, I mean, I think— I mean, you, you hit the nail on the head, right? They're, you know, with, with selling ownership in your business, right, or giving away equity While there's not an explicit cost in the same way you think about interest with a debt payment, right, a loan payment, there is a massive implicit cost, right? If you were to take 50% of your monthly profits forever, right, and think about the true cost of what you're giving up, right, relative to the interest rate on a loan, you start to think about it that way, it becomes a very different, you know, form of of calculus there. And then, the other piece, right, which I think you said fantastically, is the way that you start to close that gap is when it's not just a financial investor, right, but there's a strategic benefit to it, right? So, if you've never opened a second location and you have an investor that has, right, or someone that's willing to invest, right, their funds into your expansion plans because they've already opened 5 locations and can help, right, provide a lot of advice and guidance, that's going to provide benefits for you, right? That's going to help you avoid a lot of issues, which is, you know, the, the best way to do something is to not have to learn on your own, right? It's, it's to, you know, be able to leverage, right, the mistakes or the successes of others, you know, so that you don't find yourself in those positions. So, a lot of, a lot of benefit to a strategic investor.

Yeah. And I like— you have to make, as an owner, you have to make the decision that's right for you. My personal opinion is I don't want to give up equity unless there's a strategic benefit. If I'm bringing on a partner just for the sake of more cash, I, I would hope that my business is healthy enough that I can get that more cash from a financial institution instead of giving up all the entire percentage of future profits. But if they have a strategic advantage, which a lot of these, these guys at this event that I'm talking about, The partner they brought on did, like, I mean, they specialized in expansion and franchising, so it was a no-brainer for them to make that decision. So luckily we had a whole list of questions and topics, which is awesome, but let's close out with one more because we're getting close to the time when people are probably like, hey, how much longer is this thing going? You— I mean, this is probably the ugly part of your job where You lend out the money, they purchase equipment, and then they close, they go under, and you have to basically repo the equipment. What reasons do you think have— or what reasons have you seen why gyms are going out of business?

Yeah, I think it's probably really 2 kind of— I would put them in 2 key buckets, right? One of those is, right, especially for gyms that are Starting up for the first time, right? It's it's being undercapitalized to begin with, right? There's this you know kind of mentality, which I think is finally starting to change a little bit. But if you build it, they will come. And then probably kind of on top of that is if I build it bigger and fancier and prettier than everyone else, then I'm definitely going to get extra members. And so that's yeah, I think probably the biggest you know problem that that first time gym owners have is you know they. not only overspend in terms of getting the facility open initially, but they spend all of what should be maintained as cash reserves. And those are not only because, one, almost every gym owner that I think has worked through that startup process is gonna say is that it took longer than I expected, it was more expensive than I expected, and the growth rate, the inflection to break even took longer than I thought. Right, and so if you start out with little to nothing in savings to be able to rely on through that period, you're going to immediately find yourself in trouble. And maybe not to the point of shutting down your doors right away, but what it's going to do is allow you to underinvest in marketing, underinvest in your staff. It's going to create a lot of other, right, downstream issues within your business that would have all been avoided Right? Had you either, A, started with, you know, a kind of larger, right, or would have started with more capital in general, right? Or 2, invested less in things that, you know, you can invest later on as your business starts to grow, right? And then the other side of that, which kind of again winds into it, is people are unable to manage their cash flow appropriately. And part of that is, right, the lack of understanding or lack of a good system to help them do that. You know, but it's also right, if you can grow your sales enough, right, you can stay in front of problems for a while, right? But if you're not, again, creating those feedback loops to where you can start to make better decisions about your business, that mismanagement of cash flow is ultimately going to catch up and cause huge issues. So, which again only gets you know, exacerbated by not having the cash on hand to be able to invest in your business in the appropriate areas. So that's, that's probably the biggest issues that I see out there. And then actually, maybe to tie it back to one of the bad debt examples from earlier, one of the things I've seen is that will most rapidly accelerate that downfall Is taking on the bad debt to cover expenses, right, but doing it in the form of a merchant cash advance, right? And so the quick overview of that is essentially the company that processes your credit card payments or your monthly membership drafts will say, here, we'll go ahead and front you, right? We'll advance you cash and we're just going to take a, you know, very small percentage of every dollar that comes through our processing system until it's paid back. Right. And a lot of times they actually will kind of market it kind of deceptively where, you know, it's like, oh, you're only going to pay 10% of your revenue next month, right? So, it's a fairly, you know, reasonable cost. Well, that's 120%, right, effective annual interest rate on that. Oh, and by the way, you don't get the cash first to then make a decision whether you can pay them, right, versus your landlord. or versus your employees, they're taking that money before you ever see it, right? And so, the companies that do start to get into that bad debt bucket and then use the worst form of bad debt to help provide a band-aid ultimately are the ones unfortunately that we see really accelerating the issues that they're having towards failure.

Yeah. I mean, it's really just another form of the payday loan, right? Where the guy comes in with their paycheck and they get a loan on that. And then next month, they're expected to pay it back. Now their cars are getting repossessed because, yeah, people don't think about it. 120% interest rate is psychotic. And some of them, it's even higher when you look at, yeah, it's 10% and a flat fee until we pay it back.

Yep.

It's brutal. And one of the other things you said that I love, it is so true. Hard work can hide bad cash flow management for a while. And yeah, hard work plus good cash flow management. Now that's how you turn your gym around and become profitable. Well, Clay—

Which you know firsthand.

Yeah, we're still working on it. What a process. Holy Toledo. Oh man. But we're— it's good now. I mean, we had the Morning Chalk-Up article where I laid out our dirty laundry, got a little bit of pushback from Some of the people who were the dirty laundry, but we have an excellent staff and team right now. We're all on the same page. We're all trying our hardest to get GSL to profitability. Anyways, but so Clay, thanks for your time. I think we, I think we've covered a lot. We don't want to make people's minds explode with the sexiness of talking about numbers for too long. Um, but anyways, I appreciate you being on, man.

No, I, I appreciate you. Congrats again, John, on the launch. You know, I think it's a phenomenal tool that's going to help a lot of people out there. So, um, awesome job and thank you again.

Thanks, Clay.