Is buying a business a good investment and a strong path to wealth creation? Even in uncertain times
Some background: From the best-selling book The Millionaire Next Door, almost 98% of American millionaires are, or were business owners & Americans with a $5 million dollar net worth were also in the business owner category.
Compelling evidence that to build real wealth, owning your own business is a solid path both in the U.S. and in Canada.
Is buying a business a good investment:
· Let’s take into account three measures of a good investment.
1. ROI or Return on Investment
2. Measure of safety. Default loans for small business in U.S. is less than 2% on average at any given time.
3. Upside potential of the investment.
· Other investments: A good stock portfolio on average returns 8%. Real estate in the U.S. has grown at 3.6% since 2006. A good cap rate for real estate averages between 4-12%.
· You find and buy a business that generates $1.4m in revenue and earns an SDE of $216,000 per year. (Sellers Discretionary Earning = pre-tax cash flow benefit for the owner)
· You pay 3.2x the SDE and another $200k for inventory and $50k closing cost. (legal etcetera) for total of $941,000.
· You put down 10% of the purchase price and finance the rest at 6%. That automatically gives you a 231% return on the SDE.
· You service the loan of $9400 per month leaving $8600 for growth or salary.
· You decide you can grow the revenues by 10% per annum which you know would double the value of the business in 7 years.
· You grew revenues by 10% per year. year 4 revenues were at $2m, $3m in year 8 & in year 10, $3.6m.
· In year 11 you decide to sell and because the business is 10 years older, and you grew revenues annually you can likely sell it for 4x the SDE.
· Assuming the SDE stayed at 15%, it is now $540,000 & the bank loan is paid off, leaving another $9400 per month in the company.
· You sell at 4x SDE or $2.2m and the inventory/working capital for another $2.5m at exit.
Summary: Not bad for a $94k investment.
· The $2.5m exit equals a 35% compounded annual interest rate on your original investment, and you also had the cash flow and equity buildup from the SDE the entire time.
· Your total pre-tax compensation from the original $94k investment, less the debt payments is $5,747,934.00. This represents a 45% compounded annual growth rate
· The same $94k invested in real estate would have appreciated to $132k in that same 11 years. A stock portfolio at 8% would have grown to $219k.