Starting a Small Business
Board: Berkshire Hathaway
So funny you should mention this! I've been thinking about a specialty urban gardening/landscaping company for a while now. It's my best idea right now:
It's pretty daunting to think about, but I'm pretty sure I'm almost ready to try it.
If you are looking to create value by starting a new business with minimal investment, you could do a lot worse than a low-investment service business. Low capex, low overhead service businesses, in something you enjoy, can yield decent returns while minimizing risk of loss.
As discussed in this thread, the ‘garden services’ landscaping-type businesses can potentially command favorable price-to-book multiples and a very key reason for this is that the value is the customer base that the founder has built up, and not so much the fixed assets. Acquirers pay for customers – profitable customers, that is – who have demonstrated some loyalty and don’t have to be continually replaced.
For these types of business ‘book value’ is often incidental to overall value. That does not mean that the customers were cheaply or easily obtained, of course, just that the cost of that asset isn’t necessarily reflected on the small business’ balance sheet.
Often enough when you see these businesses for sale, there will be a customer base that originated from when the founder was a teenager mowing lawns, or something, and the activity grew over the years into a real business. We probably all know examples. In my neighborhood an example might be the ‘kid’ who now plows the large majority of the long driveways in the area – the result of a decade of building a dominant share. He has such as concentration that now it doesn’t really pay for a competitor to drive the miles into the area each snowfall for an account here and there. And while nobody would be interested in buying the ‘kid’s’ old plow truck, as a package all those annual contracts concentrated in one area are probably valuable.
Just to re-emphasize, often in these businesses much of the value is in the customer base – and particularly the ‘stickiness’ and profitability of accounts.
I like the value-creation potential of ‘garden / landscaping’ a similar business better than I do Buffett’s stand-by for budding entrepreneurs, the paper route (forgetting for a moment internet trends, and that in many or most areas adults in cars supplanted kids on bikes decades ago) ‘owning’ the customers can have value. Related to this, you want to be able to understand and measure the value you are creating (if any) with each customer.
Some other odds and ends in this topic:
Self-fund. It never ceases to impress me that Buffett’s only personal investment in Berkshire Hathaway has been his initial controlling stock purchase (plus – for the purists – the occasional personal equity position in BRK-acquired businesses). Less than $10 million, which for that matter didn't even go into the company. Unlike so many other businesses we see, essentially all of Berkshire’s massive growth has been self-funded. Through all this growth, over all these fifty years, Buffett has never written a check into the company, never infused his own cash – either equity or a loan to the company - and he’s never issued equity to raise funding from outsiders. This is very difficult, but try to be that disciplined with your new business.
Obsess over costs. If you do start a business, keep the Buffett lesson about self-funding in mind. To every possible extent, have the business self-fund everything and conserve your own cash (and as a result, keep your personal return-on-investment healthy). Some of the worst small businesses I’ve seen relied on repeated funding – from ‘investors’ who kept getting drawn in deeper and deeper to fund ‘new investment’ for ‘growth’ (read ‘ normal spending to remain competitive’). Be absolutely obsessive about finding ways for your business to fund itself. Take a cue from the companies that are able to grow to the sky without external funding, and minimize or eliminate net working capital (Costco; Walmart).
Obsess over costs, cont’d. Know your costs, and compartmentalize your thinking about whether each dollar you spend is a ‘fixed cost’, ‘variable cost’ or ‘one-time’ (investment). Know the breakout of fixed and variable costs, as well as your one-time costs (investment). [How many readers would like even that simple breakout for Amazon?] About the most alarming thing I can hear from a small business owner is an indication that they don’t have an intimate handle on costs (eg, that they have to ‘ask their bookkeeper’ or accountant). Forget GAAP and think in terms of fixed, variable, and one-time, and apply one of those tags to every dollar you spend, as you spend it.
Know your ‘breakeven’ Be diligent about minimizing fixed costs (overhead). Know your break-even sales requirement and work to keep it as close to zero as possible; through the last recession obsessively low overhead was the difference between life or death for many small businesses. If you ‘hire’ anyone keep the payroll entirely variable to the revenues that this pay is generating. Be structured so that you can cut any overhead to ‘zero’ if you have to without affecting business. Minimize any ‘investment’ spending and be honest about how many dollars of revenue each dollar of investment is generating.
Seller’s market. We discuss quite a bit about whether the market is overvalued these days. For profitable small businesses it is definitely a seller’s market, particularly those that can produce a decent executive-level income in or near urban areas. There is a very strong demand these days from cashed-out executive-types looking to buy a second career, willing to pay maybe a million dollars for ‘sure-thing’ businesses that can (at least in their imagination) provide comfortable nicely-into-six-figure incomes, ideally without too much actual hard labor.
A recent example: an ex-Wall Streeter with savings but no severance, looking to spend a half to a full $million to buy a business that could replace his job. Like a surprising number of big city ex-professionals, he was initially obsessed with laundromats - the idea of making the rounds every few days to collect cash (or preferably just watch the electronic transfers from his laptop at home) created a nice mental picture a few steps up from reality. He even assured me he was able to personally repair washing machines. I joked that the better business might be to start businesses like that expressly for resale to folks like him.
Fortunately, he landed on a nice niche business who’s value (moat) was comprised of regulated licensing allowing it to bill the government for work performed by contracted professionals. Transactions funnel through his little toll-booth; competition is limited in his regulated niche; he loves it. In that purchase book value was completely irrelevant to economic value. (First thing he did almost impulsively was move into much nicer offices and buy all new furniture and equipment, a move that added no economic value and which he now regrets.)
In any case, think like a buyer as you spend money building a business. A buyer will pay for revenue-generating assets, and not so much for anything else.
Licensing as a moat. Taking the example above a step further, for anyone really interested in being their own boss but fishing for a concept, I would pay attention to licensing requirements. As a general guide, the more difficult it is to obtain a license, either because of restrictions on issuance, or advance educational requirements, the wider the ‘moat.’ A mental model might New York City taxicab, where the medallion on the hood is many times the value of the vehicle. Or for your local professional, the value of the CPA, DVM or other license versus their other assets. A home care agency that is licensed to bill Medicare is worth far, far more than an otherwise identical one that isn’t.
Remember Pinkerton. Likewise, if any service business that you are thinking seems like a rip-off but that you find you still have to use may have potential. Buffett rather famously bought Pinkerton’s when his sub managers complained that the company’s security services were a rip-off but that they were using them anyway. (Eventually the moat on that one narrowed but by then Buffett had already flipped it.) These days I have that reluctant acceptance about mold remediation, asbestos abatement, and other environmental-related providers I seem to be required to hire. There are probably better examples, but those are some where I just sucked it up and paid.