Allow me to make a quick analogy to the real estate market. Folks who make money in real estate by renting residential/commercial space most often do so like this:
- Person A finds a building they really like
- Person A start negotiations with Person B, who owns the building
- At some point, Person A loops in their bank to arrange financing
- Person A's down-payment is the only money they actually put on the table
- The rest is supplied by Person A's bank
- This is usually called a mortgage or something similar
- Person A now owns Building A
- They rent the two units inside of House A for $900/mo per unit ($1,800/mo total)
- Their mortgage is $1,250/mo
- They take home $550/mo passively
- Begin this with another building
Is there more to it? Sure. Does the explanation work for now? Yep!
That's all well and good, but there's one person in the middle there that holds a lot of control - the bank.
With micro private equity, deal sizes are a little smaller, so you can justify not involving a bank. Because even if you don't involve a bank, you can still make acquisitions in micro private equity for as little as $0 upfront.
Man, I feel like I'm selling you a course or something.
Sorry about that.
I promise I'm not.
When we are working on a deal here at Howdy Interactive, my micro private equity firm, we like to use a negotiation strategy called "my price, your terms Or your price, my terms". It's similar to a shotgun clause, so it's really, really hard to get screwed.
Heads up - this example features numbers that are not real, but are relatively realistic if you find the right buyer. Are these numbers what every founder's going to offer? No! Are these numbers based on what we've had founders offer in the past? Yep! We're modeling a one-person SaaS company with minimal ongoing development, and next-to-no expenses (other than hosting, small marketing retainer, the part-time customer support virtual assistant, etc.)
Let's say we're looking at a Software-as-a-Service company raking in about $175,000 per year. Of that, roughly $9,000/mo is profit, but the founder has hit a growth ceiling and can't grow it with his current skillset. It's time for him to move on, and he wants to sell to Howdy for 1 year of annual revenue. (If you're wondering how we're convincing founders to sell to us for 12x monthly revenue, we're not - it's what the founders themselves are looking for. Keeping a plump deal pipeline will bring in golden winners like these.)
If we were to take the "my price, your terms" route, we'd offer $100,000 in whatever terms the founder wanted (most often this is some sort of lump-sum payment, so one payment of $100,000 payable at closing). Unless the founder was really desperate for cash, they'd almost never take this option. Why would you?
However, the real magic happens when we take the "your price, my terms" route. Because here's what our terms are as a part of our standard offer:
- If anything implodes, we forfeit our position, return the business to the founder, and walk away (this protects us later).
- We'll pay $175,000, but over 24 monthly payments equaling $7,291 per month.
- The first payment is deferred until 30 days after close.
Boom. We owe $0 on day one, and won't owe anything until day 30. By that time, we'll be able to make those monthly payments using the profit from the micro company.
In the meantime, that first month gets us $9,000 in profit in the bank. We'll have to pay $7,291 back to the founder for his monthly payment, leaving us with $1,709 monthly without doing anything. And here's the kicker - any growth is completely ours. We want to invest in a better Google Ads guy and get it to $15,000/mo in profit? Our payment remains $7,291 to the founder.
And if something goes wrong (like it's not a fit, the founder misrepresented something during due diligence, etc)? We trigger our "implode" clause. We walk away with a few thousand in profit for our troubles, the founder gets back the business. It protects both of us in the event anything happens.
Is this risky? Sure! All investments are. Is it better than involving a bank? Absolutely. Are we the first people to do this? Nope. There are plenty of articles on private equity. It's still cool, though. Come join the micro private equity hype train.