November 2021 – If I Sold a Business Today
Multiples are high, money is cheap, SPACs and IPOs are hot, and it is a spectacular time to sell a business. If you are lucky enough to sell at a great price, what should you do with the money? With seemingly every asset class making new highs, how can you invest to preserve and grow your hard-earned wealth? To answer this and highlight some real-world problems facing those with newly liquid wealth, Brian Frank, Chief Investment Officer of Frank Capital Partners LLC wrote this piece.
Business Owners’ Dilemma
Congratulations on the sale of your business! As a fellow entrepreneur for over twenty years, I am painfully aware of the sacrifice, passion, resourcefulness, and restraint required to grow a venture. You took a risk and it paid off. Now what do you do with the money? Business owners constantly assess risk and opportunity, even if they aren’t living in Excel like professional investors. Owners continuously determine the optimal way to attract revenue. Do you spend more on advertising, trade shows, or in-person meetings? Do you put your business at risk by borrowing money to expand your operations to support future growth? Do you stretch to make a quality hire? All these decisions are capital allocation decisions, and now that you have a windfall of cash but no business to reinvest in, the opportunity set is far wider and, in many cases, opaque compared to running your business. Adding further difficulty, every asset class I look at is extraordinarily expensive. Let’s take a look at some assets and their payback periods.
Extended Payback Periods
As a business owner, you probably made quick assessments of your capital allocation decisions by looking at a payback period. If a project costs $100,000 and is expected to produce $25,000 of cash flow per year, the payback period is ($100,000/$25,000) or 4 years. You have to juggle many other things, like your cost of capital (how much banks or investors charge you) and the time value of money, but payback periods can give you a ballpark estimate on the attractiveness of a project. Now that you’ve sold your business and can invest anywhere, here are some sobering stats.
Meta Platforms (Facebook)
Market capitalization: $1.1 trillion
Trailing 12 months free cash flow: $36 billion
Payback period assuming flat free cash flow = 30+ years
Market Capitalization: $275 billion
Trailing 12 months free cash flow: $6.1 billion
Payback period assuming flat free cash flow = 45 years
What Are You Gonna Do, Buy Bonds?
Most equities we look at have similarly elongated payback periods. Also, consider Big Tech has saturated markets like the United States, incenses regulators at every turn, and may not grow nearly as fast in the coming years as they have in the past. Although business owners who understand cycles and risk are often comfortable with owning stocks, current US valuations certainly put the long-term viability of your wealth at risk. Did you muddle through tough years of entrepreneurship, building your company, just to risk serious permanent losses in stocks? No way! Instead, let’s move on to some other asset classes.
10 Year US Treasury Yield: 1.6%
Wells Fargo Corporate Bond 2031: 2.4%
Toyota Corporate Bond 2031: 2.1%
2021 Inflation = 6.2%
Consumers expectations for 2022 inflation: 5.0%
Bonds are clearly expecting inflation to decline precipitously over a ten year period. If inflation does not decline, your business sale nest egg will lose its purchasing power over time by being investing in fixed income. Bonds may have less volatility, but investors must focus on a real return, or one that is measured after inflation.
How About Bitcoin, Ether, and Real Estate?
We wrote in January 2021 about Bitcoin. My opinion is mostly unchanged: demand for Bitcoin and Ether continue to outpace the supply of sellers resulting in price increases. However, after another triple digit return in 2021, both of the major cryptocurrencies are nearing the end of their typical cycles after “halving” events. I have recommended up to a 15% allocation to cryptocurrencies in the past, but at this point in the cycle, portfolios need careful sell discipline, the liquidity of futures contracts, and consideration of other forms of yield like staking. Crypto has massive volatility but in recent past has outperformed every other asset class due to its decentralized nature, scarcity, and increasing utility. There is a steep learning curve, but I believe it is worth an owner’s time. That said, you still need to find opportunities for the other 90% of your portfolio!
Are you thinking about investing your business proceeds in real estate? Just be aware the Case Shiller Index posted a 19% increase in home prices in the US in the twelve months ending August 2021. New risks also arose in 2020, with governments allowing tenants to forego rent payments. Additionally, commercial real estate is in flux because numerous workers may never return to the office. Real estate needs to be considered on a project by project basis. I am not currently recommending any public REITs to clients as they are too broad.
The Bottom Line – Be a Sniper, Not a Bomber.
You may have had the good fortune of selling a business in 2021, but you are unlucky with respect to the current investment climate. There are no “easy” asset classes. Broad investing in indexes, ETFs, and even alternative classes are setup for long payback periods with high risks to the downside. Don’t give up and hide the money in your mattress or bank account though, because inflation is here and will slowly destroy the wealth you made. Do you want to pass your wealth onto future generations or charitable causes? My opinion is to be a sniper.
In stocks, being a sniper means looking at single stocks rather than an index or an ETF. Even the largest fortunes can enjoy adequate equity allocation diversification in less than 30 names. Since you made it this far in my article I’ll even give you one for free. Our largest holding as of October 31, 2021 is eBay. The online auction house has a payback period of just 14 years, and if you consider the immense amount of cash they will receive from various business sales, the payback period decreases to 11.5 years! The management team is extremely shareholder friendly, committing to a small, 1% dividend, as well as large stock repurchases, like 6% of the entire company in the fourth quarter of 2021. Executives are realigning the business towards high-value buyers, focusing on big-ticket items like luxury wristwatches, handbags, and collectible sneakers. The business is naturally protected against inflation because eBay takes a cut of a purchase price. Rising prices mean higher fees. Businesses like eBay that are both high quality and trading at reasonable prices can grow and protect hard-earned wealth.
Aside from single stock investments, I am also implementing hedged exposure to the S&P 500. I have exhaustively researched and written about indexation and how it affects US stocks. One way to take advantage of indexation without exposing your portfolio to unacceptable downside risk is to hedge index exposure. It may be a great time to sell a business, but being on the buy side requires some creativity and discipline.
Markets are dealing you a tough hand right now, but inflation and heavy-handed regulators like the Federal Reserve require a nimble, focused approach. Frank Capital Partners LLC is best suited to aid business owners in their newest challenge – holding onto the wealth they worked so hard to create. Good luck!