How to use leverage to quickly increase your income
In October 2015 I signed an agreement to sell my largest residential cleaning company, My Maid Service Cincinnati, to Blue Skies Services. The number one question I have gotten since then is, “Why did you sell?” There are a few reasons. First, in 8 years of owning My Maid Service I never had anything that major go wrong. No worker’s compensation claims, no audits, no employment claims, no accidents, no lawsuits. While a lot of this was due to our processes some of this was just dumb luck. While great processes can reduce risk they can never eliminate them 100% and after 8 years of nothing but wins, it seemed like a good idea to take some money of liabilities off the table. Second, and probably even more importantly, I attended a class that completely changed my view on how to use debt to grow a business. I realized that the best way to grow my business was to sell it so I could unleash some capital and use leverage to acquire more businesses.
My world view changed when I attended a seminar in 2015 on real estate investing and how to use debt. I think everyone understands that if you want to make money in real estate you are going to need to take on a mortgage. I wanted to make sure I knew the right way to do it. What was amazed me was the central premise of the class: the way to get build real wealth in America is to have pairs of well-designed debt tied to a cash generating asset, ideally real estate or a low-tech business. As someone who owned a maid service, I found the low-tech business part of that equation fascinating. Up until that point I had been trying to boot strap my company and take on no debt at all. Below is the basic premise I took from that class. Now this was an all-day class about how to use debt to grow you’re your wealth and how to take on the right kind of debt. To be clear, reckless debt will take you down. Please do not read this article and go take out a loan and say I told you to do it. This is like the preview of the class. Before you do any of this you need a lot more education, but I wanted to share the principles to start you on the journey.
Keeping and growing your business
For this example we are going to assume you own a maid service generating $500,000 a year in sales with a 20% profit margin, so you as the owner are making $100,000 per year. Now we have two choices. Option one, we can keep the business and over the next 3 years we double it. We then have a $1,000,000 business generating a 20% margin or $200,000 a year.
Using leverage to trade up
Now let’s look at option two. I sell my business for 3 times profit, which would be $300,000. With that $300,000 I am going to buy a new service business with the exact same 20% margin. Most small business loans require a 20% down payment, so my $300,000 down payment will allow me to get a $1,500,000 loan. If I buy a company for the same three times cash flow that I sold my old company for making a 20% margin, I now own a company with $2,500,000 in revenue and $500,000 a year in profit, TODAY, not in 3 years. With a 10-year loan at an 8% interest rate, my monthly payment is $14,500 or $174,000 a year. So even after my loan payment I keep $326,000 in cash. I am able to trade up my $100,000 in profit to a $326,000. That is the power of leverage.
Now it gets even more exciting. If I grow my old company by 20% I add $20,000 profit. If I grow my new company by 20%, I get to keep an additional $100,000 in profit, and since the loan payments are already covered, it is pure profit. The new larger company is 5 times larger. With that higher revenue there are a lot more funds for middle and upper management, meaning it is probably easier to manage than the smaller company I started with.
All of this is a brief explanation as to why I sold my cleaning company in 2015. With that capital I have invested in other cleaning businesses and real estate. I have used leverage to scale up my business by trading one wealth pair of good debt and cash producing assets to buy several larger wealth pairs.
Derek Christian has been involved in the cleaning industry for more than 20 years and is an owner or investor in several cleaning companies. Derek founded My Maid Service which was later merged into Blue Skies Services and now he works with Castle Keepers in various marketing and sales Capacities.
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