A Silver Opportunity

Two partners and I own a leather shop in the craftshop, and another individual owns a silver shop. During a conversation with the silver shop owner the other day, he fleetingly intimated that his shop might be on the market.

With fire kindling in my eyes, the gears in my brain instantly processed the opportunity at hand. His station is the proverbial corner office (though it’s not quite actually in the corner). The craftshop is a large square room with twenty-five woodshop style tables. Each table shares four craftsmen at each corner, and their respective lockers beneath.

The stations on the outside edges of the outermost ring of tables get the wall space behind them as well. The rows of stations at the front and sides of the craftshop are close to walls, but the ones at the back have a very large space between them and the wall. And they all have desks, display cases and a larger bevy of tools in that large wall area. The silver shop is one of those, and that real estate was almost as appealing to me as the actual business.

The silver shop has generated an average of two hundred dollars a month in operating cash flow during the past six months. As it’s not very labor or capital intensive, it averages 65% operating profit margins. Revenue growth has been in an upward trend for better than two years. Moreover, as its debt was incurred to buy fixed assets in recent months, future capital expenditures will be lower, and free cash flow higher.

So, I consulted with one of my leather shop partners who also happens to hold $1,300 of the silver shop’s $1,700 debt load, and offered to go half with him on a bid for the silver shop (granted that I get the station). I ran down the numbers to him and said that we could bid 12.5 times cash flow (that is, by assuming the $1,700 in debt and paying $800 more). Though admittedly pricey, if we could simply maintain cash flow at its six-month average, we could pay down debt in 8 ½ months, and break even on our equity component in the subsequent four months. Hence, after roughly a year, we’d be splitting profits thereafter.

My leather shop partner’s upside was the fact that while the silver shop owner must live off of his business (thus taxing cash flow and impeding growth opportunities), both he and I get more outside financial support, and he’d certainly prefer to have a 50% equity stake in his own company and owe the debt to himself, rather than having a debt stake, which he admittedly questions the worth of, in another’s company.

My upside was even greater. By partnering with such a large debt holder, my negotiating leverage was powerful. And by making this debt holder an equity holder as well, I’d guarantee his having a longer-term perspective (and not strangling the business to get his debt investment back at any expense as soon as possible).

Moreover, to limit his equity stake, and if we did well, I’d pay him half back—making him half owner—but if we didn’t do well, I’d pay him all of it back—making me full owner. He felt more comfortable with this set up because my credit is pristine. Hence, acting as bank, he was providing the leverage for my buyout, and I was to pay him back $50 a month out of my commissary stipend going forward. Depending on how the business performed, I was going to aim to pay him back out of extra cash flows (instead of out of my commissary stipend), or ask if he’d agree to extend the debt payback time to the whole year so I could pay him back my debt out of my portion of our cash flows at the same time!

Thus the takeover would have no downward effect on my personal spending power, and a long term risk/reward ratio of at least three times my worst case investment and six times my best case investment.

Unfortunately, the silver shop owner mawkishly back pedaled out of our finalization plans the very next day. The prospects of a quasi-venture he’s a part of brightened, and he decided that he didn’t need capital so rapidly after all. Perhaps our little cobble shop haven isn’t yet ready for an era of black hat corporate raiders, but mark my words…

I’ll have my day!