Why Buying a House is like Buying a Startup 🏚
In the past few years, I've gotten very interested in online businesses and SaaS.
I've tried to acquire a few SaaS businesses but all of my deals so far have fallen apart. (I'll write about that soon). I'll find one some day.
SaaS and these online businesses have become an asset class as we see private equity and investors trickling in to the space. Early-stage funding companies like Earnest Capital are popping up in response to this wave of "bootstrapped" startups. A laptop, some books and an internet connection can change the course of your life.
It's no wonder why -- you can calculate IRR, cap rate and other financial mumbo jumbo on an online business much like you can real estate and other assets. The recurring revenue structure of many of these businesses makes valuation, acquisition and risk management attractive to investors.
I'm not a real estate investor, really. I have a pile of books on my shelf by Bigger Pockets about Real Estate investing. It's incredibly interesting to me still.
The process of sourcing, valuing, negotiating, financing, flipping and exiting these two kinds of assets have a lot in common.
Big Disclaimer that I have ZERO MBA's, Wharton Degrees, or multi-million dollar businesses funding my lifestyle. I'm just a dude on the internet with an interest and small understanding of this world I want to share. I write about this stuff because I want to understand it better myself. If you spot anything incorrect, let me know.
Location & Type of House = Thesis
Are you looking for a single family home? In what neighborhood? City or Suburbs? How many bedrooms? What size yard? Is there a basement?
Before setting out to acquire an online business, you should have an investment thesis that defines exactly what you are looking for. That way, when you see it, you'll know it.
- What's in an investment thesis?
- Size of the business (in MRR/ARR, employees, etc)
- What tech stack does it run?
- What industry is it in?
Finding a Home = Deal Sourcing
Deal sourcing refers to the pipeline of possible deals you can make and the sources in which you find them. This is your process for finding an asset to purchase.
In real estate, finding a deal is the first step of the process. Investors often say that you make most of your money when you purchase.
How do you find a deal? In real estate it's achieved by networking, outbound cold-calls, bandit signs, driving for dollars and other methods.
Driving for dollars is a term that refers to hungry investors driving through random neighborhoods looking for a potential purchase. What do they look for?
Downtrodden houses. Grass that hasn't been mowed for weeks, trash in the yard, a roof that's falling apart, empty driveways indicating no one is living there. You get the picture.
These homes are often a deal because they're declining in value. Someone doesn't really care all that much to maintain the place.
Online assets are the same way.
How do you find a deal?
- Build a network of Sellers / Buyers
Become known. Your network is your net-worth, right? (I think Tony Robbins or some other bullshit-huckster said that once)
Building a network is among the best ways to build solid deal flow.
- Perform Outbound Outreach
Drive for dollars.
Go trawl through google results in niche software
Browse IndieHackers and other sites for old businesses that are not maintained.
Deals aren't known – or are they?
"There's an old joke about two finance professors walking down the street and seeing a dollar lying on the sidewalk. One leans over to pick it up, but the other one stops him, saying, "Don't bother -- the market is efficient. If that dollar really existed, it wouldn't be there anymore."
Bill Mann
Market efficiency says that market prices reflect relevant information. There are no undervalued or overvalued securities or assets available.
This clearly can't be true since deals are found every day.
The best deals don't seem to be found on public marketplaces. Good deals are found "off-market". In Real Estate, this is the multiple listing service or MLS where houses are listed and distributed to realtors in a specific area. In online-asset world it's marketplaces like Flippa, Sideprojectors and others.
Most of the sellers on these marketplaces are prepared to sell their business, so they've put in work so that they can get the highest price or retail price.
The best deals are not found in these marketplaces, they are found off-market.
They are the ugly house down the road or the SaaS business making $500 a month that the founder hasn't marketed in months (or years, eek).
Making an Offer = Deal Negotiation
When you find a home you're interested in, you'll check it out a bit and probably decide to make an offer on it. Your realtor drafts up your offer – the price you want to pay, whether you want the fridge in the garage and when you want to get it done.
Online assets follow a similar process through a Letter Of Intent, Due Diligence process, negotiation and finally deal close.
Valuing the Asset = Comps
Real Estate generally seems to be valued based on comps or homes in the same neighborhood that recently sold.
Investors also might try to apply the "1% rule" to a home if they plan on renting it out. This rule of thumb states that monthly rents should be equal or greater to 1% of the purchase price of the home.
In online businesses, you might value based on a multiple of the annual income and industry the business operates in. EBITDA multiples and EPS by industry can give some insight into these types of valuations.
Mortgages and Closing = Funding and Acquiring the Asset
Real Estate investors have multiple creative ways of funding deals. You could just drop a fat wad of cash on the table and purchase the home. Or, you could take financing in the form of a bank loan, hard money (short-term, high interest rate), borrow from some rich friends or even take on seller financing.
Online assets have similar options. You could take a small personal loan for small deals. Larger deals might be funding by an SBA loan. Seller financing is also an option where the seller is paid back over a period of time.
Aside from these standard agreements, there are many other creative ways to fund a deal.
Due Diligence = Home Inspections
Home inspections are not that old. The process started around the 70's when buyers began hiring building contractors to perform inspections on homes before purchase. Home inspections are fairly common place now and inspectors are Licenses and certified differently in each state.
If something turns up, like a cracked foundation, the home owner can negotiate further based on the new information.
When purchasing an online asset, it is wise to do Due Diligence. Typically, you will make an offer via a Letter of Intent and proceed with Due Diligence.
During this process you assess the financials and quality of the business to make sure there aren't any red flags in the business. (maybe the industry is declining, maybe the seller isn't selling for the reason they say). Many investors have contingencies in place written into their LOI so they can back out of the deal if things don't check out just right.
Sweat Equity = Flipping the House
In Real Estate, you'll look at the ARV or After Repair Value of the house. This is the price that the house can be sold for after putting in work to fix up everything that's broken.
Investors often say they are "forcing equity" into a property when they do things like remodel the bathroom and kitchen.
Kitchens and bathrooms sell houses
Someone said that once. I don't know who. I can't find it on google. But I hear it a lot so it's true, right?
Remodeling your online asset is a similar process. What needs fixed up? Is the landing page old as crap and web 2.0-ey? Does it look dated like the 70's bathroom on a ranch house in the suburbs?
Finding Equity in Other Places
What else are the founders of the SaaS business paying for that they don't need to be? Are they subscribed to $100/mo help desk software when cheaper solutions exist and revenue is $1000/mo? Cancel that shit and find some equity!
Collect Rental Income or Sell
Finally, once the asset has been renovated to become more efficient and profitable, you can either keep the asset indefinitely for monthly cashflow or sell it for an exit.
Monthly Cashflow = Rental Income
Exit = Selling Your House
Both can be good options. If you have an automated money machine that takes care of itself and spits off cashflow indefinitely, why would you sell it? Usually because the multiple may be many times that of the yearly revenue.
Calculating your sale price is generally the same process as you made in your initial acquisition, except now you're on the other side.
Summary
As best I can tell, this is the condensed path to success:
- Find an under-valued asset that may be declining in value
- Negotiate to purchase it
- Put in sweat-equity to make the asset more valuable through additional customers/revenue
- Exit the biz via a sale or enjoy the cashflow and maintain the asset
How do I learn more?
I'm not an expert real estate or successful SaaS investor yet. But maybe one day I will be. I enjoy reading about these things from people far smarter than me.
The BEST resources I've found for these topics are the book Buy, Then Build by Walker Deibel and the Microacquisitions course from Ryan Kulp. ( Affiliate Link disclosure! If you decide to purchase via these links, I may be reimbursed. Thanks FTC).
Microacquisitions is a video course from Ryan Kulp all about buying, growing and selling small (usually) internet based businesses.
If you aren't familiar with Ryan, he's the ultimate blend of self-taught developer and marketer. He buys and grow smalls companies via ForkEquity.
Ryan has condensed his knowledge into this course and it's fascinating to go through as a n00b. It includes well-informed advice for every step above from sourcing to exit strategy. I cannot recommend it enough!
To finding a good deal 🍻