The Game with Alex Hormozi - The Buy Box: What We Look for in Companies to Invest In | Ep 546

Episode Date: June 6, 2023

"The bigger the investment, the more the leadership team matters.” Today, Alex (@AlexHormozi) talks about the criteria they look for investing in companies, including the importance of cash flow-positive and profitable businesses that are founder-led and have exceptional products or marketing. He also emphasizes the value of finding a niche that's easy to win in and having a compounding vehicle within the business.Welcome to The Game w/Alex Hormozi, hosted by entrepreneur, founder, investor, author, public speaker, and content creator Alex Hormozi. On this podcast you’ll hear how to get more customers, make more profit per customer, how to keep them longer, and the many failures and lessons Alex has learned on his path from $100M to $1B in net worth.Timestamps:(3:58) - Founders lead cash-flow growth(5:02) - The things that make a company attractive to us(8:25) - Compounding loyalty & finding vehicles(10:57) - Recurring revenue & founder fit(13:44) - What is your Buy Box?(16:01) - Word of mouth boosts profitsFollow Alex Hormozi’s Socials:LinkedIn | Instagram | Facebook | YouTube | Twitter | Acquisition

I like to find ways that I can put some sort of compounding vehicle in the business because otherwise, the only way to you scale is by force, and that is more difficult to sustain when you're trying to go to the big numbers, like $10 million a month. Welcome to the game where we talk about how to sell more stuff to more people in more ways and build businesses worth owning. I'm trying to build a billion dollar thing with Acquisition.com. I always wished Bezos, Musk, and Buffett had documented their journey, so I'm doing it for the rest of us. Please share and enjoy. My wife and I have been public about going from $100 million net worth to a billion of net worth through our Acquisition.com vehicle, which if you don't know, is a portfolio of companies that does right now north of $200 million a year. And it's what funds all these. And I make this stuff so that we can attract more companies to invest in. That's how we make our money. And what I want to do is break down what we look for in companies that we invest in.

And if you're a business owner, you're an investor, if you're a business owner, you can think about these frameworks as how can I use these to make my business more valuable. and if you're an investor, you can think about these are the things or the lenses that we use in order to invest in businesses. Because if we're going to try to get to a billion, we better have a darn well good idea of how we're going to get there. And so these are the actual frameworks that we used to make the decisions about who's in and who's out. Or if you're thinking about starting a business of your own, you can start it the right way because it's much harder to fix a business that's fucked up than it is to start on the right path. And so if you have the opportunity, I mean, you might not even know this, but the first thing I did before I started my first real business was actually joined a group of other businesses. owners and I did it was a bunch of gym owners and I didn't even have a gym but I wanted to learn from

all their stuff so that I could start and try and make as few mistakes as possible. So just consider the the things that I'm going to outline as like you meeting other business owners who might be further ahead than you saying hey when you're building it try and have these elements inside of it so that you can build it the right way the first time. And so we break this into the hard stuff and the soft stuff. And so the hard stuff is all the business metrics. So I'll get you in a second of all, like the hard stuff that we'll look at that a business must meet. And then the soft stuff is the more about the team, more about the people, the more nuanced and subjective component, but I might even argue the more important component about why we choose to work with some

companies than not others. So right off the bat, there's some basic business things, and I would encourage you if you're ever going to invest in businesses, especially private businesses, which increasingly is becoming the vogue because it's becoming more and more difficult to become a public company because of the reporting requirements. And so, like, you know, 40 years ago, it was way easier to go public because report reporting wasn't as hard, but they continue to make reporting harder and harder, which I actually think is a bad thing because it means the public, the general public has less access to private investments and only accredited investors, so wealthy people, are the ones who are able to participate

in more and more big private companies. So I think that's big picture, a down thing that I think we need to decrease the expectations on companies for reporting so that more companies be willing to go public so that more of the public market who are non-acredited could participate in that growth. So that's just a two seconds on my two cents. But we do only private investments. And so we look for cash flow positive companies, meaning every month they spit off more cash than they take to grow. And that means that after growing, they still are cash flow positive. Now, there's a difference of being cash flow positive and being profitable. So this actually has to come down to accounting rules. So there's two types of account. Well, there's different types, but we'll just call it. You've got cash-based

accounting, and then you've got accrual. All right? Cash-based accounting just means like what comes into the bank account every month, what goes out, right? That's how most small businesses operate. Bigger businesses operate off of accrual, which would mean that, like, for example, if you ran an event once a year and it cost you a million dollars that month to run your event, it would look like you had a huge loss that month when realistically, you'd be saving for the year, but then you also have a huge amount of revenue that would come in that month or the next month thereafter. But what accrual does is it spreads that over the year,

so you have a much more balanced idea of how the business is operating. overall. And so we want cash flow positive and profitable companies that are growing and founder led. And so that means the founder is still the primary driver of the business. From a size perspective, we have tweaked our requirements. So originally it was they're doing over three million dollars in top line. We have since tweaked that to at least a million dollars in profit. And when I say profit, I mean cash flow profit, not paper profits. And the reason we do that is because we are cash flow investors overall. And so we invest in assets that hopefully make us more money over the long time than it costs us to buy them. And so in terms of sizes, the biggest company we had the portfolio

to $20 million in profit last year, and the smallest companies are like a million. Right. So there's a range there, but that's kind of the, I would say the midpoint is probably like five-ish in terms of profit median. So there's obviously outliers because, and that's kind of common in investing that you have two or three companies that carry a portfolio. And that's just because 80, 20 Pareto's principle, and I won't even get into that. But it's common. Now, the things that make a company attractive that we're looking for now is that I look at companies that I think are boring and simple in terms of they don't have a lot of moving parts. I don't think they're going to be disrupted by AI or they have a lower likelihood of being disrupted by AI. So for example, one of our brands is

enchanted fairies. And so that's a photography chain. I think at this point we have 40 locations open. When we first invested in them, they had one. And so that's been, 30 months. And so we've gone from 1 to 40 in 30 months-ish. So kudos to them. They have an awesome product, awesome brand. But a company like that, like, I think about AI in the future. And I think like you're still going to have to like take, you know, take your body in and get pictures taken of you to have that kind of experience. And I think a lot of it is about the experience itself. It's like, and so I feel like that is a company I feel more confident in. Like if you have a lawn care business, I feel pretty confident. You're still going to have to get the lawn cut.

Now, will there be robots in the future? Probably. The question is how long? And I think that we have more time there than we say, you know, we might in say a design agency, right? That might be a little bit harder to defend with some of the stuff that's coming out with AI in the future. So it's not will it disrupt it or not. It's how long away is that disruption and how profound will the disruption be? And so that's a big factor in some of the companies that we're looking at taking on right now. Another factor is that we want it to be. just a solid product because the company either has to have an advantage on their exceptional in marketing or they have to have an exceptional product. They have to have one of those two things. The mistakes that I've made in investing is taking out companies that had neither. They're just kind of mediocre at product and kind of mediocre at marketing. And those ones are just, they don't have anything good. And so that's the harder part of growing them. Because once you have the right products, you can wrap them around the systems that we already know grow the business, bring the players in and then explode it. So part of the way that we measure how,

good the product is we actually just look at reviews online. So just like a customer might look at reviews. We look at glass door. That's from an employee's perspective. We look at the triple B to see if they have some massive issue that's going on. We look at online reviews. We look at the trust pilot reviews. We look at all the different places that there are reviews to see. Now, mind you, every business, especially if you have a lot of volume, it's going to have someone starts. That's just like that's part of doing business. But overall, we want to see that the majority of people are very happy with the outcome because fundamentally all of the money that you're going to make is going to be based on an extrapolation of the core unit of value you can provide to the end user. So if somebody can create some very

important outcome to a specific type of person, the more valuable that outcome is, the more profit you can ultimately generate from the business as you expand and take over the market that exists in. And so that's probably the thing that we look at the most from a business perspective of like how valuable truly is the thing that they provide. And is there any element that is unique? Hey, Mosin, a nation, quick break just to let you know that we've been starting to post on LinkedIn and want to connect with you. All right, so send me a connection request and note letting me know that you listen to the show and I will accept it. There's anyone you think that we should be connected with, tag them in one of my or layless posts and I will give you all the love in the world. All right, so let's get back to the show.

Now, zooming out to a business strategy perspective, I like to figure out a way to have one element of compounding within the business itself. And so in my experience, there are only two ways to have a compounding vehicle within the business. Well, maybe three, but I'll get to that in a second. The first way is that every year, if you don't do anything, more customers buy the thing. And so that is net negative turn. So ideally that means that 12 months from now, all the customers you have now are still buying and ideally buying more. That's what makes an incredibly valuable company. If you buy Coca-Cola in the beginning, you'll probably keep buying Coca-Cola brands for the rest of your life, right?

The other way of having a compounding vehicle is having a selling machine that compounds into and of itself. And so most of these times it's word of mouth, which is always the compounding vehicle, either from a customer perspective or from an employee perspective. And so I'll give an example of an employee compounding. So if you had an insurance business and you had sales guys that did insurance sales for you, or you had a mortgage sales business or a solar sales business, and you could get each of these salesmen to recruit other sales people to continue to sell for you, then every year, let's say you grow by 10% in your sales staff,

or let's say every month you grow by 10% in your sales staff, then you're going to grow really, really quickly, and that thing will continue to compound unto itself. And so I like to find ways that I can put some sort of compounding vehicle in the business because otherwise, the only way to you scale is by force, and that is more difficult to sustain when you're trying to go to the big numbers,

like 10 million a month. It's easy to force growth at, you know, 200K a month, 500K a month, $500K a month, million a month, like you can force that growth relatively easily with paid ads or maybe some affiliates. But if you want to go to the big, big numbers, you need to have something that compounds onto itself. Otherwise, you'll flatline. And then that's when the company becomes significantly as valuable. Another element that we look for is a niche that's easy to win in. And so, you know, if we were trying to get into like AI something, right, there's going to be a lot of incredibly well

well-capitalized players who are really smart who are going for the next trillion dollar thing. Now, not to say that that's not a good opportunity it is, but you're going to be competing against the best people. In general, the people were trying to build billion-dollar companies in tech, I would say if we had to take a midline of IQ levels, is higher, and they're better capitalized than people trying to build a billion-dollar loan care business. And I see that as an advantage to have in the lawn care business. You just have fewer incredibly smart, incredibly capitalized people competing against you. And so a great investor friend of mine said, don't fish where the fishmen are. He said, fish where the fish are. right? It's like, don't fish where everyone else is trying to fish. He's like, just try and find

an open pond where you don't have to be the best fisherman, but there's plenty of fish. And we've tried to stick to that kind of thing. And we try to stick to that same mindset. Now, a compounding vehicle is basically the fundamental of what every recurring revenue business seeks to get. Now, there are two types of recurring businesses. You have reoccurring, and then you have recurring. So a recurring business is like you were on a monthly subscription for Netflix. They are a recurring business model. A reoccurring business would be something like Facebook ads. Like when you pay Facebook as an advertiser, you're not on a fixed amount, but you will come back and buy again. If you buy Coca-Cola from Coke, you're not on a subscription monthly box.

They just make sure their product's good enough that you buy it again, right? You reoccur. And so what we look at is, is there a way that we can add an element of this that is either recurring or reoccurring that we can predictably know a certain percentage of the people that we sell today will continue to buy from us five years from now? And this is like probably the biggest strategic point that I can make in this video and arguably like in business in general. Like this is very important. If you don't get credit for the sales that you make today in two years, you're always starting at ground zero. That's very hard to do for 20 years. And so I want businesses that we get credit for the stuff we sell today in five or 10 years.

And so whatever we have to do, we try and either find businesses that already have that element or we take businesses that we think we can configure ourselves. an element within their current construct of how they create value so that customers will continue to want to buy in the future from them. And that is where you can unlock huge amounts of value in cash flow and enterprise value because think about it this way. If you were to spend $10,000 a month and get 10 customers a month, okay, if you were to keep doing that and those 10 customers never left, in 10 years, you would have 1,200 customers, but you'd still only be paying $10,000 a month in advertising. That would be an incredibly profitable. business because you don't need to scale your marketing in lockstep with the number of customers

and profit they're ultimately generating. And this is a huge profit enhancer. And profit is ultimately the thing that drives businesses values now and in the future. And if you think about the value of business as the all future cash flow that it generates from now until it dies, then knowing that every single person that you've sold up to this point is going to continue to pay you for the rest of time makes it incredibly valuable. And the knowledge that everybody you sell from this point going forward also continues to stay in pay, also makes it incredibly valuable. Those are the hard mechanics of the things that we look for at acquisition.com in terms of companies. So like I said, one to 10 million dollars in profit per year is kind of like, I would say the majority of the, well, one is the minimum,

but one to 10 is kind of like, I would say the sweet spot. Like I said, we have outliers that are at 20. But that one, when they came to us, weren't at 20. I think they were at six when they came to us. And so like, obviously we seek to grow companies, but that's typically where people come in. those are kind of the hard stuff, the hard sciences of the investment portfolio, like the buybox is what they call the investor world. It's like, what's your buybox? The other part is the soft stuff. And this may be, not may, it is actually the thing that we wait more, which are two elements. Founder Fit and Leadership Team. And so I'll start with Founder Fit. So when you get into a business partnership or you invest in someone's company, like you're in, your co-owners, like you're now

locked in. It's like a marriage, right? And so you want people that, you know, you know, you invest in someone's you think you could be married to in five years, right? You want people that you look forward to speaking with. And on a personal level, like, I want people that I want to see rich. Like, the moment I feel like, I don't want this person to be rich or like, I don't want to help this person get rich, not a good deal for me, right? And so we try and find exceptional founders that live by our three values, which is sincere candor, unimpeachable character, and competitive greatness. And those are three simple sayings or three simple isms, but are very hard to find. It's hard to find people who even have one of the three, let alone all three, which makes finding great people difficult. And that's

kind of the fundamentals of most businesses, is that people are almost always the problem. And so, we have a very rigorous screening process to finding the right founders. The reason for that, besides our obvious state of mind, is like, if I want to maintain excellent talent in my business, the easiest way to kill that would be to work with shitty founders. So for me to protect the talent that I have at Acquisition.com, I have to only bring in excellent founders. The other piece is that if we want to grow these businesses, what do you think those founders need? They need an exceptional team. And exceptional teammates will not work for shitty leaders. And so if we want to build the business, even if we have some super smart, hardworking founder who's charismatic, but like they've

shitty ethics, they're not going to be able to keep a team who's really smart and hardworking or who has experience. And so when we find a founder that we like a lot, we think to ourselves, will we be able to attract the level of talent that's required to get this person from, let's say, a million a month to 10 million a month, right? That's a who question more than how question. And so the bigger the investment, the more the leadership team matters, the smaller the investment, the more the founder matters because then we're going to surround them with the leadership team that we need to build. Because one of the big limiting beliefs that a lot of founders have is that they feel like they have to learn their way from one million to 10 million to when it's

much more about becoming the type of person who can attract the people who can help get you to 10 million a month and beyond. And when we're looking at those teams, we're looking at how many these people have been there done that? We say like, how much gray hair is there on the team? Like we want at least 20% of the executive team or the leadership team, to have already been there or done that in a business that is like this one. So if they're at, let's say, 20 million in top line revenue and 7 million in EBTA, I want to make sure that there's at least 20% of the leadership team

who's been to 100 million once or twice in their career during that path so they know some of the roadblocks and they can speak and mentor some of the other people in the business. In terms of having an exceptional product, I measure the value of the product in a few ways. One is the, sure, there's reviews. The second is more of the hard metrics, which is if we can quantify how much value the product or service provides the average customer, which you can track, how much of that is being

captured and monetized? So if we feel like it is being under monetized based on the value that's being provided, that's a big opportunity for the business, both from a pricing perspective or either how we package the services. The biggest metric is always going to be the percentage of customers that come from referrals. And so if a large percentage of the customers come from referrals, not necessarily all of them, but a significant percentage, which for me is like 25 to 30 percent of the business, comes from word of mouth, then I know that this is a solid business that automatically, whenever

we spend money to acquire a customer, we get a one-third discount because one out of three people is bringing another customer in, right? And so you can factor it into how much money you make. Now, you think about this from a profit perspective, if one-third of your business comes for free, then a lot of that extra, that added or incremental revenue drops straight to the bottom line. And so that's why having strong word of mouth is such a powerful thing for the profitability of a business. Now, a lot of small businesses continue to grow off ads and no word of mouth, but what actually happens is they have negative word of mouth working against them. So if I see no word of mouth, I actually know that that negative word of mouth monster is always working. It's

just working to eat away their profits. They're making less profit than they otherwise would have that they had no reputation.