About a year ago, I co-funded the start-up of a pizza restaurant, in a city near my own, with a friend I’ve known since high school. At the end of this month that restaurant will no longer be mine. Despite breaking even, we have decided that it is time to move on to better things.
The end, as it turns out, will come one of two ways. We have courted offers from several people who would like to take a crack at the biz and see what they can do with it. Alternately, barring the transfer of ownership in the next 60 days, we will liquidate the equipment through local channels and on eBay (God help us with shipping the nearly 2 ton pizza oven).
In any event, these options got me thinking about the “Universe of Investment Opportunities” that are available to all of us. The long term objective for most business and/or property owners is the building of wealth. The return on my original investment in the restaurant, be it the original amount or somewhat less (depending on the outcome), will need to be put to work.
In the evenings, I teach finance and entrepreneurship classes to adult students at a local university. One of the topics we cover is the securities market line (SML), which is derived from the capital assets pricing model (CAPM). CAPM adjusts the expected return on an investment for the risk that it poses to the investor. Ultimately if you plot these investments on a graph you get the visual representation of the SML line.
The universe of opportunities broken down to its simplest form looks something like this:
- At the bottom of the line is Risk Free securities – Bank CDs, US treasuries, and the like are considered risk free.
- Above that you will find bonds with average returns of 6%-8%.
- Then, real estate with capitalization rates of 7% to 12%.
- Long-term stock returns of the S&P 500 at 11%-13%.
- Stock Options return 10%-20%
- Futures 15%-25%
- Small Business 25%-33%
From the above options we can see that small business is very risky which explains why about half of all businesses fail by the end of the fifth year. It also explains why businesses get priced at 3-4 times cash flow because 1/33% is 3 times and 1/25% is 4 times. That said, half of all businesses succeed and go on the create value and the long term worth sought by entrepreneurs world wide.
For me, I am taking a serious look at my personal financial statement, my stage in life and my goals for long term wealth building and making a decision on where the best place is for my money. Maybe those years I spent as a leasing agent for a local property management firm will come in handy…or maybe the business bug will bite again in the next 60 days.