Hello! Welcome to the 603 new readers since last time out, joining our community of 2,532 business nerds.

As a reminder – it’s been a few weeks! — I’m Andrew Lynch, a small business CFO here in the UK. I love finding great companies and sharing their stories, and the lessons you can apply in your own company.

One favour to ask: if you like this, please share it with a friend.

Last time out we looked at the Serif Group, a wonderfully profitable niche software company, based in my home city of Nottingham, UK. 

With zero outside funding and a small team of around 75 employees, they’ve managed to create a David of a software company that competes directly with the Goliath of creative tools, Adobe. It lets you create great art, like this:

Putting aside for a second the question of whether AI will completely destroy this industry, today Serif’s P&L looks like this:

<obama_notbad.gif>

And more importantly, their cash flow statement looks like this:

There is not a sweeter sight in the world than a company that has made £28m in operating cash flow in two years, and paid out basically all of it as dividends.

Because if there’s one thing that gets a CFO’s heart racing, it’s what my friend Secret CFO calls Maintainable Free Cash Flow, or MFCF.

Let’s do a quick primer for everyone out there and define some terms. 

Profit is an accounting definition – when we’re talking about, say, net profit, we’re talking about total revenue, less all expenses, over a period of time. 

Crucially, though, that profit figure could include a few important assumptions, like:

• Depreciation charges

• Amortisation charges

• Accrued costs or income

• Adjustments for prepaid revenue or expenses

which is why, in their books Financial Intelligence for Entrepreneurs, the authors stress repeatedly that “profit is an estimate.”

Say it again. Profit is an estimate.

Profit is always an estimate, because the poor accountant preparing that profit figure never has perfect information. We can never know exactly the value of our fixed assets at any given time, so we use depreciation schedules to approximate it. We can never know exactly what this month’s energy bill will be until two weeks after the month-end close, so we accrue an estimate. And so on, and so on.

On the other hand, cash flow is known and knowable. 

In a company’s financial statements, the cash flow literally represents the change in bank balance from the start of the year to the end of the year. If on Jan 1 your bank balance is £100,000, and on Dec 31 your bank balance is £200,000, then your cash flow for the year was £100,000, and no amount of accounting shenanigans can say otherwise.1

So where does EBITDA come in?

EBITDA stands for Earnings Before Interest, Taxation, Depreciation and Amortization. I enjoy standing on the shoulders of giants, so here’s a nice diagram from Secret CFO to show where EBITDA sits on the P&L:

The idea of EBITDA was created by the CEO of TCI, John Malone, back in the 1980s.

Malone was an incredible entrepreneur, whose journey is chronicled in the wonderful book Cable Cowboy. In the early 1970s, Malone saw that the cable industry:

1. was growing rapidly rapidly growing; 

2. was fragmented across many providers; and

3. had incredibly sticky customers willing to pay a lot for the service.

That led to Malone’s bold strategy: borrow lots of money to buy lots of cable franchises across the US, ensuring that the cash flow from each acquisition could cover the debt repayments on that asset. Over time, the debt would get paid down, the asset value would grow, and TCI’s shareholders – including Malone – would get very rich.

It’s a beautiful strategy. And it worked like a charm.

This strategy had one big downside though. 

Acquiring cable franchises – and spending money on upgrading them – leads to big costs in your P&L for depreciation and amortization.

How did Malone deal with that?

A brief sidebar on non-cash charges

Depreciation and amortization are examples of non-cash charges in accounting. But what exactly are they?

Depreciation is the cost charge that goes in your P&L when your physical assets go down in value. 

The canonical example is a car. Let’s say you’ve invested £150k to start a private limo rental business. Your first step is to go and buy a brand-new limo for £100k exactly.

When you buy that limo, you’re exchanging one asset – cash – for another asset – a car. Here’s how that shows up on your balance sheet:

The moment you drive it out of the limo dealership, assuming that’s a real thing, the car loses some value. That loss of value is the depreciation.

In this unfortunate example scenario, your fateful investment decision was on 1st March 2020, and thanks to Covid and your distinct lack of sales ability, you managed to go the whole year without ever making a single limo rental. Your limo, however, still lost a big chunk of its value. 25% of its value, in fact.

Technically you’ve lost £25k. But your cash balance has stayed the same. The loss is due to the drop in the value of your asset. That’s a non-cash expense – but it’s still a real expense, because if you tried to sell that limo, you’d get less for it than what you paid.

Depreciation applies to physical assets. Amortization is exactly the same principle, but applied to intangible assets. Things like patents, licences, IP, trademarks, that sort of thing.

Let’s take your struggling limo rental company again. What if, in order to drum up business, you bribed a city official £20k to give you exclusive limo-operating rights for the next five years?

If you managed to stay out of jail, then that exclusive operating licence is an intangible asset with a life of five years – so the correct accounting treatment is to expense £4k per year to the P&L, slowly reducing the value of that intangible asset over its five year useful life (and of course, if the city official ever goes to jail, write it down to zero).

Importantly, even though depreciation and amortization are non-cash charges, they are still tax-deductible. 

Got it? Good. OK, back to the TCI story.

Malone’s wonderful strategy

Chronicled in the wonderful book Cable Cowboy[link], Malone’s strategy was to borrow lots of money, and buy tons of cable franchises. Over time, the value of those franchises would go up. Those acquisitions also led to big interest charges (from the debt used in the acquisition), as well as large depreciation and amortization charges, all of which reduced TCI’s reported earnings, and therefore their tax bill.

Here’s a visual of the strategy:

In fact, such was Malone’s insistence on this strategy that he famously said to investors:

“If you’re going to ask about quarterly earnings, you’re at the wrong meeting, and you probably own the wrong stock. What we care about is value. We want to create value for our shareholders… There is a big difference between creating wealth and reporting income.” 

And Malone threatened to fire the accountants if TCI ever reported a profit.

(NB please don’t do this, we need jobs now before AI takes them all, ty)

The downside of never reporting a profit is that investors back in those days – unlike the ZIRP-crazed investors we’ve seen in the last 15 years – liked to see a company actually making a profit. Will Thorndike talks about this in The Outsiders:

Malone [realized] that maximizing [reported] earnings… the holy grail for most public companies at that time, was inconsistent with the pursuit of scale in the nascent cable television industry. To Malone, higher net income meant higher taxes, and he believed that the best strategy for a cable company was to use all available tools to minimize reported earnings and taxes, and fund internal growth and acquisitions with cash flow…

While this strategy now seems obvious… at the time, Wall Street did not know what to make of it. In lieu of earnings… Malone emphasized cash flow to lenders and investors, and in the process, invented a new vocabulary, one that today’s managers and investors take for granted. Terms and concepts such as EBITDA were first introduced into the business lexicon by Malone.

He invented EBITDA as a metric to give Wall Street something to focus on instead. It’s a proxy for operating cash flow.

Investors loved it. TCI got the funding it needed, and Malone repaid that investor trust was a wonderful success, returning on average more than 30% per year for 20 years, until Malone sold the business to AT&T in 1999 for around $50bn. Not bad at all. And as Thorndike points out, he created the concept of EBITDA, which these days we take for granted.

But importantly, not all EBITDA is created equally. Malone used depreciation and amortization to reduce TCI’s tax bill, sheltering their earnings from the IRS. That’s good EBITDA. But you can imagine a 

Depending on the characteristics of the company, £10m in EBITDA could result in lots of cash flow, no cash flow, or many things in between.

But what if you could cut out the middle step? What if you could just… pay less in taxes?

Which finally brings us back, for the last time, to Serif.

Sometimes tax policy is amazing

Let’s look again at Serif’s P&L.

Out of £14.2m of pre-tax profit, their net profit was £13.6m. They paid just £600k in taxes – 4.2% of their pre-tax profit, at a time when UK corporation tax is supposed to be 19%. How on earth did they do that?

Two things:

1. R&D tax credits

Thanks to a wonderful bit of tax policy, if you go to the UK government and say, “I spent £1m on researching and developing new technology with an uncertain outcome,” they’ll say, “jolly good! Here’s £300k back. Thanks for doing your bit to support innovation.” It’s there to incentivise innovation and risk-taking, which it generally does.

That said, it’s a slightly grey area, which has unsurprisingly led to an army of grifters and consultants telling you they can get you tax credits for basically anything – for a fee. Sadly, I’m yet to find a consultant who can get me tax credits for a business-themed email newsletter. If you’re out there, please email me.

2. Reduced taxes on profits from patents

If you’ve been reading Net Income for a while, you might remember the patent box from our post on Petex, another UK-based software company.

The ‘Patent Box’ – so-called because it’s literally a box on your tax return that you fill in – means that you only pay a rate of 10% corporation tax on any profits generated from patented IP.

Let’s turn to the notes in Serif’s accounts:

At usual rates, they would have paid £2.69m in tax. But thanks to £978k of R&D tax credits, and £1.2m of patent box deduction, that £2.69m of tax becomes just £600k.

In fact, we can do some quick maths here:

Serif is generating 94% of its pre-tax profit from patented IP – saving them a fortune in taxes.

This is why not all EBITDA is the same.

All else being equal, you’d pay a higher EBITDA multiple for Serif than any other business.

Not because of any market dynamics, or unique customer relationships, or reputation in the market.

But because you get to keep more of the profits.

No marginal cost of goods sold. Infinitely replicable product, anywhere in the world. And tax policy actively encourages this sort of risk-taking. Software really is the best business model of all time.

And this is why Serif was such an amazing acquisition.

1. Buy a business that’s generating residual cash flow from a legacy business.

2. Re-invest significant portions of that into new software products, which generates significant tax credits in the process.

3. If you create a great product, patent it and sell it and make loads.

4. If you don’t, well, just enjoy the residual cash flow from the thing you bought.

Heads I win, tails I don’t lose too much. A phenomenal value investment.

Next time out we’ll look at another tech acquisition that was even better. In fact, our next analysis is on what’s probably the most profitable technology company in the UK. Keep an eye out for it in your inbox soon.

Carve outs

• I finally got round to reading The 15 Commitments of Conscious Leadership. I’m about 30% of the way in right now and it’s possible this will be a transformational book for me. More to come on this.

• I read that book because Levels CEO Sam Corcos recommended it on this podcast with Tim Ferriss. If you’re into business ops, efficiency and productivity, deep work, all that sort of stuff, you’ll love this interview.

• If you want more about Levels, this piece in the Generalist is well worth a read. The title, ‘A Cultural Anomaly’, hints at why they’re interesting. The piece opens: “There is not a company on earth that runs quite like Levels.”

• Lastly, I’m starting a new professional opportunity shortly as Head of FP&A for Blue Light Card, an amazing rocket ship of a business here in the UK. They have an incredible mission, and are assembling a top-tier team too. I can’t wait to get started — but fear not, Net Income will continue.

• Lastly, I’m super-interested in what tech firms are using as their finance stack, so I’m doing some research and collating it all in one place. Here’s what I’ve got so far:

  

Thanks! Speak soon.

Andrew

A quick note from me: you might have noticed that in classic European style, I took a brief hiatus from Net Income over the summer. I’ve been busy sorting a new professional opportunity (more on that in the coming months), finishing our house renovation, and taking some well-needed rest. When I wasn’t working, exercising, or sleeping, I was doing my second job as an amateur landscaper to finally finish this beautiful deck:

and here’s the full before and after for context:

This has taken an awfully long time, but it’s totally worth it. It’s nice to actually create something with your own two hands — something you can see and touch, rather than just another spreadsheet or blog post.

Finally, today my wife and I celebrate 5 years of marriage, and tomorrow we’re off on a week’s vacation. Please send me your book recommendations — just hit reply and let me know what you think I should read.

Net Income will return on September 15th to finish off our Serif story, before taking a detour into the world of — ahem — ‘adult entertainment,’ to look at one of the best acquisitions of all time.

Going forward, expect posts every two weeks. In my mission to be the perfect blend of the Acquired podcast and Wait But Why blog, I want to err on the side of quality over quantity. If you’ve read any of my earlier posts, you’ll appreciate the time and effort that goes into writing Net INcome (on the side of a full-time job). I don’t want to drop that quality bar just to hit an arbitrary, self-imposed weekly schedule — my mantra is less, better.

To tide you over until my return, you can visit the back catalogue. As a reminder, we’ve covered:

• Petex: the vertical SaaS company doing 60% net margins

• Euroloo: the £1m/year portaloo rental business

• Baringa: scaling a consulting biz from £2m to £200m

• Center Parcs: analysing the PE structure of this real estate and hospitality gold mine

• Twinkl: the best info product business ever created?

• How rich is former Manchester Utd footballer Gary Neville, really?

• A deep dive into the boardroom drama at Gymshark, part 1 and part 2.

• Serif, the niche software company competing with Adobe

And if you want a little more, some supplementary reading:

• A turnaround story from my own career

• An intro to my research process for Net Income

Lastly, I’m a huge fan of entrepreneur Andrew Wilkinson and his company Tiny Described as the ‘Berkshire Hathaway of the internet’, Andrew and his team have built a wonderful holding company which recently went public — which means all their numbers are now public. You can check out their latest investor presentation here, which is well worth a read — they own Metalab, dribbble, Aeropress, girlboss and more, and the group now does around $150m a year of revenue at ~20% EBITDA margins:

which is fairly stunning for a company that started as a web design agency back in 2006. Andrew’s journey is an inspiration to me — who knows, maybe one day we’ll look back on Net Income as the start of my media empire.

As always, I genuinely, deeply appreciate your support for Net Income — writing and sharing this is a blast for me, and you taking the time to read it means the world to me.

Speak soon.

Andrew

Carve outs

• I LOVED this podcast from the Acquired guys about Costco. Their business model is wonderful — for more, check out this incredible deck that dives deep into the strategy, business model, and financials / market comps.

• I get asked all the time if there’s a UK-based accounting firm I can recommend for small businesses. I’ve never had a good answer — until now. The company is Ashton McGill, run by my friend Jared Cordner. No affiliate relationship, they just put more focus on customer experience than any accounting firm I’ve seen before.

• I’m getting back into chess — far and away the best and most entertaining resource for improving is GM Daniel Naroditsky. Daniel has created several ‘speedruns’ where he plays at every rating level from true novice (ELO rating of ~ 500) up to master level (ELO rating of ~2200), and explains how to master the game at each level. Fascinating to watch, and Daniel’s a great teacher.

Hello to the 165 new subscribers this week, bringing our motley crew up to 1,929 balance sheet groupies for this week’s Net Income. I’m Andrew Lynch, a small business CFO and writer here in the UK

Two things this week:

1. Yes, you’re receiving this on a Sunday, not a Thursday — you have not time-travelled, life just got in the way. C’est la vie.

2. We now have a shiny new domain name, NetIncome.co, where you can head to for all of the archive.

As always: if you like this, please share it with a friend.

If there’s one thing that Warren Buffett and I have in common, it’s our love of cheeseburgers.

But if there are two things that Warren and I have in common, the second is that we both rue our mistakes of omission. We regret the mistakes from actions not taken.

Warren, for example, kicks himself for not investing in companies he fully understood and knew to be a great investment at the time: Disney, Walmart, Fannie Mae, to name but a few.

And me? In 2011 I interviewed at a large institutional investment company, and as part of the interview process, they asked me to recommend some investments.

My two recommendations were:

1. Google

2. Apple

I gave a good justification for why: both dominant in their respective markets, both producing high-quality revenue, both benefiting from growing smartphone adoption. The interviewers agreed, although not enough to give me the job.

I promptly went away and did… nothing.

In my defence, from its IPO date to the day I recommended that investment, Google stock was up 5x in seven years, and the market cap was $166bn on $8.5bn of net income, a P/E ratio of 19.5. It looked a bit frothy to me.

Since then, Google stock is up 9.2x in 12 years, a 20.3% annual return. (I don’t want to know the numbers for Apple.)

In 2011 Google did $38bn of revenue, and $8.5bn of net income, so a net margin of 22%.

In 2022, Google (rebranded, for some reason, as Alphabet) did $280bn of revenue, generating $60bn of net income — still 21% net margins, even at that scale.

That’s despite funding all manner of speculative R&D projects, poorly executed product launches, and much more (does anyone know what Google Hangouts is called these days?).

They can generate a spectacular amount of cash because software is the best business model of all time. 

It’s a model built on a mountain of leverage, as defined by the angel-investor-turned philosopher Naval Ravikant.

With zero marginal cost of replication, you can build something once — like a great search engine with real-time ad auctions built in, or a petroleum-industry vertical market software product — and serve it up to your customer again and again at virtually zero incremental cost. Serving one customer costs practically the same as serving thousands of customers.

(and if you don’t have the ability to make software, you can do something with equal amounts build-once-sell-many-times leverage, like, y’know, a newsletter)

Today’s company is not at the same scale as Google — because very few companies are — but is a phenomenal example of software leverage even at a small scale.

This is the Serif Group:

This is a niche software company in my home city of Nottingham, UK, and they are generating £14m of net income per year, on revenue of around £24m per year, giving them net margins of around 60%.

What are they selling? How did they get here? And why do they pay so little in tax? All this and more in today’s newsletter.

This week’s Net Income is brought to you by NextScout. NextScout connects executives with highly skilled overseas talent, talent that costs 75% less than a US or UK equivalent. 

Unlike other recruitment services, you only pay NextScout when you hire a remote worker who meets your standards — which, thanks to their rigorous candidate selection process, is a near-certainty.

Not sure what tasks to delegate? NextScout have put together this guide to help you get started.

So if you want to reduce your labour cost, NextScout can help. Just fill out this short form, and they’ll take care of the rest.

Who are the Serif Group?

Founded in 1987, Serif Group to day is the publisher of three core apps across Windows, macOS and iOS:

1) Affinity Designer

2) Affinity Photo

and 3) Affinity Publisher

In other words, they’re a direct competitor to Adobe’s creative cloud suite of Photoshop and InDesign.

You’d think that taking on one of the biggest and best-known software companies in the world would make things difficult.

But while Adobe does have significantly higher revenue per employee:

...Serif actually has better operating margins than Adobe, albeit on a fraction of the revenue:

And still — who cares if you’re not the size of Adobe when your shareholders are getting rich? They’ve paid out £26m in dividends in the last two years:

So the Serif shareholders aren’t “private jet” rich, but having driven past their offices, they’re certainly “Porsche with private number plate” rich, and we all know that basically everything after that is just vanity money.

There are some key lessons to learn from the Serif story, which I’ll share next week. First, though, they’re a great excuse to do some investment analysis and break out the XIRR formula and some discount factor tables. 

Let’s analyse an investment!

Serif started out as a software and hardware reseller. Founded in 1987, its early filings contain wonderful passages like this a glimpse into what the tech industry used to be like — celebrating the widespread adoption, at last, of GUIs as a way of doing business:

Capitalising on these industry shifts, Serif grew steadily throughout the 1990s, selling a combination of hardware and software to UK businesses, until 1999, when a chap by the name of Gary Bates was appointed to the Board of directors:

At this point the company was doing about around £6-10m per year in revenue, with some good years, some bad years. 

By early 2004, the company had grown top-line revenue significantly, but that wasn’t translating into bottom-line profits: 

So, sensing an opportunity, Gary Bates and his business partner James Bryce took a bold swing, and bought the company in a management buy-out, for £4.6m:

Now, £4.6m seems punchy when the total net income of the company over the prior three years was only £1.4m. In fact, I went through the filings and calculated the EBITDA for the 2001-2003 period:

Average EBITDA over this period was £827k, meaning that on a total purchase price of £4.6m, they paid a 5.6x EBITDA multiple to acquire a fairly middling business:

One important point to note here is that the acquisition was funded by £2.3m of equity, and £2.25m of loans:

Which I appreciate doesn’t quite add up to £4.6m — my guess is the balance came from the deferred consideration in the purchase price, meaning they could run the business for 6 months or so and generate enough cash to then pay off the last bit of the acquisition price.

So putting in ‘just’ £2.3m of their own money in 2004, Gary and James acquired Serif Group, and all of its software, IP, and operations, which up to that point were mildly profitable at best.

Was that a good investment?

Hindsight is wonderfully 20/20, so we can look at the dividends paid out since that 2004 acquisition to see what returns they’ve generated. 

I’m not assuming any terminal value of the business, and I’m only counting dividends paid to shareholders as cash out. Neither of those are entirely true, but it allows us to calculate the IRR, the Internal Rate of Return on the acquisition:

A 27.4% internal rate of return over 17 years.. 

Not bad at all. And they still own the business. 

Serif today has averaged around £14m per year in EBITDA, so assuming the EBITDA multiple stays constant at 5.6x, I estimate the business is worth £76.5m today. 

And realistically, that multiple is a lot higher now than it was then -- it’s a much bigger, more profitable, more resilient business, all of which would drive the multiple up.

If we wanted to pull out another investment analysis technique, we can use a Discounted Cash Flow (DCF) model.

Again, we have perfect information here so it’s cheating a little, and again, I’m simply using equity capital out and dividends back in as the cash flows, but let’s see how it shakes out using an 8% discount rate. Let’s also throw in an assumption that they sold the business for that estimated £76.5m valuation (ignoring taxes) at the end of 2022 as well.

By acquiring Serif Group in 2004, Gary and James generated £37m of value for themselves. What a great decision.

By the way, to get the discount factors for this, I just googled “discount factor table” -- these values essentially tell you what your £1 today is worth in the future at different interest rates. The higher the interest rate, the lower the discount factor, because in periods of higher interest rates, you should value money now more than money in the future.

‘Risk-free’ investing?

The one thing I want to point out today is not that these two guys made a phenomenal investment -- which they did -- but that they made a smart investment, one in which there was asymmetric upside.

It’s a great example of what investor Mohnish Pabrai calls a Dhandho investment. 

Dhandho (pronounced dhun-doe) is a Gujarati word. Dhan comes from the Sanskrit root word Dhana meaning wealth. Dhan-dho, literally translated, means “endeavors that create wealth.”

Pabrai, Mohnish. The Dhandho Investor 

Dhandho investing, as practised by Pabrai and others, is all about finding these ‘heads I win, tails I don’t lose too much’ scenarios.

That’s exactly what Gary Bates and James Bryce did when they acquired Serif in 2004. Here’s why.

On the face of it, splashing out £4.6m for a company that is at best mildly profitable seems foolish. But: remember the company had made pretty good money in 2001, but not much at all in 2002-03. That’s because they’d hugely increased headcount:

So Gary and James probably thought that in the worst-case scenario, they could run the Elon Musk playbook (decades ahead of Elon), lay off a bunch of people, get the company back to a reasonable level of profitability, and get their money back — or most of it, at least — in a few years.

Best-case scenario? They could invest in new products, hit upon one, and become very wealthy men.

Heads I win, tails I don’t lose too much. Classic Dhandho investing.

In reality, by 2009 Serif had paid out enough in dividends that they’d essentially got back to breakeven on their initial investment:

Which meant everything after that was a freeroll, playing with house money. They could afford to take some swings. And swing they did, and it certainly paid off for them.

We’l leave it there for today — more to tell in this story next week, in particular:

• how Serif completely transformed its business model;

• and why they’ve only paid a total of £2.2m in tax on £64m of pre-tax profit over the last twenty years.

Carve outs:

Sophie, aka @netcapgirl on Twitter, had this incredible exchange with Elon Musk:

which she then expanded into this incredible analysis of Twitter’s LBO so far, and where they could go from here. Highly recommend it:

Inevitability Research

A Recap of Twitter's LBO

Inevitability Research, Citrini&junkbondinvestor Executive Summary: A convertible note private placement could allow Twitter to reduce debt burden from LBO by raising capital from investors aligned with long-term vision. This would lower interest costs and reduce bankruptcy risk…

Read more

3 years ago · 7 likes · 1 comment · Sophie, Citrini, and junkbondinvestor

Speak soon,

Andrew

Last week’s deep dive was a beastly 3,000 words about rocket-ship apparel business Gymshark, and the behind-the-scenes boardroom shenanigans along the way to reaching £500m/yr in revenue. This week, we’re back with — unebelievably — another 4,000 words on the topic, because Gymshark’s story is both educational and wonderfully salacious gossip.

As always: if you like this, please share it with a friend.

Last week we looked at Gymshark’s blitzscale journey from a bedroom in Birmingham to a £500m/yr company.

As a recap, here’s Gymshark’s revenue since 2015. It’s a pretty stunning trajectory.

And I dove into the Companies House filings to try and figure out what happened between Gymshark’s two co-founders, Lewis Morgan and Ben Francis, and why Morgan left the business in 2016.

And yes, I may have indulged in some minor libel and slander, as I insinuated that now-CEO Ben Francis deliberately and ruthlessly tried to cut out his co-founder to end up with a bigger piece of a rapidly growing pie. Look at him — he does look ruthless.

And maybe that ruthlessness is the difference between, as Jason Calacanis would say, a billionaire and a centimillionaire.

But this week we look at the other side of the story, and consider:

• why maybe it’s right to kick out a co-founder;

• how Ben Francis has made several hugely important decisions to help Gymshark along;

• and how Gymshark has financed its rapid growth in the famously cash-hungry world of inventory-based businesses.

Reminder: I put hours of research into these posts, and distil it down for your consumption. If you want more, you can grab the Excel model and charts I used in this post in the Net Income store:

• Gymshark model and analysis

• Gymshark deck

You’ll be emailed the file as soon as you check out.

We’ll start with co-founder disputes.

Maybe it’s right to kick a co-founder out

This is how Ben described the co-founder split on the Diary of a CEO podcast:

There came a point where I had my vision, and I think [Lewis] had his vision. And I just want to be clear, I don't think one is better than the other. It was just a difference of opinion. And to be fair to him, he had so many other interests in terms of investments and property and all these different things. So Lewis essentially left…

To me, that sounds reasonable. Differences of opinion between co-founders or early-stage employees do happen. A lot. And not just between, say, Mark Zuckerberg and the Winklevoss twins, or Mark Zuckerberg and Eduaro Saverin, or Mark Zuckerberg and literally anyone else he’s ever come into contact with.

In fact, one of my favourite companies, Tiny, buys internet businesses all the time, and co-founder buyout is one of their main sources of dealflow:

Ben and Lewis were just 19 when they founded Gymshark, in 2012. By 2015, they’d had some success, and had some money in their pocket too. In their shoes, I’d think I could do anything I set my mind to.

So maybe Lewis did just have other interests that he wanted to pursue.

For example, on his LinkedIn page, right under Gymshark, Lewis mentions founding Maniere De Voir in 2013, just a year after Gymshark was launched:

Maniere De Voir is more fashion than gymwear, but still, it's an apparel ecommerce business, just like Gymshark.

So it's not, like, out of the realm of possibility that Lewis being involved in Maniere De Voir would create a conflict of interest with Gymshark.

Or not even a conflict of interest, but just a distraction. When you’re growing at the rate Gymshark was back then, you need all hands on deck just to keep the ship going in the right direction. I can see why if I was focusing on one business, and my co-founder — with an equal stake — was focusing on another, I’d be getting frustrated.

But that’s not quite the whole story.

Intriguingly, if we look at the initial statement of capital for Maniere De Voir, back in 2013, Morgan and Francis were each 25% shareholders. Reece Wabara, who was playing professional football for Doncaster Rovers at the time, held the other 50%.

Maniere De Voir started trading, and did well. Not stunningly well like Gymshark, but well enough to keep going.

A couple of years later, in 2016, Lewis Morgan leaves Gymshark, in what sounds like acrimonious circumstances. As I highlighted last week, Lewis describes the split very differently to how Ben does:

“He [Ben] wants to say we had different visions — if he wants to clear his own conscience by making himself believe that, then so be it…

There’s a lot of skeletons in the closet that’ll never be spoken about because of contractual reasons…

Loads of nasty stuff went on behind closed doors though.”

But despite that nasty split, the pair remained partners in Maniere De Voir until 2018, at which point Ben either gave up his shares, or sold them to Reece Wabara — a full two years after Lewis has left Gymshark:

And Maniere De Voir today is a wonderful company, doing over £30m in revenue, nearly £3m in net profit, with a total of £7.3m in retained earnings.

It’s no Gymshark, of course, but it’s a thriving small business. Over time Lewis has given more shares to Reece Wabara, so the business is now 83% owned by Wabara, and the remaining 17% by Lewis Morgan:

All this to say: yes, it looks perfectly plausible that both Lewis Morgan AND Ben Francis had other business interests when Morgan left Gymshark.

Which means we have one potential explanation for what happened — but remember, I have zero insider knowledge or information, so this is all wild speculation to take with a pinch of salt.

The way Ben tells it, all the following things happened at roughly the same time in 2015:

• Lewis left the business due to differing visions

• Ben meets Paul Richardson, former All Saints investor and director, at the gym

• Richardson introduces Ben to Steve Hewitt, a former Reebok exec

• Ben receives some 360 feedback from his leadership team that makes his realise he’s not the right person to lead Gymshark on its next growth phase

• Ben asks Richardson to join Gymshark as Exec Chairman, and Hewitt becomes CEO.

That’s how, as we discussed last week, we ended up with Hewitt taking 5% of the company in October 2015:

That’s the version Ben tells for public consumption.

A different interpretation of this story might be:

Ben and Lewis are young, naive, somewhat distracted, 20-somethings full of ego and some money, and have a rocket ship business on their hands. They think they can do anything, and start creating other businesses like Maniere De Voir.

The pair then meet experienced businessmen Paul Richardson and Steve Hewitt, who tell them words to the effect of:

“What the fuck are you doing? Gymshark's the golden goose, just don't get distracted or fuck it up and you’ll both be rich — and we can help you.”

And maybe Ben takes that message to heart — and Lewis doesn’t.

Ben goes all-in on Gymshark, wholeheartedly, and swears to spend the next decade building an amazing company. Lewis wants to keep building other businesses too, and investing in property, and generally being a big swinging dick.

So between them, Ben, Steve Hewitt, and Paul Richardson realise they need to tackle that problem now, rather than later.

Because if you've got a founder with a big stake in the business, who's no longer engaged, no longer pulling their weight, and racking up conflicts of interest left, right, and centre, that's a big problem. It needs to be dealt with as soon as possible, before the company gets too valuable, and dealing with the problem becomes too expensive.

This is where we have to give Ben Francis a ton of credit.

Driven by a singular vision to create an iconic British brand to rival Nike and Lululemon.

Smart enough and self-aware enough, even in his early 20s, to realise that he should bring on outside help, and step down as CEO.

Humble enough to then spend 6 years in different roles, learning at the right hand of more experienced team members, before taking up the CEO mantle again in 2021:

I’ve spoken to a couple of people who know a bit about Gymshark, and the one thing they both mentioned was this:

Ben Francis didn’t really know what he was doing. He didn’t have a clue how to actually run a business. But he knew enough to find the right people.

Which is the entrepreneur’s job! That’s what entrepreneurship is: assembling the team, the resources, setting the vision, and driving the company forward towards that vision. It’s a classic story of who, not how.

So driven by that vision, Ben did what he needed to do and removed the obstacle that could prevent Gymshark from becoming the company he knew it could:

and in exchange, he agreed to forfeit, or sell, his shares in Maniere De Voir in 2018:

at which point the two co-founders go their separate ways, both wealthy men.

One, the relentless, focused, billionaire CEO of Gymshark.

The other, a mere centimillionaire, investor, property magnate, and plenty more besides.

Just different visions. But look at this chart:

Looking at that, it’s hard to say that Ben made any wrong decisions, or that Lewis was hard done by — remember, he sold half his stake at the 2016 valuation, and the other half at the 2020 valuation, for a rumoured $200m.

Billionaire-level tax planning

I’m starting to tire of fawning over two guys who are both younger, more ripped, and significantly richer than me, so we’ll round off with a couple of other interesting things I found out in my research that didn’t quite fit into the story we just told.

Firstly, Ben Francis has excellent tax advisors.

I shared some of my research with a friend of mine who’s had some business success. In particular, she saw the shareholdings, with half of Ben’s stake held via Francis Family Office Ltd and saw something I didn’t:

Francis Family Office Ltd isn’t a mere holding company, it’s a family investment company:

A Family Investment Company (FIC) is a bespoke vehicle which can be used as an alternative to a family trust. It is a private company whose shareholders are family members. A FIC enables parents to retain control over assets whilst accumulating wealth in a tax efficient manner and facilitating future succession planning.

The tax experts in the audience can correct me, but I believe this means:

• Francis can gift shares in the FIC to his children now;

• Those shares become more valuable over time as Gymshark distributes dividends to the FIC, which the FIC does not pay tax on;

• FIC invests those distributed dividends in other assets over time, increasing the value of the shares he gifted to his kids;

• Assuming Francis survives for seven years after donating those shares, they become exempt from inheritance tax.

A wonderful bit of tax planning. The sort of thing I won’t bother doing unless this newsletter really takes off, but I like to know about anyway.

To top it off, there’s a nice human interest story in Gloucestershire Live about him buying a farm in the Cotswolds for his family:

which sounds just lovely. So idyllic. Ben and his wife being the Gen Z influencers they are, they even released an announcement video about it.

Is this just a case of a family wanting some space to retreat to in order to get away from the hustle and bustle of daily life?

No! It’s a tax thing.

Buying a farm means you benefit from Agricultural Property Relief.

Which again, means that when Francis dies and passes on the family farm to his kids, they won’t pay inheritance tax.

Just remember that tax strategy every time you see a rich guy who, for some reason, owns a farm, despite having no farming knowledge, ability, or desire.

Or maybe they just want the farm to use as a set for a tremendously popular Amazon Prime show, I don’t know.

Lastly it’s worth pointing out that Francis Family Office Ltd took a big chunk of Ben’s shares as part of General Atlantic’s investment in 2020, valuing their 35.5% of the company at £407.5m (implying an overall Gymshark valuation of £1.15bn):

But between June 2020 and July 2021 they sold off £25.2m of that stake:

Meaning that Ben Francis has very much secured the bag.

Gymshark could go to zero tomorrow, and he’ll still be a rich man. Not billionaire rich, or even centimillionaire rich, but he’ll have enough to retire to his (tax-efficient) Cotswolds farm and live out his days in peace.

Managing cash in a growing business

I say this as someone who works in an inventory-based business: managing cash flow is brutal, especially when you’re growing rapidly.

Every penny you get from customers ends up being reinvested into more inventory. Cash is often the key constraint on how quickly you can grow — imagine a scenario where you could sell 100,000 gym t-shirts next month, but you’ve only got the cash to pay for 50,000. Well, that means you can only buy 50,000, which means you can only sell 50,000. Once you’ve collected the cash from those sales, you can buy more t-shirts.

The time it takes to turn money spent with your supplier into money in your own bank account is called your cash conversion cycle.

Cash conversion cycle =

Inventory days + Receivables Days - Payables Days

Managing this cycle is one of the most important parts of running an inventory business.

The perfect scenario would be getting credit terms from your supplier, buy the whole 100,000 t-shirts, sell them all, collect the money, and then finally pay the supplier. If you can get paid before you have to pay for things, that’s a negative cash conversion cycle, and it means your customers are funding your growth.

That’s what Gymshark was doing back in the day. This article, rather unimaginatively, is called How Gymshark used negative cash conversion cycles to build a billion-dollar business, and suggests Gymshark had a cash conversion cycle of minus 36 days:

This writer claims these figures come from Gymshark’s financial statements. So, following in the footsteps of former US president Ronald Reagan, I adopted the mantra of “trust but verify,” I decided to dig into the numbers myself.

I couldn’t match up these numbers exactly, but I got close to the overall number using the figures from Gymshark’s 2016 financials:

Looking at the 2016 figures, Gymshark was being paid on average 3.1 days after it sold the goods — which makes sense, it’s a DTC business, so customers are paying by credit or debit card at point of sale. No credit risk there (and my guess is the 3 days is the approx. time it takes the cash to clear from the card processor into Gymshark’s bank account).

More importantly, Gymshark looks to be holding inventory for only 81.6 days, and paying for it after 122.2 days — meaning that when they sell the inventory, they have another 40 days before they need to pay the supplier.

Wonderful! A negative cash conversion cycle, right?

Well, things have changed.

Since then, Gymshark’s cash conversion cycle has gotten continually longer and longer, every year. It’s now at 102 days.

Now, that might down to a couple of things:

• International expansion, and dealing with a global supply chain

• A deliberate choice to make sure they keep up with sales growth

• Stockpiling inventory to make sure they never run out

Or, it could be that they’re just getting less and less efficient as a business. I don’t know.

So if they’re not funding their growth through a negative cash conversion cycle, and they only recently took outside money, how did they fund their growth?

Debt.

In the UK, when a company takes out a secured line of credit with a bank, it goes on Companies House as a registered charge. It’s so other lenders can credit check a company and see what assets are already pledged as security against other loans.

Here is a list of all the charges for Gymshark’s different entities:

Going back as far as 2015, they’ve taken out debt to fund growth. That’s fine — the company is profitable, and hasn’t had a problem servicing this debt. No doubt it comes with various conditions, covenants, and more, but for now, Gymshark hasn’t had any issues meeting those covenants.

That’s good, because if for whatever reason they fell into trouble, HSBC could take the keys to the kingdom.

As a reminder, this is Gymshark’s corporate structure:

And against its line of credit, Gymshark Group has pledged 100% of its shares of Gymshark Holdings as security. Gymshark Holdings has also pledged 100% of its shares of Gymshark Ltd.

Here’s the schedule from the registration of charge:

Now, that’s not necessarily an issue — as long as Gymshark can keep servicing the line of credit and meet its covenants. But this is a £50m line of credit we’re talking about, and they’ve drawn down every penny of it:

And their net borrowing increased by — you guessed it — nearly £50m in their last financial year:

They needed that money to finance the £49m increase in inventory in the year, which, along with some unfavourable exchange rate movements, is the main reason their cash flow from operating activities was negative £32m:

Again, none of this is necessarily an issue as long as the company is able to service the debt and meet its covenants.

On the face of it, Gymshark still has plenty of working capital to service the debt:

But its cash conversion cycle is getting longer and longer. In particular, Gymshark has a lot of cash tied up in inventory. If we exclude inventory from the working capital calculation, things look a lot worse:

Ouch. That’s why the debt is needed, to finance that negative working capital.

But as long as sales keep coming in, things will be fine.

On to the final piece of the puzzle.

Has Gymshark peaked?

Gymshark’s growth is certainly slowing. Here’s their year-over-year revenue growth since 2016:

You could argue that this is just an issue of scale — there are only so many people that want fancy workout gear, right? But remember last week we compared Gymshark to other brands in its category.

Lululemon is 13x the size of Gymshark, doing $8bn in annual revenue, and still growing at a faster rate:

We can also dive into some of the commentary in Gymshark’s financials to learn more.

Firstly, they disclose that units sold grew by 27.5% in the year, and 63% in 2021:

but remember, revenue only grew by 20.5% in 2022, and 54% in 2021.

So if unit growth is outstripping revenue growth, that means the average selling price per unit sold is dropping.

In fact, in the last two years, the average selling price per unit is down 10.7%:

A bunch of Gymshark’s sales are international and priced in USD, so that price decrease might just reflect adverse exchange rate movements. It could also be a deliberate strategy as they increase their unit volume with suppliers, driving down their buying price, and passing the savings on to their customers.

Overlaying Gymshark’s gross margin onto this average price per unit tells us it’s a bit of passing on savings, and a bit of margin compression too. Between 2020 and 2022, average sales price per unit is down 10.7% , and gross margin has dropped by only 4.0%, implying that the other 6.7% is cost savings passed on to customers:

Not too bad then.

The only other worry is that the drop in selling price per unit, and the fall in gross margin, coincides with the big increase in inventory.

The concern here is that sales are slowing, inventory is accumulating, and Gymshark is having to discount to get rid of that inventory, possibly in order to meet debt covenants or solve cash flow issues.

This possible cash crunch is coming at the exact time that Gymshark are expanding into retail and wholesale — albeit only tentatively for now — which will both a) increase their receivables days, making their cash conversion cycle longer; and b) decrease their gross margins.

In their 2022 financials, Gymshark also hint at the revenue trajectory for 2023 year to date:

“Revenue is tracking at the same level as for the corresponding period.”

In other words, revenue hasn’t grown at all this financial year.

What does that mean for inventory levels? Cashflow? Ability to meet debt covenants?

No idea. But it looks like the stakes are higher than ever, and I’ll be watching closely to see how the company performs this year.

Of course, in the unlikely scenario that Gymshark runs out of cash, can’t meet its obligations, and HSBC take the keys, the co-founders will be just fine.

Remember Ben Francis has already sold off about £25m of his stake, and invested in his tax-efficient farm, among other things. Hence why he probably sleeps OK at night, and has a beaming smile.

The irony in that situation is that Lewis Morgan would have sold off his remaining 20% in 2020, at the absolute peak of the company’s growth trajectory and zero-interest-rate based valuation. He’d have played an absolute blinder.

Maybe being kicked out of Gymshark would be the best thing that ever happened to him.

The story isn’t over yet. I’ll report back when the next financials are filed, which will be… April 2024.

Stay on the edge of your seat until then, OK?

Carve outs

This Gymshark thing ended up being a ridiculously large amount of work over the last couple of weeks, so only one carve out this time. If you’re a fan of Net Income, you’ll undoubtedly enjoy this fantastic interview with Jeremy Giffon on Invest Like The Best. Jeremy was the first employee and General Partner at the aforementioned Tiny, and has a ton of experience buying and selling wonderful internet businesses. A fascinating discussion that covers topics like:

• Esoteric opportunities that exist in private markets

• How misaligned incentives and coordination problems create special situations for people like Jeremy to invest in

• Compensation advice for CEOs

• Meeting your heroes

and much more. Highly recommend it. Listen here or wherever you get your podcasts.

Support Net Income

As a reminder, you can support Net Income by visiting the Net Income store on Shopify to grab any of the models or slides used in this post, and other posts.

You can also click here to become a founding member of Net Income. Your support means a ton to me, and by signing up, you’ll get a host of other benefits, including first-look (and free) access to future courses, a monthly catch-up call with me, and access to the Net Income community.

Thanks. Until next week,

Andrew

As a reminder, I’m Andrew Lynch, a small business CFO here in the UK. Net Income is a weekly breakdown of the interesting companies I find.

This week’s deep dive is a look at one of the UK’s fastest growing companies, Gymshark, and the drama, intrigue and behind-the-scenes moves that took place as the company scaled from £10m to £500m/yr.

One request: if you like this, please share it with a friend.

Note: this is part 1 of the Gymshark story, For part 2, click here.

What do Andre Agassi and Prince Harry have in common?

Aside from a slightly brattish demeanour and a receding hair line, I mean.

The answer I was thinking of is: they both used the same ghostwriter.

Agassi’s wonderful, brutally honest memoir Open, and Prince Harry’s salacious, baffling, gossip-filled book Spare were both penned by the same man, JR Moehringer, a Pulitzer Prize winning writer.

Moehringer is also the man behind Shoe Dog, the autobiography of Nike founder Phil Knight, which in my mind is probably the best business book I’ve ever read.

Most autobiographies suck because they give way too much time and space to the boring parts of the story:

• the person’s family history going back five generations (I don’t care)

• what the person’s life is like now they’ve succeeded (boring)

Shoe Dog, on the other hand, covers the interesting part that we all love to read: the drama.

It’s full of stories about Knight’s hard times building Nike: disagreements with co-founders, his shortcomings as a leader, and constantly being broke in a cash-hungry business — all while pursuing a singular vision of what he wants the brand to be.

This week we’re looking at a company that now competes with Nike, and has just as much drama in its story: Gymshark.

Gymshark was founded by 19-year-old best friends Ben Francis and Lewis Morgan back in 2012, and since then their growth has been meteoric.

By 2016 the company was already doing £13m in revenue, and it’s been on an absolute tear since then, reaching nearly £500m of revenue in 2022.

Gymshark is now a unicorn, probably worth around $2bn, and it’s made its founders fabulously wealthy. It recently opened its first flagship retail store, in the heart of London, and growth continues at breakneck pace, with ambitions to continue to expand in the US and Asia.

Ben Francis, MBE, is now 31, and continues to be CEO of Gymshark today, with a vision to create a truly iconic, global, British brand like Jaguar, Aston Martin, or Burberry, and in the process, to rival Lululemon, Nike, and Under Armour as a top-end sportswear company.

Ben now owns 71% of the company, and is worth around £1bn.

Co-founder Lewis? He owns 0% of the company, having resigned his role in 2016, and selling off his shares in 2020.

Don’t cry too much for him: he’s rumoured to have sold his shares for around £100-200m.

But still: that’s only like a tenth of what his fellow co-founder Ben is worth.

What the hell happened? Let’s get into it.

Gymshark’s numbers

First, let’s dive into Gymshark’s P&L.

From their founding in 2012, it took Gymshark just 6 years to get to £100m in revenue, and they’ve continued to grow at a tremendous rate since then. Here’s their P&L over the last five years:

Now Gymshark is a business doing ~£500m per year in revenue, at 65% gross margins, and net margins of 5-10% per year. Not only that, but it’s still growing revenue at more than 20% year-over-year.

Where does that put Gymshark in its mission to become a global sportswear brand?

Let’s compare it to the three brands that Ben Francis himself mentions: Nike, Lululemon and Under Armour.

In terms of revenue, it’s no surprise that Nike is the absolute behemoth of the industry, doing nearly $47bn a year in revenue.

Of course Nike has had a 50 year head start on Gymshark, so it’s not really a fair comparison.

Lululemon is a better analogy — the company was founded in 1998, and after 10 years in business, Lululemon went public, and was doing $353m in revenue at the time. Adjusted for inflation, that’s about $500m in today’s money.

Which means that in terms of revenue, Gymshark is ahead of where Lululemon was at the same point in its journey.

The flipside of that argument is that Lululemon then went on an absolute tear for 14 years, growing at a compounded rate of 25%, and now does over $8bn a year in sales:

and while Gymshark is growing faster than Nike and Under Armour, Lululemon is still the leader of the pack:

which is all the more impressive when you consider that Lululemon’s revenue is more than 13x that of Gymshark.

One thing Gymshark has in its favour vs legacy brands is on gross margins. As a native DTC brand, Gymshark may pay eye-watering fees to Shopify, but it doesn’t have the same cost of physical retail stores that other brands do, meaning higher gross margins:

but then again, being a DTC brand, if it’s not Shopify picking your pocket, it’s all that pesky sales and marketing expense, or the breakneck costs of rapid growth (although Lululemon still does fine).

The end result is that Gymshark has the lowest net margins of the comparison group.

Gymshark’s a great business, and if it can keep growing, it could definitely find itself in the same class as the comparison companies. It’s not there yet — but it’s done pretty damn well for business that only recently celebrated its 10th birthday.

It’s even more impressive when you consider the tumult and drama that Gymshark has gone through in its short history.

Key lesson: pick your co-founders carefully

Gymshark was founded by two best mates, Lewis Morgan and Ben Francis, back in 2012. Both keen fitness enthusiasts, they’d tried their hand at a couple of different business ideas in the gym and fitness space, none of which quite took off. Gymshark was another of these business ideas — it was originally intended to be online supplement store.

One day, so the story goes, Ben found himself frustrated at his inability to find good gym clothes that fit. (I’ve had the same problem because I’ve got such swole thighs. Seriously.)

So Ben and Lewis pivoted to making and selling gym clothes — and it worked! Instant traction.

At the time, Ben was working at Pizza Hut, making minimum wage, and sewing clothes in his parents’ garage, and he kept doing so until Gymshark had well over £100k in revenue, until finally Lewis and Ben both agreed to go full-time on Gymshark.

It’s right here, right at the beginning of the story, that the seeds of the drama are sown:

1. The two co-founders are best mates.

2. Each co-founder had an equal 50/50 stake in the business.

“Let’s keep it simple,” they said. “We’ll split everything right down the middle.”

So they incorporated Gymshark Ltd. The company had two shares, and they each owned one of them:

They also, according to Ben, didn’t really have any structure or clear roles and responsibilities. When you don’t have a clear split of roles, and neither one of you can outvote the other, that’s a recipe for disaster and paralysis.

So what happened? Here’s an excerpt from a podcast interview Ben did a couple of years ago:

Interviewer: So what were you the CEO? Or were you both CEOs?

Ben: No, in the early days, that never really happened. It was just a bit like, right, this is a list of things that we need to do. Let's just tackle them as we go. There was no organisation in those days.

… in the early days, we were literally inseparable, and then there came a point where I had my vision, and he had his vision… so Lewis essentially left.

Oh, OK. Just a difference of opinion over the direction of the company, and so Lewis decided to leave? Seems reasonable.

But what does Lewis have to say on the matter?

On a different podcast, Lewis says:

“He [Ben] wants to say we had different visions — if he wants to clear his own conscience by making himself believe that, then so be it…

There’s a lot of skeletons in the closet that’ll never be spoken about because of contractual reasons…

Loads of nasty stuff went on behind closed doors though.”

Oh dang. That sounds salacious. But we don’t know any more than that, and it’s possible we’ll never know any more. Curse you, non-disclosure agreements!

What we can do is track the shareholding changes over time. It’s time to put our detective hat on, and do some sleuthing.

The evolving shareholder list of Gymshark

As mentioned earlier, Gymshark started with a very simple structure: Ben and Lewis each owned one share.

Couldn’t be simpler. Each share is worth £1, and vote. An easy 50/50 split of both voting and economic rights.

Over those first three years the co-founders grafted, and grew the business rapidly. By 2015 Gymshark was close to eight figures in revenue, around 35 employees, and looked set to keep expanding rapidly.

The company was a rocket ship, and they all knew it.

Which is why it’s incredibly surprising that at that point, as Ben Francis tells it, he decided to remove himself as CEO.

Ben says he got some 360-degree feedback from his leadership team that made him realise he wasn’t the leader he needed to be if Gymshark was going to fulfil its potential. He subsequently stepped down to Chief Brand Officer, and appointed an external CEO above him.

To put it in context, Ben Francis was just 23 at that time. He and Lewis had built a company that by that time was doing about £9m a year in revenue. And he decided to step down for the good of the company.

Assuming that is indeed what happened, I’ve got a huge amount of respect for that call. That’s a level of maturity, self-awareness and humility I wouldn’t have had at that age.

So, enter Steve Hewitt.

Steve came to Gymshark with a pedigree in the sportswear industry, having served 6 years as Commercial Director (EMEA) for Reebok. Steve was appointed as a director of Gymshark Ltd in June 2015, taking on the CEO role — as well as 5% of the company for his troubles.

At the same time, in June 2015, Paul Richardson, former director of All Saints Retail1, is appointed a director of Gymshark too, taking on the Executive Chairman role — but Richardson doesn’t get any shares at this point.

After a cheeky little 100-1 share split, and the creation of a new share class, we find ourselves with this shareholder list by October 2015:

One important thing to note: Steve Hewitt’s shares are a different class, B shares, than Ben and Lewis’s A shares.

This is pretty common. Often different share classes exist to assign different rights to each share class. Different share classes may have more or less power when it comes to shareholder votes, or dividends, or a claim on the company’s assets in the event of liquidation. That sort of thing.

In this instance, it’s so that holders of A shares (Ben and Lewis) had right of first refusal to buy B shares, which we can see in the filing docs:

This still all looks kosher to me. Ben and Lewis bring in an outside CEO — someone more mature, with industry experience, to help guide them — and give him some equity so that he’s got some skin in the game. But make that equity a different share class — just to make sure you get first right to buy his shares back, and you don’t risk losing control of the company. All makes sense.

Crucially, though, the B shares have the same voting rights as the A shares. Which mean if the two co-founders disagree, Steve Hewitt has the swing vote.

*ominous music*

Then we hit September 2016.

The great restructure of 2016

According to Ben’s Instagram page, he was on a Gymshark world tour in Canada at the time when all hell broke loose in a matter of days.

On 17th September 2016:

• Gymshark Holdings Ltd is formed (originally named the Clade Group), and takes 100% ownership of Gymshark Ltd (the trading company).

• Ben Francis, Paul Richardson, and Steve Hewitt are all named directors of Gymshark Holdings.

That same day Gymshark Holdings files its initial list of shareholders:

and Lewis Morgan’s name is nowhere to be seen.

We see from Gymshark Ltd’s filing in January 2017 that all shares of Gymshark Ltd had been transferred to Gymshark Holdings (aka Clade Group):

So we know that on 17th September 2016, the ownership structure of Gymshark looked like this:

Four days later, on 21st September 2016, a new list of shareholders for Gymshark Holdings gets filed, and Lewis is back on the list:

But his shareholding is now only 20%, down from the 47.5% he previously held. Ben Francis increases his stake to 67%, and Paul Richardson swoops in with a cheeky 6% of the company too:

That same day, Lewis Morgan resigns as a director of Gymshark Ltd.

And, y’know, maybe this is all a coincidence, but this happened to be the financial year in which Gymshark tripled revenue, and made nearly £10m in net profit, more than it had in all its previous years combined.

It’s possible that Lewis Morgan’s equity stake went down simply because he sold his shares. I can’t see evidence of that anywhere particularly — but if it was a private transaction between the shareholders, we wouldn’t see it.

But why would you hugely reduce your stake in a business when you know its value is about to skyrocket?

You wouldn’t.

Surely, you wouldn’t?

So it frustrates me to have to say this, because I hate throwing shade on successful British companies.

But it’s entirely possible that Lewis Morgan was forced out of Gymshark by Ben Francis, Steve Hewitt, and Paul Richardson.

Maybe Lewis Morgan got the full Eduardo Saverin treatment.

For four days, between 17th and 21st September 2016, Lewis Morgan appeared to have no stake in Gymshark at all. Or at the very least, it looks like Ben Francis, Steve Hewitt and Paul Richardson were forming a separate holding company without him.

Why?

Maybe it’s just a filing issue or a timing issue with Companies House — it’s entirely possible that Lewis just sold a big chunk of his stake to the other shareholders, including Ben, at a fair price.

Or maybe Lewis wasn’t pulling his weight and Ben and Steve did what they thought was right for Gymshark, which was to get rid of him.

Or maybe they used this restructure to somehow threaten Lewis to force him to sell his shares to them at a deep discount?

I really have no idea what the truth is here. But I love the drama.

The resolution

The morally ambiguous ending to this tale comes in August 2020, when private equity house General Atlantic plonks down a cool £200m to acquire 21.1% of Gymshark.

As part of the deal, co-founder Lewis Morgan sells his remaining stake for somewhere in the region of £100-200m. We don’t know exactly how much. But in the press release around the sale, his name doesn’t even get a mention:

Today the shareholder list is basically the same as it was following that transaction.

The only difference is that Ben Francis gave a big chunk of voting shares to his brother, which includes 1% economic ownership of the company. Ben also transferred half of his ownership stake into Francis Family Office Ltd (which Ben Francis owns 100% of personally):

Based on that valuation of $1.3bn — a valuation agreed in 2020, so make your own judgement about which way it’s gone since then — Ben Francis himself is worth around $900m.

In 2021, he felt he was ready to take the CEO seat back off Steve Hewitt, who moved into a non-exec chairman role.

And in 2023, Ben Francis was awarded an MBE.

Now, he even gets to do fun rich people stuff, like take £10m of his own money that’s been distributed out of Gymshark to his family office co, and lend it back to them at a 3% premium to the SONIA rate:

which, given the SONIA rate of ~5% per year, plus the 3% premium, means he’s making the best part of £1m a year just in interest! Isn’t being rich fun?

All you need to do is ruthlessly cut out your co-founder and best mate from the deal, and you’re golden.

This guy knows what I’m talking about:

Gymshark part 2, next week

There’s actually a bunch more in the Gymshark story that I want to talk about — bringing in external talent, identifying your best role in the business, managing working capital in a brutally cash-hungry business like ecommerce — so we’ll be doing a Gymshark part 2 next week as well.

But with Succession finished for good, I was looking for a slice of boardroom action, and I just couldn’t resist diving into this side of the Gymshark story.

Speak soon.

Andrew

EDIT: part 2 is out! Head here to read more about co-founder exits, billionaire tax planning, securing the bag, and cash crunches.

Hello to the 1,513 people reading this, and a warm welcome to the 123 new subscribers since last week.

As a reminder, I’m Andrew Lynch, a small business CFO here in the UK. Net Income is a weekly breakdown of the interesting companies I find. Or, in this case, a deep — some might say intrusive — look at the business and finances of a former professional athlete.

One request: if you like this, please share it with a friend.

I recently went to the movies to watch Air. It’s the story of how Sonny Vaccaro, played by Matt Damon, was a marketing executive at Nike in the company’s early underdog days. Sonny, through some combination of charm, persistence, and salesmanship, managed to land Michael Jordan as one of Nike’s marquee athletes.

In exchange, Jordan asked for a then-unprecedented term in his sponsorship agreement: a cut of all gross sales from any Jordan shoe that Nike sold.

Vaccaro and Nike agreed, and the rest is history. This deal transformed public perception of Nike, revolutionised sports marketing forever, and made Michael Jordan richer than Croesus.

In fact, did you know that Jordan made more money from that deal with Nike to put his name on a shoe than he ever did from playing basketball?

Of course you knew that. Everyone knows that.

It’s the most famous factoid in all of sports, up there with “Apparently Tiger Woods cheated on his wife.” Yeah, no kidding.

But we still love talking about it, don’t we?

This intersection of sports and business is fascinating, not just to me, but to everyone. Movies like Air, Moneyball, Jerry Maguire, and shows like Ballers, capture our imagination.

Who can resist the combo of famous athletes and big money deals? It’s a sexy topic so popular, it has its own Pompliano sibling. There’s a reason they turned the MJ/Nike story into a movie.

And there are some phenomenal examples of athlete-turned-entrepreneur stories.

My favourite of the genre is Junior Bridgeman. Having played 13 years in the NBA, and never making more than $350k a year, Bridgeman parlayed this modest career into a net worth of around $600m.

Bridgeman built his wealth by investing in fast-food franchises, even while he was still playing. He went as far as working in his locations during the off-season to get to grips with the business — and he just kept re-investing the profits in more and more franchises.

At its height, Bridgeman Foods, Inc, owned around 160 Wendy’s and 120 Chilli’s locations, with revenues of over $500m a year. In 2016, Bridgeman sold all his franchises, and with the proceeds bought a Coca-Cola bottling and distribution business.

Bridgeman’s franchise playbook has at least one dedicated disciple: Shaquille O’Neal.

Shaq followed Bridgeman’s example to a tee. At one point the former Lakers star was the largest Five Guys franchisor in the US, with around 10% of all locations (which he later sold). Shaq now owns, among other things, 17 Annie’s Pretzels, 9 Papa John’s, 150 car washes, and 40 gyms.

In fact I wouldn’t be surprised if Shaq launched a social media campaign telling people all about the wonderful opportunity of buying boring, cashflowing businesses, and then launched an online course.

But in the pantheon of athlete-entrepreneurs, neither Shaq nor Bridgeman can hold a candle to the true GOAT, his airness, Michael Jordan.

Jordan’s net worth is estimated at $2bn, even before he’s sold the Charlotte Hornets for a huge profit. Jordan continues to bring in around $100m a year from his Nike deal alone. As long as he doesn’t gamble it all away, he’s set for that /r/fatFIRE life.

Such is the glitz and the glamour of American sports.

But who’s doing the same over in the UK? Who’s our best athlete turned entrepreneur?

Who’s the British Michael Jordan?

And is it…

Gary Neville?

Spoilers: it’s not, but he’s doing a pretty good job anyway.

That most trusted and venerated British institution, the BBC, clearly think Gary Neville is a good example of an athlete-entrepreneur, because he’s going to appear as a guest star on the next season of Dragons Den.

British newspaper The Guardian estimates his net worth at £20m. Not bad at all. But is that right? What does he own? In what pies do we find Gary Neville’s fingers?

Let’s dive in.

Who is Gary Neville?

(Firstly, some ground rules: I know about a huge chunk of you are from the US, but for this piece, we’re using British words, British spellings, and British turns of phrase.)

Gary Neville was a professional footballer.

Not soccer player. Footballer.

Neville’s career began in the early 90s, as many careers did back then, with a boyish grin and a wonderful centre parting haircut.

Sport runs deep in Gary’s family:

• Father Neville Neville (yes, really) was a cricketer.

• Mother Julie was a netball player, and is now GM and Club Secretary for Bury FC, in England’s lower leagues.

• Sister Tracey was an England international in netball, winning medals as both a player and a coach.

• Brother Phil was a professional footballer, also coming through the ranks at Manchester United, before playing for England and Everton.

Gary continued that family sporting pedigree with an illustrious playing career.

A true one-club man, Neville played for Manchester United from his professional debut in 1992 until his retirement in 2011. He came into United’s senior team as part of the fabled Class of ‘92, along with , Ryan Giggs, Paul Scholes, Nicky Butt, his brother Phil and, most famously, David Beckham (another athlete-entrepreneur for another day).

Over 20 years, Neville racked up an impressive list of accomplishments:

• 400 senior appearances for Manchester United

• 85 England caps

• 8 Premier League titles

• 3 FA Cups

• 2 Champions League titles

• 1 FIFA World Club Cup

(but sadly, no partridge in a pear tree)

Solely from a sporting point of view, that’s a great career. But after hanging up his boots, Neville turned his hand to a number of other ventures, including TV, media, property, and education.

Thanks to the wonderful source that is Companies House, this is all public information too. So with some diligence and research, we can find out what Neville owns, and figure out how rich he is.

Mapping the Neville empire

The first step in our research process is to head to Companies House, and search for Neville’s name to see what companies he’s associated with.

Here we are:

Oh, OK, 63 companies. That’s a lot. A bunch of them are probably dormant or dissolved, so let’s just filter for active companies, which should make the job easier.

God dammit Gary.

OK, let’s take a different tack.

After a little scouting around I managed to identify Neville’s holding company: Relentless Holdings Limited.

Gary and his wife Emma each own 50% of Relentless Holdings, and in turn Relentless Holdings has four wholly-owned subsidiaries:

• Relentless Investments

• Relentless Media

• The Overlap

• Tiger Sports Management

Brief sidebar here to note that Gary Neville shares his love of the word ‘relentless’ with a certain Jeff Bezos.

Neville has included that word in a number of his company names, and his HoldCo. It’s an interesting glimpse into the man’s psychology — and it’s not surprising when you consider how Neville’s playing style is described on Wikipedia:

“Gary Neville was an aggressive, tenacious, and hard-tackling player, known for his work-rate, professionalism, determination, and consistency as a defender… [a]lthough he was not the quickest, tallest, strongest, most talented or most technically gifted player.”

Neville is a guy who made the absolute most of his talent through hard work and determination. Put another way, he was relentless. That idea of never giving up, of persevering, of getting everything you can out of a situation is clearly close to his heart, so he wants it represented in this small way through his company names.

Similarly, Amazon.com was almost called Relentless.com in the company’s early days. Bezos thought the word ‘relentless’ aptly described how he wanted his company to act, so he bought and registered the domain. To this day, relentless.com still redirects to Amazon.

Maybe Gary Neville has more in common with entrepreneurs than we originally thought.

Anyway, back to the Neville empire. If we dig in a bit more into each subsidiary, we end up with something like this:

To clarify: book value is the total assets of the company, minus all the liabilities. It’s what would theoretically be left over if you turned everything the company owns into cash, then paid off everything the company owes. It’s an imperfect measure — but most of these companies aren’t big enough to report a P&L, so the balance sheet is all we have to work with for now.

As a result, these four companies don’t look like much.

Tiger Sports Management, which has accumulated a bunch of profit over the years from Neville’s image rights, royalties, etc., is all of the value of this group. The Overlap, a recent creation for Neville’s YouTube channel of the same name, has a small amount of accumulated profit, and the other two companies have zero book value.

Let’s go further. Firstly, Relentless Holdings, the TopCo, has a book value of £1.5m itself.

Secondly, we can dive into the *counts* 25 subsidiaries of Relentless Investments.

I won’t bore you with all the details, but I went through every company that’s in the Relentless Holdings family, including subsidiaries of subsidiaries of subsidiaries.

After discarding any company that was dormant, dissolved, or had a book value of £100 or less, I came up with this list:

Purely looking at book value, the Relentless Group looks to be worth about £5.4m.

But wait, the devil is in the detail

Three things to note here.

Firstly, a bunch of these businesses have negative book value.

That’s usually because they’re borrowing money from other companies in the group, in what’s known as an inter-company loan or a related party transaction.

Those inter-company loans will drop the book value of the company borrowing the money, but should increase the book value of the company lending the money by the same amount — so it should all net out to zero.

Secondly, as I mentioned, only looking at book value is an imperfect measure, because it hides the underlying profitability of each business.

Let’s take the bottom business, The Man Behind The Curtain (Leeds) Ltd as an example. It’s a high-end restaurant that’s 50% owned by Gary and Emma Neville, and 50% owned by head chef Michael O’Hare.

All we have to go on is their balance sheet, which as at 31st Dec 2021 shows net assets of minus £81k.

But that’s understandable — it’s a restaurant, coming off the back of two Covid-impacted years. As at 31st Dec 2019, the company had net assets of £125k. Does that mean the business lost £206k in 2020-21? Well, maybe. Or maybe it made £500k in profit, and distributed out £706k to its owners. We can’t really tell. We just don’t have enough information.

Thirdly and finally, at least four of these companies are property investment vehicles — which means the book value of their assets might not reflect reality.

Are Neville’s assets understated?

As an example, let’s look at Relentless 17 St John Street. This is a company specifically created just to hold an investment property. This investment property, to be precise:

It’s a lovely, period commercial property in a fantastic location — right in the heart of Manchester, a city which has seen a huge boom in recent years. Think Austin, Texas, but with more rain and Britpop bands.

Relentless 17 St John Street is a fairly simple balance sheet then: the assets are the investment property, valued at £783k, and the liabilities are the money the company has borrowed to buy those assets.

So far, so good.

But wait — they’re valuing the property at £783k this year, just like they did last year, and the year before?

How can a property valued at £783k in March 2020 still be worth exactly the same in March 2022? Seems sus imo.

In fact, with a bit of data wizardry (downloading a CSV), we can take figures from Land Registry for average property prices in Manchester, index them back to March 2020 when Neville first acquired the property, and see how prices in the city have changed since.

Looks like average property prices are up 20.7% in those two years.

Again, this is an imperfect comparison because these figures are for residential property, rather than commercial, but nonetheless, they’re an indication of the direction in which prices have gone.

Which means we could do some restatement of Neville’s numbers:

All of a sudden we’ve increased the net worth of Relentless 17 St John Street Ltd — and therefore Gary Neville himself — by £162k.

Now, let’s recap:

• no P&L

• asset values likely don’t reflect market reality

Multiply those two issues by 18 subsidiary companies, and we come to the conclusion: I don’t have a clue how much Gary Neville is worth.

In fact, it gets even worse when we try and account for Neville’s minority investments, which I’ve detailed here:

One more time for fun: this is an imperfect analysis, but using just book value, Neville’s share of these minority investments means he’s £4.5m in the hole.

So let’s smash this analysis together and see where we end up:

Damn. Is Gary Neville even a millionaire?

Did he play elite level football for 20 years only to piss most of his money away on hotels and unprofitable lower league football clubs? Is he less of a Shaquille O’Neal, and more of a Dennis Rodman?

And really, should he be on Dragons Den, dishing out investment, when it looks like he’s one unexpected electricity bill from declaring bankruptcy?

Not so fast

Neville’s probably not on the verge of bankruptcy, let’s be honest. I don’t know if he’s worth £20m — what we’ve uncovered so far suggests not — but let’s look at why the value of all his companies might not look that impressive on paper.

There are four possible explanations. These are speculation, and I have no idea which one is correct, but all are possible.

Explanation #1: high distributions

It’s entirely possible that the reason Neville’s companies don’t look that flush with cash is because they generate a high amount of profit every year, and Gary Neville and his wife take a bunch out in distributions each year.

They’ll pay their UK tax on it, then invest it personally in their own names in a combo of tax-advantaged accounts, private investment trusts, and other assets that we can’t see through Companies House or other public domain information.

Explanation #2: offshore investments

Neville and the rest of the Class of ‘92 have a close business relationship with Singaporean investor Peter Lim, who co-owns Salford City FC with the group. It was Lim who bought the majority share in the imaginatively named Hotel Football and Café Football when the Class of ‘92 sold their shares. Neville and Giggs are still directors of GG Hospitality Management Ltd, the company behind those two venues, but that business is now owned by GG Collections Private Ltd, in the British Virgin Islands, which in turn is owned by Thomson Medical Group Ltd, in Singapore.

So as an example, either Neville cashed out his shares, paid tax, and then invested the proceeds personally rather than through his companies, or he holds shares in the offshore companies, facilitated by Lim.

Explanation #3: reducing tax burden

Going back to 17 St John Street as an example: the reason the asset value might be understated is because restating the value of property upwards leads to a taxable gain, meaning tax to pay. And who wants to do that?

I sure don’t, and Neville probably doesn’t either. So he might be keeping the value of his assets artificially low to avoid tax — or at the very least, he’s not enthusiastically revaluing his property every year.

To be fair to him, that’s not really tax avoidance — it’s actually fairly common practice when it’s hard to get a true market value on what your assets are worth — but it does have the beneficial side effect of reducing tax, which no one ever in the history of mankind has ever thought of as a problem.

Explanation #4: the numbers are broadly right, and Neville’s just not a very good entrepreneur

You can call yourself and everything you own Relentless, but if you’re spending £1 to make £0.90, and you keep doing that for a few years, you won’t have much left at the end of it.

So which is it?

If I had to guess, I’d probably say a combo of #1, high distributions, and #3, some mild tax optimisation.

To be clear, I don’t think Neville’s a terrible entrepreneur. And he doesn’t seem like the type to engage in huge tax fraud either. He’s probably just taking a bunch of money out of his companies each year, paying his taxes, investing some money personally, and then funding his lifestyle and his love of loss-making Salford City FC.

So is Gary Neville the British Michael Jordan?

Sad to report: no, he’s not.

Gary Neville is to Michael Jordan what I am to the incredible Bloomberg columnist Matt Levine. He’s more British, with less natural talent and athleticism, and a lot less money — but he’s trying hard, and his heart’s in the right place.

Carveouts

I finished Will Thorndike’s book The Outsiders, and wanted to dive deeper into the story of John Malone and TCI, so I started reading Marc Robichaux’s book Cable Cowboy. Fun fact: John Malone was the guy who invented the concept of EBITDA. Recommend checking it out, it’s a great read.

As always, thanks for reading — see you next week.

Andrew

As a reminder, I’m Andrew Lynch, a small business CFO here in the UK. Net Income is a weekly breakdown of the interesting companies I find. But, confession time: I didn’t find this company. In fact, three Net Income readers mentioned it to me in the last couple of weeks, so I had to take a look.

What happens if you read Four Hour Work Week back in 2007, and decided, yes Tim Ferriss, you’re right, I should sell info products with no marginal cost? We’re about to find out.

One request: if you like this, please share it with a friend.

Let’s say you woke up this morning feeling particularly cruel and vindictive.

The scenario is this: you have a new starter in your organisation, and your mission, should you choose to accept it, is to make sure your new starter either fails, quits, or gets so burnt out that they leave the company in the next three years. 

Step one, of course, is to watch this absolutely iconic noughties rom-com for some #inspo:

But let’s take that as read. What’s your gameplan to force someone out of their job?

I don’t have all the exact steps figured out, but I think we can all agree a plan would work if it ticked these boxes:

• Pay is significantly under-market compared to their skill & education level.

• Long hours expected regularly, with no overtime or bonus.

• Pay is linked to tenure rather than performance — no matter how hard they work, they won’t make any more money.

• Little or no onboarding, training or ongoing reviews, just chuck them into the job and expect them to figure it out for themselves.

• But they’d best not screw up, because there’s a constant threat of external inspection AND YOU MUST SCORE HIGHLY OR YOUR LIFE IS RUINED.

• High percentage chance of verbal, emotional, or even physical abuse from your customers, with whom you have to interact for hours at a time.

Well would you look at that? We’ve just described teaching.

In the UK, one in seven teachers quit in the first year on the job. A third of teachers who have qualified in the last ten years have left teaching. And another 44% plan to quit in the next five years.

In her earlier career, my wife was a teacher, and a good one. But she ultimately left teaching about two years after qualifying. When we compared the hours she was working to the amount she was being paid, it came out significantly below minimum wage. It just wasn’t worth it.

Of course there were other benefits. Long summer breaks, lucky dips in the lost property box, and that warm feeling of seeing someone reach their potential — but those benefits don’t pay the bills.

The most difficult bit of the workload to handle wasn’t the time in the classroom, or marking the kids’ books. It was lesson planning. 

Let’s say you had to give a 15 minute talk at your job. It’s an important one, and you want to do well.

How long would you spend writing, planning and practising that talk? Significantly more than 15 minutes, I’d say. At least an hour, maybe more?

Whatever the actual answer is, it’s almost a certainty that you’d spend more time planning your talk than actually delivering it.

Now imagine you have to do five hours of presentations per day, five days a week.  And if you screw up, the audience of 13 year olds laughs at you and tells all their friends how cringe you are.

The result is that teachers end up spending an inordinate amount of time on lesson planning. That burden is particularly hard for new teachers, who don’t have years of material to pull out when they need it.

But... what if there was another way?

What if your school, or the government, or some non-profit, provided a huge bank of teaching resources for you to download, use, amend, and remix to your heart’s content, all for free?

Well, that’s a pipe dream. The education system is too screwed up for that.

But what if a private, for-profit company provided a huge bank of teaching resources, for just a few pounds a month, and you had to pay for it out of your own pocket?

Eh, close enough, you’d say. I’ll do it.

This is Twinkl, the world’s largest provider of educational and teaching resources.

Twinkl’s origins and numbers

Twinkl was founded in 2010 by husband and wife duo Jon and Susie Seaton. Jon, a solicitor, was shocked at the amount of time his wife, Susie, was spending creating her own teaching resources. 

In fact, Jon was in a very similar spot to where I was circa 2012. If comparison is the thief of joy, then I’ve been robbed blind.

Let’s examine the paths that the two of us have taken since that sliding doors moment:

Jon and Susie took the more difficult path, and it’s paid off handsomely. I don’t begrudge them that, I just wish I’d been smart enough to do the same myself.

What started as Jon and Susie creating PDFs and PowerPoints in their spare bedroom at 4am is now into an international company with over 1,000 employees.

And guess what?

Selling digital products with no marginal cost of goods sold is a great business.

(ahem get the model from this article and others in the Net Income store k thx bye)

Just how great a business? Well, here’s Twinkl’s 2022 P&L:

Yes, that’s a 71% gross margin, and a 42% net margin. 

These numbers are not a one-off. The first time Twinkl disclosed a P&L was in 2016. Even back then, it was less than 1/10th the size, and it was still a wonderful business, and it’s just gotten better and better ever since:

From £5m in revenue and £2.5m in net income back in 2016, to £55m in revenue and £23.3m net income in 2022.

It’s a rocketship. Since 2016, they’ve grown revenue at an annual rate of almost 50%. And whether you’re looking at gross profit, operating profit or net profit, they’ve all grown at an annual rate of 40-50%.

What a phenomenal business.

Back to capital intensity again

You might remember that last week we looked at measuring capital intensity using the asset turnover ratio. Remember:

Asset turnover ratio = Revenue / average assets

It’s a measure of how effective a company is at turning what it owns into revenue.

Well, when you’re selling digital goods, you don’t need a lot of capital. Really all you need is a functioning website and a Stripe account.

So Twinkl does a marvellous job of turning its assets into revenue.

Firstly, Twinkl crushes a capital-intensive business like Center Parcs — its asset turnover is around 8x higher. That much should be obvious.

But even compared to relatively capital-light industries like consulting or SaaS, Twinkl is in a league of its own:

This is not a company that needs that much reinvestment as it grows. In fact the vast majority of Twinkl’s assets are either cash, or accounts receivable that’s about to become cash.

As a result, those lovely, thicc 45% net margins translate directly into distributions for the owners. How much in distributions, you ask?

£60m alone in the last two years.

Lovely stuff.

Twinkl’s growth model

One beautiful thing about Twinkl is that it’s recurring revenue.

Teachers — and parents — can sign up for a monthly membership fee of between £4.49 and £8.49 per month, depending on the level of access they want. The

There’s also a free tier with more limited access.

Let’s make some very basic assumptions:

• The average membership fee is £6.24 per month (less VAT)

• Prices haven’t changed since 2016

• All revenue is membership fees

Then we can estimate the member growth over time:

Of course, with a bit of quick googling, we reveal that there are only about 500,000 teachers in the UK.

I spoke to a couple of teachers I know and they confirmed that yes, they know Twinkl. In fact they reckon every teacher knows Twinkl, purely through word of mouth and staff room chat — and they said they wouldn’t be surprised if basically every teacher has used it at some point, even if they’re not an active paying member right now.

So what do you do if you’ve maxed out your domestic market?

Go international, baby.

Back in 2016, Twinkl was doing £5m total revenue, of which £0.7m was international.

In 2022, they did £55m in revenue, and £18.5m of that was international. Here’s the split:

Since 2016 they’ve grown international revenue at a significantly faster rate that UK revenue, meaning that International is now about one-third of their total revenue, up from about one-seventh back in 2016:

Now, Twinkl has around 1,000,000 separate teaching resources for over 200 countries, in 60 languages. Look at this curriculum list:

Do you spot any gaps? I sure don’t.

But how? How did they do this?

They borrowed Facebook’s playbook.

Back in 2004, Facebook was only available for Harvard students. They grabbed that market until they were ubiquitous on campus. Then expanded to other universities, one by one, then to other countries, then finally, to everyone.

Uber was exactly the same. Started in SF, built up their reputation and product offering, then ctrl +C ctrl +V’d the model into lots of other cities, one by one.

The reason that strategy works is because they’re network businesses. Facebook is useful if other people you know are on it. Uber is useful to riders if lots of drivers are using the platform, and useful to drivers if lots of riders need a cab.

Twinkl did the same thing, but focused on each age category. They started in one age range, and built up a great bank of resources targeted at that age range. Then they leveraged their reputation and cashflow to create resources for the next age range, and then for international markets.

The great thing is, you can see this for yourself. We can use the Internet Archive’s wayback machine to look at Twinkl’s homepage for every year, going back to 2010, to see how their offering and branding has changed over time.

Here’s a screenshot of their homepage from early 2011:

Notice they call out their focus on early years and key stage 1, which is ages 3-7. That’s where they started, because that’s where founder Susie’s expertise was.

Here’s a screenshot from 2012, by which time they’d added key stage two (8-11 year olds):

By 2016 they’re pushing heavily into international markets, particularly in the US. Here’s their US homepage showing resources from pre-K up to 8th grade:

By 2018, they’re showing a full range of resources for both primary and secondary schools in the UK, meaning they cover ages 3-16:

And by 2023, they’re covering 200 countries, 60 languages, and targeting not just every teacher in the world but, thanks to Covid, thousands of parents too. They also have a huge social media following — as an example, their instagram page has 124k followers:

Twinkl now has such an advantage that they’d be a nightmare to compete with.

Firstly, they have an army of around 650 education experts around the world, always creating fresh new resources, which keeps their members coming back for more.

Secondly, the size of that teams mean they can respond instantly to current events and new product demand. As an example, when Stephen Hawking passed away in 2018, Twinkl responded, and fast.

Just a few hours after the news broke, Twinkl released some resources for teachers to be able to explain the impact of Hawking’s work to their students. That same day, teachers all over the world were using those resources in the classroom.

Do you want to start competing with that, today? I don’t.

It’s a beautiful strategy, executed to perfection. Bravo, Jon and Susie Seaton. Bravo.

Do you want a piece? Too bad

If you’re one of the many private equity investors reading this — and I know there are a good number of you, I see your email addresses — then take a look in the mirror, and tell me if this is broadly what you see looking back at you:

You’re just begging to provide Jon and Susie with ‘growth capital’ and ‘a chance to diversify your risk.’

If so, I’ve got bad news for you.

You’re too late.

I know how you feel. I’d give my right arm to invest in Twinkl.

But alas, my right arm is not worth £150m, which is what Vitruvian Partners are rumoured to be investing, for around a 30% stake. That values the company at £500m, or around 21x earnings based on the 2022 net income number of £23.3m.

And it looks like the transaction closed on 21st February of this year, with the appointment of a new director, and Star Pupil Bidco Ltd becoming a person with significant control of Twinkl Ltd:

Now, bear with me as we walk through the corporate structure of a PE transaction:

Start Pupil Bidco Ltd is 100% owned by Star Pupil Topco Ltd. Star Pupil Topco Ltd is in turn owned at least 75% by Twinkl UK Holdings Ltd, and between 25 and 50% by Vip IV Nominees Ltd (a Vitruvian company). Lastly, Twinkl UK Holdings is 100% owned by Jon and Susie Seaton.

Not all of the updated shareholdings have been disclosed yet, but here’s my best guess:

And if all that is too much work, just look on Vitruvian’s website and you’ll see it right there:

So the transaction is done and dusted, and you’re too late to get your piece of the pie. Vitruvian have already grabbed their 25% of an absolute cash machine.

And Jon and Susie?

Jon and Susie are sitting pretty with about £150m, and that cash is probably sat in Twinkl UK Holdings.

Their nest egg of £150m is now ready to be deployed into all manner of other investments, property, trusts, or charitable causes. They’re probably also ploughing money into Twinkl Hive, their startup accelerator, in a desperate effort to figure out how to not get competed away by ChatGPT in the coming years.

And thanks to a sliding doors moment a decade ago, I’m here. Grafting away at this post, in the vague hope that you’ll like and share it with other P&L nerds like you and me. I do not have £150m, I have no startup accelerator, and no PE firms are returning my calls about investing in Net Income (yet).

But of course, as we mentioned earlier, comparison is the thief of joy.

*sobbing noises*

Carveouts

I got into a brief Twitter debate about someone making the outlandish claim that “AI just killed Microsoft Excel.” I lept to defend my beloved Excel on behalf of Microsoft, leading to Daryl’s wonderful zinger:

Well played sir.

Speak soon.

Andrew

Hello to the 1,173 people reading this, and a warm welcome to the 198 new subscribers since last week. If you go down to the woods today, you’re sure of a big surprise: a giant private equity deal in the making.

As a reminder, I’m Andrew Lynch, a small business CFO here in the UK. Net Income is a weekly breakdown of the interesting companies I come across. Imagine if one of the people off Dragons Den was actually young, likeable and with some charisma, but not as cool as Steven Bartlett.

One request: if you like this, please share it with a friend.

It’s hard to enjoy yourself when your eyeballs are being ripped out.

You know, that feeling when you’re being squeezed for every penny? There’s not much you can do to shake it.

You can try to relax. You tell yourself, “I’m on holiday, it’s not real money! You only live once, just enjoy yourself.”

But in your bones, you feel it. Every swipe of the card is another papercut on your soul. That’s just too expensive.

For my readers outside the UK, we sometimes refer to this as being “mugged off.” Taken for a ride. Swindled, blagged, robbed.

But if at the same time, your kids are safe, they’re being civil to each other, and the whole family is having the time of their lives on the water slide, is being mugged off a fair price to pay?

Today’s company would argue that yes, it is a price worth paying.

This is, of course, the story of Center Parcs.

Quick note: there’s a lot of data and images in today’s post. If you want those for yourself, I’ve made them available here:

• Get the Excel model

• Get the PowerPoint presentation

You’ll get the files emailed to you as soon as you’ve finished checking out.

The UK’s happiest place

Again, for my readers outside of the British Isles, let’s make sure we’re all on the same page. First, some headline figures to level set:

Center Parcs UK operates six leisure and hospitality sites around the UK and Ireland. These sites are all ensconced deep within wooded forests, with a ton of amenities on site like bars, restaurants, swimming pools, archery courses, mountain biking, paintball, and more.

They all kinda look like this:

All the guests stay in individual lodges, like this:

And every Center Parcs site has a huge swimming pool, like this:

They are fantastic places to go on a family getaway.

Center Parcs came to the UK in 1987, having already established itself in mainland Europe, which is why it’s spelled in the somewhat Francophile Center Parcs, and not Centre Parks. (I thought this is why we did Brexit?)

The first UK site was built in Sherwood Forest (yes, that one, from the Robin Hood legends). Since then, Center Parcs have opened four more across the UK, and another in Ireland. They now have over 4,000 lodges, serving approximately 2m customers per year.

Each site is huge — acres and acres of woodland — and because guests only arrive and depart two days per week (Mondays and Friday), the sites are also blissfully quiet and car-free. That makes them safe and pleasant to get around, either on foot or by bike.

Imagine: getting the whole family on their bikes, leisurely cycling down to the restaurant to enjoy a pint and some dinner, then heading off to a bar for a couple more scoops1 while your kids head off to the table tennis area to occupy themselves. Later, you all saunter back to your lodge, the kids go to bed, and you and your spouse enjoy a quiet glass of wine on the patio and listen to the sound of trees rustling in the cool summer breeze.

I’ve only stayed at Center Parcs once, with a group of friends. As someone who loves the outdoors, cycling, adventure sports, and a pint or two, it was glorious. A truly idyllic weekend.

And yet…

At this point in our story, I’m reminded of one of my favourite books and movies, The Big Short.

Ryan Gosling’s character, Jared Vennett, is pitching to Vinny Daniel, played by Jeremy Strong. Jared wants Vinny to buy some of his credit default swaps. It’s a wonderful deal, says Jared. You’ll make a killing. Vinny, ever the sceptic, can't understand why Jared is pitching him this deal if it’s so good. Why is Vinny the lucky one?

Vennett explains:

“Swaps are a dark market. I set the price, whatever price I want. So when you come for the payday, I’m gonna rip your eyes out. I’m gonna make a fortune. The good news is you’re not gonna care because you’re gonna make so much f**king money.”

Well, the pricing team at Center Parcs know what they have. The market for high-quality forest lodges is a dark market.

They know how much you’d love to take your family there. They know you can’t resist that feeling of biking down a quiet road, surrounded on all sides by 50ft trees. Not a care in the world. At one with nature. The feeling that this is what life is all about.

So if you want that feeling, they’re gonna rip your eyes out. They’re gonna make a fortune. And hope you don’t care because you’re gonna have such a good f**king time.

As an example, watch the price of a family-sized lodge miraculously double from one week to the next, thanks to school holidays.

Why so aggressive on the pricing? Well, firstly because they can. Their lodges are a cornered resource2, in limited supply, so they get to set the prices.

And secondly, because Center Parcs UK is owned by a huge private equity firm, Brookfield Property Partners, and they want to get paid.

Center Parcs has changed hands a few times, actually. Back in 2001, Center Parcs UK was split from Center Parcs Europe, then sold to Deutsche Bank, who took it through an IPO in 2003.

In 2006, the Blackstone Group bought Center Parcs UK, and took it private. They spent a bunch of money to upgrade it, then in 2015, sold it on to its current owners, Brookfield, for around £2.4bn.3 (source)

Brookfield in turn spent a bunch of money upgrading the sites and the systems and infrastructure of the business. Now, having owned it for seven years, Brookfield is  looking to sell again.

Depending on the timing of the sale, Brookfield are hoping to get as much as £5bn from the sale.

Will they get £5bn? Is Center Parcs worth £5bn? In fact, how much money does Center Parcs actually make? Let’s answer all of these questions and more.

Today, we’ll cover:

1. What the hell is private equity?

2. How much money does Center Parcs actually make?

3. Capital-intensive vs. capital-light businesses

4. How to value Center Parcs

Let’s get into it.

(Introduction completion fee: £4.99)

Wait, what actually is Private Equity?

Private equity, or PE, basically just means “buying and selling ownership interest in companies that aren’t listed on the stock market.”

Equity means the value of shares issued by a company. Amazon and your local corner shop are both companies, they both sell products to consumers, and they’re both ultimately owned by either one or multiple people.

The difference: if you want to buy 100 shares of Amazon (not investment advice, read the disclaimer) on the NASDAQ, any member of the public can log on to a computer and do so at a moment’s notice, assuming the market is open. Amazon is a public company, whose shares trade on the public market, which is the place where you can buy and sell public equities.

On the other hand, if you want to invest in your local corner shop, you can’t just do that online. You need to find the person or people who own it, get them around a table, and cut a deal. It’s a private company, which you buy or sell on the private market -- which basically just means ‘everything that isn’t the public market.’

So, simply put, private equity (PE) is buying and selling shares in private companies. Ideally, in an effort to make money.

Still with me?

How do PE firms actually do that? With a combination of money raised from investors (equity) and money borrowed from banks (debt).

The issue is that investors want their money back at some point, so most PE funds will have a life of around 7-10 years. The investors give the PE fund money in 2014, and the PE fund promises to give it back to them by 2024, hopefully with a good return on top.

That’s why these headlines are almost exactly seven years apart.

Brookfield must be coming to the end of its fund term, and needs to sell Center Parcs to be able to return capital to its investors. It’s no more complex than that. Such is the life of a PE fund4.

How much money does Center Parcs actually make?

In its last full financial year, 2021-22 year, Center Parcs did:

• Revenue of £503.4m

• EBITDA of £245.6m

That’s despite occupancy only being around 80.5%, still well below their pre-Covid levels of 97-98%. Center Parcs also track a couple of hospitality specific metrics:

• ADR is Average Daily Rate, e.g. the total accommodation revenue, divided by number of lodge nights sold.

• RevPAL is Revenue Per Available Lodge Night. In most hotel businesses you’d call this RevPAR because most hotels sell rooms, not lodges, but Center Parcs is special like that.

Center Parcs has only released three quarters worth of results for the 22-23 financial year, but they look damn good. I’ve estimated the full-year results here, and compared to prior years. Their financial year runs from May to April, meaning the 18/19 year is the last full year with no Covid impact.

Looks like they’ll do over £600m in revenue this year, which is a big improvement on pre-Covid.

Lastly, let’s zoom out a few more years and look at how this company has performed over the period Brookfield has owned it.

Revenue is growing at a steady clip, and recovered incredibly quickly post-Covid.

EBITDA is looking damn fine too.

And finally, occupancy is back up to — and even above — pre-Covid levels, hence why 2023 revenue is around 20% better than the prior year.

The obvious thing to point out is that Covid was brutal for Center Parcs, and the impacts lingered for a long while. Now they’re clear and on the other side of it, they’re firing on all cylinders again.

Here’s a look at the P&L in a little more detail. I’m keeping it to 2018-2022 to show the last full year results with no Covid impact.

Those margins are fantastic. 71-75% gross margins, and 48% EBITDA margins. Wonderful.

Digging into the numbers:

• About 60% of revenue is accommodation revenue (the cost to actually book the lodge)

• 40% of revenue is on-site spend

Put another way, if you’re the mug who spent £4,299 on a family lodge for the week, Center Parcs reasonably expect you to spend another £2,900 on site when you’re there. Beers, meals out, paintballing, bike hire: it all adds up, quickly.

The on-site spend is also high-margin because the prices in their restaurants and bars are expensive, particularly compared to the quality of the food. £18 for a burger. £6 for a pint of lager. £28 for a mediocre steak. 

Of course their gross margins are high. Anyone can make 75% gross margins if they sell Wetherspoons food at Hawksmoor prices.

Translation for the North American readers: Anyone can make 75% gross margins if they sell Olive Garden food at Ruth’s Chris prices.

But still, you’re not there for the food, you’re there for the experience. You grit your teeth and get on with it.

So that leaves Center Parcs with nearly 50% EBITDA margins. Not bad, eh?

But obviously there’s more to the story.

EBITDA is Earnings Before Interest, Taxation, Depreciation, and Amortisation.5

So it’s not a great measure of profit for Center Parcs, because they have a LOT of ITDA.

Here’s the rest of the P&L:

Excluding 2021, their average EBITDA margin is 47.5%.

But their average net margin is just 8.4%. Even in 2019, fully pre-Covid, the net margin was only 13.1%.

Using 2019 as an example, £232.6m of EBITDA only turns into £62.8m of net income. The rest disappears into the ITDA ether.

Two things are crucial here:

1. Center Parcs is an incredibly capital-intensive business, which means a lot of depreciation; and

2. Because Center Parcs is owned by PE, the company is also carrying a ton of debt.

First, let’s look at that capital intensity.

Capital intensity

By capital-intensive, we just mean: how effectively does the business turn what it owns into revenue?

We can quantify that using the asset turnover ratio, which is:

Asset turnover ratio = Revenue / average assets

We’ve looked at a couple of businesses recently, Baringa and Petex, which are relatively capital-light. Here’s how they compare to Center Parcs:

Baringa is a very capital-light business: they’re mostly selling people. For every pound they have in assets, they generate £1.46 in revenue per year.

Petex, a SaaS company, is slightly more capital-intense: for every £1 of assets, they generate £0.96 per year of revenue.

Way, way down the pecking order is Center Parcs, who generate just £0.26 per year of revenue for every £1 of assets. They have £1.9bn of assets, and nearly £1.5bn of that is fixed assets:

That represents all the land, lodges, bars, restaurants, car parks, computer systems and more that it takes to run such a big business.

Not only that, but the land, lodges, swimming pools, bars etc. all constantly need repairing, replacing and upgrading. Over the last ten years, Center Parcs has spent £542.9m on capex. Even just since Brookfield took over, they’ve spent £468m.

In their investor updates, Center Parcs split that into investment capital and maintenance capital. The former is focused on improving the business; the latter is what Center Parcs needs to spend just to stay still.

According to this half-year update, that just-to-stand-still number is £16m in the first half of the year alone.

That’s a big number. They’re spending millions on water slides. Literally, this is next in the presentation:

Now, this capital intensity isn’t necessarily a bad thing. It takes a ton of capital to maintain and grow the business — but that also keeps competition out.

This is the idea of capital as a moat.

Do you want to go and spend several years and a few billion quid buying a forest, building water slides, and then hoping people show up?

And even if you did want to do that, could you convince enough people to give you the money? How would that investor meeting go?

It’s not exactly the most compelling pitch.

That makes Center Parcs an incredibly defensible brand. They have a cornered resource that would take billions to replicate, which is why they have such strong pricing power — and take full advantage of it.

That debt though

So there’s a lot of capex, and with it, a lot of depreciation. What about the interest?

Well, Center Parcs has been carrying debt of anywhere from £1.8bn to over £2bn for the last few years, paying around £100m per year just in interest costs, at rates of 5-6%.

That seems like an awful lot. At £500m of revenue, that means around 20% of revenue goes straight towards servicing that debt.

But, crucially, Center Parcs has the cashflow to cover it. Remember, they’re making 75% gross margins: because the accommodation has almost no cost of sales attached to it, outside of cleaning and maintaining the lodges. They own these assets outright — they just borrowed a bunch of money to buy them.

So in fact, this interest is essentially the COGS for the accommodation business.

It’s no different to taking out a mortgage, buying a single family home, and renting it out. It’s just on a bigger scale, with added whirlpools.

So we could restate the P&L like this, with a new measure we’ll call EBDAT:

Which means that even with this debt servicing, Center Parcs produces a decent amount of EBDAT that they can invest in maintaining and upgrading their sites.

Given the asset-heavy nature of this business, the cashflow statement is where we see all this action in detail. Let’s take a look.

This is for FY 2022. As it turns out, the EBITDA of £245.6m is a good proxy for the cash generated from operations, which was £276.6m.

Center Parcs took that £276m of cash, re-invested £46m back into business in capex, and paid £100m of debt service.

There’s also a big movement of £70m in there, which is repaying a working capital loan to Brookfield, which they presumably needed during Covid.

So on a normalised basis, Center Parcs generates around £130m per year in free cash flow.

That means EBITDA of £245.6m isn’t a good measure of profitability. Neither is the net profit of £66.2m. The real number is somewhere in between those two, and it takes some digging to get to a reasonable answer.

So how much is Center Parcs worth? That’s where we’ll make our final stop today.

Is Center Parcs worth £5bn?

At very rough numbers, if Brookfield bought Center Parcs for £2.4bn, and have averaged a debt load of around £1.9bn over the last five years, that implies they brought around £500m of their own money to the party. These numbers won’t be perfectly correct, but they’ll be close enough.

And in fact these numbers match what was reported in the Financial Times. Brookfield acquired Center Parcs for £2.4bn in 2015, and the sale is expected to include assumption of the existing debt of around £2bn.

Importantly, the FT claims the independent valuation of the five UK sites was around £4.1bn, based on the real estate alone.

That’s £4.1bn to buy yourself some wonderful forest land, lodges, swimming pools, bars, and restaurants. Like Richie Rich, this could be yours and yours alone:

There is, of course, also an operating business on top, generating anywhere from £20-60m in net income per year, depending on occupancy.

Given that occupancy is back up at the 98% level, it seems fair to use the pre-Covid years as a good barometer of net income going forward. Admittedly I’m cherry-picking the best years here, but let’s see where we land.

The operating business alone could be worth around £700m.

I’ve been generous and stuck a 12x multiple on earnings because it’s such a durable brand, with low competition, and big pricing power, so that feels fair to me.

You’ll want to buy both the property and the operating business, I assume? You can’t really have one without the other.6

Given the £4.1bn valuation of the property, and around £700m for the operating business, we can quickly come to an all-in valuation of around £4.8bn.

Which is bang in line with the price Brookfield are hoping to get.

The final question is: given the need for so much debt to be involved, what happens as interest rates increase?

Remember, right now Center Parcs has just under £2bn in debt, and is spending around £105m a year in interest cost, which implies an interest rate of around 5.4%.

Importantly, that debt is at a 3.6% premium to the UK base rate.

And, crucially:

• an acquirer will need to borrow another £2bn

• UK base rates are now 4.5%, and still likely to climb.

Let’s say the buyer agrees on my £4.8bn valuation. They’re also bringing 20% equity to the table.

That means the buyer will need to find an additional £1.9bn from somewhere — and take out new debt, at significantly higher interest rates.

So at an acquisition price of £4.8bn, the buyer will need to come up with an extra £155.1m per year, just to service the debt.

And looking at the 2022 cashflow, it’s not there.

There’s no margin for error here, and I certainly wouldn’t lend someone £1.9bn to get after it, unless I had some mega-covenants in there.

Which means that for a £4.8bn acquisition to make economic sense, the buyer has to do one, several, or all of the following:

• find cheaper debt

• bring more equity to the table

• increase operating cash flow

• decrease capex reinvestment

This does not bode well for the price of a 4 bedroom lodge exclusive lodge.

That said, the cashflow figures above are based on 2022 results, and the performance in 2023 so far looks significantly stronger. It’s possible that going forward, this deal still works.

Right now, an army of analysts around the world are doing exactly what I’m doing, and building their own forecast model to figure out how to make this deal pencil. They’re likely figuring out where the cheap debt is, how much they can increase room rates, and calculating the price elasticity of a leathery rump steak.

So is Center Parcs worth £5bn?

No idea. I guess we’ll find out if and when a deal closes.

Sorry. Not the most satisfying answer, is it? Life’s like that sometimes.

Carveouts

I have barely anything to recommend this week, because writing this post has consumed so many free hours. I am re-reading Will Thorndike’s fantastic book The Outsiders, a study on several unconventional CEOs, and the capital allocation decisions they made. If you like this sort of post, you’ll love the book.

Speak soon.

Andrew

Hello to the 975 people reading this, and a warm welcome to the 702 new subscribers since last week. From the poop business last week, to the people business this week — here’s your satisfying serving of business breakdowns.

As a reminder, I’m Andrew Lynch, a small business CFO here in the UK. Net Income is a weekly breakdown of the interesting companies I come across. I’m like Sam Parr’s poorer, not-as-good-looking British cousin.

One request: if you like this, please share it with a friend.

I think Paul Graham is wrong.

I know, I know, that’s heresy.

The Y Combinator founder is venerated, idolised, worshipped by the Silicon Valley tech crowd. People hang on his every word, and his essays are stuff of legend.

But Paul also says stupid things.

In this instance, I’m thinking of his essay Do Things That Don’t Scale, in which Paul blithely states:

Consulting is the canonical example of work that doesn't scale.

Well, tell that to this consulting firm based in London:

This is Baringa Partners LLP.

Since Baringa’s inception in early 2002, they’ve grown revenue at an average rate of 30% per year — for twenty straight years. According to the founder, Mohamed Mansour, in those twenty years they’ve had just one unprofitable month.

What should I do, Paul Graham? Go and tell them that consulting doesn’t scale?

Their growth story demonstrates some great themes: spin-offs, incubating new business lines, and the idea of selling your sawdust.

Let’s get into it.

Quick note: there’s a lot of data and images in today’s post. If you want those for yourself, including the full P&L data going back to Baringa’s inception in 2002, I’ve made them available here:

• Get the Excel model

• Get the PowerPoint presentation

You’ll get the files emailed to you as soon as you’ve finished checking out.

Wait, what is consulting?

It’s easy to make fun of management consulting. If you google “consulting jokes,” you’ll find a ton. A consultant is someone who steals your watch and tells you the time. That sort of thing. Management consulting is seen as such a rich vein of humour that HBO went as far as making a TV show about the whole thing:

Spoilers: it was not very good.

Fundamentally, management consultants are people you hire to help your business solve a problem. That could be adapting to changing regulation, implementing a new IT system, or expanding internationally. You, the business leader, can’t solve those problems alone, so you hire consultants to help you.

Why not just hire full-time people instead? Three main reasons:

1. You genuinely need expert, outside resource: people who have done what you need to do, for other companies just like yours, in your industry. People who are so good, they don’t want a full-time role with you.

2. You need high-level temp resource. Not those minimum-wage temps that can only file and fetch coffee. Actual, hard-working, Excel wizard, know-some-stuff, Harvard MBA-kinda temps. You need them for 6 months for a fixed term project, then you can cut them loose when you’re done.

3. You need career insurance. Your company needs to make a big strategic change — but if you do it, and it fails, you’re fired. So you hire consultants, they write a nice report that details their recommendations (which coincidentally line up perfectly with what you already think), and you give that report to your boss. Then, if you execute that strategy and it fails: hey, it’s not your fault, we just followed the consultant’s recommendation.1

(I know, so cynical.)

At its heart, consulting is a people business. Really it’s the same labour arbitrage that temp agencies do every day. Hire someone on one rate, bill them out at a higher rate, pocket the difference. Your people are the product — and it’s on you to keep them busy and earning revenue.

How do you do that? Again, it’s a people business: the selling process is up close and personal. You need to find and meet potential clients, and get them to like you, and trust that you and your team can solve their problem.

The good news is that if you get it right, it’s incredibly profitable. Here’s Baringa’s P&L for 2021 and 2022:

70% gross margins, and £185m in profit on just £268m of revenue.

In 2022, Baringa had an average of 1,089 employees. For now, I’m excluding that suspiciously vague other operating income of £74.4m — more on that later — but here’s how the simple labour arbitrage breaks down on a per-employee basis:

Not bad at all. Even taking into account employees that don’t earn revenue (like Finance, HR, and IT) Baringa makes £246k of revenue per employee, and spends only £144k, including salary, bonus, travel, and all other overheads. The highly profitable, cash-generating labour arbitrate consulting model is alive and well.

Here’s a simplified view of their five-year P&L. I’ve split out the other operating income to show the vanilla consulting model:

Like clockwork, this consulting business generates around 40% operating margins, every year. Profit per employee is steady, between £85k and £109k per year.

This drives home just how much of a people business this is. Want to grow? Hire more people, and bill them out. It’s that simple.

Check out the revenue per partner too. It’s flat year over year, even as the company more than doubled revenue. Whatever the size, they’re at almost exactly £2m per partner, per year.

That reveals Baringa’s growth strategy:

1. Hire a partner with their own expertise, reputation and great industry relationships.

2. Give them a £2m revenue target and a team of 6-7 consultants to deliver the work.

3. ????

4. Profit

Note: the ???? in the growth strategy reflects the fact that I’ve never worked in management consulting, and I have no idea what actually goes on in the delivery phase.

If you work in consulting, yes, I think it’s a real job, and yes, your parents are proud of you. I know you could have been a doctor, but hey, those PowerPoint slides won’t design themselves, will they?

Looking at the P&L in more detail, two things stand out. Firstly, the margins are extraordinarily high. Secondly, why does Baringa pay almost no tax?

Because this company isn’t a normal company. It’s a partnership.

The partnership model

Baringa Partners is an LLP, a Limited Liability Partnership. LLPs are different to limited companies (or LLCs). They don’t have shareholders or directors. They have partners.

LLPs are common in professional services firms like mangement consultants, and lawyers, precisely because these are people businesses.

An LLP structure means that if you find a great person who can bring in tons of revenue to your company, you just make them a partner. You don’t have to issue equity, or give them share options, or mess around with your cap table. A simple partner vote, and they’re in.

And if someone isn’t pulling their weight, a simple partner vote, and they’re out.

As an aside, this is why “making partner” in a law firm or consulting firm is such a big deal. It’s not just a promotion, a pay rise, or a fancy title. It’s a piece of the action.

How big a piece? Well, in 2022 Baringa had 114 partners, sharing profit of £185m. That’s an average of £1.6m per partner. Even excluding the one-off profit bump of £74m, it’s £974k per partner.

There are two other quirks of the LLP structure to be aware of:

1. That partner remuneration of £1.6m each does not show up on the P&L. The P&L excludes all partner comp, because whatever is left over after paying all the other costs — employees, expenses, office leases — gets split between the partners, according to their partnership agreement. That’s why the margins look so fat: the partners are earning revenue as well, but their costs aren’t included.

2. Baringa Partners LLP, as an entity, doesn’t pay much tax, because a partnership structure is designed to pass all the profits to the partners. Rather than a limited company which pays tax on its profits, then distributes the remainder to shareholders, a partnership passes all the profit to the individual partners, who then personally pay the tax on their share of the profits.

Here’s a visual representation:

Let’s look at the 2022 figures. On average, each partner brought in £2.3m of revenue with a team of around 7 consultants and 1.6 admin staff.

Breaking that down, here’s how the numbers look:

The £2.3m revenue covers £1m of consulting costs, and £231k of overheads, leaving around £1.1m profit per partner, which they take home as their personal income. That’s an average — the (confidential) partnership agreement will detail the exact split between the partners — but it’s good enough for our purposes.

You see? This isn’t one business: it’s a federation. A franchise model. Each partner is running their own small business, under the Baringa brand.

That’s how partnerships work. You live and die by your ability to bring in revenue. To make it rain.

This federated model could lead to conflicts though — every one of your 114 partners has a stake in the brand name of the company. That could be hard to manage — but among those partners, there is a “first among equals,” known as the Managing Partner.

This brings us on to the origin story of Baringa, and the wonderful world of spinoff companies.

Don’t start a consulting business from scratch

Baringa was actually started back in 2000, as the European arm of a US consulting company called The Structure Group, or TSG.

TSG was based in Houston, Texas, and its main area of expertise was the oil and gas industry. Seeing many of its clients expand into Europe, TSG wanted to do the same, so tapped up three smart guys to go establish TSG Europe over in London.

Those three guys were Andrew Chittenden, Jim Hayward, and the original Baringa Managing Partner, Mohamed Mansour.2

After Enron collapsed in late 2001, many of TSG’s energy clients retreated from Europe back to the US, leaving Andrew, Jim and Mohamed with a choice: follow the clients back across the Atlantic, or forge onwards and build a business in Europe.

Like Shackleton, they chose to forge ahead.

But — here’s the crucial point — at this point they’d already been consulting in London for 3 years under a different brand.

They’d used the TSG name to build their relationships and reputation, and then when the opportunity presented itself, they span off into a separate business, with TSG keeping a stake.

Sidebar: this is similar to how TSG itself started. The founding partners were all at Accenture (then Andersen Consulting), and all their clients were in the energy industry. Those guys built up their network and reputation at Accenture, then when they felt ready, went out on their own, targeting those same clients. They did so successfully until 2015, when they were acquired by — you guessed it — Accenture.

So in 2002, Baringa was essentially a spinoff of a spinoff. Andrew, Jim and Mohamed set up at first to specifically focus on the energy industry, as that’s where their specific expertise, reputation and network was.

To highlight just how crucial the right people are to making it in the consulting business, Mansour candidly admits in an interview, referring to his other founding partners:

“No two of us could have done it without the third.”

This alchemical mix of talent led to rapid early growth. Here’s how revenue grew under the leadership of Mansour (pictured below) in the early days:

By 2007, the company had 11 partners, and another 38 staff, and was growing nicely.

But Baringa was still only serving clients in the energy industry. They wanted to diversify and add a new, lucrative practice area: financial services. So what did they do?

Well, this being a people business, driven by expertise, relationships and reputation, they went out and hired a partner to lead that new practice area.

Enter Adrian Bettridge.

Adrian was a veteran of — yes — Accenture, where he’d made partner at a young age. But Adrian had an entrepreneurial bent, and wasn’t happy with the status quo at such a large company. In Adrian’s words3, after making partner at Accenture:

“I felt like I’d made it to the top of the tree and I was in the wrong jungle.”

Climbing down that tree and scanning for an alternative arboreal climbing challenge, Bettridge met Mansour. They clicked immediately. Here’s an artist’s rendition of that first meeting:

Adrian joined Baringa in 2007, bringing with him a career’s worth of expertise, relationships and reputation in the financial services industry.

Starting to see the pattern here?

With Mansour heading up their energy practice, and Bettridge (pictured below) leading FS, Baringa took off. Even the Great Financial Crisis in 2008-09 did nothing to slow their growth.

Mansour retired in 2015, at which point Bettridge took over as Managing Partner.

Baringa have since added practices in Telecoms and Media (2014), Consumer products and retail (2016), Pharma and Life Sciences (2019) and Government Advisory (2019). They’ve also opened offices in the US, the UAE, Australia, Singapore, and mainland Europe.

Each time, they’ve followed the same playbook: find who has built their expertise, relationships and reputation at another firm, and wants to do something entrepreneurial — and poach them.

That new partner comes in, using their existing reputation to generate more revenue, and hires a team to deliver that work.

The result: every new practice lead and partner essentially incubates then operates their own business, using the Baringa brand, resources and infrastructure as a platform.

As long as Baringa can stick to around £2m revenue per partner, and each partner can use 6-7 consultants to deliver that work, they can keep scaling.

That’s what Paul Graham forgot to say — and what everyone’s favourite angel investor turned philospher Naval Ravikant pointed out.

Leverage can come from people as much as it can from capital, code and media.

What Paul Graham should have said is “Consulting is the canonical example of work that doesn't scale unless you can hire more people.”

It’s the classic tradeoff. Paul Graham’s world, software, is hard to start and turn profitable, but does have the potential to scale massively. In that industry, WhatsApp is the canonical example: at the time they were acquired by Meta for $19bn, they had just 55 employees. That’s leverage from code.

On the flipside, Baringa has leverage from people. In their history they’ve never had a loss-making year, and the company needs almost no extra capital to expand.

As a result, Baringa throws off gobs of cash every year. Almost all the profit it makes turns into cash that can be distributed to its partners:

Entrepreneur and investor Andrew Wilkinson, the founder of Tiny, summed up this dilemma between scalabilty and cash flow nicely:

“Every consulting company owner I know wants to own a SaaS software company. Every SaaS software company owner I know wants to own a consulting business. The grass is always greener.”

But Andrew:

Can you have the cashflow of a services company with the scalability of software?

Sometimes, yes.

Let’s look at the last piece of the puzzle.

The curious case of £74m other operating income

For the final lesson from Baringa’s growth story, let’s go back to their 2022 P&L.

One of these numbers does not belong.

Other operating income is so vague, and the number is so big. What on earth could they have done to generate an extra £74.4m in one year?

Note 5 is where we’ll find the juicy details.

Oh dang! Internally developed software. I thought this was a consulting company?

For an upfront payment of $35M, plus future payments of around $69M, Baringa sold a piece of software they’d built themselves.

What was this software? After a bit of googling, we find out:

Here’s the press release for more info.

Baringa spent years consulting to the energy industry. Over that time they built an advanced, complex model to help clients examine the impact of different climate change scenarios:

Baringa developed its market-leading climate scenario modelling capabilities on 20 years of experience. Baringa’s solutions support net zero commitments, TCFD reporting, regulatory reporting, investment and capital allocation strategies, as well as developing climate risk management capabilities. As the leading solution in the financial services sector, Baringa’s Climate Change Scenario Model is informing clients with assets totalling more than $15 trillion.

Baringa built their climate change model to help them better serve clients. Over time, that model became a significant asset in itself — so much so they could sell it, to the tune of $100m.

A consulting firm, and a software firm. Beautiful.

The founders of software company Basecamp, Jason Fried and David Heinemeier Hansson, describe this in their book ReWork as selling your sawdust.

To sell your sawdust is to examine the by-products of your work, and see if they have commercial value on their own.

For lumber industry, that’s the sawdust they generate while cutting wood, which goes into synthetic logs. For Fried and Hansson, it’s the principles on building and operating software companies that they’ve codified, and packaging that into a book. For me, it could be the spreadsheets, PowerPoints and memes that have lovingly been crafted in service of this article.

And for Baringa, it’s a climate change model they built during years of consulting — that they sold for $100M.

Not just a consulting firm after all.

Key takeaways

Let’s wrap up, because I actually also have a day job I need to get back to.

Baringa is a phenomenal example of scaling in a difficult-to-scale business. Paul Graham’s not totally wrong. Consulting is difficult to scale unless you can keep finding and hiring great people.

Baringa are also an amazing example of just how lucrative and cash-generating the consulting business can be — especially if you’re building assets along the way.

The key takeaways from the Baringa growth story:

• Pick your poison. Software is hard to start because it’s high fixed cost, and it can take you a long time to get cashflow positive. Consulting is cashflow positive almost from day one — but scaling is more difficult. Any business model will have challenges. Just pick one and get going.

• To grow a people business, hire people who will bring revenue with them. People who have been there, done that, and have the network and reputation to prove it — and give them a more entrepreneurial opportunity.

• Sell your sawdust. Look for the by-products you’re creating while doing the work. They might be more valuable than you think.

If you do those for 20 years, maybe one day I’ll write an article about you too.

Carveouts

• I’ve been re-reading Steven Pressfield’s book Turning Pro. If you’re trying to do anything creative or entrepreneurial, I highly recommend it. It’s a wonderful and honest look at the differences between amateurs and professionals. For a taster, check out this article on Pressfield’s idea of “shadow careers.”

• Ted Lasso season 3: we’re about halfway through so far. Much better than season 2, and possibly as good as season 1. Aside from Parks and Recreation I don’t remember a show ever being as feel-good as this.

So long until next week!

Andrew

Hello to the 273 people reading this, in particular to the 124 new subscribers since last week. Not every post is about a multi-million pound SaaS company — we’ve got something very, very different in store today.

As a reminder, I’m Andrew Lynch, a small business CFO here in the UK, and Net Income is a breakdown of the interesting companies I come across. If you like this, please share it with a friend.

There’s a certain democracy to pooping.

No matter who you are — you, me, the King of England, the President of the United States, and the person who does the President’s dry cleaning — at some point in the last day or two, we’ve all had to sit down and perform this most basic of bodily functions.

(If you haven’t, please see a doctor urgently, or at the very least, eat more fibre.)

And when people have been doing something for thousands of years — eating out, building homes, swimming, watching plays, and yes, pooping — there’s probably a profitable business in that niche.

That brings us to Gary Mead, the poop millionaire of Chelmsford, Essex.

Gary’s story begins in the late 90s. At the tender age of 22, he started a small property management company in his home town of Chelmsford, Essex, about 30 miles northeast of London. According to his LinkedIn profile, he grew it every year for five years in a row, achieved profitability, and sold it. A successful exit by the age of 27 — not bad at all.

Possibly just to prove it wasn’t luck, Gary then started a small property management company in his home town of Chelmsford, Essex. He grew it every year for three years in a row, achieved profitability, and sold it. Again.

If you take nothing else from this article, learn this: if Gary Mead ever sells you a property management company, make sure you include a non-compete clause.

As a result, at just 30 years old, Gary had two successful exits under his belt. Likely holding some capital and a well-earned degree from the University of Hard Knocks, Gary scouted around for the next chapter in his career.

What next for this intrepid entrepreneur? Go for the property management three-peat? Start a petroleum-focused software business?

Not for young Gary. No, Gary saw his future paved with brown gold.

The portaloo business

Let’s make sure we’re all on the same page first.

This is a portaloo.

You might know them as porta-potties, chemical toilets, builders’ loos, mobile toilets, or “blue lavs.” Yes, I made that last one up.

You’ll come across these at construction sites, festivals, weddings and the like. Basically, anywhere there's a large group of people and nowhere to do your business. You can get fancy ones with hand dryers and sinks, or more basic units like the ones in the picture.

In 2003, Gary Mead founded Euroloo. Euroloo rents portaloos to you, for a fee, including drop-off, pick-up, and weekly servicing.

This is what Mike Rowe would call a Dirty Job. When these portaloos are dropped off on site on day one, they’re clean. When they’re picked up again on day seven, they are not. Someone has to make them clean again before renting them to the next customer.

That’s both a blessing and a curse. It’s a curse because, you know, you have to clean up poop. For more detail on this subject, check out this article from the wonderfully named company Poles and Holes:

“A good pair of gloves and a spray bottle full of cleaner is all it really takes to keep a portaloo looking like new!”

— Poles and Holes (2023), “How do you clean a portable toilet?”

It’s a blessing because grads from Harvard Business School and the LSE don’t want to go into this business. It’s not glamorous, it’s not sexy, and you probably don’t get admiring looks when you talk about it at the dinner table.

That’s great, because you don’t want to be competing against HBS and LSE grads. You want to compete, as Nick Huber says, with the type of person making a lot of money and using a fax machine. You are more likely to find those people in an industry like portaloos. And with some smart use of technology, you can out-compete them.

SEO works with poop too

Euroloo are doing a couple of things you don’t usually see from companies in industries like this.

Firstly, they’re putting time and money into paid search. If you google “portaloo hire [city]” you’ll see them come up. I did this for my city, Nottingham, and Euroloo are #2 in the sponsored search results:

and they’re also #2 in the organic search results:

If I click through on mobile, I’m taken to this landing page, which makes them look like a Nottingham-based company, and they include a phone number with a local area code too.

But wait! If I google “portaloo hire Manchester,” they’re the #2 sponsored result again. If I click through, I’m taken to a different landing page, with a different local phone number, which makes them look like a Manchester business:

They also have a very easy quote process that you can fill out in seconds, which then passes all your details to a sales rep to get back to you.

This is good SEO and paid acquisition. A solid marketing and sales funnel. Not something you usually associate with a business or an industry like this.

Is there money in the portaloo business?

Short answer: yes.

Long answer: yes, definitely, and we can do some analysis to figure out how much.

As usual, I dove into Euroloo’s financial statements. The first thing we should highlight is that these are audit exempt accounts. The UK government doesn’t require you to get a full audit of your financials if you meet two of the following three criteria:

• an annual turnover of no more than £10.2 million

• assets worth no more than £5.1 million

• 50 or fewer employees on average

Let’s take a look at the balance sheet.

Total assets of £4.7m, which is under the threshold. Later in the financials, they also disclose the average number of employees as 93:

That’s over the threshold. We can therefore deduce that their revenue must be less than £10.2m — otherwise they would have had to undergo an audit and submit a full P&L.

Fear not. Even without a P&L, we can figure out a lot about this business. Let’s do some maths.

How to back into a P&L

We start with the balance sheet. Let’s take another look.

The key figure here is the retained earnings. That’s the total cumulative profit the company has made throughout its existence, less any dividends paid out in that time.

In Euroloo’s case, retained earnings went from £3.1m to £4m in the latest financial year. That means that after tax AND after any dividends paid to owners, Euroloo made £900k profit.

The UK corporate tax rate is 19%, so £871k is the after-tax profit, meaning the pre-tax profit must be £1.075m. Remember, we also know their revenue is less than £10.2m, so these are decent margins.

They also disclose a total depreciation charge for the year of £410k. If we make a reasonable guess around their people costs of an average of £50k per year per person, we can come up with a range for their revenue and margins:

Revenue is somewhere between £6.1m and £10.2m, with margins between 10.5% and 17.5%.

Lastly we can estimate their revenue based on the accounts receivable. Euroloo are selling to trade customers, probably on credit terms, so those construction crews and event management teams are paying for their portaloos after they’ve used them.

On 31st March 2022 they had £422.8k outstanding from customers. That does include 20% VAT that they can’t count as revenue, so if we strip that out, then assume 14 days credit terms, we come up with a revenue estimate:

Somewhere in the £9.2m range, which lines up with what we know before.

Lastly, just for fun, I got a quote from Euroloo. It’s £32.50 for a single portable toilet per week, plus the same in delivery and collection fees:

The small print says the minimum period is 4 weeks, for a total of £195 plus VAT. Including delivery and collection, that works out as £48.75 per week.

If their revenue is around £9.2m and each toilet rents for an average of £48.75 per week, we come up with a total of 188,438 toilet hire weeks per year:

Let’s guess that each toilet is in use 90% of the time to account for time spent picking up, cleaning, and delivering.

Then with one extra bit of info from their accounts — that they’ve spent £3.2m on plant and machinery (presumably toilets), we can see our £9.2m guess on revenue is about right if each toilet costs £795.88.

And according to ToiletsForSale.co.uk we’re in the right ballpark:

Lastly, this tells us that the real business here isn’t buying expensive assets and renting them out. Portaloos aren’t that expensive. If you buy every toilet brand new for £905, and the average weekly rental is £48.75, then the toilet pays for itself in less than 5 months.

No — as my friend and incredible entrepreneur points out, this is a logistics and distribution business. The trick here is making sure that your 4,000 portaloos are on site, earning income, as much as possible.

So what’s their secret?

The secret sauce

Given everything we know so far, our best guess is that my man Gary Mead has a business with around £9m in revenue, a fleet of around 4,000 portaloos, netting him at least £900k a year, while employing 93 people in the process.

What I love is how Gary describes the secret sauce. The engine of growth. It’s word of mouth and repeat business.

How do they drive that word of mouth? What ensures their incredible reputation?

Gary’s LinkedIn page reveals all:

Did you get that? Their secret is:

• being easy to work with
• doing what they say
• being friendly and customer-focused
• being trained and good at the job

These principles are not rocket science.

Euroloo is a phenomenal example of, as Charlie Munger says, “taking a simple idea, and taking it seriously.”

The Euroloo playbook is:

1. Pick an unglamorous industry.

2. Focus on operational and customer excellence.

3. Layer in some technology.

4. Keep at it for 20 years.

That’s what Gary Mead has been doing since 2003. Over that time he's built an incredible business worth millions that provides a great living for him, his family, and his team. I love to see it.

Anyone could do this. It’s not easy, but it is simple.

Carve outs

• In today’s episode of My First Million, Sam and Shaan talk about Petex, the company I covered last week. As you’d expect, Sam and Shaan have some great insights that I didn’t hit on. Recommend a listen if you want more.

• I’m currently reading Fire Weather: A True Story from a Hotter World by John Vaillant. It’s the story about a tremendous wildfire in Alberta, Canada, which is Canadian oil country — it’s really the story about how what goes around, comes around. Our reliance on fossil fuels, leading to climate change, leading to extreme weather events which devastate a town that benefited from our reliance on fossil fuels. John’s an incredible writer — if you haven’t read his book The Tiger, I highly recommend that too. It’s one of my top five non-fiction books.

• Succession finale 👏👏👏 Loved it. No spoilers here, but my god, what a show. I’m legitimately sad it’s over, and I’m already writing a spec script for a show about the Logan Roy origins story.

Speak soon,

Andrew

Hello to my wonderful 149 friends reading this, in particular to the 69 (lol) new subscribers since last week. If we keep doubling every week, I estimate that everyone on Earth will have signed up in the next 6 months, which I’d consider a success.

As a reminder, I’m Andrew Lynch, a small business CFO here in the UK, and Net Income is a breakdown of the interesting companies I come across. If you like this, please share it. If you don’t like this, feel free to close your browser, go outside, and touch some grass.

There are lots of things I associate with Scotland. Robert Burns. Haggis, neeps and tatties. Clamouring for independence. Deep-fried Mars bars. The two famous Williams: William Wallace of Braveheart fame, and Willie the groundskeeper of Springfield Elementary School.

What also comes to mind is a key economic driver for Scotland: North Sea oil.

Aberdeen, up in the north east of Scotland, is the European capital of oil. It’s the UK’s answer to Houston — a town heavily reliant on the energy industry for its economic output (at least until Brewdog came along).

Wikipedia estimates that between 1960 and 2014, approximately 42bn barrels of oil were extracted out of the North Sea, all off the coast of Scotland, across all of these different exploration sites:

That’s a lot of money sloshing around.

The wonderful thing about capitalism is that any time an industry springs up, like drilling for oil, ancillary and supporting industries sprout up as well, ready to serve that market and capture some black gold for themselves.

Which brings us to 2nd August, 1990, when Abdelhamid Guedroudj founded Petroleum Experts Ltd.

The original articles of assocation are still on Companies House, in microfiche. Guedroudj stated the business purpose as:

Petroleum consultants and retailers of mathematical models and software. Sounds complex.

Since that auspicious day in 1990, how has that company fared?

Pretty fucking well.

The company now trades as Petex, and is one of the biggest software providers to the oil and gas industry. Their core product offering is IPM, Integrated Production Modelling, which is made up of several products with descriptions like “multiphase network modelling and optimisation” and “thermodynamics fluid characterisation package.”

You get the picture. This is highly technical, specialist software, sold into an industry that cares an awful lot about getting these things right, who use this software as the backbone for some of their most important operations. When you combine that with the fact that software is the best business model of all time, you get a wonderful business.

This is what’s known as VMS, Vertical Market Software. Finding and acquiring small VMS companies like this is why Constellation Software has been one of the best-performing stocks in the world over the last 20 years.

Here is Petex’s full Profit & Loss statement. Honestly, this might be the best P&L I’ve ever seen for a company this size:

Let’s start with the obvious. This is a wildly profitable business. 96% gross margins on £78.4m of turnover is just insane. Yes, software is the best business model in the world because the marginal cost of goods sold is as close to zero as you can get, but even among SaaS companies, Petex stands out.

Which makes perfect sense when you think about it in context. Imagine you’re running an oil rig that extracts hundreds or thousands of barrels of oil per day. Brent Crude is currently trading at about $75 per barrel, so every hundred barrels is $7500 in revenue.

Your IT guy comes up to you and says, “Boss, Petex just put their prices up by 10% this year. I think we could save $3k annually if we switched software providers to another thermodynamics fluid characterisation package instead.”

You tell him to piss off, don’t touch a thing, and just make sure nothing breaks. A measly $3k is nothing in the grand scheme of your huge capex-intensive business. Petex put their price up 10% and everyone carries on as before.

That’s the power of sticky software.

Market comps

That pricing power and operational criticality means Petex enjoy extraordinary margins, even compared to other software companies. Here’s a quick comparison to Adobe, a world class consumer & pro-sumer SaaS company, and SAP, the stickiest software in the world:

Petex enjoys gross margins significantly better than both of those comparables. And the picture looks even rosier when we look at operating profit margin, which is the real measure of profitability given the fact that the bulk of a software company’s costs tend to sit in opex:

71% operating margins. I appreciate that in sheer revenue dollars, Petex is significantly smaller than either Adobe or SAP, but it gives you an idea of their outperformance.

Given that they’re UK based, they’re only paying UK software engineer salaries too. Looking at the last 10 years of data, their average all-in cost per employee is around £101k per year.

Interestingly, cost per employee spiked massively in 2022, implying some sort of large one-off bonus or payment to staff — despite which they still achieved 60% net margins.

In 2022 Petex discloses that they had 86 employees. That translates to £911k revenue per employee. It doesn’t take a genius to work out that if people are your main cost, and revenue per employee is £700k higher than cost per employee, you’re probably doing well.

Tax avoidance — or, tax incentives?

One thing to highlight on the P&L is the effective tax rate, which is just 11.2%. For 2022, the UK corporation tax rate was 19%, meaning all else being equal, I’d expect Petex to be paying around £10m per year in tax. Instead, they’re paying just under £6m.

Here’s the tax reconciliaton from their accounts:

There are two big things going on here.

1. R&D tax credits: companies are entitled to claim back a large percentage of the money spent on R&D, as long as the work meets certain criteria.

2. Patent box adjustment: companies that hold patented intellectual property that is commercialised in the UK pay just 10% tax rates on the income generated from that IP.

The patent box is the real golden goose here — it’s worth £4.3m per year to Petex, as it reduces their income tax rate from 19% to 10% on a certain chunk of their income.

Given the fact that Petex says the patent box adjustment is worth £4.3m, and we know it reduces the effective tax rate by 9%, then we can figure out how much of their £53m profit is attributable to that IP.

So 91% of Petex’s profit is generated through patented IP, meaning they’re only paying 10% tax on 91% of their profits. That’s a massive advantage.

It’s also exactly what the patent box tax relief is designed to do: get companies to create, patent and commercialise IP here in the UK. In this case, it’s working.1

Cash machine

Remember in 2022, Petex’s total revenue was £78.4m.

From that £78.4m revenue, they generated £66.3m of cash from operations.

With only minor capex requirements of £1.7m, that leaves a huge £41m to be paid out as dividends, while still increasing cash balance by £23.6m in the year.

Can I just stress that again? £78.4m of revenue turned into a £41m dividend. Ignoring the owners’ personal tax situation, for every £1 of revenue, £0.52 went directly into the owners’ pockets as a dividend.

Valuation

This business is a stunning wealth generation machine.

This is why, a few years ago, founder Abdelhamid Guedroudj was named as the 4th richest man in Edinburgh, with an estimated fortune of £313m. It’s unclear exactly how much of this business he owns today — the company is wholly owned by a HoldCo in another country — but I don’t think they’ve ever taken outside money. Their websites states:

All our product development activities are self-financed, which enables us to focus on technical innovation and quality of technology, instead of the search for external funding.

I’d have to imagine the business is worth at least a 10x multiple of earnings, which puts it around the £500m mark. Given the Scottish Herald’s estimate of Guedroudj’s net worth, it’s not outlandish to guess that he owns over 75% of this business.

And until someone on Twitter sent me this company, I’d never heard of it.

An incredible story. I love that you can quietly build a company in a niche like this — that through years of hard work and grit pays off, hugely. This is 10/10 execution applied to a 10/10 opportunity space, turbocharged by some healthy tax credits along the way.

Carve outs

• I’m currently reading How Big Things Get Done, a look at megaprojects like building skyscrapers or massive IT projects, and what makes them either succeed or fail. Fascinating so far.

• Obviously I’m watching the final season of Succession. I still strongly agree with Owen’s assessment.

Speak soon.

Andrew

I’ll be the first to admit the UK has its faults.

Brexit, mild alcoholism, colonialism, Philip Schofield, always talking about the weather, constitutional monarchy — any number of reasons why you might not love Blighty.

But we do have one wonderful, wonderful resource: Companies House.

For the uninitiated, Companies House is the government body where every UK company — regardless of size — must file annual financial statements, as well as notifying about changes in ownership, details of directors, and more. The vast majority of this is public information.

So when my Twitter buddy Nik Fuller, an American, sees me sharing a company P&L, he fairly asks:

And the answer is: they’re all from Companies House. It’s a treasure trove of info. If you’re a business nerd like me, it’s incredibly fun.

Companies House also benefits from the UK government’s efforts to digitise lots of its service, so they have an open API that anyone can connect to.

Using that API, credit checking services like Experian or Dun & Bradstreet pull all that data from Companies House, format it nicely, stick it behind a paywall, and make pretty good money.

Which we can see, of course, because they have to file their financial statements with Companies House:

You also get services like Endole and Duedil that allow you to search the whole Companies House database, and filter by size, company type, location, and more.

Long story short: if you’re a business nerd like me, it’s fucking brilliant.

The research process

It’s worth pointing out first that the below is all for privately-held companies. For public companies, research is easy — head to the website, find the tab that says ‘Investors’ or ‘Investor Relations’ and start reading everything you can.

For private companies, it’s a little more complex.

The process starts with the company name. Once you have the company name and number, you can start searching.

It’s worth highlighting here that when I say company name, I’m looking for the legal entity. That’s the legal company name, not the trading name.

Most of the time, finding the company name is easy. It’s on the side of a company’s van, or on a letter or email, or on Google Maps. Most of the time it’s easiest to find on their website. For example, with Dun and Bradstreet, I googled “Dun and Bradstreet”, go to their website, and scroll down to the footer — you usually see something like this:

Bingo. Company is Dun & Bradstreet Limited, and the number is 160043.

Other times it’s slightly harder to find. For example, last week I saw a job ad for a company called Flawless Vape Shop, googled the company, and ended up on their website.

Scrolling down to the website footer, I don’t see a legal company name, just a trading name:

But have no fear! I’m not so easily defeated.

Over to the page that reveals all: the privacy policy.

Under good old GDPR, any company that holds customer data needs a privacy policy — and because it’s a legal agreement, it usually includes a section like this:

Huzzah! The company name is actually Flawless UK Vape Distribution Ltd, company number 10343378.

Failing that, one way is to visit the company’s premises and spot their certificate of Employers’ Liablity insurance. Companies are legally required to hold EL insurance and display their certificate somewhere on their premises, and the certificate will say the name of the company.

This works well for businesses like hotels and fast food restaurants where the company is probably franchised. The sign on the door might say McDonald’s, but the actual operating company is called something else. The biggest one here in Nottingham is Blades Restaurants Ltd:

The financials

To look at the company’s numbers, we can use any number of the services I’ve already mentioned. The downside is that Experian, D&B, Endole, Duedil and other services like it are all pay to play — and in some cases they’re pretty expensive. I just start with good old Companies House.

Let’s look at Flawless Vape first:

All the good stuff is in ‘Filing history,’ then filter to ‘Accounts’ — you can see all the financial statements they’ve filed with Companies House.

I’ll look at the most recent accounts they’ve filed, which is for their financial year ending 30 November 2021, and flick through to see what I find.

One thing I notice when I look at this company is that they haven’t included a full Profit and Loss statement. That’s because the reporting requirements for companies differ depending on size.

For example, if you meet two of the following three criteria, you must produce full accounts including a P&L:

• Revenue above £10.2M

• Total assets above £5.1M

• Total employees of 50 or more

Flawless Vape has assets of £6.9M:

but only 47 employees:

which means their turnover must be below £10.2M, otherwise they’d have had to publish a full P&L.

But even with the data we have — their balance sheet, employee count, and knowing the turnover is below £10.2M — we can start to form a picture of the company.

Extra steps

Those are the basics. Find the company name and number, scope out Companies House, and use whatever info you can in their disclosures to start to form a picture of the business.

To go further, I might look at trade press, local news, LinkedIn, and others. If it’s a B2B company I might even try to get a quote from them (which I did for a portaloo company) to get an idea of pricing.

If I have access to something like Experian, you can also see the list of shareholders and amount of share capital, and the company group structure including parent companies and subsidiaries. This often reveals a tangled web of interest which is fun to chase down.

The last step would be to look at their registered office address on Google Street View. Often these are simply PO boxes, or their accountants’ offices, which aren’t much use — but sometimes, it’s a residential address. If it’s residential, you can look up the property on Rightmove or the UK Land Registry to find out how much it sold for most recently, which could give you a clue as to the wealth of the company owner.

Or it could be totally misleading bollocks. Hard to tell. But that’s the fun of it. It’s like a puzzle you’re trying to piece together over time to give you the full picture of how a business is doing. And it’s all publicly available information.

Like I said, if you’re a business nerd like me, it’s endlessly fascinating.

Carve outs

Inspired by the wonderful Acquired podcast, I’ll also have a small section at the end of every post to share what I’ve been reading and watching recently.

Two book recommendations this time. Firstly, I re-read Phil Knight’s wonderful autobiography Shoe Dog, which correctly is only 1% early family story, 90% struggle, 9% basking in the glory of success. I love this book so much.

Secondly, I’m also reading this biography of Cato, which is excellent. The co-author, Jimmy Soni, also wrote The Founders, a history of the founding of Paypal, which I also highly recommend.

Thanks for reading! If you enjoyed this post, feel free to share far and wide.

Andrew

Without further ado, here’s a story about an SME I worked for a couple of years ago.

EDIT (28-Aug-24): more than a year after I started this newsletter, we’ve now got over 3,000 incredible subscribers. I’m blown away that so many people want to read what I have to say about small company financial statements, but it warms my heart to know there are thousands of us. Thank you. Without further ado, here’s the post.

A million pounds in profit.

After tax.

A lot of people are looking for a quick way to get rich. One weird trick or a hot stock tip that’ll set them up for life. Buying options on Gamestop at the right time. Bitcoin. An AI chatbot. A viral online course.

This is not that. This is a story about how you can take an OK business, in a difficult industry, and use it to create wealth for yourself, and for your team. If you’ve ever come across Nick Huber, aka @SweatyStartup on Twitter, you’ll know the kind of business I’m talking about.

This is a story about doing simple shit well, and generating millions of pounds of wealth as a result.

Background

For three years I had the pleasure of working in the finance department of a small business here in the UK.

Here’s a screenshot of the P&L from 2015, the year before I joined.

£9M in revenue, and £19k in profit after tax. A great big meh.

‍

Here’s a screenshot of the P&L for 2019, the year I left:

• £21.6M in revenue

• £1.1M in profit after tax

Not a bad improvement.

(By the way, this is a UK company, so all of these numbers are completely public at Companies House. I’ve taken the liberty of putting them into some handy charts below).

There was no magic bullet here. No transformational change. And no single stroke of luck. Just a lot of hard work by a lot of people, and some financial discipline.

Here’s how we did it.

What was the company?

The company was a boutique facilities management company. They provided cleaning, security, reception, and maintenance services to companies across the UK. These are typically done on 3-5 year fixed price contracts.

Facilities management is a business with razor-thin margins. To get business, you need to bid for it. Bids are typically done on a cost-plus basis: you figure out how much it’ll cost you to deliver what the client wants, you add on a margin for overhead and profit, and that’s the price you bid. 

Your competitors will be doing the same,  driving margins down for everyone. Not every customer goes for the lowest bidder, though -- some are willing to pay extra for good service or a company they like -- but there’s only so much you can push on price.

So it’s hard to win a contract but, if you do, you lock in a certain amount of profit for 3-5 years, assuming you can deliver the services within budget.

On top of that, your clients may ask for extra services outside the scope of your fixed price contract, which you can provide to them, again on a cost-plus basis.

That means the game is:

• Running your contracts efficiently

• Getting extra income from clients where you can

• Managing overheads

• Winning more contracts

In a nutshell, this is just good old-fashioned financial discipline. So that’s what we did.

There were four key steps to get there:

1. Report accurate financials

2. Cut out leakage in both cost and revenue

3. Create reasonable, bottom-up budgets

4. Put together reasonable, well-costed bids to win more contracts

‍

Step 1: Reporting accurate financials

When I first joined, our financials were a mess. Although payroll and billing were pretty accurate, accounts payable was metaphorically and literally all over the place: invoices in drawers, invoices with no purchase orders, invoices being posted in the mail to people to physically sign, invoices for things no one recognised. 

Basically, we didn’t know what our costs were, or what they should have been, at any time. And because we didn’t have an accurate picture of the current state, we couldn’t say whether we were truly doing better or worse than the month before, or what a steady state month was, which made it impossible to budget and forecast accurately.

So, to fix this, we:

• Put all the unpaid invoices on a spreadsheet

• Sent out that spreadsheet to all the contract managers

• Followed up relentlessly with contract managers to tell us what should be paid and what shouldn’t

That eventually cleared the backlog. Next, we put in these processes:

• We refused to pay any supplier invoice that didn’t have a purchase order (PO) number quoted. Our suppliers quickly learned that they needed to push our contract managers to give them a PO before they supplied us with any goods or services.

• We created a PO request form for our contract managers, which had the primary benefit of making sure the PO was coded correctly in our system, so the costs would end up in the right place, and we could track the financials accurately.

• I created and automated a suite of reporting dashboards for each one of our contracts. That meant we could track, line by line, what costs we were incurring on every contract, and check all the variances, in detail, every month.

This all took about 4-6 months. By the end of that time period we were confident that we were accurately tracking our financial performance, across all of our contracts.

Step 2: Cut out leakage

In any business there is leakage. There are things you should be getting paid for, but you’re not. And there are things you’re paying for that you shouldn’t be.

We had both problems.

Our contract structure meant that certain work was in scope of the contract, and covered under the fixed fee. Other work would be outside of that and charged to the client ad hoc.

As an example, imagine you have a contract to clean someone’s office three times a week. The fixed price contract might cover the staffing costs and quarterly deep cleans of carpets and windows. Outside of that would be any cleaning equipment and materials like soap, toilet roll, mops, bucket, rubber gloves, and so on.

This means that when you buy those cleaning materials, you need to make sure you bill the client for them. If you’re not, you’re missing out on that revenue, and picking up the cost yourself.

Here’s the problem, though: each contract is different. One client may be happy to pay the cost of cleaning materials, and another might want that to be included in the fixed cost. One client might include quarterly carpet cleans in the fixed price, and another doesn’t, because they want the option to only do them every 6 months.

We had to make sure we were capturing the revenue we were entitled to. So we dug out the paper copy of each contract, and painstakingly made a schedule for each one of what was in scope, and what was out of scope. There were a bunch of things -- hand towels, mops, feminine hygiene products, landscaping, carpet cleaning, recycling, and so on -- that we documented for each of our contracts, and confirmed with our contract managers.

That was 2016, where we had accurate financials but not much of a budget. This is the P&L from that year:

10x the profit after tax despite revenue only increasing by c. 30%. Not bad. But we knew we could do better.

Step 3: Create reasonable, bottom-up budgets

By this point I’d been at the company just over 6 months. 2016 was a good year -- now we had to budget for 2017.

Thankfully, all the hard work we’d done up to this point made budgeting pretty straightforward. For each contract, we created a budget model, including the fixed fee charged to the client, and all of the labour and subcontractors we were obliged to provide under that contract. We checked this against the last few months of actual results to make sure it seemed reasonable.

Then, most importantly, we sat down with the individual contract managers to go through their budget line-by-line to make sure they a) agreed with it, and b) understood it.

All the contract managers had an opportunity to ask questions, clarify which costs they were responsible for, and understand how we’d arrived at the budget.

Then we sent them on their merry way (with the understanding that they now had a budget target to hit, and would be incentivised to hit it).

Over the next couple of years I ran monthly budget review meetings with every contract owner to discuss performance against budget, check any variances, and correct our numbers where we had to. These review meetings led to greater accuracy, less leakage, and greater commercial awareness all round.

From that point on, all our contracts were well managed and profitable. We were off to the races! All that was left was...

Step 4: Put together reasonable, well-costed bids to win more contracts

I take very little credit for this part. While I did a lot of the hard work in steps 1-3 to make sure the business was well run, winning new business was all thanks to the senior leaders in the organisation. They were great sales people with excellent relationships in the industry, and they drove the vast majority of the new business between 2016 and 2019

But I will take a little credit, for two reasons:

1. I helped to either create, or kick the tyres of, the cost models we used to price bids; and

2. All the work we’d done to make sure the business was well run gave other senior leaders more time to focus on winning new business, rather than running around putting out fires and trying to manage our existing business.

We were also able to be a little more strategic in which contracts we decided to bid for. We knew which of our existing contracts were the most profitable, so we could go after more like those. We knew we could keep the lights on with our current contracts, so we could be more discerning in what we decided to bid for, rather than chasing any opportunity we found. And so on.

The results

I joined the company in early 2016, and my boss and I did most of the hard work in 2016 to fix things, then we just kept a tight-run ship for the next couple of years. So while I only take a bit of  credit for this revenue trajectory:

I will take quite a lot of credit for managing and maintaining this gross margin trajectory:

So we’ll split the credit for making this much money after tax:

And the owners can feel good about being able to take a good amount of profit out of the business for themselves even while growing the business:

So how much value did we create through the work we did? As I mentioned before, this isn’t a speculative investment on a growth stock. We’re not hoping that /r/wallstreetbets pumps up the value of the business so we can sell it tomorrow for a 100% gain. And it’s also not a hyper growth startup with a ton of stock options and early employees hoping for a big exit.

Instead, let’s say that this business is valued at 3 times after-tax earnings. At the end of 2015 that means the business was worth around £60k. At the end of 2019, it was worth £3.3M. That’s a gain of £3.24M in four years. Not bad.

Not only that, but in that time the business has paid out a total of £934K in dividends. So in four years we created over £4M of wealth, which all accrued to the company’s two owners.

Not bad for a little company from the north of England.

Those are the kind of opportunities you can find in the world of small business. You won’t get rich overnight, but if you’re willing to put in work over time, you can still make life-changing money. It just takes work.

And as an after-thought, the founder, Mark Cooper, sold this company in 2021 for an undisclosed amount — my guess is mid-seven figures, probably £5-8M — and sailed off into the sunset as he richly deserves to do.