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A Law Firm Owner's Guide to Demystifying Financial Statements with Brian Feroldi
00:44:46
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- [00:03]
A
It's beginning to become a tradition. If it's January, Maximum Lawyer is heading to Scottsdale to Mastermind. January is the perfect time of year to step back, assess where your firm is and create a strategic plan for growth. This Mastermind is designed to give you a jump start to make sure 2025 is your most successful year yet. Our day and a half events combine business training and hot seats. On day one, you'll learn how to use AI and automations to drive growth with the latest tech innovations for law firms. Followed by Mastermind Hot seats on day two, where you'll receive tailored advice and strategies on what to do next. You'll walk away from this event with an action plan created from personalized solutions that you can implement immediately. To learn more about this event and grab your ticket, head to maxflawevents.com foreign. This is maximum Lawyer with your host, Tyson Mutrix.
- [01:05]
B
Today I'm joined by Brian Feroldi, a seasoned stock picker on a mission to demystify the stock market. Brian specializes in breaking down complex financial statements and helping professionals make smarter business decisions. I wanted to bring Brian on because his expertise in evaluating businesses offers invaluable lessons for law firm owners. Whether he's deciding to add a stock to his portfolio or analyzing the financial health of a company, Brian's approach is rooted in precision and practicality, skills every business owner can benefit from. In this episode, Brian shares his step by step framework for assessing a business, including how to decode profit and loss statements, identify red flags and effectively manage cash flow cycles. It's packed with actionable advice that you can start using today to evaluate and strengthen your law firm. Here's my conversation with Brian Feroldi. Enjoy. Brian, I'm, I'm very excited to have you on. Welcome to the show.
- [02:01]
A
Thank you, Tyson, for having me. It's a pleasure to be here.
- [02:04]
B
Yeah. So I first found you on, on, on X and I just saw you kept posting these images. I think they're from your book of financial statements, which we're going to get into that stuff in a little bit. But I just love, I love the stuff that you're doing and you just, you just kind of put it all out there. You make it really, really easy for people when it comes to financial statements. So what, I guess what made you want to start doing that? Because it's a really clever idea. I don't see anybody else doing it.
- [02:32]
A
So learning. So my mission statement, the mission statement of my company is to demystify the stock market. I myself am a stock picker and have been for 20 years. So I really like to dive into the weeds of analyzing businesses. And of course that includes financial statement analysis, SEC filings, valuation, risk analysis, proxy statements, et cetera. That kind of stuff interests me. But it can be very hard to learn. Like the learning curve to understanding how to do that well can be very, very high and very, very steep. So I have found through trial and error that visuals, catchy visuals, can help people to process information way faster than text can alone. So I came up with the idea of creating some infographics that explain basic financial concepts, especially around analysis. And they seem to have caught on. And like anything you do online, if something resonates with people, you try and do more of it.
- [03:28]
B
Yeah, how, how far into your career did you realize that that was something that people needed? Because I think lawyers needed, accountants need it, you name it. But I guess how, how far into your career did you say, okay, I'm going to start doing this for people? Because it is, it is really, really helpful. So when did you decide to do that?
- [03:44]
A
So only in the last few years. I have a business partner, his name is also Brian. And three years ago we created a online cohort based course, People how to Find, Read and interpret Financial Statements. So we've been teaching that course for three years now. And learning to analyze financial statements is something I've been doing on my own for almost 20 years. Right. I've been stock picking for 20 years. And that's just a critical part of learning to analyze a business, to tell if it's any good or not. Warren Buffett calls accounting the language of business. And not understanding accounting is like being financially illiterate in the business world. But yet, just through talking with friends and family, my rough guess is that 95% of people in business that aren't in accounting have no clue how to read financial statements. So we saw that there was a market opportunity to kind of teach people beyond just investors. It could be business people, entrepreneurs, executives, or even people that aspire to be in the C suite at some point in their career. In my opinion, learning the basics of financial statement analysis is absolutely critical.
- [04:50]
B
So, and that's something I want to get into. So I'm gonna go ahead and jump into it because I, I want to ask you about assessing other businesses and what you're looking for, because I think this could be really helpful for law firm owners, because that's our audience is law firm owners in, in evaluating their own businesses, or let's say that they're Looking to buy another law firm and they kind of absorb it. So what are those things that you're looking for in a good stock pick? And, and I guess here a follow up question might be is, does that necessarily make a good company?
- [05:20]
A
So financial statements are like a report card for a business. They leave a trail of success. Now, just because a company has good looking financial statements doesn't mean it's gonna be a good investment. And the inverse is also true. However, the ultimate direction that a stock goes in the long term will be dictated by the financial results the company produces into the future. So I think that learning how to analyze, analyze financial statements to kind of come up with reasonable assumptions about what they will look like in the future is a very critical step. And to your point, if I was a law firm and I was looking to acquire other law firms in the area, how could you possibly make a decision about how much to pay for those law firms if you didn't understand the numbers behind them?
- [06:06]
B
Yeah. And so what are those things you're looking? So you're looking, let's say you pull their financial statements. And so let's just give a fake scenario where we're going to, we're looking at another law firm to buy. What financial statements are you going to start with to analyze to see if this is a firm worth buying?
- [06:22]
A
So when it comes to. So the lessons that I teach are around publicly traded companies simply because those financial statements are easily accessible and they are standardized. So when it comes to analyzing any company, there are three primary statements that I'm interested in looking at. The income statement, which is also called the P and L, or the profit and loss statement, the balance sheet, which is also just called the net worth statement. It's what a company owns and what it owes. And for publicly traded companies, there's a very important statement called the cash flow statement. And that actually shows the cash movement through the business, which can be quite different than the income statement. Now if you're acquiring another law firm, I'm guessing you're not going to get a cash flow statement at all. Oftentimes I'm guessing again that law firms use simple accounting like cash accounting, which would negate the need to have a cash flow statement. So if you're going to be analyzing another law firm, there's two statements that really matter. The profit and loss statement, which shows things like revenue and expenses, all of a company's expenses, and then a profit or loss at the bottom. And then the firm's balance sheet, which is things like the Assets that they own could be cash in the bank, could be notes receivable, could be real estate and the debt that they have, which again, could be debt on real estate or even past acquisitions that they've made. So if I was analyzing a law firm for the first time, I would start with the P and L and I would say, one, is the company generating a profit, yes or no. Two, what is the direction of this company's financial results? Is revenue and profits increasing over time or are they decreasing over time? And then three, I would say, does the balance sheet, does the balance sheet have lots of cash and no liabilities or a little bit of cash and a lot of liabilities? Those factors would dramatically impact my interest in acquiring that business and importantly, how much I would pay to do so.
- [08:15]
B
Are there situations where you might see where there's, let's say cash is a little low, but debt's high. Are there any scenarios where you would say, you know what, this might still be a good investment?
- [08:24]
A
Absolutely, absolutely. The amount of debt that a company has isn't as important as can the company easily afford to carry that debt. So there's a metric that you can measure, which is called EBIT to interest payment. EBIT is earnings before interest and taxes. And then you would take that and divide it by the company's interest expense. And that is one quick way to measure can the company easily afford its debt load? If a company's, let's just say a company's EBIT is a million dollars per year and the company's interest expense is 100,000 DOL per year, that would be a coverage ratio of 10, meaning the company's profits could fall by 90% and the company could still make an interest payment. So plenty of wiggle room there. If on the flip side, a company's EBIT is a million dollars and its interest payments are $900,000, well, all of a sudden the company has to really work hard just to pay the interest on its debt. And that would be an untenable situation. So debt in its, in absolute terms isn't always a bad thing. But a key question to ask is, can the company easily support the debt that it has?
- [09:31]
B
Gotcha. What are some of the other, I guess, red flags that you might look for when it comes to. And, and I'm sure you're, you're going to be looking at, I'm guessing that initially that high debt is going to be a red flag, but then you might be able to do some sort of analysis like you were just doing to determine, okay, it's not that bad. We can, we can work with it. Are there other initial red flags that you're like, okay, we need to look into this a little bit more?
- [09:53]
A
Yeah. So again I'm a specifically focus on acquiring a law business. Yes, that since that relates to your audience. So to me, one of the first things that I look at and one of the most important numbers on a company's financial statements is revenue. And most importantly the quality of that revenue. Not all revenue is created equally. Let's distinguish between the two types. So great revenue, great revenue is high margin, meaning it doesn't cost you a lot of money to produce it. It's recurring in nature. It's not a one and done sale. It's something that repeats Adenim and it's recession proof, meaning that if the economy goes down, that revenue is still dependable. That is very, very good revenue. So what's the opposite of good revenue? Well, bad revenue would be one time in nature it does not recur in any way. It is low margin, meaning it costs you a lot of money to create that, that revenue. And it's cyclical. When the economy goes down, which it always eventually does, that revenue disappears. So that would be the very first thing that I look at. How durable and how high quality is the company's revenue in nature. Now I would love it if you could fill me in. What do you think most law firms revenue is? Would you consider it high quality or low quality?
- [11:10]
B
I'd say generally high quality. I was, I was actually just thinking as you were talking about that how what you might think of my business, because we were personal injury, it is generally because, because of litigation, it can be pretty expensive, especially medical malpractice. So like we, I mean kind of based on the similar assessment, we've, we've cut out 99 of our medical malpractice cases because the, even on the cases that are expensive for us, let's say it's a car crash and let's say we have to spend $20,000 to get it to trial, which is not completely unheard of. That's not a huge number. Our upside is pretty good on it. And you know, the chances of losing that trial are pretty low is car crash. But a med Mao chances of losing really, really high cost, you know, 50,000 to $150,000 to get it to trial. So the risk is really high when it comes to that. So that's, that's why we, we have scrapped 99.9% of our medical malpractice cases. We still have a couple, but we've, we've referred the rest of them out. So that is interesting, but I do think we're recession proof. So I think that's good. That part's good. But we, it is, I would say it is expensive to litigate the cases. However, I think our upside is so high. That's why I think a lot of, I think a lot of business owners, they look at personal injury and they think, I would love to get into that business. So I, it is interesting, but to answer your question, I think that most income is probably pretty good income when it comes or revenue is pretty good revenue when it comes to law firm owners. It's, if I'm thinking like a criminal defense attorney, pretty cheap to run that law office. Even their malpractice insurance is really, really low. But it's, you know, cash up front for the most part. They do, some do take payment plans, but I'd say a business like that, pretty good family law, pretty good low. You start to hire attorneys and that's, that's whenever your overhead starts to get a little higher. But I, I think for the most part, pretty good revenue.
- [12:57]
A
Okay, so here's another factor that I neglected to say out front, which you reminded me of when you said the, the capital cost to you. So when high quality revenue becomes cash, low quality revenue becomes accounts receivable. So do law firms, when, when they book revenue, is that cash instantaneously or is that a receivable?
- [13:18]
B
Oh, so it depends on the firm. So it, even for us. So we have, we have a lot out in receivables right now because we've had a pretty good quarter. But because the cha, I mean our, we're gonna, we're gonna be able to collect on all of that because it's from insurance companies. So it's not like it's gonna, we're a huge difficulty. But some of them have been outstanding for like 90 days. And, and I think in a normal firm you'd think, oh no, that we're not, not going to collect on that. But I've never, never not been able to collect from an insurance company. But sure, let's say I'm a criminal defense attorney. I used to do it years ago in that scenario, if I've got an account that is okay. So I charge you up front. Let's say you make a down payment, you still owe me $3,000. If it goes past 90 days, I'm probably not going to collect on that. So I think the Vast majority of firms do have receivables.
- [14:06]
A
Sure. And in addition, there, like you said, there is a, there's a capital cost to the firm, there's a cash outlay just to bring it to trial, to have a chance at being collected.
- [14:14]
B
Correct, correct. On, on personal injury, yes. Yeah.
- [14:17]
A
So there's an important concept in business called the cash conversion cycle, which is the way that cash flows through the business and becomes cash again. Now the cash conversion cycle is typically applied to manufacturing companies that have inventory. Right. Cash buys inventory, inventory sits on the shelves, that shelf, that a sale is made and it becomes receivables and then it becomes cash again. We measure the total time period that it takes to go around that circle in a period of days. So with, with law firms, if there's a capital cost out front, that's money out the door right away. Then there's a period where the trial is happening and then even if you win, there's. There's a cash collection period.
- [14:59]
B
Correct, Right, exactly.
- [15:00]
A
Yeah, yeah. So, so that means that the cash conversion cycle on law firms is, is measured in probably months. Would three months be reasonable? Or six months? Or what would you say is typical?
- [15:13]
B
Okay, so on a personal injury case, it's pre litigation, we resolve it. It's probably, it's, it's about 10 months for something that's in litigation. Right around 17 months or a case that's in litigation. So it depends on what stage of the case we're in. So I do look at them pre lit versus lit. So yeah, about 10 months or right around, you know, 16, 17 months.
- [15:32]
A
Right. But, but either way there's a cash outflow immediately and then there's a 10 month period when you have to wait to get your cash back. Correct.
- [15:40]
B
Kind of the money comes out at different times. But yeah, the concept's correct. Yeah.
- [15:45]
A
So, so here's why that's an important thing to know. For a law firm to grow, that means that the business is consuming more cash.
- [15:55]
B
Sure.
- [15:55]
A
If you take on more and more and more cases, that is more and more money out the door today to finance the costs over time. So that to me would be a very negative trait of investing in a law business is that cash conversion cycle. Let me tell you the opposite. There are businesses out there that get paid before they do anything. So like a software company, for example, if you buy like I just bought, I just paid Twitter for the next year of premium services for Twitter. Right. So I had to pay prepay a year up front. So I gave them the cash on Day one. Even though they don't have to provide me with the. They provide me with the services over the next year. So Twitter collects cash immediately and then gives me the service over time. So the faster Twitter grows, the more cash the business generates. That's called a negative cash conversion cycle. Law businesses, or I'm guessing it depends on the nature of the law, has a cash positive cash conversion cycle. In this case, positive is actually. Is actually a negative thing. So that means that the faster the law firm grows, the more cash is drained from the, from the balance sheet. Now that's okay. You just have to be able to plan about it. But if you had a pure choice between being cash conversion cycle negative and positive, you would take cash conversion cycle negative every time.
- [17:19]
B
Yeah, I agree with that. And that's. It's. We played with ideas on. Okay. You know, there are other. Other things that we can do to kind of upsell people. And we've never done it, but we thought about that because of that. And it's. We've seen this quite a bit with like, injury firms that are scaling specifically because we are. I mean, we're in the red on every single case. We're in the red from the beginning in it, and it gets worse and worse and worse. And then you have a massive spike at the end of the case whenever we settle it. But you see a problem with firms that are scaling where they're just eating cash and they've got to have access to capital because that's why most firms have a line of credit, because you've got to eat into that line of credit to make it profitable. And that's. We've seen it with several firms where they just get so crunched with cash because they're just eating away at it so much. And, and that's. It can be a vicious cycle. But once you. I think there is a point where most firms that are established, that are injury firms specifically, they. They get to a point where it's not an issue, but it can be if they hit like a massive growth spurt, that's. That is a problem for sure.
- [18:16]
A
Totally. So I, I have a friend that had a food business, and his cash conversion cycle was about 90 days and his food business failed. It went bankrupt because he was growing too fast.
- [18:27]
B
Yeah.
- [18:27]
A
So there was so much demand for his product that he could not finance the inventory he needed to. To supply the demand. And his banks eventually said, no, we're not giving you any more credit. And he actually crashed. So that's just something you need to keep in mind, if you're a law firm, there are constraints, real constraints on how fast you can grow. So you need to always be balancing growth with do we have the cash to support it?
- [18:50]
B
Yeah, that's, that's a really good point because you see a lot of times people on like Shark Tank and they'll say, you know, they've got really good numbers. And you kind of wonder, okay, well how, how is it need all this money right now and how, how is it that they're going to go out of business? It's because of that, because they're just, they're, they're just getting up all their cash, which makes complete sense. So, okay, so that's a scenario where you might see, okay, they've got all these sales, it's growing, that's great. But you know, if you're, if you really look into it, it could be a really bad thing. So initially it looks great. Are there other things like that that you can look at on the financial statements to say you, you know, by looking at it seems like it might, might be great, but in reality it might be really bad and really detrimental to the firm?
- [19:30]
A
Absolutely. So this is why looking at three financial statements, the income statement, the balance sheet and the cash flow statement is so important. So in this particular scenario, I would actually really push to see a cash flow statement or at least the company's bank balance, because the profit and loss statement could say, hey, we're growing, we're booking all this new business, look how much we're taking on. And we're generating quote unquote profits from this business. But if the company's growth has a 10 month cash conversion cycle to it, and you look at the actual bank balance, the bank balance is going down or the line of credit is going up to finance that growth, that is a completely different scenario. Even if you are extremely confident that you'll eventually get paid because it's with very high quality receivables partners. So that would absolutely be something that I looked at and considered. The other thing that I would look at would be the cost structure of the firm. I would imagine that personnel is.
- [20:26]
B
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- [21:44]
A
The number one expense that a, that a law firm has on. It's a very capital light business. Meaning you just need what like files and an office space. So not, not much in terms of capital to run. It's a, it's a capital light for non injury firms.
- [21:58]
B
I'd say yes. Yeah. For the most part. Yeah.
- [22:00]
A
Yep. So I would look at the margin structure of the business. So again, let's pretend they do a million dollars. A million dollars in, in, in top line revenue. What percentage of that million dollars gets eaten up by internal legal fees like the salaries to the lawyer and the support staff and all that kind of stuff? Because there are ways to run very efficient legal operations and those should be applauded. And there are ways to run very bloated legal operations and those should be avoided. So it's not necessarily the expenses in absolute terms that matter. It's the expenses in relationship to revenue that matters.
- [22:38]
B
Yeah, I think that that's, I think it' smart. I do want to pivot a little bit to using checklists because I think that you use checklists to evaluate companies. If I, if I read that somewhere, I think I read that somewhere. And so is there a. I guess what is the if that is true? Do you have some sort of like, what is the checklist criteria? Is, are the, is it the things that we're, we're talking about now or are there other things on your checklist that you look at whenever you're assessing a potential investment?
- [23:07]
A
Oh yeah. So I am a huge fan of systems and systemization. The more that you can write down on paper, the better your thinking. Because, and most importantly, when I've written things down on paper, I can show them to other investors and say, hey, this is what I'm doing. What do you think? What am I missing in this? And when I make an investment using my checklist and it goes poorly, I need to update my checklist to make sure I don't. I'm not overlooking a risk that I, that I am unaware of. So the I do have a checklist that I use. It's currently on version 3.0. So this is like the third time that I've gone through it and I've battle tested it and it helps me to identify companies that are the best match for my investing personality. Not the best companies, not the lowest risk companies. It's the best match for what I'm looking for an investment. So I'm happy to tick through with some of the things, if that's what you're asking.
- [24:02]
B
Yeah, I would love to hear that. And I want to hear more about the last thing you said too about, you know, about you, for you, because I think that that's, that's important too. But so if you can kind of touch both of those, that'd be great.
- [24:14]
A
So I am an investor that is looking. My goal is to grow my net worth at an above average rate for as long of a period of time as possible. So my goal is to maximize my net worth and to achieve financial independence. So that's my, that's the North Star that I'm going for to get there. I am interested in investing in primarily small, fast growing companies that I believe are building a sustainable advantage and can grow for many, many years to come. So I'm not interested in the Coca Cola's of the world or the Hershey's of the world or the Walmarts of the world. Those companies are big, dominant, slow moving behemoths. I'm interested in the next Walmart or the next Home Depot, for example. So that's what I'm targeting. Now the thing that I'm giving up to get there is I'm taking on more execution risk and more business risk. And I'm also giving up profits today. Oftentimes companies that interest me have very, very minuscule profits because they're reinvesting in themselves so aggressively that it makes today's profits look small. But the trade off I'm making is, well, yes, small profits today, but those profits should grow at an exponential rate and 10 years from now the profits will be huge. So that's what I'm trying to target.
- [25:32]
B
Yeah. Will you, will you help me understand a little bit how like the companies like Uber that just have burned through so much cash for years and lost money, how those are. And maybe they're a bad investment now, but at some point, at one point at least, you know, investors were talking about how great of an investment someone like a company like Uber is. But like they're negative for so many years. How is it, how does it make sense that at some point they're going to, they're going to finally, finally flip the switch and then become a great investment? Because it just doesn't to me, it's, it's hard to, to understand.
- [26:02]
A
Can I share my screen by chance?
- [26:04]
B
Of course, go for it.
- [26:05]
A
So I'm going to show you a visual that I think should help dramatically to understand this, because before you understand how raising capital and the business model works, it is completely backwards to you, backwards to someone like me as to how a company can make a can, can lose money and be successful. So for those that are listening by audio, what I showed here is a visual on the screen that is called the business growth cycle. And there are six distinct phases that successful companies go through in their life in order to generate a profits for investors. And this is a very typical visual that companies that go public go through. So phase one is called the startup phase. This is when a company comes along and that company has an idea for a business or a product or a service to bring to market. Now very often those companies have a great idea in mind, but there is a certain amount of cost that a company has to take on to simply realize that idea. Think about ChatGPT just as, as, as an example, ChatGPT, OpenAI was in research and development mode for like five years, creating ChatGPT easily. And they were trying to hire the smartest, best engineers that they possibly could. So they had to compete against Google and Apple and Microsoft who have unlimited budgets to attract the best talent. How could you possibly do that without paying those people hundreds of thousands of dollars per year? To say nothing of the server space that you need and all the trial and error that goes on. So there was a multiple year period when OpenAI had huge costs, millions, tens of millions in dollars in costs and no revenue. None. Zero. Right. So that would be a phase one company trying to create a product or service that can be eventually brought to market in 2020. Was it 2021? I forget what year they launched ChatGPT, but that was the year that they finally started to generate revenue. Right? They launched it to market and it was a massive success, like 100 million new customers in like a month or something like that, like the fastest growing product of all time. And then a few months later, they decided to start offering ChatGPT for like eight bucks a month. And within a period of like a couple of months, they went from no revenue to a few billion dollars in revenue because their product was so huge. However, OpenAI, their costs are growing even faster. They're growing even faster because they have all this server space they have to take on. They're now hiring more engineers. They have legal costs up the wazoo to try and defend themselves. So they went from stage one, which is we're going to have an idea, to stage two. Stage two is we're losing even more money, but we're now bringing in revenue. The hope is that the company eventually makes it to stage three. Stage three is when the company starts to optimize its cog structure and it's pulling in so much revenue that it's producing no profits at all. It's breaking even. If OpenAI can get to that, that would be a huge achievement for its investors. It would be a huge achievement, but on paper, the company wouldn't be making any profit at all. It's only after a company reaches break even that it continue to grow its revenue at a rapid clip. And then, and then the cost structure becomes under control and profits start to grow for a long, long time. So if you think of so that's OpenAI, Uber has done the exact same same thing. Uber was losing money from its birth in 2010 until today. Like two years ago? Was it 18 months ago?
- [30:00]
B
Just recently? Very recently, yeah.
- [30:03]
A
However, Uber has been a sensational investment. Now think about the cost that Uber took on during the last 14 years. It was hiring engineers, it was onboarding drivers. It had to set up systems galore to make that work. It had legal costs to battle taxi companies and try and get its systems set up. So the reason that investors were willing to fund the company and fund those losses for such a long period of time is that the promise was eventually Uber would become the top dog in its space and it would be able to increase prices and produce billions of dollars in cash flow once it reached stage three and stage four. So that has worked with Uber, that promise has worked. And Uber is Now worth like $100 billion or something along those lines. So the key to. The key to understanding investing is that what stage of the business growth cycle a company is currently in dramatically impacts the risk that you take on as an investor. If you're investing in stage one, extremely High risk, extremely high risk. If you're investing in stage five, this is where Coca Cola, Johnson and Johnson, Walmart, Home Depot live. Way lower risk. But the returns that you can earn on those stage five businesses are far lower.
- [31:23]
B
So this question is more about your actual investment strategy, not some hypothetical law firm that we might buy. Are you looking as an investor in stage one or stage two, so the startup phase or the hyper growth phase or both?
- [31:38]
A
So I am, my sweet spot is stage four.
- [31:41]
B
Oh, okay, so you're, you're past that point.
- [31:43]
A
So stage four is a company has gotten past the startup stage. It's, it's found product market fit, it's gotten to the hyper growth phase where it's already, it's proven that it can lower its cost structure. It's reached break even. When a company reaches break even, it's no longer dependent on outside capital for success. It doesn't have to access debt markets or capital or equity markets in order to fund itself. When a company reaches break even, it is dramatically, dramatically lower risk than it is when it's in the hyper growth phase. So to me, the upside potential, I'm willing to give up upside potential to avoid stage one and stage two in order to have a little bit more certainty about the company's future potential. So stage three and stage four are my sweet spot. Companies that are profitable but not yet optimized for profits.
- [32:36]
B
Yeah. And I think that if I'm, let's say we go back to the hypothetical where I think if I were buying a law firm, I mean four would be seen, would seem very safe. But I could totally see, you know, going into, you know, stage two, company law firm and say, listen, I'm going to absorb your firm anyways. We're going to implement all of our processes and systems and everything and our marketing and we just essentially just want your, your market or we want your clients or whatever it may be. So I, it would be a little bit safer and investing is a little bit than actually absorbing a firm or buying a company. So that is, that is interesting. I think this is a great chart. I have seen this before obviously, but I think it's normally like the business lifecycle I think is like five stages if I'm, if I remember correctly.
- [33:17]
A
But there are many variations of this chart and how you lump it up totally depends on, on you. This is my system. So I think there are six distinct phases, but these lines are blurry.
- [33:27]
B
Yeah, 100%.
- [33:28]
A
And to your point, what we talked about before that, those law firms before that were Chasing growth, growing like crazy. But they were, they were fund, they had to keep increasing their line of credit in order to pay for all those. Those would be stage two companies, right? Right. Growing like crazy. But the faster they grow, the lower profits are today. And the hope is that eventually they reach enough scale to get to 3 and 4. Like companies in stage 4 are still funding all of that growth, but they have enough money coming in from their mature, the mature side of the business that it can easily cover it. So, so stage two, lots of growth potential, but higher risk. Stage three and stage four, lots of growth potential, but, but lower growth potential, but lower risk and return.
- [34:13]
B
It's funny, it's amazing how much this graph trends with like our typical typical personal injury case where we lose money on at the very beginning, but as time goes by and as we get it closer to litigation, it actually gains value. So I do, I think this is interesting how it does, it does track that quite a bit.
- [34:29]
A
There you go.
- [34:30]
B
So you have a, there's a quote, you say, winners tend to keep on winning. And I don't know if you remember saying that quote, but I do wonder in your, in your view, why do, why do winners. And so you know, they could be companies, they could be law firms. Why do they tend to keep on winning? And I wonder how, you know, maybe a law firm owner might, what they might be able to take from that so that they can make sure that they either become a winner or that they, they keep on winning.
- [34:57]
A
So that quote specifically applies to publicly traded companies. However, it does extend beyond them. That idea was first presented to me by an investor named David Gardner who co founded the Motley Fool. And once I heard that, I kind of saw it everywhere. And that fact was really reinforced to me by this wonderful study by JP Morgan Chase which spanned a 30 year period. So what JPMorgan Chase did is they tracked 33,000 publicly traded companies over a 30 year period and tracked what was the end result for investors. Now prior to me seeing that study, I thought the odds of a company doing well as an investors were 50, 50, half of them go up, half of them go down. That was my natural inclination. That study showed that the actual odds are 2/3 of companies lose money for investors and one third of companies make money for investors. However, the amount of money that one third of companies make is so much bigger than the amount of losses that the losing companies have. And then they said, okay, well what kind of traits do those one third of companies have? What kind of similarities do they have? One Thing that David Gardner identified is that a trait of winning investments is that they were already winning investments and that the winning companies, the best companies, stay ahead and keep on winning. Where losing companies, companies with a history of losing, losing for investors, losing market share, they tend to keep on losing just within the last 10 years. A great example of this is Nvidia 5 years ago Nvidia was winning. It was a huge winner since when it came public. And yet if you bought Nvidia five years ago, that winner kept on winning. Microsoft kept on winning, Apple kept on winning, Amazon kept on winning. But in their stead, there is a whole bunch of losers out there that went down from their ipo, were just losing companies and they have kept on losing or even gone bankrupt. So if your first criteria, if, if you first criteria for picking a business was is this business already successful? I think that just having that single criteria as a first mark will dramatically increase your win rate.
- [37:24]
B
You know, that's interesting. I didn't know about the 1/3, 2/3, that's, that's really interesting. But it makes me think a lot about like employees and how the good, good employees keep on winning. I wonder, whenever you're looking at companies, do you assess it? Do you go that deep when it comes the actual personnel?
- [37:40]
A
To a point, yes. When I'm assessing a business on my checklist, there are four things that I check for from a, from a management perspective. So number one is who is in charge? Who is the CEO? Best case scenario, it's the person that founded the company. It's the person that has been there since day one. The reason why that is such a good sign is that person has soul in the game. That person has given up a tremendous amount of their life to make this business work. And if you're the type of person that founded a company and got it all the way to being publicly traded, you have all the money you'll ever need in your life already already, right? But if you're still working at a company, why would you do that? Because you love winning and because you love the business. Moreover, founders often have their best friendships and relationships through the business. So they care about the long term health of the business. The same way a small law firm cares about its employees. Right? It feels like a family. So the founder of the business treats the business differently than a hired gun CEO that wasn't there from day one, going through all the trials and tribulations to get it off the ground. So number one, who is the CEO, who is the founder and hopefully the Same person. If they're not the same person, I like to see, well, has this person at least been at the company for five years? Because again, I want that person to have personal relationships with the employees and to really care about the people that they work with because that makes them act differently than again, if they weren't. A real simple analogy. How do you treat your home versus how do you treat a hotel room? Right. You want somebody who works at their home, not that works in a hotel room.
- [39:35]
B
Yeah, that's, that's, I love that. I do find it interesting how much you look into this and it's so much deeper than just looking at something, seeing, like looking at a stock, okay, where was it, you know, three years ago? Where is it now? There's, there's so much more to it, which I think is really, really, really cool.
- [39:51]
A
So that's thing one. So do they have soul in the game? Do the numbers or their tenure indicate that they actually care about the long term viability of the business versus a hired gun that's just trying to maximize their paycheck? Number two, inside ownership. How much of the business do the insiders own themselves? I like to see at least 5% inside ownership for a smaller business. And if it's a larger business, I like to see at least $10 million of ownership for this, for the CEO. So that, that again helps to indicate that they will make more money when the stock goes up and they will get hurt badly if the stock goes down. Doesn't guarantee the stock will go up or down, but it does guarantee they're going to get hurt just as much as I am.
- [40:39]
B
Yeah. So they're going to keep fighting because they, they don't want to feel the pain. That is, that is great. Before we run out of time, I want to, I want to ask you a little bit about maybe some personal investing advice because I mean law firm owners, the vast majority of our listeners are small to mid law firms. And so they're, you know, like personal and professional. Their, their businesses are almost like their, their little personal babies. So it's, it's so intertwined so much and I want to get into that a little bit. But before I do that though, how do people, if they want to reach out to you, how do they follow you, how do they get in touch with you? And if, if you want to give the link to your, to your book, I know you've got the online book or just plug whatever you want, but what's, how do people get in touch with you?
- [41:16]
A
Sure. So I'm pretty much on every social platform. My name is Brian. For all the F, E, R, O L D I. If you're on YouTube, I'm there. If you're on TikTok, I'm there. If you're on Instagram or X or whatever social platform you're on, just search my name, you're bound to find me. And my direct messages on every platform are open. If you do want to email me, it's brianongtermindset.co. my company's called Long Term Mindset.
- [41:39]
B
Love it. And definitely check out your YouTube channel because it's, you've got, you got a lot of followers there. But you, you and your partner both have quite a few videos that you do a really good job of explaining things. But I would. For anyone that's listening, follow Brian because it's. The content you put out is really, really cool. It's just you're, you're doing things that no one else is doing. So I think, I think it's really, really good. But.
- [41:58]
A
Well, thank you. I super appreciate it.
- [41:59]
B
Absolutely. But so the, the last, you know, I guess, couple questions I want to start with, you know, personal, maybe some personal investing advice that, I mean, because, I mean some of our, our listeners are, you know, brand new, attorneys are a little bit younger, but some people are in, you know, kind of like middle of their career. So I wonder what, and I'm guessing that your advice might be a little bit different to each one of those, but are there any general principles that people could follow that are pretty sound when it comes to investing?
- [42:23]
A
Absolutely. To me, the first step of investing is always the same, whether you're 20 or you're 70. Step one is educate yourself. Know what the heck you're investing in, know why you're making that investments, know what risk you're taking on as an investor and know what the potential upside is. So many people make investments because of something they hear on CNBC or their friends said it was a good idea or they hear about some cryptocurrency that's going to be coming out that some celebrity is endorsing. To me, if you can't explain what the thing you're investing in is and why that asset should increase in value, you haven't done enough work. You are literally taking the capital that you put your life force into. When you work, you create excess capital and then you're putting that at risk somewhere. You need to be fully aware what risks you are taking on when you put that capital out there. Now there are ways to be a low risk investor and there's a way to be a very risky investor. There's no right or wrong way to invest. There's only the right or wrong way for you. But to me, step one always the same. Educate yourself. Make sure you know what you're investing in before you do it.
- [43:34]
B
I love it if there are if there's one. And hopefully it's not the one you just gave. But I do wonder if, and this will be my last question, if our if our listeners were going to take and implement one piece of your investing wisdom into, let's say, either their business strategy or their own personal investment strategy when it comes to wealth building, what would it be?
- [43:55]
A
I mean, the name of my company is Long Term Mindset, so I like to say think long term. The number of choice that you should take in life always becomes obvious when you change the time frame in which you're looking at it. If you're going to be a lawyer, you are in the game for the long term. So optimize for long term relationships and long term success, not short term relationships and short term success.
- [44:19]
B
Thanks Brian. Really appreciate your wisdom on this and thanks for coming on and explaining. I know we covered a few different things, but really, really appreciate coming on and anyone one hopefully any of our listeners that are listening, they'll follow you. But I really appreciate it. Thanks so much for coming on.
- [44:31]
A
Thanks for having me. Tyson. It was awesome to be here.