As background, Tonnie learned how to bake cupcakes from his mom and started a business baking them in 2006 in New York City. Initially things went well for the business as it won accounts with Macy’s and Bloomingdales. It even expanded to three stories. Unfortunately, Tonnie is a bad manager and as a result lost his big corporate customers and was forced to shut down two of the shops. When Marcus arrives there’s only one shop left and it’s swirling the drain. Will Marcus be able to save it? [Cue dramatic music]
While cupcake shops are a dime a dozen business idea what catches Marcus’s attention is that Tonnie has an earth shattering new business model to launch if he can only find enough money to do it with: Build Your Own Cupcake! Think of Subway but with cupcakes instead of sandwiches. This is not exactly a patentable idea.
“In business, I look for economic castles protected by unbreachable ‘moats’.” -Warren Buffett
By the above quote, Buffet means that you need to look for a business that is highly likely to still be in a strong position ten years later due to enduring competitive advantages. These advantages form the moat that protects the castle (i.e., the business). The problem with these tiny low barrier to entry cupcake, donut, muffin, and/or pie type businesses is that there’s no way to build a moat. If the build-your-own-cupcake fad takes off every shop will be doing the same before the craze finally dies off in six months.
As Marcus observes, there’s no work flow. Everything, including equipment and inventory, is strewn about the place. There’s also no quality control with the result that many cupcakes come out of the oven in unsaleable condition and have to be thrown out. What helps to keep the business going is free labor from family members and very cheap labor from others.
Visually the shop’s a disaster and eye-sore.
The store, according to Tonnie, sells about $500 per day but no one knows the gross margin. The shop has twelve employees. 30 days X $500 = $15,000 in gross revenue per month. Yet the shop has twelve employees? Even if most just work a few hours a week it’s tough to see how this place stays open.
On top of all that, Tonnie’s wife, Erenisse, has personally sunk $250K into the shop but has reached the point where she’s unwilling or unable to sink in another dime.
Marcus does a quick calculation and concludes that it’s operating at a loss. No kidding.
Then at the sit down in the restaurant we discover that the business owns a huge amount of money ($134K) to both suppliers and various individuals, including loan sharks. Long-suffering Erenisse went into shock.
Marcus should have walked at this point.
Despite the huge financial hole the business is in ($134K + $250K), bad management, and an easy as pie concept for competitors to steal, Marcus decides to put in an offer. He offers $100K to pay off some of the debts and use the balance to redo the shop. In return he wants 20% of the business. I was surprised by how Marcus was skimping here. Normally he puts in much larger amounts. There was probably a part of his mind screaming “Noooooo, don’t do it!” but then he does have a show to produce after all.
Tonnie then confessed that he had been hoping for $600K for 33% of the equity.
They finally agreed on 25% for $125K with the additional $25K used to pay off mom and the loan sharks.
Small Business Growth Strategy for Tonnie’s Cupcakes
Marcus put a stop on Tonnie’s plans to open up a second location with part of the capital coming from the developer as a loan and no mention of where the balance would spring from. As with all of Marcus’s small business growth strategies, you need to get the first location just right before you start cookie-cutting it.
Marcus also informed Tonnie that the operation would no longer bake its own cupcakes because the baking part would be subcontracted out to a much larger bakery which can do big volumes and cut their per muffin costs by 18%.
After the new shop had been open for a while it was averaging $1500 per day in sales with $400 as profit.
In the end, Tonnie also proved himself to be a good salesman which is extremely important for any entrepreneur to be. Marcus now just needs to find him a good COO/CFO to take care of the operations and numbers.
I have to admit that the happy ending caught me by surprise as I had been expecting the project to implode over a clash of egos.