Even before the previous Presidential Administration lowered corporate tax rates to allow U.S. companies to be more competitive domestically and internationally, the smart business owners already knew to reinvest their income back into the company instead of taking out high, current, taxable income.
Dr. Thomas Stanley wrote years ago The Millionaire Next Door in which he explained how true wealth was not found in the neighborhoods of large homes, small trees, and BMWs in the driveways. These communities contained substantial debt and nightly spending arguments between husbands and wives. Real wealth and independence were found in neighborhoods with small homes, large trees, and early model Buicks in the driveways.
The homes with Buicks were inhabited by the owners of Sammy's Heating and Air, Tommy's Auto Body Shop, and Susan's Premier Staffing Agency. These business owners had built value into their corporate entity, as well as saved significant dollars in defined benefit plans, deferred compensation plans, and second-to-die whole life insurance policies. These people had real walk-away, liquid, tax-favored money for whenever they chose to move onto the next adventure; and they had worked their buns off and deserved every dime.
If we choose to maximize our short-term income, we will be taxed at the highest rates, not long-term capital gains rates, and we will likely increase our standard of living to match however much income we bring home. Children psychology studies conclude that lower IQ children will choose 2 M&M's now instead of 5 M&M's in five minutes, while higher IQ children will forego instant gratification in anticipation of a much greater reward. They must innately understand at an early age the power of tax-deferred compounding, which even Einstein labeled, "The 8th Wonder of the World."
As entrepreneurs building our Special Companies, we must find our comfortable monthly income level for our family, and then fix that number and decide to, at least for a while, reinvest all surplus income back into growing the value of the company. In the year 2000, I pegged my monthly take home pay from our companies, and even though our revenue increased significantly over the next ten years, I reinvested all of this extra income back into acquisitions and personnel which greatly increased the enterprise worth of our businesses.
But we must understand how to increase our company's marketable value far beyond the simple math of revenue and earnings multiples. I always like to reference how IBM acquired Red Hat. The acquisition of Red Hat only added 4% additional revenue to IBM's financial statements, but IBM paid in cash $33 billion for Red Hat, which equaled one-third of the total value of IBM. 33% for 4% more revenue! Is IBM crazy or brilliant? We will see. But how can we make our organization extremely valuable, even outside the numbers, like Red Hat:
1) Maximize intellectual property (IP) which includes patents, copyrights, and trademarks. So often we miss this opportunity to add value by protecting our long-term reputations and achievements, and by even re-licensing this property to others (Google "three-peat").
2) Build recurring revenue instead of a transactional business. If you have to wake up every day, every month, and milk the cows, you will be valued much lower than the organization which milks them automatically. In the investment world, firms whose revenue is generated by quarterly asset-based fees are valued substantially higher than firms which rely on transactional brokers.
3) Ensure the company can eventually run without you, and not miss a beat. In my book, Building Special Companies, I recount the month in which I took a sabbatical from the business for this very purpose and to re-charge my batteries. Not only did the organization not miss me, but they also elevated their game and accomplished so many tasks of which they believed I might object. They were brilliant, and our value stepped to the next level.
4) Work on consistency of earnings. If your income is all over the map due to contracts won and lost, lawsuits, or windfalls, a buyer will greatly discount your expected future earnings, thus lowering your current value (Net Present Value - NPV). This is why Microsoft, Apple, and others have always been accused of artificially "smoothing" their earning. This gives their stock a higher valuation.
5) Monetize your brand and your followers. Our investment firm was valued higher because we had the honor of servicing over 3,000 clients who mostly utilized our firm for three or more services: planning, portfolio management, insurance, mortgages, wills & trusts, and more. Psychologists claim that once a client utilizes an organization for three separate services, their retention rate is nearly 100%, as it is too much trouble to transfer all of these relationships. Maximize the Twitter followers, the blog subscribers, and all of the people you may influence. Be an influencer!
Building your valuable organization, I want you to begin with the end in mind. Forego the 2 M&M's and position your company to be so much more valuable to a strategic buyer who will take advantage of the substantial value you have built. I mean, really, how many Teslas do you need?
"If you want to change the world...don't back down from the sharks." - Admiral William H. McRaven, Make Your Bed
