As we continue our deep dive into the world of investments, I’d like to talk about an investment strategy that you may not have considered as a business owner. Because of the fact that I’m a business strategist, you might be surprised to hear me say I recommend NOT investing in your business… at least not solely. Although it may seem counterintuitive, you should be investing in assets that are outside of your business. Join me as I explain why investing in your own business may not always be the best long-term strategy.
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When I was first starting in the business world, my brother and I were running a very successful landscaping business. I was eighteen years old and clearing well over $100,000 per year in income. Looking back, this may have been the beginning of my loathing of corporate Wall Street. You see, I decided that I wanted to take some of my hard-earned money and invest it in the stock market so I went to a broker at one of the large financial planning firms. Here I am, eighteen years old, operating my own business, and making more money than probably 90% of kids my age and this broker looks at me and says, “Come back to me when you’re more successful.”
As my daddy used to say, “that chapped my hyde.” You see, most of these corporate Wall Street types don’t truly understand business. They don’t get that you and I could net a larger return, — most of the time — in a proportionate amount of time, by keeping those funds within our business than we can by investing in stocks. And, since that’s the case, why do we continue to invest outside of our business?
As a business owner, chances are, you’re not too keen on the idea of just handing some investment person your cash and simply trusting them to handle it properly. Just because they are professionals that work within that particular market doesn’t necessarily mean that they are going to know what’s best for you and your business. However, there are many reasons for investing outside of our businesses but I want to take a look at some of the statistics surrounding the liquidation of or selling of a business.
First, there are three basic market categories that your business will fall into. The majority of businesses live within the micro-market. These are businesses with annual revenue of $5 million or less. Next, we have businesses that produce $5MM to $100MM and they make up the middle market. Finally, we have the upper market which is where the giants of industry — McDonald’s, Apple, Coca-Cola, etc, live. Companies in the upper market receive revenue of $100 million or more.
According to the Exit Planning Institute, 80% of businesses will never sell. That means that for every ten people reading this, only two of them will be able to sell their businesses. Now, here’s the concerning part of that statistic, 80% of business owners’ net worth is tied up in their business. Therefore, when it comes time to retire, eight out of ten business owners are going to find themselves losing 80% of their worth.
If you’re thinking, “Well Justin, that number is probably skewed by the fact that many business owners don’t want to sell their business. However, out of the 351,000 businesses in the middle market, 250,000 — nearly 75% — will attempt to sell by the year 2030. Furthermore, it is anticipated that only 25,000 of that 250,000 will be deemed market-ready when they do.
When we continue to follow this thread, the picture grows even direr. A mere 15,000 of the 25,000 will actually sell. Half of the companies that sell will do so without concessions. Therefore, just 3% of business owners will make The Ultimate Sale in the next eleven years.
Looking at the numbers, it is pretty clear that many of us will be left unable to sell our businesses when we wish to exit. Sure, there’s plenty of ways that we can increase the value of our business and make it more attractive to investors and potential buyers but we need to also prepare ourselves for the possibility that our companies won’t sell. Does that mean we shouldn’t focus on growing our business’ value? Absolutely not. Increasing the value of the company has benefits and merit regardless of whether or not your business will sell. So what do we do to prepare for a future that doesn’t go according to our best-laid plans?
When we began this article, I asked why business owners should invest in assets outside of their businesses. The answer is that we need a plan B. We have to eliminate every risk in our path and therefore, we need to have a backup plan in place. Look, I’m speaking from experience, folks. I’ve owned and sold three businesses in my lifetime. I currently own three businesses and I’m working on opening a fourth business right now. If I didn’t put that plan B into place and all of my businesses failed, I would be like so many business owners that have come before me. I would be broke and desperate.
These are the owners who become enslaved to their businesses. They don’t spend time with their families and they merely exist, rather than living their lives. I don’t know about you, but I don’t want that for myself or my family. I don’t want that for my business or for the team that I’ve put together to operate it. All of this is why we should invest in assets outside of our businesses. We don’t want to be stuck with all of our eggs in one basket.
We have a lot of chickens on our farm and I promised my sweet wife, Emily that I would build us a new chicken coop. So I’m slowly but surely putting this coop together. However, we still have to collect eggs in the meantime. During the summer it wasn’t uncommon for us to have 60 eggs per day. As a result, I’ve given my son, Jude, the responsibility of collecting the eggs each day.
Recently, while collecting the eggs, Jude tripped over the water hose and all of the eggs he’d just collected shattered. This was a valuable lesson for Jude. He learned the value of not putting all of your eggs into a single basket. In investment terms, we call that diversification. This is a principle that applies to our cash, our shareholdings, our businesses, and our properties.
We need the safety net of diversification so that, as.business owners, we don’t have all of our eggs in one basket. The last thing we want is to trip over the water hose and watch as our eggs go crashing to the ground, leaving us with nothing to eat. It may sound dramatic but if you really think about it, our businesses are literally putting food on our tables. If those businesses suddenly ceased to exist, we would find ourselves in a pretty awful situation.
By now, we understand the need to protect ourselves through diversification. So I’ll leave you with this one final thought and example. We can do things with investments that are outside of our businesses that we just can’t accomplish otherwise. Think about it. By investing a portion of our profits into retirement accounts, we may be investing our most tax heavy money to greatly mitigate our tax burden.
RELATED READING: Small Business Retirement Plans Comparison – Picking The Best Fit
Let’s assume you’re in a 27% tax bracket. If you pay yourself first by investing funds into your retirement accounts, you effectively remove the funds that you’ve invested from the 27% tax burden. By removing the highest taxed funds, we could possibly move ourselves into a 15% bracket. Notably, you may also reduce the tax burden on the funds that you didn’t place into your retirement accounts, by 12% or so. I have seen tax reductions through proper investing provide an instant ROI of 30%-70% just because of the tax effect. It’s pretty uncommon to see that type of return on investment by simply putting the funds back into your business.
Life is hard, life is good, and life can be frustrating. Money doesn’t have to be. Let’s continue to make our lives at least financially simple.
Get the most out of the Investing segment by following along with our Personal Finance for the Business Owner series.