Because I joined the equities business a year before the 2000 dotcom bust, I’ve always been a little wary of stocks as a source of long-term wealth. It was crazy to witness so many people go from having millions to zero in a matter of months. Where does all the wealth go?
The irony about my suspicion is that I firmly believe the only way for someone to reach “next level wealth” is if you build enough equity in your own business. Unless you make Managing Director at a major financial firm, Partner at a big law firm, or get hired as a Senior VP at a large tech company, it’s very hard to get really rich through a day job.
Therefore, the best way to reach next level wealth is to not only build a business, but to make your business LAST for as long as possible.
Making Your Business Last Forever
Netflix killed Blockbuster. Amazon killed Circuit City and a bunch of other businesses. Redfin is slowly squeezing real estate commissions to death thank goodness. Every single business has a life cycle. If you don’t constantly reinvent your business, you will die. If you believe your business will die despite your best efforts, you should sell.
Part of the reason why I like converting long term profits in the stock market into real assets is because I’m always paranoid that nothing lasts forever. Instead of seeing my profits turn into losses, like I’ve seen so many times in the past, I might as well lock in some profits and convert them into something that will last e.g. a new $55,000 master bathroom from a DJIA investment made in 2012.
I know my master bathroom will last for at least 30 years. Sadly, the same cannot be said for most businesses, which is partly why index investing is the predominant way to go. Besides, there’s no point investing money if you don’t one day take profits to use for a better life.
I’m not sure how the online publishing business will evolve over the next 10 years. My business could very well die a sad death. The only thing I can consistently work on is building a strong brand that will allow me to pivot to something new when the time comes. Financial Samurai drinking water anyone?
Let’s say everybody stops reading independent personal finance sites that are written by financially independent authors who spent their career in the finance industry. Instead, people decide it’s more beneficial to get financial advice from entertainers due to their good looks. Well crap! I’m SOL since I’m not much of a self-promoter. What is a blogger supposed to do?
If my business or your business is faced with a structural decline, we must CHANGE the composition of our respective businesses. But instead of converting profits into a bathroom that produces no income, a business should consider buying income producing assets.
The only income producing asset I know of that has a high degree of certainty for lasting a long time is real estate. Let’s do a mental exercise.
There’s no restriction as to what type of business you must operate, especially if you run a privately held business. See this comment from an entrepreneur reader:
My growing company was recently valued at $3m but my business partner and I each making over $500k a year (and I’m only working an easy 20-30 hours a week). Why would I ever sell?! In reality my equity will end up being sold to some valued employees. I don’t see selling to an outside party. Plus we own the commercial building (in a separate real co and renting it to our operating co) and are building a nice asset (equity just passed 50% of value).
Thanks FS – I agree (DON’T SELL YOUR CASH COWS!!)
Do you see the nugget of wisdom in this comment? The reader structured his business into two separate entities: 1) a real estate company that owns the commercial building, and 2) his operating business that pays rent to his real estate company! This way, he recycles all his profits within his business empire while taking advantage of tax shields through non-cash depreciation expense. Further, he rests easy knowing the landlord will never kick him out, unless he turns schizophrenic.
Let’s see how this business works with some numbers.
Real Estate Company Rental Revenue: $120,000
Real Estate Company Commercial Building Value: $2,000,000
Annual Non-Cash Depreciation Expense: $100,000
Operating Expense: $20,000
Operating Profit Before Taxes: $0
The actual cash flow from Real Co. is $100,000 while he gets to pay no taxes and see the value of his real estate holding(s) grow over time.
Operating Company Revenue: $1,500,000
Office Rent: $120,000
Operating Expenses: $380,000
Operating Profit Before Taxes (distribution to two partners): $1,000,000
Plus $100,000 in net rental income = $1,100,000
Because this entrepreneur’s business needs to rent office space anyway, they decided to buy a commercial office building in order to charge their operating company rent.
If you own commercial buildings in superstar cities like San Francisco or New York City, there may come a time when the value of your real estate holdings SURPASSES the value of your operating company itself! Let’s look at a real example in San Francisco below: Lombardi Sports.
The owners of Lombardi Sports bought a 50,000 square foot building in the prime Russian Hill neighborhood to house their store in 1993 for several million bucks. They had a great run, but selling sporting goods slowly started to lose its edge due to the rise of e-commerce. As a result, the owners decided to sell the building to an investor.
“After a while it got to the point there were more lucrative things for the family to pursue,” said Steve Lombardi Jr. “We were working twice as hard for half the money. This was not a whimsical decision; our family has been in business in San Francisco since the early 20th century.”
I heard the sale of the building was for more than $25 million in 2014. Not bad at all, especially since Sports Authority went bankrupt in 2016. Instead of completely getting squeezed, the owners were able to capitalize on their business’s most valuable asset: real estate.
I’m sure the owners liked the idea of owning their building in order to control costs and have maximum stability, just like a homeowner does. But I don’t think they forecasted their real estate holding would become a gold mine. Wholefoods plans to move into the space and charge $10 for an organic apple in the near future.
Buy Lasting Assets
Although I run an online media company, I’m considering buying real estate with the company’s retained earnings. First I’ll start with an office building since I need somewhere to type my magic. Then I’ll rent out the remaining 98% of space since I don’t need that much space to type my magic!
Slowly but surely I’ll buy more and more real estate to build a rental property empire under Financial Samurai Incorporated. Perhaps one day, rental income might equal online media income (doubt it). But given the disconnect in valuations (SF real estate valuations are much higher than online media valuations), I might be able to raise my final company valuation multiple if I ever sell. Talk about forward thinking!
By actively turning online media funny money into real assets, I’m basically ensuring my company will be worth at least the value of the company’s real estate holdings (book value). I’m also elongated the lifespan of my company forever. If real estate inflation continues to grow the way it has in San Francisco over the next 30 years, I will create some serious next level wealth for my children.
Plan. Execute. Predict. Diversify. Don’t stay complacent because things are always changing.
Business owners, have you actively used your company’s operating profits to buy real assets? If so, how has that turned out? Do you know other examples where the value of the company’s real estate holdings makes up the majority of the company’s value? Are there any other hard assets with lasting value a business owner should buy? Any tax accountants want to poke some holes in this business longevity extension plan?