I met a small business owner a few weeks ago …
He was a smart young guy [AJC: aren’t they all?] who was setting up his own Internet design studio, building Internet-based software projects for other business owners.
His business is essentially a professional service business, and my advice to him was pretty much the same as I give to all professional service business owners (consultants, accountants, attorneys, doctors, etc.):
Except in rare circumstances, you don’t have a business, you have a high-paying job … with perks!
[AJC: the perks are around the tax benefits that attribute to business owners but not to paid employees; ask an accountant for examples.]
Most of these kinds of businesses don’t scale very well i.e. they can’t grow very large; they rely on the owners’ personal exertion (sometimes called ‘partners’); and, either can’t be sold, or can only be sold for small multiples of annual profit or turnover.
In short: you can’t rely on selling these businesses to fund your retirement.
But, what they do generally provide is income …
Because they are professional services, the owners are able to sell their own labor – and, those of their employees – at high multiples, usually generating excellent recurring revenue.
And, because they often take years of hard work and relationship building over many, many clients they can be quite “bullet-proof” (if well managed) in terms of providing that income reliably.
This was certainly the case for the young guy that I met.
Even though his agency was still quite young/small, it was already generating a nice income and showing signs of growing well.
My advice for him was to grow his personal income very slowly (this is advice that I would give to any business owner), and to pull as much money out of the business as possible (this is not advice that I would give to other business owners) …
… my advice was to treat the business as his personal ATM
[AJC: but not to the detriment of the business, or his partners, employees, clients, backers, etc.]
But, my advice was not to spend that ATM-cash on personal lifestyle building (homes, cars, vacations, etc.), but on passive investments.
I recommended that he use that cashflow to fund an aggressive investment portfolio, outside of his business: one that would one day grow to replace his personal income as generated by the business.
When the day comes that his passive income surpasses his personal business income, he becomes free.
What would you advise?
I agree with what you say, but I would also advise him to begin to multiply himself, by developing his leadership and management ability (unless that is something that he doesn’t like doing.)
Then to employ people who have skills similar to his, but not the entrepreneurial instinct – and you would be amazed at how many of those there are out there.
At first, he’ll continue doing his current job, whilst coaching few understudies. After a while, he’ll maybe have about twelve people, and he will only be managing. Then he can select two of his understudies, to start teaching them how to each manage a group of people – and so on.
Admittedly, salaries in this model is a massive expense – but in my experience, if you deliver a good service, you can still “sell” your “product” (people’s hours) at a factor of about 2.5 times what you pay them. Typically of that 2.5, 1 is their salary, 1 is overheads, and .5 is profits for the business. If you’re a sole proprietor, or even if you have some partners, it can become good money.
We used that model to buy such a unit out of a larger business – which gave us a small business of about 20 people, using a combination of bank and self-financing. We grew it to about 80 people in four years. We then sold it for much, much more than 4 times what we paid for it, and (lucky for me) the guys that did the deal locked it into a trust, which gave us an even bigger boost when that larger company sold again, to an even larger one.
Two sales later, and I’m a millionaire. (At least on paper – the money is still in the trust for now 🙂
But the point is that you can take a professional services business, grow it, and sell it.
@ Ashton – That’s great advice, and exactly what makes professional services firms so attractive (otherwise, you are merely self-employed).
In fact, this is what he is already doing (and, has a number of staff/contractors working for him) … not bad for such a young guy.
However, what’s typically missing from these types of businesses is: goodwill i.e. the ability to sell the business for more than the existing income stream is worth.
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