Creating next-level wealth is all about next-level thinking. When you first graduate from school, you may have a desire to make six-figures a year. Then once you make six-figures and get taxed out the wazoo, you start wondering how to create next-level wealth.
Next-level wealth is based on net worth, not income. Earning a top one percent income is nice, but paying over a 40% marginal federal + state tax rate isn’t.
If you want to create next-level wealth, your goal should be to create as much equity as possible that is never sold.
You can build as much wealth as Jeff Bezos so you can laugh at all of us peasants trying to make ends meet during a global pandemic! You and the next 100 generations of Bezoses would become untouchable.
The Desire To Create Next-Level Wealth
Ever since I was a kid, I’ve wanted to become rich. I saw so much poverty growing up throughout Asia that it made me scared to be poor.
In Malaysia, when I was in middle school, my poor friends lived in a studio with their parents and siblings. They subsisted on one or two simple meals a day as their parents worked multiple jobs to make ends meet. My rich friends lived in mansions in the hills with chauffeurs. Their parents were all business people. It was such a different world.
One of the luckiest things I’ve ever done was not sell any major assets during the downturn between 2008 – 2009. It’s understandable to panic sell when things are crashing and burning.
It’s also easy to sell in a down market when you have a major life event e.g. losing your job, having a baby, etc. But fortunately, many of my investments were either illiquid (real estate) or were locked up with long vesting periods (private funds). Even if I had wanted to sell, I couldn’t have!
Just like how the 2008-2009 downturn jolted me into trying to build more wealth, the current 2020-2021 downturn is doing the exact same thing. These painful periods are often the most motivating to build next-level wealth.
Hang On For As Long As Possible
There was a period of time during the 2008 – 2009 bear market when several personal finance sites sold for between $1 – $4 million. Although $1 – $4 million is a lot of money in absolute terms, based on the cash flow, the acquisition prices were all absolute steals.
For example, one guy with an operating profit of about $700,000 a year sold his site for only $2,500,000. You’re not even a real millionaire at $2,500,000 thanks to inflation. If you have a partner, then you’re definitely not a millionaire because you’ve got to divide the after-tax proceeds by two.
To generate $700,000 a year at a 8% rate of return requires $8,750,000 in capital. At a more conservative 4% rate of return, you’d need a whopping $17,500,000 in capital to generate $700,000 a year!
It’s hard to say someone making $2,500,000 got robbed, but robbed he was. If he had held on for just 3.6 more years, not only would he have made a total of $2,500,000 in operating profits, but he would still own a site making $700,000 a year or more for the foreseeable future.
To build next-level wealth, you’ve got to hold onto your equity for as long as possible.
Related: Why I Regret Selling My Site For Millions
Think About Your PayBack Period
The payback period is the length of time required to recover the cost of an investment. In the site sale example above, if the buyer can maintain his operating profit level, he’d recover his full $2,500,000 investment in just 3.6 years. 3.6 years is his payback period.
All money earned after the payback period is 28% a year gravy. Earning 28% a year for a decade will make you rich.
Let’s say the buyer has some hustle and expertise. He could conceivably grow operating profits from $700,000 in year one to $850,000 in year two and $1,000,000 in year three.
In this scenario, the buyer lowers his payback period to 2.9 years AND could sell the site for $3,600,000 (44% more) based on the same pitifully low multiple of 3.6X operating profits ($1,000,000 operating profits X 3.6 multiple).
But since 2009, something magical has happened. Valuations for media companies and the entire S&P 500 expanded by ~100%. See the chart below.
When the site owner sold his site in 2010, the S&P 500 was trading at 15X Cyclically Adjusted Price to Earnings (CAPE). Now valuations are at around 30.5X.
A 100% increase on a 3.6 multiple equals 7.2X. Let’s do some math and find out how much the person who spent $2,500,000 on a site back in 2010 has made so far!
This is a perfect example of how one person can create next-level wealth through equity.
Investment Returns Scenario For Next-Level Wealth
2010 Investment: $2,500,000
Business Operating Profit: $700,000
Estimated Payback Period: 3.6 years
Forecast Operating Profits
Year 1 Operating Profit: $700,000
Year 2 Operating Profit: $850,000
Year 3 Operating Profit: $1,000,000 – Everything paid back in 3 years
Year 4 Operating Profit: $1,000,000
Year 5 Operating Profit: $1,000,000 – Keeping OP flat to stay conservative
Year 6 Operating Profit: $1,000,000
Year 7 Operating Profit: $1,000,000
Year 8 Operating Profit: $1,000,000
Year 9 Operating Profit: $1,000,000
Year 10 Operating Profit: $1,000,000
Total Operating Profit Over 10 Years: $10,000,000
Percentage Return If Not Sold: 400% ($10,000,000 / $2,500,000 investment). Not bad! The owner will continue to make $1,000,000+ a year in cash flow.
But because valuations for online media properties have increased by 100% since 2010, the buyer can now turn around and sell his $1,000,000 a year operating profit business for $7,200,000 based on a 7.2X multiple instead of a 3.6 multiple.
Total Return After Sale: 680%. $10,000,000 operating profits + $7,200,000 sale price = $17,000,000 divided by $2,500,000 purchase price = 680%.
Now imagine if the business grew operating profits to $2,000,000 before selling, instead of keeping operating profits flat for all 10 years. We’re talking a total return of over $30,000,000 from a nice little lifestyle business.
Compared to the measly $2,500,000, having $30,000,0000 is some REAL F YOU money. Compared to the returns of the S&P 500, there is really no comparison.
You can either buy a business or build your own. Why not do both?
Don’t Be Tempted By Short-Term Gains
To create next-level wealth, you must have patience.
Now obviously an investor might be stupid enough to drive a newly acquired business into the ground. But most people who spend $2,500,000 have enough smarts to make sure they hold operating profits at least flat to reach their base case payback period.
Large absolute dollar amounts are enticing to business owners. But they are dangled in front of you because you have something even more enticing for the buyer! Never forget the rationalness of finance. In our permanently low interest rate environment, please do not sell your cash cows.
If you can buy a cash generating business with a payback period of less than five years, you should get excited. Your investment essentially becomes risk free after five years. It will then make a 20% return into perpetuity. A 20% return is a home run compared to a historical average 8% – 9% S&P 500 return.
If you believe you can increase operating profits after acquisition, then you should get pumped. Finally, if you believe there will be valuation expansion on top of business growth, you should go all-in.
Creating Next-Level Wealth In Real Estate And Products
Two of my favorite ways to build passive income is through real estate and creating your own products.
Below is a chart showing how much capital you need to have to generate $55,000 in net rental income and $20,000 in revenue with a product at various interest / return rates.
Notice how the lower interest rates go, the more valuable the real estate and product becomes. With the 10-year bond yield below 0.7%, the value of these two types of cash cows have gone way up in the new decade!
Is there any wonder why the demand for real estate is so strong? When you can create your own products with minimal up front costs, it must be done if you want to build more wealth. I’m personally going to create a new book to be published next year.
Profits + Equity = Next-Level Wealth
There’s a reason why so many of today’s wealthiest people are entrepreneurs. Not only do they create businesses that generate revenue, they also own equity that can be sold for multiples of annual revenue or earnings.
Most day jobs don’t build equity. When it’s time to go, workers are left with nothing because they are no longer contributing their time. There is no leverage in only being a laborer.
Of course, sometimes you do get equity and your equity doesn’t go anywhere. For example, you may have joined Uber in 2015 when the company was valued at $51 billion.
Today, Uber is still valued at about $51 billion. This is despite employees accepting a lower salary for all these years. But at least you have a chance to create next-level wealth through equity ownership.
Best Ways To Create Next-Level Wealth
1) Build a business
I encourage everybody to build a business that also grows a strong brand. I’m talking about many types of businesses, not just a website business. With a strong brand, you can pivot more easily as the world changes. With a strong brand, you can command higher prices and take more marketshare.
Making money from your day job is fine, but you’re slaving away making someone else who owns all the equity rich. Even if you are at a startup with equity, just know that for every $1 you make, you’re literally making someone else more senior 20 – 10,000X richer. Instead, get in the mindset of making yourself rich by growing your own equity.
If you own a business, please be patient and do away with short term thinking. I still remember people mocking the founders of Snapchat for rejecting a $3 billion offer from Facebook in 2013. But unlike the peanut gallery, the founders knew that if they just sat in their seats and continued to execute, their business would be worth much more over time. Today, no matter how ridiculous the value proposition, Snapchat is worth ~$32 billion.
Yes, growing a business is not easy. But at least starting one today is. Most people never try, which is why most people will never come close to creating next-level wealth.
There are endless examples of people who’ve created something from nothing and sold it for mega millions in a relatively short amount of time.
2) Take a gamble and join a startup
Joining a startup will likely make you poorer rather than richer. Startups pay below-market salaries in exchange for equity that could be worth a fortune. But most of the time, startup equity will be worth a ho-hum amount or nothing due to startup failure. If you plan to join a startup, please sleep with one eye open.
It’s very hard to win the lottery. So long as you remember this, you are free to join a startup to seek your fortune. The earlier you join a successful startup, the more equity you will build. However, the earliest startup employees have the highest amount of risk. Therefore, please negotiate a solid equity package.
3) Become an angel investor
I also don’t recommend anybody angel invest with money they cannot afford to lose. Hitting it big with angel investing is even harder than hitting it big with a startup. You have no edge. Further, you need to invest a decent sum of money to have a large return.
For example, let’s say you invested $25,000 in a startup that returned 100X. The gross amount of your $25,000 is now worth $2,500,000. However, you need to cut the amount in half due to dilution from subsequent funding rounds. Then you’ve got to pay taxes. You may end up walking away with only $800,000. Not bad, but not next-level wealth.
4) Join a tech monopoly
You might not create next-level wealth quickly if you join a tech monopoly like Google, Facebook, and Apple. However, you will get paid way more than the average employee and receive extremely generous equity packages.
For example, Google pays 23-year-old software engineers with one year of experience around $200,000 a year. By the time these employees turn 30, they will have a median total compensation of $350,000. If you are in the top 15%, your total compensation package is around $400,000.
The Easiest Way To Build Wealth
Obviously, joining a hot startup or a tech monopoly is difficult. The competition for these jobs is fierce. Meanwhile, investing a large enough sum as an angel investor also takes guts or already having a decent amount of money.
Therefore, the easiest way to build next-level wealth is by starting your own business on the side. Work your day job and then spend your remaining hours building your side business. If you want to build next-level wealth, you must put in the extra time.
The great thing about building your own business is that it’s permission-less. You don’t need a fancy college degree. You don’t need a lot of capital. Nor do you need to be invited. All you’ve got to do is start.
If you want to build next-level wealth, you need to own equity that grows. You could get lucky by joining a Google in its nascent period. However, you don’t only want to rely on luck if you want to get really rich. Ride your company’s growth and try and increase your own luck by taking further action.
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That is a super interesting point to talk about the value of your income producing assets going up in value as interest rates go down. I hadn’t thought about that, but that is extremely powerful! I need to write an ebook! LOL.
Long time read, I appreciate all the insights – you’re the man.
Dividend Power says
Great article! Not selling during downturns is soldi advice. It’s usually time to buy at that time in my opinion., Of course volatility is hard to handle for many people.
Sport of Money says
As someone who has a hidden desire to be a successful entrepreneur one day, I find it hard to get started. I’ve started some mom and pop businesses when I was younger and made some minimal money from them. But never did I reach 6-figure with any of them. They all just went down to zero eventually.
I think there are 2 impediments to success:
(1) A lack of defined path of action – starting a business means figuring it all out by myself. It involves a lot of effort and work. I opted to spend my time building a real estate portfolio instead. Maybe in hindsight, it would have been better to spend more time on an online business.
(2) Sometimes the ramp time is long and the reward uncertain. For instance, I’ve started my personal finance blog at the start of 2019. It is a grind and is very slow in gaining an audience. I don’t earn anything from it (or try to at this point). It is certainly a challenge to keep working on it without seeing any financial reward. Money is motivating, that’s for sure. And the lack of money has the opposite effect.
Financial Samurai says
I think it’s smart that you have been building a real estate portfolio. A real estate portfolio is easy to understand, provides immediate benefits and appreciation, and can be improved upon.
It is the uncertainty of starting something with no results that puts people off. But there definitely won’t be anything happening if you never start.
MI 186 says
It would be hard to walk away from a 7 figure offer for a business but your example of the website that sold for $2.5M does make sense to hold on to for much larger gains.
There is a risk though that things could go south and you end up with far less. Think of all the businesses that Amazon and Netflix have laid to rest. I’m sure the owners of these companies would love to go back in time and cash out.
But if the income you mentioned is guaranteed for those 10 years it would definitely be a no brainer to hang on
Hugh Hunkeler says
The 2.5 Mil may make sense if:
-The business required full-time effort, and wasn’t just passive income
-There was risk of being crowded out of business by a major player. For example, the Netscape browser used to sell for (IIRC) $40. Then Microsoft used free Internet Explorer as an enticement to buy Windows, and Netscape couldn’t sell its browser any more.
Julia D says
Great article — highly relevant in 2020. Finding income streams beyond my day job is giving me peace of mind. I’m fortunate to still be gainfully employed in SF, 5+ months into COVID shutdown and layoffs. Finding other ways to make money has been a welcome distraction from the monotony of staying home in quarantine. It has given me more confidence in my ability to generate income if I were to lose my job. In addition, it’s nice to feel like you’re working towards something. 2020 otherwise is a year of stagnation, if not degeneration.
So true on the huge potential wealth benefits of starting a business. And yes it definitely takes patience and persistence. Great examples in this post. Thanks for the motivation!!
Hi FS, such a great post, I love the idea of considering how much you’d need in the bank for those same returns! *clutch*
I had thought of selling, after 4 years and losing money the first three. Now it’s growing pretty fast and there’s enough income to hire an ops manager, so I should be able to focus on growth/personal sanity. I hope, this will make my ski slope keep sloping upward or even hockey stick. The investors I talk to say I’m selling too early. They might be right.
The question I wonder if anyone else has a response to: what to do when your business is finally making decent money but you want a break for quality of life/personal sanity?
Financial Samurai says
Hire someone to do work for you I say! Half the battle is surviving for a long enough time period to see the flowers blossom.
Hah, this is true! Can’t grow if I don’t delegate. :)
Ted Hu says
What The Numbers Say About Long-Term Investments In Leveraged ETFs
– The internet is filled with articles warning people not to invest in leveraged ETFs for longer than a day.
– This article looks at common claims made about leveraged ETFs, and shows why each claim is either untrue or greatly exaggerated as it relates to leveraged S&P 500 ETFs.
– Long-term investments in 2x/3x S&P 500 ETFs can generate tremendous gains, grow with the index in a very predictable manner, and do not deteriorate to nothing due to volatility.
– You can gain big or lose big with long-term investments in leveraged ETFs. But it’s not a sucker bet, and you aren’t crazy if you do it.
Ted Hu says
Reposting from the fb page.
I’m aiming for $10MM then 100MM. My June’s 1 yr annual return was 86%. Was 90% in May.
I’m a macro investor who invests in growth sectors via 3x etfs. And a couple of moaty stocks. Thinking of newing another acct to try a new macro strat.
As Of 06/30/2017
Account YTD 1-Year
1 +38.45% —
2 +59.41%. +101.43%
3 +45.08% +84.61%
4 +36.79% +81.63%
Leveraged ETFs can be held long term provided the market has enough return to overcome volatility drag. It usually does. For most markets in recent times the optimal leverage is about 2. But some markets and time frames will reward a leverage of up to 3. No markets will reward a leverage of 4.
Tqqq last 7.5 yrs yielded over 1,725% for ex.
Granted I’ve an economist mindset since undergrad. Business cycles, seasonality, to demographics trendlines matter more then latest sensational headlines. Velocity of money accrue to growth in tech especially as boomers retire. Reading at least 5-6 hrs daily is essential. And first principles thinking and buttressing key mental models are key to success.
LendingTree just acquired another company, MagnifyMoney.com about 30 million in cash with another 10 million in earn out. It might be the time to get liquidity!
Financial Samurai says
Wow! Thanks for the heads up. I’ll have to check it out. Any idea when they started the site? I’m getting liquid by selling valuations are much much higher Then online media properties at around 29 times gross rent.
ZJ Thorne says
It will be hard, but not impossible to measure my company’s value. A good reminder that I need another that is more liquid.
Lendingtree just bought a Bank account comparison site for $33 million, the space is heating up. They also bought a Credit card comparison site for low 9 figures last year. Been a lot of shifts in financial marketing/advertising as things become more digital. I’ve seen a lot of digital assets trading at ridiculous multiples, the only reason I can gather is that these assets are difficult to scale, but given where the stock market is, I’ll take a 3x multiple all day on a quality digital asset.
Financial Samurai says
Do you know the names of these two companies? LendingTree stock is on FIRE! Higher equity valuations mean more firepower to acquire.
Might have to take advantage and set up some conversations :)
While I generally agree with your overall point (although it depends on personal circumstances) and fully agree that a 3.6x multiple is ridiculous for a stable or growing business, I do think your analysis is incomplete.
To truly assess the decision you should assume the seller takes the $2.5M and either invests it in a new business or at minimum the S&P 500 for the course of time from sale date until the end of your comparison. You can’t compare $13.5M to $2.5M. Perhaps this entrepreneur took the $2.5M and used it for a business that he needed funding for and is now worth $20M?
Again, I agree with your point on the exit multiple being bad, but make sure you compare apples-to-apples to account for the time value of money.
Steve Poling says
i think this is one of the most inspirational (maybe i should say aspirational) posts i’ve read here. They say the 2nd million is easier, but this post gives a clear view of the path to $10M and beyond. Thank you.
Great post. Its a real kick in my ass!
Currently I own two businesses. One that is in the field of consulting , where my time is exchanged for an hourly rate. Its in an enjoyable line of work ( for the most part). However the business has limited scale. With no employees, scale is reduced even further. The business provides for me just a job.
The second business is in real estate. Purchasing undervalued assets, capturing the value , and then reselling the asset. I will purchase the real estate, recoup the value of the undervalued asset and then re- sell the real estate. The risk is limited, as in very deal, the value of the undervalued asset , covers the purchase price.
The return(s) can be lucrative ..in many instances high five figures to low six figures.
My problem is that the process is slow and not always steady .
Reading this post has given me another idea that maybe starting a blog , writing about the process of investing in this asset ( problems and all) and share my experience(s) might be a great way to generate massive scale and steady returns.
I wont deny, that my reticence to seeing more people jump into this “hidden” asset , along with the inevitable loss of anonymity have impediments to making this happen.
However, its obvious that a good information packed blog can be very lucrative…both to the the readers and the owner.
Paul Andrews says
You know, it’s fun to read through frugality blogs and how people cut their expenses on groceries, cable, etc. But my degree is in finance, and it’s really nice to read something that uses the same vernacular I had to use when getting my degree! Takes me back… :)
I’m really glad you posted some numbers on how blogs are valued, and to be frank, they pretty much all seem like steals, as long as you know how to run one. Payback periods of less than 6 or 7 years sounds pretty good, and I can’t imagine that you’ll get anything better on traditional passive investments likes stocks. Except maybe when you’re talking cash on cash returns in real estate, but even hitting 25% return means 4 years.
My question is how do blogs that have wild swings in revenue get valued? I’m thinking about Pat Flynn, who’s last two blog income reports had him earning 250k one month and 100k the next. Is there some sort of average that is used? Maybe the last 6 months worth of earnings?
Of course, if anyone could make an accurate prediction about earnings, then valuation wouldn’t be the art that it is. I’m just curious to that side, if you know and don’t mind sharing. Great Post!!!
Financial Samurai says
Valuation is a lot of art. The buyer can look at the trailing annual earnings for the past three years.
Most business don’t trade on a multiple of monthly earnings. Instead it’s always on annual figures.
You’ve got to look at the makeup of the traffic. If most of the traffic is from forum traffic, that’s not that great because regulars don’t buy or take action as much as SEO traffic, who are trying to find an answer to a problem. Reddit is not worth much compared to its traffic b/c it’s just a bunch of forums.
I like sites with more than 50% of their traffic from SEO b/c SEO is the most valuable traffic that is perpetual. Much more than 80% of traffic from SEO might be risky b/c you can’t directly control your rankings.
Bottom line: I’m a buyer of websites, not a seller at these valuations!
Steve Adams says
Great differential on the traffic!! SEO vs forum traffic is a great distinction. Recurring visitors are not similar to recurring revenue. Wonder if there would be a way to convert them – maybe charge for a weekly ‘private post’. Or a private forum. For financial samurai I would pay that but Im odd that way. :). Thanks for making Mon/Wed/Fri better!!!!
Is $2.5m too small a sum to pay for a business making $700K a year (with prospects for growth)?
Yes, if you can just pay $2.5m, then put your feet up and draw $700K passive income every year (and be assured you get your capital back, and then some, when you want to sell).
But that’s unrealistic. Not only do you have to pay $2.5m; you also have to put your heart and soul into the business. In other words, the $700K annual income is a return to capital AND LABOUR. And there’s more: you also have to bear the risk that you can’t do as good a job as the founder, or some digital disruptor blindsides you, plus 1,001 other threats.
I agree with your point, Sam, that hanging onto a successful and growing business is often the better way to go. But don’t overlook the point that, if you sell, you aren’t handing your buyer a Treasury bond.
Frugal Familia says
Good point! I was going to post something very similar. In the example given this is not a passive investment we are talking about there is also a time investment that needs to be considered. The individual who sold for 2.5M also gained a much more valuable asset, TIME. It’s hard to place a value on this as everyone values their time differently and its unclear what the time investment of the site was. With that being said we shouldn’t assume this person to be a complete idiot incapable of doing simple future cash flows analysis. Perhaps given the situation this actually was the best choice for this person.
Awesome post. It is inspirational to see what growth opportunities can be with vision & hard work. I have to look at what more I can do.
I’m a 30% partner in a business that generates about $900K of annual income on revenues of $3.2m – that’s after paying salaries and bonuses, including to the partners.
Any thoughts on how to approach someone to buy 50% of me/us with another 50% where we are incentivized to grow even more?
Would anyone take a look or is it too early/small? The business could operate without me but I would stick around for the latter 50%, if wanted. I feel like multiples are very small unless you cross some threshold to be a “real business” of $10m+, even though it feels like a real business to me since I’m working so hard every day, 7 days a week. Thanks for your thoughts Sam + co.
Financial Samurai says
Call your competitors or hire a banker to call your competitors for you!
Why do you want to sell 50% of your business? If it’s too much work, I recommend talking to a business coach to see how you delegate some of your work so that you’re not working 7 days a week.
Before you decide to sell your stake in the business, talk to a CPA about how to minimize or defer the capital gains taxes. There’s a strategy where you can defer your capital gains taxes for 30 years. It’s better to pay your taxes tomorrow than today.
Brian, CPA, CFP
Thanks for sharing this post. It is important to keep a long term mindset with investing and starting a business. As you stated, profits + equity = next level rich. I once worked for an entrepreneur who would start a business, grow it, and sell it in 4-5 years. I wonder how much money he left on the table. One of his businesses in now a major affiliate network.