If you want to know how to get very rich, the answer is to build equity in a business. The majority of the very rich are business owners, and/or hold equity in other businesses.
One of the luckiest things I've ever done was not sell any major assets during the downturn between 2009 – 2012.
It's understandable to panic sell when things are crashing and burning. And, 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 wanted to sell, I couldn't!
My Biggest Lucky Break
For example, in 2012 I put my home on the market for 28 days to see if I could get any motivated buyers after Facebook went public.
I had just left my day job and was thinking it might be a good idea to get more liquid in case my early retirement plan didn't pan out. I listed the house for $1.7 million.
Fortunately, no buyers were to be found as IPO money takes a year to work its way into the economy. Then five years later, I was able to sell the property for a full $1.1 million more than I could have sold it for in 2012!
But seeing a 60% rise in an already expensive home was not my biggest lucky break. Hanging onto my business was. Every year since 2011, someone has inquired about buying FinancialSamurai.com.
There was a period of time during the 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 because they were based only only 2-3 times profits.
In other words, after only 2-3 years, the bloggers would have made all the money they sold for and then earn an infinite return each year they operated. A payback period of only 2-3 years is nothing.
Think About Your PayBack Period
When learning how to get very rich through building equity in a business, think about your payback period. The payback period is the length of time required to recover the cost of an investment. In the above example, we're talking 2-3 years.
But let's say the buyer has some hustle and expertise. He could conceivably grow operating profits 20% a year for three years and accelerated his payback period.
But since 2008 – 2010, something magical happened. Valuations for media companies as well as valuations for the entire S&P 500 have expanded. 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).
Valuations have since moved up from 15X to 33.31X, a 122% increase. Let's say the valuation increase in online media companies rose in lock step with the overall market's valuation increase.
A 122% increase in a 3.6 multiple equals 8X (3.6 X 2.22). 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!
Investment Scenario
2010 Investment: $2,500,000
Business Operating Profit: $700,000
Estimated Payback Period: 3.6 years
Forecast Operating Profits
First Year Operating Profit: $700,000
Second Year Operating Profit: $850,000
Third Year Operating Profit: $1,000,000 – Everything paid back in 3 years
Fourth Year Operating Profit: $1,000,000
Fifth Year Operating Profit: $1,000,000
Sixth Year Operating Profit: $1,000,000
Seventh Year Operating Profit: $1,000,000
Eighth Year Operating Profit: $1,000,000 – Keeping operating profit flat for four years to stay conservative despite massive leverage in online businesses
Total Operating Profit Over 8 Years: $7,550,000
Percentage Return If Not Sold: 302% ($7,550,000 / $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 122% since 2010, the buyer can now turn around and sell his $1,000,000 a year operating profit business for $8,000,000 based on a 8X multiple instead of a 3.6 multiple.
Total Return After Sale: $15,550,000, or 622% ($7,550,000 operating profits + $8,000,000 sale price = $15,550,000 / $2,500,000).
Now imagine if the business grew operating profits to $2,000,000 before selling. We're talking over a $20,000,000+ return from a nice little lifestyle business. Compared to the measly $2,500,000, we now have some REAL F YOU money. So now you can really see the benefits of owning business equity when you want to learn how to get very rich.
A ~140% return in the S&P 500 since January 1, 2010 is nice. But a 262% – 622% return based on creating something from nothing is so much better.
Who's to say the entrepreneur wasn't also diversified in stocks, real estate, bonds, and private investments as well. Further, the 262% – 622% return is on a much larger nut.
Don't Be Tempted By Short Term Gains
Now obviously an investor might be stupid enough to drive a newly acquired business into the ground. But most people who spend millions on a business 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. 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, and 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 really excited. Finally, if you believe there will be valuation expansion on top of business growth, you should go ALL-IN.
Below is a chart showing how much capital you need to have to generate $55,000 and $20,000 with various interest / return rates. For reference, the 10-year bond yield is currently around 2.25%.
How To Get Very Rich
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. It's a great formula for mastering how to get very rich.
Most day jobbers are not building equity. When it's time to go, they are left with nothing because they are no longer contributing their time. There is no leverage in being a laborer.
Check out the net worth composition by levels of wealth in the chart below. Notice how the wealthier you get, the larger the percentage Business Interests is as part of your net worth.
As your business grows in a bull market, valuations expand. You then have the optionality to sell your business at a multiple of revenue or profits.
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.
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.
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.
Related: How Much You Should Have Saved By Age
Benefits Of Running A Small Business
- Equity – As already mentioned, owning equity in a business is one of the most common ways the super wealthy have gotten rich. It's also incredibly motivating and fulfilling to be an entrepreneur.
- Flexibility – Being able to set your own hours is priceless, especially if you have dependents or don't want to be stuck working every single Monday-Friday from 8 am – 5 pm.
- Autonomy – Having the freedom to make your own decisions and choose the type of business you want to be in takes the “work” out of work and makes it fun.
- Efforts = Rewards – There's nothing worse than working hard at someone else's company and not getting acknowledged or appreciated. When you're a business owner, however, your efforts are directly correlated to rewards and recognition.
When you decide to start a business, it's important to keep all of your personal expenses separate from those for your business. Having one of the best small business credit cards makes this easy. Keeping records separate helps you take full advantage of the tax write off benefits of business ownership and keeps your records organized.
There are also many more additional benefits to having a small business credit card, such as:
- Exceptional rewards programs
- Establishing and building credit history for your business
- Better access to business loans
- Access to higher credit limits
- Added financial flexibility and cash flow
In conclusion, get very rich by building equity in a business over a very long period of time. Let your equity compound and then take advantage of high valuations and sell when the time is right. Make yourself rich, not someone else!
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About the Author: Sam worked in investment banking for 13 years at Goldman Sachs and Credit Suisse. He received his undergraduate degree in Economics from The College of William & Mary and got his MBA from UC Berkeley. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $250,000 a year in passive income. His main passive income focus is on real estate crowdfunding to take advantage of cheaper valuations and higher cap rates in the heartland. He spends time playing tennis and taking care of his family.
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