No. 24: Making a Living vs. Building Wealth

This is an excerpt from my new book, Acquiring Your Future Through a Succession Plan: A Primer for Next Gen Professionals (Chapter One, Section 3) – written specifically for today’s younger professional service providers:

As a PSP, or a Professional Services Provider in your chosen venue, there is nothing like feeling the satisfaction of providing great services to an appreciative client base. There is also nothing wrong with making a good living and building personal wealth in the process. This is not a choice you have to make. The two concepts actually can and should work in tandem on the business front if you are an owner.

Simply stated, being an owner, even a minority owner, in a profitable, growing business can provide far more effective wealth-building resources than being an employee or being self-employed as a force of one. In terms of tax efficiencies, cash flow predictability and resiliency, there really is no comparison between owning a business and owning one’s job Here is the argument and the evidence, at least in part.

Your compensation as an employee is taxed as ordinary income, the highest tax rate in the Internal Revenue Code, and not even including any city, county, and/or state taxes. You do not have the full opportunity to write off business-related expenses. You are not entitled to a share of the business profits, and you don’t share in the appreciating value of the business as it grows over time, even as you work to make that happen. You have little to no say in the operations, hiring, or direction of the business. That is the world of an employee and, for the most part, an independent contractor. This is how people, and PSPs, make a living, and many do this for their entire lives.

Let’s begin to explore the world of business ownership and, perhaps, expose you to something new and almost magical. If and when you buy an equity interest, or stock in the business where you work, you might acquire, for example, 5,000 shares of stock from your boss (or bosses) in their S-Corporation (you’ll learn all about entity structures in Chapter Four). With a total of 100,000 shares authorized and issued, this means you own a 5% equity interest. You’re an owner! This also means that you are entitled to receive, as a matter of law, 5% of the business’s profits (at a lower tax rate than ordinary income in most states), 5% of the business’s stock appreciation as it grows effectively tax free until the shares are sold, access to the financial statements of the business and a vote, or at least a say, in the operations. You directly benefit by helping to grow the business in which you are an owner. Oh, and you still get paid for the work that you do.

The basic formula that describes these results from your perspective as a G2/G3 (Generation 2/Generation 3) owner is that of Shareholder Value, and we will come back to this concept again and again because it really matters:

Wages + Profit Distributions + Stock Appreciation

This is ownership level thinking. The idea is that you will use most, but not all, of your profit distributions to service the debt on the stock you bought as multiple owners help to grow the business revenues. We generally assume that your wages are already spoken for, so this new, slightly more tax efficient revenue stream is used to pay down the debt. As the business grows and the profit dollars increase, the debt servicing can accelerate even as the value of the stock you hold grows tax free–far more information and details yet to come. That shifts the basic formula to this: 

Wages + Profit Distributions – debt service + Stock Appreciation

And then you do it all again, buying in another 5%, 10%, or more, five to seven years later. That’s life as a G2/G3 owner and investor in a nutshell. In a business that grows at just 7% a year, you might see your investment double several times over with the help and best efforts of all involved. This is the difference between making a living and building wealth (along with making a living).

So powerful is this opportunity that I strongly encourage you to raise the issue of ownership during your initial interview as you apply for a position as a PSP with a potential employer. And if you’re interviewed by the sole owner of the business, and it has always been that way, I’d listen carefully to that person’s plans for the business. If you’re applying to work for a practice that will be sold to someone else or will just one day fade away, consider your options carefully. You have some good choices and decisions to make and you need to appreciate the value of your earning power and your contributions over time.

Thanks for reading,

David Sr.