Recently, Forbes took a comprehensive look at how many Forbes 400 members founded their own businesses, and at what age they did so. The end results were clear: unless you’re planning on inheriting your wealth, it’s best to start or buy a business earlier rather than later.
Almost half of the entrepreneurs in the ranks — Forbes classifies 254 of the 400 list members as founders — started a business before they hit 30; nearly 85% had by age 40. The average age was 32. The company they founded wasn’t necessarily the one that ultimately made them rich, but it marked the official beginning of their entrepreneurial path. It’s possible to hit the jackpot if you start later, but it requires careful and deliberate strategies with little room for careless errors.
Ernest Hemingway apparently got the answer wrong when F. Scott Fitzgerald told him “the rich are different from you and me” and Hemingway responded, “Yes, they’ve got more money.” His answer should have been: “They own businesses.”
The odds of having business income increase substantially once adjusted gross income (AGI) exceeds $100,000. More than 40 percent of people with an AGI of $250,000 or more have one of these two types of businesses. More than 72 percent of the really wealthy – people who earn more than $1 million per year – have a partnership or S-Corp. And nine-in-ten of the super-wealthy – people with an AGI in excess of $10 million – have one of these.
IRS data reveal that the majority of the “top one percent” has a partnership in an S-Corp, they own a stake in a business. Research shows, most of today’s millionaires weren’t born into their wealth. No matter how millionaires obtain their money, they all share some common traits, including prioritizing savings and diversifying investments. Further, a second study by Fidelity Investments found that 88% of all millionaires are self-made, meaning they did not inherit their wealth.
Many self-made millionaires have money coming in from several places, including their salaries, dividends from investments, income from rental properties, and investments they have made in other business enterprises, to name a few examples. If one income stream slows down, there’s another that can take its place. Much of this is called passive income, or money being earned without actively spending time and effort in the enterprise.
The question remains, do rich people buy businesses or create businesses?
They do both, depending on how much capital they have to invest. However, buying a business is preferred for the following reasons.
- A buyer of an existing business cuts to the front of the line and saves time. That’s worth a premium to anyone! Thinking upon what Mark Cuban said recently, “Your most valuable commodity is your time because it is limited”. Building a business that is profitable and proven to be stable over time (1–3 years) takes a lot of hard work. If I can save that much time, it would be worth paying for, especially if it is undervalued which many are. You have to know where to look and what you’re looking for. In fact, sometimes investors buy opportunities where the business isn’t profitable but they see how it could be.
- The return on investment is better than just about anywhere else you could invest your money. Let’s run an example. The US stock market is touted as the best place to invest based on its average annual return of 9%. So theoretically, if I park $500,000 in stocks, I can expect to get an average annual return of $45,000. Instead, if I buy an established, profitable business with that money instead, right now businesses are selling on average, at about 3 times net earnings. Let’s say I just paid full price for a business at that multiple. I could buy a business that was earning $166,000 per year in annual net profits and earn 3.5 times more than the stock market.
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Edwin Mysogland, CVA, CEPA, CMEA
Managing Partner, Indiana Business Advisors