What’s the Difference and Which Should You Focus On?
Ask any entrepreneur: “Are you going to retire?” and they will say, “No, I am probably going to work until I die.”
If that’s your mentality, you have to ask yourself – are you working because you have to make money to pay your bills – or because you’re enjoying it so much that you can’t stop?
Consider if you can get to the point where:
- Money is still coming in from your business
- Your business is growing and your team is running things smoothly
- You are working on your business as much as you want
- You are able to leave as much as you want
Once you can answer yes to all these points you actually have freedom.
Freedom of your time, income, and mobility. Isn’t that the real dream most entrepreneurs have when they start their companies?
The biggest culprit that prevents us from ever achieving freedom is acting like an employee. Employees work until they die because they just can’t retire. There is no flexibility in their work life or financial life.
So, how do we stop that from happening?
We have to look at three different things that make up the entrepreneurial life:
- Wealth accumulation
- Wealth creation
- Our lifestyle fund
If we have control over those three things, then we can be the entrepreneur that we dreamt about being when we started on our journey. The kind where you have freedom, can do interesting things anytime, and are working until you die because you love it, not because you have to.
But we also need to know the difference between the three things, and specifically we need to know what activities are for wealth accumulation, wealth creation, and what belongs to our lifestyle fund.
Let’s take a deeper look at all three.
#1: Wealth Accumulation
A lot of people think wealth accumulation is the same thing as wealth creation. For example, most people see savings as a wealth creation activity. Just because it is getting compound interest over the course of your life does not make it the same thing as wealth creation.
It is simply accumulating wealth, which takes a very long time.
With inflation and other factors, it isn’t worth as much as you thought it was going to be worth when you retire. Plus, there are other kinds of problems that can come along when you start saving and when you decide to retire that keep you from ever having access to that money.
That is the downside of wealth accumulation.
Entrepreneurs that treat wealth accumulation as wealth creation end up even more stuck because not only are they in charge of running a company, but they also end up losing freedom.
They become an employee of their own company, but they have to work harder than any other regular employee.
If we want to create wealth, a business can do this far beyond what a job can do. It gives you unlimited potential. So, let’s take a look at wealth creation.
#2: Wealth Creation
The early stages of your company are all about wealth creation and building a system that will continue to produce more and more wealth.
A major mistake entrepreneurs often make is trying to hire on staff when they don’t really have the funds to make that happen. You don’t want to be spending money when you are in the wealth creation phase because it costs money to build those teams and systems.
As your business moves into later stages and is consistently bringing in more money, you will need to reinvest it into your business. There is no accumulation. There is no savings.
Funds get spent to grow the company instead of put in a bank account.
There is no place that you could put your money that could give you a better rate of return than your own business. In fact, our entire life as an entrepreneur should focus on wealth creation activities.
The Holy Grail of Entrepreneurship
Eventually, if you do keep reinvesting your profits back into your company, and you do this well enough, there will be so much excess cash that you can finally accumulate it.
That is the holy grail of entrepreneurship.
A business that throws off so much extra wealth you don’t have a choice but to accumulate it because you can’t reinvest it or spend it fast enough.
For an entrepreneur, accumulating money without reinvestment is siphoning potential away from your business. We want to make sure that the company can throw off so much excess cash that you can’t properly reinvest it inside the company.
Dilemma: You still want to do something productive with the money, so what’s the best strategy?
That is when you start diversifying— pulling the money into other assets that will give you a solid return while you figure out what to do with your business to get it to the next level.
Once you have a solid plan for getting your business to the next level, then it makes sense to stop accumulating and start reinvesting again.
Making the Switch as an Entrepreneur
A lot of entrepreneurs see themselves as “self-employed”.
They work at their company, the company grows and they get paid because of their labor inside the company. This is an opposing thought process to being an entrepreneur where you leverage systems to generate wealth.
It will definitely take a mindset shift if you want to live the life we described in the beginning.
When you are reinvesting in your company instead of just working there, you may
- Acquire new companies.
- Start new divisions inside your company.
- Those divisions could eventually spin off as a brand-new company.
Side Note: There is no way you can run a bigger and bigger organization on your own. Each of those divisions needs its own executive team. Otherwise, you are going to get tapped out.
Bottom Line: You have to reinvest into the function of a company because once it runs smoothly, it will throw off excess cash. The task then becomes leveraging that money over and over again inside and outside of a company.
Business Growth Plateaus & Entrepreneurial Wisdom
Most entrepreneurs are only focused on their one company.
This focus means the business ends up hitting a natural plateau. All companies have them. There is a plateau before $1 million, one around $5 million, one in the $20-30 million range, and maybe even another at the $50 million.
Some people get to one of those plateaus and start looking to diversify because they can’t figure out how to get their business to the next level.
This is where entrepreneurial wisdom needs to come in by asking yourself a few questions:
- Am I at a plateau?
- Can I get to a bigger level inside this industry with this company?
- Do I focus solely here?
- Do I go start a new business?
If you want to start a brand-new business (and your current operation is cash-flowing), you’ll need to pull money out of your company to do so. Those funds then get taxed with an at least 30% tax rate. Then, you have a new company and the process grind of trying to grow it.
There’s a better and surprisingly simple solution here.
If you keep your money inside the company and start a new division instead, that is an expense. Yet, you get to spend 100% of that money on your expenses inside the company.
Maybe it’s in the same market, but it’s a new product. Or maybe it’s a completely different market, but you are able to access that market by tweaking your current product to fit. If it takes off, then you can spin it off into a new company.
Leveraging a Holding Company
When companies spin off companies, the main company still owns them and because most of its income becomes passive versus active, it’s classified as a holding company.
So that begs the question: Why spin companies off when you can leave them inside your existing business?
These become more philosophical, and sometimes, financial decisions. A holding company is just a place for you to manage what you own.
So what happens if your company acquires a few other companies but leaves them as autonomous companies? The typical answer is that they run and have their own corporate structure but your company owns all the shares of that acquired company.
Once the revenue that gets shifted from the acquired company to your company is a big enough percentage of your company’s revenue (at least in the United States), the IRS classifies that company as a holding company.
Holding Company: A company created to buy and possess the shares of other companies, which it then controls.
As a holding company, its main business is managing money.
For example: Berkshire Hathaway is a holding company. It owns lots of other companies that runs independently, but the wealth of those companies gets passed to Berkshire Hathaway.
Berkshire Hathaway used to be a failed textile company. The owners kept the name of the company and the corporate set-up, and turned it into a holding company, having it own other companies that they were acquiring.
If your company never throws off enough excess cash, you are never going to be a holding company. In fact, you are probably running your company incorrectly, which is why you don’t have a lot of excess cash to be able to reinvest into these high-level returns.
Sobering Thought: You may just end up taking that money and putting it into retail assets that maybe, at best, will return 8% per year, meaning that your first dollar in that account won’t double for at least ten years.
Inside your business, however, you could double that dollar every single year or at least every two to three years.
Once you can’t get a better return in your own company, then it starts making sense to pull the money out, take the tax hit or put it in a tax-deferred retirement account, and start investing it elsewhere.
Wealth Creation & Preservation
There is a difference between an employee who needs wealth to accumulate so they can retire and an entrepreneur who is always going to have an income from their business.
Entrepreneurs don’t need a retirement income, but instead just a place to preserve wealth.
It’s this reason that so many wealthy people have a significant part of their net worth in real estate.
The wealthy aren’t trying to get rich off of it; they are just trying to preserve the wealth they currently hold.
One of the best ways to do so has been in the form of real estate because it’s likely to go up in value at least equal to inflation. Once sold, you haven’t lost any money.
#3: The Lifestyle Fund
The last thing is the lifestyle fund. Most entrepreneurs don’t do a lifestyle fund (most employees don’t do it either).
Instead of knowing much money they actually need to be happy; they just think, “I need more money to be happy.”
Example: The guy who I learned this economic engine concept from was a very wealthy hedge fund manager. He was talking about paying himself $250,000 a year as a salary. The rest of the money from his business stayed in his business to generate more wealth.
He realized that even in New York City where he lived, after he bought a home, he didn’t need much money to live, and $250,000 would cover most of his expenses.
To buy the home, he needed to get the mortgage payment down to a level at which a $250,000 annual salary could pay for it. He had a lifestyle fund that he accumulated money in to use as a significant down payment on his home.
If you start using a lifestyle fund for the luxuries that you want in life, you need to set yourself a salary. Maybe that salary increases over time but for now you need to figure out how much money is the bare minimum to live the life that you want.
Whatever the number you come up with should be your salary.
More Freedom and Wealth, Every Single Year
Then the rest of your money goes into generating more wealth and preserving wealth. You would then set aside some money into a lifestyle fund that is going to go to buying the luxuries that you desire.
Eventually, your salary will get bigger, and maybe you will get some bonuses from your company along the way. Use those things for your lifestyle fund to buy luxuries.
Seriously, make a plan for this. The lifestyle fund helps make sure you don’t end up with lifestyle creep. Trapped by your business where you have to work just to pay your own personal bills.
If you follow this path, you will end up with the freedom you always wanted, and you will get wealthier every single year.