Jonathan: Hey, how’s it going? I’d like to share with you an idea, it comes from Greg Crabtree. He’s the author of “Simple Numbers, Straight Talk, Big Profits!” He’s looked at thousands of businesses, and he knows how to make companies profitable. The idea is basically this, how should you be thinking about owner compensation, and why if you’re thinking about it incorrectly, it could be highly destructive to your business. So, here’s Greg.
Greg: If we had a group of you live and we were having a little party, and of course when I tell you this you’ll probably never talk to me if we ever see each other in person at an event. A bunch of entrepreneurs are together and they’re all telling their story, and in my mind I’m hearing them tell their story and I’m building a balance sheet and a P&L in the back of my head. Company 1 comes in and this guy is saying “Man, we’re killing it. We’re making 25% profit. Well, that’s pretty good. Cash flow is a little tight, and the bank keeps giving me grief. I mean those bankers they just never run a business. They never made a payroll in their life. If they just understood what entrepreneurs need, life would be a whole lot easier.”
Company 2 they’re listening to Company 1’s CEO talk about it, and they go “Man, we’re doing pretty good. We got to go back and figure out how we can go to 25% profit because we’re just underperforming. We’re doing great cashflow wise. We don’t have anything drawn on a line of credit. The bank doesn’t even talk to us because we don’t need them. We got to figure out how to get to that 25% number.
Then Company 3 is the guy that’s saying, I call him Bubba, Bubba comes in and says “Man, people just don’t understand how tough it is to be an entrepreneur. We’re just getting by, we’re making a profit. The bank’s on my case every day. They just don’t understand. The government they’re just causing all kinds of problems. What we need is a government bailout.
So when you’re listening to all these three stories, you realize that in reality they’re three exactly the same businesses, but the only difference is the owner interaction with the business. The first guy is taking out $250,000 in distributions, so that he has zero actual net cash left in the business. He’s destroyed the businesses net income potential by taking too much money out. The clue is, and whenever you hear somebody that says they have 25% profit and they’re saying they got cash flow problems, that’s a warning sign if that’s a person that is sucking all the cash out for other reasons. They’re taking it out through the balance sheet, not through the P&L. That’s just wrong. That’s dumb on their part. It’s just a gross distortion of business activity.
Company 2 is doing it the right way. The owner is taking a market-based wage for a million dollar business. They’re leaving all the profits in the business, that’s why they don’t have any line of credit debt in the business and the bank’s not calling them. They get to make a decision each year of the $150,000 in profit. I got to send some money in for taxes, so probably 50 grand goes in for taxes. Then they got a 100 grand they can decide what to do with. Do they want to reinvest it back into the business for growth? Do they want to take it out and diversify their wealth? We’ll talk about those strategies in a few slides later. Essentially, Company #2 is doing it exactly the right way.
Company 3 is the worst of all. This is a person that had a really good year and developed a $300,000 lifestyle on a business that really could only provide $150,000. They’re still taking out the $300,000. He’s taking out a $200,000 wage. He’s taken out $100,000 in distribution, so the actual cash flow is a negative $50,000. At the end of the day, here’s the deal for that business, where do they get that money from? Well, when you take out more money than the business can produce, it’s generally because the business had some availability of credit. Generally, you’re drawing on the business line of credit to make the owner’s required payroll or distribution. Now you have an over-leveraged business that’s damaged from its borrowing capacity for business needs because of the owner’s overdeveloped sense of consumption.
It’s your business. You can consume all you want. At the end of the day, if you’ve got a milk cow, you’re not going to go over there and cut off its legs, so you can have some meat to eat. That’s not really healthy for that milk cow. The cow’s only got four legs anyway, so you’re not going to last very long. Why would you damage that thing that is intended to produce regular recurring income and stability by consuming it? Because we tell ourselves all of these dumb ideas about taking money out of the business.
You’ve got to have a sequencing that is correct in terms of how to do it. Ultimately, the idea is we want the owner to first and foremost take a market-based wage. Typically, the reasons why people make these dumb mistakes is tax-motivated. They think that if you’re a Corporation “Oh well, I got to pay payroll taxes if I take a salary.” I’m telling you, I mean we’re batting a thousand on this one. Every time we’ve got somebody to take a market-based wage and just forget about the payroll taxes and let them be what they are. I guarantee you make a bigger wage. You actually make more net income because now you’re talking truth in the data.
Every time that you try to turn an angle and cut a corner, one, you’re taking a risk because the IRS might disagree that wage is not market and they may charge you. There’s a three year statute of limitations going back on that back payroll taxes. You’ve got that hanging over your head at any given point. Secondly, if you’re a multi-owner business, all of the owners are taking the same wage. Well, why would you do that? I’ve never seen two people worth the same amount of money anyway. This classic case of people taking the same wage because they’re owner is dumb. One of you is getting the short end of the stick.
Jonathan: I hope you found Greg’s thoughts highly valuable. I’ve been a big fan of the way Greg thinks. I’ve been a big fan of his book for years and fortunately we’ve been able to coordinate schedules and Greg will be speaking at SA4. Our Service Autopilot Conference. He will be doing a three-hour workshop. He will dig in very deep on topics like the one you just heard. He’s going to show you how to make your company far more profitable, how to build wealth, and how to make sure you’re running your company to do what a company is supposed to do, which is to make money, not just top-line revenue, but take home, out of the company, put in your bank account type of money. If you want to learn more from Greg, I hope you’ll be at SA4.