Even if you aren't a fan of his music, how can you not be impressed by Andre “Dr. Dre” Young, the intrepid rapper and impresario who helped build and sell the headphone and music streaming service Beats Electronics to Apple Inc. recently? The company he and Jimmy Iovine had founded in 2006 has made billions.
We all have clients who have saved carefully throughout their lives, but no doubt those who have accumulated real wealth did so by either owning a successful business or having equity in a larger successful enterprise. Unless you are born into it, there is only one legal way to get rich in America: You have to own equity in a growing enterprise that compounds over time and can be monetized. You have to be patient and take a long-term perspective. How many of us apply that logic to our own business and our choices?
The large brokerage firms are in an arms war to have advisers join them with ever- escalating signing bonuses. Even Ameriprise, a brokerage firm that caters to "independents" is promoting its 150% of revenue payment. It's hard to take a long- term perspective when so much money is being offered right now. But what if taking that upfront money actually reduces the ability to capture the real long-term wealth in your firm?
There are several reasons that taking a long-term perspective is so important, even when instant gratification is really tempting:
1. The magic of compounding. If you can grow your equity at 5% a year, every $1,000 quintuples in 33 years. At 15%, it takes 12 years and at 25%, it takes a little over seven years. Compounding investments really is an investment miracle if the underlying asset is growing. Can any cash you receive today grow at that rate?
2. Deferring taxes. This removes the government as a participating partner in your profits for long enough to allow compounding the value of your entire investment. If you pay taxes along the way, everything takes twice as long (depending on your state and total tax burden). That's why it's almost impossible to save your way to wealth if you do not defer gains for as long as possible on your big investments.
3. Illiquidity. This might be counterintuitive, but inaccessible money is not spendable. Equity is often an illiquid investment, either because it's in a retirement account or privately held company — this protects the investment whole and thus it compounds in its entirety. It's why so many people around the world think of their home as the best investment they ever made, even though the compound growth rate is probably in the mid-single digits. Over time, the equity keeps growing in its entirety.
Many folks "take the check" and make their businesses less valuable by being trapped in a captive world in which they have no equity. They have rented out their equity value to a firm they will not own for up to 10 years. They will probably never enjoy the success so many of their wealthiest clients have enjoyed. Even worse, many advisers take the signing bonus and treat it as a windfall, spending rather than investing the money they receive.
It might be the right choice for many, but being long-term greedy beats being short- term greedy every day.
If there is a magic solution to wealth, it revolves around a few key steps: Build the value of your business by 15% or more every year; work to ensure the equity you own can actually be sold at an attractive multiple; lastly, in order to manage risk, figure out if you can do it alone or if partnering with someone can help you accomplish your goals with higher certainty (Beats Electronics was majority owned by HTC until they sold some of their stake to Carlyle Group).
Dr. Dre and his partners built Beats International into a $3 billion enterprise in eight years. Most importantly, he understood that creating life-changing wealth meant owning equity rather than being paid as a spokesman. We can't all be Dr. Dre, but we can certainly have a portion of his success by replicating some of his choices.
Joe Duran is chief executive of United Capital." Follow him @DuranMoney.