I normally think about return on investment (ROI) because that’s what the people in my business circles are concerned with. That roughly means that you put cash into a deal, the cash generates some amount of return to you, and that is the return on investment that you receive.
Recently, my colleague, Michael Podolny, president of the Podolny Group, Inc. (www.podolny.com), gave me a different way of thinking about return on investment. I found it important and because it was an interesting perspective, I wanted to share it with my blog readers.
Mike talks about return on assets, not just return on investment. The concept of investment seems to imply taking money out of your pocket and putting it into some type of a vehicle that makes money for you. The implication seems to be that an “investment” in this context is passive.
Mike and his company do consulting work like I do – but he does a form that he calls “ownership consulting.” The focus of his practice is the development and implementation of business action plans relating to: Integrating an owner’s personal goals with their business goals; Managing growth; Developing and implementing succession and exit plans; Resolving conflicts within owner groups; Maximizing the wealth our clients obtain from their business; and Facilitating turnarounds and other crises.
Based on the types of companies that he works with, Mike thinks about return on investment as taking dividends out of an entrepreneurial venture that you own and are a part of. To Mike, this is an active investment and the investment is the dollars that you already have in the deal. The return is the salary and other cash that you’re successful in taking out of the business.
Whereas I typically work with earlier-stage companies that have very lofty goals and dreams, Mike bills himself as someone who works with “mundane businesses,” companies that are older, and companies that are somewhat out of fashion but that nevertheless need advisory services. Mike tells me that companies that are more mundane tend to focus more on the top line but don’t put enough emphasis on the bottom line.
He also believes that these older companies should put a lot of emphasis on the bottom line and that they should take their money and put it in the bank because the amount of money that comes out of these entrepreneurial ventures is sometimes 30% of the value of the entire business. That means that the ROI can be up to a whopping 30%.
Compare that to the eventual exit that an entrepreneur hopes to get. These older businesses don’t generate monstrous liquidity events when the entrepreneurs are ready to sell; they produce reasonable exits that may allow the entrepreneur to retire.
But, when the cash is taken off the table, generally that money will be put into a bank account earning 5%. It might be a little bit more at a brokerage house, but it’s not a lot of money. Mike is quick to point out that the business owner should take as much of the money that they’re making at 30% during the lifetime of the business as they can and add it to the amount they will receive when the liquidity event happens at the end.
I have to say that Mike is right. It takes a lot of discipline to get wealthy, especially if you’re involved in an older, less fashionable business where exit prices are not likely to be tremendous. Let’s face it: giving this kind of reality check to an entrepreneur is never popular, but Mike is certainly to be commended for the work that he does because this is exactly the kind of information that his clients need to hear.
One of the most important issues that comes up when Mike gives somebody this kind of reality check is the surprise when the business owner finds out that they’re not going to get as big of an exit as they anticipated. Therefore, Mike recommends the following five action points right now:
1) Start saving today – from the large ROI that your business is throwing off.
2) Make use of the retirement planning tools that allow the design of top-heavy discriminatory plans favoring owners.
3) Improve your profitability. Don’t be lazy. Address the low-hanging fruit that most companies have. This can increase your profits and disposable cash flow.
4) Understand what drives value in a business and manage to create that value.
5) Learn about succession and how variants of succession can be used to enhance your return from your business.
So, as you are working hard every day to build your company, or as you’re building your career, it makes sense to think about investments and assets from different people’s perspectives. As my colleagues present me with perspectives that are different from my own, I will pass that information along to you. With that, I want to thank Mike Podolny for sharing this perspective. I hope that you’re able to benefit from it. If you need to reach Mike, you can go to his website at www.podolny.com.
About Mike Podolny
Mike is an interesting character. He runs a consulting firm that services the owners of smaller businesses, typically in the revenue range of $3M to $30M in annual sales. Their issues tend to be related to growth and the ultimate desire to have an exit or succession. With offices in Chicago, Albuquerque, and Los Angeles, Mike has worked with private business owners for more than 30 years, and he’s been involved in liquidity transactions for owners with aggregate value exceeding $400 million. Mike’s also the author of “Shortcut to Security: How to Make Your Business Worth More to Others So That It’s Worth More to You.”
Often dubbed a “Growth Architect” by his clients, Joel Block advises companies on explosive growth strategies by driving revenue and sales. Well known in the capital markets, Joel is a successful entrepreneur, speaker and advisor. To bring Joel into your company, please visit www.joelblock.com or www.growth-logic.com. Also, be sure to check out our newest project: a blog to organize the blogs that cover entrepreneurship – http://www.entrepreneur-hub.com. And finally, for film makers: http://www.filmfundingblog.com – our newest project.