My ever-present, effervescent managing editor Suzanne came up with another good suggestion last week. “You know Richard Russell,” she said. (Richard Russell writes the Dow Theory Letters.) “I just came across an essay of his about the ideal business. It was very popular with his readers. His criteria mesh well with your advice, but I bet you’d have something to add – especially when it comes to starting a business in a down economy.”
I read Russell’s essay and found that, as Suzanne suggested, he and I share many of the same beliefs. Which is another way of saying I liked it.
Russell said that he once asked a friend, a prominent New York corporate lawyer, to name the single best business he’d ever come across. Without hesitation, he cited a client with a business that made a chemical used in making synthetic rubber. The chemical was absolutely essential to the process. He had, in effect, a small monopoly that made him a millionaire many times over.
That hardly sounds like the perfect business to me, but I understand the value of having a de facto monopoly.
To me, the perfect business would have to meet a number of criteria. First and foremost, it would have to be a real business. By that, I mean one that had the capacity to provide me with equity – not just pay me a salary.
I’ve made this point several times in ETR. Most small companies are not really businesses at all. They give the entrepreneur a modest income – $60,000 or $100 000 – but without the prospect of earning much more or cashing out for big dollars when he wants to retire.
Owning a single retail store, for example, is usually not a business. It’s more often a self-employment enterprise, with the owner working 60 or more hours a week and struggling to keep his employees, vendors, and customers satisfied. The same is true of owning a restaurant, bar, travel agency, art gallery, or bookstore.
I know this is true because I have been in all those businesses. (I still own an art gallery and a travel agency.) They all seemed attractive before I actually got involved in them. Then I quickly found out that they were commercial balls and chains, tied around my financial neck.
No, the perfect business certainly would not be retail. If you are contemplating retail, you should get a copy of Automatic Wealth for Grads… and Anyone Else Just Starting Out and read Chapter 3. It will save you a lot of money and emotional distress.
Richard Russell’s father warned him against retail. He said, “The hours are too long, and you’re dealing with every darn variable under the sun.”
Russell’s dad also advised him to stay out of real estate. (He was a real estate executive during the Great Depression.) “When hard times arrive,” he told his son, “real estate comes to a dead stop and then it collapses. Furthermore, real estate is illiquid. When the collapse comes, you can’t unload.”
I don’t like real estate development as a business. (I know at least a dozen developers who have gone from being multimillionaires to near broke in the past two years. Many more will follow this year before the market hits bottom and begins to turn around again.) But I do like it as an investment, for reasons I explained in detail in Chapter 5 of Automatic Wealth: The Six Steps to Financial Independence. I don’t have time to go into all of them here, but these are the main ones:
- It’s easy to learn.
- It’s easy to leverage.
- You can limit your exposure.
- It’s easy to spot an overvalued market unless you are a fool, so there is little chance of going broke.
That’s not true of real estate as a business. When you are developing properties, your personal wealth is at risk. The better you do, the more insistent the banks are that you put your own neck on the block.
FYI, I have just bought a property in my neighborhood to add to my real estate portfolio. It is a duplex that is currently generating $1,350 a month in rent. It was on the market 18 months ago for almost $300,000, and I bought it for $110,000. I expect to be able to fix it up and increase the rents – but it will yield a nice positive cash flow even if rents go down. And I know how to sell rentals – something I didn’t know when I started investing in rental real estate.
But this is an investment, not a business. So let’s get back to the question: What is the perfect business for today? In my opinion, this is what it would look like:
1. I’ve mentioned my first criterion already. It would be a real business that could become more valuable over time and eventually be sold for millions of dollars. Single-store retail enterprises, as I’ve said, seldom qualify. Most have a net zero balance sheet when they are mature. You can sell them for a portion of the inventory and physical assets. That’s about it. No big payday.
2. It would have unlimited upside potential. It could go from 10 million to 100 million as easily (actually, more easily) than it could go from zero to a million. (For a complete explanation of what I mean by this, read Ready, Fire, Aim.)
3. To have that kind of upside potential today, it would have to have the entire world as its marketplace – not just a local community or even an entire country.
4. Richard Russell pointed out in his essay – and, of course, I agree with him – that the perfect business would sell a product that benefits from “inelastic” demand. Inelastic means that the price you charge for the product is determined by you, not the market. If you are selling canned goods or beer, for example, you can’t charge whatever you want. But you can do that if you are selling luxuries, rarities, or unique pieces. That’s one of the reasons I like the art business. (Still, as those of us in that business know very well, even art can be affected by the market. Prices have dropped by about 30 percent in the past year.)
5. In addition to benefitting from inelastic demand, it would be a product that could not be easily substituted for or copied. Ideally, as Russell said, it would be “an original, or at least… something that can be copyrighted or patented.” (There are many ways to make seemingly ordinary products unique and, therefore, “original.”
6. The perfect business would not employ blue-collar workers. Forgive me for saying this, but, in my experience, the hassles are just not worth it. Working with professionals is infinitely easier. Take my word for it – or learn on your own.
7. The perfect business would be financially leveragable. By that I mean it could be grown – at some point – without requiring an enormous amount of your attention. This is the difference, for example, between owning one hamburger joint and owning a string of burger joints. Opening a second restaurant is always a high-risk, low-return prospect. But adding another location to an already-successful chain is much easier.
8. The perfect business would not take up all your time. In the beginning, you’d surely have to put in 12-hour days. (I’ve never encountered a business where that’s not true.) But after you learned the industry secrets and taught them to your top employees, they would be able to take over day-to-day operations.
9. Similarly, the perfect business would not depend on you to keep it going. After a few years, it would run on its own.
10. The perfect business would have a very high net-revenue-to-employee ratio. This is an idea I developed many years ago. (I’m sure MBAs have a name for it – but I don’t know what it is.) Whenever I contemplate starting a business, I insist that it can reach $10 million in sales, after refunds and cost of goods, with no more than 20 employees. That’s a $500,000-to-one employee ratio.
11. The perfect business would have little or no inventory. If you have been in an inventory business, you know how important that is.
12. The perfect business would be cash-based and, therefore, have no receivables – meaning your income would never be held up by payment terms or bad debt. Receivables are fine when an economy is booming, but disastrous when the market sags.
13. The perfect business would have no debt. Customer payments would be sufficient to pay all bills and finance growth. (Imagine how lovely that would be!)
14. Another Russell criterion that I endorse: The perfect business would not need “an expensive location… large amounts of electricity, advertising, legal advice, high-priced employees, etc.”
15. Yet another Russell criterion: The perfect business would be relatively “free of heavy government and industry regulations. The cost of dealing with such regulations is always burdensome but will break you during a serious and long recession.”
16. And yet another Russell criterion that I agree with: The perfect business would be portable or easily moved. In other words, you could take your business (and yourself) anywhere you wanted – Nevada, Florida, Texas, Washington, South Dakota (none of which have state income taxes). Or, hey, maybe even Monte Carlo or Switzerland or the South of France.
17. I was trying my best to keep Russell’s criteria out of this article. In fairness to him and you, I wanted all the advice to be uniquely from me. But that’s not happening. My final requirement for a perfect business is from Russell too: It must be able keep your mind thinking and your heart pumping. You don’t want to become bored with it after a few years. You want it to be intellectually and emotionally satisfying, which is another way of saying “fun.” Most businesses simply can’t offer that.
That’s my list. It’s pretty demanding, I’m sure you’ll agree. Is there a perfect business? By golly, there is. In fact, there are several. Next week, I’ll tell you exactly what they are.[Ed. Note: Mark Morgan Ford was the creator of Early To Rise. In 2011, Mark retired from ETR and now writes the Palm Beach Letter. His advice, in our opinion, continues to get better and better with every essay, particularly in the controversial ones we have shared today. We encourage you to read everything you can that has been written by Mark.]