John and Adam walk into their cubicles for the first day of work: “Welcome to Company X! We pride ourselves in client service, diversity, going the extra mile and of course grooming bright up and coming stars like yourself. Last year we grew revenue and net income by X%! You’re joining an elite group of hard working individuals dedicated to gaining market share and building long-standing relationships with our customers” Since it’s the first day, everyone drinks the Company Kool-Aid and heads out to “happy hour” (Note: there is nothing happy about happy hour).
John and Adam – Year One: John and Adam do well in year one at the company. They are both ranked within the top bucket at their firm. This means they both obtain an extremely high bonus equal to ~100% of their base salaries. John does slightly better since he is ranked as the #1 person and receives 100%, Adam does comparably well and receives 95%. Both become friends for political reasons and they continue to work hard selling as much product as they possibly can.
Realization – Year Two: Since they are friends for political reasons, they discuss how the bonus structure is created and how much they are being paid relative to what the Company makes in profit. After running the math for year two they realize that net income at the company will be up about 20% with revenue going up about 10% as well. However, when they receive their bonuses they are both up approximately 10%! Instead of growing their bottom line at the same rate as the Company they are increasing at half of the rate. Immediately, they realize they are never going to be paid for what they are bringing in.
Fork in the Road: Since John has been #1 at the firm for two years in a row now, he decides to focus even more on growing his Career. He begins putting a bigger difference between himself and Adam when it comes to total revenue generation. Adam on the other hand takes a second option, he does the minimum to remain at the top of the group. Adam realizes that he will be promoted so long as he is in the top 10% at the firm… and his income will only drop by about 5%. By taking option two he commits himself to developing a second revenue stream with his free time. Sure beats watching Netflix and sports replays everyday (or worse reading about politics).
Time Passes By – Year Five: Both John and Adam have been promoted. They are now solidified as being top-tier workers while John makes approximately 15% more than Adam. Adam has become much more cunning. Every year he lies down. When the group gathers up to talk about bonuses he explains that he makes 10% less than he actually does (makes sure the lie down is believable). This makes everyone less likely to be jealous of him and they still view him as a top tier guy to know since he has been in the top bucket five years in a row. What they don’t know is that he has developed a second income stream that now makes his income comparable to John. While John Makes $250,000 a year, Adam makes $210,000 a year with $40,000 a year from his other idea.
Management Time Begins: John and Adam are now responsible for managing a small team of junior sales representatives. This is an important turning point and both see an increase to their total income. The value of creating a second income stream is now seen. John becomes a micromanager, Adam becomes a delegator. Why does this happen? Well John has 100% of his income tied to the Company and obsessively hounds all of his employees to give 110%. Adam on the other hand attempts to leverage his time by giving away some additional responsibility when the junior employee shows she is good enough to make the sale. Not only does Adam save time, he also improves his political standing (he’s a good “leader”). When the reviews come around again, John makes slightly more again, however his “360 degree review” comes in a tad below Adam. While John makes $350,000, Adam now makes $310,000 with another $90,000 coming from his secondary source of income.
Levering Up: John and Adam are now levering up. They both buy a property to live in and obtain a second property for rental income. The difference is that the leverage now feels even more stressful for John. Not only does he have to micromanage his employees he also has to perform otherwise he won’t be able to cover his interest payments on the debt. His stress levels have gone no where but up for the last 7-10 years. Adam? He is continuing to stay in the top bucket (no more no less, essentially an A- student). He refuses to invest any more time than that and consistently gives one of his employees a 5-star review (the top in the group, focusing entirely on meritocracy/performance – highest sales).
Churn Rate: At this point, the people on John’s team see a higher attrition rate, while he is still making slightly more money than Adam at the Company, the instability of his team makes it difficult to scale. Adam on the other hand sees minor attrition. He gives slightly more work to the star performer (Alison) who then receives a small promotion. Not only does she get promoted but Alison can now handle slightly larger accounts freeing up even more of Adam’s time with a growing revenue line (no slow down). By shirking partially to build his other income streams he is actually gaining ground now. John makes $380,000 while Adam makes $350,000 and $150,000 from his secondary source of income. Their rental properties and current homes are running at rough break even so they ignore the values in terms of cash flow.
Structural Change: A new competing product emerges in their space. Unlike anything they have seen before the Company is no longer growing and instead is struggling to see flat-lined revenue numbers. Unfortunately both of them cannot earn any more money and since they are higher paid they are asked to “take one for the team”. Both of them go down ~25% y/y and earn significantly less than they did the year before. John makes $300,000, while Adam makes $285,000 and his secondary source of income stays at $150,000.
Firings Begin: Unfortunately, the Company needs to downsize. John is let go. Most will assume this doesn’t make any sense however, from the Company’s perspective it can certainly happen. John does not have anyone on his team to fill a bigger role. Adam on the other hand gets paid less and has a person younger than he is that is ready to take on a bigger role. The decision has been made. Adam will take on slightly more responsibility and his trainee Alison will take on a bigger role as well. Adam and Alison take over a large chunk of John’s business. John’s income goes to zero (he does have some investment income of $40,000 a year). Adam makes the exact same amount at $285,000 and his secondary income is stable at $150,000. He decides it makes sense to commit more time to the Company this year just to make the new structure runs well, after that he’ll go back to his business.
Stabilization of the Environment: Everything is flat the next year and Adam finds time to focus more on his business. Adam is able to get his business up to $200,000 a year while Alison has taken on more responsibilities (her income goes up 20%!). Adam is back to generating almost $500,000 a year in total compensation with a 60/40 split between career and business income. On an after tax basis, he’s actually earning more from his Company.
What Happened to John: John is searching for work and it will take him a solid 6 months just to find something that pays ~20% less than what he was making before. It is harder to find a position when you’re unemployed than when you had a career in the first place. In addition, he is living a terribly boring life given that his income stream is only ~$40,000. The Company man has done everything right in his eyes. He was always the #1 guy at the firm and yet he couldn’t get through the layoff round. The one bright side is he does have transferable skills. He harbors quite a lot of resentment for the Company given that he always outperformed Adam.
A Year Passes: The Company is doing better and Adam’s business is still outgrowing his compensation at the firm. Alison has also been doing a lot better with her new accounts. Instead of stepping on the gas, Adam continues to lay off the gas pedal. He spends more time developing his other business line and even came up with a third idea that generates a decent $50,000 in its first year! At this point he Makes $300,000 from his Career, $350,000 from his second income stream and $50,000 from his third (not to mention his investment income).
Adam Gets Laid Off: Well after surviving the first round of cuts the Company goes through another tough patch. Luckily Adam was able to raise his hand for the next round in a politically correct manner. This gives him a nice severance package and Allison is now heading up the group with a couple of other junior employees. The company cannot figure out why Adam would raise his hand (he wasn’t on “the list”). Five weeks later they find he is running a business (the third one) and believe that was his small amount of income. What they don’t realize is that he now has two incomes $400,000 from his secondary source and $100,000 from this third source. His career goes to zero but he gets a nice severance package to buy yet another rental property.
Adam Gets a Call From John: John asks Adam to grab “lunch” the standard corporate move to catch up with someone in the corporate industry. Always some sort of sushi or seafood place right in the center of downtown. John expects Adam to be a bit stressed but finds that Adam looks a solid 5 years younger than he expected. John on the other hand is back to the grind making good money at $400,000+ a year in another Enterprise sales position. Adam finally spills the beans and explains he makes more now than he did at the Company. John is shocked by this given that Adam doesn’t have a “prestigious employer”. Instead of asking about networking Adam just talks about some new rental properties, traveling and his new idea that made $100,000 last year (not much but he sees potential now). John begins to question a lot of decisions and wonders if it makes sense to put all his eggs in the company basket ever again. Unfortunately, it’s a bit too late for John. He’ll have to start from square one paying a hefty life tax to make it. While he gets some traction it just never gets above $5,000 a month.
How Does This Play Out Mathematically? The math is painful but the risk avoidance is the real killer. Instead of looking at this from a pure financial position (which is bad) we should also look at the numbers from a risk perspective. When Adam begins to make $90,000 a year from his secondary source of income he is able to *think about scale* instead of squeezing the profit line. This change in thought process is worth more than $90,000 (nothing compared to his overall income.) Note: we assume 45% of income as the savings rate and a 4% return profile.
Now the value becomes incredibly clear. While Adam has made ~47% more than John, the real value is in ownership and equity. If Adam believes in his third idea, he can sell the asset from Idea #2. While we have used a 10% discount rate giving the value of the assets $4M and $1.5M respectively, you could argue for both more and less (implies a 10x P/E multiple). Even if we give it a 2x P/E valuation that is $1.1M in equity value for his two assets. That $1.1M is approximately equal to John’s $1.4M total net worth from a 4.5% yield in investments. This is why the quickest path to financial freedom is by becoming an owner.
What Happens Over the Next Five Years? We wish this had a better ending but it doesn’t. John and Adam worked in a sector that has now been largely automated. While there is a need for a few account managers to do some face to face interactions, the primary re-billing business has no need for material human interaction anymore. John ends up seeing a 50% paycut and now makes $200,000 a year (he made the same amount at just 25 years of age). Lucky for him, he was investing a lot of money so he has enough passive income to survive. The problem is that he is still friends with Adam. Adam is officially “living the dream”. Instead of selling his Company he ended up hiring a couple of employees to run the business. It still generates $400K a year for him. His third business? Well that was a 10 bagger and now generates over $1M per year… John now questions if being a top performer was worth the risk… The risk of not diversifying his income streams.
John and Adam Catch Up: John finally asks how Adam was able to do all of this work while maintaining his career. Adam simply says “I decided to live efficiently”. Instead of focusing on being the #1 person in the firm he realized that being in the top group was “good enough” to get promoted. While he would “lose” an extra $20-50K per year… that gave him extra time to pursue other ideas. Instead of trying to go the extra-mile for the Company… he went the extra-mile for the person that matters: himself. While he never dropped the ball at work, he also knew relying on a single source of income was a dangerous matter. After all, he could never sell his career since there was no equity value and who knew if the business would last for 20+ years (quite a long time for change). Besides, if he was unwilling to lose ~$20-50K a year during his youth, then he never really valued his time in the first place. Finally, Alison who is still at the Company, has followed the path laid out by Adam so she is less worried about the near-term decline in the industry.
Concluding Remarks: This is one of the cleanest ways to get rich. People believe working for a Company is “less risky” even though a Company is just a machine within an industry. And? No one knows if that specific industry will last for 20 years. While there are many takeaways from this story (names changed for good reason) here are the big ones: 1) You don’t need to be the #1 performer when you’re working for someone else, 2) levering up can be stressful if you’re relying on one income stream, 3) always lie down when it comes to your income in a corporate environment, 4) when you build an income stream for yourself, it can be sold so you should at least double the value of annual business income; 5) companies look at return on investment, just because someone is being paid more than you does not mean they are first to get laid-off/fired, 6) learning how to delegate and leverage your time can be more valuable than doing everything by yourself, and 7) you only live once so you should give yourself a shot at being rich… besides it’s the least risky option if you’re living your life efficiently…. Oh and one last thing. The Company man has his life identity tied to his career… No need for further explanation.