So, if building a business with a bottom line makes it more sustainable and more valuable and sets up a strong succession plan, why don’t more owners employ this method? The answer lies in the fact that most practice owners tend to focus their efforts almost entirely on production without thinking about the trade‐off in terms of equity and enterprise strength. In this section, we compare the produc- tion model and the business model works, side-by-side, and show you the math.
A typical arrangement is illustrated in Figure 3.8 ; assume a fee‐based practice with annual gross revenue of $1 million. The producers in this model, including the owner/founder, are paid on a 50 percent revenue‐sharing arrangement; in other words, everyone receives 50 percent of every dollar of revenue they produce. After paying the overhead (staff compensation, lease costs, benefi ts, utilities, marketing, technology, management, etc.), there is little or no meaningful profi t.
Most independent practices and businesses operate as pass‐through tax conduits (sole proprietorships, S corporations, and LLCs taxed as a
FIGURE 3.8 Typical Production Model PRODUCTION MODEL
CURRENTLY
Gross Revenue $1,000,000 Revenue Share/EWYK −$500,000
Expenses −$500,000
Profit $0
disregarded entity, partnership, or S corporation), so actual owners may not consider lack of profi ts an issue. If the goal is simply to generate a good living and to have maximum individual control over the engine of produc- tion, there is nothing wrong with this approach. But consider what this same model looks like fi ve years later (Figure 3.9 ) when there is little or no meaningful profi t compared to the business model in Figure 3.10 .
Assuming a 7 percent annual top‐line growth rate for the five‐year period, the production model has grown at the same rate as the business model. Both have the same top‐line revenue, and both owners make about the same amount of money. So what’s the difference? Equity. The business model is worth in the neighborhood of $3 million; the production model is unsalable as a business because the nonowners control their own books and it is highly unlikely that all producers will sell in unison. In fairness, the production model is built for producer enrichment, not owner’s equity—but with the business model, you have the same production and the advantage d of equity value.
In the business model, the function of controlling and gradually fl attening the compensation line with a salary/bonus structure, as we illustrated in the preceding section, results in a bottom line. The profi ts, in turn, are reserved for those who legally own and who fi nancially invest in the business—
advisors who buy stock from the founder. Because the business model now has two or more owners who focus on the bottom line (and for good reason FIGURE 3.9 Creating a Bottom Line: Current Production Model
PRODUCTION MODEL
+5 YEARS (APPROX. 7% GROWTH)
Gross Revenue $1,400,000 Revenue Share/EWYK −$700,000
Expenses −$700,000
Profit $0
FIGURE 3.10 Creating a Bottom Line: Business Model in Five Years BUSINESS MODEL
+5 YEARS (APPROX. 7% GROWTH)
Gross Revenue $1,400,000 Salary/Bonus −$500,000
Expenses −$650,000
Profit $250,000
since it impacts their take‐home pay), expenses tend to be better controlled as well. The margin between revenue growth and expense growth tends to improve, and that further improves the bottom line over time.
The profi ts generated in the business model are distributed approxi- mately quarterly to the owners in the business. If minority owners want to increase their profi t distributions, they will have to think like an owner:
(1) grow the top‐line revenue (production is still job number one), (2) reduce overhead costs, and/or (3) buy more stock. All of a sudden, the implicit value of ownership has increased without lessening the business’s rate of growth.
Granted, the compensation systems we examine a thousand times a year are more varied and a little more elaborate than we’re illustrating here, but the common denominators in almost every case are some type of EWYK system and a one‐owner practice model focused almost exclusively on production.
In sum, remodeling your cash fl ows means that things are going to be different. You will have to learn to use your fi nancial data more effectively, and that function will make you a better owner and advisor, especially to your business clients. Once these systems and processes are in place, however, most owners fi nd that the cash fl ow structure is not more complicated—
it is more sophisticated. It will increase business formalities, which is to be expected as a business becomes investor‐worthy. From the founder’s perspective, fl exibility (in terms of his/her personal salary and distributions) is gradually exchanged for predictability and reliability, even longevity.