Passive Income is a term that is thrown around constantly and is often misunderstood by many. Passive Income is defined by Investopedia as “Earnings derived from a rental property, limited partnership, or other enterprise in which a person is not actively involved.”
Generally speaking I think it is understood to be money that a person makes while being uninvolved. Many people will say something like “I have this great stream of passive income where I am making money right now.” Meanwhile the individual is on the beach, on vacation, or involved in some activity that is more fun than working! Now that sounds pretty good if you ask me, making boat loads of money while sipping a corona on the beach, sign me up! But here is where the misunderstanding takes place.
To develop a solid stream of passive income takes an incredible amount of work, time, and often money. It falls under the same misbelief of get rich quick schemes or get rich over night seminars. But solid passive income is very possible and is enjoyed by millions of people every minute of the day so why not you? Whether you are a current business owner, employee, or dreamer it is possible to achieve the American dream which has become far more than simply a nice house with a white picket fence in the suburbs. Nowadays the American dream has become more about achieving wealth and becoming an every day millionaire.
Millionaire, you might be thinking “Craig, that is a big statement I don’t think I can ever become a millionaire like the people I see on TV.” Well fortunately those are not the millionaires that I am talking about, I am talking about the millionaires that are your neighbor and you do not even know they are millionaires. Millionaire is defined as having a net worth of one million dollars or greater. This dream is very attainable by just about everybody.
Many people, 32% of Americans, contribute to a 401K with every paycheck. And this number should be a lot higher considering 59% of Americans have access to a 401K. Well guess what I consider a 401K, passive income. While investing in the stock market you are making 7-10% on your investment every year, this means that you are making money even as you are sleeping. This is by far the simplest way to create passive income.
The more complex ways are to start a self sufficient business, buy real estate (Even owner occupied real estate is passive, as real estate appreciates at 3-5% on average), or some other enterprise. So no matter where you are in life you have an opportunity to create some stream of passive income even if you are not realizing that wealth today. However, in this blog post I want to specifically speak to business owners or prospective business owners.
My number one objective when working with new clients is business valuation. Business valuation is not exactly our specialty but I am talking about the term generally not about actually valuing your business. The entire point of starting a company, owning a company, operating a company is obviously to make money but more importantly to generate wealth. Your business should be the largest item on your balance sheet within your financial statement. Even if a business owner has no desire to sell you should be looking to make it worth more each an every day and thus more desirable to purchase.
Growing your businesses worth can be done through a multitude of ways; increasing sales or revenue, cutting costs, or increasing capacity by hiring more people. Although those aspects are incredibly important, the most important thing about a business valuation is how easy is it for someone to buy you and take over.
How easy is it for someone to buy you and take over, this is an ambiguous statement and what I mean is what systems do you have in place, what processes run your company, are these systems and processes commonly known, is one person largely responsible for more than 20% of your revenue, can the owner be removed from the business and it will run swimmingly?
These are the questions that you need to ask yourself as a business owner or as a prospective business owner looking to develop a business plan. The age old example of this is McDonalds, which we have talked about in our blog before. Every McDonalds has the same procedures, protocols, and manuals. This makes the business very desirable, as just about anybody can own and operate a McDonalds franchise. Your business needs to be more like McDonalds and thus making it more similar to passive income versus active income.
This means every position needs an employee manual, you need a proper succession strategy for every management member, proper CRM (To track past, present, and future clients), solid marketing plan, business plan, goals and plans for minimum 5 years out, and a process for all business operations.
This is why we stress the importance of processes because this allows for a higher valuation for the business, increases wealth on a daily basis, and creates a stream of passive income so that you can go start another business that follows that same model. Starting a business is hard work but the reward should not be working 80 hours a week making a million dollars a year but rather to create a business process that allows you to make a lot of money in a more passive nature while increasing valuation and personal wealth.
If you are a business owner or prospective business owner and you do not have this mindset it is time to change your frame. Begin to remove yourself from the business by creating processes. If you are knee deep in your business and find yourself putting our fires everyday, this process is going to take time but be patient as it will be worth it. As always if you have any questions or need help creating this structure give us a call.