🔑 How Buffett saved billions in taxes
Welcome to The Business Academy with Sieva Kozinsky. Here's what we have in store for you today:
- How Warren Buffett structures his company
- Selling a business to a public company
- Home healthcare business trading at 4.4x cash flow
UPDATE: The Business Academy is opening a spot for our first outside advertiser. But not just any advertiser. We have a unique audience of 70K+ smart investors plotting their next business to buy (see results below from our recent reader survey, over 60% of readers come to learn about how to buy a business or to find a business to buy).
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🔑 How to Build a $200 Million/Year Business
Mike Beckham built Simple Modern to $200 million in annual revenue.
But his journey is just as much about failure as it is success. He didn't get into business until age 30, and he made several mistakes along the way.
Many of those mistakes would have been fatal for other entrepreneurs, but Mike trudged on.
Check out Mike's story here:
"What if companies could buy and own other companies?"
It's pretty common today - almost every major merger & acquisition is one corporation buying another.
But the concept is younger than you think.
The idea of a holding company didn't become popular until the late 1800s and early 1900s when Titans of Industry like John Rockefeller, and JP Morgan started rolling up smaller competitors to form mega corporations that dominated their industries.
The first legislation focused on holding companies that I could find came out of New Jersey in 1889.
It's generally believed that New Jersey was the first state to pass legislation as the basis for a holding company in 1888-1889. In essence, it allowed one corporation to own the stock of another.
Before long, holding companies acquired a reputation for creating monopolies. Railroads and utilities became associated with taking clever advantage of holding company legislation.
The Northern Securities Company, a railroad holding company formed in 1901, led to a landmark federal lawsuit alleging restraint of trade and resulted in the company being broken up.
Today, holding companies have numerous legal & taxation benefits.
I'll give you an example using our own holding company:
We took inspiration from Berkshire Hathaway when structuring our company. Here's our plan:
- Pay 0% capital gains
- Compound with low taxes on profits
- Give our investors the same luxury.
Here’s the playbook (that you can use too):
The overarching structure is a C Corporation.
An active U.S. C Corp with gross assets at original cost at issuance under $50M is considered a Qualified Small Business.
This is critical for building your tax shield.
There are five key components here:
- Qualified Small Business Stock (QSBS)
- C Corp Dividend Deductions
- C Corp Consolidation
- C Corp Redemptions
- BONUS - ESOPs To build a cash compounding engine, an efficient tax strategy is key.
Let’s take a look at each one:
Qualified Small Business Stock If you operate a QSB, then you can issue Qualified Small Business Stock (QSBS). If you purchase C Corp shares at “original issue” and hold them for at least 5 years, you pay no federal capital gains tax when you sell (up to the first $10M).
C Corp Dividend deductions When one C Corp owns more than 80% of any subsidiary, it can deduct ALL dividends received.
You can use those dividends to reinvest in new opportunities.
This is how Buffett moves cash from his subsidiaries to the main office to reinvest. And is why we prefer to own 80%+ of a business.
Berkshire famously never pays dividends. Here's why:
"The test about whether to pay dividends is whether you can continue to create more than $1 of value for every dollar you retain"
-Warren Buffett
Dividends are also a taxable event for investors, so Buffett has a higher threshold for dispersing cash because of the tax hit investors will take.
C Corp Consolidation Similarly, if a C Corp owns more than 80% of a subsidiary, it can consolidate financials.
This is important:
If you have a profitable services business and a money-losing startup, you can shield services business profits with the startup losses.
C Corp Redemptions
Your investors might want to hold forever.
But what happens if investors want to sell some shares along the way?
You can establish a structured share buyback program in which you use free cash flow and repurchase shares at fair market value.
Corporate taxes can get complicated, so this is nowhere near a comprehensive guide. If you want more content on this topic, check out the interview I did with Ankur Nagpal.
🔑 Selling a Business to a Public Company
Business buyers and sellers can learn from this story of a founder who built up a business and sold it to a public business.
This one has some good insights on key questions like: When is the right time to sell? Why do sellers part with good businesses? How to pick the right buyer?
🔑 One interesting deal
Home health care is booming. Let's take a look at a listing that I'm sure will garner lots of interest from buyers.
What I like
This business seems great at first glance: Reasonable valuation, given the in-demand industry and the fact that private equity loves to snatch these businesses up.
It's been in business for over 27 years, which is a huge plus for me.
What I don't like
Personally, I stay away from medical businesses because it often falls in the "too hard" bucket. I wouldn't look at this business, but I think the right operator with healthcare experience may do well with this deal. You will need to understand the insurance dynamics for this business. Is it cash pay? If it requires insurance, be sure to diligence the challenges of relying on insurance to run your business. Labor can be very hard in these home health companies. Attracting great people and retaining them in a fairly competitive level. There's also a licensing risk when businesses like this change hands; the new owner will need to apply for and maintain the licensing required.
Have a great week,
Sieva
P.S. I've been publishing more shorts on YouTube with some of the most interesting moments from my interviews. Take a look and please subscribe on YouTube if you haven't already.
Disclaimer: nothing here is investment advice. Please do your own research. The information above is just for information and learning.
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