The McDonald's Model

[Ryan Wydler]

I've been reading the 4-hour work week and it talks about building a 'Muse', a system that passively generates income for you (usually in the form of a product that can be easily/quickly manufactured).

It got me thinking a lot about starting some kind of 'side hustle' as a lot of people in the FIRE community might call it, to generate some additional income outside of my W2.

Then I started to think about what a business really is, it's an entity just like your neighbor Joe. Joe has a Balance Sheet that Lists his Assets, Liabilities, Income, and Expenses. A business also has a balance sheet.

Simultaneously I was reading about the business model of insurance companies (not sure why), from what I understand, An insurance company will charge monthly premiums from customers (using some mathematical model involving risk quantification to determine a premium) and make payouts to legitimate claims, Ideally there is a positive delta between the total premiums charged and the sum of all the claims paid out, That is the company’s profit. HOWEVER, these companies also invest the premiums in safe short-term assets like bonds in the meantime (between payouts) to make additional income.

Isn't this a business model that all businesses should adopt? Doesn't it make good financial sense for a Business to have multiple streams of income just as it does for your neighbor Joe? If Joe was to rely 100% on his W2 income to survive, most of us here in the BP community at least would consider that Risky. Joe should invest in real estate to have some passive income in addition to his W2, but so should Joe's Custom Cowboy hat business, right??

Let's say ‘The Four-Hour work week' has got me FIRED up, I'm ready to build my Muse and get some passive income. Say I'm starting a Lunch box company targeting Young professionals that travel a lot. Does it make sense for 'LunchBox LLC' to have two departments, one that sells lunchboxes another that invests company profits into Office Space, Commercial Space, or even income producing Residential Real Estate?

I'm curious what people on BP and in my local area (Richmond, VA) think? Isn't this what big companies like Berkshire Hathaway do? Does BP own the building it's HQ is located at? What reason would a business owner have not to own its own Office building? Should every business owner adopt the McDonald's model? Why or why not?

[Ryan Wydler]

@Scott Trench, I would be really interested to get your input on this. 

[Scott Trench]

@Ryan Wydler

Great question and set of questions here. 

In my opinion, there should really only be two goals for most investors: 

1) To build the greatest possible amount of long-term wealth. 

2) To build a portfolio that produces predictable, reliable income.

It's the yin and yang, the tradeoffs between these two goals, that force all of the debate about which types of investments are the best and worst. 

Personally, I strive to get the optimal blend here for myself. My assets are as follows:

- My interests in BP

- Private real estate investments (mostly small multifamily in Denver, CO)

- Stocks (mostly vanguard index funds)

- Cash

- The book, Set for Life

- Misc. Smaller investments

I derive income from all of the above, plus my compensation as from my job here\.

Clearly, I conform to your thesis of having multiple income streams and assets across different asset classes. I could not agree more. While this diversifies my portfolio, it also allows me to be ridiculously aggressive in most of my allocation. Private business, private, highly leveraged real estate, a high concentration in stocks, NO bonds or fixed income investments, and royalty payments are all pretty aggressive. This is why I currently have a large cash position - to offset that risk. Frankly, I think I'm pretty undercapitalized now, and need to sell some real estate and reinvest, re-leverage, or invest more of my cash. But, I digress.

So, I wholeheartedly agree with you that all of us should have multiple income streams. I think that for most, a supermajority in one asset class (yes, even real estate) exposes one to too much risk, and will force one to be less than optimally aggressive on various other fronts. Some people will rightfully disagree with me, however. It probably makes sense for an entrepreneur to put nearly 100% of their portfolio into just one business and MAKE it work, at least at first.

I also agree with you on the business side of things.

If you are interested in learning more about the concept you describe, I invite you to read a book called The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success. 

Each of these CEOs employed basically the philosophy you describe here with unparalleled success (note: Jack Welch is notably NOT among those CEOs who dramatically outperformed to the level of these eight!). 

All this said, this is NOT my job as CEO of BiggerPockets to the same degree - at least not in our current form. It's my job to grow this business and our related lines of business in technology and media and distribute capital tax-efficiently to shareholders. I do not, for example, take our proceeds and purchase real estate and do not plan to do so in the future.

Instead, shareholders, such as our private equity sponsors, should in turn then take those proceeds and do exactly what you describe above.

[Dave DeMarinis]

@Ryan Wydler Great thoughts and questions. BTW - I have a freshman Spider, so I'm very interested to start investing in Richmond but that is another story. Here is my input. Fair disclosure, I'm an entrepreneur who loves real and leans heavily toward owning the real estate associated with my businesses. However, I'll give you the counter argument which is a very strong case.

#1 - Investors want to see FOCUS. That is why Scott's job is structured the way he defines. Grow business and tax efficiently distribute returns. (Division of Labor - Google Adam Smith and pin manufacturing to see a pretty good 250 year old example of why this makes sense)
#2 - A great business has a higher return on capital than commercial real estate and that is really true in a small business. If you can keep growing your business and getting 15% to 20% (unleveraged) return on your capital, that is much better than 5 to 7% (unleveraged) that you can get on real estate. 

Now, if your business growth is not capital constrained, then you could argue it makes sense to deploy capital on the underlying real estate. However, your job in running the business is to generate max returns on all available capital so instead of investing the spare capital in real estate, you should figure out how to be able to invest it in expanding the business more.

This is also why Warren Buffet HATES dividends. He views dividends as distributing capital (and triggering investor taxes on it) rather than investing that capital and generating the healthy business returns they are supposed to do by running the business.

[Frank Jiang]

Your premise is ok, but your conclusions are pretty far off.  Dave is correct that investors would prefer to see companies with focus as opposed to companies that generate multiple different streams of income.  The very simple reason for this is that individual investors can choose to diversify on their own.  They can buy stock in a company that is great at real estate and then stock in an insurance company and then stock in a finance company.  Each of these companies will likely be much stronger than a company that does real estate and finance and insurance.  A company that stretches too far into too many products loses overall competitiveness.  Just look at companies like GE.

[Sean Morrison]

Aside from whether it's a good idea to focus on many things, having the same LLC do those two different tasks is probably not a great idea. First, you could be mixing active and passive income, which might lose some tax benefits. Second, if the same LLC holds property and lunch boxes, then your property is exposed to any lunch box problems. For example, your lunch boxes have sharp edges that cut people. If they sue, they can go after your commercial properties. Third, your business is exposed to the property. If somebody slips and falls, they could go after your business.