But something unexpected popped onto my radar screen just recently. A local small business owner who amassed a tidy fortune by patiently building his business.
A guy who basically played the long game. But won big because he did. Even though he operates in a pretty boring, mature category.
But let me explain.
Compound Interest Magic
You know about compound interest probably.
If you invest a small sum regularly, your interest earnings compound over time. Slowly at first, of course. But steadily.
Eventually, after decades, the numbers get big.
For example, if you invested $6,000 a year over your working years in the U.S. stock market? You may start retirement with about a million dollars. (I adjust for inflation here, by the way.)
Compound Growth Shows Up Other Places
But this compounding of interest, or compound investment growth, shows up other places too.
Pay an extra $25 a month on a 30-year mortgage, for example? In the end, you’ll save thousands of dollars of interest. (How much you save depends on interest rates. Your savings compound at the mortgage interest rate.)
Small business owners enjoy another possibility: Compound growth of small business revenues, profits and valuations.
And the big surprise here: This math often works more powerfully than many small business owners appreciate.
Which brings me to my real life example…
Small Business Compound Interest
A local CPA firm owner listed his firm for sale last month. His asking price? Nearly $8 million.
That’s for a firm that, according to the listing at bizbuysell.com, earns slightly less than $2 million of profits on slightly more than $5 million dollars of revenue. (I round the numbers here for readability.)
Now before you think you’re in the wrong business or profession, let me bring you back to earth. Average CPA firm revenues run maybe $200,000. (That’s the number I calculate based on analysis described here: Small CPA Firm Profitability.)
Profits? Oh gosh, it depends. But many small firm owners probably earn about what a similar-age public school teacher earns in salary, fringe benefits and retirement savings. (See this schedule, for example, and remember to add maybe $15,000 for health insurance and retirement benefits.)
The CPA firm described here, however? Massively larger. Massively more profitable.
What in the world is going on? How do we explain this outlier?
I think a simple answer suffices: Compound growth in the firm’s revenues.
In this case—and here I’m guessing at one of the numbers–roughly 10 percent annual growth in revenues.
If in 1990, for example, the firm generated $300,000 of revenue, it grew that value to $330,000 by 1991. It then grew the revenues again in 1992 by 10 percent, or to $363,000. And so on.
Continue this growth rate over three decades, however, and bingo. The business revenue grows to $5 million.
The Big Takeaway for Small Business Owners
Most CPAs and most CPA firms serving small businesses don’t enjoy growth anything like the firm I point to here.
Neither do most small businesses.
But the small business compound growth this story describes? That’s really relevant for you and your firm. And for me and my firm.
Slow steady growth over decades compounds. Further, that growth in revenues means growth in profits and the business value.
Eventually, the numbers grow bigger than one would ever guess.
A statement to provide context: If you can orchestrate steady compound growth at your small business? Your financial results should greatly exceed what you might earn from saving money in a retirement account stuffed full of index funds.
Three Smaller Points about Small Business Compound Growth
Let me share three other quick points related to the earlier example.
First, the business owner identified an engine he could use to power steady growth—and then he had a “growth” mindset. By the time I ran into him, he was regularly buying smaller CPA firms to fuel firm growth. (That’s how I met him. He offered to buy ours.) The point here? A small firm doesn’t grow big by accident.
Second, the business owner organized his operation to be scalable. His firm used procedures and technology and then employed people who supported steady growth. To point to one example, his tax software worked for a firm with two dozen employees. To point to another example, he employed a compensation formula that attracted talented tax accountants.
Third, a general comment about sustained growth. To grow revenue year in and year out, this business needed to carefully grow its balance sheet year in and year out. That subtlety gets missed by some managers. Often with fatal results. But if a firm that generates $300,000 of revenue requires, say, $30,000 of assets? Probably, to grow the revenue by 10 percent (to $330,000), the business owner also needs to grow the balance sheet by 10 percent (to $33,000). Further, that arithmetic reality grinds on as long as the firm continues to grow.
Two Quick Comments to Close
Two quick comments before I wrap this up.
First, the real-life example that triggered this blog post uses big numbers. But the compound growth math works just as powerfully for a smaller small business. To give you another example, if your business revenue currently equals $50,000 and you grow by 10 percent on average, you get to $200,000 in revenue after 15 years. Which would be fantastic. Obviously. Further, your profits probably at least quadruple if your revenues quadruple.
Second, I’m writing this blog post for a business owner. And so the earlier paragraphs talk in terms in what works for the entrepreneur. But keep in mind a growing business rewards other people too. Probably, for example, a growing business creates jobs. Probably, a growing profitable business boosts the pay rates for the people on your team. Almost surely, a growing business creates a more intellectually interesting workspace.
Some other online resources can help you think more deeply about the issues mentioned in this blog post.
For example, we’ve got several articles that describe issues and concerns related to growing a small business: How to Grow a Small Business (which supplies tips from experienced business owners), the Hidden Magic of Arithmetic Growth, and How Taxes Kill Successful Businesses (which is really about sustainable growth math).
Also, let me point out that small businesses as they get bigger often need to “grow” the ways they market themselves something discussed here: Has Your Business Stopped Growing?
Wikipedia has a good article about sustainable growth rates here. That would be a useful read for many managers.
Finally, here’s the actual listing for the CPA firm. It won’t be posted permanently, of course.