An example of getting rich from starting a business selling underwear
I am going to tell you precisely how this works, but first we need to define “rich.” For most people who are not entrepreneurs this means having a lot of cash to spend on things. For the wealthy this definition is a little different. The majority of wealth held by rich people is in the form of investments, one of which can be a business. Only a small portion of wealth is normally held in cash - maybe 5 - 10%. Rich people have their money work hard to earn them more money.
When one starts a business your ownership in that business is what would make you rich. To be clear, your shareholding in that business will grow in value as the business becomes more successful, and it is the value of those shares that can make you wealthy. But let’s backtrack and use your example:
I start a small business from my living room selling underwear. People in my community need underwear and I have a great supplier from China who can manufacture and deliver stock at a very low cost. I can sell my stock with a high mark-up, maybe 2 x or 2.5x the cost. This means the Y-fronts I buy for $1 can be sold for $2 or $2.50. I decide to buy 3000 pairs of underwear.
I continue to sell the underwear - with the profits I buy more stock, which sells out rather quickly. Apparently the people in the next town over also need underwear and news of my great products have spread.
As demand grows for my products I find myself in a difficult position - one of the largest underwear chain stores closed down in two other towns close by and suddenly there is a massive need for underwear. I am one of the few people selling it, but with my current cash I can’t buy enough stock to keep up. Also, my living room is way too small for all the boxes and my wife is tired of all the people trampling our new area rug. I need storage space and a web site for online ordering.
Let’s pause here. The value of my business as it stands is decent for a small business, for the past year I made $50 000 in profits, and I can see myself doing this for another 5 years before I exit. I also have stock of $5000 and cash in the bank of $20 000. Using a quick earnings multiplier valuation, and adding my assets, the company is estimated to be worth ($50 000 x 5 years +($5 000 + $20 000)) = $275 000. Assuming that I have no other assets, my net worth is $275 000. Not rich yet, but not a bad start.
Back to my problem of space and stock. I approach some friends and family with a proposition. If they are willing to put in $100 000 to get a storage space, build an online store and acquire more stock, I am willing to part with 20% of the business. With their cash injection I can expand the business and earn 5 times as much annually. A friend of a friend decides to buy in.
We incorporate the business so that there is a proper shareholders agreement in place, just in case something goes wrong. It is also a good plan for tax and accounting purposes.
The fact that my new partner was willing to pay $100 000 for 20%, means that my business is suddenly worth at least $500 000. I own 80% of that, which means that this simple move increased my net worth from $275 000 to $400 000. I still only draw a small salary, but my shares are worth quite a bit.
In spite of some hiccups with the web site, we make a success of selling underwear in my own town and 15 others within a 100 mile range. In fact, the business earnings went up 5 times! Some of my competitors are noticing and two set up their own web sites. The competition takes a bit of a bite of our market. It isn’t nice but we must be doing something right!
We are approached by one of our competitors who wants to buy us out. We decide to consider it, and after a lot of work come up with a valuation of $2.5m. Our suitors can’t afford it, but they are willing to buy 40% for $1m on the condition that they cease operating their web store and they get access to our supplier.
We have a tough decision to make when our financial manager pipes up: “Why not use this money to expand nationally?”
We accept the deal. My partner worked hard and he is having a tough time after his divorce, so I decide to dilute my shares so that he can hold on to his 20%. I now own 40% of a company worth at least $2.5m which means that I am officially a millionaire! I earn a decent salary and due to my great credit score, I have good credit at the bank and I can afford a mortgage on a nice family home. I drive the company car which is a good SUV. It is a good tax deduction.
With our latest partners we gained both cash, as well as a new team of people who can manage customer support. This was one area we struggled to build, but now we are good. We use the money to expand our operations nationally, which is simple as we do purely online sales - it is purely a marketing and logistics problem.
Two years later the company is doing very well. We have an annual turnover of $6m with a gross profit of 40%. For the past two years I earned dividends as well, over and beyond my salary and some bonuses. My last dividend payout gave me nearly $300 000 in cash that I invested in some stocks, a small property and seed funding for a new venture I have been fiddling with.
I have been with the business now for 6 years. It is going well and I am enjoying it. I earn a great salary and have many benefits of being a high net worth individual. And then the call comes for which we were all hoping. The Chinese conglomerate linked to my suppliers noticed our national success and they want to buy us out. They want to use our platform to launch a global underwear portal to service their wholesale customers, as well as millions of retail customers. They want to control the entire supply chain.
After doing some math and three months of tough negotiations, we come up with a fair valuation. The price is $55 million and covers our stock, our storage buildings, our web properties, goodwill and our recently acquired delivery company.
We decide to exit. My original partner is overjoyed - after working through the tough times he got remarried and will now get $11m for his initial $100 00 investment after 5 years. This is a massive return on investment which you will never see in normal stocks, savings bonds or even property.
And me? I bootstrapped this baby from my living room with my initial stock costing me all of the $3000 I had in my savings account. I walk out with $22m. Maybe now I am rich.
One day I sit in my living room and discover a great supplier for running shoes…
This is how one could get rich starting your own business. Not everybody can make it work - failure rates for new ventures are extremely high, as high as 90%. However, there are no clear stats for failed entrepreneurs. We often try 10 different businesses before one sticks.
This is one possible approach. There are others, but this should give you a clear understanding of how one leverages money to grow the value of a company, much like one would grow healthy pumpkins by enriching the soil with fertilizer.All it takes is a small start and a lot of grit!