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OWNING A BUSINESS VERSUS OWNING STOCKS

When you own stocks, you own shares in a business. That is obviously different than owning your own business. But there are some similarities. The table below explores some of the differences between owning your own small business versus owning shares of stock in a publicly traded business.

For most people the choice would be between buying one small business that you are going to own and operate (and perhaps grow into a large business) versus continuing to work for others and doing some investing "on the side".

 

 Issue  You Own and Operate a Small Business  You Own Stocks (shares) in Businesses. And You Keep your day-job.
 Money Needed  Usually you need a large sum of money to get into an owner-operated small business. If a business is going to replace your former employment income it is likely going to cost you at least a year's salary, perhaps MUCH more. You can start buying mutual funds with as little as $50 or $100, and usually with a plan to buy additional funds monthly or yearly.

You can start buying individual shares with as little as about $1000. However $10,000 to $25,000 is more realistic before you open a self-directed account to buy shares. We have an article that explains how to get started.

You could buy shares with the assistance and advice of a full service broker if you have at least about $100,000

 Borrowing to Buy  For a small business that has real estate you can borrow some of the money. However for many businesses you will find the bank unwilling to lend. You could borrow on your personal line of credit or against your house. Vendor financing is also sometimes possible. In general you will want to have a large down payment and avoid too much debt. 

The better franchise opportunities, for example, will insist that you bring a very substantial down payment to the table.

Borrowing to buy stocks is often frowned upon. You can, through a margin account, use some leverage. In theory you can borrow on your line of credit or against your house to buy stocks. It can be appropriate in some circumstances. In general though, investors tend to purchase stocks with their own money such as in a retirement account.
 The Initial Buy Decision  You will want to think long and hard about the type of business you buy. Once you buy it may be difficult or impossible to sell. Almost certainly a quick sale would involve a large loss. You may be virtually locking yourself for life into this business, so do think long and hard. You can buy easily for a very small commission. Usually the buy / sell spread is tiny and, if you wanted to, you could exit immediately at a only a tiny loss. You still need to be careful what you buy but not to the same extent as when you buy a business.
 Diversification  Often the owner of a small business has no diversification. He or she is "all in".  Diversification is almost automatic when investing in stocks. There is usually little reason to expose too much of your money to any one stock.
 Job for you  As an owner you can hire yourself. (Though it's not guaranteed that you will have the money to pay yourself!) You will be keeping your day job, unless you are retired or quite wealthy
 Jobs for the family and friends You have the option of hiring family members and friends, depending on your needs. This can be good, but it has its down sides as well. Having to fire or layoff these people would be no fun  Not applicable
 Management   Depending on your view point you "get to" or you "have to" manage the business. You get to make the decisions. But also it is your phone that rings when any trouble arises or any material decision is required.  Not applicable, you don't have to worry about managing the businesses you own shares in, nor do you have any say in it.
 Who's the Boss?  To a large degree you are the boss. No one tells you what to do. (Well except that bankers and customers often can be pretty bossy as well.) You are the boss over your investments.

In your day job with rare exceptions like sales jobs, and certain professions you always face the fact that there are bosses that run your life. They judge you, often in arbitrary ways. As you get older and wiser you will usually face working for bosses who are younger than you at some point, and not as knowledgeable. It can be annoying. 

 Financial Security A business may or may not offer financial security Keeping your day-job usually offers financial security although that is not guaranteed forever.
 Pension  not applicable  Sometimes applies
 RRSP savings   If you take a wage from your business you can contribute up to 18% of earned income to a limit of $22,450 for 2011. But that is only useful if you can afford it. If you have a pension your allowable contribution to RRSP may be small or non-existent.
 Physic Income related to the Asset  There is an important mental satisfaction to being able to drive up to you business and to point out to others that you own a business.   While there is a mental satisfaction to owning a growing pile of loot invested in stocks, it's not quite as satisfying as driving up to your own building. And bragging to friends about your loot is socially frowned upon.
 Calculating Profits from the business(es)  Profits are calculated by your book-keeper or accountant (who may be yourself) It would take some effort to calculate your share of the profits of the companies you own shares in. It will not be reported to you by your broker. It can be calculated by dividing the P/E ratio of each stock into the value of stock owned but few people make this calculation.
 Who gets the profit For a lot of small businesses there may not be any profit beyond a modest wage for the owner. But if there is a profit, you get to decide how much to dividend out to yourself and how much to keep inside the business for reinvestment or perhaps just to shelter it from the taxes that would apply if you paid yourself a dividend Businesses in which you own shares are likely to make profits. They will decide how much (if any) to pay out as dividends.

Profits that they retain are meant to be used to build up the business. In most cases retained profits help the business grow and its share price to increase over the years.

 Making the Profits Grow  Through hard work, and / or smart work or through good luck you may be able to increase profits. The sky may be the limit in some cases. In other cases especially if you don't work hard, or smart or you have bad luck, profits can evaporate. You will have zero control over the profits of the companies you own shares in. But you will have the ability to try to choose companies that will grow their profits.
 Importance of Profits versus the Value of the business The cash flows and profits of the business and the wages or dividends that it can pay you are extremely important. The value that you could get if you sold the company may be of no importance at all except in the rare event that you do decide to sell. The value of the shares on the stock market is usually the most important factor. In some cases you will also value the dividends.

If the price of the shares fall you will likely not be comforted much if the profits have actually increased. 

Similarly if the share price increases you may not be much bothered if that happened despite a reduction in profit.

In the longer run profits matter a LOT, but stock investors usually focus on the short term.

 Liabilities  You could face liabilities even beyond the investment in your business You have no liability, the worse that can happen is that your shares become worthless.
 Liquidity  As noted in the Initial Buy Decision above, you will often have limited liquidity. It might take months to sell if you decided to sell. Often the sale price might be less than you would like. If you are  very key part of the business, it may be difficult to sell because perhaps the customers will leave if you leave.

Often there is a large buy / sell spread and so unless a motivated buyer comes along, you may need to lower the price to attract a buyer. You will face legal fees as well. 

You can sell anytime. You always know the price at which you can sell. In most cases the bid/ask spread is tiny and the Commission to sell is VERY tiny. Capital gains taxes apply to any gain unless you were investing in a tax sheltered account.
 Market value  Usually you will not know the market value of your business with any precision. And, if you intend to operate the business for a long time its market value may be largely irrelevant. The market value of an investment portfolio is presented "in your face" at least monthly and often daily or minute by minute as you obsessively check it value online. It can drive you to distraction and cause you to bail out at at inopportune times.
 Tax Advantages  You may be able to deduct certain living costs and a portion of vehicle expenses. You may even be able to claim certain travel expenses - such as attending a conference, which you may be able to combine with a vacation.

You can choose to pay  yourself a salary and create RRSP room and CPP contributions. But you are taxed heavily.

Paying yourself with dividends instead of profit may offer a lower tax rate (counting corporate and personal tax)

There may be some limited exemption from capital gain taxes on the ultimate sale of the business

Income from your day-job is heavily taxed and there are very few deductions available.

Investment capital gains can be sheltered by not selling. And investment capital gains are taxed at half the regular rate and dividends are tax advantaged. Investments in RRSP are not taxed until withdrawn but then are taxed heavily. Tax Free Savings Accounts offer tax-free investing forever. In general no investment expenses are deductible except the direct costs you pay to your broker. Even your subscription to an investment newsletter is not deductible.

 Becoming Truly Wealthy  Most business owners will never become truly wealthy but definitely some will. Few stock investors will become truly wealthy through this means. But a few will, those who start young and save and invest aggressively may become truly wealthy late in life.

 

How to Make Owning shares more Business Like

Warren Buffett often quotes from chapter 20 of Benjamin Graham's classic book, the Intelligent Investor that.

"Investment is most intelligent when it is most businesslike" (from the last section of the last chapter)

You should think of your ownership of stocks as what they are; partial ownership of actual businesses. Do not think of yourself as a share holder (which suggests your ownership may be brief and transitory) but rather as a share owner, a part owner of the business.  Where reasonably possible visit one or more of the business locations that you partially own. If you own shares of Wal-Mart or Costco, remember your ownership when you shop there. Look around with satisfaction (or not) at what you see. If you own Tim Hortons, you can take a certain pleasure out of standing in those long line-ups.

If you can, estimate your share of the profit of each company you own shares in. Profit is the share price divided by the P/E ratio.

Try to understand the business model of the companies you own. shares in. What is their competitive position in the market?

Buying a Business

The following is a good web site that lists businesses for sale all across the world. Most of these businesses may not be attractive (at any price). But I think you will see at least some good ones listed. You can search by Country, State, Province and City as well as other search terms.

http://www.businessesforsale.com/#

END

Shawn Allen, CFA, CMA, MBA, P.Eng.

President, InvestorsFriend.com

October 29, 2011

 

 

 

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