Be an Ethical Entrepreneur, Marketer, and Business Builder

Why WhatsApp is NOT everything that’s wrong with the economy

By WhatsApp Inc. (http://media.whatsapp.com/) [Public Domain], via Wikimedia CommonsFacebook recently purchased a startup with no profits for $19 billion dollars in the largest tech acquisition in history.

The venture capital-backed, tech startup world is rife with problems as I’ve blogged about before.

However, Robert Reich has brought up one of the more popularly alleged economic problems.

He claims the problem is that tech companies like WhatsApp are hurting the economy by not creating enough jobs.

In Reich’s words:

Productivity keeps growing, as do corporate profits. But jobs and wages are not growing. Unless we figure out how to bring all of them back into line – or spread the gains more widely – our economy cannot generate enough demand to sustain itself, and our society cannot maintain enough cohesion to keep us together.

In other words, Mr. Reich is saying, “55 employees were able to make a business worth $19 billion dollars serving 450 million people and that’s not fair. Why do such a small group of people deserve so much?”

Of course, he offers no solutions other than to mention income inequality implying that it’s the fault of successful companies like WhatsApp for being successful.

Venture backed start-ups with insanely high valuations, minimal revenue and no profit have all sorts of issues.

But not creating enough jobs is not one of them.

Remember the Luddites rioting to destroy new machines that made the textile industry more efficient back in the 18th century?

Richard Arkwright invented his cotton-spinning machine in 1760 which became one of the main instigators of the Luddite riots.

After all, the cotton-spinning machine would displace the jobs of all of the seamstresses who used to make the clothes by hand, right?

In 1760, there were about 7,900 persons in England engaged in production in the textile industry. In 1787, 27 years after Arkwright’s invention and only 8 years after Ed Ludd destroyed 2 stocking frames allowing his name to become synonymous with all the machine destroyers, there were 320,000 people employed in textile production in England.

Why did more efficiency results in a 4400% increase in jobs?

Because with increased efficiency came lower prices so, instead of having 2 sets of clothes, people could afford to have dozens.

The same complaints have been lodged against every major technological advancement.

Every time we progress, the Luddites come out claiming this time the new increase in efficiency is going to hurt the public by reducing jobs.

The exact opposite is true.

About two centuries ago, the majority of America was an agrarian (i.e. farming) society.

However, the invention of farm machinery didn’t result in the majority of Americans starving because they were no longer needed on the farm. In contrast, less people on the farm meant more people inventing, building, and creating other things.

At its core, economics is very simple.

If something increases efficiency it’s good for the economy. If it decreases efficiency it’s bad.

WhatsApp figured out how to connect 450 million people with only 55 employees. That sounds hyper-efficient to me.

Our knowledge-based economy has seen the fastest and greatest improvements in efficiency and leverage the world has ever known.

The end result of that increased efficiency is always an improvement for society.

Massive fortunes were made by Rockefeller, Ford and Carnegie when we transitioned from an agrarian to an industrial economy.

More recently, Gates, Zuckerberg, Page and Brin have been richly rewarded in our transition from an industrial to a knowledge economy.

Would we all be better off if none of them were allowed to reap the rewards of their creations?

You have 2 options

Become a Luddite, slow down technological innovation, and reduce the reward for being an innovator by asking the government to intervene.

OR

Learn what it takes to excel in the knowledge-based economy and join the successful companies that are improving our lives.

Time will prove, once again, that Robert Reich, despite all of his experience, power, and prestige, is no different than Ned Ludd whose name became synonymous with the machine destroyers’ failed attempt to halt progress.

The problem is education

The problem is not our exponential increases in efficiency.

The problem is an education system that was built at the beginning of the industrial revolution and is still designed to teach students to be good “workers” instead of great thinkers.

As the owner of a marketing tech company who has been almost steadily hiring for 2 years, I can assure you that the education or degree of people who succeed on my team is irrelevant.

A particular degree, or college education at all, cannot predict job success as well as cognitive reasoning abilities, emergent leadership, the ability to learn quickly, a passion for your expertise and a willingness to make mistakes while admitting when you are wrong.

Google recently revealed their top 5 hiring attributes and indicated that the number of people at Google without degrees is increasing.

So whether it’s Twitter, Google, Facebook, WhatsApp or my company, Optimized Marketing, fast growing companies that understand how to leverage technology are coming to realize that relying on someone’s particular degree or level of education is not a good predictor of future job performance.

In other words, our education system isn’t reliably producing people with the skills we need.

The problem isn’t successful companies.

The problem is we haven’t yet learned how to educate students for the knowledge economy.
Don’t blame successful entrepreneurs for not making more jobs.

Celebrate their success and start teaching more people how to do the same thing.

There’s a reason Ken Robinson’s below TED talk explaining how schools kill creativity is the most popular TED video ever with over 25 million views.

Mr. Robinson’s talk is popular because he’s right.

Whether creativity comes in the form of becoming the dance choreographer who wrote Cats or the founders of a successful startup company that sells for billions, creativity is the solution.

Taking away the rewards of creativity, as Mr. Reich seems to be implying, would further hinder creative pursuits and not help anyone.

Imagine what the next 100 years will look like if we are all allowed to “come up with original ideas that present value”, as Mr. Robinson defines creativity.

To your passionate, creative success,
Bryan

P.S. For more examples of technology increasing employment in various industries, check out Henry Hazlitt’s Economics in One Lesson.

Your business should be an LLC filing as an S-corp

*DISCLAIMER: I am a mechanical engineer. (Do I really need to say anything else to emphatically point out that I am not a lawyer or accountant advising you on legal or tax matters?)

So here’s the plan:

Buy the assets of a business, create an LLC that files taxes as an S-corp, and sell the LLC.

First a little background. You have a few options when forming a business entity:

  1. Sole-proprietorship – single owner as disregarded (pass-thru) entity
  2. Partnership – multiple owners as disregarded entity
  3. Sub-S C-corporation – up to 75 shareholders as disregarded entity
  4. C-corporation – unlimited shareholders with corporate tax on profits and capital gains on distributions
  5. LLC – unlimited members

However when filing your taxes you have to choose one of the top 4 OR an LLC (for legal purposes) filing as one of the top 4 (for tax purposes). So not including all of the types of partnerships (Limited, Family Limited, Master Limited etc. etc. etc.) or Trusts you have about 8 options when forming your business entity. Of those 8 basic options, the LLC filing as a Sub-S seems to be the best for our buy, build, and sell purposes.

Reasons why you want an LLC filing as an S-corporation:

  1. An LLC is the simplest legal entity requiring the least amount of corporate formalities.
  2. An S-corp is a pass-thru (disregarded) entity so all distributions pass-thru to the owner on his personal tax return and are only taxed on state and federal income (and in several states such as Texas, Tennessee, Nevada, and Wyoming there are no state income taxes).
  3. You only pay tax on your Net Profit in your P&L – not on the actual cash distributions.
  4. With Amortization, Depreciation, Interest on the loan you used to buy the business, and a Section 179 of your equipment expenses, you can have quite a lot of cash distributions with no paper income.

Taxes you won’t have to pay with your LLC filing as an S-corp:

  1. FICA – you only pay that on your “reasonable” salary, not on your distributions
  2. Self-Employment Tax – this is only necessary with a sole-proprietorship or a partnership
  3. Corporate Tax – currently around 34% on the profits of a C-corp plus another 15% capital gains on your distributions (is there any reason a small closely held business would be a C-corp???)

The reason you buy only the assets of a business is your depreciation and amortization schedules start all over again and with the numerous business valuation methods you can always come up with some “goodwill” to amortize. Keep in mind, that amortization is your best friend. It’s a non-cash accounting expense that can save you thousands in taxes. For a more in-depth analysis of Amortization and Depreciation check out my Business Valuation 2 – EBITDA can eat my shorts blog.

The reason you sell the shares of the S-corp is that you can provide vendor financing to the new owner and only pay capital gains little-by-little every month as the payments come in. However if you sell the assets out of the S-corp, you have to pay the entire capital gains up-front EVEN if you’re carrying a note for the new owner. This obviously is the worst part about an S-corp. I believe the only way around paying all of the capital gains up-front on an asset sale would be a Like-Kind exchange. This could be very tough if you’re selling a business to buy another one because it would have to be an extremely similar business and you’d have to meet all the strict deadlines for the transfer (usually less than 90 days). And of course if you’re carrying a note then you may not have the cash to buy that other business. Is there a better way?

Exceptions.

  1. If you’re never going to have any income (such as with a rental property or if you have a great accountant) you might as well file your LLC as a partnership or sole-proprietorship. Without income you won’t have to worry about taxes and when you go to sell, you can sell the assets, carry a note and still not have to worry about immediately paying for all of the capital gains. In other words it gives you a bit more flexibility when you go to sell.
  2. If you have multiple owners/shareholders and you don’t want the distributions to be evenly split along ownership percentage lines you can’t use an S-corp.
  3. If you’re going to buy, build, and sell very quickly (i.e. less than a year) you’re probably better off filing as an LLC sole-proprietor or partnership. I say this because if you can flip a business that quickly you’re probably able to grow it extremely rapidly and your biggest tax concern would be the capital gains on the sale. With the sole-proprietor or partnership you could be flexible and either sell the assets or LLC with vendor financing and not have to pay all of the capital gains up-front.

Unfortunately, I can’t claim that I learned all of this from a single book. As a matter of fact, it took about an hour with my accountant which will cost me about $55. Money well spent! 😉

To your success, Bryan