Many successful businesses generate substantial profits but fail to accumulate meaningful wealth
for their owners. This is often due to various expenses, such as administrative costs, leases, and insurance, which significantly reduce revenue. Additionally, taxes can further diminish profits, limiting wealth accumulation opportunities.
To overcome these challenges, business owners can employ advanced strategies like vertical integration, where they start or acquire a second business that complements their primary one. This approach proves effective as the second business, usually a supplier or service provider, is already profitable from serving the parent company.
Let’s explore three hypothetical examples of these advanced strategies:
- Real Estate and Equipment Investment: Imagine a successful business owner who decides to purchase a facility through a new company owned by themselves instead of continuing to lease. By doing so, the business owner can now generate profits from two companies. Furthermore, they can depreciate the real estate asset within the second business, reducing taxable income. This strategy enables the business owner to build significant wealth through real estate and equipment investments.
- Supply Chain Control: Consider a manufacturer that acquires or starts a business within its supply chain. This strategic move allows the manufacturer to earn profits from both companies while gaining better control over the risks associated with a key supplier folding or selling to a competitor. By integrating vertically within the supply chain, the manufacturer safeguards its operations and secures its position in the market.
- Captive Insurance Company: For many successful businesses, the most advanced strategy involves forming a captive insurance company. A captive is a unique insurance entity that functions as a self-insurer, providing coverage for the risks of its owners and related third parties. This approach can serve as the backbone of an Enterprise Risk Management (ERM) strategy.
Implementing ERM with a captive insurance company offers several benefits:
a. Comprehensive Risk Coverage: The parent company can now insure previously uninsured risks, covering operational and existential threats that could jeopardize the business’s survival. By plugging the gaps in commercial coverage, the captive provides an added layer of insurance protection.
b. Cost Reduction: As the captive matures and accumulates loss reserves, it can help lower third-party insurance costs for the parent company. This can be achieved by increasing deductibles on commercial policies and purchasing deductible insurance from the captive. Over time, the captive’s reliable loss history and reserves may even allow it to provide “first dollar” coverage for core risks, further reducing commercial insurance expenses.
c. Increased Overall Wealth: The inclusion of a captive insurance company in an ERM strategy can elevate the overall wealth of one or more companies. The parent company’s taxable income is reduced as it pays insurance premiums to its captive. Additionally, the captive’s underwriting profits may qualify for a favorable tax rate, depending on its classification as a “small” insurance company. Moreover, the captive can earn a return on its reserve pool, enabling asset growth on a more extensive starting base.
By employing these advanced strategies, business owners can enhance wealth accumulation opportunities, protect against risks, and maximize profits. However, it’s important to note that each business’s circumstances are unique, and consulting with professionals specializing in these strategies is recommended to determine the best course of action.