Episode #176: Adam Tkaczuk, Sterling Point Capital, “We Think There Is About A 3% Per Year Tax Benefit To This”
Guest: Adam Tkaczuk has served as a financial and tax consultant for Fortune 500 firms including Johnson Controls and Tyco International Ltd. (#242 and #288 on the Fortune 500 list) as well as family owned and private equity owned businesses. To date, he’s secured over $400 million in direct grant financing for his clients.
Date Recorded: 7/24/19 | Run-Time: 1:04:47
Summary: Adam and Meb kick off the episode with an overview of opportunity zones. Meb then asks about the best way to source investments in OZs. Adam provides some background, resources, and some wisdom that it is important to look closely at fees and be careful about diligence into OZ investments. He notes that there are all types of projects available, not just real estate, and that location can have a huge impact.
Meb asks Adam about location based sources of capital. Adam describes examples of what that is and some examples of how business can use this practice to find money to fund business projects. Adam then gets into the role he plays with small business owners in helping them navigate tax credits, find project funding, and maximize after-tax income. He talks about tax and investment strategies, and business sale tactics such as considering OZs and a structured sale.
Next, Adam talks about some case studies on helping clients find tax credits. As the conversation winds down, Meb asks Adam to get into the general flow of how he works with clients.
Sponsor: Global Financial Data
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Links from the Episode:
- 0:50 – Sponsor: Global Financial Data
- 1:31 – Welcome our guest, Adam Tkaczuk
- 2:28 – Adam’s origin story, shifting from physics to finance
- 3:46 – Overview of opportunity zones in the US
- 7:51 – Best way to source investments using opportunity zones
- 14:15 – Risk curve of opportunity zones
- 16:51 – The concept of location-based sources of financing
- 23:00 – Defined Benefit Plan
- 27:25 – R&D Tax credit
- 36:31 – The overall state of financing
- 40:28 – Strategies when looking to sell a business
- 40:30 – Want to Minimize Capital Gains Taxes? Check Out Our Guide to Opportunity Zone Investments (Tkaczuk)
- 50:10 – Case studies where he’s saved someone a lot in taxes
- 55:34 – How he works with clients
- 58:08 – Best resources from Adam
- 58:37 – SterlingPointCapital.com
- 1:00:05 – Most memorable investment
Transcript of Episode 176:
Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
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Hey, podcast listeners. Hope you’re keeping cool this summertime. We got a fun show for you today. We’re gonna go deep with the principal of Sterling Point Capital. Prior to that, he served as a financial tax consultant for Fortune 500 companies as well as family-owned, private-equity-owned businesses, helping them reduce their taxes across their investments in business ops. He’s also served as director of portfolio services at Alpha Architect. You can go back and find lots of old episodes with that crew, Jack, Wes, etc. Welcome to the show, Adam Tkaczuk.
Adam: Thanks a lot, Meb. And you did a great job on the last name, pronouncing it.
Meb: I’ve been practising my Polish all week. There’s a fun little Polish bar in Los Angeles that has some of the best vodka that has some sort of, like, buffalo grass in it. If I can remember the name of it, I’ll add it to the show notes. But anyway, glad to have you. I wanna hear, first and foremost, you’re in DC, but once upon a time, how does a physics guy get into taxes? Give me the origin story of that.
Adam: Yeah, so I started out in physics, and then after that…that’s my undergraduate degree. I was surprised as anyone that I got a physics degree. I just really enjoy science. I call it like four years of the “Discovery Channel.” Every time you go into class, it’s just you’re learning something new about the world and also a lot about what you don’t know.
But after college, I worked for GE Energy, did a lot of work with them on renewable energy projects and distributed energy projects around the U.S. and internationally. And then moved on to get an MBA, focused in finance, spent a little bit of time in Singapore, actually did an MBA exchange program at the National University of Singapore. And so all that to say I got a job working for the government of New York State deploying tax credits and cash incentives to businesses, trying to lure them to come to New York State as opposed to France or Germany or Alabama or some other state. And that got me in the tax credit, what we call state and local tax world, SALT, and did that for quite a while.
And then after that, I moved into a private side of this, a consulting firm, where I worked on projects all around the world, internationally, and here in the U.S. Yeah, that’s a quick recap of how I got from physics to finance.
Meb: So a lot of this will probably be targeted, I imagine, at business owners but also individuals, too. I think there’s probably more tax alpha in our world than almost any other lever to pull, but it’s probably the area that people ignore the most. One, because it’s complicated. My God, it takes me like a week to do my own personal taxes every year, and I don’t even own a house. I have the most basic taxes. But even on the corporate side, it’s infinitely more complicated. But why don’t we start out with kind of a relatively simple concept, and then we’ll get wonkier and deeper as we go along.
One we’ve talked a lot about on the podcast to date that I’m excited about, I’m optimistic about, I know there’s some haters out there, but it seems like the incentives are aligned in the right fashion between all the various constituents. Talk to us about the status of Opportunity Zones here in the U.S., a brief overview and then kind of where that world’s going.
Adam: Sure. So the Opportunity Zone program is what I call a location-based source of financing. And it’s one of probably 30 or 40 of them that are out there. And it’s the most well-known right now, because it allows people who may not be in a location that qualifies for these programs. Typically, they’re distressed municipalities or census tracts. But you can live in Manhattan and take your capital gains, get a great tax benefit and deferral if you invest in a low-income community or a distressed census tract.
And so it’s a little bit different from other sources of location-based financing where you actually have to be located there, your business, your employees, your project has to be there. And you yourself are the one that benefits from the financing. In this case here, the program breaks up two components of a project: the project sponsor, which is looking for money, and the project investor, which is looking for places to put their money. And so in that respect, it opens the whole world up to anybody with a capital gain to get involved in the program rather than combining the two and saying, “You have to be the project sponsor and the one financing the project in the same location.”
Meb: What is the current status? It seems like the legislation is mostly codified at this point. Where in the process are we? People starting to deploy real money?
Adam: Yeah, they certainly are. There’s been a lot of money raised. There’s something like 136 registered opportunity funds, at least through a couple of websites like Novogradac is an accounting firm that deals a lot with this program. You could go to their website and pull down a list of 136 opportunity funds. And there’s probably more of them, because you actually don’t have to publicly notify anyone that you have an opportunity fund. If you’re an investor, and you have a capital gain, and you have a project in the zone, you can start your own opportunity fund and just self-certify the whole thing, and no one needs to know except you and the IRS and maybe your CPA.
But there’s real deal, real money, real deals happening. Most of them are real estate-based. Most of them are hotels, mixed-use developments, multi-family housing, that sort of thing, but we are starting to see a lot of operating businesses get involved. And there’s some public-private partnerships and low-risk, high-risk projects coming forth. And we could talk more about that if you’re interested. But there’s real money to be made and real money being deployed. And it’s in full gear. I would say we’re in high gear. We probably have one more to gear to go before we’re really there. Right now, people are still getting their head around it. And projects are being funded.
Meb: It’s interesting from me, probably less on the real estate side and more on the startup investing side, there’s some other tax benefits like the QSBS tax benefit for investing in startups already, but it seems like an area to me that would be really interesting would be that focus. And I’m optimistic that, again, it helps those communities. But, like, any time there’s massive amounts of money sloshing around and the government is involved, you certainly get the hucksters and the predatory people involved, too. So, listeners, certainly be careful and source your deals and be thoughtful.
So let’s say you’re an investor and you have some capital gains, which is a problem I consistently do not have, but say you’ve got a bunch of capital gains, what is the best way do you think to go about sourcing investments? Because I know a lot of listeners say, “Look, I love this concept of Opportunity Zones. I don’t wanna pay taxes. But how do I find something to put my money into?” What would you suggest?
Adam: Yeah, well, again, like I mentioned, Novogradac has a whole list of opportunity funds. And if you wanna just pick up the phone and start calling, that’s one way to go. But I would watch out for a few things. And I’ll also just mention the listeners, full disclosure, I do not have an opportunity fund that I manage. But what I have done is I do have clients that are making use of the program, and I’m helping them navigate the process. But overall, I would say, from a big-picture perspective, we think there’s about a 3% per year tax benefit to this.
So let’s say you just invest in a real estate project with a cap rate of 6%. You can very likely expect this to make a 9% return out of a 6% return cap rate, which is great. That’s a 50% increase in your returns. You know how long a 50 basis point improvement in your investment returns will make over a 10-year period. It’s quite considerable. But when you think about that 3% per year benefit, you really have to look closely at the fees.
If you have an opportunity fund that’s charging you a 4% or 5% upfront closing fee, well, there goes a few years of benefit right there. And then if they’re charging the 1%, 1.5%, 2% per year asset management fee, well, they’ve just now taken about 80% of the total net benefit that an investor would get. And it almost gets to the point where the investor almost comes out just as good as if they just pay the taxes and invest in the project outside of the fund without the fees. So I think fees are a big deal.
The next thing you wanna watch out for is you don’t wanna be the only one at the poker table, that’s the show, and they say that, right? If you go to a poker table and figure out who’s the one here who’s gonna lose their money, and if you don’t know who that is, that means it’s you. So a project that’s being funded only by Opportunity Zone funding is probably not a good deal. The best deals are the ones that were actually already in development. They were already getting financing, already doing permitting. If it’s a startup company, they’ve already got some financing in place. And they’re using the Opportunity Zone program to complete their capital stack.
And a capital stack basically means, like, look, if I need $10 million for a project, I get $2 million from Grandma, I can put in $1 million, that’s $3 million. A bank loans me $2 million. That’s $5 million. Now I’ve got a $5-million gap and my “capital stack” when they all stack up like that. So from an investor’s perspective, you wanna make sure that there’s real money at the table, not just tax-benefited money through the Opportunity Zone. And you also wanna make sure that the fees are right.
And the other thing I’ll throw out is I see a lot of internal rate of return being posted on these projects. And IRR is what it’s called. It’s what your return should be. And they call it a targeted return. And I’m not lying to you, I’ve seen a 40% IRR quoted on a project once that came across my desk. I’m just thinking to myself, 40% return. That’s so hard to get. How do you get that for 10 years in a row? Forty percent, you’re gonna own the whole East Coast of the U.S. if you put enough money into that. It doesn’t make any sense.
And how they do that is what they do is they say, all right, let’s say you have a real estate project. Well, the first assumption is how much am I gonna charge for a lease, either a commercial lease or a residential lease? Well, that could be anything you want it to be. So there’s one point. It’s all an assumption. Second is how much am I gonna increase the lease rates per year? Well, there’s another assumption. And these assumptions all go in the favour of the opportunity fund, by the way, to raise money.
The third thing is gonna be what’s my occupancy rate gonna be? And the fourth is what am I gonna sell the project for later on, because typically after 10 years, you sell the asset to a “undisclosed, unknown investor” like another hedge fund or a REIT. And they’re gonna pay me 10x what I paid for it. And so you quickly see there’s a lot of assumptions that go into that internal rate of return, plus there’s also some sort of a leverage ratio. They might put in 30% equity and borrow 70%. Now you’re leveraged 70%. You’ve got all those rose-coloured glasses on and all these expectations. And really quickly you can see that, look, if I don’t know what I’m doing, I’m gonna lose my money.
Meb: You just described the marketing deck of every private equity or leveraged hedge fund that says, “Targeting 20% returns.”
Adam: [inaudible 00:12:37].
Meb: Why so low? You may as well target 100% returns. And at least you say you’re shooting for the moon. I don’t know.
Adam: Yeah. So here’s a real straw. I talked to a guy named Taylor. And he’s trying to raise an opportunity fund. I like him. I like the group he’s working with. And I’m like, “Hey, how are you doing on raising your fund?” He’s like, “We’re not doing so well. We’re targeting 8%, 9% return.” I’m like, “Oh, that sounds pretty good right now. I mean, like, where else can you get that?” It’s like, “I know, but all the investors are being told they can get 15% with this other funds, so that’s where they’re going, and we’re not able to raise money.”
I just, like, roll my eyes go, “It’s the same thing over again. Everyone is chasing performance. Everyone is chasing a targeted performance right now.” So that’s something to watch out for just. Make sure the fees are right, and that those assumptions that are going into those and pitch decks are valid. And, yeah.
Meb: Yeah, I’m interested. I mean, I think it’s a space where I’m definitely gonna pay a lot of attention in the coming years. I think as a young business, we used to pay quite a bit of attention, you mentioned kind of location-based tax benefits in decades past. And I think even current, the U.S. Virgin Islands used to have a lot of economic incentive for business owners that I think may have declined over the years. And then more recently, of course, is Puerto Rico, which you heard a lot about where the people in your part of the world were talking about moving there for all sorts of different tax benefits. I don’t know really how that’s continued to play out with Puerto Rico struggles over the past few years, but those are areas that we used to pay a lot of attention to.
Again, our problem is we just don’t have enough revenue for it to matter, but it seems like a pretty interesting idea. Every time tax season would come around, my partner used to say, “All right, we’re moving to Nevada,” which is a very simple location-based idea, because California is pretty expensive. Any other thoughts on Opportunity Zones?
Adam: Yeah, so I’ll say this. Where I’ve landed with this is on the risk curve, on the risk spectrum, there are all sorts of projects you can invest in. And I’ve kind of bookended some of the things I’m doing here. There is a business owner who sold his business for $45 million. He had a $30 million capital gain. And he reached out to me through his advisers, asking me, “Hey, could you find us some very low-risk projects to invest in?” Like, everything we see out here is 20% IRR. We’re not comfortable with that.”
And so I sourced about $110 million dollars’ worth of low-risk, public-private partnerships municipal projects for this gentleman. So these are like police stations, libraries, fire departments, fire houses, where an investor would come in, build the asset, it would exist, and then they would get a lease rate from the municipality over a 10-year period. And then after that 10-year period, a municipality or county would buy it back from them. The returns are about comparable to what you would get in a municipal bond fund, but you also get the added benefit of having some depreciation pass through to you. So there’s that.
And then on the high-risk end of the spectrum, I’m working with some startup companies that have growth plans that if they’re successful would make them a very good investment on the capital gain side of it. So I’ve kind of liked the distance. All right, there’s a lot of real estate projects that are middle-of-the-road, great-return projects, and I curate some of these for some clients, for some investors, but there’s also low-risk projects you can invest in and higher risk projects.
And I would recommend treating this as like any other part of your portfolio. You’re accepting some risk, there’s some return. I would diversify if you’re a large investor, or if you’re looking to work with clients. I know you have a lot of investment advisers who are listening to this podcast. I’m throwing it out there, there are other things other than real estate to invest in in this program.
Meb: It’s actually a really interesting point, because I feel like most people when they think of the Opportunity Zone just automatically assume, hey, I’m trying to shield some capital gains, but also I’m going for high returns, when, in reality, it’s probably equally as important and probably more thoughtful and intelligent to say, “No, I’m just gonna try to find someone who give me some projects that aren’t gonna implode somehow by investing in a bunch of Miami condos,” or whatever it may be on the risk spectrum. That’s interesting. I think most people tend to think of it as the higher risk opportunities, but some of those ideas are pretty interesting.
So you mentioned this bigger umbrella of location-based sources of capital. And I know you’ve worked with many business owners. I mean, the sweet spot seems to be companies with $20 million to $200 million in revenue, but all the way up to $2 billion. When you say location-based sources of capital, what are some other concepts that we can kind of drill down into that might be interesting?
Adam: Sure. Just so your listeners can know, if you run a business or you’re a real estate developer, you have got some sort of a project you’re expanding, or you’re buying new property, you’re building a new manufacturing plant, or relocating an office, whatever it might look like, where you locate can have a huge impact on the costs you’re gonna have to pay for that project.
So you can literally take, say, a manufacturer with a $20-million manufacturing plant that they wanna put somewhere. If they put it in location A, their costs would look like X. But if they put it in location B, their costs might be higher or lower by a significant margin. And that’s based on tax rates, ability to acquire the labour that you need, the prevailing rate on that labour.
But this is where the states and municipalities and taxing jurisdictions come into play, and this is true at the federal level, international level, all the way down to the city level, where governments are competing for your business. They want you to locate there. They want you to hire employees there. And they wanna increase the overall economy within their jurisdiction. And there are all sorts of incentives. And I call it almost free money. And I’ve obtained about $500 million of almost free money for clients.
And it’s a little bit of a chuckle in a laugh when you say almost free. They’re like, “What does that mean?” Well, in some cases, it literally means a $25-million grant to a company paid out over a period of 5 or 10 years if they hire the employees that they say they’re gonna hire and they’re going to make the investments that they say they’re gonna make. It’s almost free because there are commitments that you’re making to the state or the municipality or the federal government.
On the flip side, it’s real money, because that’s real cash that you get that impacts your bottom line. And there’s ways of managing the tax liability around that, ways of negotiating that, ways of going through that process such that, A, you’re in the right location for your business, two, you’ve raised the cheapest cost of capital that you possibly can, and three, it’s just a fit for your customers and your employees and your family.
And so I’ve done a lot of work around that. Examples might be like new market tax credits, which is an interesting one, which dictates if you’re in a severely distressed census tract, and that means the poverty rate is a certain level, the income rate, other sorts of economic indicators are low enough, if you locate your business there or a project there, you can get a tax credit, a federal tax credit.
Now what can I do with a federal tax credit if I don’t have a tax liability? Let’s say it’s a $5-million tax credit. Well, you can actually assign that tax credit or sell it to a bank or to a taxpayer that actually does have the liability. So they may give you a $4-million cash check for a $5-million tax credit. This happens in the film tax credit industry in many many states: New Mexico, New York, Connecticut. All these states have film tax credits where a production company might, if they have a $10-million budget, they might get a $3-million tax credit, which becomes today at $2.7-million, $2.5-million net benefit to them at the end of the day.
It happens with jobs. It happens with investment tax credits. There’s a whole world of this that exists out there. And if you know what you’re doing…I often tell clients, “Look, if you’re gonna do something new, talk to me first. And if you’re agnostic as to where you’ll locate, we could probably pay for 20%, 30%, 40% or more of this whole project through these types of incentives if you’re willing to make the commitments to the local or state municipality.
Meb: It reminds me on the stock side, we often talk about managing a business where we say, everyone spends 99% of time talking about the sexy part of running a business, which is product development, working with customers, R&D, all the things that run the business, but we often say, when it comes to a stock and a business publicly traded, equally important is these capital allocation decisions that people often ignore.” And that comes with how do you finance a business, how do you consider returning cash to shareholders through dividends, buyback, yada, yada, all that stuff.
And so this is, to me, in many ways, a very similar line of thinking, which is everyone’s trying to think, all right, all day, how much do I pay employees, should we enter a new market, should we launch this new line of clothes, should we do this new update to the website, should we implement a new marketing or PR initiative, when, in reality, you’re like, “Hey, no, actually, let’s audit what we’re doing now and we could save $10 million just by being thoughtful about taxes and location.”
The film one is very near and dear here. We’re all the time talking to producer buddies and people involved in that industry. And they’re like, “Yeah, we’re getting ready to go film in Kentucky. We’re getting ready to go film in XYZ, because they have these big tax credits.” And one of my producer friends, he says, “Look, my main value add is that sort of accounting thoughtfulness where you’re applying the lens of almost like a CEO or a CPA to what most people just see is a creative project that’s mainly just about the script and the actors, when, in reality, it’s a business, too.
Adam: It is. It’s like being on an airline flight. You look around and you know nobody is paying the same price for a ticket. It’s the same thing in the business world. No one is paying the same tax rate. It’s what did they negotiate, what’s their cost of capital, are they taking advantage of some unknown loan guarantee that subsidises their business that I could take advantage of but I’m not aware of. And so, yeah, that whole world exists.
And I will say a couple of caveats. Typically, you’ve got to be expanding or growing a business. And it’s usually the last money in, meaning you’ve got to make your investment first, and then it’s often refunds that you get. It is real. So it’s worth considering for…Real estate brokers are aware of this, and there’s a whole consulting industry around it.
Meb: Yeah, so a lot of people who are probably listening are actual business owners, I imagine. Are there any sort of umbrella ideas or concepts that you think, I’m sure it doesn’t apply to everyone, but some that may be more applicable to more than not? So as all these conversations you’ve had with these companies, are there some specific examples you might could give us about programs or ideas that you think either with good case studies or things that people should start thinking about? Anything come to mind?
Adam: Yeah, so let’s start on the small business. Let’s say it’s a single-member LLC. You’ve got maybe you, your spouse might be involved. There’s something called the defined benefit plan, a DBP. I really like this. This is great for all the wealth managers in the audience as well as business owners. A defined benefit plan is actually a pension plan. And if we think about what a pension plan is, it means the company is actually guaranteeing you a certain cash benefit in retirement. And so they might pay into this defined benefit plan, this pension plan over time. And when you retire, you’re guaranteed $70,000 a year, or whatever it might be.
Now those are no longer in favour in the corporate world, because they’re so expensive. And these liabilities to employees get so overburdened that companies just are defaulting on them. But that same tax rule can be applicable to somebody who’s a small business owner. If you only have yourself and maybe a couple of family members in your company, you can give yourself a defined benefit plan and stash away hundreds of thousands of dollars a year in income, nearly tax-free.
You do have to pay FICA tax on it, self-employment tax. But you can, instead of being limited to like $18,000, $19,000 a year into a 401(k), you can put $500,000 into this thing and really quickly build up a nice retirement nest egg. I will touch on how to sell your business using this, too, down the road in the conversation if you’d like.
Another thing you could do as a small business owner is take advantage of a solo 401(k), which allows you to put a little over $50,000 a year away into this. And then, as well, there’s this qualified business deduction that you can take now, a QBI, which allows you to take 20% of any pass-through income, and that comes to you federally tax-free.
So those are some tax investment strategies that I like for small businesses, because you only have a couple of owners. And the reason I say it has to be a small business is that the rules around these dictate that if you give yourself a $300,000 defined benefit plan, you have to give all your employees a $300,000 defined benefit plan. I mean, I’m using very high-level analogies here. But if you give yourself a great benefit plan, you have to give that to all of your employees. So suddenly if you’ve got 20, 30, 40, 500 employees, it doesn’t make financial sense anymore. But if you’re a very small business, and you’re profitable, and you can do this for a few years, that becomes really really lucrative.
For larger businesses, you can get into loan guarantees. There are state federal programs for helping you grow and expand your business or refinance your debt such that you’re paying less money. Some of those do require personal guarantees as well. But typically, business owners are comfortable with that.
A lot of businesses use energy. And so because I worked with GE Energy and I’ve got this background in utilities, I will tell you that there’s the Tennessee Valley Authority, and in New York, there’s the New York Power Authority. There are utility riders, they call them, or infrastructure grants you can get from utilities. Because, hey, if we can help you build your business, we’re gonna get a bigger check from you each month. And so there’s ways of reducing your utility costs that are quite lucrative, especially if you’re in a deregulated state or you’re in a state or geographic location that’s within the TVA or NYPA boundary.
And there’s other utilities around. There are sometimes local municipalities that might have a legacy power plant, which might be a small dam. Well, you can get incredibly low power from hydro power. And if you know where to look and who to ask, and again, it’s location-based, if you’re in the right site, you can get a lot of these types of things to help grow your business. And the economies around these infrastructure points have grown as a result. Just touched on a lot there. So anyway, take it where you want from there.
Meb: No, it’s interesting. Because, again, I mean, I sympathise with all the business owners out there, because it’s an endlessly complex world. I mean, it reminds me of the high school students that are applying for scholarships and grants, and there’s, like, I don’t know, certainly thousands if not tens of thousands of them, and so many go unused every year. I don’t know the sites offhand, but there’s certainly websites that have spawned and have grown out of this space to kind of assist people in that. And so essentially, you’re kind of playing that role, where, I imagine, it’s almost like a company comes to you and says, “Look, audit our business, you tell us what sort of areas we can really benefit from.” Is that sort of the traditional way people kinda…
Adam: You’re exactly right. In fact, a lot of CPA firms outsource this work when they know about it. So there’s something called the R&D tax credit, which is a federal program, which gives you this tax credit in return for producing new products. And we think Research & Development, well, I’m not an R&D company. I just manufacture dog food. Well, truth be told, if you buy new equipment, you’re trying to figure out how to get that equipment up and running, manufacturers take over 60% of the R&D tax credit at the federal level is claimed by manufacturing companies, not pharmaceuticals. And I think that the numbers work out something along those lines.
But it’s incredibly complex. And oftentimes it’s mirrored at the state level. So there might be a federal level tax credit. Well, you can also claim one like in Rhode Island. There’s an R&D tax credit in Rhode Island. Many, many, many states have this. And so again, state and local tax. And suddenly, you can go into a small business, when I say small business, this could be up to 800 people working here, and look at their books, find areas that they’re overpaying and tax, or they could negotiate their taxes if they knew enough and how to do it. Then, you can start taking a few points out of their overall cost of capital. Your profit margins might go from 6% to 7%. And, like, that’s a big number there.
And if you think about a business owner, 80% of their net worth, if you were to look at their stock portfolio, well, 90% of the stock that they own is there in their own business. So if you’re a wealth manager, and I actually have a registered investment advisory fund that I work with a small number of clients, I’ll do this for them. Like, I’ll be your CFO over your company, and I’ll try to figure out where we can save you money and run it better. But at the same time, you do need somebody to look over your college savings plans and your retirement accounts and all of that. But let’s just not look at that in a silo. Let’s also see if we can’t get more value and after-tax in your pocket profit at the end of the day. What do you walk away from with your business each year in your pocket that no one has a claim on?
That’s the money that I try to improve for business owners. And it’s a different subset. I think business owners, for those of you out there and those were working with them, I think you guys are my heroes. You really are. Because I have sat across the table from folks who are middle management in some Fortune 500 company, and they love to take these tax credits. And then two years later, they’ve got the resume built up. They move on to another company or another firm. And now their former employer is left with a 10-year commitment in New Jersey that they have to, like, manage. If they don’t, there might be a clawback, but this middle manager moved on. He’s not thinking long-term.
However, I think business owners are probably one of the few small subsets in our economy that are truly thinking long term. They’re thinking not only 5 years down the road, but 20 years down the road. How is this gonna impact their kids, their children? And what is their after-tax net benefit in their pocket gonna be in time down the road? I don’t see very many other people thinking that way.
Meb: I think it’s really important that this concept of thinking like an owner gets into all sorts of principal agent sort of issues. But you mentioned R&D tax credit. Can you explain broadly what that is, what that means? That’s something that you hear mentioned a lot in regards to businesses of all size, but what is the R&D tax credit?
Adam: All right. The R&D tax credit is an incredibly complex part of the tax code at the federal level. It’s mirrored oftentimes at the state level as well. And you’ll see this a lot with many of these programs I’m referencing, like the Opportunity Zones has the same thing where some states are complying word-for-word and item-by-item with the federal. In other cases, they differentiate.
But effectively, the R&D tax credit says, if you’re spending money, often a salaried money, a portion of your salary that you pay your employees into new product development, new software, new ways of doing things…Now it doesn’t have to be new to the world, product or ideas. It just has to be new for you and new for your business. So if you’re doing something new, you’re figuring out how to get this piece of equipment to operate more efficiently, you’re developing a new product that your clients are…even as for internal use, software sometimes counts, you can take a percentage of your overhead costs attributed to that project and claim it as a tax credit on your federal tax returns.
That becomes really really lucrative. And there’s a lot of rules around it. One of the caveats is that you have to have really good record-keeping in order to take advantage of this. Because you do start getting into the world of defending your tax credit, defending your claim to the IRS, and there may be some back-and-forth with that, but you do need to hire a firm that’s got experience and that knows what they’re doing. And very often your local CPA may or may not be aware of it. They may be afraid of it, or if they do do it, it’s often they outsource it to a specialist firm.
Meb: We’ve had a few specialist firms reach out to us and pitch this idea, and I kind of got to the point where I threw my hands up and I said, “Man, I don’t know. This seems awfully complicated.” And you can correct me if this is true or not, but they also said, “Look, you can retroactively even claim it over a certain amount of years.” Is that snake oil, or is that that true?
Adam: No, no, that’s true. That’s true. There’s one caveat. So folklore or not, everyone is worried about an audit with the IRS. And it may be true that if you do claim the R&D tax credit, you may get audited. I would probably say that there may be some truth to that. It may also be that if you are overly aggressive in what you claim, like, “Hey, I just took a trip to Colorado, and that’s R&D-related,” you throw that in the mix, like, it gets to be a little bit grey. So you wanna make sure that you’re working with someone who’s gonna help defend that audit.
First of all, most of the time, when you claim a tax refund, there is an audit process. There’s a back and forth that goes on with the taxing jurisdiction before they actually disperse a check to you. But the answer is yes, Meb, to your question. You can go back, I think it’s three tax periods, to revise your books and claim the tax refund, but you do need good records. That’s the caveat.
Meb: I mean, I think the simple advice, which is probably always good advice, is don’t do shady shit when you’re dealing with the IRS. Just be upfront and honest about it. And if you have potential R&D tax credits, great, but don’t be sketchy, otherwise you’re gonna get in trouble no matter what. Although, I said IRS audit, no sweat to me compared, man, we’ve been through SEC, FINRA. Those, I imagine, are a million times worse, but who knows.
I was laughing, because it’s funny about taxes, there’s a great story about how there was some sort of tax on pool owners in Greece. And there was, like, claim there was 200 pool owners in all of Greece. And then when Google Maps came out, it was like, you know, 10,000 or 20,000 or something, just going to show all the people that do their best to evade. But good advice, people, don’t mess with the IRS.
I got a letter in the mail the other day that’s like, “You owe $1,500 from 2012,” or something. And I’m like, “You know what, I have no idea if I do owe this or not, but I guarantee you it’s gonna take me probably a dozen hours to figure out if I do owe it, and they just got you.” That’s why it’s not worth…IRS, I love you guys, so it’s not worth it. But it’s interesting, because, like, I would love to say, “Hey, look, Adam, take Cambria’s business audits without us having to move to Lake Tahoe or Puerto Rico, which both sound kind of awesome, what’s some optimisation ways?” By the way, it feels like, at some point in the future, we could AI Adam and turn him into somewhat of a software program that could probably make some suggestions to at some point. There’s a business idea for you.
Adam: There it is. And you come out with a lot of business ideas, Meb. I see about…
Meb: They’re all terrible.
Adam: Somebody has got to come up with this. Anyone? Anyone?
Meb: They’re bad. They’re all bad.
Adam: Has anybody ranked podcasts yet for you? I think I see it every month you’re asking for someone to do that.
Meb: You’re just poking me in the side. It’s a continued frustration, but AI Tkaczuk I think would be a good name for a company. There’s no way that domain is taken. Okay, so what else we got? So thinking about are there any other things that we should talk about before we get to selling your business?
Adam: Let me step back from location-based financing and just talk about financing overall. More often, if you need a loan, you’ll just call your bank and ask them for financing. What can you do for me here? I strongly suggest that you build an RFP, a request for proposal, and go to many banks. And people don’t know this, but there’s something called the CRA or Community Revitalisation Act. And what that means is, at the federal level, banks are required to make loans to certain geographic areas where they do business.
And you’ll see that certain banks are just, like, will tell you, “That’s outside of my CRA. I’m not gonna give you a loan.” But if you know which banks are in your CRA, or what location you’re in is in a CRA, you can target those banks, and they’ll be more inclined to give you a loan, because they would rather give a business a loan that has a probability at least of giving them a return rather than just giving a loan to a defunct project that they just have to get money out into these geographic areas.
So knowing which banks are in the CRA, issuing an RFP to banks, and putting your best foot forward, you’re actually asking banks to invest in you. So you got to do it right. There’s a polished way to do it. And the best time to do it is when you don’t need the money. That’s absolutely true. But people are not wired that way. If your business is strong and you need money, just don’t go to one bank. Go to multiple banks, hold an RFP process, and have them compete for your money. And you’ll get the best terms and rates, and very often these banks have access to all these location-based bells and whistles that they can bring down to you. So if you’re working with the right bank, they may be able to help you in these other areas I’m talking about as well.
Meb: What type of loan? Are you referring to just traditional term loan? There’s a lot of…
Adam: Traditional loan. Traditional loan where you need money. And that can be anywhere. And these CRA s overlap all over the country. But then, if you wanna talk about SBA financing, USDA financing, there’s loans and grants and, again, a whole litany of subsidised financing you can go down that path with as well. But that’s all under the umbrella of subsidised financing. But the whole process of shopping your business around as though you’re looking for an investor, an equity investor, even when you’re just trying to get a mortgage for a new plant or a line of credit, that’s all very very useful. It can start eliminating a lot of your overhead cash flow needs immediately.
Meb: And is that something you assist with or is…
Adam: Yeah, that’s why I bring it up, because the location-based financing does require a certain fact pattern to be in place, but absolutely. Like, there’s a non-profit college Buffalo I’m doing a project for. It’ll probably be about a $26-million project. Reached out to a dozen banks. We’re getting RFPs back. And they’ll be able to bring the banks in, sit them down.
The story they told me was we were working with our local bank. And when we told them that we’re gonna issue an RFP, they said, they got serious. They sat up straight. They’re like, “Oh, well, we wanna keep your business.” I guarantee you they’re gonna get a better rate from their local bank just by virtue of the fact that they mentioned they’re issuing an RFP. And, yeah, it’s just like shopping around for a car or a house. You do have some leverage when you’re working with banks that people don’t realise.
Meb: Right. It’s like why would you ever go to one when you could go to multiple sources?
Adam: Correct. And then if you could add the subsidised financing on top of that, you start really reducing your cost of capital.
Meb: It’s funny. I remember talking to a bank once, and they were saying, you know, “What can we do to win your business?” And I said that’s such a funny question in my head. I’m like, “Give me the best terms?” Like, what do you mean? Or is this some other underhanded, like, are you asking me if we need Lakers tickets? Like, what are you talking about? Like, just give me the best deal. Like, what do you mean? Do you want me to name the number? Like, it’s a weird.
All right. I remember reading your article about selling your business, and then reading it again, and then reading it a third time. And this goes to show how complex this world is, but you’re probably a lot better explaining it than my trying to read it. Give us an overview of some of the ideas. You’ve probably worked with a gazillion businesses where the owners are exiting or they’re selling them and creating capital gains. A lot of people I think optimise on as if they’re selling a house, they optimise on the price, and then they just think about all that once they’re done with it, where you should probably think about all this way ahead of time.
Talk to us about some of the ideas on retiring or…You had a quote on this article. You’re like, “When the owner wants to retire, the process is significantly more complicated than employee that just has to give a few weeks’ notice, maybe roll over a 401(k), lifesaving is locked up in the business, in fact, selling it is the retirement plan. Talk to us. What’s the best way to…
Adam: Yeah, so if you’re selling a business, it’s a huge decision, and the IRS is gonna be right there waiting for you, kind of like a vulture waiting for you to come out, finish your deal, and then they’re gonna come and take as much of that as they lawfully can.
Meb: I think that was a Richard Marx quote. Was that Richard Marx singing in the background? All right, keep going.
Adam: So debt and taxes. You’re gonna owe taxes when you sell your business. But if you do it right, you can minimise a lot of that. Now the article. So Meb is referencing an article that I published on Alpha Architect’s website. And if you go there, you’ll find a few articles by me, and I’ll be sending them another one soon on another method. But there’s three ways I would suggest that you look at when selling a business to reduce the taxes.
One is Opportunity Zone. So if you do have a capital gain, you can take that capital gain and roll it into the Opportunity Zone program. Folks like me will help curate a project or two for you. We could find something for you that’s low-cost, fits you, your risk curve. There’s a ton of funds out there to take your money. But ultimately, look into the Opportunity Zone program. That’s number one.
The second area I would consider is the article that Meb is talking about. I would actually rank this maybe number third, because of its complexity. It’s called a structured sale. And what that means is let’s say you sell your business for $5 million. You get a $5-million check at closing. Well, there’s something in the tax code, or people refer to it as constructive receipt. So if you receive that $5 million, and the IRS deems you have actually received that $5 million, they’re gonna tax you on it.
Now it doesn’t matter if you put that money in the bank or if you get the money through a check. Let’s say you collect the check on December 20th at the end of the year. And it’s a $5-million check. Well, because you could go to the bank and cash it in, the IRS sees you as having had constructive receipt of that. Even if you wait till January the following year to actually cash that check, the IRS used to have had the money or access to the money in a prior year, so they tax you in your prior year’s income on that money.
So a structured sale is a methodology of selling a business or an asset through a third party where the third party actually receives the money, but you do not receive the money. They have constructive receipt. You do not have constructive receipt. And then they would invest that money on your behalf, where it would grow from $5 million to $6 million to $7 million to $8 million over time, and then they would pay you out on a note. Maybe they give you a note for $8 million. They receive a $5-million check from the buyer, they invest, it grows to $8 million, they give you an $8-million check later on. When you receive the money, when you have constructive receipt is when you pay the taxes. So you’re able to defer your tax liability over time with a structured sale.
Now the tax code gets incredibly complex. If you go to the Alpha Architect website, you’ll see the structure diagram I put in place there. It’s really complex. And it’s not for everyone. But it can be useful, especially if you’re relocating, say, from a high-tax state to a low-tax state and provided that state doesn’t have an exit tax. It gets complicated. But talk to me. Maybe I can help you out with that and put you in touch with the right people to make that happen.
Meb: It wouldn’t be the government, it wouldn’t be the IRS, if it wasn’t complicated. But to summarise, it’s mainly a way of deferring taxes. What is the time frame? Is it something you have to do it for a year, is it 10 years, or 20 years? Does it not matter?
Adam: At the end of each year, you have to have deferred some of it. So the typical rule is each individual, each owner, can put $5 million away into a structured sale, structure without having to pay excess tax on that. If you put more than $5 million in, then the IRS says, “Wait a minute, you’re deferring too much tax. We’re gonna give you a penalty tax on that.”
So the IRS knows there’s a tax benefit. They understand this. So they limit you to $5 million per owner per year. So a working couple could probably put $10 million away. You could set up a trust to take another $5 million. So maybe you could do $10 million, 15 million a year. And if you structure the sale over through the holidays, you can do a $30-million closing in that respect and defer all this tax, let that pot of money grow over time.
Meb: Oh, because they would have bought half in December and a half in January?
Adam: Yes, yes, you know.
Meb: So theoretically, if you’re, like, really in no rush, you could say, “Look, you’re gonna be buying this over 5 years, and you could sell it for $25 million or $50 million…
Adam: And now you’re getting into something called an earnout, which is very common, where there might be some cash that you receive upfront, and then based on performance of the business and your involvement in the business over time, you will start receiving more money over a two, three, four, five-year period. It’s a little riskier for the seller, because the seller…that money is at risk. You may not get the money a certain…profit margins aren’t hit. If you lose a key account, a client leaves the business, and the new owners are left with a less valuable business, they’re gonna pay you less money for that.
But the IRS isn’t gonna tax you on the…Let’s say you do a $50-million sale structured over a 5-year period. They’re not gonna tax you for a $50-million sale on year 0. They’re gonna tax you as you receive the money over time. But in a structured sale, you could potentially get a very large chunk of that $50 million upfront, and it’s held by that third-party intermediary, and you receive that money over time. So it reduces some of the risk of an earnout and still defers your taxes over time.
Meb: So that’s number three.
Adam: That’s number two.
Meb: Oh, that was number two.
Adam: Opportunity Zone is number one. A structured sale is number two, just in the order we’re discussing it here, though I would probably place at number three. And another one that I’ve been working on is an earnout model. So in this particular model, let’s say you have 200 employees, and you typically earn $2 million a year in EBITDA or net income at the end of the year. You sell the business for, let’s call it, $10 million. And maybe $2 million or $3 million of it is paid out upfront. Well, now you have a $7-million payment plan set up. Well, you could either take that money as capital gains or as part of the sale of the business over the next few years. You may stay on as a consultant to help the new management with that transition of that business sale.
But here’s where it gets really unique and very interesting, in my opinion. If you’re going from an owner of a 200-employee business, you have not taken advantage of a solo 401(k), you have not taken advantage of a defined benefit plan, and you’ve not taken advantage of a lot of the things that a small business actually can take advantage of. But after the sale of the business, you’re no longer an owner, you’re no longer an employee. You may be a consultant to the business now for the next few years. And you may set up a consulting contract with the new owners where you might be paid $1 million a year for the next 5 years or $2 million a year for the next 5 years.
Well, you and your wife each can work in that LLC, you set up a special purpose LLC to be the other side of the consulting agreement, and most of that $2 million, through a defined benefit plan, solo 401(k), through the QBI tax deduction, you can defer most of that tax. You can take most of that tax-free, put it into a pension plan, after the three or five-year earnout period is done, you can roll that over into an IRA. And suddenly you’ve got your nest egg that you’re hoping to get, most of it tax-free, and it’s sitting in a tax-sheltered account for you, and you can manage that any way you want: stocks, bonds, and however your wealth manager would like to manage that for you. Does that make sense?
Meb: It makes total sense. I’m just, as usual, when it comes to this stuff, my head starts spinning, but that’s why you have a great business. Because I imagine a lot of people listening to this, the usual reaction is probably just say, “Look, I’m gonna hand it over to you. You take care of it. Just don’t get me in trouble. Don’t get me in trouble with the IRS.”
But it’s a good example of how much it pays to be thoughtful about these things. Because, I mean, look, we talked about this all day and the public investing side, where we say, people, the traditional active mutual fund world is 5X the size of the ETF world, but the ETF being a superior tax structure particularly for equity funds. Why wouldn’t everyone on the planet use ETFs? Well, it’s just too complicated. It requires a lot of effort, and not as much in this case, but effort in thought and inertia. And for many, it’s not the fun part of the job.
Wow, we’ve covered a lot. What else we missing out on? Do you have any good stories of clients you’ve worked with where it’s like, without name and names, an interesting case study on…you’re like, “Man, I saved this guy 10 million bucks, or this woman’s business, we implemented A, B, and Z, and it changed their life? Anything that comes to mind over the years and stuff that…
Adam: Yeah, so some of the biggest wins have recently been…I’m gonna leave the state unnamed for various reasons, but they literally, if you just move from one state to another, would get a tax credit in the form of a job tax credit that’s worth $10,000, $15,000 per employee per year. And so a number of my clients have made this move from one state to another up here in the Northeast and are literally receiving $2 million to $3 million a year for the next 10 years, and they’ve done very very well. That program has just sunsetted, though the state legislature may pass that, extend the program. If they do, people will jump back in again.
There’s another, I think, a diamond in the rough, something very few people know about. There’s a site, I’m gonna say it’s east of the Mississippi, where if you invest any money at the site, there’s an investment tax credit worth about 18% to 20% of any investment you make in the site. It’s a refundable tax credit to you. So if you invest $100 million, the state will give you $18 million to $20 million back when you file your tax return the next year.
The caveats around this particular site are the county, the local county controls it, and so you got to go through toll gates to get approval to locate and buy the land and build on it. There’s some big companies I know of that are taking advantage of that site. There’s about 150 acres and about 100 acres are taken. It’s a hush-hush thing, because the developers and people don’t want a lot of people rushing at it, but it’s an asset that the local economic development community is using to attract business to this particular state.
I’ve seen it go really really well. And I’ll also say that there are times I’ve seen business owners go through the process, and at the end of the day, they’re like, “We would never do this again.” We have to file annual compliance reports. If I fall below 75 employees, I owe money back to the state. We have to pay consulting fees to this whole process. And I just wish I didn’t have to deal with any of this. And for a lot of people, that’s the case, too.
So probably about two or three out of every five companies I talked to on the front end, I talked them out of pursuing these subsidised financing options. So I don’t wanna make it sound like this is it for everybody. It’s got to be the right pattern for you, but it can either change your life, or it can make you feel like you just got married to some compliance fiend that you got to deal with for the next five years, and you wish you never met me. Or I shouldn’t say me, but you met this this whole program. So it’s got to be right for you.
Meb: Right, I mean, I think that applies, we know a certain amount of people that have certainly, some podcast guests, that have relocated to say Puerto Rico. Some of them absolutely love it. They’re like, “It’s a great lifestyle. I live at the beach. People are wonderful. Food is great.” Other people are like, “Oh my gosh, it’s…” you know, in many ways, certain parts of the country are run just so abysmally. You’ve seen all the situation going on with the governor. By the time this podcast publishes, he’s probably, I assume, not gonna have a job anymore, but who knows.
So again, I mean, it’s picking up and moving, you know, going back conversation with my partner where he’d said, “Every time tax time comes around we got to move into Nevada.” I said, “That’s all great, but then we got to give up living at the beach. Is that something realistically that you really wanna do? And how much money would it take to do that sort of thing?” So I think that’s a really important caveat. But in many cases, some of the things we’ve talked about today are almost like free money, not quite, but in many cases, it’s silly not to be doing them.
Adam: Yeah, the final thought I’ll just say for business owners and those who advise them on, as a wealth manager, I know that business owners are way more concerned about how their business runs than they are about how their stock portfolio does. Unless you’re near retirement and you’re trying to build that nest egg, the more a wealth manager can do to kind of take on the role of a CFO for their company or their clients and their clients’ businesses, the more valuable you’ll be to your client.
And I did for a few years try to get business owners to invest in stocks and bonds. They just don’t do it. They plow their money back into their business. And so I’ve had to really focus on, hey, how can I help you grow your business? How can I help you reduce taxes increase cash flow? There’s a whole world of management consultant out there where most likely 80% of what you’re doing is not generating a whole lot of return for you, but there are some nuggets, there are some hinges to your business that, if you swing and press on these buttons, we can reduce the amount of time you spend on your business and really make it the valuable asset and joy to be an owner of a business.
Hopefully, we’re all enjoying what we’re doing, but a lot of times it’s a love-hate relationship when you own a business. And if you have someone who’s there to help you, for a wealth manager, I think you’d do really well if you try to sit in the seat that your business your clients are sitting in and try to look at their whole worldview on what you can do to help them. You might find your relationship grows quite a bit more with them.
Meb: Can you talk a little bit about how you actually work with clients? I mean, as a starting point, is there a situation where it’s like an hourly consulting, or is it a fee-based part of business? How do you general…Let’s say you’re gonna get a call from a broom maker on here that listens to the podcast, says, “My gosh, we’re doing $50 million in revenue. I got to figure out what to do to optimise this.” Calls up Adam. What’s the way you traditionally work with the business like that?
Adam: Right. So if you’re an ongoing business outside of a specific project, typically, what I’ll say is, “Look, if you don’t have a CFO, if you’re looking to hire CFO, put the pause on that for a moment. Maybe what you really need is an interim CFO.” So I act as a CFO for clients. I’m not there on-site every day, but I do put time into their projects. You know, it might be a couple hundred hours in a season, and then other times a little bit less, but I go through the business, I try to get their business to run on rails.
And there was a survey done that says that 70% of business owners who are considering selling their business, they’re motivated by burnout. They’re just frustrated with everything that they’re doing. And if you’re at a point where you’re frustrated with your business, maybe we could simplify it for you. Maybe you need someone to come in and help manage things a little bit better. But effectively, to answer your question, it’s a retainer, a quarterly retainer typically, and I’ll manage the CFO side of the business as best I can. And when I say that, it’s really in these key areas, reducing your cost of capital taking a hard look at what you’re doing and making sure you’re doing the right things.
And on the asset management side, it’s a blend. It could be a flat fee. It could be an assets under management. It’s something holistic, where I’m managing both the business side of this as a CFO and also the wealth management tax management for the family as a wealth manager.
Meb: Very cool. It’s interesting. Because so many of these business owners and high-net-worth people have so many different people usually involved in their life, whether it’s, you said, CPA wealth manager. It doesn’t feel like a lot have your kind of almost exact role. I know a lot of CPAs may sort of blend over into kind of the some of the things you’re talking about, but very rarely does it seem to be kind of this holistic idea on optimisation. So, interesting, very cool.
We’re gonna start winding it down at some point. I’d love to keep you all day, but it’s probably 100 degrees in Washington, D.C. and humid. That’s the only thing I don’t miss about the East Coast, is the really sticky, gross summers. But air conditioning, what an amazing modern invention. Great rooftops in D.C., a fun city.
Anyway, winding it down, resources, what are the best places people can find your information, more about you, what you guys are up to? And part B, what are some of the other top resources around the interwebs and elsewhere that could be some good background reading, books, anything else that you think would be a good education aid to the listeners?
Adam: Right. So a couple of points. I’ve got my website, which is sterlingpointcapital.com. There’s a few articles I’ve written that are there and also on Alpha Architect’s website. In addition, I would just say talk to your local county, your state. Most likely, there’s an office called economic development. And if you talk to some of those folks, they may not know everything, but you talk to enough of them, and they’re gonna be able to tell you what programs and resources are available in your particular jurisdiction.
There’s the SBA, the USDA. Those websites are full of information. It can get confusing really quickly. And certainly, your CPA accountants, tax lawyers are also really good. So I like to throw people out into the wide world there with just look it up yourself. But if you are looking at something, you’d like some feedback, I’m available as well. And you can find me, as I said, at sterlingpointcapital.com.
Meb: Well, don’t worry, you and I are gonna talk immediately at the end of this podcast, so we may have a new Cambria CFO here in a minute. All right, talk to me about any final advice for business owners, investors. I think we’ve covered most of it today. Is there anything that we may have skipped over on or you think that it’s particularly relevant here and in the summer of 2019 that we didn’t touch on?
Adam: I think we’re good, Meb.
Meb: Good. Well, good. That leads to my final question, which we’re gonna somewhat skew this one a little bit so you can answer it in two different ways, as you choose, or both, the first being, we usually ask people what their most personal memorable investment is, and so you can take it and run with that, or/and you can answer it as your most memorable engagement, where you work with a client to hide some bodies somewhere in a marsh in New Jersey for tax purposes, whatever it may be. Most memorable investment or engagement or both.
Adam: All right. Maybe I’ll throw out the…I knew this question was coming, so I thought about it. How do I answer? But I will say this. I enjoy poker. I know a lot of people who listen to this, and I think you as well enjoy poker. So the first time I ever spent money at a casino was at a poker tournament. There might have been 110, 120 players.
But a couple nights before, what I did is I played around with the math and the statistics here, and I came up with a heuristic, which is just a set of simple rules to play the game. And I took that. It’s only like five decisions I ever have to make. Like, regardless, it’s a very simple way to play the game. Basically, the point of it was I would only put money into the pot if I think that there’s an expectancy of me actually making money in this, a positive expectancy, as they say in the trading world. And I also tried to keep my variance low, because it’s a very volatile game, where you could win a lot, lose a lot. So I tried to keep the pot small but play a certain way.
And the first time I ever played in a tournament, ever went to a casino, I ended up winning the thing. And I wanna say winning, because we were down to three players, and we all split the pot. I made 1,200 bucks or something. And I was tickled pink. This is awesome. It’s a lot of fun. So I think heuristics are really interesting. I think of the S&P 500 as a heuristic. It’s just a buy the top 500 companies, rebalance each year. It’s just a couple of decisions you make. And if you repeat that over time, you do okay, and most of your value, momentum ETFs, and strategies are similarly built.
I think you can play poker the same way, very simple, almost dumb, just keep doing the same thing over and over again. After time, you’re gonna make money. And I’ve replicated that sense in cash games tournaments. When I was lived in Manhattan, I played it in a poker league there and had a lot of fun with that.
Meb: My situation is I love playing poker, but I like playing poker sitting around, drinking beers, BSing with people. The struggle with the tournaments is always that they take so damn long. And if you ever wanna burn through 10 hours of podcast, that’s probably a good way to do it. But I get so bored sitting there.
I’ve always wanna play in the World Series, but I think next year I’ll pick out one of the short World Series games that don’t go on for two weeks, because it’s more of a stamina issue for me than anything. I can’t take sitting in that long. I get too impatient. But that’s probably part of the advantage people have, is they take advantage of people that are time-constrained or just can’t sit out all the hands like the pros do.
Adam: So good poker is like good investing. It’s boring. You sit there sometimes for an hour without playing a hand. You fold and fold and fold. And then you’re in a casino, which I don’t really enjoy casinos very much, and you’re touching chips that, like, man, you know, you’re gonna get sick by the time you’re done playing at one of these places. It’s just the whole scene is difficult to deal with. There’s other work and things to do that generate more income and are more interesting.
But, yeah, playing with friends over some whiskey, having a good time, is a tremendous amount of fun. But trying to actually make money at a casino or in a tournament, it’s just grinding. It’s boring. It’s just routine. And you quickly find yourself making mistakes because you just wanna have fun. And fun and poker, gambling, it’s just it doesn’t necessarily work that way. But as a first investment, coming up with a heuristic to play poker, I would say that would be my best investment or most memorable.
Meb: Good. Well, we’ll get you in a game next time you come out to Los Angeles. I think our next podcast guest is a big poker player, so we’ll organise one. Adam, it’s been a lot of fun today. I think you’ve given everyone a lot to think about. I’m sure people are gonna be reaching out with a lot of enquiries in the coming months. We’ll add all your various articles and contact and websites to the show notes. So, people, definitely check out mebfaber.com/podcast for the show notes. Thanks so much for joining us today. It was a lot of fun.
Adam: Absolutely, Meb. Thank you.
Meb: Listeners, you can find those archives, again, everything else, at mebfaber.com/podcast. Shoot us any feedback, any criticisms, comments, leave us a review, email us, email@example.com. Thanks for listening, friends, and good investing.