90: The E-Myth and a 401K for your Business with Van Carlson

24
Mar

Van Carlson is the CEO of SRA 831(b) Admin, a company that helps private businesses set up their own captive self-insurance to cover oversized and unusual risks threatening their businesses. We talk about the 831(b) insurance captive, tax-efficient strategies for funding insurance premiums, and the risks your business should be protected against when setting up an insurance cover.

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The E-Myth and a 401K for your Business with Van Carlson

Our guest is Van Carlson, the CEO of SRA 831(b) Admin, a company that helps protect private businesses, set up their own captive self-insurance companies to cover oversized, unusual risks threatening their businesses. So welcome to the show, Van.

Thank you for the opportunity to be on your show and look forward to our conversation.

I’m excited to have you and I’m excited to learn about what 831B is and what SRA 831B admin does. I’m practicing the name of the company so that I don’t screw it up again. But before I go there, how did you get to set up this business and become an insurance entrepreneur, if I may call you that?

No, I appreciate the, I think that’s a good description. Insurance is really exciting, as business owners love dealing with insurances. You know, truthfully, it took away in our in the US when the great recession hit and I had a lot of friends, you know, you clients become friends over time and you’re their risk manager and unfortunately you didn’t really address the financial risk business owners typically take. And so that, you know, I just saw there was a need in the market, this idea was introduced to me and then I started thinking, well, you know, unfortunately I spent a lot of my time on the phone telling clients they weren’t covered for a lot of risks that they were hoping they were going to be covered for.

It took a lot of risk to do what I did. I built an insurance agency from scratch. Those are all things that I recognize in other business owners. It’s not easy to turn a profit and take care of employees and take a dream that you, some idea you have to run a business and then you get through there, you thread the needle and do all those things, and then in the back room, you don’t have a lot of strategies in the back room to mitigate risk. And so, that’s really where, because of my entrepreneurial ways already to start my insurance agency, this was just a natural evolution. And really, I wanted to evolve.

Like I made a joke earlier, businesses, they have to have insurance, so consider it a necessary evil in some ways, because it’s just a line out of the bill you have to have. I mean, you got a building, you got a loan on it, you got to insure it. You got employees working for you, you got to have work comp. I mean, these are all expenses in the eyes of business owners. So anytime a business owner saw me, they like me, they know me, but I was always a cost to them. And so I brought this idea up to elevate my professionalism with my business owners. And it’s really managing the financial risk business owners take every day.

And how do you mitigate that more effectively to be able to put yourself in a position to take on more risk? And life is nothing but a reward or risk factor. And if you can identify the risks they’re taking, and how do you help mitigate that, I think it just puts a lot of business owners, entrepreneurial and so forth, in a lot better position to handle the unforeseen and the, all I have to say is COVID-19, right? And everybody can agree with me that that wasn’t seen as coming, right? So that’s how I started.

So, basically what I’m hearing is that in 2008, you basically realized that when a seismic economic impact happens or something, a big recession in the business, in the economy, then the ordinary insurance is not satisfactory to protect people. And that kind of showed you that there should be something else which covers these kind of eventualities.

Absolutely. I just, I ran across a gentleman that had these programs in place already. And my gosh, he thrived during that time. And that was when I realized, man, there’s even, smart money doesn’t go into the market when it’s an all time high, right? Smart money kind of waits to pull back when pullbacks come in and then they go in. And I thought, you know, there’s businesses that given, you know, certain situations should be able to position to take advantage of downturns in economy.

I think a lot of businesses kind of position themselves that way. And that’s good strategies, that’s good business, that’s good. It’s a great way to mitigate and be able to position yourself to take advantage of those situations when they come up. And again, I think it’s tools that big companies use that if we can bring this stuff down to the small to middle market business owners to do those types of tools, it just gets them in a better position to survive downturns, but maybe even thrive during downturns.

Okay, all right. So we’ll get into this a little bit later. What I’d like to talk about first is the theme of the podcast, which is managing blueprints. And in our pre-interview, we discussed about the E-Myth as something that you kind of stumbled upon early on and were inspired by. So what did actually, did you like about E-Myth and Michael Gerber’s E-Myth, the program which was the first management blueprint that I also talk about a lot. And what did it inspire, how did it inspire you, and what are some of the things that you learned from it?

You know, a couple of things. The biggest thing was, is recognizing the most successful business models we’ve had probably in the last 30, 40 years has been a franchise model. Where really it’s, you know, business owners, entrepreneurs becoming a franchisee, where they would buy into a McDonald’s or whatever you might have out there. That’s really been a very successful model. That’s one of the arguments in the book is, the reason why they’re successful is because they have processing procedures in place and they can plug people in and it’s already done. So it becomes much more, it’s a turnkey process for a lot of franchises.

And that’s what gives them the ability to scale, duplicate, do all those other things. And he makes the argument in that book where basically you can adapt those same things with your small business as well. Even though it’s not a franchise, you should be able to work and look at places where you can plug in processes and procedures. Because one of the things that business owners get into, especially if you’re small to middle market, you end up with several key employees between salespeople, your controllers, your CFOs, and all those. Sometimes they’re so key to your business that if they were to go away, either quit, go find another job, or God forbid something happened to them, it can dramatically affect your business.

I’ve witnessed that through my own clients. And that’s really where I embrace that concept, where if I can put in policies and procedures, so we’re always looking to put that in place. We definitely believe in, you know, artificial intelligence is becoming a big process of our business. And, you know, we do see it replacing some positions that are, you know, can cause human error. I mean, all the things that come into that too, as well. So I’m a big believer in technology.

I try to, you know, and I have a young team of professionals that work for me that help me see things I don’t normally would see at my age, like, you know, somebody in their 20s, and they’re faster to respond. And God, you know, I’m very thankful for that. But it’s the process and procedures that are really adapted to the e-myth. And regardless of what size business you’re in, I think it’s, I think as an owner, you got to be looking at that all the time.

So there’s a lot of things to unpack there. I mean, you mentioned several things. So the first one is franchise being successful business model and that arose the idea that how can you create this franchise prototype that Michael Gerber talks about, which is a business that is duplicable, replicable in different geographies. So that’s definitely, it’s a great thing to create a business which is duplicable, but sometimes you don’t have to duplicate for systems to make sense for you because the second point that you raised was avoiding that single person dependency in the business if someone leaves, you should be able to have someone else come in because you have processes documented. You also talked about scaling the business, which requires these processes.

The franchise model's success is rooted in having robust processing procedures in place, enabling a turnkey process that allows for scalability and duplicability. Click To Tweet

You also talked about maybe intelligent automation, replacing people. When you have the processes defined, maybe you can actually automate some of these processes. AI was an example that you mentioned, which I think Michael Gerber didn’t foresee in 1986 or 76 when he first came out with the original email. But unless he was a fan of the Jetson cartoon maybe then he envisaged it. Okay, that’s, that’s, that’s great. So yes, the image was the first dimension blueprint. Really it’s a great idea to figure out one of the concepts I really like about Gerber is that he said, figure out what are the functions that your business needs in order to grow and then define those functions. I think it calls them a function description or something like that. I have to look it up, but essentially make sure that it’s not the people that define the business, but the business that define the kind of people that you need in the business.

To add to that real quick, you know, part of the E-myth is entrepreneurial myth, where, you know, everybody thinks there’s somebody, I think his description was an entrepreneur’s on top of a mountain waving a flag and he’s conquered it, right? But nobody shows how he climbed and what crevices he got stuck in and how he had to reroute and go up the mountain a different direction. The grind of being an entrepreneur is not easy. And I think sometimes that gets missed when somebody has risen to the top, is successful. Nobody was there to, I make the joke when I talk to my presentations, you know, I tell people we’re a 14 year overnight success story. Because nobody’s around to see the myth, you know, see the hard work that comes into being an entrepreneur. And anyway, so that’s another great aspect of that book as well.

Make sure it's not the people that define the business, but the business that defines the kind of people that you need in the business. Click To Tweet

Yes. He also says that most of the part of this myth is that most companies are started by entrepreneurs and it’s not the case. It’s technicians who start the business and then they have to learn to become entrepreneurs and then they have to learn to become managers, which is even harder than being an entrepreneur. But that’s a big rabbit hole. Let’s go down that this time. So you basically, you were inspired by the email. You started your first business, then the second business in 2008. You saw this opportunity for protecting businesses of these overwhelming big risks that the Ronald Real Property Insurance, Life Insurance perhaps was not covering. So tell me a little bit about this concept of 831B and what is this 831B plan that you are helping companies implement? And why does a business need one?

You know, so an 831B is just where it belongs in the US tax code. So it’s real similar to the 401K, right? So the 401K, all that means is where it’s at in the tax code. So an 831B is the same thing. And in 1986, in the US, we were having what they called the Great Liability Crisis, where I wrote an article recently before discussing it, because of what we’re seeing in today’s markets. But back in the mid-80s, if you had a claim, you would get non-renewed. And just in general liability premium for businesses, there was a 250% increase from 1983 to 1986. And these are fast raising bills to where, very difficult to pass it on to the consumers, is one of those unforeseen.

Is it pension liabilities that you talk about or is it legal product liabilities?

All of that wrapped in. So I think general liability, it’s product liability, and it’s general liability, right, for slip and falls. And there was some stuff going on too with lawsuits. I mean, it was a big spin up of, and there was some tort reform and all that stuff done. But anyway, so basically Congress got together in 1986 Reform Act and introduced 831B. And it basically says, hey, we have to create an incentive, no different than the 401K was an incentive to create for owners and employees retirement. The same thing for an 831B.

How do we create an incentive for business owners to own some kind of form of a box that looks and feels like an insurance company? And by doing that, you’re deferring income inside that box. And that’s really what the 831B has advantages to it. It started out at 1.2 million. The PATH Act that was passed in 2017, put it up to $2.3 million with a pricing inflation index on it. So I think this year, for example, in 2022, I think clients can put up to $2.4 million into this vehicle. Expensive at the operating company level and in the box, which is an 831B plan that is also a standalone C-Corp, doesn’t pick that up as income. It does pick it up on investment income.

So if those reserves are invested, you will pay taxes on the investment returns, realized gains. So those are things that, big tax advantages, and because here’s the thing, if I have an exposure to something, like if I have intellectual property, I wanna protect it, and it’s gonna cost me legal to go do that, I can’t just set a dollar aside in my balance sheets and call it a liability and have that dollar sitting there, right? Under our tax, you know, the year you incur the income is the year you pay the taxes. So, that’s why this 831B exists.

So, now you can put it through this mechanism, drop it into an 831B plan, elect that vehicle to be taxed under an 831B, and avoid paying income taxes or corporate taxes on the premium that was seeded into it. And that gives you the ability to build up reserves. It gives you the ability to create surpluses and do all the things that, you know, and really build up a rainy day fund. So when you have unforeseen risk, you know, when I talk about financial risk, you know, you can either retain the risk or you transfer the risk.

And you transfer the risk by buying an insurance policy. For example, for fire on your building, you know, I’m going to transfer that risk to an insurance carrier for a premium. And then there’s finance, there’s other things I can’t buy that for, right? I can’t transfer that risk. So basically I’m retaining that risk and I’m relying on my cash flow to manage that if something was to happen. A great example again I use is COVID-19 where a lot of businesses were simply forced to shut down and that was an indirect loss where there was no fire.

You just couldn’t do business. Either your customers couldn’t come to you or you were mandated by, you weren’t an essential business any longer. That didn’t mean your rent went away. That didn’t mean your loan payments went away. That didn’t mean that, hey, I have to keep my employees employed because I don’t want them to leave when I can reopen. And so where was the money gonna come from, right? Banks are gonna pull back on the lines of credit. They were doing everything they had to do too.

So this gives you the ability to manage risk and much more effectively and efficiently. And I will just say this, Fortune 500, the 1000s, the Russells, whatever, any publicly traded company, and any company that you would consider a major brand in your area, already owns some kind of form of their own insurance company their own 831B plans. This has been utilized since 1986 by big, big companies.

So let me ask you this. So tell me which analogy is correct, or maybe it’s neither, but I have kind of two, I’m hearing two things. One is that you mentioned the 401k 401k is basically a pension saving that you make during your working year so that when you get old and and you know have no longer the A31B that it’s kind of you’re saving a pension for your business or it is more like a disability insurance. Whereas it’s not something that you for sure know that you will need this, but you might become disabled and then you’re saving up this nest egg so that you can pay for your, maybe it’s long-term care insurance, disability insurance kind of thing, where you are actually are covering for rainy day in a tax efficient manner?

I would say you’re right on both factors, on both analogies. I think they’re, absolutely. I think for me, you know, when I look at it from a business standpoint, it’s just good strategies. You know, if I can take a little bit off the top, park it off to the side, that’s just good risk management. And not only is it good risk management, it’s just good business. Because of what you’re just, you know, the second analogy is where the unforeseen comes up.

The first one is, you know, you hope, like every insurance policy you buy or transfer that risk to, you hope you never need it. I mean, when I was selling insurance traditionally, clients would always say, ah, I just keep paying premiums and never use it. And I would tell them, well, good for you. I can’t think of one good situation where insurance is being used that you’re triggering insurance coverage, something bad happened, right? You know, count your blessing that you never get sued and you don’t have to use your general liability policy to pay legal bills and God forbid if you have to have a settlement.

Insurance is about hoping you never need it, but in times of unforeseen crises, having a strategic safety net—like a risk management plan—is not just good practice, it's essential for safeguarding businesses. Click To Tweet

You know, I promise you that is not a good day. Regardless of whether you’re right, wrong, or whatever, it doesn’t matter. It’s gonna take a lot of energy to fight lawsuits and you know, you got your own business to run still. So those are things that I think are absolutely, and unfortunately, you pay all these premiums traditionally, and you find out you’re not covered.

Now, you’ve got to be pushed back to your own cash flow. I call it the double whammy. When that’s happening, let’s talk about cyber. You get your company breached, you make the local news, you get a contraction of customers using you now, but your expenses are going up. If you didn’t do a standalone cyber policy, most standalone cyber policies don’t cover you for loss of income, or if they do, there’s such a small sub limit in there that it’s a tic-tac-toe well at the end of the day. So where’s the money going to go?

What are the categories? So let’s say there is the general property insurance and there’s life insurance, there’s key man insurance, this kind of stuff which you know all exists. There’s also professional liability insurance that we can cover, it’s pretty standard. But typically what are the kind of things that would not be included? What are the, just give me the categories of things that I want you to think about when it comes to 831B.

One is, probably on paramount today, is supply chain risk. You’re in a supply chain risk situation where you’re dependent on, and you may have to pivot to another carrier or another supplier, and now you’re gonna pay a higher premium than you were contracted from the previous one. So supply chain risk is extremely glaring today. And then also third-party reliance. Third-party liability is extremely high right now. And what I mean by that is, you know, you put your information up in the server but somebody on that third, somebody on that server was compromised and then it comes back through you.

You know, you were using stuff up in the clouds and it became compromised, now you’re compromised. That’s third party liability. If I can’t get to my CRM system because I’m locked out because somebody somewhere else got into that server and locked me out, if I can’t get to my customer base and call them and fill orders and do all those things, again, traditional insurance will not cover that stuff. And in brand protection today, I mean, it takes years to build up your brand, and it takes seconds to destroy it. You know, if you’ve got to go out and fight that fight, where’s the money gonna come from again?

So, you know, you’re gonna pull it out of cashflow, but if the cashflow is being constrained, that’s a debt, I mean, those are life and death situations to any business. So those are the, I would say those are, you know, dispute resolution lawsuits, unfortunately, you know, lawsuits are, you know, real.They happen all the time. So you got legal bills that may not be triggered under your general liability. You may not have a right to defend and your exclusions. Here’s what I’ll tell you about traditional insurances. They know you can bear the cost for so much. And we’re seeing a hardening of the market. Prices are going up. I think in the first quarter of 2022, the average renewal policy for business owners were about 22 percent increase.

And so not only seen in your products, but now you’re seeing it in the services that you haven’t seen rate increases now for 10 years. But now they’re hitting them all at once. And a lot of it has to do with COVID and other reasons. And but they’re also plugging in a lot of exclusions. Unfortunately, you brought up professional liability insurance, professional liability insurance right now. Ton of exclusions are being introduced into those policies. You know, when you see your policy get thicker, paper-wise or in a PDF that they send you electronically, it’s not because they’re offering you more coverages. Those are putting more exclusions in there.

That’s absolutely true. I used to be an investment banker and the longer the contract was, the more risk the buyer wanted to keep with the seller so that anything that happened in the next few years that could be traced back to the future, they would be covered for. And you mentioned that your product would cover such indemnities as well. So what I like to understand is that generally, this is basically very oversimplified.

This is kind of a rainy day fund that you create for your business, tax-free basically, in order to cover like tax deferred. We don’t like that. Yes. But I mean, if you have to use the funds, it never gets taxed because that money stays in the business. It never gets out of the business, never gets taxed. Hopefully you will get it taxed because you won’t need it. But if you need it, essentially it’s the business that puts the bill and not you personally. The bill. That’s very interesting. So what is the minimum business size where creating this captive insurance vehicle makes sense and what are the costs and the benefits? So what the cost of the savings, what does the math look like?

So I would tell you that, so unlike a 401k, we’re talking about 401ks earlier, 401ks.Your kind of kicking the can down the road. When you pull it out, it’s going to be taxed as ordinary income as if you received it. Again, the year you incur the income is the year you pay. And that’s income rates. And then you have capital gains and dividend rates, which is when you sell a piece of real estate, stocks, and so forth. Well, as a shareholder of the 831B plan, when you go to close it down, hopefully, you’ll be in a much favorable position versus capital gains and dividends.

Right now, capital gains and dividends are less than ordinary income rates, depending on your tax bracket and all those things. But, and I think that’s where the strategy comes in a little bit, where you get a little bit of tax arbitrage. You know, we tell our clients, we hope you win on that, but there’s no guarantees. I think one of the things that get kicked around a lot is dividend tax rates and capital gains tax rates. So if you’re in the wrong cycle at the wrong time, you know, you can find yourself paying higher taxes than if you would just pay the taxes that year. But the point about this program is really keeping the business alive while you’re working.

It’s, you know, when I was doing financial services, you know, when I was working with a business owner, your greatest investment is you. Your greatest investment is your business. You know, you put a dollar back in your business, you’re probably gonna make two, three times that back on. I can’t sell you a stock or a strategy that’s gonna make you three, four hundred times percent growth in that investment because you own a business and you understand it well and you make money.

So that’s really the important part is keeping that business alive during those working years for you so someday you can go off to the sunset. And now let’s say you never use this vehicle, you know, through because God forbid you threaded the needle and you didn’t get sued and all the other things that happen, you’re able to shut it down and pay long-term capital gains. That’s the end game for a lot of business owners. And we hope they all win on that.

Right now, if you used it one year, if you, you know, I tell clients, this is a long-term planning strategy, and this is a concept that you need to work on your business not in your business. We also were conscious of fees. One of the things that we do, and we pride ourselves on is, we try to be the low-cost provider with a five-star service. And I think we do a very good job with that. I think that’s any business owners hope is can we keep our costs in line and still offer the services that business owners would expect. And I think we do a really good job with that.

Your business is not just an investment; it's your greatest investment. Keeping it thriving during your working years can yield far more than any other stock or strategy. Click To Tweet

But in terms of the math, so if I’m, you know, $100,000 solopreneur, I presume it would not be worth for me to create an S31B because the cost of setting it up and maintaining it, it’s going to be more than the taxes I would pay on the money that I would.

They’re better off paying your taxes and taking that 50, 60 cents and parking it off to the side with after tax money. And we come across clients that have been doing that. And that’s when we say, hey, there’s a little bit better way of doing this. So I would tell you that you want to at least be able to position yourself to contribute $80,000 a year into your own plan, into your own 831B plan, probably a million dollars or more in gross revenue. That’s really where the break points still work for you as a business owner, and it’s still good business to, it makes sense. And that’s really where, and we help clients with that. We help them guide their way through that.

We are very candid with our clients when it comes to does this make sense or not. And the other thing too I should point out, there’s a four part test to owning these things. So one of the tests is, the biggest thing that gets you in trouble if you don’t have this aspect is distribution of risk. One of the biggest principles of insurance is the Wal-Mart’s numbers. How can I take a little bit of premiums here and there, spread that risk out over many different insurers, and still be able to, because if you owned 100% of your own risk and you didn’t have anybody’s outside risk in there, are you really an insurance company? So one of the big part tests that we do is there’s a distribution risk. So you do have some risk of paying claims that are not affiliated to you within those pools.

And that’s going down some rabbit holes we don’t need to go down. We have educational videos to explain that. But that’s one aspect of the risk of making very clear to our clients that this is not a risk-free deal. Just because you don’t have claims doesn’t mean your 831B plan has a participation in other people’s claims. And you have to have that element in your plan in order to elect under the 831B. And that’s one of the calculated risks, right? Hey, I’m getting some upfront benefit here because I’m expensing it on my operating company. I’m dumping it into this 831B. But what’s the risk on the backside? And that’s-

So you can cover a bigger risk than the money you put aside? So if I put aside $2 million over 10 years and then I get hit by a $3 million lawsuit, then can I get more money from a pool where I was kind of re-insuring other people?

Yes, you can. Not to get too much down the rabbit hole, but you always will have a transfer of risk for value as well. So the dollar you put in, you get more coverage back than when you put into it, right? But at the same time, we have to mitigate that risk on the back end through our pool mechanisms. Our pools will have three, 400 clients in it, and which means you’re typically going to spread between 40, 50 to 10% of the risk inside those pools. It really depends on the claims and the scenarios. Again, these are rabbit holes. We have some pretty good videos that we feel do a really good job explaining that risk. I want to make sure business owners all the time understand that. Again, these are calculated risks, and I think it’s a risk we’re taking, but I think it’s important to understand the risk you are taking.

Ok, so if people would like to learn more about SRA 831B admin, which is your company, or the actual opportunity that this law and this regulation allows, the 831B in the tax code, how should they find out? Where can they find out this information? Where could they connect with you as well, if they want to personally talk to you, what are your availabilities?

So really, 831b.com is our website. We have a really good marketing now, you’ve met Bri, and she was able to get that website for us, and we’re really excited to have it, because our other domain was hard to spell, and it was too long. So our website today is 831b.com. And inside there is our team, our drop-down menus. You can email me directly. We have a great sales team and operations. I’m very proud of our team. And in two, we have about 180 representatives around the country representing our products as well that absolutely do the, put you in contact with them as well. So we’re happy to talk to clients directly.

And I think when I talk to business owners and CPAs and financial advisors and property casualty agents, these are strategies that I think it’s important to understand and know. And for the right client, at the end of the day, these are just tools and tool chest. And for the right client, it’s a great tool. And I think you owe it to the risk you took, recognize the risk you took, the employees that you help support. And hopefully going off to the rainy day you know selling your business doing all the things that we want to do on the inside of this I think you owe it to yourself to investigate these types of tools

Okay well definitely do that so 831b.com is the website and your email address is 831b.com okay very simple all right so thank you then for coming on the show and sharing this really an interesting opportunity for our listeners and for those you are there if you enjoyed the show please don’t forget to rate and review us on Apple iTunes and subscribe on YouTube. And stay tuned because next week I’ll have another entrepreneur sharing their management blueprint with you and as well as their story sharing their management blueprint with you and as well as their story. So thank you for listening and thank you for coming on the show, man.

 

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