Last month we looked at three inspiring stories of employee-owners building life-changing wealth. We saw how regular grants of company stock at companies like WinCo Foods and Springfield Remanufacturing Company helped front-line workers build eye-opening account balances, in some cases over a million dollars.
These stories are incredible, and perhaps even sound too good to be true. But what if I told you that these employee-owners were able to build such large amounts of wealth by leveraging the same force that billionaires like Warren Buffet used to build their wealth?
The magic behind employee ownership is the magic behind all great fortunes: compound growth. In this post we’re going to take a peek under the hood at the surprising power of compound growth including:
- Warren Buffet’s Journey to Twelve Figures
- What Exactly is Compound Growth?
- Compound Growth Helps Employee-Owners Build Wealth
- The Key Ingredient is Time
- You’re Only Successful if Your Company is Successful
This article has two big takeaways for employee owners. First, the most important factor in building wealth with employee ownership is giving compound growth plenty of time to work. Second, the better your company does, the faster your wealth will grow. Even small improvements in company performance add up to big changes thanks to compounding.
Warren Buffet’s Journey to Twelve Figures
Compound growth is simple to understand but can be difficult to appreciate. Imagine if I proposed the following deal: today you hand me a dollar, and a year from now I’ll come back and give you that dollar along with two dimes. Would you do it? If you’re like most people, that deal doesn’t sound exciting. But that deal, executed repeatedly and at scale, is how Warren Buffet became one of the richest people in the world.
If you don’t know about the “Oracle of Omaha,” Warren Buffett is a legendary value investor with a net worth of roughly $108 billion. Buffett built his wealth as the majority owner of Berkshire Hathaway, a holding company that he took over in 1965. According to publicly available shareholder letters, over the next 50 years, Berkshire Hathaway’s stock grew at a compound growth rate of 21.6% a year. To put it another way, a single dollar invested alongside Buffett would have grown to $18,262 (source: Berkshire Hathaway Letters to Shareholders). That’s the power of compound growth.
What Exactly is Compound Growth?
In terms of investing, compound growth is when invested money earns returns on both the original amount as well any accumulated growth.
Here’s a simple example. Say you invest $2,000 and earn a return of 10% per year. In the first year, you'll earn $200, bringing your total to $2,200. In the second year, you'll earn returns on the full $2,200, which comes out to $220. This includes $200 of growth from the initial $2,000 investment plus $20 from the $200 of growth from the first year. That $20, the growth made solely from prior growth, is your first bit of compounding.
Compound growth means your money is growing at an accelerating rate. This effect starts small, but it becomes more and more powerful with time.
Compound Growth Helps Employee-Owners Build Wealth
Employee-owners tap into compound growth by owning shares of company stock. Their stock has a value determined by their company’s share price, which changes each year based on the value of the business. If the company’s share price goes up over multiple years, then the value of the stock grows with compound growth.
While practices vary, most employee-owners receive an allocation of company stock each year paid for out of company profits. Annual allocations supercharge an employee-owners growth by building the account value in the early years while compound growth is still picking up steam. Building on the example above, say an employee-owner receives an allocation of $2,000 of stock at the end of each year and their company’s share price grows at 10% annually. Here’s how their account balance would grow initially:
Our employee-owner sees $200 of share price growth in year 2 and their first compound growth in year 3. After 5 years of ownership, allocations add up to $10,000, over 80% of the total account value. In general allocations make up the bulk of an employee-owner’s account value early on, but that changes dramatically with time.
The Key Ingredient is Time
Let’s check in on that same employee-owner after compound growth has had time to work its magic. Let’s assume the allocations continue at $2,000 a year and the share price continues to grow at 10% annually:
The first thing to notice is that our employee-owner’s total account value is accelerating. After 20 years they have over $110,000 in their account. After 25 years, they’re almost at $200,000. And after 30 years, they’re over $320,000! This acceleration is the tell-tale sign of compound growth.
This example also shows how compound growth ends up driving most of the wealth building. Allocations continue, but they become less and less important as compound growth ramps up. By the end of their career, our employee-owner has accrued over 80% of their total account value from share price growth, exactly the reverse of what we saw after the first 5 years!
You’re Only Successful if Your Company is Successful
We started out talking about employee-owners becoming millionaires, but so far the highest account value we’ve shown is under $350k. This is where the share price growth rate factors in. After time as an owner, the next most important factor for employee-owners looking to build wealth is the success of their company. In general, the more successful a company is, the faster its share price will grow.
To demonstrate the importance of company success, let’s look at how our employee-owner’s account value after 30 years changes with the rate of share price increase:
For context, a 10% average annual share price is roughly what the public stock markets have returned over time. But it’s certainly possible for a successful private company to outperform this benchmark. Increased company success has a dramatic effect on our employee-owner’s account balance. Roughly speaking, a 1% annual increase in the company share price leads to changes in final account value of between $100,000 to $200,000. That’s huge!
One very important caveat to all this is that no company’s share price is guaranteed to go up, and it’s possible that a series of events could lead to any company going bankrupt, which would make those company’s shares worth zero. For employee-owners, this risk is offset by the common practice that shares are paid for out of company profits, with the employee-owners not putting in any of their own money. And of course no financial gain comes without risk.
What does it take for our employee-owner to become a millionaire? If their company is able to achieve a 20% rate of return over 30 years, they would retire with well over $2 million. Not every company will accomplish this, but it’s not without precedent. WinCo Foods managed to grow at roughly this rate from 1986 to 2014, a 28-year period.
The minimum required performance for our employee-owner to see a seven-figure account balance is 16% annual share price growth over 30 years. Make no mistake, that is a solid performance that not every company can accomplish. But I personally have spoken to multiple employee-owned companies that have turned in this record, or better. Ultimately it comes down to how the company performs, which is something that every single employee-owner can impact through their ideas and their effort.
Connecting the success of the company and the success of the employee through wealth building is perhaps the biggest reason we see employee ownership as a win-win for business and people.
Note: The examples provided in this article are solely for illustrative purposes only and should not be relied upon in any way, nor should be construed as an appraisal, legal, financial, tax, or other professional advice.
This article was originally posted on 3/10/23 and was updated on 7/11/23 to update the discussion of “compound interest” to “compound growth” which more accurately describes wealth building at stock-based employee-owned companies.
