Happy Day to you. This is Ken Kaufman and I’m thrilled you’re here for episode number five, Prioritize the waterfall. As you recall, we’re working our way through the IMPACT Your Net Worth model, using IMPACT as an acronym and each letter identifies one of the six key principles for building net worth, getting ahead financially, and building financial freedom.
As a reminder, here are the six:
I is for Iterate mindset and prop process.
M is for Maximize income and joy, which we covered in the last episode.
P, which will cover today, is for Prioritize the waterfall.
A is for align with partner and waterfall.
C is for Cultivate assets.
And T terminate debt.
So this concept of prioritizing the waterfall – let me start by just meshing together several experiences that I’ve had in my business career that helped me to connect the concept of a waterfall to money and to building financial independence and building net worth.
In business, when you are going to sell a business for cash, there are usually a lot of different people or entities or institutions that are going to be standing in line to get paid. What is developed as a waterfall that shows the prioritization of when that business sells, and that one time lump sum payment comes in, there is a prioritization in terms of who gets money first, and then who gets money second, and third, and fourth, and so on. In the mergers and acquisitions world, this is called a financial waterfall.
Imagine with me, if you will, you’re looking at a beautiful waterfall and the water is coming off of the edge of a beautiful cliff. And it falls, let’s say 10 or 15 feet, and there’s a small pool there, where the water goes into it, and it fills that pool up. And then as it fills up, it spills out over the edge of that pool and drops down to another pool, say another 10 or 15 feet below. And as it fills that pool up, then it spills over and fills in the pool down below.
I had actually looked this up to learn what the name of this type of waterfall was, I thought it should be called a tiered waterfall, but the proper name is a cascading waterfall, where it comes down and fills up the next ditch or pool below it. And then it comes down to the next one and the next one and the next one.
In business, you have this large, one time lump sum payment when the business is sold, and the money comes in. And first you have those debt holders, your senior debt holders first, and then the unsecured or subordinated debt holders. So it comes down off of the off of the cliff and it fills up the bucket so that those debt holders get paid off, then the remaining amount as it’s spilling over spills over to the next one and you have your subordinated and unsecured debt holders. Then, if there’s anything left after that it spills over down to the next pool and you have your preferred shareholders. And then ultimately, it spills down to where your common shareholders are waiting for anything that’s left. And it’s split up pro rata based on their percentage of ownership.
So this concept of a waterfall, and using it with money, I first connected this when a financial transaction takes place in a business. As I have worked over many years, and over 20 years of marriage, my wife and I have tried to align on how the money that comes into our bank account each month, how that should be spent, I started to make more of a connection with that income coming in, which the last episode we talked about maximizing our income that comes in, and then we need to figure out what is that first priority for our money, or that first pool in that cascading waterfall that needs to get filled up before any money is available to go to the next, and the next thing, and so on.
I’d like process. I mentioned in the episode about Iterate mindset and process that having a process in place where you don’t have to put a lot of brain work into making decisions about what to do in your life or in your business or in other areas or even with your money. I like to make that brainless, meaning I like to make all those decisions about what should happen with it and then have a process where it just happens. So the concept of prioritizing your waterfall is really sitting back and saying what is my number one priority. And when I receive money coming in, how much needs to go in to fill up that bucket, or that pool in the cascading waterfall, and then everything left can now go down to my second priority. And then my third priority.
Here’s a quick example. My wife and I have very concrete, non negotiable waterfall when it comes to our income. I can go back to when I first graduated from college and started a business that failed. And then about eight months later, got a job and started into a career that really has been an amazing trajectory since then. My wife was a school teacher and earning I think $800 a month and I had no income coming in. And then I got that first job and we had more income coming in. And over the years we’ve had higher income and lower income.
Of course, we’ve just been adding children, if you recall, we have eight children total, the oldest is 19. And the youngest is three. And our expenses have certainly gone up as we’ve added to our household. And we always, whenever we have a significant change in income, we sit down and try to have a conversation about what are our priorities and what should come first.
Very early both of us, before we even knew each other, had committed to God that we should tithe and pay 10%. So when you look at the Kaufman waterfall, the very first cascading pool is 10%. And so 10% of everything that comes over that first ledge, it stays there, and we feel an obligation to pay God this tithing. Then we have a next one, which is we also want to be generous and find ways to give and help others around us. And so we have another percentage that catches in the second pool.
And then in the third pool, we also want to be saving for ourselves. I view it as the biggest expense, the biggest one-time bill any of us will have will be trying to have enough to be financially independent through retirement all the way until we’re done. And if we have a desire to leave anything to our heirs, then then we can go through that process. So we then have a percentage that we save everything coming in, that gets set aside, and we pay ourselves, or, in essence, I would refer to it as we’re paying our future selves. Then we have another pool to fill because most of my income throughout my career has come in as self employment income. And so we then have to set aside money for taxes. And so we have that cascade. And then we come down to our bills. And we come down to, ultimately, is there anything left for saving for vacation or any and all priorities that we want to set for ourselves.
The two key components of the letter P is prioritize and waterfall.
So you could say “Hey, I don’t care, I just want my money to come in, I’m going to spend it however I fell like I want to.” That’s great, but guess what? You actually are prioritizing wherever you’re choosing to go and spend that money. And your waterfall is happening as you’re spending down until hopefully you’re not draining the bank account. Hopefully, you’re not building or incurring any more debt than you already have. Hopefully, you’re figuring out how to pay it down.
Now the connection of this principle to net worth is this. When we build our priorities, if net worth is truly a priority, we should, at the top of our list of priorities, we should have in place the things that are going to help us to build our net worth and make those a priority ahead of maybe some other things that aren’t quite as important. They’re fun and exciting, sure. But we need to find a balance so that we make sure we’re building our net worth while we’re also using our money to enjoy life to be fulfilled, and even to do something maybe frivolous from time to time.
So I hope that this example has made sense the concept of a cascading waterfall. My wife and I have found this super helpful. You’re going to find in the next episode, I’m going to be focusing on talking about how this waterfall actually empowers us to align ourselves with our partner, and to make sure that we’re staying in the line of the waterfall. We’ll get into more on that in the next episode.
So that’s it. There it is. Prioritize the waterfall.
Next episode is align with partner and waterfall. Make sure to subscribe to the podcast so you don’t miss it and the following episodes on the IMPACT your net worth model. I will mention that once we get through talking through the IMPACT acronym, we will be spending more time to dive in on how exactly we prioritize and pick and then ultimately get ourselves aligned with our partner and then start cultivating our assets and then terminating debt.
Many, many thanks to you for joining today. This is a wrap for Episode Five. Happy Day.