The fox knows many things,
but the hedgehog knows one big thing.
An employee must know what the employer wants, but the employer must know what everyone wants. Employees’ insurance and tax-deferred retirement accounts are most often set up, funded and managed by their employers or one of its agents. The employee must protect home and family; the employer must protect the source of the employee’s protection. Employees are urged to plan their financial lives around their homes, retirement accounts and future employment opportunities.
Entrepreneurs, the employers, are often also urged to follow the same financial plans as employees, but the creative capitalists who start, build and manage the businesses that hire the employees do not mean to depend upon retirement accounts as their exit strategies. An entrepreneur’s retirement plan is an extension of the business’s financial plan. The business is a separate entity which indirectly pays the owner’s personal bills but has a life of its own with a separate circle of employees, customers, agents and advisors.
But entrepreneurs have distinct advantages over hourly or salaried workers. They already have a retirement plan in place; it is their business, and that is where their real wealth is built. An entrepreneur might also build a secure retirement apart from the business, so when the time comes to exit the business, it can be a life-altering payoff.
Entrepreneurs take risks in order to gain flexibility, control and the financial situations they desire. When bad times come, an entrepreneur has more than just family and home to worry about. An entrepreneur also has employees upon whom the business depends and who depend upon the business. All businesses need savings for times when revenues are light but the business is healthy. Savings also serve as a war chest accessible for expansion opportunities. Significant savings, beyond the budget for three months, can be invested for a longer time horizon. Those investments, inside the business, but outside retirement accounts, while not as instant as cash, can be accessed in a matter of days or used as collateral for short-term borrowing.
Savings accounts become investment accounts when they grow beyond the amount needed for short-term budget demands. Interest rates on intermediate-term (2-7 years) US Treasury Securities are higher than they have been in a decade. The Standard and Poor’s 500 Index has an average annual return 15% over the last ten years and is up 16% this year.
Entrepreneurs are comfortable taking risks on companies they know and understand because they are the owners and managers of those companies. But quality stocks with growing earnings are now available with dividend yields that are twice the Treasury Rates. Common stock investments and stock-oriented mutual funds must first be diversified by risk and industry in order to mitigate the risk of one bad choice. Regularly rebalancing the portfolio to align with the investor’s risk tolerance will also augment long-term returns.
The first and foremost risk to the health of the business is the life and health of the owner. Injury, disability or sickness affecting the entrepreneur or a key employee, affect the performance of the business. Business overhead expense (BOE) insurance covers the costs of running a business in case of incapacity of the business owner. In the case of the founder’s death or permanent disability, a Buy-Sell Agreement will protect the interests of both the departing owner and the business. The entrepreneur is also responsible for harm caused to others by an employee, product or service the business provides, but a Personal Liability Umbrella Insurance Policy will protect the insured’s personal finances from lawsuits filed against the business. A comprehensive Business Owner Policy (BOP) combines protection for all major risks in one package: property, casualty, liability, crime and medical.
Access to credit will at some point be important to any growing business. If further capital investment can increase profits, then borrowing to fund it makes sense. “Good debt,” or productive debt, benefits the business. When the return on the investment is greater than the cost of the debt, the loan will pay itself off. Reductive debt is “bad debt” because it does not provide a future return to mitigate its cost.
Key to getting the best rates and terms when borrowing from a bank other other credit facility are the three C’s—credit, cashflow, and collateral. Credit is measured by the three major credit reporting agencies. The cashflow of the business proves its access to future funds for principal and interest payments. Just as a home is collateral for a mortgage loan, so the assets owned by the business are collateral for the lowest rate business loans.
Entrepreneurs love risk, but dread taxes. Luckily they have tax-management tools available only to them. Business expenses are deductible, personal expenses are not. While involved with the business, which may be every day, all day long, money spent can be deducted as business expenses.
Just by taking less income out of the business, taxation is deferred and reinvested. Those funds not taken, but instead left in the entrepreneur’s own business have a known return on investment (ROI). Earnings on business savings and investment accounts are taxed at the business tax rate and are reduced by business expenses.
Contributions to retirement accounts are tax deductible and business owners have multiple options. The amounts that can be deferred from taxation are also multiples of the maximum $7000 an employee may deposit into an individual retirement account.
For financial planning for entrepreneurs, retirement is not defined by age, but by the financial plan. Like personal retirement planning, financial planning for an entrepreneur should have a target, but not a retirement date. A retirement number should be the focus of an entrepreneur. What does the business owner require in monetary terms in order to exit?
When that number is near, or at least foreseeable, an exit strategy should be the final chapter written of the entrepreneur’s financial plan. An exit strategy, to be executed in two or three years, with a targeted monetary value for the business, can become a self-fulfilling prophecy. What is written down may indeed come true.
There are as many ways to transfer a business, as there are types of businesses. Ownership of a sole-proprietorship might naturally be transferred to a member or members of the owner’s family, a partnership to partners, an S-corporation or a Limited Liability Corporation (LLC) to other shareholders, and a publicly traded company at the common stock market value. Partners and shareholders already have a clear picture of the value of the business, its potential and how important the seller is to the business.
Selling to a third party involves an evaluation of the business’s worth, but other delicate issues complicate the process. Plans to sell the business must be kept confidential because the knowledge that a business is for sale can affect the attitudes of employees, customers and competitors even though they may be potential buyers as well. One way to handle this situation is to hire a business broker who, like a real estate agent, is in business to assist both buyers and sellers. Negotiations will include terms of payment, whether a lump sum or in payments over time.
Anyone with money needs a plan, but entrepreneurs especially need financial plans for their businesses. Starting and running a business is a risk, but the rewards include the control of one’s time and the flexibility to change plans when needed. A business owner’s financial plan can be a map of the shortest route to an entrepreneur’s desired destination.
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions of Spire Wealth Management, LLC, Spire Securities LLC or its affiliates. Investing involves risk, including the loss of principal. Past performance may not be indicative of future results.
Spire Wealth Management is a Federally Registered Investment Advisory Firm. Securities offered through an affiliated company, Spire Securities, LLC a Registered Broker/Dealer and member FINRA/SIPC
This material is distributed or presented for informational or educational purposes only and should not be considered a recommendation of any strategy or investment product, or as investing advice of any kind.