When people run their own businesses, they tend to put everything into them. We know… both through our own personal experiences and through working with our clients. Being an entrepreneur or running your own practice requires that you are completely focussed on making it work. Yet there is, always, much at stake.
We believe there are seasons to entrepreneurship: a time to put all your eggs in one basket, and a time when you need to start playing it safer…or at least, making informed decisions based on your personal circumstances. Whether you are an entrepreneur, a doctor, an accountant in your own practice or even employed by a company, the key words to live by are: you need to diversify your investment in the business, away from the business, over time.
Autonomy, freedom and potential for financial success are three great reasons people start their own businesses. Yet with 80% of new businesses shutting their doors within the first three years, failure can be a real likelihood for some. In spite of the stats, few entrepreneurs take that critical step back and look at where their business as an asset fits into their overall financial position.
Invest in yourself
Generally, entrepreneurs tell financial planners that investing in retirement funds is a waste of time, as they can make a much better return by investing in their own businesses. This is quite correct, but it is important to consider the risk associated with making this higher return. Our response is usually something along the lines of: “You had better make that big return, as the risk you are putting on you and your family is much higher. You could lose the whole investment whilst in most cases a retirement fund loss would be temporary in nature.”
Our approach as financial planners will generally be to encourage business owners and entrepreneurs to “Go for it!”, particularly if they are younger. Investing in yourself will generally be the best return you will ever get. Once you get a bit older and have family responsibilities, that is when you need to realise the risks that you have taken on personally and start to diversify your investments.
Understand the risks
There are more risks to starting your own business than you might realise. Just as every business needs some sort of capital investment, whether machinery or a salary, nearly every entrepreneur has to take a salary cut until cash flow is steady enough from which to draw a living wage. Adding further pressure, entrepreneurs usually have to borrow money. While bank adverts tend to project that they will be your business partner, the reality is that you take on the risk yourself: you may well end up borrowing from your own bond. When this is done, few entrepreneurs realise the risks they have put their families under. If the business goes under, you lose not only the capital and loss of earnings, but also years of potential savings in a diversified and generally safer environment.
Then there’s the risk of sudden changes within your industry, either due to market factors, new technology, competition or even the law, which could render your business worthless. The short-term and long-term ramifications could be crippling, to you, your family and even your employees, if their investments aren’t diversified.
When do you diversify?
Think of your business asset as one share in your financial life. If someone advised you to put all your money into just one share on the stock market, you’d probably think they were crazy. The same is true for business owners. As an entrepreneur, it’s time to start diversifying when your business is paying your lifestyle expenses, through your salary, profit share, or dividends.
So how do you go about diversifying your portfolio? It’s a three-pronged approach. First, make sure that you are aggressively paying down your home loan or any other lifestyle debt. Second (and simultaneously), max out your retirement contributions to the company pension/provident fund (or RA for self-employed). Lastly, build up a discretionary local/offshore portfolio on a monthly basis.
Beware of the big pay day
It’s a fact of life that every business owner believes their business is worth significantly more than it is. Waiting for that big pay day can be a very risky strategy, particularly if your financial plan has you counting on selling a business for a lot of money, but you only get what a buyer is willing to pay at the time. Unless your business is a tech start-up designed to be sold quickly, your financial plan should not hinge on selling your business. Income generation should be the main benefit of your business in the financial plan. If at the end, there is a capital sale, this is a “bonus”.
In our next newsletter we will look at the importance of succession planning.