By Marcio Silveira, CFP, CFA, Founder of Pavlov Financial Planning
The financial industry typically focuses on financial
planning for regular employees. The probability of financial success is very high for
employees that pay attention to detail and deadlines, especially when using the help
of a qualified professional.
In the case of business owners, however, the challenge is
much greater. It is very common for the owner to be so absorbed in running the
business that the big picture planning is often overlooked. The benefits of
proper planning, however, are very large - both in terms of peace of mind and
The first step is to properly account for business revenues
and expenses while avoiding the mix of business and personal activities in the
same bank account. Hiring a part-time bookkeeper is
a good first action.
Then, for each phase of the business, a financial strategy
should be designed and implemented. A small business goes through the following
phases: start-up, fast growth, consolidation, and exit. Each of these phases
represents a unique set of financial challenges for the owner.
In the start-up phase, the owner must decide how to finance the launch. He or she may decide to self-fund
with personal savings or take on debt. This has clear implications to the
personal finances. It can mean a depletion of long-term assets previously
destined for retirement. It can also mean more individual debt that can cause
problems in the future. The founder may also invite equity investors into the
business, but this can limit the financial upside. A clear assessment of the
risk tolerance of the business owner can be very helpful to determine the best
financial strategy at the start.
It is common in the start-up phase for business owners to
have business plans that are used to attract outside capital. Besides this
fundraising business plan, an operating plan can be a great tool for owners.
The best-case scenario is to integrate this operating business
plan into a personal financial plan. Notice that this integration has
nothing to do with commingling of accounts.
High Growth Phase
In the high growth phase, the business is proving its
viability. At this point, some businesses may be able to access credit lines
and loans directly, but owner guarantees are common. A critical and honest assessment of the business prospects is paramount
at this time. If growth rates are not that high and breaking even is still
far away, the business may encounter difficulties in raising debt or equity
capital from outsiders. If the owners insist in funding this business by using
savings or debt, the consequences can be very negative.
In the consolidation phase, the owner can consistently make
a living and rely on the business. Growth tends to be slower, but now the
business generates profits and cash flow. At this point, strategic decisions should be made about the use of business income,
including retirement and insurance plans.
Specific retirement strategies for small business like a SEP IRA or a SIMPLE IRA should be
considered together with the more traditional 401(k) plans. Portfolio
investments should be in different industries and geographical locations from
the business in order to mitigate the risks. Life and disability insurance can
be used to protect the business and the family of the owner. Also, a high
deductible health insurance plan with a tax-advantaged Health
Savings Account may make sense.
The last phase is the business exit. In order to obtain a
good value, adequate preparation is fundamental. Typically, the business is the
largest asset of the owner and any succession event has the potential for
meaningful tax consequences. Waiting too long to plan or simply assuming that
the children will take care of the business can be costly. After the exit is
completed, the effective management of the proceeds is critical to the economic
independence of the retired business owner. In life after the business, sound personal financial planning is what
maintains prosperity and leaves a legacy.