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 wealth creation.
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-timebookkeeper 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 Accountmay 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.