Successful small-business owners tend to be hard-working, tenacious, smart and highly focused. They have to be. According to a study by Dun & Bradstreet, businesses with fewer than 20 employees have only a 9 percent chance of surviving a decade.Yet even those that are successful fail miserably when it comes to planning for their financial future. In fact, it’s their proclivity to hone in so intensely on their business — certainly an attribute of being successful — that often gets in the way of their personal financial planning.
Take the case of a client of ours, husband-and-wife owners of an extremely profitable seasonal business. When we first started working with them, they had built a very profitable company that earned millions in revenues. They spent 24/7 on the business, always keeping their eyes on the ball. Yet they had not saved any money outside of the business, their benefits package was modest, and they had little invested in their kids’ college or their own retirement funds.
Today, they have pulled out more than $1 million from the business and placed it in a well-diversified portfolio. They have opened a profit-sharing plan for the company (of which 85 percent of the $500,000 already invested is earmarked for them). And they have purchased appropriate life and disability insurance, and 529 plans to fund their children’s college, while continuing to invest in the business.
Their story is hardly unique. In fact, such a rosy outlook is possible for many small-business owners — if they are prepared to make a few changes. Here is a look at common mistakes made by many successful entrepreneurs that may impede their financial future, and what can be done to help turn it around:
* They do not implement proper benefits, such as health, life and disability insurance, and retirement plans. This is the case with too many small-business owners. When one begins a business, benefits are often a low priority. Costs, after all, may be prohibitive. As time passes, the question of purchasing proper benefits is often not revisited, even if the business has now grown and added employees so that it can take advantage of significant group discounts for benefits. In the case of retirement planning, there are many options available for small-business owners, including those with built-in flexibility that take into consideration fluctuations in annual cash flow. These need to be taken care of as soon as possible.
* They do not properly provide for their families should the unexpected occur. Many small-business owners scrimp on life or disability insurance, rationalizing that, “My business is worth millions of dollars — if I die my family will be taken care of once the business is sold.” What they fail to consider is that without them, the business is likely to be worth far less. How much life insurance is enough? There is no hard and fast rule and no formula that exists.
Not all people who earn, say, $200,000, require the same amount of life insurance. Rather, it depends on one’s stage in life in terms of ongoing cash flow needs and financial obligations.
* They do not save money outside the business. Small-business owners have a tendency to become so focused on their business, pouring money into it so that it can grow and prosper, that they fail to save for their future. They may enjoy a very upscale lifestyle while the business is alive and well, but end up with nothing to show for it should the business fail. This is why some small-business owners end up working well into their 70s and even 80s — they never drew sufficient cash out and have no choice but to continue working.
To prevent this from happening, money needs to be invested during profitable times to fund retirement plans and invest in a diversified portfolio. This does not mean sucking the business dry, but rather not putting all of one’s eggs into a single basket. This way, even if the business ends, there can be a comfortable retirement.
* They do not establish business credit as soon as possible or use business loans, rather than personal credit. Many fail to establish proper financing not only during the very beginning, when personal credit may be the only option, but also during the growing stages of the business. Without proper financing, businesses often cannot grow (unless owners sink their own money into it, which can inhibit their ability to invest properly in their personal financial future). The recommendation is to acquire a minimum line of credit early on in the business name and to increase it over time to show banks and other institutions that the business is a good credit risk, which in turn will help sustain business growth.
* A proper succession plan or exit strategy has never been developed. Many small-business owners work very hard to build a viable enterprise and at the end, shortly before they plan to retire, they suddenly wonder, “What am I going to do with my business?” By then, it’s usually too late and the business dies. As a result, while the company may have sustained the owner’s lifestyle for many years, it suddenly has no value.
To prevent this from happening, a plan needs to be put in place between five and seven years prior to one’s planned retirement. It all starts with looking at where the owner wants the business to go (along with having the value of the business assessed). Is there a family member to take over the business? Are there key employees? What about selling to a competitor? If the decision is made to pass the business on to a child, should it be sold or gifted? (There may not be any choice if a sale is necessary to fund retirement.) Finding someone who is willing to take over the business and someone who is capable of running the business are two entirely different things. We’ve seen too many businesses run into the ground by the next generation of ownership. The consequences can be catastrophic, costing the owner their retirement stream of income.
* They often live for today and not tomorrow. This is the philosophy of many people, not only small-businesses owners. Yet, unlike those who receive W-2s and know what they will take home annually (with the exception of the very small minority of salaried employees who receive significant yearly bonuses), small-business owners often experience up and down years. While they may tighten their belts during the rough times, many make up for it during the good years by spending, rather than investing for the long-term. And yet it’s during these peak earning years that money needs to be tucked away for the future.
For small-business owners, running a successful business is just the first hurdle to achieving financial security. They still need to keep their eyes focused on the finish line.
Howard Milove, CPA, PFS, is a financial planner with the wealth management firm Access Wealth Planning in Roseland, N.J. Reach him at firstname.lastname@example.org.
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