Business owners face a unique investment dilemma. To what degree should they invest their capital back into their own business, and to what degree should they invest in other assets?
Most business owners invest 110 percent into their business. They plough in the hours and they will take a salary cut if it means putting more capital back into the enterprise. Of course this makes a lot of sense because every dollar and every hour invested can net good returns in the long run. More than that, the risk of investing in your own business seems minimal – surely - because you just know that ‘management’ is making sure that every dollar is working hard. After all – you are the management.
But hold on there. What about the solid gold rule of investment that says you shouldn’t put all your eggs in one basket? Even if the basket is your own? This is a real conflict for business owners. In our experience, it is common for entrepreneurs and executives with stock options to be heavily exposed to the success of their own company, ploughing in capital with little in the way of an alternative savings scheme.
While it is important to use your capital to keep your business healthy and to take advantage of opportunities for growth, there comes a time when you must spread some of your risk.
If this sounds like a lack of self-confidence – an unwillingness to back yourself as a winner – then stop, stand back and look at some of the business risks that are fundamentally outside your direct control.
- Market risk. A major competitor aggressively takes customers – or a key customer goes under, or moves offshore.
- Environment risk. A September 11th occurs, a new legislation changes the trading environment.
- Technological risk. A smart innovation renders your service or product yesterday’s news.
- Business risk. A great customer becomes a bad debtor.
- Liquidation risk. The market cycle hits a bad downturn just when you decide to sell your business and take retirement. The price is wrong – or you can’t find a buyer.
The question is – why should you expose your entire retirement plan to these variables? Our recommendation is to reduce this exposure and to build an investment plan quite independent of the company.
Retirement Strategy – Part 1. Diversify. Set up an independent retirement plan.
A good suggestion is to invest in the growth of other companies that are
not related to your industry. The most efficient way to do this - especially when you don’t have time to select stocks - is to invest in a personal tailor made portfolio which will include share funds that offer a spread of companies (most overseas ones comprise stocks of
at least 300-400 companies) across a range of sectors and countries.
How well do these perform? Over the last 10 years - even with the September 2001 crisis - the MSCI (an index representing global sharemarkets) returned a handsome 10.9% pa, and over the last 5 years, 16.7% pa.
How and when do you release capital from your own business to build up your independent retirement fund?
Perhaps this is the heart of the dilemma. The answer depends on how you intend to grow your enterprise in the future – and part of the answer comes down to how much you should single-handedly finance your own business. Perhaps if the business-growth requires more capital you should choose to include other equity investors, letting them take on some of the risk – and yes, some of the profits too. While they are doing this, your money can be working for you elsewhere, spreading your personal wealth and easing your risk.
Retirement Strategy – Part 2. Reduce liquidation risk. Get a succession plan.
If creating an independent retirement fund is the first part of a business owners
risk reduction strategy, then the second part of the strategy is equally vital: reducing your exposure to Liquidation risk. What you need is a succession plan – a roadmap for how you’ll go about setting your enterprise up for sale.
Even if the prospect of a sale may seem over the horizon, the planning really begins now. Issues to be considered include:
- How do we preserve the value of the business even if my skills are removed from it?
- How will I teach others to run the business?
- What if I can’t liquidate the business in a timely fashion?
- How much do I need for retirement - and how much of this will come from the sale of the business?
- What is the most tax effective way to obtain these funds?
- What is the most effective structure for my business in order to give me the most personal security?
The last question regarding your business structure is a vital one. Any assets that you are accumulating for retirement should be protected from potential creditors and from the risk of a lawsuit. One suggestion you should seriously consider is to establish a family trust that can help protect your personal assets from business risks.
The core of the business owner’s investment dilemma is actually emotional. There’s no getting around the fact that your enterprise is close to your heart – it’s an extension of you. It reflects your skill, your commitment and your dreams. Those are the elements that can make owner-operated enterprises particularly effective. All we’re saying is – apply some of those same values to your own retirement as well. Spread your risks and start planning for the day when you can sell the business and reap the rewards of your commitment. Go for it.
