Investing in your business v personal wealth creation: How to set yourself up for the future

Why did you start your business? Was it to give yourself a job, to follow a dream, or perhaps it was to create financial security for your children and grandchildren? Whatever the reason, business owners tend to channel all their energy and finances into their companies, especially when starting out.

On face value this may seem like a great idea, after all starting a business is inherently risky, but with a wave of business sales about to hit and companies selling for less and less, many business owners will be left without adequate funds for retirement.

A recent study by PwC found in the next decade 1.4 million business owners are expected to retire, causing a “pent-up wave of sales” which will see the market flooded with companies up for grabs.

Businesses up for sale

Grant Thornton partner Robert Powell told SmartCompany this oversupply of businesses will cause prices to drop, meaning business owners need to start thinking about how to fund their retirement.

“What a lot of these businesses don’t understand is they generally only get one chance to make a successful exit from their business. They don’t realise how important it is to plan for that,” he says.

“Most business owners have an inflated view of the value of their business. They always overstate their business, not understate it, but post-the global financial crisis business values were really impacted and people just aren’t prepared to pay the kind of money they were before.”

Business owners of bootstrapped companies will readily invest in their business before their own financial security, but with the value of companies falling, business owners can no longer assume the sale of their business will support them through retirement.

Powell says failing to invest in personal wealth, not just the business, is a common problem with potentially serious repercussions.

“It’s a particular issue with family owned and operated businesses where the founder tends to make financial decisions for the business not for themselves, because of future generations,” he says.

“They’re focused on the future benefits of the business, not how it could benefit them later. I see a lot of business owners who pass it onto the next generation coming up short financially because they don’t put enough away for themselves.”

Powell says business owners often don’t see their own finances as a high priority, or “assume it will take care of itself”.

A study by the Australian Women Chamber of Commerce and Industry published last year revealed the majority of female small business owners didn’t pay themselves a wage.

Only 37% of women reported paying themselves a market wage and many of the women were also not paying themselves superannuation.

Company structure

Hewison Private Wealth director and private client advisor Chris Morcom told SmartCompany business owners need to ensure they have the right financial structures in place to allow them to adequately prepare for their future.

“Make sure it’s the right structure for now and for the future. Whether it be a company, a family trust, a partnership or a sole trader. In the first year or two of business you should seek advice to ensure you get the structure right and don’t have any tax issues down the track,” he says.

“Once that’s in place it will motivate the way you get money out of the business.”

Morcom says he favours a structure where the corporate entity runs the company, but the business owner sets up a family trust to distribute money as dividends to other family members, thereby reducing the amount of tax needed to be paid by the owner.

“If the money is distributed through a trust to the owner’s family members, whether it be their spouse, parents, children or cousins, this adds a lot of flexibility,” he says.

“However there are tax issues associated with distributing money to minors… so it’s not tax effective to distribute large amounts to your kids.”

Emotional attachment

Powell says business owners tend to form an emotional attachment to their business, which prevents them from seeing it objectively, harming the likelihood of them making smart financial decisions.

“They don’t compare the business with any other type of investment like their superannuation or their holiday home,” he says.

“It’s something I see a lot of and when I ask many business owners what their company is worth, they’ll only have a rough idea, but they’ll be able to tell you to a decimal place what’s in their super.”

To be adequately prepared to reap financial gain from the business, business owners need to see their company as an asset to be managed.

“What we see are business owners putting money into their company like it’s a black hole and they don’t even expect to see the money back,” Powell says.

“They’ll support their business to the enth degree, but don’t treat it as an investment. Business owners don’t treat the money they put into the company with the same degree of respect they would a third party lender.”

To avoid ending up in the queue with other creditors if the company goes bust, Powell recommends ensuring money put into the company is secured.

Making the right investment decision

Pitcher Partners wealth management client director Jordan Kennedy told SmartCompany deciding whether to invest in the business or in personal wealth depends on what stage of the wealth cycle the business and the person are in.

“The advice is different depending on these cycles and the age and maturity of both business and business owner,” he says.

“At the start-up phase, and perhaps if youth, time and energy is on your side, you might have a higher risk/reward threshold but not enough money. At this stage you would be looking at others to invest to take your business to the next stage.

“At the mature phase you might survey the landscape to assess the potential for growth should investment be required. This may be a cash injection to acquire competitors or for new investments into the business that will give you a better return than alternative means such as directing funds to superannuation.”

Kennedy says the business owner should consider the timeframe of the investments and whether there is enough time and cash to see the idea through to its full potential.

“Diversifying away from the business is seen as a risk mitigation strategy so you don’t have all your eggs into one basket leading to retirement phase,” he says.

“You may need to consider whether you need to resist the temptation riding the risk wave cycle again as a trade-off to preserve your wealth for your future retirement.”

Is it a business or a job?

Ultimately, if a business owner decides to dedicate most of their finances to growing the business, they need to be confident the company will be sellable.

Powell says if a business is unable to function without the founder, no one will buy it unless they’re just looking for a job.

“You cut out a whole pool of potential buyers and investors. You’re only going to attract the person looking to buy another job,” he says.

“The idea is to set the business up so it can run without you. That means investing in providing the right organisation structure, well-documented systems and a good management team. It needs to run without you and if it can’t, then my suggestion would be wait until it can before putting it on the market.”

Powell says a lot of businesses aren’t able to make this transition if the company is built entirely on the relationships between the owners and the customers.

“It’s possible, but a lot more difficult. Ideally you want it to be a turnkey type situation.”

Morcom says he always likes to take a step back and ask SME owners if they’re in it to create something long-term, or just to give themselves a job, before working out what approach to investing to take.

“If you’re building the business and know you’ll have something valuable at the end of it, investing in the company isn’t a bad thing, but you’ll only have a proper business if it’s making money while you’re asleep,” he says.

“If the business isn’t reliant on you and neither is the company’s profitability, you can plan for a future where there will be a lump sum available at the end, but if you’re business is really just a job, you need to be accumulating wealth because if it’s not sellable, you’ll be left with nothing.”