Shielding Your Personal Wealth: Strategies for Business Owners
Being at the helm, carving your unique route, and the sky-high potential for earnings—these define the thrill of owning a business. But what about the hurdles? Amidst the relentless focus on business expansion (and juggling multiple tasks), managing personal wealth often takes a backseat.
We've seen how personal financial planning and business continuity are connected and can affect each other for entrepreneurs. Here are seven strategies to help protect your money and prepare for a secure future.
Don't Ignore Retirement Planning
Your business may be the main way you save for retirement, either through ongoing profits or selling your company. However, solely relying on your business for retirement poses several risks.
Firstly, many business owners tend to overestimate the ease, speed, and price of selling their business. If you work for yourself, you have to plan for retirement on your own.
There are no employer pensions or retirement plans to rely on. Sadly, this can result in having all your money invested in the business, which can be risky and not diversified. In essence, all your financial eggs are in one basket.
To help keep your money safe and help ensure a stable financial future, you may invest some business funds in retirement savings. For self-employed individuals or small-business owners, there are five primary options:
Traditional and/or Roth IRA – Allows contributions of $7,000 to these individual plans in 2024 ($8,000 for those aged 50 and above).
SEP IRA – Simple and cost-effective, enabling contributions of up to 25% of your net self-employment earnings, capped at $68,000 for 2024.
SIMPLE IRA – Geared towards larger businesses (up to 100 employees), permitting deferrals of up to $16,000 in 2024, with a $3,500 catch-up contribution for those over 50.
Solo 401(k) – For those without employees (except a spouse, if applicable), enabling pretax contributions up to $69,000 in 2024, along with a $7,500 catch-up contribution for eligible individuals.
Defined Benefit Plan – Also known as a cash balance plan, ideal for individuals without employees, high income, and a desire to save substantially for retirement continually. Contribution limits vary based on retirement benefits, current age, and expected investment returns.
Each plan type offers different tax advantages and rules. Our financial advisors can assist in determining the most suitable plan for your circumstances.
Proactively Manage Income, Expenses and Debt
As a business owner, you understand the deep connection between your personal financial situation and your business. Yet, what might not be immediately apparent is how intertwined your financial welfare is with your business partner(s). Setting clear rules for managing money is important for protecting your personal wealth.
A Contributions and Distributions Agreement outlines the protocols for transferring assets between personal and business accounts. Consider these aspects:
Capital Infusions: How will you determine the necessity of additional capital injections, whether from external investors or personal funds? What responsibilities or protections accompany these infusions?
Profit Distribution Targets: What benchmarks are set for partners to receive profit shares? Will you and your partners or co-owners draw equal salaries?
Debt Management: How and when will debt be utilized? Taking on debt significantly impacts both personal and business finances.
Everyone involved must agree on when it is necessary to borrow money. They must also agree on the maximum amount of debt the company can handle. Additionally, they must agree on the different ways to obtain funding.
Setting clear rules for money coming in, going out, and owed helps protect your business as it grows.
Firm up your Estate Plan
You might not initially connect your business's operating agreement with estate planning. However, what unfolds if you or a fellow owner faces death or disability? It's not a scenario anyone wants to ponder at the outset of a venture. Having the right provisions is crucial for maintaining business continuity and personal financial stability.
While many business exits are voluntary, in unfortunate situations, a buy-sell agreement serves to safeguard your heirs. Moreover, if an owner passes away, their heirs (and your stake in the company) can also benefit from protection.
Ensure that your business's exit strategy encompasses plans for an owner's death or disability. Specifically, incorporating an entity-purchase agreement or redemption agreement is crucial.
This agreement allows the business entity to acquire the share of the deceased owner. The entity-purchase agreement is like insurance. It protects you from having to work with the deceased person's spouse or adult children as co-owners.
Diversify like a Business Owner
Diversifying investments is a key strategy to reduce risk and is important in managing assets. However, many small business proprietors overlook integrating their business assets into their broader investment portfolio. Consequently, there's a chance that you might be underestimating your exposure to risk.
Put simply, what might constitute an appropriate asset blend for an executive or a W2 employee might not be suitable for a business owner of the same age and retirement aspirations.
Our firm adopts a comprehensive approach to wealth management, considering every aspect of a client's financial landscape and its potential impact on long-term objectives. For business owners, this entails an added layer of consideration to prevent excessive exposure to risk within your individual portfolio's asset allocation. Elements we analyze include:
The overall volume of business assets
Type of business entity
Consistency of cash inflows
Vulnerability to business cycle fluctuations
When you think about these risks in your portfolio, your personal assets can help you if your business has problems.
Invest in Liability Insurance
Your company today might bear little resemblance to its early days. You've absorbed lessons from past missteps, fine-tuned your systems and processes, and steadily amplified your business revenue.
With the growth of your personal net worth, your exposure to risks and liabilities escalates. Perhaps you've invested in one or more homes, bought a car for your child, or even indulged in luxury items like a boat.
To shield your family, lifestyle, and assets from unforeseen circumstances, it might be prudent to reassess your insurance coverage. We've observed that our clients benefit significantly from a safety net comprising a blend of coverage types:
Umbrella Insurance: This form of personal liability coverage extends beyond typical home and auto insurance, encompassing claims like bodily injury, personal injury, property damage, and landlord liability.
Luxury Goods Insurance: While homeowners insurance has limits, luxury goods insurance covers items surpassing those thresholds.
Income Protection Insurance: Also recognized as disability insurance, this shields you in case of temporary or permanent disability, preventing the need to deplete personal savings or liquidate assets.
Business Income Insurance: In the event of a crisis or disaster forcing your business to cease operations temporarily, this insurance aids in maintaining payroll and covering business expenses.
Maintain a Liquid Emergency Fund
Establishing an emergency fund is crucial—for business owners, it's even more vital. Even the most prosperous companies can encounter unforeseen events that impact cash flow. Our usual advice involves maintaining a cash reserve capable of covering at least six months' worth of personal expenses.
This reserve exists separately from the business and stands ready for personal emergencies. You may consider putting your money in a high-interest savings or money market account instead of keeping cash or getting a CD. This can be a better option for managing your funds.
By doing so, you can potentially earn more interest on your savings. Take the time to explore the benefits of high-interest savings or money market accounts before making a decision. This choice helps ensure the emergency fund remains easily accessible while earning interest concurrently.
Additionally, for business owners, we may advocate having a reserve line of credit. This provides extra protection when business capital is limited by time or has a long period of poor performance.
Develop a Disaster Plan
Preparing your business for a natural disaster is just as crucial as securing your home. However, numerous business owners lack an emergency plan. In places like the Bay Area, earthquakes can happen suddenly, and California's frequent fire season shows the power of nature.
Is your business ready for unexpected events? These events could be major disasters or smaller problems like a pipe burst or power outage. At the very least, you should have:
A comprehensive and practical comprehension of potential threats to your business. Assessing your business interruption insurance coverage can aid in this process.
Essential emergency supplies onsite, including non-perishable food, bottled water, flashlights, batteries, a portable radio, and a first-aid kit.
An evacuation strategy encompassing alternative exits and an external rendezvous point.
A communication plan for staying in touch with employees, customers, and suppliers during and post-emergency, outlining how you'll access their contact information.
Physical and digital duplicates of crucial records—like building plans, insurance policies, employee contacts, and identification details. Physical backups should be fireproof, portable containers or stored at a separate location 50 miles or more away.
Encourage employees to prepare emergency kits, whether they work remotely or in your business premises. It's beneficial for everyone.
Bottom Line
Wealth strategy as an entrepreneur can be far more intricate than it appears, particularly when managing a flourishing business. Ideally, you won't ever need to rely on your disaster plan, emergency funds, or insurance policies. However, having these measures in position grants you the freedom to concentrate on sustained advancement and success. Should the need ever arise, both you and your business stand to gain immensely from their presence.
Sources:
https://advisorygroupsf.com/business-owner-protect-personal-wealth/
Disclosures:
This information is an overview and should not be considered as specific guidance or recommendations for any individual or business.
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