How Small Business Owners Should Think About Personal Wealth
Small business owners continuously reinvest in their businesses: New equipment, more staff, bigger marketing budgets. Every dollar of profit that could theoretically go into your pocket goes back into the operation instead.
It’s discipline … to an extent.
By not extracting every dollar of value from your firm, you’re allowing it to breathe and to grow. But done to the extreme, and done over the years, you’ll wind up in the same position many small business owners find themselves in. They’re in their 60s with a thriving company, but with minimal personal savings and a three-word retirement strategy: “I’ll sell it.”
It’s a plan, but it’s a mighty rickety one wrought with risk. Leaving your retirement up to the future financial value of your small business can leave you exposed in ways that have nothing to do with how well you run your company.
In short, your road to retirement should be mapped out in concert with your small business, not scribbled out once you’ve left it behind. Today, we’ll talk about how owners should think about building personal wealth.
The Business Equity Trap
Business equity is real wealth. If you’ve built a company worth $2 million or $5 million or $10 million, that’s something.
But that wealth isn’t liquid. Nor is it diversified. Nor is it guaranteed.
Look at the following bullet points and ask yourself, “What do these have in common?”
- A buyer falls through.
- Consumer trends hobble your industry.
- A key employee leaves.
- A major client walks.
- An economic downturn compresses valuations in your sector.
The thread linking all of these things together is that you have little to no control over them.
Owners who have poured everything into their business and planned to monetize it through a sale often discover that the exit they expected either doesn’t materialize or doesn’t produce the proceeds they’d counted on. And in many cases, the reasons are largely out of their hands.
In other words: The eventual sale of your small business can absolutely be part of your long-term wealth designs. But it shouldn’t be the whole picture.
Start With How You Pay Yourself
Owner compensation is where personal wealth accumulation either gets traction or stalls out. So it’s worth being deliberate about the structure.
Many owners underpay themselves, especially in the early years, and never fully adjust as the business matures. Others take money out in ways that aren’t optimized from a tax standpoint. They’re heavy on distributions but light on W-2 wages, or vice versa, or they’re otherwise imbalanced for their entity structure.
Getting compensation right involves more than just picking a number. It means thinking about issues such as what salary is reasonable for your role (important both for IRS compliance and for building a personal income base to fund savings) If you’re an S corp owner, for example, you’re required to pay yourself reasonable compensation, but many owners set that number lower than it should be, which can limit retirement plan contribution room and undercut long-term savings. Or you may need to consider how owner’s draws or distributions fit into the picture.
Use Retirement Plans to Build Wealth Faster
Retirement plans aren’t just a perk you offer employees. For business owners, they’re one of the most powerful personal wealth-building tools available.
Depending on your size, business structure and other factors, you’ll be able to access retirement plans such as 401(k)s, self-employed 401(k)s, SIMPLE IRAs and SEP IRAs, among others. These typically allow for annual contributions in the tens of thousands of dollars, and they enjoy tax-advantaged treatment that helps your savings grow even faster over time.
Owners who skip or underutilize these vehicles are leaving a significant advantage on the table. The math is really compelling when you compare the compounding growth of tax-deferred retirement assets over 15 or 20 years against the alternative: letting that money sit in the business and hoping the exit event makes up the difference.
A few questions worth asking yourself:
- Do you have a retirement plan in place?
- If so, are you contributing the maximum amount allowable?
- Is your current plan the right fit for your income level and goals?
- If not, what’s the most ideal structure?
- Are there employees who need to be covered?
- What are the cost implications of your chosen retirement plan type?
If you’re able, you should also contribute to accounts outside of workplace plans. Ideally, you’d start with an individual retirement accounts (IRA), which also enjoys tax advantages. If you manage to max out your IRA contributions, you could even consider putting money away in a taxable brokerage account.
Treat Personal Finance Like a Business Function
Business owners tend to be diligent about their companies. They track revenue, watch margins and plan ahead.
Personal finances, by contrast, often get managed reactively — when there’s time, when the business is doing well, when things slow down.
The better approach is to treat personal wealth accumulation as its own specific function, with structure and accountability, just like any other part of your operation. That might very well mean working with an advisor who understands the intersection of entrepreneurship, tax planning and managing your own money, because those pieces don’t work in isolation.
Tending to Your Retirement Can Make You a Better Business Owner
Owners who accumulate outside assets have options that others don’t: the ability to weather a bad year without draining the company, the ability to step back from operations without panic and the ability to negotiate a business sale from a position of patience rather than necessity.
If you want top dollar for your business someday, being financially comfortable without the sale is one of the best negotiating positions you can have.
Need Help Building Personal Wealth?
Building personal wealth as a business owner requires a plan that accounts for how you pay yourself, how your business is structured and what role that business equity ultimately plays in your financial future. That planning is most effective when your accounting and tax professionals are involved from the start.
McManamon & Co. is an accounting, tax, fraud, forensic and consulting firm that serves small and midsize businesses. Our experienced consulting team can help you address many of the issues we’ve discussed, including selecting a fitting retirement plan. And when it comes time to make your exit, we can help you sell your business, too.
Call us at 440.892.8900 or contact us online to learn how we can help you build a stronger financial foundation.
Tags: McManamon, McManamon & Co., retirement planning, small business, small business finances | Posted in McManamon & Co., Retirement Planning, small business