Financial Planning Advice For Business Owners
A business owner is any person or persons who set up an enterprise to trade goods or services for profit. Legal business structures include Sole Trader, Partnership, Limited Company and Public Limited Company. The size of a business can be Micro (one to ten people) Small (ten to fifty people) Medium (fifty to two hundred and fifty people) and Large (two hundred and fifty people and above). There are four stages to the business life cycle, launch, growth, maturity and decline. Owning and running a successful business is a tremendous feat given the casualty rate of many businesses over time. Serial entrepreneurs know that you either win or you learn, failure and setbacks are part of the process of becoming successful.
Ireland is a small open economy that attracts multi-national companies for a variety of reasons. We benefit greatly from the jobs these global businesses create, both directly and indirectly. There are also 250,000 small and medium size businesses in Ireland accounting for 99% of all businesses in Ireland. These businesses collectively employ one million people. Irish businesses and their owners are the backbone of the economy. In many instances business owners are the business, driving the strategic direction and day to day decision making within the business. Being a business owner means that personal financial success is dependent on business success. There are significant financial and personal sacrifices in being a business owner. The time and money required to launch, survive, grow and hopefully thrive is substantial. It can be, all-consuming. So why be a business owner? For many it is the cut and thrust of competition, creativity, autonomy, professional growth and of course the financial rewards. Having direct control over our own financial future and belief in our abilities to achieve success is a major motivating factor. A successful business is one of the best wealth building vehicles available to us. It can create, and store wealth based on its productivity. The goal is to transfer this wealth from the business to the owner tax efficiently. This is achieved through many of the same mechanisms available to employees. Businesses have allowable expenses and some tax incentives when selling a business. An allowable business expense must be wholly, exclusively, and necessarily incurred in the running of the business. For business ownership to be worth it, the rewards need to outweigh the risks. This begs the question, what should the rewards be, given the risks? In theory, the rewards should be better than being an employee in the same line of work. Therefore, we can use being an employee as a benchmark for business ownership.
The benefits of being an employee can vary drastically depending on the industry, job responsibility and level of skills required. Basic pay is a good place to start. A successful business owner should be aiming to earn the same if not more than the employee equivalent basic salary. Ideally, a business owner will have calculated their required level of income to live the lifestyle they want during and after their working lives. This level of income provides an anchor or baseline level financial goal that the business needs to achieve in order for the owners to be successful. An employee is contracted to complete certain tasks and works a set number of hours. A business owner’s tasks are varied and can be endless, requiring many more hours work. It needs to be worth our time being a business owner. The income per hour formula discussed in episode 2 will help us determine if we are better off financially. The more hours we work the more we dilute our income per hour.
Of course, employee benefits don’t stop at base salary. Many employers currently pay for or subsidize, private health insurance, income protection, life insurance, pension contributions, additional annual leave, flexi time, bike to work, tax saver commuting, bonus incentives, overtime, food, gym, social events, professional and education fees and so on. These perks are in addition to our base salary. Employer supplied work benefits are used to attract the best people. A company’s human capital, it’s people, are one of its most valuable assets. The right team and company culture can do wonders for a business and ultimately lead to less employee turnover, a costly business expense. When evaluating our employment package, we need to attach a monetary value to these benefits and not just solely focus on our base salary, overtime and bonuses.
We need to ask ourselves what is the replacement cost of these additional benefits? As a business owner, we need to remember how important these benefits are and how much we will need to replace and improve upon them. Even if these benefits are not part of being an employee in our industry it’s important, we factor them in to our financial goals being a business owner. Here is an example of some of the costs attached to employment benefits with a base salary of €80,000 per year:
· Private health insurance. Cost €2,000 per year. Benefit you and your family are looked after quickly in the event of an accident or ill-health.
· Income protection. Cost €1,200 per year. Benefit, we continue to receive up to 75% of our income if we are unable to attend work due to injury or illness.
· Death in service. Cost €600 per year. Benefit, a tax-free lump sum of four times our base salary which in this case is €320,000 in the event of our death.
· 10% employer pension contribution. Cost €8,000 per year. Benefit, free money. Employer receives tax relief on the pension contribution, and it does not affect the employee pension contribution relief.
· Five days additional annual leave. Cost €1,538. Benefit, more time spent on vacation with family and friends.
These costs are born by the employer. These are just some of the core perks an employee may be entitled to as part of their employment. The combined replacement cost of these employment benefits is €13,338. That’s on top of the base salary of €80,000 for a total employment package of €93,338. These baseline level employment benefits are generic. Their uniformity means they are not wholly comprehensive to our unique circumstances. Some employers pay a higher base salary but do not provide additional employment benefits. Whether we get none, some or many of these benefits, they should be a top priority as an employee and a business owner. This is because it won’t be done on our behalf. There is a greater concentration of personal and financial risk being a business owner given personal success is dependent on business success.
The previous eleven episodes are a chronological road map to personal financial success, if implemented. There are many parallels between good personal finance and good business management. As business owners, how we allocate our time across the functional areas of a business is critical to its success. Auditing how we spend our time and prioritizing what matters most to the business can reveal a lot. Using technology to automate tasks, delegating to employees or outsourcing to third-party providers where possible can free up valuable time. The value of a good team and support network in the form of family, friends, staff, suppliers and other stakeholders cannot be understated.
Personal, professional and financial goals keep us honest and focused. Remembering why we are doing what we are doing may seem obvious but can get lost on us over time. Doing more of what makes us happy and less of what doesn’t is the aim. Sometimes what we truly value and how we spend our day to day lives are out of sync. As the author Peter Drucker says “Tell me what you value and I might believe you but show me your calendar and bank statement and I’ll show you what you really value.” Identifying our personal and financial goals can help determine what the business needs to achieve to meet these goals. You know your business best. It might sound obvious, but a business should have the following objectives:
· Obsess over the client experience and journey.
· Know how much the business costs to run.
· Spend less than the business makes by keeping costs lean.
· Save one months’ worth of business costs as a buffer.
· Pay off all debt.
· Save six months plus of business costs in an emergency fund.
· Manage and plan cashflow.
· Identify and explore areas for growth.
· Explore scalability options.
· Diversify income streams.
· Be sale ready.
Profitability for a business is the same as savings rate for a person, both are fundamental to building wealth. The better business profits are the more options a business will have. We can reinvest in the business, take it as salary, pay a dividend or contribute towards our pension.
Being financially organized is an important part of being successful in business. Personal and business finances need to be kept separate. Being financially organized allows us to have a clear view of our cashflow. When it comes to business cashflow is king. Spending more than we earn can lead to debt and building debt is risky and unsustainable. Personal financial organization is discussed in episode 4. The value of good accountancy software, a good bookkeeper, accountant, and financial planner are not to be underestimated. Many business owners recognize the value and benefits in the skills of others, much in the same way clients recognize the benefits and skills of their business. Part of being a leader is utilizing the strengths of others.
Personal protection and business protection have many parallels. Business owners can protect themselves and the business through the business. Human and business insurance is all about protecting people, the business, and debt. Small and medium size business owners are often the driving force of their businesses. From a risk perspective this can be a blessing and a curse. Business owners reap the rewards of their effort, skills and knowledge in growing and driving the business forward but at the same time, the business can be highly over reliant and dependent on the business owner to succeed. All our eggs are in one basket so to speak. Exposure to risks outside our control can threaten the long-term viability of the business. Such risks are accident, serious illness or death. In larger companies these risks are less concentrated and spread out among management and employees. If a small or medium size business owner or key employee to the business were to become seriously sick or die, it can jeopardize the survival of the business. As they say, hope for the best plan for the worst. If an employee is invaluable to the future success of the business due to their unique skills, business contacts, management expertise or business knowledge, the business can insure them through key person insurance. This covers the company if the key person becomes seriously ill or dies. Policy proceeds can be used to repay debt, replace loss of earnings and recruit a replacement. A sole trader can take out personal cover as discussed in episode 6. Partnership insurance is to protect all business partners and their families in the event of death. The policy proceeds are used to buy back the deceased partners share of the business. This ensures the partners retain control and ownership of the business while the deceased partners family are compensated for their share in the business. Shareholder protection is the same only it is for a limited company. Shareholder protection can be implemented personally or through the business. The remaining shareholders retain control of the business and the family of the deceased shareholder receive payment for their share of the business.
For business owners of limited liability companies, profits are taxed at 12.5%, income tax is either 20% or 40% along with PRSI and USC and company dividends are subject to corporation tax, dividend withholding tax & in all likelihood income tax, PRSI and USC too. Pensions are a great vehicle to extract business profits into personal wealth tax efficiently. What can be transferred is determined by our salary and service. That is paying ourselves a regular consistent salary above the 40% income tax threshold over a number of years. The reason I say above 40% income tax threshold is so we can avail of the 40% income tax relief for pensions. Both the business and the business owner can contribute to the pension. The business pension contributions reduce the corporation tax liability, and the business owner pension contributions reduce the personal income tax liability of the owner. If the business has sizable profits, there is also a pension catch up facility for those previously missed years depending on salary and service. It is not unusual for company directors to be spouses and both working in the business in some capacity. This provides further options for the extraction of business profits tax efficiently. It is important we maximize all tax incentives available to the business and business owners. The way a company is structure will mean there are different pension vehicles for different company formations.
Some business owners view their business as their retirement. This means we are financially dependent on the sale of the business which can be a high risky strategy. The aim of financial planning is to make business owners financially independent of their business. So regardless of what happens with the business in the future we are financially independent of its sale. The sale of the business is icing on the cake rather than an absolute necessity. Being sale ready does not mean we are selling the business. It means that if we receive an offer we can’t refuse or are forced to sell the business that it is in the best possible shape financially to facilitate it’s sale. There are a variety of options when selling a business. It can be sold to family, to company management, merging with a competitor or a related business or a new entrant seeking to hoover up market share.
As briefly mentioned in episode 11, retirement relief is capital gains relief on the sale of a business. If aged between 55 & 65 and we sell our business to a child there is no CGT payable. If 66 and above there is a €3,000,000 limit for CGT purposes. If selling a business to anyone else between 55 & 65 there is a €750,000 limit for CGT purposes and this drops to €500,000 from 66 onwards. This relief is per person. So if there are two directors and the company is not sold to the children, both directors can receive up to €750,000 each so long as they are between 55 & 65 years of age. This is another great way to extract value build up in a business tax free and for the business to continue into the future.
Entrepreneur relief is where capital gains tax relief drops from 33% to 10% on the sale of a business up to €1,000,000.
A good financial planner can review and provide if necessary, the employment benefits an employee and business need for their financial future. What is financial planner? A financial planner is a forward-looking accountant, a financial risk manager, a listener, educator, coach and financial counselling. What is financial planning? Financial planning is the process of identifying our values, creating and prioritizing financial goals from these values and implementing a financial plan to meet those goals into the future. Financial planning starts with the big picture and becomes progressively more granular the more defined our goals become. Here a few of the value-added services a financial planner provides:
· Financial Organisation – We request you populate a fact find and risk tolerance questionnaire which consolidates all your financial information into our cashflow modelling software.
· Cashflow modelling – Using financial forecasting software and conservative assumptions we project your current financial circumstances to age 100.
· Values based goal setting – Identifying short, medium, and long-term life goals that require financial resources.
· Pragmatic planning - can we afford another child, can one of us afford to work in the home and raise the kids, college tuition for the children, a wedding, home renovation/extension, upsizing, selling the business/farm, trip of a lifetime, work sabbatical, downsizing, buying a new home, when will I be financially independent, what happens if I get sick, injured or die, how much can I gift to my family etc. Providing some financial piece of mind and a focus to prepare financially for your future self and future events while making sure you are covered if disaster strikes.
· Behavioral Coaching – Avoiding expensive money mistakes, stewardship during temporary investment market corrections and keeping you on track to meet your financial goals.
· Human Insurance – Protecting people and debt. Hope for the best plan for the worst.
· Tax planning across pensions and estate planning
In summary, being a successful business owner has many advantages. Business owners should have their own company benefits and maximize these to their personal benefit. Extracting company profits tax efficiently should be a top priority so long as the company is in good financial health. Much of what has been discussed in the previous 11 episodes for good personal finance is also applicable to good business finance. Business owners can claim tax relief on the cost of professional services. If you feel you could benefit from a financial planner please let me know. I offer two levels of service, the first being a pay as you go pre financial plan service that provides guidance on setting financial goals, financial organization and debt elimination. The second being a full financial planning service. A free fifteen minute initial chat precedes both service offerings.
This week’s book recommendations are The E Myth Revisited: Why Most Small Businesses Don’t Work and What to Do About It by Michael Gerber. Getting Naked: A Business Fable About Shedding The Three Fears That Sabotage Client Loyalty by Patrick Lencioni. Blue Ocean Strategy: How to Create Uncontested Market Space and Make Competition Irrelevant by Chan Kim and Renee Mauborgne.
This week’s movie recommendations are War Dogs, a massage therapist and guns dealer are awarded an arms contract by the Pentagon. Starring Jonah Hill and Miles Teller. And Whiplash, an ambitious young drummer wants to be the best in the world. The movie tracks the music students practice sessions with a highly demanding mentor. Starring Miles Teller and JK Simmons.
Link to Spotify podcast episode: https://open.spotify.com/episode/6QHPxgz8LZDzhzGIxzhtSO?si=596d3ac0e1ce48fc
Link to Apple podcast episode: https://open.spotify.com/episode/6QHPxgz8LZDzhzGIxzhtSO?si=596d3ac0e1ce48fc
For personal financial planning advice email team@vantagefp.ie or call (01) 539 2670.