Advising entrepreneurs is one of the most enjoyable parts of my role. Meeting entrepreneurs is exciting, they’re full of energy and it’s impossible not to pick up the positive vibes they emanate. I’m full of admiration for their ability to work long hours, spin many plates, and climb a steep learning curve as they face new challenges daily. For the most part, they rely on their wits and on ‘executing’ – focusing on attracting clients and getting the work done.
Yet no matter how successful your new venture as an entrepreneur may be, starting a business is only the first step on the path to prosperity. In my experience, as your business becomes established and revenues increase, your thoughts shift from ‘wealth generation’ to ‘wealth preservation’. It may seem like there are many options, but as with most things in life, each choice comes with its own specific implications.
How to pay yourself
One of the first challenges you face as an entrepreneur is how to find the right balance between reinvesting in your business and financing your private life.
Take compensation, for example. As an entrepreneur, you should be rewarded for all the hard work you’ve put into your business. However, it’s not always clear what’s the best way to do so. Should you pay yourself through dividends or increase your salary? Can you return some of the capital invested? Could you grant yourself a loan? Each option has differing tax consequences and your choice can affect your company and your private wealth.
Then there’s your pension and all your social security benefits. Many entrepreneurs tend to disregard these aspects or pay the minimum possible. However, these payments are often tax-deductible and contribute to your future, depending on the jurisdiction. When you’re focused on the day-to-day management of your business, it’s easy to let retirement planning fall by the wayside. You need to carefully determine how much you need to save and invest to live the life you want after you move on from your business.
Don’t put all your eggs in one basket
Nobel Prize winning economist Harry Markowitz is credited with the saying: “Diversification is the only free lunch”. With that in mind, one of the main recommendations I give my entrepreneur clients is to diversify their wealth.
It’s normal to put a big proportion of your assets in your company in the early stages, but as soon as you start getting some compensation, it’s important to allocate those assets somewhere else; after all, if things go south, you’ll need something to rely on. Diversification can even save your business: during the pandemic I witnessed entrepreneurs who used their private assets to provide liquidity to their companies.
It’s important to be aware that your business must be seen as part of your wealth, and normally you have a bulk risk with it. The rest of your wealth should be diversified, if possible, in assets that are not correlated with your business – either by industry or geographic location.
Wish for the best, plan for the worst
Entrepreneurs are renowned for their perseverance and determination. Yet, this very focus on success can cause you to turn a blind eye to the potential pitfalls that everybody is exposed to, such as disability, death, or divorce. These events are part of life, and everyone, including entrepreneurs, should be aware that they could happen and consider the effects for wealth preservation.
This might involve having a difficult conversation about ownership structures, contingency plans and the distribution of assets. None of us has a crystal ball so it would be negligent not to take a long view when it comes to discussing the complexities of life and families.
Benjamin Franklin once said: “in this world, nothing is certain except death and taxes”. Life insurance is a must for any entrepreneur. Besides the sorrow that comes with the loss of a loved one, the spouse and children may face challenges in running a business if they are not prepared to. In such cases, life insurance is a lifeline. Insurance may also compensate in case of outstanding debts or inheritance taxes: it can provide liquidity in those difficult moments.
Below, I set out the three main pieces of advice I share with my clients as their business grows and they look to bolster their own finances:
1. Separate business assets and personal wealth
Entrepreneurs often encounter situations that may require them to use their personal finances to fund their business aspirations. My strong advice has always been to diversify and have a clear separation between business assets and personal wealth. This helps to protect your wealth from the contagion of risks, such as claims by creditors, that an operative business may entail. If possible, and your jurisdiction allows it, put your private assets in a wealth planning structure that ringfences your wealth and incorporates succession.
2. Make the most of your tax saving potential
Some entrepreneurs underestimate the savings potential they can generate from tax optimisation. The taxman gives us plenty of options under the law, so let’s use them. This applies to both business assets and private wealth. Managing our tax situation is a cornerstone of wealth preservation. And don’t forget to analyse and understand the intricacies of inheritance tax, particularly when multiple jurisdictions are involved.
3. Pass on wealth, not problems
A strong family governance framework can preserve the family’s wealth and consolidate the company’s future. Of course, business owners need to consider the emotional aspect of their decisions and the impact they might have on the family dynamic. However, strong governance is the only way to keep the family together, despite the tough decisions involved. Engage in open dialogue and be open to different views and values – after all, wealth preservation is about ensuring a legacy.