Who hasn’t dreamed about starting their own business?
According to the latest figures from the Central Statistics Office (CSO) many of us in Ireland have, with close to 250,000 Small & Medium Enterprises currently active in Ireland employing close to 1,000,000 people.
Most compelling to the thousands of us individuals starting a small business every year is the allure of being master of one’s own professional success. While being the boss can be exhilarating, there are also significant risks to going out on your own. Unfortunately, the failure rate of small businesses is high, with between 50-80% of SME’s failing in the first 5 years.
The old saying, “No one plans to fail, but many fail to plan,” has a special resonance to a new business owner. Starting up can seem to be deceptively simple: Facebook was launched with just an innovative idea, a laptop, and a dorm room. But from the very outset, business owners need to be aware that even the most basic business model entails considerable financial planning complexity.
Comprehensive financial planning for an individual or couple generally involves elements of tax planning, risk management, investment planning, retirement planning and gift and estate planning. For each of these areas, let’s consider how business ownership takes this planning to another level.
The legal structure chosen for the business – a limited company, partnership or sole-trader will determine how the business profits are taxed. As a sole-trader your business income is treated the same as your personal income, making tax compliance considerably simpler (but not always advantageous). Add partners or additional limited company directors it is possible to split the taxable income (and losses) of the business in ways that can benefit multiple owners. To the extent that individuals and limited company structures have different marginal rates at different brackets of income, it is possible to coordinate the taxation of business and personal income in a way that provides the greatest benefit to both the business and its owner.
Most individuals need to plan for the financial risk of early death, disability, illness and infirmity, and liability or loss related to property ownership. Once you a business, however, the risks multiply to include: interruption of the business due to a disaster; death or disability of a person key to the success of the business; loss of business property; and lawsuits resulting from negligence or defective products. These latter risks can be addressed in part by the legal structure of the business, but the others require specialised insurance coverage over and beyond what the owner holds for themselves and their family. If the business has employees, worker’s compensation may also become necessary as well.
It’s not uncommon for business owners to assume they will never retire. After all, you are presumably doing what you love, so why not continue indefinitely? Alternatively, you may see the business as the only retirement plan necessary – as a source of capital that will fund your retirement needs. Thinking along these lines is generally a mistake: If anything, a business owner may need more retirement planning rather than less, to prepare you for the time when you no longer can or wish to work, and/or the business cannot fully provide for you financial needs. The good news is that business ownership affords you all sorts of tax-advantaged ways to save for retirement, and the ability to put aside amounts considerably larger than what is permissible to non-business owners allowing you to fund your personal financial independence aside from your business.
Most small businesses tend to be self-financed by their owners, which results in the business becoming the owner’s major or only investment. In many cases even when you have extra capital to make other investments, you may still prefer to put your money back into your business, where you may feel you have most control over your returns. Prudent planning nevertheless must be focused on diversification. Asset classes and investments must be carefully selected for your personal portfolio to offset the concentrated risk you are taking with the business.
If your small business grows and becomes a valuable asset, simple wills or family trusts set up for personal affairs may no longer suffice for the transfer of the business. More sophisticated financial planning techniques will be necessary to ensure business continuity after death, reduce any estate taxes assessed for the business, and to provide liquidity to heirs to pay those taxes. A reorganisation of the business might be advisable to create different types of ownership for family members, and to make full use of Revenue reliefs in valuing the business for purposes of gift and estate taxes. Insurance trusts and charitable trusts can also play an important role in the efficient transfer of a small business.
One point should be clear when it comes to financial planning for the small business owner: the do-it-yourself, can do attitude that helped you start your business will not serve you well when it comes to managing the many financial issues created by that business. This is where professional expertise often becomes necessary.
What are you waiting for? Exercise your privileges as Owner/Managing Director/CEO, and delegate these issues to a qualified financial planning professional such as myself. My advice can make all the difference in improving your chances of business success and creating your financial independence.