Financial planning must integrate all parts of a person’s life and it must take all aspects of financial planning into account. This is especially important for entrepreneurs.
The key focus for entrepreneurs is the growth of their business. Typically they leave the planning of their own affairs either to a staff member or an outsourced consultant: a business accountant may do their taxes and provide tax advice, an insurance consultant may advise on their personal insurance (and investment here and there), and a tax consultant will focus on saving tax. Together, it doesn’t make for a great strategy.
It may sound workable, but no one oversees and integrates the planning. No one keeps track of the execution of the strategy or keeps the entrepreneur accountable.
So whilst they may grow a successful business, often their personal financial planning lags way behind, or even worse, destroys the value they have built in their business due to the lack of planning and concomitant risk.
The difficulty is that entrepreneurs often don’t distinguish between themselves and their businesses. They see wealth in the business as personally theirs, and the business as an extension of self. This mindset has behavioral consequences, such as a reluctance to pay tax, and often leads to the build-up of wealth in the business. The benefits of delineating between business wealth and personal wealth are multiple.
Why should you consider building wealth outside your business?
To ensure that your personal risk is not subject to your business risk.
Wealth inside the business remains exposed to business risk. As an optimistic entrepreneur, you can easily overlook or ignore business risks or simply be blindsided by unexpected risks, such as tax claims or litigation.
Typical business vehicles (i.e. a company or a company held within a trust) may not make direct offshore investments – and these are essential protection for wealthy families.
They provide direct access to funds offshore and cater to potential emigration. Without direct offshore investments, you and your family are exposed to political risk and are unable to safeguard yourself against any financial consequence of that risk. There is the option of indirect offshore investments through local unit trusts, but these are frequently more expensive, less tax efficient, and not accessible offshore. In other words, it’s not good financial planning.
The reality is that South Africa does have real risks. To plough all your profits back into your business or, worse still, to have no offshore investments when you know that South Africa carries political risk, is unwise.
So that you can build a retirement portfolio, which offers protection from creditors and has significant tax and estate planning benefits.
You can only benefit from tax deductions for retirement vehicles if you are paid a decent salary by your business, like a regular employee.
So that you can control and account for your expenses.
Putting expenses through the business is alluring from a tax perspective - we all advocate paying lower taxes and getting DSTV, petrol & internet paid for by your business. And if your accountant is happy and SARS never comes knocking it can be beneficial. But, it also means that you often don’t have a handle on expenses and that you are unmindful of the drag.
For example, planning for retirement can be affected if you plan for R60 000 but at retirement, you are still responsible for an additional R20 000 in expenses – remembering that the business is no longer there. This means that the R20 000 would need to be funded with after-tax money which could cost you R30 000. This kind of under-providing for retirement happens when people underestimate their lifestyle costs – which is the result of poor expense control. Unfortunately, savings and investments also often then fall short.
Because if there are multiple shareholders, the wealth may not be under your control.
For this reason, it is essential that financial planning for entrepreneurs should also include risk management and succession planning. Wealth built up inside a business - in the form of equity value, investments in the business, or amounts owed to the entrepreneur - carries high risk if you have no other personal wealth.
For example, in the event of death, disability, or a fallout with a business partner, that wealth may be inaccessible to you. If there are no formal agreements in place between shareholders in the form of shareholders agreements, employment contracts, and Memorandums of Understanding, it can all come to nothing in these events. You run the risk of being robbed of the value of your business when things go sour between you and your partners.
Not all these reasons may be applicable to every entrepreneur. A thorough financial planning exercise will highlight what is important.
Furthermore, successful entrepreneurs will point out that they can generate better returns in their business, than outside their business. This is possible – an entrepreneurial endeavour should also have higher potential returns than savings or retirement vehicles can offer. However, it also comes with higher risk. Past performance is not an indication of future returns, even in established businesses.
Let’s look at two examples of financial decisions entrepreneurs might have to make.
Scenario: Should you as a business owner pay yourself a bonus instead of paying tax on the profit within the business?
You already pay yourself a salary of R100 000 per month. Then in February, you realize your profit for the year will be R1 million. You have two options to consider:
In first, you could leave the entire amount in the business and pay R270 000 tax.
In second, you could utilize the tax break of saving into a retirement annuity (RA). Here, you would pay yourself a R350 000 bonus which you in turn contribute to a RA. The entire amount is tax deductible in your own name. The benefit is that your net profit reduces to R650 000 and you only pay R175 500 in taxes. You would have reduced your effective tax rate from 27% to 18%.
We must recognise that most people we come into contact with, are on the treadmill and they’re tired. We must accept that we will have to adjust our expectations of each other. And of ourselves.
These examples show how integrated financial planning can help entrepreneurs to think about not only immediate tax savings but also long-term risk management and tax planning.
Holistic financial planning, specific to an entrepreneur’s circumstances, provides better results for a client. Even simple organisation, like having the correct documentation in place, can mean the difference between deriving value from your entrepreneurial effort or not.
We believe that wealth is for your life – and this is especially true for entrepreneurs. However, your business is not you and it is not your life. It is a means by which you create wealth. We help our entrepreneurial clients plan so that they can focus on growing their businesses, growing their wealth, and then enabling their life.
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