As
entrepreneurs themselves, financial planners
understand well the tendency for small-business
owners to invest heavily in their own business.
But investing solely in your business presents
significant risks, caution planners interviewed
in the July 2003 issue of the Journal of
Financial Planning, published monthly by the
Financial Planning Association.
“The
business is essentially your money printing
press,” says Elisabeth C. Plax, CFP of Plax &
Associates Financial Services in Pepper Pike,
Ohio. “The better your business, the more income
you make. But having your business represent a
huge proportion of your total assets is a bad
risk. Not only do you have everything you own in
one asset class, it’s invested in one company
within that asset class.”
Putting
all your investment eggs into your business
carries several risks. One is liability. “If one
of your products malfunctions and hurts someone
and you have everything invested in your
company, a single liability issue can wipe you
out,” says Richard Stumpf, CFP, of Financial
Benefits Inc.
Stumpf
recommends to his small-business clients that
they incorporate and put different assets in
different pots. For example, it’s common for a
business to buy the office building it works in.
That building should be set up in a separate
corporation to shield it from any liabilities
arising from the underlying business.
Liquidity is another concern. If owners have
everything tied up in their business and little
or nothing in savings and investment accounts,
where do they go for money? Some planners
advocate borrowing to fund the business while
funneling some of the company’s cash flow into
outside investments. Other planners are
comfortable with owners putting all their money
back into the business during its early stages
and diversifying once the business begins to
mature.
Another
investment risk is the tendency of owners to
invest in their own industry. An owner whose
company produces software may want to invest in
other software companies because that’s the
business he or she best understands. But that’s
not really diversifying, saying planners. You
need assets that move differently than your
company does. Plax draws the analogy that if
your company sells umbrellas, you want to invest
in companies that sell sunscreen.
How
much investment risk to take is another key
concern. “Business owners can afford to take
more risks with other investments if their
business can easily get bank loans,” contends
Deborah Lucas, a professor of finance at Kellogg
School of Management at Northwestern University
in Evanston, Illinois. Ironically,
small-business owners often think nothing of
risking everything in their own business, yet
are reluctant to take risk in outside
investments, say planners.
Even
though small-business owners often assume that
the eventual sale of their business will be what
funds their retirement, the risk is that the
business or industry might be under performing
when it comes time to sell. That’s one reason
planners recommend setting up company-sponsored
retirement accounts as a place to invest, though
surveys frequently show that small-business
owners are not familiar with the benefits and
operation of company-based retirement plans.
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