Don't Shortchange Personal Finance
Although successful entrepreneurs excel at running their own businesses, they are often appallingly bad at managing their personal finances, says Ed Bowman, a general partner at Veritable. The firm is an investment consultancy, based in suburban Philadelphia, whose clients include CEOs of private companies.
Bowman sees many entrepreneurs so focused on their business efforts that they ignore the need to plan their retirement financing. He spoke recently with Smart Answers columnist Karen E. Klein about the mistakes small business owners make and how to remedy them. Edited excerpts of their conversation follow.
Startup entrepreneurs are sometimes tempted to cash out pension plans or tap their retirement savings to finance their new companies. How dangerous is the practice?
It's not only dangerous, it really shouldn't be necessary. If you have a clear business plan, in which you understand what your cash flow needs are going to be, you should be able to tap other sources of capital to meet those needs. Private investors, friends and family, and successful entrepreneurs who have liquidity should all be approached, along with commercial lenders.
It all depends on having that sound business plan, assessing the competitive landscape for your company and [assessing] whether you're a commodity business or are uniquely positioned. You certainly want to make sure -- before you risk your nest egg or borrow money -- that you really have a thoughtful product or service, that you can prove people want it, that it can be priced correctly, and that the barrier to entry for other companies is high enough so that your competitors won't take the market away from you immediately (see BW Online, 05/04/06, "Countdown to Product Launch, Part I").
What's the worst mistake small business owners make with their personal finances?
We see many business owners who are generating significant amounts of cash and delegating the management of their personal finances to their company CFOs. That's a decided mistake for a variety of reasons, but it's quite common.
What's wrong with doing that?
When the business owner starts out, he may have a small personal investment portfolio, so he asks the CFO for advice. It seems to make sense: This is a trusted, knowledgeable adviser from a corporate perspective. But the challenge is that as the portfolio continues to grow, that CEO should start availing himself of an increasing array of investment options that a corporate CFO may not be familiar with. Also, the priorities for an individual -- minimizing taxes and measuring the retirement time horizon -- and the priorities for the company, which is taxed at a different rate and may have a different exit strategy, are probably quite different.
At some point, does the CFO have to stand up and say he or she is getting stretched too thin to stay in both roles?
Yes, and that can be tough to do because of loyalty issues, especially if that person has a long history with the CEO. But honesty is the best thing when the CFO recognizes his boss would be better served with a full-time adviser who specializes in individual investment choices. No business owner really wants a CFO who is torn between helping the CEO personally and managing growing responsibilities with the company. It's a bad situation for everybody.
Do a lot of entrepreneurs rely heavily on the idea of selling their companies to provide them with a retirement nest egg?
Sure, and it's understandable. These are entrepreneurs who are very confident in themselves and they figure they don't want to take chances investing in other companies...when they have conviction about themselves, their products, and their business. They're willing to invest aggressively in their companies with the goal of having a liquidity event at some point and then retiring on the money they make.
How wise is that strategy?
Well, again it depends on the company and on the individual. The key, we find, to managing a personal or a small business portfolio is to have a sound plan in place. Individuals too often don't really know what they're aiming for, so they don't know how much money they'll need, and when, and how realistic it is to believe their company is going to provide all that money. Once CEOs sit down and figure out what their time horizons are for retirement and how the company's value fits into a mix of investments, then they can aim for a specific objective.
As a small business owner's portfolio is growing, it's important to put some real thought into what the CEO wants to accomplish with it, and with his company, in the long term. And that kind of thinking needs to be done early on, rather than at the last minute as the retirement years are looming. Not enough people start with a plan. It sounds so simple, but it's the biggest challenge that we see continually.
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