June 01, 2017

If you were asked to list the fundamentals of personal finance, you might include the following:

  • live within your means,
  • control debt,
  • manage risks, and
  • save for the future.

These are fairly universal actions; they apply to everyone’s personal finances. But execution of these basics can vary significantly – in priority, timing and proportion – depending on the source of your income, and your status as an employee or owner.

Much of the generic advice in personal finance is intended for employees, i.e., people with regular paychecks, simply because they represent the majority of economic households. In the employee paradigm, wealth management consists of allocating income on a monthly basis (often using automatic withdrawals) to build savings, pay for insurance, or fund retirement. For employees, the only intersection between their work and personal finances is the income they earn; when they get a paycheck, that money immediately becomes part of their personal finances.

In contrast, the distinction between work and personal finance for self-employed entrepreneurs and small business owners is fluid; what’s “business” and what’s “personal” often changes. And while the lifetime earnings from a successful business may exceed a typical employee’s wages, this income will fluctuate, and perhaps include times where there isn’t enough to meet current expenses. These factors mean entrepreneurs and small business owners can’t “do” personal finance like employees.

A Different Mindset

Every time an entrepreneur or small business owner realizes a profit, they have a decision: to move the money to their personal finances, or re-invest it in their business, with the hope of increasing profits and equity.

This ever-present question of whether to re-invest profits impacts long-term planning as well. Where employees are focused on saving enough to fund a future retirement, an entrepreneur or business owner knows a prosperous company is also a potential retirement asset. An owner can sell the business, and use the proceeds for retirement. Or he/she can hire management, and “retire in the business,” continuing to collect the profits, while keeping many of the tax advantages that come with ownership.

This business-centric perspective doesn’t always mesh with personal financial programs that attempt to project a steady progression of accumulation leading to retirement. As Garrett Gunderson, founder of a consulting firm that works exclusively with businesses, puts it:

Financial planners look at where your finances will be when you hit age 65, whether that’s in 10, 20, 30 years or more. Entrepreneurs, by contrast, focus on cash flow over the next few weeks, months and a handful of years at most.

Gunderson offers another interesting, perhaps counter-intuitive observation about entrepreneurs and small business owners: they may be more risk-aversein their personal finances than employees:

Entrepreneurs wonder why anyone would take the risk of putting money into the stock of companies you don’t know, understand or control. It is difficult enough to keep up with everything going on in the boardroom of one company, let alone a diversified portfolio with hundreds of companies.   

Different Priorities, Different Strategies

A sampling of commentary from consultants who work extensively with entrepreneurs and small business owners suggests three areas where personal finance has to be done differently.

Get Risk Management Right – For Business and Personal. Because business and personal finances are often inseparable for an entrepreneur or small business owner, risk management needs to address both sides.

For the business, this could mean legal structures, like a corporation or LLC, to segregate the business from one’s personal affairs. It certainly means insurance, particularly liability protection, as an unfavorable legal judgment can end a business. (A 2015 report by specialty insurer Hiscox found that one in five small to mid-sized businesses will face legal actions from employees, with an average defense cost of $125,000 for attorney’s fees or settlement costs.)

Risk management on the personal side is just as important. Nelly Alkalp, in a November 2015 Forbes article, understands the reluctance to take money out of the business for personal insurance “but it’s a huge mistake to neglect your personal needs,” especially since the owner is the company’s most important asset.

This means health insurance, disability coverage…and life insurance. “The younger you buy life insurance, the better,” says Alkalp, citing lower premiums and the possibility that future health conditions might make you uninsurable. And since life insurance may often be required as collateral for business loans, having it before you need it is simply good planning.

Make Cash Reserves a Priority. Adequate cash reserves are critical for both the business and personal finances of entrepreneurs. In terms of “financial planning,” the first use of profits that are not reinvested is to build cash reserves. Per Matt Lloyd, of (MyOwnBusinessEducation): As a business owner, liquidity is your strongest ally.

As a business owner, liquidity is your strongest ally. Take that excess cash and start building a war chest for when your business needs it most, or when that perfect opportunity arises, such as acquiring a competitor that complements your operation.

A “war chest” means a $1,000 emergency fund isn’t going to cut it. The 3-6 months of living expenses often recommended for employees? Probably not. Jason Papier, president of a Silicon Valley financial management firm, told Entrepreneur in an April 2013 article that he recommends entrepreneurs “have one year’s worth of personal expenses set aside in a liquid account for an emergency.” That’s a sizable amount. But as Gunderson notes, “If your business hits hard times, you won’t have to finance payroll on your American Express card at 18 percent interest.”

There are some areas where personal finance is measured differently for Business Owners and Entrepreneurs, compared to Employees.

Delay Retirement Plan Contributions. Some of the strongest and most consistent advice to entrepreneurs and small business owners relates to contributing to retirement plans. Or rather, not contributing to them until later in the life of the business. In the same April 2013 Entrepreneur article, Peter Dunn, another small business consultant, estimated that 95 percent of his clients “paused retirement saving,” while reinvesting in their business. Some additional commentary that reflects this point of view:

  • Lloyd: Every dollar you sock away is a dollar that could have funded your business’ growth…Every time your 401(k) balance drops, it’ll feel like a slap in the face. This feeling will only be compounded by the realization that your account’s overall health is largely out of your control, at least compared to the ongoing investments you make in your business, which fall completely under your control.
  • Capterra Finance Blog: Investing business cash into stocks, bonds or mutual funds uses up your cash flow. Instead, save your profits to build up a reserve for rainy days, and, if you do decide to invest your business profits, invest in yourself and your company.
  • Gunderson: Businesses are where true wealth is built, not in 401(k)s or IRAs. For most entrepreneurs, it’s best to reinvest and keep money inside of your business.

(To be fair, a few articles suggested diversification into retirement plans. But guess what? They are written by investment professionals recommending the products and services they provide. So the adage “When all you have is a hammer, everything looks like a nail,” might apply.)

When it comes to their personal finances, entrepreneurs and small business owners shouldn’t try to act like employees. The basics are the same, but the circum- stances of ownership often necessitate different strategies and priorities.  

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