Building wealth outside your business: the principles

For many business owners, the business is the plan. Every spare dollar goes back in, and retirement depends on selling it one day for a good price. Sometimes that works. Often the sale takes longer, raises less than hoped, or never happens because of ill health, a change in the market or the loss of a key customer. Building wealth outside the business is not a lack of confidence in it. It is a recognition that putting everything in one place is a risk.

This article sets out general principles. It does not recommend any investment or financial product. Decisions about what to invest in should be made with a licensed financial adviser who understands your circumstances.

The concentration problem

A business owner's financial life is often concentrated in a single asset in at least three ways:

• Income. Their salary or drawings come from the business.
• Wealth. Most of their net worth is the value of the business.
• Risk. Their home may be security for business borrowings, and they may have given personal guarantees.

If the business has a bad year, all three suffer at once. An employee who loses their job still has their savings; an owner whose business fails may lose their income, savings and home together. Spreading wealth across different places reduces the chance that one event affects everything.

Principle 1: Pay yourself deliberately

Wealth outside the business starts with money leaving the business in a planned way. That means a regular, sensible amount to live on, plus a deliberate decision about how much profit to take out beyond that, rather than whatever happens to be left over. How this is done depends on your structure; see paying yourself as a business owner.

A business that can only survive if the owner takes nothing out is telling you something worth knowing.

Principle 2: Build a personal buffer first

Before thinking about investing, most owners benefit from a personal cash buffer that is separate from the business. It covers living costs if the business has a slow period, and it means you are not forced to pull money out of the business, or borrow, at the worst time.

How large that buffer should be depends on your income, commitments and how variable the business is. As an illustration only, an owner with $8,000 of monthly household costs who decides on six months' cover would aim for about $48,000 set aside. The right number for you is a personal decision.

Principle 3: Separate business risk from personal assets

Wealth you build outside the business should, as far as reasonably possible, sit outside the reach of business creditors. General principles include:

• operating the business through an appropriate structure rather than personally, where that suits;
• being cautious about personal guarantees and understanding exactly what they cover;
• not holding valuable assets in the same entity that carries trading risk;
• keeping clear records, because asset protection relies on transactions being genuine and properly documented.

Asset protection has legal limits. Transfers made to defeat creditors can be reversed, and arrangements put in place after problems arise are rarely effective. This is an area for planning in good times, with legal advice. Our business structuring work considers these issues.

Principle 4: Use super deliberately

Superannuation is one of the main ways Australians build wealth outside their business. Contributions are generally taxed more lightly, and super is usually protected from business creditors. The trade-off is that it is locked away until you meet a condition of release.

Many owners contribute little to super because the business always seems to need the money more. Making a deliberate yearly decision, within the contribution caps, is better than leaving it to chance. See superannuation basics for business owners. How your super is invested, and which fund you use, are matters for a licensed financial adviser.

Principle 5: Manage personal debt

Debt affects wealth in two directions. Borrowing can help build assets, but it adds risk, particularly when your income already depends on a single business. General principles:

• Understand which debts are tax-deductible and which are not. Interest on a home loan used for private purposes is generally not deductible, while interest on money borrowed to produce assessable income generally is.
• Consider how secure your income is before taking on large personal commitments.
• Be wary of using the family home as security for both business and personal borrowing at the same time.

Principle 6: Diversify over time

Diversification means not relying on one asset, one sector or one source of return. For a business owner, the starting point is not to have everything tied to the same industry as the business. If your business is in construction, for example, wealth that also depends heavily on construction adds to the risk rather than spreading it.

What to invest in, how much and in what proportions are personal financial product decisions. They depend on your goals, timeframe, attitude to risk and tax position, and they should come from a licensed financial adviser.

Principle 7: Think about ownership and tax

Who or what owns an asset, whether an individual, a couple, a trust, a company or a super fund, affects how its income and gains are taxed, how protected it is and how it passes on when you die. These decisions are much harder to change later, because moving an asset can trigger capital gains tax and stamp duty. Getting the ownership right at the start is one of the simplest and most valuable steps.

Principle 8: Plan the exit

If you do intend to sell the business one day, treat it as part of the wealth plan rather than the whole plan. A business that is well run, not dependent on the owner, and has clean financial records is generally easier to sell and worth more. Planning a sale years ahead also gives time to consider the small business CGT concessions and the order of events. See our business sales and purchases work.

The business can be your biggest asset without being your only one. The aim is that a bad year in the business is a bad year, not a financial crisis for your family.

Putting it together

A simple yearly routine helps: review what the business can afford to pay you, top up your buffer, decide on super contributions, check your debt, and meet your licensed adviser about investments. Small, regular decisions over many years tend to matter more than one large decision made under pressure.

How we can help

We help business owners work out what the business can sustainably pay them, plan structures and tax, and coordinate with licensed financial advisers on personal investment decisions. To talk about the business side of your plan, contact us or read about our investment and financial advisory work.

This article is general information only and does not take into account your circumstances. It is not financial product advice. Speak to a qualified, licensed adviser before acting on it.