Entrepreneur’s Wealth Digest
What happens when your business is not performing financially as well as you thought it would? What happens when that underperformance means that some of your family priorities are not met? When these things happen, you can either increase the amount of owner benefit being withdrawn, take on debt or sell some or all of the equity in the business. Let’s dive into each path.
Increasing owner benefit
This is easier said than done, right? There are often periods when a business will invest in longer-term growth at the expense of short-term profitability. You can plan for this, and often it works out just the way you hoped. Alternatively, for example, what happens if you need $1 million of owner benefit annually, and you reinvest one year (only receiving $500 thousand owner benefit) with a return to $1 million plus in the second year? What happens if, in that second year, your investment has not produced, and you only have $600K of owner benefit instead of the $1 million that you need?
It all depends on why you need that owner benefit. Your personal living expenses, debt payments and other priorities all get a say in your business strategy. For example, if you are planning on building a home and need the $1 million of owner benefit to fund land purchase and design, waiting another year for your business investment to perform also means waiting another year for your new home.
So how do you increase owner benefit? Take a look at the expense side first. Where have you increased your investment in the company, and is it paying off? Staff, equipment and vendors are all under consideration for reduction. Think about other elements of your business. What isn’t working? Are there products, services or initiatives that need to be shown the door?
This is never a fun part of entrepreneurship, but if you have the ability to prioritize profitability without harming long term growth, take action. If there really is nowhere to cut, look at the remaining options below.
Taking on debt
Obtaining business loans or lines of credit from traditional banks is incredibly nuanced. From a general perspective, taking on debt in the short term can allow you to fund your growth initiatives with outside capital while protecting your equity ownership for long term growth. The bigger your business gets, the more often you will lean toward using debt to fund new initiatives. Here are some of the trade-offs to consider:
Lengthy application and approval process:
Traditional banks often have complex application processes that can be time consuming and require extensive documentation. Business owners may need to provide detailed financial statements, business plans, tax returns and collateral information. Furthermore, the approval process can take several weeks or even months, causing delays in accessing the funds they need for their business operations or expansion plans.
Strict eligibility criteria:
Traditional banks have stringent eligibility criteria that small businesses must meet to qualify for a loan or line of credit. These criteria typically include factors such as a minimum credit score, established business history and collateral requirements. Startups and early-stage businesses may face challenges meeting these criteria, limiting their access to traditional bank financing.
Limited flexibility:
Traditional banks often offer fixed loan terms and repayment schedules. Small business owners may not have the flexibility to customize the loan terms to align with unique cash flow patterns or seasonal fluctuations. Additionally, traditional banks may have strict penalties for early repayment or changes to the loan terms, reducing the business owner's ability to adapt to changing circumstances.
High interest rates:
Interest rates offered by traditional banks can be relatively high compared to alternative financing options. Small business owners may end up paying more in interest over the life of the loan, affecting their profitability and cash flow. The interest rates are typically based on factors such as the business's creditworthiness, collateral and market conditions.
Collateral requirements:
Traditional banks often require collateral to secure the loan or line of credit. Small business owners may need to provide personal assets such as real estate or equipment as collateral. This puts their personal assets at risk, in case of default. This can be a significant trade-off for business owners who may prefer not to risk personal assets for their business financing needs.
Limited access to small loan amounts:
Traditional banks may have minimum loan size requirements, making it difficult for small businesses to secure small loan amounts. This can be a disadvantage for microenterprises or businesses with lower financing needs. Non-traditional lenders like hard-money investors or specialist banks may offer more flexibility in providing smaller loan amounts to meet the specific needs of a particular business.
While traditional banks provide a trusted source of financing for small businesses, there are a number of trade-offs to consider. When deciding to obtain business loans or lines of credit from traditional banks, small business owners should carefully evaluate the lengthy application process, strict eligibility criteria, limited flexibility, high interest rates, collateral requirements and limited access to small loan amounts.
Selling equity
If you have made it this far in your thought process, it likely means that you do not have the ability to adjust your expenses enough to meet personal needs without hurting your long-term growth. You also may be in a position where lending will not meet your needs due to the stage of the business, its lack of assets to secure the credit needed or the debt structures that are offered do not meet your needs. Selling equity tends to be cheaper than debt in the short term but much more expensive in the long term. True, you do not have interest payments or additional drain on your cash flow, but as your company grows over the long term, you receive less of the benefit of that growth.
If you do want or need to sell equity, be sure you know how much control you want to maintain over the business, the rights you want your new partner to have and how this new owner will impact your long-term growth prospects. You can always look for a strategic partner to offer you skills, relationships or knowledge in order to advance your company. Think of a larger competitor who sees you rising and wants to be sure they have some ownership in your growth, perhaps even with a right of first refusal to buy you in the future. Equity sales are the most complex and specific to your business, so if you are going down that road, be sure you have clarity about all the elements involved.
Being able to meet your personal priorities increases your entrepreneurial endurance so that you can persevere for the long term. There are always avenues to continue to meet them and your business growth goals at the same time.
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DISCLOSURE: Jarrod Musick is an officer of Destiny Capital and Entrepreneur Aligned, a DBA of Destiny Capital. This article is for informational purposes only and should not be relied upon as a basis for your investment, business, or personal financial decisions. We recommend consulting with your wealth advisor, CPA/tax advisor and/or attorney, as applicable to your situation, prior to implementing any new tax, legal, or investment strategy.
ABOUT JARROD
Jarrod was born into financial planning and solving financial problems. With his financial advisor father Steve telling stories about finance around the dinner table from an early age, the idea that everyone has a different financial situation was always there. After an early professional career spent in nonprofit and government, Jarrod came back to his roots helping people plan and invest in 2011. Since then, he has worked with individual clients, led internal teams and ultimately became partner and the CEO of Destiny Capital in 2017. With a passion for helping entrepreneurs change the world, Jarrod ultimately oversaw the creation of Entrepreneur Aligned in 2020. With both Destiny Capital and Entrepreneur Aligned, Jarrod leads teams that help people live lives of abundance where money is simply a tool to let everyone be a positive force for the world around them. When he isn’t working with the talented teams for EA and DC you can find him chasing his twins, wily trout or a podium spot at an OCR race.
Jarrod Musick
CFP®
Posted: 06/16/2023
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