Running a small business requires superior problem solving and the ability to see the big picture. In addition to making sure your business is turning a profit on a regular basis, you also need to be concerned about your own long-term financial health. That includes having a wealth-building strategy in place so you can enjoy a comfortable retirement once it’s time to hand over the reins of your business to someone else. As an entrepreneur, there are certain obstacles you need to be prepared for that can hinder your ability to build wealth. (For a detailed overview, see the Starting a Small Business investigator tutorial.) These are four major challenges facing small business owners.
1. Too much business debt
Getting a small business off the ground usually requires a certain amount of cash. Getting a term loan from a bank or a loan from the Small Business Administration (SBA) may be the answer, if you don’t have significant savings to tap into. With a 7 SBA loan, for example, it is possible to borrow up to $5 million to set up a new business.
Even if you don’t need a loan to start, that doesn’t mean your business will remain debt-free. For example, you might decide to open a business credit card to earn rewards on everyday spending or take a business cash advance to help cover your cash flow during slower periods. Or maybe you want to borrow to expand, especially if business is doing well. While credit cards, advances and loans can be invaluable in keeping your business running, their convenience comes at a cost.
If a substantial portion of your business income goes to paying off your debts, that leaves less income to devote to growth. It also leaves you, as the business owner, with less money to funnel into a single 401(k), SEP IRA, or similar qualified retirement plan to secure your own future. While the interest on a small business loan, the payments themselves are not. Paying off your business debts allows you to redirect funds into your retirement or a taxable brokerage account instead.
2. An inefficient fiscal strategy
As a small business owner, filing and paying taxes can be one of the most unpleasant tasks on your to-do list, but it is a necessity. If you’re not taking advantage of all the tax breaks available, your wealth will go by without even realizing it. Are there a number of tax credit deductions you can claim on your personal or business tax return? An expense must be considered both ordinary and necessary. This means that the expense must be something that is commonly associated with the type of business you own and directly related to its operation.
When you don’t take the time to maximize all possible tax advantages, the result is too large a tax payment. Hiring an accountant to manage your filing may slightly increase your business expenses, but it can also help minimize your tax liability. In terms of building wealth, the long-term benefit can easily outweigh the cost.
3. Lack of diversification
Owning a business requires a certain amount of juggling, and you may simply not have the time to pay as much attention to your investments as you’d like. The size of your assets affects your overall financial picture, including how banks view you, especially if you’re a sole proprietor. Investing in mutual funds or exchange-traded funds takes the hassle out of trying to put together an entire portfolio, but it can be problematic if the funds you’re buying have the same underlying securities.
Business owners can also run into trouble if they don’t rebalance regularly. This is critical to ensure you maintain the correct asset allocation, based on your investment objectives and risk tolerance. If you don’t rebalance regularly, you could end up with a portfolio that is too aggressive or too conservative. At one end of the scale, you risk losing money by betting too much on stocks. On the opposite side of the spectrum, you risk limiting your earning potential if you’re playing it safe with a lot of jumping. Either way, you are jeopardizing your future profitability by not paying attention to the level of diversification in your portfolio.
4. External risks
In addition to managing market risk, you must also be careful to protect yourself and your business from threats that may arise in other areas. For example, what would happen to the business if you fell ill and could no longer supervise its operation? How would your business and personal assets be protected if your business became the target of a lawsuit? What would you do if your business was damaged by a hurricane or other natural disaster?
These are the kinds of questions small business owners should consider, because while such scenarios may seem unlikely, they can have a substantial impact on how wealth grows. Choosing the right business structure is an important step in minimizing liability, but you should also be proactive when reviewing your business and personal insurance coverage to make sure you’re protected against all odds.
