You’ve sunk endless hours of thought, hard work and lost sleep into making your business a success. Can you say the same about your personal finances? It’s unlikely, says Julie Sheen, a vice-president of BMO Financial Group in Toronto. “It’s easy for a successful business owner to assume that if their business is going well, they don’t need to worry about developing an investment plan.”
But no matter how successful your company is today, its fate will be influenced by uncontrollable external factors such as government policy; the health of the general economy; key clients and suppliers, and even your personal health. Essentially, relying on your business to sustain your lifestyle and fund your retirement is like betting the farm on a single stock.
To preserve the golden future you’ve worked so hard to build, you need to protect your assets and build a safety net. Here are five easy ways to safeguard your nest egg.
Buy some security
Given that equity (i.e., your company) forms most of your portfolio, you need to balance that volatility with guaranteed investments. Index-linked GICs, for example, protect all or most of your initial investment and still allow for potential growth in the returns by being linked to some non-guaranteed investments, such as a stock market or mutual fund.
Segregated funds are essentially mutual funds with insurance. You typically get returns similar to traditional funds, but at least 75% of your principal is guaranteed at the end of a predetermined holding period, typically 10 years. Plus, some seg funds allow you occasionally to “lock in” your gains, resetting the guaranteed principal amount to the appreciated value of the fund — although it also resets the clock on your contract.
Although management fees for seg funds are typically 0.5% to 1% higher than for mutual funds, there’s extra value for the money. Because seg funds are legally insurance contracts rather than equity funds, in the event of your death, they pay the guaranteed principal to your beneficiary. Perhaps more important for entrepreneurs, they’re creditor-proof.
Sheen also suggests “laddering” to limit your exposure to fluctuating inflation and interest rates. This involves purchasing a set of bonds or GICs with incremental maturation dates. In a five-year ladder, for instance, you’d start with a one-year bond, a two-year bond, etc., with each successive bond having a higher interest rate than the one before it due to its longer term. At the end of each year, you’d reinvest the principal in a five-year bond. This continual rollover irons out interest-rate fluctuations over time, making the long-term investment outcome highly predictable. Says Sheen: “It’s what I would consider the ultimate in terms of a security blanket.”
Shield your assets
Today’s business environment is global, complex — and litigious. A survey by Warren, N.J.-based Chubb Group of Insurance Companies shows that one in four U.S. private companies has been the target of a lawsuit in the past five years. Threats come from customers, suppliers, employees and competitors. “Think about potential liability and take simple, low-cost solutions to protect your assets in the event that you’re sued,” says David Phipps, senior financial advisor at Assante Capital Management Ltd. in Ottawa. He suggests putting personal assets, such as your family home or vacation property, in your spouse’s name, because creditors can’t touch assets you don’t legally own. But be forewarned: laws prohibit last-minute transfers of title if the purpose is to hinder creditors, so take action before trouble looms.
Other creditor-protection strategies include avoiding or removing personal guarantees on loans, which can void the protection offered by incorporation. Also consider moving accumulated wealth from your business into a family trust, holding company, spousal RRSP or an individual pension plan or retirement compensation arrangement. (See “Better ways to retire rich.”)
Know your escape route
Because business and life are such uncertain affairs, you can never take for granted that you’ll sell your business at your preferred time and price. If ill health or market forces compel you to sell within the next decade, your business could fetch a lot less than you’ve been hoping for. According to the Canadian Federation of Independent Business, more than 71% of entrepreneurs intend to sell their companies in the next 10 years, a statistic that presages a glut of companies for sale at depressed prices. Sufficient preparation will soften the blow during bad times and maximize your returns during the good. “The earlier you think about it, the more flexibility you have,” says Sheen. Enlist the help of your accountant and lawyer to plan and facilitate the sale.
Never get sick — or just insure yourself
Statistics show that one in three Canadians will be disabled for 90 days or longer before age 65. Unfortunately, for entrepreneurs, major accidents or health problems could cripple them and their businesses. “As an individual, you should have a long-term disability policy, a life insurance policy and a critical illness policy, in that order of importance,” says Phipps. “All three provide money to assist the business to stay viable should a key person suffer a disability, death or critical illness.”
Disability insurance usually pays out monthly and replaces lost income if you’re unable to work due to illness or injury. Critical illness pays a lump sum if you are diagnosed with an illness specified by your policy, such as heart attack, stroke or cancer, regardless of your ability to work. Many people stop at life insurance, says Phipps, “but the probability of becoming disabled is significantly higher than the probability of premature death.”
Put it all in writing
Business owners commonly overlook or defer up-todate wills, powers of attorney and buy-sell agreements. “With those documents,” says Phipps, “in a worst-case scenario, where you can’t provide instruction, you can still to a certain degree determine the outcome.”
Preparing two wills can prevent you from paying unnecessary probate fees. Create one for assets subject to probate fees (bank accounts, real estate or public-company shares), and one for assets not subject to probate (jointly held property, assets left to family or private-company shares).
A buy-sell agreement establishes rules and dispute mechanisms for how shares will be dealt with or paid for when one shareholder sells, retires, becomes disabled or dies. Without one, “you could lose a significant portion of your wealth just in legal fees by arguing with a partner,” says Phipps. It’s well worth the $2,000 or $3,000 it takes to draft this agreement while everyone is still healthy and happy. Ensure your agreement has a source of funding to pay for buyouts, such as an insurance policy.
Plan an effective agreement by running through the “what ifs” of death, disability or a shareholder buyout, suggests John Nicola, CEO of Vancouver-based Nicola Wealth Managment Ltd. To ensure the outcome is fair, he says, “first assume you’re the buyer and do the exercise, then assume you’re the seller and redo the exercise. Somewhere between these two events will be the right result.”
Finally, ensure you have a prenuptial agreement or marriage contract, which defines how you and your spouse will divide your assets in case you separate or divorce. Without one, your assets will be split according to provincial laws — which could make your ex your new business partner.