Ian: Welcome to the Business Coach Podcast, an advice-oriented series for Canadian entrepreneurs. I’m Ian Portsmouth, Editor of Profit Magazine and I’ll be your host as we tackle the hot issues and opportunities facing Canada’s small businesses. We’ve developed this podcast in cooperation with BMO Bank of Montreal. Over the course of the series I’ll be drawing on experts in a number of fields including some BMO experts in order to provide the credible information and prescription you need to run your small business better.
Why do people go into business for themselves? Well its not because they enjoy long working hours and great financial risk, rather they do it for the challenge, for the independence, for the opportunity to improve the lives of employees and customers and, more often than not, the chance to generate great personal wealth. However many entrepreneurs fail to capitalize fully on the financial opportunities that come to them.
In this episode of the Business Coach we’ll speak to a pair of experts on personal finance for entrepreneurs in the hope of helping you maximize the financial rewards you should get from business ownership. Joining us to discuss the importance of financial planning for entrepreneurs and to share a few wealth building fundamentals is Steve Bing. Based in Toronto, Steve is the Regional Sales Leader, Sales and Channel Support at BMO Term Investments. Hi Steve, welcome to The Business Coach.
Steve: Hi Ian thanks for having me.
Ian: Steve in my experience I’ve found that entrepreneurs have a rather poor reputation for personal financial planning. What’s your perception of the financial planning needs of business owners?
Steve: I think you’re right Ian I think entrepreneurs generally don’t do financial planning that well. They’re very very wound up in their own businesses and of course they’re taking a lot of time in the their own business. I think they perceive financial planning as being a long process and it doesn’t have to be that way. In fact a lot of financial planners understanding their needs will say, “I’ll meet with you for an hour and then we’ll meet again sometime later for an hour and we’ll be able to wrap things up.” So I’m really thinking that it’s a time perception by the entrepreneurs. They’re just too busy, they’re trying to run their business and they just can’t get around to doing the planning that they need to do.
Ian: And quite often they have a tendency to wrap all of their wealth into their business and I guess they think that their nest egg is their business so why should I bother investing in other things, is that correct?
Steve: That’s correct and that can be a great risk. Obviously if the business is doing very well at the time when they’re prepared to retire they can sell it for a pretty good price and probably relax and retire on the proceeds of the business. However, as we all know economic times can go up and can go down and if at the time when the entrepreneur’s ready to retire it just happens to be a lower economic time they may find they don’t get the money out of their business that they were hoping for.
Ian: And often poor health, disability, other things will force them to sell their business before they’re ready.
Steve: Yes exactly that’s one of the keys, I was a commercial account manager for a few years and I worked with a number of entrepreneurs and in fact a couple of them did get sick and it had a real impact on the sales in their business. Of course everybody says, “It’ll never happen to me” you know, “it’s somebody else that’s going to get sick and it won’t be me” but they really must be prepared for that and we would encourage all our clients to get what we call key man insurance’ which would just make sure that they had a fall back position if they did get sick or passed away.
Ian: Now Steve whether or not an entrepreneur has a financial plan currently, what are some of the fundamentals to ensuring that the plan gets on track, either from the get go or the plan gets rehabilitated so to speak?
Steve: Well I think that an entrepreneur who doesn’t have a plan probably should really focus on taking the time or at least putting time aside to be with a planner and there’s many free planners in the industry available today and just trying to get that put together. A lot of the entrepreneurs we see they top up their RSPs every year and they think, “Well you know what that’s my financial plan, I’m putting as much as the government will allow me to put into my RSPs” however generally entrepreneurs are living a much higher lifestyle than they’ll be able to afford to maintain on what the government will allow them to put away. So they have to look at other areas to invest in hopes that they can diversify a bit and have some more income at retirement.
Ian: And later on in the podcast we will be discussing IPPs and RCAs so those are vehicles that every entrepreneur should be considering. We spoke a bit earlier about the fact that entrepreneurs tend to put all of their eggs in one basket, namely their business. Is there any general rule of thumb as to what percentage of an entrepreneur’s retirement savings or net assets should be in their business?
Steve: Well there’s a rule of thumb that we go by and its maybe not as a percentage of course cause you may have an entrepreneur whose business is worth fifty million dollars, it would be hard to say, you know, if the same percentage should be put away for that then say a client or an entrepreneur whose business is worth two or three million. But I would like to think that they would be safe if they were able to keep around say three to five years’ worth of living expenses invested outside of their business itself. Because of course they’re hoping they’re going to be able to sell their business and have a rather large cheque to invest at that time. The downside is if there is a lull at the time they want to sell they might want to hold on a bit longer until the economy picks up or the business picks up and they can sell later and they’ll need that cushion to fall back on. Of course also if something happens to them from a medical standpoint they may find that they’re going to need that kind of money put away. So depending on what their living expenses are try to keep it at least three to five years invested somewhere fairly liquid that they can get at that they can access to fund any living expense they need that’s a cause of maybe an illness or maybe just in a downtime.
Ian: Sure now you mentioned the word liquidity and of course that brings up the notion of diversification and making sure that all of your eggs are not in the same basket. Can you recommend some of the fundamental moves that entrepreneurs should be making with their finances?
Steve: Yeah some of the more successful entrepreneurs that I dealt with have done things like rental property, owning a rental property. They’re looking at potentially funding their retirement with some sort of cash flow and of course as we know in Canada if you own a house long enough the value’s going to go up, value in most parts of Canada go up on a regular basis so its not hurting to have one or two high end rental properties that are kind of a nest egg that if you ever needed to you could sell and get quite a bit of cash out of. In the mean time you can rent out and get some sort of, some sort of monthly revenue and monthly income to supplement your pension. Of course, topping up your RSPs is very important. Some entrepreneurs actually get into the private mortgage market. That can be a little risky but it can also be lucrative and it can, again, provide you with a monthly income that you might need. So there’s also getting into, you know, stocks, bonds, mutual funds. I would probably suggest that they do that with the help of an advisor. Many people say, “Well I’m going to diversify and maybe I’ll buy another business.” Well unfortunately some of the businesses I’ve seen that haven’t done so well is because they got out of the business that they were really really good at, making money at and decided to buy another business that wasn’t sort of the same as theirs and they said, “Well okay I can run that other business” and it generally milked their initial business for quite a bit of money and it wasn’t a positive investment. So if they’re going to invest in anything it might be apropos to invest in maybe suppliers. If they’re in a business and they’re dealing with some really high quality suppliers that have stock on the market and they like the management style of those suppliers then that might be an interesting investment because they of course have a good feel for how well that company is doing.
Ian: And how about the notion of investing in industries that are counter cyclical to your own? So that when your business is down if you are forced to sell at least you’re holding onto investments in companies who’s stock is up so to speak.
Steve: Yeah that’s, that’s a good¦ a good option. Of course its like the way we build our mutual funds you’re trying to hedge against one side being down and one side going up and I think it’s a great option. You just have to make sure that you remember that the people that run those other businesses are the experts so if you’re going to invest in that business let them continue to run it if you’re going to buy into the business versus just buy stocks in it. Of course if you’re buying stock then you’re actually creating a good diversified portfolio that’s going to have a really good opportunity to provide a long-term growing return for you.
Ian: So the rule there is stick to your knitting and that probably applies when it comes to making a lot of investments if you don’t have the time to really create and follow your financial plan and pick your investments then you should probably hire somebody to help you do that correct?
Steve: I think that’s really the key. In fact a lot of the entrepreneurs I saw when I talked to them and tried to encourage them to see a financial planner I’d ask them, “What are you good at?” and they’d say, “Well I’m good at this business.” I said, “That’s right and the financial planner is good at their business.” So you’re good at making money by your business, let the financial planner help your money make more money and make sure that you don’t get into trouble in terms of investing in something that’s not going to turn out the way you planned.
Ian: That’s right everybody wants more money and nobody likes any nasty surprises.
Steve: You’ve got it, yeah.
Ian: Steve thanks for sharing your expertise on The Business Coach.
Steve: My pleasure Ian.
Ian: Steve Bing is the Toronto-based Regional Sales Leader, Sales and Channel Support, for BMO Term Investments.
Ian: By building a business from the ground up entrepreneurs enjoy a special opportunity to create immense personal wealth. Surveys show that the majority of entrepreneurs believe they will fund their retirement through the sale of their business, however, there’s never any guarantee you can cash out of your business on your own terms at the time of your choosing and at the price you want. So for that reason its worth taking a look at specialized retirement vehicles for business owners. Among the most common are individual pension plans or IPPs and retirement compensation arrangements or RCAs. Here to provide a primer on these two financial instruments is John Favro, an Associate Partner of KPMG and the Leader of Private Clients Advisory Services within the firm. John welcome to The Business Coach.
John: Thanks a lot Ian.
Ian: So John why should entrepreneurs consider specialized wealth building tools above and beyond what the rest of us participate in such as regular savings, mutual funds, various equity investments?
John: Well Ian I think there’s really two main reasons here. One is that these tools typically assist in diversification of investments. As they say its always good to have all your eggs not in one basket. And secondly, they can assist in maximizing after tax rates of return. As these specialized investments they usually have an element of either tax deferral or tax reduction. Remember, its not what you make its what you keep.
Ian: Of course. Now in a nutshell what is an individual pension plan and why should an entrepreneur consider having one?
John: Well an individual pension plan or an IPP what it is, is it’s a registered defined benefit pension plan and its designed for the key executive employee or owner/manager. Its similar to being a member of a “features” pension plan. In this case contributions to the plan are made by the employer and they are based on actuarial computations and they must first fit into specific regulations. So there are limitations to what can be contributed. They should be viewed as an alternative to registered retirement savings plans or RSPs. They are beneficial since they could provide much more retirement savings as compared to RSPs and they are best suited for employees over 40 years old and earning in excess of $100,000 a year. And finally I would say that IPPs also assist in protecting the owner’s assets from creditors.
Ian: Now as a defined benefit plan there would be a maximum on the amount that could be paid out in any given year is that correct?
John: Yes, yes of course it is always governed by regulation and its similar to, again, similar to something like a Teacher’s Pension Plan and there are computations that have to be adhered to.
Ian: So this sounds a little bit complicated. What and who is involved in setting up and administering an IPP?
John: Well initially what’s required is there’s an actuarial valuation and, which is based on the years of service and the earnings of the individual. Now this actuarial evaluation also has to be redone every three or four years just to make sure that there are appropriate assets in the IPP to fund the retirement of the employee. Now also an administrator has to be appointed which could be a corporate trustee or usually is an insurance company. The plan has to be registered with the Canada Revenue Agency so there is a certain amount of legal work that is required. The employee may be required to transfer all or part of their RSP into the IPP right at the initial stages of the IPP. And I guess finally there’s also annual filing requirements that have to be maintained. So, in other words, there’s upfront costs and there’s ongoing costs but the company can pay for these and can deduct them for income tax purposes.
Ian: Now IPPs I’ve heard them referred to as RRSPs on steroids. They conjure up the image of a body builder. Meanwhile retirement compensation arrangements as I understand them are a lot more nimble. Can you tell us a bit about Retirement Compensation Arrangements?
John: Yeah Retirement Compensation Arrangements or we call them just simply RCAs they are almost an element of a supercharged retirement plan okay. And what they are, they’re a special retirement plan intended really to supplement IPPs or RSPs. The big difference with RCAs is that there’s no dollar limitations like RSPs and IPPs. Again, contributions to the RCAs are made by the company but they can be based on the employee’s actual earnings, again with no dollar limitations. The difference here is that 50% of the contribution has to be submitted to the CRA as a refundable tax. Now this tax will come back to the plan when payments are made to the individual once they reach retirement. Something to remember is that the refundable tax does not earn any income while in the hands of the RCAs. So they are good, they are also good because they do not affect RSP room. So somebody can have, building up their RSP and as well supplement their retirement income with the RCAs and similar to IPPs they do provide protection against creditors. And also they’re of particular value if the owner/manager were to become a non-resident of Canada when they actually retire.
Ian: Now you mentioned RCAs as a supplement to an IPP. Does that mean that the average business ownership probably want to set up an IPP before they proceed with an RCA?
John: I think initially you should consider the IPP as I said earlier with RCAs. One big difference is that there is a 50% tax that must be submitted to the CRA when you’re doing Retirement Compensation Arrangements and you will not have that when you’re doing IPP. So our first recommendation is to really consider IPPs before the retirement compensation arrangements.
Ian: One more question about IPPs. Of course business owners can often be sole proprietors and therefore the company that is contributing to their IPP is actually themselves. Is it still advantageous in a situation of a sole proprietorship to participate in an IPP?
John: Well a sole proprietor will have to incorporate their business and become an employee of their business to be able to use IPPs. So its still advantageous, you should consider transferring their business into a corporation and running their business through a corporation for a period of time and then take advantage of the IPP strategies.
Ian: John, thanks very much for joining The Business Coach Podcast.
John: Thank you very much Ian.
Ian: John Favro is the Leader of Private Client Advisory Services and an Associate Partner at KPMG. He spoke to us from his office in Toronto.
Thanks for listening to this episode of The Business Coach Podcast. I hope you discovered a few insights that will help you grow your business.
Your feedback is always welcome. Drop me a line at Business Coach at email@example.com. Meanwhile be sure to visit us online at profitguide.com or bmo.com. Until next time I’m Ian Portsmouth Editor of Profit Magazine wishing you continued success.