Creating a capital plan that keeps your business operating — and flourishing — while giving you the personal financial flexibility to send your children to college and retire comfortably is paramount. How much business owners pay themselves depends on a number of considerations.
Depending on personal considerations, owners can structure their business in a way that helps them meet their own financial goals. Factors that influence a small-business owner’s capital strategy should include:
? The company’s legal structure.
? The business’s capacity to borrow for growth.
? The owner’s ability to take money out of the company to invest in a retirement plan.
Legal Structures for Small Businesses
Deciding what kind of legal structure you have and how it affects the business’s capital strategy depends on the kind of business you are running and how much flexibility you need. Small businesses typically fall under two types of legal structures: sole proprietorships and incorporated businesses.
In a sole proprietorship, the company’s assets, liabilities and risks belong to the owner. Sole proprietors report and pay business taxes as part of their own IRS return. If you are a sole proprietor, you have much more flexibility with the business’s finances and cash, making it a lot easier to pay yourself and invest the money.
C corporations are the most common type of incorporated businesses. A C corporation’s income is legally separate from the owner’s personal finances. If the company is sued, the individual owner’s assets cannot be touched. With a C corporation, owners must receive a salary or a dividend as income. Dividends are taxed both at the corporate level and on your personal income tax return as capital gains, whereas your salary would only be taxed as personal income.
Different businesses have different needs at various stages. At the beginning of the business, you will likely need to borrow money from a bank for start-up costs and reinvest all your profits in order for it to grow.”
Once a business becomes profitable, it will need a fixed amount of capital to continue growing. You can address these costs by either borrowing the money or reinvesting the profits back into the company. If interest rates are high and it costs you more to borrow than you could earn reinvesting the profits outside the company, it would be wise to reinvest most of your profits back into the company’s operation. If the opposite is true, borrowing from a bank to fuel your company’s growth while taking profits out to invest in your personal portfolio may be a smarter choice.
It is wise to take some money out when you can afford to do so. Plowing all your profits back into your company rather than taking them out and reinvesting them is similar to buying one stock rather than a diversified portfolio. That can be dangerous. If your company goes out of business, all of your resources are gone. If you have reinvested some of the profits elsewhere, you have some ground to stand on.”