Drawing on Your Business Assets:
How Much Is Too Much?
Compass On Business Feature

Consider these two business owners. Owner #1 leads a modest lifestyle, draws a miniscule salary and reinvests all profits and cash flow back into his or her company. Owner #2, on the other hand, milks the company with overly generous compensation and bonuses to him- or herself, and has numerous expenses paid by the company which are in reality personal lifestyle enhancers, such as the company yacht and the company lake house. Which owner is in a more secure financial position?

While on the surface, Owner #1 looks more virtuous, the reality is that neither one is pursuing the most advantageous financial strategy. "It is important for both the health of the company and the business owner’s overall financial situation to carefully consider the ramifications of taking too much or too little from the company," cautions Connie Rogers, senior vice president in Compass Bank’s Wealth Management Group in Dallas.

The key lies in a diversified approach to asset allocation, not putting all one’s eggs in one basket, so to speak. "Just as an investment advisor will diversify a client’s marketable security portfolio, the business owner needs some diversification in assets, as well," says Rogers. With proper planning and advice from the right team of advisors, business owners, even those getting a late start, can use their companies to protect their financial future and create personal liquidity regardless of their age.

Balancing assets for the best long-term position
In the previous examples, Owner #1, who draws a substandard level of income, has more of his or her overall personal balance sheet concentrated in the ownership of the company. This may seem like "absolutely the right thing to do," concedes Rogers, adding that, "true wealth is usually built through concentrated effort," and that she would always prefer to see "someone living below as opposed to beyond their means." However the problem with this approach is that even a well-run company that is also well-capitalized may encounter significant financial difficulties due to issues and events extraneous to the business itself and completely out of the owner’s control. "Without counterbalancing assets away from the company, the business owner doesn’t have as much flexibility in the event something goes wrong," says Rogers.

Likewise, Owner #2 is in a precarious position as the assets he or she is building up outside the company are more like toys than long-term financial assets, and the plundering habits will likely result in the company being undercapitalized. Just like the overly conservative business owner, the extravagant one needs to create diversification in his or her overall personal balance sheet, as well. In addition, in the event of a sale, in both cases, company financials will need to be recast to reflect a more appropriate compensation for the owner/manager to properly value the company. Not doing so may jeopardize the sale price.

Let’s say you have taken the middle road and set an appropriate salary and bonus structure for yourself. How else can you protect yourself and use your company to create future net income flows?

Using a portion of your salary to create outside savings accounts such as money market funds and marketable securities is usually a good idea (see "High-rate Money Market Funds and CDs Are Back" below), says Rogers. In addition, there are vehicles within your company, apart from equity, that can benefit you and your employees. These include plans like profit sharing, 401(k) plans and simple IRAs. The idea is to set aside tax-deferred income, typically for retirement purposes. Setting up a Section 529 Plan, which is essentially a tax advantageous college-savings account for children, is another way to diversify asset allocation.

In addition to spreading one’s assets both within and outside of one’s company, these strategies can provide the added benefit of rewarding, motivating and even retaining key employees. Because each plan is different and can be "skewed" to achieve the desired effect, it’s important for business owners to consult CPAs and retirement planning specialists before setting them up. Another key area to think about: different corporate structures come with different tax and liability issues, so it’s important to incorporate estate planning into the ownership structure of your company.

"It’s not only important to create wealth, but to keep wealth post retirement, or post sale of your company," reminds Rogers. Her advice? "Put a team of advisors—legal, tax, banking, and investment—to work early on to maximize the value of your overall financial picture."