Is it Time to Pocket Your Profits? - Nicola Wealth

Is it Time to Pocket Your Profits?


MEDA-2013-05-01-Is it Time to Pocket Your Profit - Header

By Eleanor Beaton

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MEDA-2013-05-01-Is it Time to Pocket Your Profit - Header ImageWhen it comes to safeguarding her financial future, Kelsey Ramsden is betting on the most secure investment she can think of: herself.

Like many entrepreneurs, Ramsden has experienced some wild ups and downs. She built Belvedere Place Development Ltd., her civil-construction company in West Kelowna, B.C., into a thriving business. Then Ramsden almost lost it all in 2009, after the recession bankrupted many of her clients. But over the next two years, she reinvented her firm and took it to triple-digit growth. Which means Ramsden’s decision to leave almost all her wealth inside her company is a smart one, right?

Most financial advisors would disagree. They recommend protecting your wealth by moving a big chunk of it into a diverse array of outside assets. David Lloyd, chief wealth management officer at Newport Private Wealth Inc. in Toronto, warns that a lifetime of rolling the dice can numb entrepreneurs to clear and present dangers, such as unexpected health issues or downturns: “They’re mortal, like everyone else.”

Ramsden’s response to the conventional wisdom? Heard it, got it, doing it anyway. “We’ve all heard the statistics about the number of businesses that fail,” says Ramsden. “But I’m used to taking risks—and to reaping the rewards when those risks pay off.” When Ramsden compares the “significant” return on the profits she plowed back into her firm to the annual 7% or 8% typical in public markets, she’s happy that she left her wealth in her company.

So, who’s right? You should think hard about whether you’re underestimating the risks of betting it all—or almost all—on your business. Still, there are situations in which this can make sense.

One is if you reinvest in your business to build its value and maximize its eventual sale price. But you need to be realistic about what your firm will fetch. Bill Sivell, a Windsor, Ont.-based business broker at VR Windsor Inc., which advises business sellers across North America, says most owners sell for less than they had expected.

Read 7 Steps to Selling Out Big

You can guard against an overly rosy view by having a professional valuator estimate your firm’s value every few years. Even if this suggests your ROI won’t be as high as you had hoped, it may still beat most other investments. David Sung, president of Nicola Wealth Management, a private wealth planning firm in Vancouver, says many of his clients have seen annual returns of 15% to 25% on reinvesting profits in their firms—if the business is sustainable.

Financial planner Alfred Feth of Feth Financial Services in Kitchener, Ont., points to another reason to leave your wealth in your firm: to avoid stunting its growth during its first five years. After that, says Feth, it’s wise to start moving cash out of the business and into outside investments— with 40% to 50% as a rule of thumb. Still, says Feth, few entrepreneurs do. “Your passion is your business,” he says. “Once you’ve made it through the first five years, you tend not to think about diversifying.”

Read The 5 Winning Strategies of High-Growth Companies

The third situation is if your business isn’t worth much. Under the Lifetime Capital Gains Exemption (LCGE), you can shield from taxes the first $750,000 from the sale of your small business corporation for each family member who’s a shareholder. Lloyd says the LCGE is a compelling reason to leave money in your business only if your sale price is low enough that the exemption would shield a substantial portion of the total. Even then, he adds, this would be prudent only if you had withdrawn enough from your business to create a financial security blanket for your family in the event your firm ran into trouble.

That’s why Corey Ross started taking money out of his company, Starvox Entertainment and Marketing, as soon as he could afford to. The president of the Toronto-based company says that once Starvox became profitable in its fifth year, he pulled money out to put into “the things that kept me up at night”—his RRSP, mortgage and his daughter’s RESP. “That allowed me to focus on growing my business without the fear that it might hurt my family if things didn’t pan out.”

Today, Ross takes just enough money out of Starvox to max out his RRSP. But he still has the great majority of his wealth in his business, pumping his reinvested profits into areas such as developing new productions and opening new offices.

Once Ramsden had turned around her business, she hedged her bet by taking some cash out to invest in the market. “It’s my ‘start again’ fund,” she says—just enough to give her family a few years’ reprieve in the event Ramsden loses it all.

But she’s still letting the vast majority of her wealth ride on her company. Ramsden is betting on her firm’s growth potential and her in-depth knowledge of her sector to keep delivering returns superior to those from a balanced outside portfolio.

Sure, it’s a risky play. But people who aren’t comfortable making a big bet on themselves may be better off in a less perilous line of work—say, being a financial advisor.