Starting up a business takes a certain comfort with risk and leverage: that makes conversations with entrepreneurs on debt – both personal and professional – all the more challenging for advisors.
In part, the comfort level that small business owners tend to have with debt comes from the extensive experience that most have had with it in the course of setting up and running their business.
“I’ve learned so much from my entrepreneurs in terms of how to leverage all the assets they own,” says Susan Fulford, investment advisor at TD Wealth Private Investment Advice in Toronto. Indeed, Fulford says, many entrepreneurial clients display a tolerance for risk that is well beyond what most advisors would be comfortable with.
One of the first steps in keeping debt under control for business owners is to make sure their personal and business finances are kept separate. Doing so will help these clients build their personal wealth, and shield that wealth from possible downturns in their businesses in the future.
Says Fulford: “If everything is tied to them personally, if the business goes under, they will lose it all.”
However, keeping personal and professional assets separate is often easier said than done for a small business owner. For instance, banks are likely to ask for a personal guarantee on a business loan for companies that are small or in the start-up phase, says Kent Coulter, director, wealth management, portfolio manager, Richardson GMP Ltd. in Edmonton.
To help clients protect their personal assets from business creditors, explore other options with them. For example, they could offer assets owned by the company, such as a building, as collateral instead of a putting personal assets at risk.
A key strategy is to use a corporate structure in which to hold the business and its assets: this limits a business creditor’s claims to the assets that are held inside of the company. Less crucial but useful practices include using separate credit cards for personal and business expenses, Fulford says.
Even if it’s not possible to keep professional and personal debt separate at first, help your business clients develop a timeline for when they can start to create a barrier between the two. There’s no set rule for when an entrepreneur has to separate his or her personal and business assets. However, Fulford says it should be one of their highest priorities.
“In my head, I say, yes, under two years [to separate],” she says, “but in reality that may not be plausible.”
Whether a client’s personal and business finances are separate or not, it’s important for advisors to maintain constant communication with the client through regular meetings. To give those meetings a focus and to make it easier to bring up the topic of debt, James Gardiner, commercial banking area manager, Bank of Montreal in London, recommends coming up with yearly financial projections for revenue and debt levels to create a kind of benchmark.
“[The projections] give you a focal point to work from,” says Gardiner. “And beyond that, advisors need to be honest and transparent with their clients.”
If clients are consistently missing those projections and seem to be taking on more and more debt, it may be time to remind them of the risks of carrying so much debt.
Try and gauge what they would want to do with the company in the event of a crisis. For example, would the clients want to fight for the business? Or, would they be willing to let the company go in order to protect their personal savings?
“That’s a delicate, delicate conversation,” Fulford says, “but it is a conversation that I would have with people.”
When addressing a business owner’s personal investments, highlight the importance of protecting their savings and the wealth they have accumulated from their business. Getting this message across can prove challenging, given that many entrepreneurs are very comfortable with investment risk.
Talk to clients about why it may be best to balance the risks of carrying on a business with a more conservative approach to their personal investments, says Fulford. In particular, higher risk investing strategies, such as using a margin account, may not be the best choice for clients who are also running a business.