Chapter 01 – Businesses as investments

Introduction

Businesses are the best investments. Young clients will often ask their financial planner what they need to do to secure their financial future. Should they be saving up to buy a home, investing in the stock market or starting their own business? The best answer is usually to buy or start a business, and then use the extra cash flow to buy a better home. The best investments for most clients are their businesses and their homes, in that order.

Most clients who become wealthy do so by owning businesses. They generate strong cash flows, spend less than they earn, save the difference, then invest in other areas, first the home and then other assets, to build up a significant and diversified asset base. The leading textbooks in the financial planning field do not touch on investing in one’s own business and instead focus on traditional financial planning products, such as super and insurance products. However, a client’s business can become a major source of cash, income and wealth. The business is the engine room: this is where it all starts. Therefore, the business deserves special prominence in any discussion about clients’ investments and financial plan.

Clients who are in business also have a greater need for the adviser’s extra services, and in the new fee for service world it’s all about providing extra services. That’s where the extra fees come from. A client who is in business has a greater need for a financial planner’s skill and experience, including risk insurance planning, income tax planning, debt planning, estate planning, super planning and, of course, investment planning.

The average business client is worth five average non-business clients. Dover is dedicated to helping advisers develop the skills needed to develop a competent business development advisory capacity as part of their financial planning practices. Dover believes financial planners should be their clients’ primary business adviser, with a broad knowledge of all relevant areas, and the capacity and inclination to bring in other specialist advisers including accountants and solicitors where appropriate.

Why recommend businesses to clients?

Dover believes financial planners should systematically recommend the creation, purchase or development of a business to appropriate clients, and that a statement of advice that does not at least consider this option is flawed. Dover believes businesses are the best investments and that advisers should routinely recommend their clients to buy or start businesses, or further develop existing businesses, wherever a client is suited to this by inclination, personality or training. The extra economic benefits, improved tax planning and, hopefully, the CGT-free profit on the ultimate sale of the business mean this is an option clients cannot afford to overlook. The adviser’s duty of care means this advice should be presented wherever the adviser feels it is appropriate having regard to the client’s individual personality, skill base and life circumstances.

Dover believes that financial planners should acquire the knowledge and expertise to advise clients on most aspects of setting up, running and selling a business, should position themselves as the primary adviser on business matters and should control, or at least be involved, in the client’s access to other business advisers including accountants and solicitors. Encouraging clients to set up, run and develop businesses will maximise business development for your own practice. It will make sure you are involved in all aspects of your clients’ business, which is where a true professional should be, and not relegated to a secondary role dependent on someone else‘s decisions as to whether you are involved.

Businesses are safer than employment.

Most employees get their cheque from one source, their employer. Most businesses get their cheques from multiple sources, their clients or customers. The safest and fastest way to create wealth is to build a quality business that does not rely on one client or even one source of income, and which has a market value that others are prepared to pay for. At best, employment is a precarious occupation. Done properly, setting up and running a business is a low risk and conservative option that protects your clients from the vagaries of the market and opens the door to a much larger income and much faster wealth accumulation. Every day private businesses change hands for multiples of two, three or even four times’ maintainable profits. That’s the equivalent of a return on investment of between 25 per cent and 50 per cent per annum. There is no better investment. Yes, some businesses are risky. But risk can be managed. A good business with a competent operator almost always produces returns well ahead of any other investment.

Who should start a business?

Raising the idea of self-employment through new and existing businesses to young clients, and in some cases older clients, should be standard practice no matter what field they are in. The concept of self-employment is universal and should at the very least be discussed. For the right client, starting or buying into an existing business can work very well. For example, a good recommendation to young tradespersons (plumbers, electricians, builders etc) is to stop being employees and start their own business in their relevant field. They can engage apprentices and other employees and create a good base of income from multiple sources. Not every client will be suited to be a business owner and some will struggle with the responsibilities that come with it. Starting a business is hard work and requires a lot of skills, efforts and determination to make it work in the long run. It also can come with a lot of financial risks if the business is not structured properly. Careful planning is key to getting it right and this is where the guidance of a financial planner comes into play. John Rampton from Entrepreneur magazine has written an article on the 50 signs you need to start your own business. In summary, some of the key indicators are as follows:

  • You are creative and have an idea for a business that you’re passionate about;
  • Your field lacks jobs or you have identified a gap in the market and you want to develop that product or service that is not available yet;
  • You prefer working independently, feel that your job is holding you back and you believe you can build a better business yourself;
  • You are organised, a problem solver, you can multitask and enjoy acquiring new skills and knowledge;
  • You can afford to take risks.

Getting started

The Commonwealth Business Entry Point outlines the key steps required to starting a small business. In summary, they are:

Selecting a business structure

It is important to select the correct business structure before you get started. Part 11.4 of this book provides a detailed guide on choosing a legal structure for the business.

Drafting a business plan

It is important to have a business plan to document the objectives and ambitions of the business to ensure that the business processes are implemented successfully. Part 11.3 of this book provides a detailed guide on how to draft a business plan.

Registration and licensing

Ensure that you have the correct licenses and registrations for the industry you are operating in. The Australian Business License and Information Services is a useful website to search which registrations and licenses your business needs. The site can be accessed here: https://ablis.business.gov.au/pages/home.aspx.

Finances

There are a number of things you will need to do to manage the finances of the business. These include:

  • Setting up bank accounts;
  • Setting up bookkeeping software;
  • Obtaining finance and managing cash flow; and
  • Preparing financial reports and Business activity statements (BAS).

Part 11 of this book provides detailed information on different forms of finance that can be used for a business. Part 11.5 provides an overview of a business’ obligations regards BAS and an overview of the leading accounting software on the market.

Tax planning

It is important to be aware of the small business concessions available for small business entities. The small business concessions are outlined in Part 11.5 of this book. Part 07 also provides a detailed guide on how to invest in your business and business premises in a tax efficient way.

Supplies and equipment

ASIC provides a business check service which provides information about the other businesses, suppliers and operators a small business may deal with. This is to ensure that you can verify information you have been provided and to avoid dealing with unreliable operators. More information can be found here: ASIC Business checks.

Business premises

Some businesses are located in prime real estate next to large shopping centres, where there is a high level of pedestrian traffic that generates a constant supply of potential customers or clients. Other businesses are in residential or industrial areas and rely on reputation for customers or client’s to come in. How suitable a location is for a business will depend on the types of goods and services provided by the business. What will work for one business may not work for another. More information about buying or leasing business premises can be found here: Business premises. Part 07 of this book discusses investing in your business premises in a tax efficient way.

Employing staff

All businesses employ staff; therefore appropriate management of these human resources is a vital process. Businesses have legal obligations to fulfil, whilst building a positive and cooperative culture. The practice needs to ensure that human resources policies and procedures are kept current with changes to legislation. Business managers and owners frequently require assistance in understanding legal requirements pertaining to employment and dismissal of staff. Part 11.6 provides a detail guide on the recruitment process as well as your legal obligations towards employees.

Example case study

Let’s assume next Monday young John comes to see you. John is 26, and has been in the plumbing game for ten years now. He is still with his first boss and he knows his stuff. And he knows lots of people too. He is friendly, personable and reliable. People like John. He has just become a dad for the second time, and his wife Betty is now a full-time mum, flat out 24/7 caring for their young family. What should you say to John? You should tell John it’s time he set up his own business and started making profits for himself, not his boss. Ask him who he loves the most, his babies or his boss? ‘John, hang up that shingle and start your own show. You will never regret it.’

John takes your advice. He trusts you. And you show him how to do it. John cuts out the middleman to double his income overnight. He can now make $120,000 a year. He can claim better tax deductions for cars and similar costs. The ATO allows him to form a “mum and dad” partnership with Betty, so he can split his (bigger) income with Betty. That makes for more deductible super contributions, and even more tax savings. John is delighted with you.

After a while, John leaves CBUS and sets up his own self-managed fund and invests in direct equities. You administer that for him. John needs more income continuance, life and trauma insurance. You do it for him. John needs finance for his new ute, and help buying and funding a (CGT-free) factory for his equipment (and caravan and boat). You do it for him.

The business gets better and better. Soon John is off the tools and supervising a team of ten maintenance plumbers and running a very tight and profitable show. You introduce John to an allied accountant who will not compete with you and respects your role as a primary adviser. The accountant pays you a referral fee of 20%. He also refers you clients in return. You reciprocate, and respect the accountant’s role as the primary adviser to those clients. Your alliance works. You are a team.

As John’s wealth builds he needs your help buying and funding a new home. John’s estate planning becomes more complex. You take him and Betty through the labyrinth of wills, powers of attorney and SMSF binding death benefit nominations. You are John’s guide, mentor and trusted advisor. It’s a 30-year relationship, and over that time, John refers his business associates, friends and family to you.

This is a case study in why businesses are the best investments for clients. It is also a case study in why business clients are the best investment for financial advisers. 

The Dover Group