Diversity is the key to financial success in the long run. Yet some small and medium size business owners have trouble breaking away from the idea of reinvesting everything in the business.
It is fairly easy to reinvest earnings in the business for a while. Paying down debt is attractive and builds security against the cyclical bad times. Investing in productivity usually works, but most entrepreneurs wait too long to start investing outside the business. The homeless dollars in the business soon find a purpose. Sometimes one that is not productive.
A common one involves, should you own your real estate?
As with all business assets, the value is in the using. If you could lease space for about the same cost, should you? Many people answer no. They prefer to own.
If control of the property is crucial, then own it. If the property is not unique, then lease it. The idea is for the owner to separate the owning and using aspects of real estate.
If you could use your real estate assets without owning them, and had homeless dollars available to buy the real estate, would it make sense to buy this property or if real-estate is your thing is this the best available? Maybe there is a more attractive investment that you could make. If your business real-estate is not must own, be objective.
How about a 10-store strip mall instead? That might be better for you than buying your factory building. Less risk because if you own the factory and cannot use it because business is bad, you lose your rental income value too. Plus potentially higher return on your capital.
If there is extra money around, most tend to automatically invest it in business assets. You can and should decide based on the facts. Diversity is essential eventually so maybe now is the time. Use a cutoff rate for investment returns. If the default project does not earn enough don’t do it.
Having minimum rate of return requirement makes capital decisions easier.
Some of the happiest business owners I have noticed divested themselves of things that were a significant part of the business overhead. Selling the transportation department and the rolling stock, to a logistics company that knows what they are doing is good for everyone. Why do you need 18 semi tractors and all those trailers? If you are a manufacturer your skills are unlikely to be in logistics and the capital committed there might do better somewhere else.
Appropriate capital allocation is an important part of advanced business management. The first step is to find what you use and what parts of that you must own to do so. Then apply the cutoff rate. Finally decide how to invest outside the business without imperiling its growth.
A properly organized business is easier to sell and easier to transfer if you decide to sell in the family. Spend a little time thinking about your value for capital and the use it / own it question.
Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: email@example.com