Why Small Businesses Fail to Grow
Running a small business requires superior problem-solving and an ability to look at the bigger picture. Aside from ensuring that your business turns a profit on a regular basis, you also need to be concerned with your own financial health over the long term. That includes having a strategy in place for building wealth, so you can enjoy a comfortable retirement once the time comes to hand over the reins of your business to someone else.
As an entrepreneur, there are certain hurdles you should be prepared for that can hinder your ability to create wealth. (For a detailed rundown, see Investopedia’s tutorial Starting a Small Business.) Here are four important challenges small business owners face:
- Too Much Business Debt
Getting a small business off the ground typically requires a certain amount of cash. Taking out a term loan from a bank or a Small Business Administration (SBA) loan may be the answer, if you don’t have sizable savings you can tap into. With a 7(a) SBA loan, for example, it’s possible to borrow up to $5 million to establish a new business.
Even if you don’t need a loan to get started, that doesn’t mean your business will – or should – remain debt-free. For instance, you may decide to open a business credit card to earn rewards on day-to-day expenses or take a merchant cash advance to help cover your cash flow during slower periods. Or you may want to borrow to expand, especially if the business is doing well.
While credit cards, advances and loans can be invaluable to keeping the business running, their convenience comes at a cost. (For more, see 7 Unconventional Ways Businesses Can Borrow Money.)
If a substantial part of your business’ revenue is going toward repaying its debts, that leaves less income to devote to growth. It also leaves you, as the business owner, less money to funnel into a solo 401(k), SEP IRA or similar qualified retirement plan to ensure your own future. While the interest on a small business loan is tax deductible, the payments themselves are not. Paying down your business debts allows you to redirect funds toward your retirement or a taxable brokerage account instead.
- An Inefficient Tax Strategy
As a small business owner, filing and paying taxes may be one of the most unpleasant tasks on your to-do list, but it’s a necessity. If you’re not taking advantage of every available tax break, you may be shortchanging your wealth without even realizing it. There are a number of tax credits and deductions that you can claim on your business or personal tax return. To qualify as tax deductible, an expense must be deemed both ordinary and necessary. This means the expense must be something that’s commonly associated with the type of business you own and directly connected to its operation.
When you don’t take the time to maximize every possible tax advantage, the result is an overly large tax payment. Hiring an accountant to manage your filing may increase your business expenses slightly, but it can also help to minimize your tax liability. In terms of building wealth, the long-term benefit can easily outweigh the cost.
- Lack of Diversification
Being a business owner requires a certain amount of juggling, and you simply may not have time to pay as much attention to your investments as you’d like. The size of your assets affects your overall financial standing, including how banks see you, especially if you’re a sole proprietor.
Investing in mutual funds or exchange-traded funds (ETFs) eliminates the hassle of trying to put together a well-rounded portfolio, but it can be problematic if the funds you’re purchasing hold the same underlying securities.
Business owners can also run into issues if they’re not rebalancing periodically. This is vital to ensure that you’re maintaining the right asset allocation, based on your investment goals and risk tolerance. If you don’t rebalance regularly, you could end up with a portfolio that’s either too aggressive or too conservative.
At one end of the scale, you run the risk of losing money by gambling too heavily on stocks. On the opposite side of the spectrum, you risk limiting your earnings potential if you’re playing it safe with an abundance of bonds. Either way you’re putting your future returns in jeopardy by not paying attention to the level of diversification in your portfolio.
- External Risks
Aside from managing market risk, you also need to be cautious about insulating yourself and your business from threats that may arise in other areas. For instance, what would happen to the business if you were to become ill and could no longer oversee its operation? How would your business and personal assets be protected if your business became the target of a lawsuit? What would you do if your business was damaged by a hurricane or other natural disaster?
These are the kinds of questions small business owners must consider, because although such scenarios may seem unlikely, they can have a substantial impact on how you grow wealth. Choosing the appropriate business structure is an important step in minimizing liability, but you should also be proactive in reviewing your business and personal insurance coverage to ensure that you’re protected against every possibility. (For more, see Insurance Coverage: A Business Necessity.)
The Bottom Line
A successful small business can put you on the right path toward building wealth, but you can stumble if you’re not thinking ahead. Keeping your eyes open for these and other challenges that may pop up along the way is the best defense when your wealth-building plans are threatened.
This article was originally published at Investopedia.