Last week, an article on CNNMoney shared stories of entrepreneurs who had started successful businesses in oil-rich areas like Williston, North Dakota. As I read through the different stories, I couldn't help but feel a sense of unease. Of course, I am excited that entrepreneurs are succeeding, but I'm also concerned that they won't recognize success is never guaranteed. In some ways, entrepreneurs might have shorter time spans to succeed since they can experience just as many bad years in business as they do in good ones. And the bad years can wipe out the savings of the good years.
In working with a lot of business owners (and being one myself), I have found that optimism is a double-edged sword. Small business owners (entrepreneurs in some circles) tend to have a very strong optimistic streak-they have a sense that they will always come out on top. While this confidence is key to overcoming many bumps in the road to success, it can also lead to bigger problems that will ultimately affect retirement and families.
Here are some mistakes to avoid when you are having a good year in business:
Increasing Spending: If you have had poor income years in a business, you know how hard it is to have a good year and not spend all the extra cash. Often, a spouse is waiting in the wings to catch up on all the projects that have been pushed to the side when you did not have money. But be cautious, because it is very hard to reduce your standard of living later; often, an increase in spending now leads to family fights down the road if spending needs decrease again. Additionally, the real cost of "toys" (e.g., boats, motorcycles, and a bigger house) is often the ongoing maintenance, and you need to pay that bill whether you have a good year in business or not.
Reinvesting Everything: Many business owners keep plowing money back into the business to keep it growing, but also because they tent to think in large numbers. They might not view a few thousand dollars in a health savings account (HSA) or maximizing 401(k) contributions as very important because in the back of their mind they are thinking that somewhere down the road there will be a big payday when the business sells. But saving slowly (and especially during good years) puts you in a better position to weather the bad years. It also takes pressure off when you ultimately sell your business-many sales never happen because the business owner cannot afford to retire on the amount someone else is willing to pay for their business. Build up retirement savings now so you give yourself a choice to sell when and if you want.
Not Saving Enough Cash: While the typical financial planning advice is to have three to six months of a cash reserve, I think most business owners should have 12 months or more of cash set aside. When the economy slips, this reduces the pressure to make short-term decisions that hurt the business in the long run (like letting key staffers go). It also means much less tension in your home life, since you can assure your spouse that you thought ahead to the possibility that you'd need to reduce (or not even take) a salary for yourself. Save cash when you have good years so you're prepared for the bad years.
Being a business owner is a lot of fun and brings a lot of flexibility. But with that comes a responsibility to be disciplined when things are good so that you can enjoy the flexibility when times are not so good. I have seen business owners who do this well and have found that they tend to be able to make better business decisions, especially when their competitors might be struggling, that ultimately make them more successful in the long run. If nothing else, they tend to have more money because they thought about it along the way-not a bad place to be when you retire and want to take that trip around the world with your spouse.