It takes big match temperament (BMT) to make the kinds of decisions entrepreneurs make in their businesses every day. There are times when ‘going with your gut’ may be appropriate, but when it comes to financial decision-making, analysing all the implications greatly increases your chances of making the right choice.
Here are some key insights that might help you make the right financial decisions for your business.
Putting money into the business
Your business needs funds to operate. You can inject funds into your business in three ways: by dipping into your personal savings, borrowing money or identifying a funding partner.
If the only route open to you is self-funding, you need to be confident that your business will yield a suitable return.
Weigh up this return against simply leaving the money in the bank, which will earn you five or six percent, or investing it on the JSE, with a long term expected return of between 12 and 15 percent. As a general rule of thumb, taking into account the risk of investing the money in your own business, as well as the effort associated with running the enterprise, you should look for an expected return in excess of 25%.
If you’ve taken the decision to use your own funds to finance your business, you need to consider whether to put it in as equity (share capital) or as a loan. In almost all scenarios the answer would be to structure it as a loan because the money you loan to the company can be taken out again without being taxed, and interest paid is deductible in the company. Taking out share capital, on the other hand, involves declaring a dividend at 15% dividends tax, making it a more expensive exercise. You can also not charge any interest on equity invested.
If you’ll be borrowing the money needed to fund your business, your first consideration is whether or not you will be able to obtain a loan at a reasonable rate.
- What security is required?
- What are the repayment terms?
- What are the penalty clauses for early repayment?
Once you’ve identified a suitable borrower, make sure that the loan is structured as a loan to the company instead of to the owner. This way, interest paid can be deducted for tax purposes.
If you plan to bring a funding partner on board, the non-financial implications are the major considerations. These include:
- Will they be actively involved in management of the company, or will they just supply funds for a fixed return?
- Do they have the right personality and skill set for the role they intend on playing?
When taking on a partner, take the time to set up a detailed Memorandum of Incorporation and Shareholders Agreement setting out how the relationships will work. This will save you a lot of pain if and when a partner decides to exit.
Also consider the cost of taking a partner on. What are the salary or interest implications, for instance, of their involvement and what is the long-term impact of the percentage given up in return for the funds they offer?
Taking money out of the business
Congratulations, you’ve made a healthy profit. This begs the question, if you want to now take money out of the business, should you pay yourself (and the other owners) a bigger salary or declare dividends? The answer lies in the tax implications attached to each.
Dividends are currently taxed at 15% of after tax profit. So if you make R100 profit, you will pay R28 in company tax (the company tax rate is 28%), leaving you with R72 in after-tax profit. On this, a 15% dividends tax is charged (R72 x 15% = R10.80), leaving R61.20. The total tax paid on the R100 profit is R38.80, an effective tax rate of 38.8%.
The tax rate on your salary depends on the personal income tax bracket you fall into. But, the only tax bracket in which salaries are taxed higher than the above combination of companies and dividends tax (38.8%), is the highest one of 41%. To reach this bracket, you would have to earn 701 301 or above annually.
It’s clear from these examples that when taking money out of the business, it is cheaper to increase owner salaries up to a point where you earn R701 301 or above annually, than to pay out after tax profit as dividends.
*Louw Barnardt is the co-founder of Outsourced CFO, a financial consulting business tailored to the financial needs of start-ups and SMEs. Outsourced CFO is currently hosting a series of FREE workshops on leadership in financial decision making. Visit www.outsourcedcfo.co.za or email email@example.com for more info.