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Big match temperament is a prerequisite for entrepreneurship.
As an entrepreneur you have to make big decisions on a daily basis that impact various aspects of your company. ‘Going with your gut’ is great for intuitive leadership and direction for your business, but when it comes to financial decision-making when steering your business, making sure that you have thoroughly thought through all the implications of a big decision greatly increases your chances of it being the right one.
Putting money into the business and taking money out of your business are, however, not ‘gut feel’ decisions.
Taking financial leadership around these two issues will set you apart from the entrepreneurial rat race. Here are some key insights that might help you make the right financial decisions for your business.
1. Funding Your Company:
Every business needs funds to operate. Let’s have a look at the ways in which to allocate capital into your business and the considerations to keep in mind.
You can inject funds into your business in three ways:
i) Dipping into your personal savings
ii) Borrowing money to put into the company
iii) Getting a funding partner
i) Putting your own savings in
When putting in your own money, the main consideration is the expected return on the investment.
- Because it is your own money, simply leaving it in the bank can earn five or six percent interest.
- You can also invest it on the JSE, with a long-term expected return of 12-15%.
- But if you take into account the risk of investing the money in your own business as well as the effort of managing it, entrepreneurs generally have an expected return in excess of 25%. You need to be confident that your business can yield a suitable return.
Do you put in the money as equity (share capital) or do you loan it to the company?
- In almost all cases the answer would be to structure it as a loan. The money you loan to the company can be taken out again without paying any tax thereon, and interest paid is deductible for tax in the company.
- To take out share capital, you will need to declare a dividend at 15% dividends tax, making this a more expensive exercise. You can also not charge any interest on equity invested.
ii) Borrowing money for the company
The first question here is can the funds be borrowed at a reasonable rate?
It is no secret that there is not a long line of lenders offering loans to young companies.
When investigating taking out a business loan, consider the following:
1. What securities are required?
2. What are the repayment terms?
3. What are the penalty clauses for early repayment?
When a suitable borrower has been found, 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.
iii) Getting a funding partner
When bringing a funding partner on board, the non-financial implications are the major considerations.
- 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 stipulating all the details of how your relationships to the company will work. This can save you a lot of pain when it comes to one of you exiting the company.
On the financial side also consider the cost of having them on board – the actual salary or interest to be paid for their involvement with the company, as well as the long-term effect of the percentage given up in return for the funds they bring on board.
2. Taking money out of your company
Congratulations — you have made a healthy profit! Now the question begs — do I pay the owners bigger salaries, or do I declare dividends? The answer lies in the tax implications.
Dividends are currently taxed at 15% of after tax profit. A simple example to illustrate the actual cost:
A company makes R100 profit. It pays R28 in companies’ tax (28% companies’ tax rate) and is left with R72 in after tax profit. On this, 15% dividends tax is charged (R72 x 15% = R10,80), leaving the owner with R61,20. The total tax paid on the R100 profit is R38,80, an effective tax rate of 38,8%.
The tax rate on salaries is based on the bracket that the receiver falls in. 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 40%. To reach this bracket, you would have to earn R673,101 annually (R56,092 per month).
The conclusion that can be drawn from this is that it is cheaper for tax purposes to increase owner salaries up to a point where they earn R56,092 per month or more, than it is to pay out after tax profit as dividends.