Along with his brother Michael, Andrew Warner built Bradford & Reed, an online greeting-card company, into a business generating $39-million (U.S.) in sales.
When I recently asked Mr. Warner about the sale of his business, he revealed that “in total, we made more money from regularly pulling profits out of the company each year than we did in selling.”
I think it can be tempting to reinvest all of your profits into creating a business to be sold, or avoid the feeling of double taxation by keeping your cash in your company.
But I’d like to make the case for why you should consider paying yourself a healthy dividend each year – just in case.
Assuming your accountant thinks it makes sense given your personal tax situation, here are six reasons to pay yourself a dividend now:
1. To avoid sloppiness
If you have a lot of excess cash sitting in your company, you can get sloppy. Cash sitting in an interest-bearing account earns very little interest.
If you pull the money out (even if it is just to another holding company), you’re forced to run a tighter cash ship – charging your customers more up front, collecting faster, paying slower. The less of a cushion you give yourself, the more efficient you become.
2. To avoid missing out on $750,000 in tax exemptions
“If there is too much cash in your business when you are ready to sell, the company may not be eligible to access the $750,000 (per shareholder) small business exemption from tax on capital gains,” explains Toronto-based accountant Cathy Tune.
She says this ineligibility results if more than 50 per cent of the value of a company’s assets is non-active (excess cash, investments, property not used in the business) in the two years before the company is sold, or if more than 10 per cent is non-active at the date of sale.
“Quite often a dividend is needed to ‘purify’ the company prior to sale for this reason. If you are offside on the 50 per cent and two-year rule, it may be too late to fix if you suddenly find yourself in a position to sell,” she says.
3. To benefit from compounding
If you’re left with $100,000 after-tax from a dividend and, assuming you have the room, you put it in a registered retirement savings plan that has a balanced portfolio of stocks and bonds and that earns a 7-per-cent return, in 20 years that $100,000 would be worth $386,968.45.
Take the money out now and get it working for you, and you’ll have the magic of time on your side, and won’t need to rely solely on selling your business to fund your retirement.
4. To diversify
If you leave the $100,000 in your company, it remains an asset of the company. If you get sued, it’s at risk. If you decide to use it to finance a new product you’re excited about, you could lose it.
Take it out of your business and invest it conservatively, and you have taken a step toward diversifying some of the risk of having the bulk of your wealth in your business.
5. To have a safety net
The business-brokering industry estimates that somewhere between 20 per cent and 33 per cent of businesses that are listed for sale every year actually change hands. For every business listed, there are many more whose owners work a lifetime only to realize they have nothing to sell.
Planning to sell your business to fund your retirement is a high-risk strategy. Pulling a regular dividend out along the way is a good hedge against the long odds of a home-run sale.
6. To increase your company’s valuation
If you do decide to sell your business, an acquirer is going to want to understand how much working capital will be needed to run your company.
If you have too much cash sloshing around in your business bank account, an acquirer may reasonably assume they too need to keep a larger than normal cash cushion. The more money they need to commit to your business in working capital, the less they will be willing to pay you for it.
It can be tempting to pin all of your financial hopes on selling your business one day. However, like the Warner brothers, steadily pulling money out of your company can solidify your financial position and, given the favourable financial position you’ll be in, give you more bargaining clout when you do go to sell your business.
Special to The Globe and Mail
John Warrillow is a writer, speaker and angel investor in a number of start-up companies. He writes a blog about building a valuable – sellable – company. He is the author of Built To Sell: Creating a Business That Can Thrive Without You, which will be released in April.