Small Business: Re-invest or Save / Invest Somewhere Else?

[cdoliveros]

Hello fellow Mustachians! I resort to your collective wisdom with a topic that at least I find very seldomly addressed. And that is:

If I own a small business, what is the wisest thing to do if thinking about an early retirement: reinvest the cash flow back in the business, or save it / invest it as an employee would do?

All of my life I've seen posts, books, seminars and so on (even MMM's teachings) about how you need to save certain percentage of your income as to retire early. But in 100% of every of the sources of information mentioned, they are thinking of a person with a steady paycheck.

Which would you say then is an intelligent way to move about life thinking about early retirement but with a small business that gives you the option of reinvesting on it or taking the cash it generates and investing it elsewhere?

Carlos O.

[terran]

There's no way this can be answered in a blanket statement. If you believe you can achieve high returns from your business then reinvesting in the business makes sense, if not you shouldn't put more money into the business.

Personally, even if I was confident of high returns I would want to be building investments outside the business even as I was building the business for purposes of risk diversification. A very successful small business will probably make you richer in the end, but lots of businesses aren't successful, so it all comes down to how you want to balance risk and reward.

[BECABECA]

For me, I’d be measuring the risk vs reward, but before that I’d be putting the max I could into pretax retirement accounts. For what I had left to invest after tax, I would be thinking about how investing in the business is even more risky than putting my investment into a single stock, since I already have my salary tied to the performance of my single small business. Basically, it’s like when employees have all their money in the employee stock purchase program. But a bit more risky than that, since that company stock is publicly traded and you can sell off a bit without having to sell all of it.

So investing back in your small business would have to be likely to make you a much higher return than index funds, otherwise the risk isn’t worth it. For me, that’d need to be above 25%, but it’s different for everyone, just like asset allocation is. And as you get closer to retirement, and so your appetite for risk reduces, then reinvesting in the business becomes less attractive.

[Fuzz]

I struggle with this. If you own a decent small biz, you ought to be able to beat a 7% stock market return pretty easily (and if you can't, then that is a strong signal that something is wrong in the business).

However, I think there is something to be said for diversifying away from your industry/skills. So if you work for Amazon, don't put all your money in Amazon stock. Something could happen to Amazon and you'd lose your job and savings. Except Amazon also illustrates the counter-argument: if you worked for Amazon in the mid 2000s maybe you were highly confident that Amazon was going to dominate the world, and in which case you'd be better off doubling down on Amazon stock and investing as much as you can in your company. That strategy would have out-performed nearly any other investment strategy--and in fact, if you look at actual wealth, I am pretty sure that all *truly wealthy* are pretty concentrated. For example, Bill Gates didn't cash out and buy Vanguard funds when Microsoft IPO'd in 1986.

I have some fear that long term my industry will go away or larger players will enter my market and out compete me (lots of handwringing about AI/tech in my space). That said, relative to other small businesses in my market, I think I will adapt better. So do I invest or not in my firm?

I tend to think we should invest more in our firms because YOLO and by investing in yourself you write a richer story of your life. But that is not an economic argument.

[feelingroovy]

I also have a small business and have been thinking about this.

I've gotten the impression that a lot of entrepreneurs have all their net worth in their business and only cash out upon selling. Built to Sell podcast is a fascinating look at entrepreneurs.

I am not comfortable with that, even if it means I am not going to sell for 7 or 8 figures.

So this is what I am thinking, somewhat based on Greg Crabtree's book Simple Numbers.

I am reinvesting profit, but not salary. Salary funds my retirement accounts (maxed) and college fund. Right now profits are funding a tax account and  a cash reserve account. Taxes are forever but once we hit 2 months expenses on the cash reserves we will start using some profits for growth.

From what I've read and discussed with other business owners is the key to reinvesting is to have a static initiative for the investment. So not an ongoing expense like a new employee but a one time cost for which you can measure the ROI within 12-24 months.

The return has to be in profit, not revenue.

Anyway this may be obvious to everyone else, but I'm just finally figuring it out.