One of my favorite ways to use a business in a wealth strategy is as a source of cash flow for new investments. Being able to leverage that cash flow into new investments is a powerful way to grow your wealth.
When I share this idea, I usually get these three questions:
Question #1: Can My Business Do the Investing?
Technically your business probably could do the investing, but in most cases it shouldn’t. Usually, the business generating the cash flow should be kept separate from the investing activity. This is often due to both tax and asset protection reasons.
This means cash needs to come out of the business in order to do the investing.
Question #2: Does It Matter What Type of Entity I Use for My Business?
The type of entity you use for your business has a huge impact on your ability to take cash out of the business.
The key is being able to take cash out of your business entity efficiently.
By efficiently, I mean with ease (so, not a lot of hoops to jump through) and with little or no tax on the cash being taken out.
It is almost always possible to take cash out of a business. But, if it is heavily taxed, then there is less to invest, which can have a big negative impact on a wealth strategy.
Or, if there are a lot of hoops to jump through to take cash out of a business, it is likely that it will be difficult to get the cash when it is needed.
Question #3: What is the Best Way to Take the Cash Out of My Business?
Taking cash out of a business can be done in a few different ways. The most common are:
The trick is knowing which ones to use (including which ones you are required to use for tax and legal purposes), when to use them, and how much to allocate to each one used.
There is a “magic” formula in all entity structures that legally minimizes the tax on the cash taken out. This formula is specific to the entity and the owner.
What is Your Formula?
In order to use the cash flow from your business to make new investments, the first step is to identify your formula for taking cash out of your business entity.
If you have more than one business entity, then you’ll want a formula for each entity because the formula will vary based on the how an entity is taxed, how much income it has and how you are taking cash out of your other entities.
If you have a business and you haven’t gone through the steps to identify your formula, this time of year is the perfect time to do it.
Or, if you already have your formula in place, when was the last time you reviewed it? It’s not uncommon to get your formula in place and then forget to review it every year.
Being able to take cash out of your business to invest in new assets that create more wealth is a great way to keep your money moving and working for you.