As a business owner, the importance of being liquid is escalated. “He Who Has Cash” is in a position to take advantage of opportunities whenever they come along.
Let’s say you had an investment that will give you 40 percent on your money in 12 to 14 months. The only catch is you need to come up with $200k now to get in. $200k to earn $80k is not bad.
Now comes the hard part: Where do you go for the cash? If you take it out of your company account, you’ll kill compounding (even if it’s just a little). You could borrow it from a bank, but then you would have to pay interest (that said, it’s prudent to keep in mind that you probably get to deduct the interest as investment expense).
If you do borrow from that bank, you’ll have to come to terms with many factors. At what rate will the bank lend? Will you qualify to borrow money? Even if you’ve been banking with said bank for 20 years, don’t expect special treatment. Today’s commercial loan rates range from 6-8 percent.
If we examine the high end of that loan rate, we’re looking at 8 percent of $200k, so it would cost you $16k to borrow the money. Don’t forget the taxes. Let’s use a 25 percent effective rate to keep the math easy. $80k x .75 = $60k left or $20k in taxes. $20k taxes + $16k interest = $36k. That’s almost half of the profit with all the risk.
My point is that this is the type of decision that businesses are faced with every single day. Once you find that project that you can’t pass up, setting yourself up to have access to capital is the smartest thing you can do.
If you could, wouldn’t you want to access your money without asking a bank or qualifying for the money, and without risking market loss? Does the ability to deduct interest expense, if your CPA allows it, sound appealing? If you could avoid killing compounding at a reasonable 6 percent rate of return and have the ability to put the money back when the project is done, how would that sound?
Business owners should learn what the banks have known for years: Properly structured cash valued life insurance is the single greatest gift Congress has ever given the American tax payer. Most business owners are customers of the banks. How about becoming the bank?
Consider BOLI, for instance. Bank Owned Life Insurance constitutes one of a bank’s largest assets. BOLI allows banks access to cash whenever they need it. When a project comes along, they tap into their BOLI to fund it.
It’s an old secret, and you can do it, too. It takes time to build and the IRS has strict rules to follow to design it properly, but it creates the freedom most businesses are looking for.
About the Author: Christopher J. Lester is president of Somerset-based Professional Planning Services, a company that provides a broad range of financial planning services. He can be reached at 732-302-1810 or firstname.lastname@example.org.