By Russell Holcombe, an EO Atlanta member and president of Holcombe Financial, Inc.
The entrepreneur is unique when it comes to financial planning, because risk is something we don’t generally fear. Every day we survive on the frontlines of business by taking the kind of make-or-break risks most people can’t even imagine. It can be rewarding, but there is also an eventual cost to this behavior: the potential for a financial suicide. Running up US$50,000 on credit cards to make payroll, for example, can only last so long.
As a financial advisor, clients often arrive in my office with critical business wounds— wounds called “cash flow,” “liquidity” and “leverage.” In the past 15 years, I have met countless entrepreneurs on the brink of financial destruction. Depending on when I met them, I’ve been able to save many. The truth is most financial disasters are clearly avoidable. The following warning signs are based on a tapestry of experiences. When life happens, these signs seem to be consistently involved in making bad events worse.
1. Not Enough Personal Runway: Cash flow for business is your oxygen— without it, you die. For entrepreneurs, having cash flow is analogous to knowing your “burn rate,” or how fast you burn through your cash. Most entrepreneurs know their business burn rate like it’s tattooed to their foreheads, but when I ask about their burn rate at home, an uncomfortable silence ensues. Survival requires having sufficient cash to live through the rough times.
2. Inflexible Financial Muscles: Imagine what would happen if you lost all flexibility in your body. Likewise, without financial flexibility, bad things happen. Take the entrepreneur who purchased a Beechcraft King Air 350, for example. The plane was extraordinary, but so was the expense. In business, we categorize overhead into two categories: fixed and variable. This plane met the definition of a fixed expense. However, when a crisis occurred and the plane had no buyers, the owner’s only option was to liquidate his retirement plan in order to live. Any expense in our personal lives that cannot adjust to real-time circumstances should be approached with extreme caution.
3. Abusing your Leverage: Leverage is like steroids— it accelerates our ability to accomplish our goals, but not without risk. Just like steroids, the abuse of leverage can have severe side effects. Take, for example, the entrepreneur that purchased the million- dollar beach home and took on a uS$800,000 mortgage. Her business was making headlines and her cash flow approached US$1 million per year. The mortgage was a pittance in comparison. Now, because of a mortgage payment on a second home she can’t sell and a business that is struggling to make it through the recession, she’s miserable. When you’re in the risk business, leverage at home amplifies the bad event at your company.
4. The Mirage of Net Worth: A mirage occurs when light rays are bent to produce a displaced image. Desert travelers often mistook the glare of the sun on the desert floor for the water they desperately needed to survive. Similarly, net worth creates the mirage of survival. I have worked on countless financial suicides with massive balance sheets. Unfortunately, none of it was liquid. I have seen several situations where entrepreneurs couldn’t even turn US$300,000 of it into cash to fight a battle with their former partners. The moral: While you may have a sufficient net worth, if you don’t have immediate access to your cash you don’t have a runway.
Understanding your personal burn rate and its flexibility is half of your survival. The other half is having little or no leverage, cash flow and liquidity. If good fortune finds you, I hope these warning signs will help you make smart financial decisions for you and your family.
Russell is the founder of Holcombe Financial, Inc., a firm that helps individuals with assets between US$3-20 million. Russell is the author of the forthcoming book, You Should Only Have to Get Rich Once. You can e-mail Russell at [email protected].