Setting Financial Goals for Entrepreneurs

Wealth Versus Income

It is critical for the entrepreneur to understand that there are two types of financial goals to be considered: income and wealth. By understanding how a business creates income and wealth, the entrepreneur is better able to engineer personal financial goals into the business plan. Simply put, income is the cash that is available from the business to pay the entrepreneur’s salary, whereas wealth is the value of the business if sold. Certainly, entrepreneurs may also build wealth through savings from the salary they draw, but for most entrepreneurs their single most valuable asset by far is their business.

Income is fairly simple to understand, as it is the means to meet the day-today, month-to-month, and year-to-year monetary needs of the entrepreneur and her family. The entrepreneur should plan not only for short-term income needs but also for long-term needs. It is a myth that bankers are impressed by business plans that show the entrepreneur taking no income from the business for a long period of time.

In fact, to many bankers and other investors, this is a red flag. They have seen too many entrepreneurs who give up on a business that does create enough cash to adequately pay the entrepreneur. Certainly, bankers and investors do not want to find excessive salary being paid to the entrepreneur early on, as they maybe funding part or all of this salary through their loans and investments. On the other hand, a business plan that includes a modest, reasonable salary for the entrepreneur is not only acceptable but also desirable for most financial bankers.

Stanley and Danko’s best-selling book the Millionaire next door (1996) gives insight into the difference between wealth and income. They point out that many people confuse real wealth with the trappings of wealth. True wealth is the difference between what someone owns less the debts that owed. Living in a big house or driving an expensive car may give the impression that someone is wealthy. However, many people rely heavily on debt to fund such purchases. If the big house and expensive car are purchased mostly with debt, there’s little actual wealth. Stanley and Danko (1996) cite an old Texas saying, “Big hat, no cattle,” to express the illusion of wealth without the reality.

In their book, Stanley and Danko (1996) report the results of their research on millionaires: how they live, and how they created their own wealth. Two-thirds of the millionaires they studied are self-employed, and three out of four of these consider as physicians or lawyers). Most of the entrepreneurs own a “dull” business rather than a high-tech, high-growth venture; they are contractors, auctioneers, farmers, mobile home park owners, pest controllers, coin and stamp dealers, and office building cleaners. They live in typical upper-middle-class neighborhoods, although they average about 6.5 times the wealth of their neighbors. Most reported that they buy inexpensive suits and drive American cars that are at least a couple of years old.

Since most of the wealth of entrepreneurs comes from the value of their business, it is important to understand how businesses are valued. Formal business valuation uses a variety of financial models. Such formal valuation is critical when buying or selling a business. However, many entrepreneurs find it helpful to use a “quick and dirty” method of valuation to monitor progress in building value in their businesses as they grow. Most forms of valuation, whether formal or “quick and dirty,” share a common assumption. The real value of a business is its potential to generate profits or, more specifically, cash in the future.

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Integrating Nonfinancial goals into the business

A gifted computer specialist sought assistance from an entrepreneurship professor in getting his cash flow and financing under control:

“He had identified a market niche for a computer application he had been developing with his previous employer. The employer was not interested in the idea, so the entrepreneur gained permission to take the idea and start his own company to develop and market the product. He had methodically refined the concept and done a remarkable job in making the program operational and ready for market. He reported that he was on the verge of breaking through into the market, but was “dealing with some financial distress.” If he could raise a little more money, he would be able to make the business profitable. When asked how bad his financial condition was, he matter-of-factly stated that he had funded his start-up primarily through his life savings (i.e., cashed his retirement accounts) and through a second mortgage on his home. He had gotten “a little behind” on his loan repayment and lost his house. This frustrated his wife, who took their children and left him.

And, oh yeas, he was about to have his car repossessed. But he only needed to raise another $50,000 and he could deliver his product to several customers. He did raise the funds and did become financially successful. However, at what cost? He… left behind a trail of damage to his family, friends, creditors, and many others.”

(Naughton and Cornwall 2001)

Network for Teaching Entrepreneurship (NFTE), founded by Steve Mariotti, is an international educational organization that has brought entrepreneurship education to more than a half a million young people around the globe. During the twenty-five years grew NFTE, Mariotti neglected his health and allowed himself very little time for a personal life. Mariotti worked more than seventy-five hours a week and took little time off. Mariotti never got married and never started a family as he was convinced he could not build NFTE into what he knew it could become and be a husband and father. The many years of hard work took its toll on Mariotti’s health. He developed a serious health condition that almost took his life (Simmons 2013).

The mental health of entrepreneurs can also suffer. A study published in Small Business Economics found that 72 percent of entrepreneurs surveyed reported that they had suffered mental health-related issues, including higher rates of depression and substance abuse than the general population (Freeman, Staudenmaier, Zisser, and Andersen 2018).

Many entrepreneurs create ventures, such as those in the examples above, that consume all their time and focus. It is understood that many jobs go through periods where long hours are required. This is very common when starting a new business as well. However, the entrepreneur in the second example has a business that is now two years old and she shows no sign of changing her behavior. According to Cornwall and Naughton (2008), there is a growing recognition of the importance of creating a more tempered approach to work and a more balanced life, even during an entrepreneurial start-up. Without addressing the issue of temperance of work and balance in life, entrepreneurs risk damaging their physical and mental health, as well as their relationships with family and friends.

In addition to the financial goals discussed above, entrepreneurs should establish specific nonfinancial goals. Before launching a business, entrepreneurs should consider questions like the following:

·????????How much time do you want to spend with your family?

·????????What other interests or hobbies do you want to be able to continue to pursue?

·????????Do you want to continue your formal education?

·????????Do you have other aspirations that you want to pursue at some point in your life?

·????????Do you want to be able to travel and take vacations?

·????????Do you hope to retire early?

These nonfinancial goals can be even more important than financial goals for some entrepreneurs. For example, one entrepreneur had a goal to always be at home for dinner with his family when he was in town. Sometimes this meant that he had to go back to work to finish an important project, but he made sure to integrate this commitment into his work. Another entrepreneur was faced with the possibility of an initial public offering for his business. Experts told him that he could expect a large personal return from the offering. However, he realized that taking his business public would mean a great deal of travel that would keep him away from his family.

Instead, he chose to find a buyer for his business so he could spend even more time with his children before they grew up. Although the sale resulted in a good financial return, it was a fraction of what he could have received from a public offering. To him, however, the trade-off was well worth it.

The entrepreneur should integrate nonfinancial goals into business planning.

Many nonfinancial goals revolve around the ability to dedicate time to family, friends, or other interests. Rapid business growth is one of the major drains on the entrepreneur’s time. When planning the business, the entrepreneur may choose to plan for growth that allows some balance in life, rather than planning for the maximum growth the market will allow.

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The Importance of Self-Assessment

The process of self-assessment plays an important role for the entrepreneur through out the life of the business. Aspirations for income and wealth can change over time, so it is important to periodically revisit the process of self-assessment. Lifestyle changes such as getting married or having children require an adjustment to both short-term and long-term financial goals.

For example, the addition of children to the family means that the entrepreneur needs to plan for added day-to-day expenses, as well as possible long-term costs such as college and weddings.

Changes in life style can also create new nonfinancial goals. For example, an entrepreneur who was a single with no children she started the business marries and eventually has children. She will need to be able to take maternity leave. She may also want to have more time to spend with her children as they grow up. To meet these new nonfinancial goals, she may need to add management staff to take some of the burden from her workload and to cover for her when her new family requires she takes time away from her business. She may also decide to temper the growth of her business and forgo opportunities to expand sales or move into new markets.

?Changes in aspirations can also occur if ventures either exceed or fall well short of initial expectations, and entrepreneurs need to adjust their expectations accordingly. For example, assume that an entrepreneur had hoped to be able to earn $100,000 a year from his business. But after the business has been in operation for a few years it becomes clear that this goal is unrealistic: he can earn only $75,000 from the business. The entrepreneur needs to bring his personal financial goals in line with the reality of the true earning power of the venture or choose to exit the venture and pursue a more promising business that can meet the income needs created by his desired lifestyle.

Figure 2.2 displays the distinct phases of growth and development that businesses go through. During each stage, both the entrepreneurial venture and the entrepreneur go through transitions and changes (Churchill 1983). Each stage of development can lead to changes in goals and aspirations.

The first stage is prelaunch, during which the entrepreneur develops the business model and plan and does all the work necessary to open the business, such as securing needed resources, setting up operations, and hiring and training staff.

Self-assessment can play a prominent role in the planning of a new venture. In evaluating opportunities and conducting feasibility analyses, the primary criterion is the financial viability of the business idea under consideration. Some entrepreneurs mistakenly assume that breaking even equates to financial feasibility. In reality, to be financially viable the new venture must not only break even, but also meet the financial needs and expectations of the entrepreneur and other investors. Many entrepreneurs fail to factor in their own financial goals during this critical step in evaluating opportunities. Goals like “making a lot of money” or “providing for my family” are not specific enough to integrate into the planning process. Entrepreneurs should take the time to assess their specific expectations of income and wealth from their business venture and integrate those expectations into the feasibility analysis, their business model, and business planning. The salaries that entrepreneurs want to earn from their businesses need to be treated as a fixed expense of the business.

What the entrepreneur needs financially should be considered part of the business’s fixed expenses. The salary the entrepreneur needs to make is every bit as real a cost as rent, marketing budgets, and employee costs. It is hard to imagine that someone applying for a management position in a publicly traded company would enter negotiations for the job without a salary and benefit goal in mind. Yet, many entrepreneurs do just that when planning their own ventures.

One young entrepreneur started a small business when he graduated from college. Although the product he sold was well received by the market, he could not generate large enough customer base to allow him to draw a regular salary. Unfortunately, after a few years of struggles, he recognized that the business would never support even a modest salary and had to shut it down. In looking back, he admitted that he could have seen this before he launched had he honestly looked at the financial model of the business. He wanted to start it so badly that he ignored whether or not the business could support him with a salary.

The second stage is start-up. This is when the venture is launched and begins basic operations. This stage can last until the business is producing well over $1 million in revenue. The entrepreneur is usually very hands-on with the business during this stage, building a customer base and refining the product or service to meet the needs of the market. The start-up of any business can be a time of much excitement and confusion. Many entrepreneurs suddenly identify additional opportunities that were no part of their original plans. There is also a tendency to help cash flow by taking on any orders that come through the door. While this may be necessary, the entrepreneur should have a well-developed plan based on thoughtful self-assessment in order to keep the business focused and headed in the desired direction. Entrepreneurs who stray off course from their plans in order to reduce their anxiety over cash flow can sometimes lock themselves into a business model that will not let them achieve the personal goals and objectives they hoped to achieve through their businesses. Therefore, any change in direction for a new start-up business should be carefully evaluated.

The third stage is growth. This is when revenues and, hopefully, profits begin to grow quickly. However, the growth phase of a business can be one of the most perilous periods for an entrepreneurial venture. The business may begin to experience many stresses and strains on systems and staff. Flamholtz and Randle, in their book Growing Pains (2015), call this the transition from an entrepreneurship to a professionally managed business. During this transition, the entrepreneur’s role begins to change. He no longer can use the hands-on, day-to-day management style he used during the start-up. Management and operating systems need to be put in place and upgraded to manage growth effectively. The management team begins to grow and take on ever-increasing responsibilities. One entrepreneur who successfully navigated this transition stated that his “business took on a life of its own.” This is a common feeling. Growth is pursued simply because the business can grow. However, the reason that the entrepreneur started the business – that is, her own goals and aspirations – can become blurred and even secondary in importance to the growing body of decision makers. It becomes crucial for the entrepreneur to reinstall her own goals and vision into the business. This may not be as easy as it first appears.

However, it is still their company, and they must undertake its leadership based on a strong vision of where the business is headed. This vision should be fundamentally based on the entrepreneur’s own goals and aspirations, which may require revisiting the self-assessment process to make sure that any changes in the entrepreneur’s goals and aspirations are accurately reflected.

The fourth stage is maturity, which can include the exit of the entrepreneur from the business. Every entrepreneur exists from the business at some point, whether by selling the business, transitioning to the next generation in a family business, going bankrupt, or simply dying. The process of preparing for this departure is called exit planning. Most experts recommend beginning the exit planning process at the very beginning of a business venture. They recommend that the entrepreneur be clear on what he wants from the business, how long he wants to be involved in the business, and what he would like to see happen to the business once he leaves. Clearly the exit process, if well executed, relies on careful and thoughtful self-assessment. It is important to note that most ventures do not evolve exactly as planned and that exits do not always happen as the entrepreneur originally intended. However, that does not diminish the importance of such planning. Chapter 16 will examine the exit process in more detail.

― Jeffrey R. Cornwall, David O. Vang, and Jean M. Hartman, Entrepreneurial Financial Management, An Applied Approach, Fifth Edition.

Note that:

You’ll have to return to the book for further details and to view the financial methods that are introduced.