By Veronica Dagher, Anne Tergesen, Amber Burton and Julia Carpenter
Aug. 3, 2020
How entangled should your personal and business finances be? For many small-business owners, the line is blurry, which can put them in a precarious situation when things go south. Here, WSJ's personal finance team answers some common questions to help business owners through these trying times.
My business is in serious trouble due to COVID closures. How should I be prioritizing expenses?
Start by thinking about the nonnegotiable, primary expenses. For many, this includes paying employees and vendors, and taking into account the cost of goods. Without these taken care of first, you can't sell anything, said Steve Denny, co-founder and lead adviser at Innovative Business Advisors in Missouri.
Once the primary expenses are taken care of, move on to addressing your lease and utilities. These expenses can often be negotiated or deferred. Check with your landlord to find out if you can defer payments for a period. Mr. Denny also recommends business owners look at their debt schedule to see if it's possible to get deferrals on existing debt as well.
Malik Lee, a managing principal and advisor at Felton & Peel Wealth Management Inc., reminds his clients that in tough times it's not uncommon for your personal or business credit to get hit. In many cases, he suggests trying to attack business credit first, because you want to consider focusing on the credit that you get the majority of your loans from.
I've been paying my staff and business expenses from my personal accounts. Should I continue doing this?
Paying your business expenses from your personal accounts is a "terrible" idea, as it opens the door to possible personal liability, says Nina Kaufman, a lawyer in New York City who specializes in advising small businesses. Stop doing it immediately, including using personal credit cards.
Many small-business owners form a business entity such as a limited liability company to protect against their personal exposure. But protection isn't absolute, she says.
With the privilege of liability protection comes the responsibility to run your business in a professional way. This means having a separate bank account for the business and properly accounting for personal expenditures.
Paying business expenses directly from your personal accounts can make you vulnerable to a creditor's claim that you weren't running your business properly and therefore your personal assets should be open and available for collection.
In addition, if you're running part of your business from your personal account and part from your business, it's difficult to know if your business is profitable.
If you're paying these expenses from personal funds because your business isn't generating enough money to pay them, you need to ask yourself some hard questions about the viability of your business before you get further down the road, Ms. Kaufman says. The IRS could declare your business to be a hobby, in which case, you may need to pay more in taxes and penalties to overcome all the deductions you've been taking.
Paying business expenses from personal accounts also makes for a more complicated tax picture—especially when the underlying bookkeeping isn't clear. This can cause your accountant to spend more time advising you, preparing your tax returns and ultimately cost you more.
"It's not sustainable," said Preston D. Cherry, founder and owner of Concurrent Financial Planning. "If you're financing your business with personal debt, then if the business potentially expires, then you're saddled with increased personal household debt, and then it's harder to secure financing for your next potential business venture."
I have some funds in my retirement account. Should I tap those for the expenses or debts my business is facing?
For those with smaller-size businesses or those operating family businesses, separating your work finances from household finances can feel especially difficult, said Mr. Cherry of Concurrent Financial Planning.
Though he's hesitant to advise any mingling of the two, he says there are occasionally instances where a business owner may be right to tap their personal funds—so long as they're certain the business is sustainable after the pandemic.
"If it's a short-term fix that won't saddle your personal household with your business debt, I could consider it," he said.
If your small business is viable and needs short-term financing but can't find it at a reasonable cost, you might consider filling the gap by borrowing against your home or tapping retirement accounts.
You may come out ahead by borrowing against your home. That's because if you leave your retirement account intact and invest it in a diversified portfolio of stocks and bonds, you are likely to earn more than the 3% you'll pay in annual interest on a 30-year mortgage taken out today, said Trent Porter, an adviser in Durango, Colo.
But there are significant risks. "If you lose your business and cannot pay the mortgage, you risk becoming destitute," said Arek Puzia, a financial adviser in Pleasant Hill, Calif.
If tapping your retirement account is a more palatable alternative—and you are highly confident the business will eventually reimburse you—the stimulus law Congress passed earlier this year allows you to withdraw up to $100,000 and spread the tax bill over three years. The federal government is waiving the 10% penalty that normally applies to money taken out before age 59 ½ and is allowing those who do this to repay the money within three years and recoup the taxes.
To qualify, the account owner or a spouse or dependent must have been diagnosed with the virus or have lost income due to a layoff, business closure, quarantine, reduction in hours, or inability to work due to a lack of child care.
My small business is my retirement plan. What can I do now?
You're not alone. "Business owners often plow all their profits back into the business rather than contribute to a retirement account, and so they have all their eggs in one basket which can be devastating when something like this happens," said Steven Medland, an adviser in Orange, Calif.
If your business is no longer viable, you may have no choice but to start over.
Otherwise, look for ways to cut costs to free up cash to contribute to a retirement account, said Mr. Puzia, who has helped clients save money by restructuring as an S Corporation to reduce payroll taxes.
It's also important to come up with an "exit strategy," Mr. Puzia said. That may involve selling the business once it rebounds or finding someone to run it so you can derive a retirement income. Many business owners also line up retirement "side hustles," said Mr. Puzia. One doctor client, he said, picked up part-time work assessing claims for workers' compensation benefits.
How much of a margin should I have and should the old rules of accounting be different now that we know a sudden event can shut me down for months?
The shutdown can teach business owners some painful but important lessons, Mr. Cherry said.
"We're seeing that businesses that could survive this first round and had some liquidity on the books, they're able to survive with temporary layoffs and whatnot," he said. "But now a second round is coming and you see businesses shuttering."
Much of the traditional guidance "goes out the door," in times like these, said Manny Cosme, president and CEO of CFO Services Group.
"In a normal world, we aspire to a 10% profit margin before taxes," he said. "Right now, I'm not even saying you should be concerned about profit. Do you have enough cash to survive?"
Mr. Cosme said he is hyper-focused on helping his clients to understand their cash flow cycles.
"Creating projections and staying on top of them is absolutely critical right now," he said.
Business owners should study their pandemic-era books to see how past cash flow cycles have been altered by customers' changed spending habits. Seeing how past economic downturns have affected the business could also be helpful, he said.
Mr. Lee says while it might not be helpful to go line by line when looking at your books from the last economic downturn, you can look at the overall losses and use that as part of your forecast for the worst-case scenario. Still, "no recessions are the same," he said, especially with the government-mandated shutdown of some businesses, which can be considered more like a faucet unpredictably being turned on and off.
Some of the most successful businesses have pivoted during economic downturns to reflect new customer behavior. In the pandemic era, that often means altering your business to fit the new need to remain socially distanced or at home.
I'm facing default on some of my small business loans. What will happen and how can I take steps to minimize the damage? And, what if I've signed a personal guarantee?
Defaulting on a business loan can have business and personal consequences. Be proactive, says Ms. Kaufman, the New York City lawyer. Don't wait for the loan to default—contact your lender right away. Many lenders are offering relief in light of the pandemic. You may be able to negotiate lower rates, interest-only payments for a period, or modify your loan terms until your business is back on track.
Generally, when you miss a payment, your lender will reach out to see what can be done to get you back on track. If you don't respond—or don't start paying what you owe, the loan may be "accelerated." Instead of owing your monthly payments of principal and interest, the entire loan becomes due, she says.
Once accelerated, a lender usually imposes collections fees, attorneys' fees, and other charges. If you used collateral to secure the loan, the lender may seize and try to liquidate it to pay off the loan.
If you've signed a personal guarantee, your personal assets could be at risk as well, Ms. Kaufman says.
If you do default, "what happens" can depend on where you're located as well as the terms of your loan agreement. The process varies state by state, she says.
Remember, lenders want to get their investment back.
"They'll appreciate it if you're honest and forthcoming about the situation so you both have more options at your disposal," she says.
I took out a Paycheck Protection Program loan. How do I pay it back if I didn't use it for payroll or other qualified expenses?
Loans from the federal government's small business-relief programare forgivable if at least 60% of the loan goes toward a business' payroll expenses. It must be paid back if that threshold isn't met, but no payments have to be made until 12 months from the date that a business received the money.
After that time period, if the loan is not forgiven, it is expected that the loan will be paid back within two years if your loan was issued before June 5, and five years if your loan was issued after June 5. The interest rate for the PPP loan is 1%. Consult with your lender first on specific procedures for paying back the loan.
Mr. Lee suggests that if you are still in need of funds outside of the PPP loans, try checking with your local city, county or state government. Some of the federal stimulus money from programs approved by the U.S. Congress trickled down to local municipalities. Many of these entities received funding that could be dispersed to local businesses. Cobb County in Georgia where Mr. Lee is based, for example, set aside $50 million in business-relief funding from the funds it received from the feds. The county is now accepting applications for its second round of funding.
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