Surplus Capital - How I Invested $500k+
What should you do when money accumulates in your business bank account? You have several ways to spend it - each depends on what kind of risk you're prepared to tolerate.
Hi, I’m Rich, welcome to my consultancy newsletter. Please subscribe and discover our systems for scaling your consultancy practice to $1m+ in revenue.
A few years ago, before he became a Netflix superstar 🤯, I was having coffee with Ramit Sethi in NYC and told him of a pleasant problem.
I was accumulating money in my business bank account and didn’t know what to do with it.
By this point, I had around £500k ($635k) in the business account.
The options were pretty simple:
I could do nothing. I could leave the money where it was. The upside is that it would also be instantly accessible if I needed it, and I wasn’t putting any of it at risk. The downside is that inflation would steadily chip away at it, and it wasn’t doing anything to help me grow my business.
I could pay the money to myself by either increasing my salary or issuing a large dividend. The upside is that the money would go directly into my bank account for personal use. The downside is that the taxes would be significant. Taxes on salaries in the UK can be as high as 45%, and dividends can be taxed at the highest threshold of around 40%.
I could invest the money in my business. I could use the money to try and grow my business. For example, if it was possible to invest £200k and get £220k back - that’s a good enough return to make it worthwhile. The upside of this is it potentially generates more wealth in the future. The downside is it puts the money at risk. It wasn’t clear where I could invest to grow the business. And even if this approach succeeded, I’d likely need to hire more staff to support the additional work…Is the additional revenue worth the extra stress?
None of the options seemed ideal, so for too long, I just let the money accumulate. Alas, I’d missed out on a lot of better options.
Part One - Investing On Behalf Of The Business
Ramit came up with an option I hadn’t previously considered.
Why don’t you get a financial advisor and invest the money in other businesses?
I’ve been investing personally since 2008 (an excellent time to begin, it turns out), so I have a good grasp of risk and investing principles. Yet I only really considered it a practical option at that moment.
I read that companies like Apple and Google have entire divisions devoted to investing excess capital, but I hadn’t considered it a practical option for small businesses.
I found a financial advisor in the UK who helped me set things up.
How The Investments Are Structured
When we talk about ‘investing the money in other businesses’, we’re not talking about angel investing. I didn’t try to find promising startups and give them money. That would be far too high of a risk for me, and I have zero expertise in picking startups or structuring deals.
It’s far more mundane than that. Instead, I wanted to invest the money in places where it would likely increase in value, have an acceptable level of risk, and not require any active management on my part.
Most of our clients paid in dollars at the time - so we had a US dollar account and a UK GBP account. This helped hedge the risk of one currency collapsing (as happened after Brexit). It also meant I could shift money between the two and take advantage of changes in the exchange rates.
This meant I had a tricky requirement that 40% to 50% of the money remained in dollars to hedge the risk of currency fluctuations.
It turns out it’s tremendously complicated for UK companies to hold shares in US businesses. But eventually, we found a fund from Prudential that made it possible (albeit at a higher management fee than I would’ve liked).
We then invested the remaining money in Pound Sterling (GBP £) into a similar (low-cost management fund) from Aviva. All in all, we invested around $400k.
The Results
The results have been broadly positive thus far (although they would have been a lot better if we had waited another six months instead of investing at the top of the market in 2020).
The USA account has averaged an 8.6% return yearly since the investments.
The UK account (investing in UK shares) has returned an average of 6.1% yearly since the investments.
There are undoubtedly other ways to invest money and generate better returns than this. It’s also worth noting that if/when these shares are sold, the gains will be subject to corporation tax.
However, I’ve been pretty happy with the returns considering:
It generated far better results than if the money had remained in the bank account (especially given inflation rates in the past few years). Generating an extra $20k to $35k a year solely through investments is a good outcome.
It required almost none of my time to manage to generate the returns proactively. This was critical. I didn’t want to spend additional time or energy setting this up.
The level of risk was acceptable - even during two sharp declines in the stock market in the past few years, I never seriously worried that I would lose the money forever. This doesn’t mean these investments are free of risk, but they are within the acceptable level of risk.
Part Two - Paying Myself More
As I mentioned previously, it’s tricky to pay yourself more without incurring losing more tax.
However, another benefit of hiring a financial advisor is that he informed me of more tax-efficient methods of paying myself. The biggest was paying myself up to £40k a year as a pension and less through dividends.
Pensions are tax deductible, which, at a present 25% corporation tax rate, saves the company £10k per year.
Around this time, I began exploring options to buy a property. I realised that not my previous approach of staying under specific tax brackets when I paid myself and letting money accumulate in the business itself would limit the income multiple mortgage companies would use when deciding how much they could loan me.
In short, I needed to increase the amount I paid myself. I’ve also been coming around to the Die With Zero mindset. Money accumulating in a business account is an experience I’m not having.
Part Three - Invest In Business Projects
This still left a healthy amount of money in the company accounts - some of which I knew I wanted to invest in strategic growth areas.
Having more money in the bank allows me to make bigger bets in key parts of our consultancy roadmap (p.s. you should have a consultancy roadmap by now)
I’ve made several additional investments during the past year or so, which I believe will pay off this year and the coming year. This includes:
Getting ISO27001 certified (£15k). Being data-driven is a key part of what we do, and I wanted to put us ahead of the curve by becoming ISO27001 certified. This shows clients we’re serious about protecting their data. We’ve spent around £15k on this, mostly through consultancy support and the examination process. We finally received certification two months ago.
Revamping our training courses (£15k). I invested around £15k to revamp our training courses to the highest possible quality. Almost immediately after completing these, one company sponsored our courses and another paid for universal staff access at an amount which matched the cost of producing the courses. So we’re already ahead and haven’t officially launched them yet (but check out this course for free if you like). I’d be surprised if we don’t get at least a 500% return on this.
Launched a new website (£10k). We completely revamped our website last year. It now reflects the quality of the work we deliver. In hindsight, I should have allocated a lot more towards this given it’s importance.
Hired more staff (£££,£££). I also hired more staff over the past year to pass on more of the consultancy work to the team so that I could focus on growth. I expect this will pay off this year and in the coming years too.
It’s very possible (and likely) that not all of these investments will generate the desired return. But that’s the nature of investments. However, even if they don’t immediately pay off, it’s still a better use of excess capital than leaving it in a bank account.
We’re also making numerous smaller bets on things we believe will pay off in the future.
Set Some Rules For Surplus Capital and Stick To Them
This is the real lesson from this post. Your rules might vary, but I’d suggest.
Create a safety net. You should build enough capital in the business to survive a year without attracting clients. That helps alleviate or avoid any stress. Anything over the safety net, you should aim to either invest in or pay yourself.
Pay yourself a fixed % of profits. Don’t stick to a fixed amount each year, pay yourself a % of your profits. As profit increases, so does the amount you pay yourself. Don’t even think about it - you’ve earned it. Anything between 30% to 50% of the profits is usually fine.
Be tax efficient. Speak to someone to figure out the right balance of what to pay yourself as a salary, through dividends, and via your pension. Never break the rules (or intent of the rules), but make use of the structures your government have set up for you.
Set aside a fixed percentage to invest in the business. I’d suggest setting aside 15% to 25% of the profits to invest in your ‘bets’ to grow and improve the business. This leads to point 5…
Have shovel-ready projects ready to go. For the percentage of revenue which you’re not paying yourself, have some projects on your roadmap fully costed and prepared (i.e. with vendors identified etc) which you can invest in.
Invest the remaining surplus capital to generate low-risk returns. Find index-tracker funds (or equivalent) and invest the remaining capital in them. Stagger the investments over a year if possible and then invest regularly.
Good luck!
Thanks for reading