I see this scenario all of the time. A business owners starts to become very successful. So successful that they start developing a significant amount of cash that isn’t needed by the business to grow.
The first couple of years the business owner won’t take the cash out of the business because there might be a downturn where the cash is needed. After several years the owner just keeps letting cash grow and grow until it becomes apparent to all who aren’t in the business that the excess cash could be a problem.
Some of the problems that I see from having too much cash in the business are:
- It’s more likely the business will be sued than the individual. If there’s cash in the company it’s a nice target for people to go after.
- Business owners might make bad business decisions when cash is available. I find business owners are much more careful about capital or new business decisions when cash is either outside the business or they have to borrow money from a bank.
- I find that business owners think differently about money in the business versus money that’s outside the business.
- Having investments outside the business allows business owners to leave their business and not have to find another job. (See our blog entry on the four boxes of financial independence.)
- Excess cash tends to cause hubris. If there is little cash in the business decisions might be more conservative. Building cash is hard work. Having it disappear through poor decisions is easy.
- Cash left in the business becomes a general asset for creditors of the business. Cash that has been distributed can be loaned back to the business as senior debt with appropriate security arrangements making the owner first in line if things really go wrong in the business.
Cash really doesn’t create any enterprise value. Enterprise value comes from great strategies and efficient operations. Many business owners believe leaving cash in the business makes their business more valuable. I believe cash is at best a neutral thing in building enterprise value in a business. At the worst it becomes a drag on long-term value.
What are your thoughts about leaving cash in the business? If you think it’s a good idea, why?
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