Once you have achieved a certain level of success as an entrepreneur, you may find yourself weighing whether to put more money into your own business or to invest in the stock market. While Harvard Business Servcies, Inc. is not here to offer specific investment advice, we do suggest considering the following factors when facing this decision.
Begin by taking a look at your entire investment portfolio, including the value of your ownership stake in your business, to see if you are sufficiently diversified. While there are no hard and fast rules about what an entrepreneur’s portfolio should look like, a well-diversified portfolio usually includes investments in stocks/bonds and enough cash to meet projected needs, in addition to the stake in the business. If you feel too much of your net worth is wrapped up in your company, then investing outside of it to realize the benefits of diversification (less risk, lower volatility) may make sense.
If you are sufficiently diversified but still weighing whether to invest inside or outside of your business, you’ll want to consider the rates of return that you can reasonably expect to receive from different investments. For investments within your own company, you’ll want to look at the internal rate of return (IRR) of various projects you could potentially take on. IRR calculations can get pretty complex, so be sure to involve your CFO or other in-house finanical expert, but in general terms you can think of a project’s IRR as the growth rate it is expected to generate.
For investments in the marketplace, you’ll want to look at the historic returns of the different asset classes (stocks, bonds, cash, etc.) over a long period of time and see how those compare to the IRR of investing in your own firm. If the gap between your IRR and external market returns is rather large, this can help you to invest your cash in the right direction. Keep in mind that past market returns are no guarantee of future performance, and the actual rate of return you earn from investing in your own company may differ from your projected IRR. Still, comparing your IRR with historical market returns can be a healthy and instructive exercise.
If you decide to invest in your own business, your options, of course, are not limited to taking on new projects. If your company is profitable but operating below capacity, then you may want to increase your marketing budget. In this case, you should take a look at the marketing channels you are currently using and the return on investment (ROI) of each one. ROI is a performance metric that can help you evaluate and compare the efficiency of different investments to help ensure you are funneling your dollars toward the strategies that generate the most profit.
Finally, you’ll want to consider the tax implications of the different investments that are available to you. A 7% return in the stock market versus a municipal bond with a 7% coupon versus a project with a 7% IRR can result in vastly different after-tax returns, so consult your accountant or tax advisor for help in determining which investments make the most sense for you and your company from both a state and federal tax standpoint.
Although diversification is a worthy goal, losing money in the stock market is disappointing, and you gain nothing from the experience; investing in your own company always brings you some value, even if your investment doesn’t pay off. Remember, entrepreneurs are famous for learning how to succeed by failing first.