Life after debt

The Givens (whose names we’ve changed to protect their privacy) want to make the next 15 years really count for their investments. But they don’t know the best way to do that. “Our friends tell us different things,” says Oliver, who earns $67,000 from his full-time job and another $5,000 doing extra work from home. “One, to leverage the equity in our house and invest, because it’s cheap to borrow. And two, the total opposite: to keep our debt low and just save consistently in RRSPs and index funds. It confuses us.”

The Givens, whose only debt is the $15,000 on their line of credit, want to beef up their savings and investments. After their home, the $99,052 in RRSPs is their largest asset. But even though they could simply choose to top those up over the next few years (they have a combined $80,000 in unused RRSP contribution room), they are tempted by the idea of investing in a small business. Many of their friends talk about spectacular returns of 20% or more annually on their business ventures, and the Givens feel they need those types of returns to have any chance of building enough wealth to allow them a comfortable retirement.

“I’m nervous that we’re missing a time in our lives where we can take some risks to better our returns,” says Lucy. “We don’t have pensions, so we need to build wealth. At the same time, with me only working part time, we’d also like to increase our cash flow. So we’ve been looking at small business opportunities in our area but haven’t found the right one yet.”

The Givens feel comfortable borrowing up to $150,000 for a small business investment. Once their line of credit is paid off in December, they’ll have $16,000 or so a year to invest. And if Lucy returns to working full time in a few years, she’ll be able to boost her salary to $60,000 a year, giving them even greater cash flow to fund their business venture. “We’re not strangers to investing,” says Oliver, who spent several years as a landlord of two rental properties the couple owned in Edmonton before moving to Kimberley in 2006. “Having Lucy work part time these last few years means our RRSPs and the kids’ RESPs have suffered. We need to catch up. What’s the right path for us?”

Lucy met Oliver in California in the summer of 1997 while on a road trip in the United States. Along with a friend, Lucy was driving across the country to celebrate the completion of her business degree from the University of Alberta.

Both Lucy and Oliver came from families that taught their kids the importance of saving. Oliver’s father encouraged him to save the money he earned through part-time modeling and working at his father’s building company, and he had socked away almost $50,000 by age 20.

The couple married in 1999 and settled in Edmonton. Three months later Lucy’s dad gave them $10,000 for a down payment on a duplex. For two years they lived in one unit and rented out the other. At the same time, they both settled into full-time jobs—Lucy as an advertising rep with a local food company and Oliver as a cabinet maker for a builder. They loved living downtown, spending a lot of time eating out at restaurants, and going to movies and local theatre.

In 2004, expecting their first child, the couple moved out of the duplex and bought a house. When Lucy was pregnant with their second child, catastrophe struck. Oliver became seriously ill and was diagnosed with an immunological disease. The doctors weren’t hopeful, giving him only two years to live. That’s when the Givens decided to move to Kimberley—a small city in B.C. that they had visited two years earlier and fallen in love with. “We just decided that we were going to take the bold step and live our dream while we could both still enjoy it,” says Lucy.

The good news is that Oliver pulled through. The couple sold their Edmonton properties, and when they added the proceeds to their savings, they had $300,000 to put toward a house in Kimberley that was listed at $420,000. It was their dream home—a four-bedroom bungalow on three acres with a small apple orchard in the back. “We’d like to do some upgrades to the home but that can wait,” says Lucy. “We’d really like to invest our money for the future—but not in real estate, because even though we’ve done well with our real estate investments, the housing market is in a bubble.”

Right now the couple’s RRSPs are invested in index mutual funds and they’ve been happy with their modest returns. But with Lucy’s part-time salary during the last few years, the couple’s retirement savings have barely budged, and that worries them. They’re also not putting much aside for the education of their two sons.

The Givens hope that a small business investment will put them back on track, and an opportunity came up earlier this year. The owner of a landmark diner in town was retiring and wanted to sell the business. The Givens were excited about the opportunity and were considering a huge $200,000 stake, but they had second thoughts when they realized there would be eight partners involved in the purchase. Then, last month, the diner burned down to the ground, and the opportunity went up in smoke. “We realized we were less prepared and less knowledgeable about investing than we thought,” says Lucy. “But we’ve learned a lot and want to look for another opportunity. If we find the right one, it may make sense for us to forgo RRSP and RESP contributions and invest in the business instead.”

Lucy also thinks it’s a priority to augment her income to reach their savings goals. That could be accomplished by helping Oliver with his small sideline of drawing up plans for renovators and designing kitchen interiors. “We’re even considering investing a bit more time and money in Oliver’s small business,” says Lucy. “He made $5,000 last year working just on weekends and he’s getting quite a reputation as a good designer and builder.”

Over the next few months, the Givens are focusing on paying off their line of credit—money they used to entertain family who came to visit from England, and for a new roof and furnace. But they also want to nail down some firm new financial goals. “With a clearer financial plan in hand,” says Oliver, “I think we can move forward with confidence.”

What the experts say

Investing in a small business might be a good move for the Givens, but they need to be cautious. “I’m a big believer in small business and entrepreneurship,” says Al Feth, a fee-only adviser in Waterloo, Ont., who spent several years running his own telecommunications company. “It’s a powerful vehicle for growth, but unfortunately it also means taking on much greater risk than more standard investments like GICs, mutual funds and stocks.”

Rick Spence, a consultant in Toronto specializing in entrepreneurship, agrees, adding that even if the Givens are in good financial shape, investing a whopping $200,000 in a business like the diner would be risky—especially with so many partners. “At least with stock investing you have diversification,” says Spence. “Not so with small business investing. All your eggs are in one basket.”

Still, Spence says the Givens can make it work. “With interest rates so low—3% on a home equity line of credit—it’s a good time to borrow. They just have to do their homework and proceed cautiously.” Here’s what the Givens should do.

Make RRSP and RESP contributions. Once the Givens have paid off their $15,000 line of credit, they will have about $16,000 available for investing every year. Oliver should use about $10,000 of that for an RRSP contribution, netting him a healthy tax refund of about $4,200. They can save that for emergencies, or reinvest it. “They need to build up their RRSPs,” says Feth. “They have no pensions whatsoever so they can’t afford not to—not if they want a comfortable retirement.” About $4,000 can be put towards RESPs for Cooper and Tim, and the remaining $2,000 can be used for fun activities with the kids. “The government grant on the RESPs is a risk-free 20% return for them,” says Feth. “They should take that.”

Run the numbers. The banks will have no problem allowing the couple to tap 75% of their home equity for a small business investment, but it’s unwise to borrow that much. “It’s just too risky,” says Lenore Davis, a financial planner with Dixon, Davis & Co. in Victoria. “I think they should only consider a small business investment once Lucy returns to work full time. While the interest on the loan will be tax-deductible and solid returns are possible, they don’t have a safety net to fall back on in terms of pensions or big RRSP savings if something goes wrong.” Feth agrees that the Givens need to tread carefully and advises that they keep any business loan amount to a minimum—no more than $100,000.

Consider a franchise. Good franchises have a proven formula for mitigating risk, plus the couple can be silent partners if that suits them. “Franchises come with an operating manual, a predetermined market and an operations team,” says Spence. “Most of the pages are already coloured in and it’s a good possibility for them, provided they get the right partners.”

For $100,000 or less, they could get a small franchise such as Pro Fleet Care (a rustproofer) or Renobac (a container rental business). If they chose to go into business with partners, their $100,000 will buy part ownership in a more lucrative franchise, such as Rockwell’s Bar & Grill (a $1 million investment) or Teriyaki Experience ($300,000). “Before investing in anything, have a lawyer look over any partnership agreement,” Spence advises. “If a disagreement arises over how the franchise is run, you have a clause that allows you to buy the other partners out or sell your share—no questions asked.”

Invest in themselves. Ultimately, the experts feel the best small business investment for the Givens may be right under their noses. “They should give serious thought to investing in Oliver’s part-time business, which would require only a few thousand dollars to increase their client base,” says Feth. “They should upgrade their AutoCAD design software and train Lucy on it as well. She can also use her marketing and advertising skills to drum up some more business.”

As an added benefit, Lucy can draw a small salary—maybe $10,000 or so once the business gets going—in order to lower the family’s tax bill. Combined with home-business tax deductions, this move will increase their cash flow in no time. And as the business expands, Lucy may find that her salary can grow along with it. “Their best option is really to invest in themselves,” says Davis. “Be a tortoise, not a hare. Control the business and the growth yourself. There’s nothing like a little sweat equity to boost the bottom line.”

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