Family-operated businesses face the usual business challenges, ranging from how to increase revenue and sales to rising expenses and taxation.
However, many small-business owners also struggle with diversification. For many business owners, the vast majority of their wealth is concentrated in a single asset: their business. Since this asset is neither diversified nor liquid, this potentially places their retirement at high risk.
Business owners often utilize insurance policies to create capital for contingencies such as death, disability or liability lawsuits and to avoid business liquidation in an untimely fashion. The inherent risk of concentrating their wealth into a single asset is often overlooked.
One way to diversify outside the business is to invest a significant portion of income into other assets such as stocks or bonds via a 401(k) or other qualified retirement plans. Not only do contributions reduce your taxable income, but the funds also have the potential to participate in market returns. Spreading wealth over various assets should help to lower the risk associated with having a large portion of the owner’s wealth invested in the business.
Business owners and operators should consider using a professional financial adviser to develop an overall investment policy, incorporating the business as an asset in the portfolio. Other key factors to defining the investment policy are the business owner’s age and time horizon to retirement, risk level and income requirements.
Planning an exit strategy
Business owners can receive significant value by clearly defining retirement income needs prior to negotiating the sale of a business.
All too often, business owners engage a financial professional for detailed planning after finalizing buyout terms. Earlier involvement in creating a financial plan provides a framework for negotiations. After all, how can you negotiate a beneficial deal if you don’t know the portfolio value required to fund your retirement?
For example, specifying the income desired in retirement, determining the actual financial need and projecting the longevity of the portfolio are the basis for quantifying goals and evaluating alternatives. Using a structured process will help in weighing alternatives and consequences of the goals that matter most.