Anyone who has spent time around successful entrepreneurs and business owners have probably heard them say something like, “This business is my retirement plan.” And while it makes perfect sense that a successful enterprise, especially in the early years, would form most of an owner’s net worth, over time and especially as an owner begins preparing for retirement, it makes sense to diversify wealth away from the business. However, too many haven’t formulated a plan for diversifying their wealth. In fact, less than half of business owners have a formal exit plan in place. In other words, while many business owners intend to fund their retirements with the value of their businesses, they haven’t done the thorough planning that is required to balance the ongoing health of the business with their need for liquidity to fund a secure retirement.
Reinvesting in the Business vs. Diversifying
As a business owner and entrepreneur, you’re hard-wired to reinvest in the business. Especially in the early years, concentrating your capital on driving growth is what made the business successful. But over time, that same strategy can create undue financial risk for you, the owner, especially as you begin to think about handing the reins over to a younger family member, a trusted employee, or an outside stakeholder. By keeping your wealth focused on the business, you amplify your exposure to concentration risk: having too much of your net worth represented by a single asset. When you’ve got everything riding on a single source of wealth, you are financially vulnerable to anything that creates unfavorable conditions for that source.
Don’t let your business be your only nest egg. As your retirement horizon nears, balancing internal reinvestment with external diversification is essential to protecting your total net worth and ensuring a secure transition.
How Can I Diversify My Wealth Away from the Business?
The first step toward building a successful diversification strategy that balances the needs of the business with the needs of an owner is to have a solid financial plan in place. When an owner has a detailed financial blueprint that incorporates the business with their financial goals, several alternatives can be considered that allow for the needs of both entities to be adequately met.
1. Investment Outside the Business.
As the business becomes increasingly profitable, owners may wish to begin systematically redirecting a portion of the profits to outside, market-based investments. Over time, this can enable the owner to create significant sources of personal wealth that are unrelated to the ongoing operation of the business. By building a well-diversified portfolio of assets designed to benefit from a wide range of market conditions, owners can position themselves more favorably to consider various options, both personally and for the business and from a position of strength.
2. Business Retirement Plans as a Diversification Tool.
A properly structured employer-sponsored retirement plan can serve as an efficient vehicle for wealth transfer outside the business, both for the owner and for valued employees. Plans may be designed to allow owners and other highly compensated employees to contribute significantly larger amounts to a tax-advantaged account than is available with other plans. In fact, the law also provides significant protection for assets in 401(k)s and other employer-sponsored plans, which can serve as a way of insulating personal wealth from potential legal exposure. And, because employer-sponsored plans typically offer a range of investment options, this is another way that owners and other participants can invest to build wealth for the future.
3. Wealth Diversification and Succession Planning.
Perhaps one of the greatest benefits of diversifying wealth away from the business is the leverage it can provide for eventual succession planning. When business owners are not overly dependent on the business as a source of liquidity or retirement income, they can approach a potential sale, merger, or reorganization from a position of confidence and security, rather than urgency. Essential processes like valuation, deal structure, and tax planning can proceed at a controlled pace. Greater personal wealth for the owner can also relieve price, timing, and financing pressure in situations where the business is being transitioned to the management team, a younger family member, or an outside buyer.
Without question, a successful business is often the cornerstone of wealth. But a cornerstone is a beginning, not a complete structure. Thoughtful owners and entrepreneurs protect their legacy and their lifestyle by converting business surplus into personal assets. By establishing a formal program to build wealth outside the company, owners de-risk their personal balance sheets without compromising the business’s operational integrity.
JFS Wealth Advisors, as a fiduciary financial planner and wealth manager, works with successful business owners and entrepreneurs to create financial solutions that promote thriving businesses and the individuals who build them.
How can I keep my business retirement plan efficient and compliant?
